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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal year ended February 3, 2001
Commission File number 0-16309
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FACTORY 2-U STORES, INC.
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(Exact Name of Registrant as Specified in its Charter)
Delaware 51-0299573
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(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
4000 Ruffin Road
San Diego, California 92123
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(Address of Principal Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (858) 627-1800
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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 the 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 [X]
At April 13, 2001, the aggregate market value of the voting stock of the
Registrant held by non-affiliates was approximately $218,355,062.
At April 13, 2001, the Registrant had outstanding 12,773,776 shares of
Common Stock, $0.01 par value per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy Statement for its June 21,
2001 Annual Meeting of Stockholders, to be filed subsequent to the date
hereof, are incorporated by reference into Part III of this Form 10-K.
Such Definitive Proxy Statement will be filed with the Securities and
Exchange Commission not later than 120 days after the conclusion of the
Registrant's fiscal year ended February 3, 2001.
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 9
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 18
Item 12. Security Ownership of Certain Beneficial Owners and Management 18
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 Alabama,
Arizona, California, Louisiana, Nevada, New Mexico, Oklahoma, 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 February 3, 2001, we operated 243 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 stores average 15,000 total square feet and are located mostly in shopping
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
prices 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 the 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.
Expansion Plans
Opening of New Stores: We plan to open 65 stores and close 4 stores in the
fiscal year ending February 2, 2002 (fiscal 2001). We expect that approximately
60% of our new stores to be opened in fiscal 2001 will be
3
in new markets and the remaining new store growth will be in markets in
which we currently operate. New market growth will predominantly be in the
southeastern United States. During the fiscal year ended February 3, 2001
(fiscal 2000), we opened 70 new stores and closed 14 stores. During the period
from February 4, 2001 through April 13, 2001, we opened 5 new stores and closed
1 store. The number of stores that we opened and closed each quarter during
fiscal 2000, 1999 and 1998 were as follows:
Quarter
-----------------------------------------------------------
First Second Third Fourth
Fiscal Year Beginning Open Close Open Close Open Close Open Close Ending
- ----------- --------- -------- ------- -------- -------- -------- -------- ------- -------- --------
2000 187 25 (9) 11 (3) 20 - 14 (2) 243
1999 168 9 (8) 10 (1) 15 (6) 4 (4) 187
1998 166 - (4) 3 (3) 6 - - - 168
Our average store opening costs for equipment, fixtures, leasehold improvements
and preopening expenses currently approximate $315,000. 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 the 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 our 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 2000, we renovated 5 stores and
completed the conversion of our stores to the Factory 2-U name with the
conversion of 18 stores. During fiscal 2001, we plan to renovate 8 to 10 stores.
Distribution Centers: We opened a new 300,000 square-foot distribution center in
Lewisville, Texas in February 2001. This new distribution center will service
Texas, parts of New Mexico and new stores that we plan to open in the
surrounding states. We also operate a distribution center in the San Diego area
which consists of two facilities and a combined total square footage of 365,000
square feet. 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 are currently developing plans to relocate and expand our current
distribution center in San Diego, California. This new distribution center would
be approximately 500,000 to 600,000 square feet and serve our west coast,
Arizona, Nevada and New Mexico markets. It would become operational in our
second quarter of fiscal 2002.
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), 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
4
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. We rarely request markdown concessions, advertising
allowances or special shipping and packing requirements, but insist 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 our 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 increase
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 equipment 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 timely
pricing and distribution information.
Our stores are characterized by easily accessible merchandise displayed on
hanging fixtures and open shelves in well-lit areas. Our prices are clearly
marked, usually in whole dollars, with the comparative retail-selling price
often noted on the price tag. 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 business. 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 layaway and gift card programs. 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.
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."
5
Our Stores
As of April 13, 2001, we operated 247 stores located in 10 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 April 13,
2001, our stores were located as follows:
Strip
State Center Metropolitan Other Total
----- ------ ------------ ----- -----
Alabama 1 - - 1
Arizona 25 3 4 32
California 92 10 20 122
Louisiana 1 - - 1
Nevada 7 - - 7
New Mexico 9 - 1 10
Oklahoma 1 - 1 2
Oregon 9 - 5 14
Texas 31 - 10 41
Washington 13 2 2 17
-- - - --
189 15 43 247
=== == == ===
Our stores range in size from 6,000 square feet to 34,800 square feet, averaging
15,000 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 new store lease, one of our new store opening teams prepares the store
for opening by installing fixtures, signs, racks, dressing rooms, checkout
counters, cash register systems and other items. An outside service team
supervises the merchandising of the new store and trains the new store
associates in proper merchandising procedures before the store is opened. We
select store sites based on demographic analysis of the market area, sales
potential, local competition, occupancy costs, 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
fifteen to twenty 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 operating costs.
We continually review store performance and from time to time close stores that
do not meet our minimal performance criteria. The costs associated with closing
stores, which consist primarily of inventory liquidation costs, provisions to
write down assets to net realizable value, tear-down costs and the recognition
of remaining lease obligations 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.
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 off-price
chains, such as TJ Maxx, Ross Stores, Marshall's and 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.
6
Employees
As of April 13, 2001, we had 5,397 employees (2,950 of whom were part-time
employees). Of that total, 5,089 were store employees and store field
management, 180 were executives and administrative employees and 128 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 "Factory 2-U" and "Family Bargain Center", 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 13, 2001, we operated 247 retail stores located in Alabama, Arizona,
California, Louisiana, Nevada, New Mexico, Oklahoma, 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 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 243 stores open
at February 3, 2001 was approximately $27.4 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 54,000 square feet
of office space and 215,000 square feet of our San Diego distribution center.
During fiscal 2000, we closed the 8,000 square-foot retail store previously
located at the facility and converted the space to additional office space. 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.
We lease another 150,000 square feet of our San Diego distribution center at
7130 Miramar Road, San Diego, California. Our lease term expires in April 2002.
The lease provides for annual base rent at an average of approximately $0.8
million over the primary lease term.
In February 2001, we opened a new 300,000 square-foot distribution center at
1875 Waters Ridge Drive, Lewisville, Texas. Our lease expires in December 2007.
The lease provides for annual base rent at an average of approximately $1.0
million over the lease term.
7
Item 3. Legal Proceedings
On December 15, 2000, Pamela Jean O'Hara ("O'Hara"), a former employee in our
Alameda, California store, filed a lawsuit against us, entitled "Pamela Jean
O'Hara, Plaintiff vs. Factory 2-U Stores, Inc., et al., Defendants," Case No.
834123-5, in the Superior Court of the State of California for the County of
Alameda (the "O'Hara Lawsuit"). On January 10, 2001, O'Hara and two other former
employees in our Alameda store, filed a First Amended Complaint in the O'Hara
Lawsuit.
The First Amended Complaint in the O'Hara Lawsuit alleges that we violated the
California Labor Code and Industrial Wage Commission Orders, as well as the
California Unfair Competition Act, by failing to pay overtime to the plaintiffs.
Plaintiffs purport to bring this action on behalf of themselves and all other
store managers, assistant store managers and other undescribed
"similarly-situated employees" in our California stores from December 15, 1996
to present. The First Amended Complaint seeks compensatory damages, interest,
penalties, attorneys' fees and disgorged profits, all in unspecified amounts.
The First Amended Complaint also seeks injunctive relief requiring payment of
overtime to "non-exempt" employees.
We believe that the O'Hara Lawsuit is meritless and are vigorously defending
against it. On February 15, 2001, we filed an answer in which we denied the
material allegations of the First Amended Complaint. The Court has scheduled a
hearing on plaintiffs' anticipated motion for class certification for November
9, 2001. The Court has scheduled the trial for July 22, 2002.
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 other 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 February 3, 2001.
8
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our Common Stock is traded on the NASDAQ National Market under the symbol
"FTUS." The following table sets forth the range of high and low sales prices on
the NASDAQ National Market of the Common Stock for the periods indicated, as
reported by NASDAQ. Such quotations represent inter-dealer prices without retail
markup, markdown or commission and may not necessarily represent actual
transactions.
Common Stock
------------
High Low
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Fiscal 1999
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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 2000
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First Quarter $34.63 $21.75
Second Quarter $41.50 $31.00
Third Quarter $43.13 $27.44
Fourth Quarter $45.19 $28.50
Fiscal Year Ending February 2, 2002
First Quarter (through April 13, 2001) $42.63 $21.00
As of February 3, 2001, we had approximately 370 stockholders of record and
approximately 2,100 beneficial stockholders.
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."
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
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February 3, January 29, January 30, January 31, February 1,
2001(1) 2000 1999 1998 1997(1)
---- ---- ---- ---- ----
(in thousands, except per share and operating data)
Statement of Operations Data
Net sales $ 555,670 $ 421,391 $ 338,223 $ 300,592 $ 252,165
Operating income (loss) 31,868 22,753 10,464 5,097 (27,939)
Income (loss) from continuing
operations before income taxes and
extraordinary items 30,322 20,481 6,275 (129) (36,564)
Net income (loss) 21,264 12,442 2,269 (129) (37,390)
Dividends on Series A Preferred Stock - - 2,593 3,456 3,509
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 21,264 12,442 (5,338) (6,246) (40,899)
stock
Weighted average shares outstanding
Basic 12,589 12,214 3,381 1,477 1,358
Diluted 13,066 12,864 3,381 1,477 1,358
Income (loss) before extraordinary
item and discontinued operations applicable
to common stock
Basic 1.69 1.02 (0.77) (4.23) (29.50)
Diluted 1.63 0.97 (0.77) (4.23) (29.50)
Net income (loss) per common share(2)
Basic 1.69 1.02 (1.58) (4.23) (30.12)
Diluted 1.63 0.97 (1.58) (4.23) (30.12)
Operating Data
Number of stores 243 187 168 166 150
Total selling square footage 2,979,000 2,169,000 1,804,000 1,788,000 1,567,000
Sales per average selling square foot $ 211 $ 209 $ 192 $ 180 $ 172
Comparable store sales growth 4.4% 10.3% 10.9% 3.4% 5.3%
Balance Sheet Data
Working capital (deficit) $ 18,896 $ 1,241 $(9,179) $ (2,749) $ 248
Total assets 142,265 108,466 90,167 84,817 80,669
Long-term debt and revolving credit
facility, including current portion 11,218 11,067 13,773 29,076 37,894
Stockholders' equity 79,737 46,430 27,765 17,218 11,208
- --------------------------------------------------------------------------------
(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 four fiscal years, a number of events occurred which have had a
significant impact on our financial condition.
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 the 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 2000 and 1999, our operational focus was on improving the
operating performance of existing stores and opening new stores. In fiscal 2000,
we opened 70 new stores, closed 14 stores and renovated 5 stores.
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Results of Operations
We define our fiscal year by the calendar year in which most of the activity
occurs (the fiscal year ended February 3, 2001 is referred to as fiscal 2000).
The following table sets forth selected statement of operations data expressed
as a percentage of net sales for the periods indicated:
Fiscal Year
---------------------------------------
2000 1999 1998
------------------------------------------------------------------------------------------------------
Net sales 100.0% 100.0% 100.0%
Cost of sales 64.5 64.3 65.7
---------------------------------------
Gross profit 35.5 35.7 34.3
Selling and administrative expenses 27.8 28.5 28.7
Pre-opening expenses 1.0 0.8 0.8
Amortization of intangibles 0.4 0.6 0.7
Condemnation award (0.2) - -
Stock-based compensation expense 0.9 0.5 -
Special charges - - 0.7
Merger costs - - 0.3
---------------------------------------
Operating income 5.7 5.4 3.1
Interest expense, net 0.3 0.5 1.2
---------------------------------------
Income before income taxes and extraordinary item 5.5 4.9 1.9
Income taxes 1.6 1.9 0.4
Extraordinary item, net of income tax benefit - - 0.8
---------------------------------------
Net income 3.8 3.0 0.7
Inducement to convert preferred stock to common stock - - 0.9
Preferred stock dividends - - 1.4
---------------------------------------
Net income (loss) applicable to common stock 3.8 3.0 (1.6)
---------------------------------------------------------------------------------------------------
Fiscal 2000 Compared to Fiscal 1999
As of February 3, 2001, we operated 243 stores compared to 187 as of January 29,
2000. In fiscal 2000, we opened 70 new stores and closed 14 stores.
Net sales were $555.7 million for fiscal 2000 compared to $421.4 million for
fiscal 1999, an increase of $134.3 million or 31.9%. Comparable store sales
increased 4.4% in fiscal 2000 versus an increase of 10.3% in fiscal 1999. The
increase in net sales was related to new store growth, an increase in comparable
store sales and a 53rd week of sales in fiscal 2000. Comparable store sales
increased as a result of increased customer traffic and average purchase.
Gross profit was $197.3 million for fiscal 2000 compared to $150.4 million for
fiscal 1999, an increase of $46.8 million or 31.1%. As a percentage of net
sales, gross profit was 35.5% in fiscal 2000 compared to 35.7% in fiscal 1999.
The increase in gross profit dollars was related to sales growth. The decrease
in gross profit percentage was primarily attributable to higher outbound freight
costs and higher distribution center processing costs due to the transfer of
in-store marking to our distribution centers. Previously, in-store marking costs
were included in selling and administrative expense.
12
Selling and administrative expenses were $154.4 million for fiscal 2000 compared
to $120.0 million for fiscal 1999, an increase of $34.4 million or 28.7%. As a
percentage of net sales, selling and administrative expenses were 27.8% for
fiscal 2000 compared to 28.5% for fiscal 1999. Selling and administrative
spending increased due to increased sales volume, new store growth, increased
labor rates due to minimum wage increases and higher utility costs in certain
operating areas. Selling and administrative expenses as a percentage of net
sales decreased primarily due to sales volume leverage and lower corporate
incentive bonus charges.
Pre-opening expenses were $5.4 million for fiscal 2000 compared to $3.3 million
for fiscal 1999, an increase of $2.1 million, or 64.1%. The increase in
pre-opening expense spending was related to 70 new store openings this year
versus 38 new store openings last year, as well as $1.0 million in fiscal 2000
associated with the opening of our new distribution center in Lewisville, Texas.
The new distribution center became fully operational in February 2001.
We recorded a non-recurring gain of $1.2 million during fiscal 2000 related to a
condemnation award from the City of San Diego for a store located in downtown
San Diego, California.
We recorded non-cash stock-based compensation expense related to certain
performance based stock options during fiscal 2000 in the amount of $4.8 million
compared to $2.1 million for fiscal 1999. In fiscal 2000, we recorded non-cash
stock-based compensation expense in the amounts of $2.7 million in July 2000 and
$2.1 million in August 2000 when stock options with market price hurdles of
$24.89 and $33.19, respectively, became exercisable. In fiscal 1999, we recorded
non-cash stock-based compensation expense of $2.1 million when stock options
with a market price hurdle of $19.91 became exercisable in October 1999.
Interest expense, net was $1.5 million in fiscal 2000 compared to $2.3 million
in fiscal 1999, a decrease of $0.7 million. The decrease was attributable to
lower average borrowings under our revolving credit facility.
Federal and state income taxes were $9.1 million in fiscal 2000 compared to $8.0
million in fiscal 1999, an increase of $1.0 million. Income taxes increased as a
result of higher taxable income versus the same period a year ago, offset by a
favorable adjustment of $2.9 million to our income tax provision during fiscal
2000 for a reduction in our tax valuation allowance and recognition of
additional net operating loss carryforwards.
Net income was $21.3 million in fiscal 2000 compared to $12.4 million in fiscal
1999. The increase in net income was a result of the operating and other factors
cited above.
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.
Selling and administrative expenses were $120.0 million for fiscal 1999 compared
to $97.1 million for fiscal 1998, an increase of $22.8 million or 23.5%. As a
percentage of net sales, selling and administrative expenses were 28.5% 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
13
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.
Pre-opening expenses were $3.3 million for fiscal 1999 compared to $2.6 million
for fiscal 1998, an increase of $0.7 million or 26.9%. The increase in
pre-opening expenses was related to higher pre-opening expenses incurred for 38
new store openings during fiscal 1999 versus 9 new store openings during fiscal
1998.
We recorded non-cash stock-based compensation expense during fiscal 1999 in the
amount of $2.1 million, which was related to certain stock options with a market
price hurdle which became exercisable.
We recorded a special charge of $2.4 million in fiscal 1998 in connection with
hiring our 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, net 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.
Liquidity and Capital Resources
General
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.
During fiscal 2000 and 1999, net cash provided by operating activities was $17.3
million and $24.5 million, respectively.
In fiscal 2000 and 1999, cash used in investing activities was $23.8 million and
$16.9 million, respectively, related primarily to new store openings and the
construction of our new distribution center.
14
In fiscal 2000, our financing activities provided a net cash flow of $1.8
million, including $2.6 million in proceeds from the exercise of stock options
under our stock option plan, $0.2 million in proceeds from the issuance of
common stock under our employee stock purchase plan and $0.5 million in payments
of stock subscription notes receivable, partially offset by $1.3 million in
repayments of our junior subordinated notes and capital lease obligations and
payments of deferred debt issuance costs of $0.3 million. In fiscal 1999, we
used $1.3 million in our financing activities, which included net repayments of
our revolving credit facility of $1.8 million and repayments of our junior
subordinated notes and capital lease obligations of $2.4 million, partially
offset by $2.2 million in proceeds from the exercise of stock options under our
stock option plan and warrants and $1.3 million in payments of stock
subscription notes receivable.
Revolving Credit Facility
In March 2000, we entered into a new $50.0 million revolving credit facility
with a financial institution and terminated a prior revolving credit facility.
Under the new revolving credit facility, we may borrow up to 70% of our eligible
inventory and 85% of our eligible accounts receivable, as defined, up to $50.0
million. The credit facility includes a $5.0 million sub-facility for letters of
credit. As of February 3, 2001, interest on the credit facility was at the prime
rate, or at our election, LIBOR plus 1.50%. Under the terms of the credit
facility, the interest rate may increase or decrease subject to earnings before
interest, tax obligations, depreciation and amortization expense (EBITDA), as
defined, on a rolling four fiscal quarter basis. Accordingly, prime rate
borrowings could range from prime to prime plus 0.50% and LIBOR borrowings from
LIBOR plus 1.50% to LIBOR plus 2.50%. The 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 credit facility. The 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.
At February 3, 2001, based on eligible inventory and accounts receivable, we
were eligible to borrow $42.9 million under the credit facility and had no
outstanding balance.
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
February 3, 2001, the New Junior Subordinated Notes had a face value of $15.3
million and a related unamortized discount of $4.1 million, resulting in a net
carrying value of $11.2 million. The discount is amortized to interest expense
as a non-cash charge until the notes are paid in full. We made a principal
payment on the New Junior Subordinated Notes of $1.0 million during fiscal 2000.
Additional principal payments are scheduled 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 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.
15
As of February 3, 2001, we had outstanding indebtedness, excluding capital
leases, in the principal amount of $11.2 million.
Capital Expenditures
We anticipate capital expenditures of approximately $21.4 million in fiscal
2001, which includes costs to open new stores, to renovate and relocate existing
stores, 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.
We are currently developing a plan to relocate and expand our current
distribution center in San Diego, California. This new distribution center would
be approximately 500,000 to 600,000 square feet and service our west coast,
Arizona, Nevada and New Mexico markets. It would become operational in our
second quarter of fiscal 2002. As a result, we may incur additional capital
expenditures in fiscal 2001 of approximately $5.0 million. We believe the
capital expenditures for this facility will be financed from internal cash flow.
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.
California Utility Costs
In California, where we currently operate 122 stores and which represents almost
50% of our total store base, utility costs for electricity and natural gas have
risen significantly over the past year. These costs may continue to increase due
to the actions of federal and state governments and agencies, as well as other
factors beyond our control. We have attempted to mitigate such increases through
energy conservation measures and other cost cutting steps. However, we can make
no assurances that these measures and other steps taken will be adequate to
control the impact of these utility cost increases in the future, nor can we
make assurances as to what impact these utility cost increases may have on our
sales related to our core customer base in California.
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.
New Accounting Pronouncements
In July 2000, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving
Stock Compensation." FIN 44 clarifies the application of APB Opinion No. 25,
"Accounting for Stock Issued to Employees," with respect to the definition of an
16
"employee" and accounting for modifications of outstanding awards. This
interpretation became effective July 1, 2000. We have applied FIN 44 to all new
stock options or awards granted after July 1, 2000 and any modifications to
existing options or awards performed after July 1, 2000. We believe the
implementation of FIN 44 did not have a material effect on our financial
position or results of operations.
In December 1999, the Securities and Exchange Commission 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. 101B, which defers the effective date for all registrants with fiscal
years that begin after December 15, 1999 to allow for the option of implementing
no later than the fourth quarter of fiscal 2000. We have reviewed the impact of
SAB Nos. 101 and 101B on our financial statements and its adoption does not have
a material impact on our financial statements.
In June 1998, FASB 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 Nos. 137 and 138, which defer the effective
date to all fiscal quarters of fiscal years beginning after June 15, 2000 and
clarify certain provisions of SFAS No. 133. SFAS No. 133 became effective for
our first quarter of fiscal 2001 and we do not expect it 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
February 3, 2001, fixed rate debt obligations totaled approximately $15.3
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 $11.2 million.
Maturities are $2.0 million, $2.0 million, $3.0 million, $3.0 million and $5.3
million in fiscal 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
February 3, 2001.
17
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 February 3, 2001
and January 29, 2000 F-2
Factory 2-U Stores, Inc. Statements of Operations for fiscal years
ended February 3, 2001, January 29, 2000 and January 30, 1999 F-4
Factory 2-U Stores, Inc. Statements of Stockholders' Equity
for fiscal years ended February 3, 2001, January 29, 2000
and January 30, 1999 F-5
Factory 2-U Stores, Inc. Statements of Cash Flows for fiscal years
ended February 3, 2001, January 29, 2000 and January 30, 1999 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 2001 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 February 3,
2001.
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 February 3, 2001.
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 February 3, 2001.
18
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 February 3, 2001.
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
February 3, 2001, 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) Restated 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 Amended and Restated Factory 2-U Stores, Inc. 1997 Stock Option Plan (4)
10.3 Factory 2-U Stores, Inc. Employee Compensation Agreements (5)
10.4 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 (6)
10.5 First Amendment to the 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
10.6 Amended Employment Agreement between Factory 2-U Stores, Inc. and
Michael M. Searles (6)
11.1 Computation of per share earnings
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants
- -----------------------------
(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.
(4) Incorporated by reference to Registration Statement on Form S-8,
No. 333-40682 filed with the SEC on June 30, 2000.
(5) Incorporated by reference to Registration Statement on Form S-8,
No. 333-89267 filed with the SEC on October 19, 1999.
(6) Incorporated by reference to Form 10-K for the fiscal year ended
January 29, 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 25, 2001
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
- ---------------------------
Michael M. Searles Officer and Director
(Principal Executive Officer) April 25, 2001
/s/ Douglas C. Felderman Executive Vice President, April 25, 2001
- ---------------------------- Chief Financial Officer
Douglas C. Felderman (Principal Financial
and Accounting Officer)
/s/ Willem de Vogel Director April 25, 2001
- ----------------------------
Willem de Vogel
/s/ Peter V. Handal Director April 25, 2001
- ----------------------------
Peter V. Handal
/s/ Ronald Rashkow Director April 25, 2001
- ----------------------------
Ronald Rashkow
/s/ Wm. Robert Wright II Director April 25, 2001
- ----------------------------
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 February 3, 2001 and January 29,
2000, and the related statements of operations, stockholders' equity
and cash flows for each of the three years in the period ended February
3, 2001. 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 February 3, 2001 and January 29, 2000 and the
results of its operations and its cash flows for each of the three
years in the period ended February 3, 2001 in conformity with
accounting principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
San Diego, California
February 26, 2001
F-1
FACTORY 2-U STORES, INC.
Balance Sheets
(in thousands)
February 3, January 29,
2001 2000
------------- -------------
ASSETS
Current assets:
Cash $ 4,739 $ 9,473
Merchandise inventory 52,444 35,048
Accounts receivable 3,160 1,354
Prepaid expenses 4,716 937
Deferred income taxes 2,503 2,184
------------- -------------
Total current assets 67,562 48,996
------------- -------------
Leasehold improvements and equipment,
net of accumulated depreciation and amortization 40,632 27,425
Deferred income taxes 4,992 1,032
Other assets 1,176 1,507
Excess of cost over net assets acquired, less accumulated
amortization of $11,742 and $10,139, respectively 27,903 29,506
------------- -------------
Total assets $ 142,265 $ 108,466
============= =============
(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)
February 3, January 29,
2001 2000
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt and capital leases $ 2,170 $ 1,251
Accounts payable 25,194 19,994
Income taxes payable 5,458 4,235
Accrued expenses 15,844 22,275
------------- -------------
Total current liabilities 48,666 47,755
Revolving credit facility - -
Long-term debt 9,218 10,067
Capital lease and other long-term obligations 1,126 1,658
Deferred rent 3,518 2,556
------------- -------------
Total liabilities 62,528 62,036
------------- -------------
Commitments and contingencies
Stockholders' equity:
Common stock, $0.01 par value; 35,000,000 shares
authorized and 12,759,304 shares and 12,390,817 shares
issued and outstanding, respectively 127 124
Stock subscription notes receivable (2,225) (2,710)
Additional paid-in capital 119,646 108,091
Accumulated deficit (37,811) (59,075)
------------- -------------
Total stockholders' equity 79,737 46,430
------------- -------------
Total liabilities and stockholders' equity $ 142,265 $ 108,466
============== ==============
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
----------------------------------------------
February 3, January 29, January 30,
2001 2000 1999
------------- ------------- -------------
Net sales $ 555,670 $ 421,391 $ 338,223
Cost of sales 358,393 270,962 222,332
------------- ------------- -------------
Gross profit 197,277 150,429 115,891
Selling and administrative expenses (exclusive
of non-cash stock-based compensation
expense shown below) 154,379 119,951 97,140
Pre-opening expenses 5,371 3,273 2,579
Amortization of intangibles 2,092 2,358 2,358
Condemnation award (1,240) - -
Stock-based compensation expense 4,807 2,094 -
Special charges - - 2,350
Merger costs - - 1,000
------------- ------------- -------------
Operating income 31,868 22,753 10,464
Interest expense, net 1,546 2,272 4,189
------------- ------------- -------------
Income before income taxes and extraordinary item 30,322 20,481 6,275
Income taxes 9,058 8,039 1,256
------------- ------------- -------------
Income before extraordinary item 21,264 12,442 5,019
Extraordinary item - debt extinguishment, net of
income tax benefit - - 2,750
------------- ------------- -------------
Net income 21,264 12,442 2,269
Inducement to convert preferred stock to common stock - - 2,804
Preferred stock dividends:
Series A - - 2,593
Series B - - 2,210
- -------------------------------------------------------------------------------------------------------
Net income (loss) applicable to common stock $ 21,264 $ 12,442 $ (5,338)
============= ============= =============
Income (loss) per share
Basic
Income (loss) before extraordinary item $ 1.69 $ 1.02 $ (0.77)
Extraordinary item $ - $ - $ (0.81)
Net income (loss) $ 1.69 $ 1.02 $ (1.58)
Diluted
Income (loss) before extraordinary item $ 1.63 $ 0.97 $ (0.77)
Extraordinary item $ - $ - $ (0.81)
Net income (loss) $ 1.63 $ 0.97 $ (1.58)
Weighted average common shares outstanding
Basic 12,589 12,214 3,381
Diluted 13,066 12,864 3,381
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 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
------------ -------- ------------ -------- ------------ --------
Issuance of common stock 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
------------ -------- ------------ -------- ------------ --------
Issuance of common stock for exercise
of stock options - - - - 341,932 3
Compensation expense related to stock option
performance - - - - - -
Tax effect related to non-qualified stock options - - - - - -
Issuance of common stock to Board members
and management as compensation - - - - 19,407 -
Issuance of common stock under
employee stock purchase plan - - - - 7,148 -
Payments of notes receivable - - - - - -
Net income - - - - - -
------------ -------- ------------ -------- ------------ --------
Balance at February 3, 2001 - $ - - $ - 12,759,304 $ 127
============ ======== ============ ======== ============ ========
Stock
Subscription Additional
Notes Paid-in Accumulated
Receivable Capital Deficit Total
------------- ---------- ------------ ----------
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
------------- ---------- ------------ ----------
Issuance of common stock for exercise
of stock options - 2,595 - 2,598
Compensation expense related to stock option
performance - 4,807 - 4,807
Tax effect related to non-qualified stock options - 3,454 - 3,454
Issuance of common stock to Board members
and management as compensation - 519 - 519
Issuance of common stock under
employee stock purchase plan - 180 - 180
Payments of notes receivable 485 - - 485
Net income - - 21,264 21,264
------------- ---------- ------------ ----------
Balance at February 3, 2001 $ (2,225) $ 119,646 $ (37,811) $ 79,737
============= ========== ============ ==========
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
----------------------------------------------
February 3, January 29, January 30,
2001 2000 1999
------------- ------------- -------------
Cash flows from operating activities:
Income from operating activities $ 21,264 $ 12,442 $ 5,019
Adjustments to reconcile income to net cash
provided by operating activities
Depreciation 10,351 6,859 4,484
Amortization of intangibles 2,092 2,358 2,359
Amortization of debt discount 1,151 1,137 1,430
Loss on disposal of equipment 581 796 163
Deferred rent expense 1,098 364 (362)
Stock-based compensation expense 4,807 2,094 -
Changes in operating assets and liabilities:
Merchandise inventory (17,396) (3,695) (1,533)
Prepaid expenses and other assets (7,984) (1,375) (4,117)
Accounts payable 5,200 (1,264) 2,255
Accrued expenses and other liabilities (3,840) 4,808 10,120
------------- ------------- -------------
Net cash provided by operating activities 17,324 24,524 19,818
------------- ------------- -------------
Cash flows used in investing activities
Purchase of leasehold improvements and equipment (23,818) (16,893) (6,798)
------------- ------------- -------------
Net cash used in investing activities (23,818) (16,893) (6,798)
------------- ------------- -------------
(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
----------------------------------------------
February 3, January 29, January 30,
2001 2000 1999
------------- ------------- -------------
Cash flows provided by (used in) financing activities:
Borrowings on revolving credit facility 111,711 454,157 354,816
Payments on revolving credit facility (111,711) (456,000) (365,630)
Payments of long-term debt and capital lease obligations (1,253) (2,426) (9,445)
Cash payments of preferred stock dividends - - (2,593)
Proceeds from issuance of common stock, net 180 - 10,000
Payments of deferred debt issuance costs (250) - (211)
Repurchase of warrants - (457) -
Proceeds from exercise of stock options and warrants 2,598 2,189 -
Payments of stock subscription notes receivable 485 1,255 -
------------- ------------- -------------
Net cash provided by (used in) financing activities 1,760 (1,282) (13,063)
------------- ------------- -------------
Net increase (decrease) in cash (4,734) 6,349 (43)
Cash at the beginning of the period 9,473 3,124 3,167
------------- ------------- -------------
Cash at the end of the period $ 4,739 $ 9,473 $ 3,124
============= ============= =============
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 651 $ 1,295 $ 2,679
Income taxes $ 9,559 $ 6,011 $ 111
Supplemental disclosures of non-cash investing and
financing activities:
Acquisition of equipment financed by capital leases $ - $ - $ 970
Issuance of Series B Preferred Stock for notes $ - $ - $ 1,972
Series B Preferred Stock dividend accretion $ - $ - $ 2,210
Conversion of preferred stock to common stock
inducement charge $ - $ - $ 2,804
Tax effect related to non-qualified stock options $ 3,454 $ 972 $ -
Issuance of common stock to board members and
management as compensation $ 519 $ 87 $ -
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
We operate a chain of off-price retail apparel and housewares stores in
Alabama, Arizona, California, Louisiana, Nevada, New Mexico, Oklahoma,
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 February 3, 2001, we operated 243 stores under the name
Factory 2-U.
Fiscal Year
Our fiscal year is based on a 52/53 week year ending on the Saturday
nearest January 31. Fiscal year ended February 3, 2001 included 53
weeks and fiscal years ended January 29, 2000 and January 30, 1999
included 52 weeks. We define our fiscal year by the calendar year in
which most of the activity occurs (e.g. the fiscal year ended February
3, 2001 is referred to as fiscal 2000).
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
basis. In addition, consistent with industry practice, we capitalize
certain buying, warehousing, storage and transportation costs. At
February 3, 2001 and January 29, 2000, such costs included in inventory
were $4.7 million and $2.4 million, respectively.
Leasehold Improvements and Equipment
Leasehold improvements and equipment are stated at original cost less
accumulated depreciation and amortization. Equipment under capital
leases is stated at the present value of minimum lease payments at the
date of acquisition. We calculate depreciation and amortization 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. We assess 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
We assess 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 February 3, 2001, January 29, 2000 and January 30,
1999 were approximately $17.7 million, $12.3 million and $9.9 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 Pre-opening and Closing Costs
Pre-opening 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 inventory
liquidation costs, non-recoverable investment in fixed assets and any
future lease obligations, 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
required by SFAS No. 109, "Accounting for Income Taxes." 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
We have 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 ("APB No. 25"), "Accounting for
Stock Issued to Employees." Under the intrinsic value method,
F-9
compensation expense is 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. We have disclosed the pro forma effect of using the fair value
based method to account for our stock-based compensation as required by
SFAS No. 123 (Note 10).
Dividend Accretion
Our Series B Preferred Stock had an increasing rate dividend feature
(Note 9). Accordingly, we recorded dividends on Series B Preferred
Stock using the effective interest method to recognize the dividends
ratably over the estimated period in which the stock would have been
outstanding. We converted the Series B Preferred Stock to common stock
in November 1998 and, therefore, no additional dividends have been
accreted since fiscal 1998 (Note 3).
Earnings (Loss) per Common Share
We compute 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 fiscal 1998 because the
effect would be anti-dilutive.
Use of Estimates
Our management 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 in the United States.
Actual results could differ from those estimates.
Reclassifications
Certain prior period amounts have been reclassified to conform their
presentation to the fiscal 2000 financial statements.
New Accounting Pronouncements
In July 2000, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions
Involving Stock Compensation." FIN 44 clarifies the application of APB
No. 25 with respect to the definition of an "employee" and accounting
for modifications of outstanding awards. This interpretation became
effective July 1, 2000. We have applied FIN 44 to all new stock options
or awards granted after July 1, 2000 and any modifications to existing
options or awards performed after July 1, 2000. We believe the
implementation of FIN 44 did not have a material effect on our
financial position or results of operations.
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.
101B, which defers the effective date for all registrants with fiscal
years that begin after December 15, 1999 to allow for the option of
implementing no later than the fourth quarter of fiscal 2000. We have
reviewed the impact of SAB Nos. 101 and 101B on our financial
statements and its adoption does not have a material impact on our
financial statements.
F-10
In June 1998, FASB 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 Nos. 137 and 138, which defer the effective date to all fiscal
quarters of fiscal years beginning after June 15, 2000 and clarify
certain provisions of SFAS No. 133. SFAS No. 133 became effective for
our first quarter of fiscal 2001 and we do not expect it to have a
material effect on our financial position or results of operations.
2. SPECIAL CHARGES
During fiscal 1998, we recorded charges to operations in the amount of
$1.0 million for costs related to the merger of our wholly-owned
subsidiary, General Textiles, Inc. into us and the Recapitalization
(Note 3). In addition, we recorded special charges in the amount of
$2.4 million in connection with the hiring of our current President and
CEO.
3. RECAPITALIZATION
In fiscal 1998, we initiated a multi-phased plan to restructure our
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 payment schedule (Note 6). The debt restructuring resulted in an
extraordinary charge of $2.8 million, net of tax benefit, in the first
quarter ended April 30, 1998.
On July 31, 1998, our two operating subsidiaries, General Textiles
and Factory 2-U, Inc., merged to form General Textiles, Inc.
(the "Subsidiary Merger").
On November 23, 1998, we carried out a Recapitalization in which all of
our 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, we 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 and we changed our name 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. We 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:
February 3, January 29,
(in thousands) 2001 2000
-----------------------------
Furniture, fixtures and equipment $ 53,561 $ 35,609
Leasehold improvements 11,295 7,891
Automobiles 645 748
Equipment under capital leases 678 1,047
------------ ------------
66,179 45,295
Less accumulated depreciation and amortization (25,547) (17,870)
------------ ------------
$ 40,632 $ 27,425
============ ============
5. ACCRUED EXPENSES
Accrued expenses consist of the following:
February 3, January 29,
(in thousands) 2001 2000
-----------------------------
Accrued compensation and related costs $ 6,287 $ 7,882
Sales tax payable 2,686 5,128
Other accrued expenses 6,871 9,265
------------ ------------
$ 15,844 $ 22,275
============ ============
6. LONG-TERM DEBT AND REVOLVING CREDIT FACILITY
Long-term debt and revolving credit facility consist of the following:
February 3, January 29,
(in thousands) 2001 2000
-----------------------------
Junior subordinated notes, discounted at a rate
of 10.0%, principal payments in annual installments
ranging from $2.0 million to $3.0 million,
final balloon payment of $5.3 million due May 2005 $ 11,218 $ 11,067
Less current maturities (2,000) (1,000)
------------ ------------
Long-term debt and revolving credit facility,
net of current maturities $ 9,218 $ 10,067
============ ============
Revolving Credit Facility
In March 2000, we entered into a new $50.0 million revolving credit
facility with a financial institution and terminated a prior revolving
credit facility. Under the new revolving credit facility, we may borrow
up to 70% of our eligible inventory and 85% of our eligible accounts
receivable, as defined, up to $50.0 million. The credit facility
includes a $5.0 million sub-facility for letters of credit. As of
February 3, 2001, interest on the credit facility was at the prime
rate, or at our election, LIBOR plus 1.50%. Under the terms of the
credit facility, the interest rate may increase or decrease subject to
earnings before interest, tax obligations, depreciation and
amortization expense (EBITDA), as defined, on a rolling four fiscal
quarter basis. Accordingly, prime rate borrowings could range from
prime to prime plus 0.50% and LIBOR borrowings from LIBOR
F-12
plus 1.50% to LIBOR plus 2.50%. The 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 credit facility. The 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.
At February 3, 2001, based on eligible inventory and accounts
receivable, we were eligible to borrow $42.9 million under the credit
facility and had no outstanding balance.
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. We paid the New Subordinated Notes
totaling $3.3 million in full in December 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 February 3, 2001, the New Junior Subordinated Notes
had a face value of $15.3 million and a related unamortized discount of
$4.1 million, resulting in a net carrying value of $11.2 million. The
discount is amortized to interest expense as a non-cash charge until
the notes are paid in full. We made a principal payment on the New
Junior Subordinated Notes of $1.0 million during fiscal 2000.
Additional principal payments are scheduled 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).
F-13
7. INCOME TAXES
Significant components of the provision for income taxes are as follows:
Fiscal Year Ended
-------------------------------------------------
February 3, January 29, January 30,
(in thousands) 2001 2000 1999
-------------------------------------------------
Federal Income Tax Provision
Current $ 11,249 $ 6,592 $ 2,857
Deferred (3,596) (302) (1,914)
----------- ----------- ------------
7,653 6,290 943
----------- ----------- ------------
Current 2,088 1,822 698
Deferred (683) (73) (385)
----------- ----------- ------------
1,405 1,749 313
----------- ----------- ------------
$ 9,058 $ 8,039 $ 1,256
=========== =========== ============
The principal temporary differences that give rise to significant
portions of the deferred tax assets and liabilities are presented
below:
February 3, January 29,
(in thousands) 2001 2000
-----------------------------
Deferred tax assets
Net operating loss carryforwards $ 8,409 $ 9,426
Compensated absences and bonuses 2,696 1,227
Deferred rent 1,695 1,304
Closed store accrual 229 593
Excess of tax over book inventory 875 520
Accrued expenses 762 1,285
Other 1,080 346
------------ ------------
Total gross deferred tax assets 15,746 14,701
Less valuation allowance (7,647) (10,711)
------------ ------------
Net deferred tax assets 8,099 3,990
------------ ------------
Deferred tax liabilities
Leasehold improvements and equipment,
principally due to differences in
depreciation recognized on fixed assets 604 774
------------ ------------
Deferred tax liabilities 604 774
------------ ------------
Net deferred tax asset $ 7,495 $ 3,216
============ ============
We have established a valuation allowance because we are uncertain
when we may realize the benefits of our deferred tax assets 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%, 35% and
34% to net income from continuing operations for fiscal 2000, 1999 and
1998, respectively, and actual expense is a result of the following:
Fiscal Year Ended
-------------------------------------------------
February 3, January 29, January 30,
(in thousands) 2001 2000 1999
-------------------------------------------------
Amortization of goodwill 656 657 658
Change in valuation allowance (3,064) (784) (2,017)
Merger costs - - 410
Business credits (86) (52) (150)
State income taxes, net of federal income
tax benefit 1,819 1,059 374
Refund of taxes (900) - -
Other, net 21 (9) (199)
----------- ----------- ------------
$ 9,058 $ 8,039 $ 1,256
=========== =========== ============
At February 3, 2001, we had net operating loss carryforwards for
federal income tax purposes of approximately $24.2 million that expire
starting in fiscal 2012. In the event of a change in ownership under
the provisions of the Internal Revenue Code, the annual use of net
operating loss carryforwards may be limited.
8. LEASE COMMITMENTS
We operate retail stores, distribution centers and administrative
offices under various operating leases. Total rent expense was
approximately $29.9 million, $22.0 million and $18.0 million, including
contingent rent expense of approximately $435,000, $447,000 and
$240,000, for fiscal years ended February 3, 2001, January 29, 2000 and
January 30, 1999, respectively.
Rent expense is recorded on a straight-line basis over the life of the
lease. For fiscal 2000 and 1999, rent expense charged to operations
exceeded cash payment requirements by approximately $1.1 million and
$364,000, 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.
We are also obligated under various capital leases for equipment that
expire at various dates during the next two years. Equipment and
related accumulated amortization recorded under capital leases are as
follows:
February 3, January 29,
(in thousands) 2001 2000
-----------------------------
Equipment 678 966
------------ ------------
678 1,047
Less accumulated amortization (508) (535)
------------ ------------
$ 170 $ 512
============ ============
F-15
At February 3, 2001, the future minimum lease payments under capital
leases and operating leases with remaining non-cancelable terms are as
follows:
Capital Operating
(in thousands) Leases Leases
-----------------------------
Fiscal year:
2001 $ 180 $ 27,876
2002 20 25,191
2003 - 23,050
2004 - 19,823
2005 - 12,802
Thereafter - 24,512
------------ ------------
Total minimum lease payments 200 $ 133,254
============
Less amount representing interest (rates
ranging from 9.0% to 14.8%) (10)
------------
Present value of capital lease obligation 190
Less current maturities (170)
------------
Long-term capital lease obligation $ 20
============
9. STOCKHOLDERS' EQUITY
Prior to the Recapitalization, we were authorized to issue Series A
Preferred Stock, Series B Preferred Stock and Common Stock. In
connection with the Recapitalization, we converted all shares of our
Series A and Series B Preferred Stock into Post-Recapitalization Common
Stock and effected a reverse stock split, which converted all shares of
our Pre-Recapitalization Common Stock into .30133 shares of
Post-Recapitalization Common Stock (Note 3).
10. STOCK OPTIONS AND WARRANTS
At February 3, 2001, warrants to purchase 82,690 common shares were
outstanding. These warrants have an exercise price of $19.91 and expire
in May 2005.
We have 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. We may grant up to 2,157,980 options
under this Plan. The options are issued at fair market value with
exercise prices equal to our stock price on 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-16
Our Board of Directors has granted stock options to members of the
Board and to our management. A summary of our stock option activity and
related information is as follows:
Number of Weighted average
options * exercise prices *
-----------------------------
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 454,232 17.93
Exercised (257,482) 6.90
Canceled (141,209) 7.86
----------- -----
Outstanding January 29, 2000 1,380,438 10.53
Granted 335,584 28.35
Exercised (341,932) 7.60
Canceled (88,658) 16.85
----------- -----
Outstanding February 3, 2001 1,285,432 $15.52
Exercisable at February 3, 2001 539,151 $ 9.29
* Options for January 31, 1998 have been converted at .30133 per option
under the Recapitalization.
The following table summarizes information about the stock options
outstanding at February 3, 2001:
Weighted-average
Number contractual Weighted-average Number Weighted-average
Range of exercise of options life exercise of options exercise
prices outstanding (Years) price exercisable price
--------------------- -------------- -------------- ------------- ------------- --------------
$ 0.00 to $ 4.23 754 1.8 $ 4.15 754 $ 4.15
$ 4.23 to $ 8.45 578,324 3.3 $ 6.95 443,483 $ 6.90
$ 8.45 to $12.68 159,920 8.0 $12.07 28,684 $11.98
$12.68 to $16.90 62,500 8.1 $15.06 14,500 $15.24
$16.90 to $21.13 25,150 5.1 $18.71 4,150 $19.75
$21.13 to $25.35 140,805 8.5 $24.05 14,780 $24.19
$25.35 to $29.58 255,736 7.7 $27.31 26,800 $26.06
$29.58 to $33.80 19,993 9.6 $31.85 - $ -
$33.80 to $38.03 32,750 9.0 $36.55 2,500 $37.56
$38.03 to $42.25 9,500 6.1 $40.62 3,500 $41.80
--------- --- ------ ------------ ------
1,285,432 5.8 $15.52 539,151 $ 9.29
========= === ====== ============ ======
F-17
During fiscal 1997 and 1998, we 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, we
recorded compensation expense in the amount of $82,000.
During fiscal 1999, the market price of our 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. We recorded a
non-cash compensation charge of approximately $2.1 million in
connection with this event.
In July 2000, our Common Stock achieved a market price of $24.89 or
greater for 60 consecutive trading days. As a result, all 92,961 stock
options with a market price hurdle of $24.89 became exercisable and we
recorded non-cash stock-based compensation expense of $2.7 million. In
August 2000, our Common Stock achieved a market price of $33.19 or
greater for 60 consecutive trading days; therefore, 71,419 stock
options with a market price hurdle of $33.19 became exercisable and we
recorded non-cash stock-based compensation expense of $2.1 million.
There are an additional 65,731 stock options outstanding that will
become exercisable once our Common Stock has achieved and maintained a
price of $49.78 for 60 consecutive trading days. At that time, we will
be required to record non-cash compensation expense in the minimum
amount of $2.8 million.
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 ours. We have 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, our net income and earnings per share would have
reflected the following pro forma amounts:
Fiscal Year Ended
------------------------------------------------
February 3, January 29, January 30,
(in thousands, except per share data) 2001 2000 1999
----------- ----------- -----------
Net Income (Loss): As Reported $ 21,264 $ 12,442 $ (5,338)
Pro Forma $ 18,759 $ 11,485 $ (6,249)
Basic EPS: As Reported $ 1.69 $ 1.02 $ (1.58)
Pro Forma $ 1.49 $ 0.94 $ (1.85)
Diluted EPS: As Reported $ 1.63 $ 0.97 $ (1.58)
Pro Forma $ 1.44 $ 0.89 $ (1.85)
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 our 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, we believe 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 98.75%, 103.33% and 106.89% for
fiscal 2000, 1999 and 1998, respectively, (iii) expected life of seven
years for fiscal 2000 and three to five years for fiscal 1999 and 1998,
and (iv) risk-free interest rate of 5.01%, 6.68% and 5.55% for fiscal
2000, 1999 and 1998, respectively.
F-18
11. EMPLOYEE BENEFITS
We sponsor 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. We make 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. We contributed approximately
$208,000, $199,000 and $167,000 in fiscal 2000, 1999 and 1998,
respectively.
We also sponsor the Factory 2-U Stores, Inc. Employee Stock Purchase
Plan which allows eligible employees to acquire shares of our 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. Our stockholders
approved the Plan 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
us at any time. As of February 3, 2001, eligible employees have
purchased 7,148 shares of our Common Stock under the Plan.
12. COMMITMENTS AND CONTINGENCIES
We are at all times subject to pending and threatened legal actions
that arise in the normal course of business. In the opinion of our
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 our financial position or results of operations.
We have entered into an employment contract with one of our officers,
which defines his duties and compensation and which could provide
severance in the event of his termination of employment.
13. RELATED PARTY TRANSACTIONS
In March 1997, we entered into an agreement with Three Cities Research,
Inc. ("TCR") engaging TCR to act as financial advisor to us. Under this
agreement, we pay TCR an annual fee of $50,000 and reimburse TCR for
all of its out-of-pocket expenses incurred for services rendered, up to
an aggregate of $50,000 annually. We reimbursed TCR for out-of-pocket
expenses in the approximate amounts of $37,000, $46,000 and $48,000
during fiscal 2000, 1999 and 1998, respectively. TCR controls
approximately 24% of our outstanding common stock and certain
principals of TCR are members of our Board of Directors.
F-19
14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The results of operations for fiscal 2000 and 1999 were as follows:
First Second Third Fourth
(in thousands, except per share data) Quarter Quarter Quarter Quarter
------- ------- ------- -------
Fiscal 2000
Net Sales $108,375 $116,678 $136,831 $193,786
Gross profit 38,225 42,135 48,957 67,960
Operating income 3,092 3,289 6,112 19,375
Net income 1,602 1,661 5,836 12,165
Earnings per share:
Basic $ 0.13 $ 0.13 $ 0.46 $ 0.95
Diluted $ 0.12 $ 0.13 $ 0.44 $ 0.92
First Second Third Fourth
(kn 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
As a result of rounding differences, total amounts disclosed in the
Statements of Operations may not agree to the sum of the amounts
disclosed above for the four quarters.