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 2, 2002
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
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Common Stock, $0.01 par value None
Securities registered pursuant to Section 12(g)of the Act:
Common Stock, $0.01 par value
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(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 8, 2002, the aggregate market value of the voting stock of the
Registrant held by non-affiliates was approximately $110,471,396.
At April 8, 2002, the Registrant had outstanding 12,941,137 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 19, 2002
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 2, 2002.
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 23
Item 8. Financial Statements and Supplementary Data 23
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 23
PART III
Item 10. Directors and Executive Officers of the Registrant 24
Item 11. Executive Compensation 24
Item 12. Security Ownership of Certain Beneficial Owners and Management 24
Item 13. Certain Relationships and Related Transactions 24
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 25
2
PART I
Item 1. Business
THE COMPANY
We operate a chain of off-price retail apparel and housewares stores in Arizona,
Arkansas, California, Idaho, Louisiana, Missouri, Nevada, New Mexico, Oklahoma,
Oregon, Tennessee, Texas and Washington. We sell branded casual apparel for the
family, as well as selected domestic and household merchandise at prices that
generally are significantly lower than other discount stores. At February 2,
2002, we operated 279 stores under the name Factory 2-U.
Our stores average approximately 15,000 total square feet and are located mostly
in shopping centers. Our products include a broad range of family apparel,
domestic goods and houseware. Our typical customers are families with more than
the average number of children and average household income of approximately
$35,000, which 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.
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 corporate name from Family
Bargain Corporation to Factory 2-U Stores, Inc.
We define our fiscal year by the calendar year in which most of our business
activity occurs (the fiscal year ended February 2, 2002 is referred to as fiscal
2001).
OPERATIONS
Recent Developments
We started fiscal 2001 with expectations to add 61 net new stores and improve
operating margins and profitability. However, during fiscal 2001 we faced a
difficult economic environment with a slowing economy, the impact of the
terrorist attacks on September 11, and a highly promotional environment within
the retail industry. We believe that our core customers have been
disproportionately disadvantaged in the current economy. Fiscal 2001 has been a
very difficult year for us and apparel retailers in general.
As part of our ongoing store evaluation process, we have closed 36 stores over
the past three years, generally due to non-renewable leases or relocation
opportunities to a newer location in the same marketplace. During this same time
frame, we accelerated our store growth, opening 147 new stores, including 65
stores in nine states in which we had not previously operated. Unlike in
existing markets, we have learned that in new markets, and particularly in a
difficult economic environment, we initially require a larger population of our
core demographic consumer to achieve our financial objectives. As a result, in
the fourth quarter of fiscal 2001 we reviewed our real estate portfolio and
store operating performance and decided to close 28 under-performing stores
(i.e., stores that do not meet our then current minimum operational performance
criteria established by management). In conjunction with the store closures, we
realigned our field organization and streamlined our workforce. As a result of
these restructuring initiatives, we recorded a pre-tax restructuring charge of
$21.2 million, including lease termination costs of $13.7 million, inventory
3
liquidation costs of $2.9 million, fixed asset write-downs of $2.1 million,
employee termination costs of $1.2 million and other costs of $1.3 million. As
of April 8, 2002, we have closed 24 of these under-performing stores.
With these lessons behind us, we believe we now have a much clearer
understanding of the demographic requirements for a successful store. In
addition, our strong financial and liquidity position should continue to allow
us to internally finance future new store growth. In the fiscal year ending
February 1, 2003 (fiscal 2002), we currently intend to open 20 to 25 new stores.
In addition to the 28 under-performing stores, we also plan to close six other
stores, which are either due to non-renewable leases or relocation. The number
of stores we opened and closed each quarter during fiscal 2001, 2000 and 1999
were as follows:
Quarter
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Fiscal First Second Third Fourth
Year Beginning Open Close Open Close Open Close Open Close Ending
- ------ --------- ---- ----- ----- ------ ---- ----- ---- ----- ------
2001 243 9 (1) 12 - 12 (2) 6 - 279
2000 187 25 (9) 11 (3) 20 - 14 (2) 243
1999 168 9 (8) 10 (1) 15 (6) 4 (4) 187
Our average store opening costs for equipment, fixtures, leasehold improvements
and pre-opening expenses currently approximate $295,000. 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 that are 150% to 200% higher than the expected annualized net
sales due to higher level of advertising activities associated with grand
opening.
In addition to the new store growth, 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 $25,000 to $50,000. During fiscal 2001,
we renovated four stores. In fiscal 2002, we currently plan to renovate five
stores.
We opened a new 300,000 square-foot distribution center in Lewisville, Texas in
February 2001. This new distribution center services parts of New Mexico, Texas,
and all states east of Texas in which we currently operate. We also operate a
distribution center in the San Diego area, which consists of two facilities
aggregating 365,000 square feet. In March 2002, we signed a lease agreement to
build a new distribution center in San Diego, California to replace our existing
San Diego distribution facilities. This new distribution center will be
approximately 600,000 square feet and serve our west coast, Arizona, Idaho,
Nevada and parts of New Mexico markets. We anticipate it will become operational
during the second quarter of fiscal 2003.
Operating Strategy
We seek to be the leading off-price apparel, domestic goods and houseware
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 in-season inventory of recognized brands
at bargain prices and pass along the savings to our customers.
Target Under-Served Market Segments:
Our stores target consumers who are under-served in their markets. Typical
customers are young, large families with a household income of approximately
$35,000.
4
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.
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, knowing that we
are a potential buyer of the excess inventory, typically at prices below
wholesale. We believe that in-season buying practices are well suited to our
customers, who tend to make purchases on an as-needed basis later into a season.
Our in-season buying practice is facilitated by our ability to process a large
number of relatively small purchase orders and ship merchandise through our
distribution centers to our stores. Generally, manufacturers ship goods directly
to our distribution centers or, in the case of certain east coast vendors, to
freight consolidators who then ship directly to our distribution centers. We
then deliver 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 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 lower 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. 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, lower 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 the administrative headquarters and the
stores, enabling corporate management to provide store management with timely
pricing and distribution information.
5
Our stores are characterized by easily accessible merchandise displayed on
hanging fixtures and open shelves in well-lit areas. Our prices are clearly
marked 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.
Our Stores
As of April 8, 2002, we operated 251 stores located in Arizona, Arkansas,
California, Idaho, Louisiana, Missouri, Nevada, New Mexico, Oklahoma, Oregon,
Tennessee, Texas and Washington, under various operating leases with third
parties. 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 shopping centers, where occupancy costs are more favorable. Our
stores range in size from 6,000 square feet to 34,800 square feet, averaging
approximately 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 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, one assistant store manager, two
store supervisors, and 15 to 20 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
store manager positions.
Our store management team participates in a bonus plan in which they are awarded
bonuses upon achieving established operating 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 decision is made to close a store.
We maintain customary commercial liability, fire, theft, business interruption
and other insurance policies.
Employees
As of April 8, 2002, we had 4,780 employees (2,679 of whom were part-time
employees). Of that total, 4,470 were store employees and store field
management, 186 were executives and administrative employees and 124 were
warehouse employees. None of our employees are subject to collective bargaining
agreements and we consider relations with our employees to be good.
6
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 8, 2002, we operated 251 retail stores located in 13 states, under
various operating leases with third parties. Our store locations include
shopping centers, downtown business districts, malls and freestanding sites. Our
store leases are separately negotiated. The typical lease term 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
store rent expense for the fiscal year ended February 2, 2002 was approximately
$36.5 million.
As of April 8, 2002, our stores were located as follows:
Shopping
State Center Downtown Freestanding Mall Total
----- -------- -------- ------------ ---- -----
Arizona 29 3 1 - 33
Arkansas 3 - - - 3
California 108 8 3 3 122
Idaho 1 - - - 1
Louisiana 5 - - - 5
Missouri 3 - - - 3
Nevada 8 - - - 8
New Mexico 9 - - - 9
Oklahoma 2 - - - 2
Oregon 13 - 1 - 14
Tennessee 2 - - - 2
Texas 29 - 1 5 35
Washington 13 2 - 1 16
----- ---- --- --- -----
Total 225 13 6 9 253
===== ==== === === =====
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.
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 also lease another 150,000 square feet of our San Diego distribution
center at 7130 Miramar Road, San Diego, California. This lease expires in
September 2005 and provides for annual base rent at an average of approximately
$870,000 over the lease term. Upon opening of our new distribution center in San
7
Diego, California, currently anticipated in the second quarter of fiscal 2003,
we will cease distribution activities at Ruffin Road and Miramar Road and plan
to sublease that space.
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.
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 August 2, 2001, O'Hara and four other former
employees in our Alameda store, filed a Second Amended Complaint in the O'Hara
Lawsuit.
The Second 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 Second Amended Complaint seeks compensatory damages, interest,
penalties, attorneys' fees, and disgorged profits, all in unspecified amounts.
The Second Amended Complaint also seeks injunctive relief requiring payment of
overtime to "non-exempt" employees. On September 4, 2001, we filed an answer in
which we denied the material allegations of the Second Amended Complaint.
Pursuant to an Order dated December 3, 2001, the Court in the O'Hara Lawsuit
granted Plaintiff's motion for certification of two plaintiff classes: (1) all
persons who have been employed as assistant store managers at one of our
California stores at any time after December 15, 1996, and who worked hours
which would have entitled them to overtime had they not been exempt employees;
and (2) all persons who have been employed as store managers at one of our
California stores at any time after December 15, 1995, and who worked hours
which would have entitled them to overtime had they not been exempt employees.
We have made a settlement offer to each member of the two plaintiffs classes,
pursuant to which we offered to pay $1,000 for each year of service (or a pro
rata portion of each partial year) after December 15, 1996 and between February
1, 2002 in exchange for a release of all overtime claims. Approximately 264
members of the plaintiff classes who received notice of the settlement offer in
the mail have accepted this offer. The settlement offer has been mailed again to
approximately 129 members of the plaintiff classes whose first mailing notices
of the settlement offer were returned as undeliverable. Those individuals have
until April 26, 2002, to accept the settlement offer.
The Court has scheduled the trial for July 22, 2002.
Although at this stage of the litigation it is difficult to predict the outcome
of the case with certainty, we believe that we have meritorious defenses to the
O'Hara Lawsuit and we are vigorously defending against it. If the O'Hara Lawsuit
is decided adversely, the potential exposure could be material to our results of
operations for the year in which the case is ultimately decided.
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 2, 2002.
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.
High Low
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Fiscal 2000
- -----------
13 weeks ended April 29, 2000 $ 34.63 $ 21.75
13 weeks ended July 29, 2000 $ 41.50 $ 31.00
13 weeks ended October 28, 2000 $ 43.13 $ 27.44
14 weeks ended February 3, 2001 $ 45.19 $ 28.50
Fiscal 2001
- -----------
13 weeks ended May 5, 2001 $ 42.63 $ 21.00
13 weeks ended August 4, 2001 $ 34.85 $ 18.00
13 weeks ended November 3, 2001 $ 23.55 $ 12.89
13 weeks ended February 2, 2002 $ 20.90 $ 14.17
Fiscal 2002 ending February 1, 2003
- -----------------------------------
Through April 8, 2002 $ 18.31 $ 11.35
As of April 8, 2002, we had approximately 291 stockholders of record and
approximately 4,000 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
---------------------------------------------------------------------
February 2, February 3, January 29, January 30, January 31,
2002 (2) 2001 (1) 2000 1999 1998
---- ---- ---- ---- ----
(in thousands, except per share and operating data)
Statement of Operations Data
- ----------------------------
Net sales $ 580,460 $ 555,670 $ 421,391 $ 338,223 $ 300,592
Operating income (loss) (16,786) 31,868 22,753 10,464 5,097
Income (loss) from continuing operations
before income taxes and extraordinary
items (17,746) 30,322 20,481 6,275 (129)
Net income (loss) (10,896) 21,264 12,442 2,269 (129)
Dividends on Series A preferred stock - - - 2,593 3,456
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
stock (10,896) 21,264 12,442 (5,338) (6,246)
Weighted average shares outstanding
Basic 12,807 12,589 12,214 3,381 1,477
Diluted 12,807 13,066 12,864 3,381 1,477
Income (loss) before extraordinary items
and discontinued operations applicable to
common stock
Basic (0.85) 1.69 1.02 (0.77) (4.23)
Diluted (0.85) 1.63 0.97 (0.77) (4.23)
Net income (loss) per common stock
Basic (0.85) 1.69 1.02 (1.58) (4.23)
Diluted (0.85) 1.63 0.97 (1.58) (4.23)
Operating Data
- --------------
Number of stores at fiscal year end 279 243 187 168 166
Total selling square footage 3,459,000 2,979,000 2,169,000 1,804,000 1,788,000
Sales per average selling square foot $ 178 $ 211 $ 209 $ 192 $ 180
Comparable store sales increase (decrease) (8.7%) 4.4% 10.3% 10.9% 3.4%
Balance Sheet Data
- ------------------
Working capital (deficit) $ 14,633 $ 18,896 $ 1,241 $ (9,179) $ (2,749)
Total assets 155,709 142,265 108,466 90,167 84,817
Long-term debt and revolving credit
facility, including current portion 10,376 11,218 11,067 13,773 29,076
Stockholders' equity 70,566 79,737 46,430 27,765 17,218
(1) 53-week fiscal year.
(2) Included a pre-tax restructuring charge of $21.2 million.
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 five 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 of Directors. 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 corporate 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. In fiscal
1999, we opened 38 stores, closed 19 stores and renovated 74 stores. Of all the
stores we opened in fiscal 2000 and 1999, 34 were located in three states in
which we had not previously operated.
During fiscal 2001, we faced a difficult economic environment with a slowing
economy, the impact of terrorist attacks on September 11, and a highly
promotional environment within the retail industry. We believe that our core
customers have been disproportionately disadvantaged in the current economy.
Fiscal 2001 has been a very difficult year for us and apparel retailers in
general.
As part of our ongoing store evaluation process, in the fourth quarter of fiscal
2001, we reviewed our real estate portfolio and store operating performance and
decided to close 28 under-performing stores (i.e., stores do not meet our then
current minimum operational performance criteria established by management).
Unlike existing markets, we have learned that in new markets, and particularly
in a difficult economic environment, we initially require a larger population of
our core demographic consumer to achieve our financial objectives. In
conjunction with the store closures, we realigned our field organization and
streamlined our workforce. As a result of these restructuring initiatives, we
recorded a pre-tax restructuring charge of $21.2 million including lease
termination costs of $13.7 million, inventory liquidation costs of $2.9 million,
fixed asset write-downs of $2.1 million, employee termination costs of $1.2
million and other costs of $1.3 million. As of April 8, 2002, we have closed 24
of these under-performing stores.
11
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Specifically, we must make estimates in the following areas:
o Inventory valuation
-------------------
Merchandise inventory is stated at the lower of cost or market determined
using the retail inventory method ("RIM") on a first-in, first-out basis.
Under the RIM, the valuation of inventory at cost and the resulting gross
margin are calculated by applying a computed cost-to-retail ratio to the
retail value of inventory. RIM is an averaging method that has been widely
used in the retail industry due to its practicality. Also, it is
recognized that the use of the RIM will result in valuing inventory at
the lower of cost or market if markdowns are currently taken as a
reduction of the retail value of inventory. Inherent in the RIM
calculation are certain significant management judgments and estimates
regarding markdowns and shrinkage, which may from time to time cause
adjustments to the gross margin in the subsequent period. Factors that can
lead to distortion in the calculation of the inventory balance include
applying the RIM to a group of merchandise items that is not fairly
uniform in terms of its cost and selling price relationship and turnover,
and applying RIM to transactions over a period of time that includes
different rates of gross profit, such as those relating to seasonal
merchandise items. To minimize the potential of such distortions in the
valuation of inventory from occurring, we utilize 74 sub-departments
in which fairly homogeneous classes of merchandise items having similar
gross margin are grouped. In addition, failure to take markdown currently
may result in an overstatement of cost under the lower of cost or market
principle. We believe that our RIM provides an inventory valuation that
reasonably approximates cost and results in carrying inventory at the lower
of cost or market.
o Valuation of goodwill, intangible and other long-lived assets
-------------------------------------------------------------
We use certain assumptions in establishing the carrying value and
estimated lives of our long-lived assets and goodwill. The criteria used
for these evaluations include management's estimate of the asset's
continuing ability to generate income from operations and positive cash
flows. If assets are considered to be impaired, the impairment recognized is
measured by the amount that the carrying value of the assets exceeds the
fair value of the assets. Useful lives and related depreciation or
amortization expense are based on our estimate of the period that the
assets will generate revenues or otherwise be used in operations. Factors
that would influence the likelihood of a material change in our reported
results include a significant decline in our stock price and market
capitalization compared to our net book value, significant changes in an
asset's ability to generate positive cash flows, significant changes in our
strategic business objectives and utilization of the asset.
o Accrued restructuring costs
---------------------------
We have estimated an amount for the charge and the related liability
regarding our restructuring initiatives including store closures,
realignment of our field organization and workforce reductions in accordance
with the Emerging Issues Task Force ("EITF") Issue 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to
Exit an Activity (including Certain Costs Incurred in a Restructuring)."
Materially different reported results would be likely if the timing and
extent of the adopted restructuring plan were changed.
o Litigation reserves
-------------------
Based in part on the advice of our legal counsel, estimated amounts for
litigation and claims that are probable and can be reasonably estimated are
recorded as liabilities in the balance sheet. The likelihood of a material
change in these estimated reserves would be dependent on new claims as they
may arise and the favorable or unfavorable outcome of the particular
litigation. We anticipate these reserves will be remeasured as new facts
come to light in any particular case.
12
o Worker's compensation accrual
-----------------------------
At the beginning of fiscal 2001, we transitioned to a partially
self-insured worker's compensation program. This new program has both
specific and aggregate stop-loss amounts. The maximum specific stop-loss is
$250,000 per occurrence and the deductible aggregate stop-loss is $3.2
million for the policy year ended January 31, 2002. We utilize internal
actuarial methods, as well as an independent third-party actuary for the
purpose of estimating ultimate costs for a particular policy year. Based on
these actuarial methods along with current available information and
insurance industry statistics, the ultimate expected losses for the policy
year ended January 31, 2002 were estimated to be approximately $2.6 million.
Our estimate is based on average claims experience in our industry and our
own experience in terms of frequency and severity of claims, with no
explicit provision for adverse fluctuation from year to year and is subject
to inherent variability. This variability may lead to ultimate payments
being either greater or less than the amounts presented above.
o Valuation of deferred income taxes
----------------------------------
Valuation allowances are established, if deemed necessary, to reduce
deferred tax assets to the amount expected to be realized. The likelihood of
a material change in our expected realization of these assets is dependent
on future taxable income, our ability to use the net operating loss
carryforwards, the effectiveness of our tax planning and strategies among
the various tax jurisdictions that we operate in, and any significant
changes in the tax treatment we currently receive.
Results of Operations
We define our fiscal year by the calendar year in which most of our business
activity occurs (the fiscal year ended February 2, 2002 is referred to as fiscal
2001). The following table sets forth operating data expressed as a percentage
of net sales for the periods indicated:
Fiscal Year
-----------
2001 2000 1999
---- ---- ----
(percentage of net sales)
-------------------------
Net sales 100.0 100.0 100.0
Cost of sales 66.4 64.5 64.3
------- ------- -------
Gross profit 33.6 35.5 35.7
Selling and administrative expenses 32.4 27.8 28.5
Pre-opening expenses 0.5 1.0 0.8
Amortization of intangibles 0.3 0.4 0.6
Restructuring charge 3.2 - -
Condemnation award - (0.2) -
Stock-based compensation expense 0.1 0.9 0.5
------- ------- -------
Operating income (loss) (2.9) 5.7 5.4
Interest expense, net 0.2 0.3 0.5
------- ------- -------
Income (loss) before income taxes (3.1) 5.5 4.9
Income taxes (benefit) (1.2) 1.6 1.9
------- ------- -------
Net income (loss) (1.9) 3.8 3.0
------- ------- -------
13
Fiscal 2001 Compared to Fiscal 2000
As of February 2, 2002, we operated 279 stores compared to 243 stores as
February 3, 2001. In fiscal 2001, we opened 39 net stores and closed 3 stores.
Fiscal 2001 was a 52-week fiscal year as compared to a 53-week fiscal year for
fiscal 2000.
Net sales were $580.5 million for fiscal 2001 compared to $555.7 million for
fiscal 2000, an increase of $24.8 million or 4.5%. Excluding the extra week of
sales (53rd week) in fiscal 2000, net sales for fiscal 2001 increased 6.1%.
Comparable store sales decreased 8.7% in fiscal 2001 versus an increase of 4.4%
in fiscal 2000. The increase in net sales was related to new store growth offset
by negative comparable store sales. The average number of stores in operation
was 264 for fiscal 2001 compared to 217 for fiscal 2000, an increase of 21.7%.
Comparable store sales decreased primarily as a result of reduced customer
traffic. Fiscal 2001 has been a very difficult year for our business and apparel
retailers in general. We believe our core customers have been affected by the
slow economy and in California, our largest market, increased utilities and fuel
costs. Compounding this, apparel is obviously a deferrable purchase for our core
customers who have limited discretionary income. Apparel and houseware purchases
may be reduced and deferred in favor of more current needs such as food,
housing, utilities and transportation. In addition, we experienced the most
promotional and competitive holiday period in recent memory. The highly
promotional environment was evidenced by the post-Thanksgiving offerings by many
big box discounters, which enticed consumers in with "close to cost or below
cost" items in the electronics and hard goods categories.
Gross profit was $195.1 million for fiscal 2001 compared to $197.3 million for
fiscal 2000, a decrease of $2.2 million or 1.1%. The current fiscal year's gross
profit reflected a non-cash charge of $2.9 million related to the anticipated
inventory liquidation cost for the closing of the 28 under-performing stores as
previously mentioned. As a percentage of net sales, gross profit was 33.6% in
fiscal 2001 compared to 35.5% in fiscal 2000. The decline in gross profit
percentage was primarily attributable to higher markdown volume, partially
offset by improved initial markup and favorable distribution costs. The higher
markdown volume was related to a very heavy promotional environment during the
holiday season and earlier clearance of merchandise than a year ago.
Selling and administrative expenses were $188.3 million for fiscal 2001 compared
to $154.4 million for fiscal 2000, an increase of $33.9 million or 22.0%. As a
percentage of net sales, selling and administrative expenses were 32.4% for
fiscal 2001 compared to 27.8% for fiscal 2000. The increase in selling and
administrative spending as a percentage of net sales was both spending related
and sales volume related. The unfavorable spending variance was primarily due to
higher store labor, store occupancy and advertising expenses. The increase in
store labor was primarily due to minimum wage increases for both hourly and
salaried associates, higher health care and workers' compensation costs. The
increase in store occupancy was due to higher rent and depreciation expense for
new stores. The increase in advertising was due to increased promotional
activity based on competition in the marketplace.
Pre-opening expenses were $3.1 million for fiscal 2001 compared to $5.4 million
for fiscal 2000, a decrease of $2.3 million, or 42.5%. The decrease in
pre-opening expenses was related to 39 new store openings this year versus 70
new store openings last year, as well as $1.0 million recorded in fiscal 2000
associated with the opening of our distribution center in Lewisville, Texas,
which became fully operational in February 2001.
Amortization of intangibles was $1.7 million for fiscal 2001 compared to $2.1
million for fiscal 2000. The reduction in amortization of $410,000 represented
the cessation of amortization associated with certain costs incurred in the
ownership change of the company in fiscal 1997.
The restructuring charge of $18.3 million was part of the total $21.2 million
charge related to our restructuring initiatives, as previously discussed. We
recorded $2.9 million of the pre-tax $21.2 million charge as a non-cash
inventory liquidation cost which was included in the cost of sales.
14
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 2001 in the amount of $456,000
compared to $4.8 million for fiscal 2000. During the second quarter of fiscal
2001, we removed the market price hurdle of $49.78 for 19,361 stock options held
by a former Executive Vice President who retired in August 2001. As a result of
the removal of the market price hurdle, we incurred a non-cash charge of
$456,000. 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.
Interest expense, net was $960,000 in fiscal 2001 versus $1.5 million in fiscal
2000, a decrease of $586,000 or 37.9%. The decrease was attributable to lower
average borrowings and lower interest rates under our revolving credit facility
and interest income received from the Internal Revenue Service related to prior
years' tax refund due.
We recorded a federal and state income tax benefit of $6.9 million in fiscal
2001 and a federal and state income tax provision of $9.1 million in fiscal
2000. The income tax benefit was due to the loss we incurred in fiscal 2001. The
income tax provision recorded in fiscal 2000 included a favorable adjustment of
$2.9 million to our income tax provision for a reduction in our tax valuation
allowance and recognition of additional net operating loss carryforwards.
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.
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 increased sales volume 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 expenses 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.
15
Amortization of intangibles was $2.1 million for fiscal 2000 compared to $2.4
million for fiscal 1999. The reduction in amortization of $266,000 was due to
the cessation of amortization associated with certain costs incurred in the
ownership change of the company in fiscal 1997.
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.
Liquidity and Capital Resources
General
We finance our operations through credit provided by vendors and other
suppliers, amounts available 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.
At February 2, 2002, we were in compliance with all financial and tangible net
worth covenants, as defined, and had no outstanding borrowings under our
revolving credit facility. At February 2, 2002, based on eligible inventory and
accounts receivable, we were eligible to borrow $40.1 million under the
revolving credit facility.
We believe that our sources of cash, including the revolving 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.
Cash Flows
In fiscal 2001, net cash generated from operating activities was $27.0 million
versus $17.3 million generated in fiscal 2000. The increase in cash flow from
operating activities was primarily due to timing of vendor payments and lower
average store inventories.
In fiscal 2001 and 2000, cash used in investing activities was $12.7 million and
$23.8 million, respectively, related primarily to capital expenditures for both
new and existing stores. The new store growth in fiscal 2001 was significantly
lower than fiscal 2000. We opened 39 new stores in fiscal 2001 compared to 70
stores in fiscal 2000. In addition, in fiscal 2000, we invested significant
capital expenditures in the development of our Texas distribution center, which
became fully operational in February 2001.
In fiscal 2001, we used $1.7 million for our financing activities, including a
payment of $2.2 million for our junior subordinated notes and capital lease
obligations, partially offset by $525,000 in proceeds from the exercise of stock
options under our stock option plan. 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, $180,000 in
proceeds from the issuance of common stock under our employee stock purchase
plan and $485,000 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
$250,000.
16
Revolving Credit Facility
We have a $50.0 million revolving credit facility with a financial institution.
Under this 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 was amended on April 9, 2002 to increase our $5.0
million sub-facility for letters of credit to $10.0 million. As of February 2,
2002, 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
$7.5 million.
At February 2, 2002, based on eligible inventory and accounts receivable, we
were eligible to borrow $40.1 million under the credit facility and had no
outstanding borrowings; and we had a $1.0 million standby letter of credit
outstanding.
Junior Subordinated Notes
The 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
2, 2002, the Junior Subordinated Notes had a face value of $13.3 million and a
related unamortized discount of $2.9 million, resulting in a net carrying value
of $10.4 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
Junior Subordinated Notes of $2.0 million in December 2001. Additional principal
payments are scheduled on 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 revolving credit facility,
should be adequate to finance our debt obligation as it becomes due for at least
the next twelve months.
Capital Expenditures
We anticipate capital expenditures of approximately $14.1 million in fiscal
2002, which includes costs to open new stores, to renovate and relocate existing
stores, to upgrade information systems and to develop our new San Diego
distribution center. This new distribution center would be approximately 600,000
square feet and service our west coast, Arizona, Nevada and part of New Mexico
markets. We anticipate that it will become operational in our second quarter of
fiscal 2003. We anticipate capital expenditures of approximately $6.5 million
for this facility, most of which will occur in fiscal 2002. We believe the
capital expenditures for this facility and other capital expenditures will be
financed from internal cash flow.
Store Closures and Restructuring Initiatives
As previously discussed, in fiscal 2002 we anticipate closing approximately 28
under-performing stores as part of our restructuring plan and six other stores
which are either due to non-renewable leases or relocation opportunities. The
majority of the store closures are part of our restructuring initiatives
intended to improve future financial performance. The cash charges to close a
store principally consist of lease termination or sublease costs, employee
severance and tear-down costs. In addition to the closing of under-performing
stores, we also included the realignment of field organization and workforce
reductions as part of our restructuring initiatives. Currently, we estimate the
cash requirement in fiscal 2002 for the restructuring would be approximately
$12.7 million. We believe that our sources of cash, including the revolving
credit facility, should be adequate to fund our restructuring efforts.
17
Contractual Obligations and Commitments
The following table summarizes our contractual obligations, as well as estimated
cash requirement related to the restructuring initiatives, as of February 2,
2002. These should be in read in conjunction with "Note 2 Restructuring Charge",
"Note 5 Long-Term Debt and Revolving Credit Facility" and "Note 7 Lease
Commitments" in the accompanied financial statements.
(in thousands)
--------------------------------------------------------------------
Junior
Subordinated Operating Capital Restructuring
Notes Leases Leases Charge Total
------------- --------- ------- -------------- -----
Fiscal Year:
2002 $ 2,000 $ 32,285 $ 20 $ 12,730 $ 47,035
2003 3,000 30,792 - 3,578 37,370
2004 3,000 27,187 - - 30,187
2005 5,300 20,325 - - 25,625
2006 - 13,905 - - 13,905
Thereafter - 27,065 - - 27,065
------------ ---------- -------- -------------- ----------
Total $ 13,300 $ 151,559 $ 20 $ 16,308 $ 181,187
============ ========== ======== ============== ==========
Risk Factors
Terrorism and the Uncertainty of War May Affect Our Business
Terrorist attacks, such as the attacks that occurred in New York and Washington
D.C. on September 11, 2001, the response by the United States initiated on
October 7, 2001 and other acts of violence or war may affect the market on which
our common stock will trade, the markets in which we operate and our operations
and profitability. The potential near-term and long-term effects of any future
terrorist attacks may have for our customers, the market for our common stock,
the markets for our products and the United States economy are uncertain. The
consequence of any terrorist attack, or any armed conflicts which may result,
are unpredictable, and we are unable to foresee events that could have an
adverse effect on our markets or our business.
Our Future Growth Depends on New Store Openings
Our growth in operating results depends largely on our ability to open and
operate new stores profitably. In fiscal 1999, 2000 and 2001, we opened 38, 70
and 39 stores, respectively. As of April 8, 2002, we have opened two new stores
and currently expect to open 20 to 25 additional new stores in fiscal 2002.
Our business strategy depends on many factors, including our ability to identify
suitable markets and sites for our new stores, negotiate leases with acceptable
terms, refurbish stores, appropriately upgrade our financial and management
information systems and controls and manage our operating expenses. In addition,
we must be able to continue to hire, train, motivate and retain competent
managers and store personnel. Many of these factors are beyond our control. As a
result, we cannot assure that we will be able to achieve our future expansion
goals. Any failure by us to achieve our expansion goals on a timely basis,
obtain acceptance in markets in which we currently have limited or no presence,
attract and retain management and other qualified personnel, appropriately
upgrade our financial and management information systems and control or manage
operating expenses could adversely affect our future operating results and our
ability to execute our business strategy.
18
We also cannot assure that our new store growth will improve our results of
operations. A variety of factors are critical to the success of our new stores
and such factors include but not limited to store sales, store location, store
size, lease terms, initial advertising effectiveness and brand recognition.
Assuming that our planned expansion occurs as anticipated, our store base will
include a relatively high proportion of stores with relatively short operating
histories. We cannot assure that our new stores will achieve the sales per
selling square foot and store contributions currently achieved at our existing
store base. If our new stores on average fail to achieve our minimum operational
performance criteria, our planned expansion could produce a decrease in our
overall sales per selling square foot and store contributions. Increases in
advertising and pre-opening expenses associated with the opening of new stores
could also contribute to a decrease in our operating margins.
Our Store Concentration in California Poses Localized Risks
In California, where we currently operate 122 stores, which represents almost
half of our total store base. Accordingly, our results of operations and
financial condition largely depend upon trends in the California economy.
Operating costs, such as minimum wage, health care, workers' compensation,
utilities and fuel, in California have been significantly higher than other
regions in the country where we currently operate. If operating costs continue
to increase in California, it could pose a negative impact to our overall store
contribution and operating margins. In addition, California historically has
been vulnerable to certain natural disasters and other risks, such as
earthquakes, fires, floods and civil disturbance. At times, these events have
disrupted the local economy. These events could also pose physical risks to our
properties.
In California, we employ, both in our stores and in our corporate headquarters,
a substantial number of employees who earn wages near or at the minimum wage.
Actions by both the federal and California state government have increased and
may continue to increase the minimum 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.
Utility costs for electricity and natural gas in California have risen
significantly. 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.
Disruptions in Receiving and Distribution Could Impact Our Business
Our success depends upon whether our receiving and shipping schedules are well
organized and managed. As we continue to grow, we may face unexpected demands on
our distribution operations that could cause delays in delivery of merchandise
from our distribution centers to our stores. A fire, earthquake or other
disaster at our distribution centers could hurt our business, financial
condition and results of operations, particularly because much of our
merchandise consists of closeouts. We maintain commercial property and business
interruption, earthquake and flood insurance.
Relationships with Our Vendors and the Availability of Close-Out and Excess
In-Season Merchandise Affect Our Business
Our success depends in large part on our ability to locate and purchase quality
close-out and excess in-season merchandise at attractive prices. We cannot be
certain that such merchandise will continue to be available in the future.
Further, we may not be able to find and purchase merchandise in quantities
necessary to accommodate our growth.
19
Although we believe our relationships with our vendors are good, we do not have
long-term agreements with any vendor. As a result, we must continuously seek out
buying opportunities from our existing suppliers and from new sources. We
compete for these opportunities with other wholesalers and retailers, discount
and deep-discount chains, mass merchandisers and various privately-held
companies and individuals. Although we do not depend on any single vendor or
group of vendors and believe we can successfully compete in seeking out new
vendors, a disruption in the availability of merchandise at attractive prices
could impair our business.
Our Business is Subject to Seaonality
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. Any adverse events during the third and fourth
quarter could therefore affect our financial performance. Historically, we have
realized a significant portion of our net sales and net income during these two
quarters. In anticipation of the "Back to School" and Holiday seasons, we may
purchase substantial amounts of seasonal merchandise. If for any reason our net
sales during these seasons were to fall below seasonal norms and/or our
expectations, a seasonal merchandise inventory imbalance could result. If such
an imbalance were to occur, markdowns might be required to clear excess
inventory. Our profitability and operating results could be adversely affected
by higher than expected markdowns.
We Face Intense 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 Big Lots, 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. In the future, new companies
may also enter the deep-discount retail industry. Although 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, we cannot assure
that we will be able to compete successfully against our current and future
competitors.
In fiscal 2001, we experienced one of the toughest promotional environments in
recent history. We compete in the discount retail merchandise business, which is
a highly competitive environment that subjects us to the risk of reduced
profitability resulting from lower net sales and reduced margins. We expect the
competition will continue and increase in the future. We have started new
merchandise strategies, including new category offerings, better execution of
our core businesses and broader methods of marketing our business; all designed
to improve customer frequency and attract new customers. However, we can make no
assurances that these strategies and other actions taken will be adequate to
minimize our exposure to any negative impacts due to competition.
Our Business is vulnerable to Economic Factors Beyond Our Control and Changes in
the Minimum Wage
Our ability to provide quality merchandise at everyday low prices could be
hindered by certain economic factors beyond our control, including but not
limited to:
o increases in inflation;
o increases in operating costs;
o increases in employee health care and workers' compensation costs;
o increases in prevailing wage levels; and
o decreases in consumer confidence levels.
In January 2001, California enacted a minimum wage increase of $0.50 per hour
with an additional $0.50 increase required in January 2002. We believe that
annual payroll expenses could increase approximately $850,000 over this two-year
period as a result.
20
Our Business is Subject to Many Environmental Regulations
Under various federal and local environmental laws and regulations, current or
previous occupants of property may become liable for the costs of removing any
hazardous substances found on the property. These laws and regulations often
impose liability without regard to fault. We lease all of our stores. Although
we have not been notified of, and are not aware of, any current environmental
liability, claim or non-compliance, we could incur costs in the future related
to our leased properties.
In the ordinary course of our business, we sometimes handle or dispose of
commonplace household products that are classified as hazardous materials under
various environmental laws and regulations. We have adopted policies regarding
the handling and disposal of these products, and we train our employees on how
to handle and dispose of them. We cannot assure that our policies and training
will successfully help us avoid potential violations of these environmental laws
and regulations in the future.
Effects of Anti-Takeover Provisions and Control by Our Existing Major
Shareholders
In addition to some governing provisions in our Articles of Incorporation and
Bylaws, we are also subject to certain Delaware laws and regulations which could
delay, discourage and prevent others from initiating a potential merger,
takeover or other change in control, even if such actions would benefit our
shareholders and us. Moreover, we have a single shareholder that currently owns
more than 20% of our voting stock. As a result, they may have certain ability to
influence all matters requiring the vote of our shareholders, including the
election of Board of Directors and most or our corporate actions. They may also
control our policies and potentially prevent a change in control. This could
adversely affect the voting and other rights of our other shareholders and could
depress the market price of our common stock.
The Market Price of Our Common Stock has had Substantial Fluctuation
The market price of our common stock has fluctuated substantially since our
recapitalization occurred in November 1998. Trading prices for our common stock
could fluctuate significantly due to many factors, including:
o the depth of the market for our common stock;
o changes in expectations of our future financial performance, including
financial estimates by securities analysts and investors;
o variations in our operating results;
o conditions or trends in our industry;
o additions or departures of key personnel; and
o future sales of our common stock.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (the "FASB") issued two
new pronouncements: Statement of Financial Accounting Standards ("SFAS") No.
141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001 and that the use of
the pooling-of-interests method is no longer permitted. SFAS No. 142 requires
that upon adoption, amortization of goodwill will cease and instead, the
carrying value of goodwill will be evaluated for impairment at least annually
using a fair value test. Identifiable intangible assets will continue to be
amortized over their useful lives and reviewed at least annually for impairment
using a method appropriate to the nature of the intangible asset. We implemented
SFAS No.141 on July 1, 2001 and SFAS No. 142 at the beginning of our next fiscal
year, February 3, 2002. We have evaluated the impact of the adoption of these
standards and have determined, other than the non-amortization of goodwill, that
their adoption will not have a material impact on our financial position or
results of operations. Goodwill amortization was $1.6 million for each of the
fiscal years ended February 2, 2002, February 3, 2001 and January 29, 2000.
Commencing February 3, 2002, goodwill will no longer be amortized.
21
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This statement addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. It applies to (a) all entities and (b) legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction, development and/or normal operation of long-lived
assets, except for certain obligations of lessees. This statement is effective
for financial statements issued for fiscal years beginning after June 15, 2002.
We do not believe the adoption of this statement will have a material impact on
our financial position or results of operations.
Also in August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of" and the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions" for the disposal of
a segment of a business (as previously defined in that Opinion). The provisions
of SFAS No. 144 are effective for financial statements issued for fiscal years
beginning after December 15, 2001. We do not expect the adoption of this
statement will have a material impact 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, which are within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
These forward-looking statements are not based on historical facts, bur rather
reflect our current expectation concerning future results and events. These
forward-looking statements generally may be identified by the use of phrases
such as "believe", "expect", "anticipate", "intend", "plan", "foresee",
"likely", "will" or other similar words or phrases. Similarly, statements that
describe our objectives, plans or goals are or may be forward-looking
statements. These forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause our actual results, performance
or achievements to be different from any future results, performance or
achievements expressed or implied by these statements.
The following factors, among others, could affect our future results, causing
these results to differ materially from those expressed in any of our
forward-looking statements: general economic and business conditions (both
nationally and in the regions in which we operate); trends in our business and
consumer preferences, especially as may be impacted by economic weakness on
consumer spending; the effect of government regulations and legislation;
litigation and other claims that may be asserted against us; the effects of
intense competition; changes in our business strategy or development plans,
including anticipated growth strategies and capital expenditures; the costs and
difficulties of attracting and retaining qualified personnel; the effects of
increasing labor, utility, fuel and other operating costs; our ability to obtain
adequate quantities of suitable merchandise at favorable prices and on favorable
terms and conditions; the effectiveness of our operating initiatives and
advertising and promotional strategies and other factors described in this
Annual Report on Form 10-K and in our other filings with the Securities and
Exchange Commission.
22
We do not undertake to publicly update or revise any of our forward-looking
statements, whether as a result of new information, future events and
developments or otherwise, except to the extent that we may be obligated to do
so by applicable law.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to interest rate risk on our fixed rate debt obligations. At
February 2, 2002, fixed rate debt obligations totaled approximately $13.3
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 $10.4 million.
Maturities are $2.0 million, $3.0 million, $3.0 million and $5.3 million in
fiscal 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 2, 2002.
Item 8. Financial Statements and Supplementary Data
INDEX TO FINANCIAL STATEMENTS
- -----------------------------
FACTORY 2-U STORES, INC. Page
- ------------------------ ----
Report of Independent Public Accountants F-1
Balance Sheets as of February 2, 2002 and February 3, 2001 F-2
Statements of Operations for Fiscal Years Ended February 2, 2002,
February 3, 2001 and January 29, 2000 F-4
Statements of Stockholders' Equity for Fiscal Years Ended
February 2, 2002, February 3, 2001 and January 29, 2000 F-5
Statements of Cash Flows for Fiscal Years Ended February 2, 2002,
February 3, 2001 and January 29, 2000 F-6
Notes to Financial Statements F-8
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
23
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 2002 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 2,
2002.
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 2, 2002.
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 2, 2002.
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 2, 2002.
24
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Financial Statements.
See Index to Financial Statements contained in Item 8.
2. Financial Statement Schedules.
Schedule II Valuation and Qualifying Accounts contained on page 26.
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.
3. Exhibits.
See Item 14(c).
(b) Reports on Form 8-K.
We had no reports on Form 8-K filed during the last quarter of the fiscal
year ended February 2, 2002.
(c) Exhibits.
Reference is made to the Index to Exhibits immediately preceding the
exhibits thereto.
25
Schedule II
Factory 2-U Stores, Inc.
Valuation and Qualifying Accounts
Fiscal Year Ended February 2, 2002
(in thousands)
Additions
---------------------------------------
Balance at Charged to Charged to Balance at
Beginning Costs and Other End of
Description of Period Expenses Accounts Deductions Period
- ----------- ---------- ---------- ---------- ---------- ----------
Fiscal year ended February 2, 2002
Restructuring charge accrual $ - $ 21,231 $ - $ (77) $ 21,154
There were no valuation and qualifying accounts for fiscal years ended February
3, 2001 and January 29, 2000.
26
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)
10.7 Second 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 April 10, 2001
10.8 Third 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 April 9, 2002.
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants
99 Letter to the United States Securities and Exchange Commission
(re Arthur Andersen LLP)
- --------------------------------------------------------------------------------
(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 filed with the SEC on April 24, 2000.
27
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 18, 2002
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 April 18, 2002
- ---------------------- Officer and Director
Michael M. Searles (Principal Executive Officer)
/s/ Douglas C. Felderman Executive Vice President, April 18, 2002
- ------------------------ Chief Financial Officer
Douglas C. Felderman (Principal Financial and
Accounting Officer)
/s/ Willem de Vogel Director April 18, 2002
- -------------------
Willem de Vogel
/s/ Peter V. Handal Director April 18, 2002
- -------------------
Peter V. Handal
/s/ Ronald Rashkow Director April 18, 2002
- ------------------
Ronald Rashkow
/s/ Wm. Robert Wright II Director April 18, 2002
- -------------------------
Wm. Robert Wright II
28
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 2, 2002 and February 3,
2001, and the related statements of operations, stockholders' equity
and cash flows for each of the three years in the period ended February
2, 2002. 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 2, 2002 and February 3, 2001 and the
results of its operations and its cash flows for each of the three
years in the period ended February 2, 2002 in conformity with
accounting principles generally accepted in the United States.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index
to financial statements and supplementary data is presented for
purposes of complying with the Securities and Exchange Commission's
rules and is not a required part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in
our audits of the basic financial statements and, in our opinion, is
fairly stated in all material aspects in relation to the basic
financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
San Diego, California
February 27, 2002
F-1
FACTORY 2-U STORES, INC.
Balance Sheet
(in thousands, except share data)
February 2, February 3,
2002 2001
----------- -----------
ASSETS
Current assets:
Cash $ 17,390 $ 4,739
Merchandise inventory 54,860 52,444
Accounts receivable, net 2,013 3,160
Prepaid expenses 6,357 4,716
Deferred income taxes 3,553 2,503
---------- ----------
Total current assets 84,173 67,562
Leasehold improvements and equipment, net 37,042 40,632
Deferred income taxes 7,182 4,992
Other assets 1,011 1,176
Excess of cost over net assets acquired, less
amortization of $13,344 and $11,742, respectively 26,301 27,903
---------- ----------
Total assets $ 155,709 $ 142,265
========== ==========
The accompanying notes are an integal part of these financial statements.
F-2
FACTORY 2-U STORES, INC.
Balance Sheets
(in thousands, except share data)
February 2, February 3,
2002 2001
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 2,019 $ 2,170
and capital leases
Accounts payable 36,271 25,194
Taxes payable 3,332 8,144
Accrued expenses 27,918 13,158
---------- ----------
Total current liabilities 69,540 48,666
Revolving credit facility - -
Long-term debt 8,376 9,218
Other long-term obligations 3,578 1,126
Deferred rent 3,649 3,518
---------- ----------
Total liabilities 85,143 62,528
Commitments and contingencies
Stockholders' equity:
Common stock, $0.01 par value; 35,000,000 128 127
shares authorized and 12,842,146 shares
and 12,759,304 shares issued and outstanding,
respectively
Stock subscription notes receivable (2,225) (2,225)
Additional paid-in capital 121,370 119,646
Accumulated deficit (48,707) (37,811)
---------- ----------
Total stockholders' equity 70,566 79,737
---------- ----------
Total liabilities and stockholders' equity $ 155,709 $ 142,265
========== ==========
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
-----------------
Februray 2, February 3, January 29,
2002 2001 2000
----------- ----------- -----------
Net sales $ 580,460 $ 555,670 $ 421,391
Cost of sales 385,390 358,393 270,962
---------- ---------- ----------
Gross profit 195,070 197,277 150,429
Selling and administrative expenses 188,272 154,379 119,951
(exclusive of non-cash stock-based
compensation expense shown below)
Pre-opening expenses 3,086 5,371 3,273
Amortization of intangibles 1,682 2,092 2,358
Restructuring charge 18,360 - -
Condemnation award - (1,240) -
Stock-based compensation expense 456 4,807 2,094
---------- ---------- ----------
Operating income (loss) (16,786) 31,868 22,753
Interest expense, net 960 1,546 2,272
---------- ---------- ----------
Income (loss) before income taxes (17,746) 30,322 20,481
Income taxes (benefit) (6,850) 9,058 8,039
---------- ---------- ----------
Net income (loss) $ (10,896) $ 21,264 $ 12,442
========== ========== ==========
Net income (loss) per share
Basic $ (0.85) $ 1.69 $ 1.02
Diluted $ (0.85) $ 1.63 $ 0.97
Weighted average common shares outstanding
Basic 12,807 12,589 12,214
Diluted 12,807 13,066 12,864
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)
Stock
Subscription Additional
Common Stock Notes Paid-in Accumulated
Shares Amount Receivable Capital Deficit Total
------ ------ ------------ ---------- ----------- -----
Balance at January 30, 1999 12,106,175 $ 121 $ (4,087) $ 103,248 $ (71,517) $ 27,765
Issuance of common stock for exercise of
stock options and warrants 294,798 3 - 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 4,750 - - 87 - 87
Correction of prior year conversion 173 - - - - -
Repurchase of warrants - - - (457) - (457)
Payments of notes receivable - - 1,255 - - 1,255
Cancellation of stock subscriptions receivable (15,079) - 122 (122) - -
Net income - - - - 12,442 12,442
---------- ----- --------- ---------- ---------- ---------
Balance at January 29, 2000 12,390,817 124 (2,710) 108,091 (59,075) 46,430
========== ===== ========= ========== ========== =========
Issuance of common stock for exercise
of stock options 341,932 3 - 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 19,407 - - 519 - 519
Issuance of common stock under
employee stock purchase plan 7,148 - - 180 - 180
Payments of notes receivable - - 485 - - 485
Net income - - - - 21,264 21,264
---------- ----- --------- ---------- --------- ---------
Balance at February 3, 2001 12,759,304 127 (2,225) 119,646 (37,811) 79,737
========== ===== ========= ========== ========= =========
Issuance of common stock for exercise
of stock options 66,456 1 - 522 - 523
Compensation expense related to the removal
of price hurdle for performance-based
stock options - - - 456 - 456
Tax effect related to non-qualified stock
options - - - 389 - 389
Issuance of common stock to Board members
and management as compensation 4,000 - - 106 - 106
Issuance of common stock under
employee stock purchase plan 12,386 - - 251 - 251
Net loss - - - - (10,896) (10,896)
---------- ----- --------- ---------- --------- ---------
Balance at February 2, 2002 12,842,146 $ 128 $ (2,225) $ 121,370 $(48,707) $ 70,566
========== ===== ========= ========== ========= =========
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 2, February 3, January 29,
2002 2001 2000
----------- ----------- -----------
Cash flows from operating activities
Net income (loss) from operating activities $ (10,896) $ 21,264 $ 12,442
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation and amortization 14,773 13,594 10,354
Loss on disposal of equipment 205 581 796
Deferred rent expense 264 1,098 364
Stock-based compensation expense 456 4,807 2,094
Restructuring charge 4,922 - -
Changes in operating assets and liabilities
Merchandise inventory (5,286) (17,396) (3,695)
Prepaid expenses and other assets (3,609) (7,984) (1,375)
Accounts payable 11,077 5,200 (1,264)
Accrued expenses and other liabilities 14,967 (3,840) 4,808
---------- ----------- -----------
Net cash provided by operating activities 26,873 17,324 24,524
---------- ----------- -----------
Cash flows used in investing activities
Purchase of leasehold improvements and equipment (12,694) (23,818) (16,893)
---------- ----------- -----------
Net cash used in investing activities (12,694) (23,818) (16,893)
---------- ----------- -----------
(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 2, February 3, January 29,
2002 2001 2000
----------- ----------- -----------
Cash flows provided by (used in) financing activities
Borrowings on revolving credit facility 88,044 111,711 454,157
Payments on revolving credit facility (88,044) (111,711) (456,000)
Payments of long-term debt and capital lease obligations (2,171) (1,253) (2,426)
Proceeds from issuance of common stock, net 160 180 -
Payments of deferred debt issuance costs (40) (250) -
Repurchase of warrants - - (457)
Proceeds from exercise of stock options and warrants 523 2,598 2,189
Payments of stock subscription notes receivable - 485 1,255
----------- ------------ -----------
Net cash provided by (used in) financing activities (1,528) 1,760 (1,282)
----------- ------------ -----------
Net increase (decrease) in cash 12,651 (4,734) 6,349
Cash at the beginning of the period 4,739 9,473 3,124
----------- ------------ -----------
Cash at the end of the period $ 17,390 $ 4,739 $ 9,473
=========== ============ ===========
Supplemental disclosure of cash flow information
Cash paid during the period for
Interest $ 387 $ 651 $ 1,295
Income taxes $ 5,698 $ 9,559 $ 6,011
Supplemental disclosures of non-cash investing and
financing activities
Tax effect related to non-qualified stock options $ 389 $ 3,454 $ 972
Issuance of common stock to board members and
management as compensation $ 106 $ 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. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
We operate a chain of off-price retail apparel and housewares stores in
Arizona, Arkansas, California, Idaho, Louisiana, Missouri, Nevada,
New Mexico, Oklahoma, Oregon, Tennessee, 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 2, 2002, we operated 279 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 years ended February 2, 2002, February 3, 2001
and January 29, 2000 included 52 weeks, 53 weeks and 52 weeks,
respectively. We define our fiscal year by the calendar year in which most
of the activity occurs (e.g. the fiscal year ended February 2, 2002 is
referred to as fiscal 2001).
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 2, 2002 and
February 3, 2001, such costs included in inventory were $4.6 million and
$4.7 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 estimated useful lives as follows:
Leasehold improvements the shorter of the asset's useful life
or the lease term, generally five years
Furniture, fixtures and
other equipment three to 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. See Recent
Accounting Pronouncements.
Comprehensive Income
We have adopted Statement of Financial Accounting Standards (SFAS) No. 130,
"Reporting Comprehensive Income." This statement establishes the disclosure
requirements for comprehensive income and its components within the
financial statements. We had no items of comprehensive income for the
fiscal years ended February 2, 2002, February 3, 2001 and January 29, 2000.
F-8
Asset Impairment
We assess potential asset impairment in accordance with 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. See Recent Accounting Pronouncements.
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 2, 2002, February 3, 2001 and January 29, 2000
were approximately $20.9 million, $17.7 million and $12.3 million,
respectively.
Deferred Rent
Rent expense under non-cancelable operating lease agreements is recorded on
a straight-line basis over the life of the respective leases. The excess
rent expense over rent paid is accounted for as deferred rent.
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.
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, compensation
expense is recognized only in the event that the exercise price of options
F-9
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.
Income (Loss) per Share
We compute income (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 income (loss) per share is computed based on the
weighted average shares outstanding and potentially dilutive common stock
equivalent shares. Approximately 147,000 shares of common stock equivalent
shares are not included in the computation of diluted loss per share for
fiscal 2001 because the effect would be anti-dilutive.
Weighted average shares outstanding for each fiscal year are determined as
follows:
(in thousands)
--------------
2001 2000 1999
---- ---- ----
Weighted average number of common shares
outstanding 12,807 12,589 12,214
Effect of dilutive securities:
Warrants that are common stock equivalents - 33 18
Options that are common stock equivalents - 444 632
------ ------ ------
Adjusted common shares outstanding used for
diluted computations 12,807 13,066 12,864
====== ====== ======
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 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 2001 financial statements.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (the "FASB") issued
two new pronouncements: Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and
Other Intangible Assets." SFAS No. 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30,
2001 and that the use of the pooling-of-interests method is no longer
permitted. SFAS No. 142 requires that upon adoption, amortization of
goodwill will cease and instead, the carrying value of goodwill will be
evaluated for impairment at least annually using a fair value test.
Identifiable intangible assets will continue to be amortized over their
useful lives and reviewed at least annually for impairment using a method
appropriate to the nature of the intangible asset. We implemented SFAS No.
141 on July 1, 2001 and SFAS No. 142 at the beginning of our next fiscal
year, February 3, 2002. We have evaluated the impact of the adoption of
these standards and have determined, other than the non-amortization of
goodwill, that their adoption will not have a material impact on our
financial position or results of operations.
F-10
Goodwill amortization was $1.6 million for each of the fiscal years ended
February 2, 2002, February 3, 2001 and January 29, 2000. Commencing
February 3, 2002, goodwill will no longer be amortized.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-
lived assets and the associated asset retirement costs. It applies to (a)
all entities and (b) legal obligations associated with the retirement of
long-lived assets that result from the acquisition, construction,
development and/or normal operation of long-lived assets, except for
certain obligations of lessees. This statement is effective for financial
statements issued for fiscal years beginning after June 15, 2002. We do not
believe the adoption of this statement will have a material impact on our
financial position or results of operations.
Also in August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses
financial accounting and reporting for the impairment or disposal of
long-lived assets and supersedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of" and the accounting and reporting provisions of APB Opinion No. 30,
"Reporting the Results of Operations--Reporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions" for the disposal of a segment of a
business (as previously defined in that Opinion). The provisions of
SFAS No. 144 are effective for financial statements issued for fiscal years
beginning after December 15, 2001. We do not expect the adoption of this
statement will have a material impact on our financial position or results
of operations.
2. RESTRUCTURING CHARGE
In January 2002, we recorded a restructuring charge of $21.2 million in
conjunction with the decision to close 28 under-performing stores, as well
as, the realignment of our field organization and workforce reductions.
The purpose of these restructuring initiatives is to improve store
profitability, streamline field operations, reduce costs and improve
efficiency. We believe this plan will improve our earnings for fiscal 2002
and beyond.
The charge and the related liability are recognized in accordance with the
Emerging Issues Task Force ("EITF") No. 94-3 "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." EITF No. 94-3
provides specific requirements as to the appropriate recognition of costs
associated with employee termination and other exit costs.
Employee termination costs are recognized when, prior to the date of the
financial statements, management having the appropriate level of authority
to involuntarily terminate employees approves and commits us to the plan of
termination and establishes the benefits that current employees will
receive upon termination and the benefit is communicated to employees.
Other exit costs are costs resulting from an exit plan that are not
associated with or that do not benefit activities that will be continued.
The components of the restructuring charge are computed based on our
estimate of the realizable value of the affected tangible assets including
non-cash fixed asset write-downs and inventory liquidation costs and
estimated exit costs including primarily lease termination or sublease
costs, employee severance based on existing severance policies and local
laws. The restructuring charge is described in more detail in the following
table.
F-11
Prior to February 2, 2002, we adopted a plan to close 28 under-performing
stores, terminate approximately 400 employees and liquidate the inventory
of the stores through going-out-of-business sales. We expect to close the
majority of these locations by the end of April 2002. Additionally, we plan
to buy out the remaining store leases, which range from three to ten years.
Employee terminations and severance will be paid as the stores are closed.
(in thousands)
--------------
Lease termination costs $ 13,724
Inventory liquidation costs (non-cash)* 2,870
fixed asset write-downs (non-cash)** 2,052
Employee termination costs 1,206
Other cash costs 1,379
--------------
$ 21,231
==============
* Non-cash inventory liquidation costs of $2.9 million is recorded as a
component of cost of sales.
** Non-cash fixed asset write-downs of $2.1 million is recorded as a
valuation allowance for leasehold improvements and equipment.
The balance of liability related to the restructuring charge at
February 2, 2002 is as follows:
(in thousands)
--------------
Balance at
Restructuring Cash February 2,
Charge Payments 2002
---------------- ------------- --------------
Lease termination costs $ 13,724 $ - $ 13,724
Inventory liquidation costs (non-cash) 2,870 - 2,870
Fixed asset write-downs (non-cash) 2,052 - 2,052
Employee termination costs 1,206 (47) 1,159
Other cash costs 1,379 (30) 1,349
---------------- ------------- --------------
$ 21,231 $ (77) $ 21,154
================ ============= ==============
3. LEASEHOLD IMPROVEMENTS AND EQUIPMENT
Leasehold improvements and equipment consist of the following:
(in thousands)
--------------
February 2, February 3,
2002 2001
----------- -----------
Furniture, fixtures and equipment $ 57,971 $ 53,561
Leasehold improvements 13,683 11,295
Automobiles 823 645
Equipment under capital leases 3,153 678
----------- -----------
75,630 66,179
Less: accumulated depreciation, amortization
and valuation allowance (38,588) (25,547)
----------- -----------
$ 37,042 $ 40,632
=========== ===========
F-12
4. ACCRUED EXPENSES
Accrued expenses consist of the following:
(in thousands)
--------------
February 2, February 3,
2002 2001
----------- -----------
Accrued compensation and related costs $ 4,554 $ 6,287
Accrued restructuring charge 12,653 -
Other accrued expenses 10,711 6,871
----------- -----------
$ 27,918 $ 13,158
=========== ===========
5. LONG-TERM DEBT AND REVOLVING CREDIT FACILITY
Long-term debt and revolving credit facility consist of the following:
(in thousands)
--------------
February 2, February 3,
2002 2001
----------- -----------
Junior subordinated notes, $ 10,376 $ 11,218
non-interest bearing, discounted at
a rate of 10%, principal payments in
annual installments ranging from
$2.0 million to $3.0 million, final
balloon payment of $5.3 million due
May 2005
Less current maturities (2,000) (2,000)
----------- -----------
Long-term debt, net of current maturities $ 8,376 $ 9,218
=========== ===========
Revolving credit facility $ - $ -
=========== ===========
Revolving Credit Facility
We have a $50.0 million revolving credit facility, under which we may
borrow up to 70% of our eligible inventory and 85% of our eligible accounts
receivable, as defined. The credit facility was amended on April 9, 2002 to
increase our $5.0 million sub- facility for letters of credit to $10.0
million. As of February 2, 2002, 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 $7.5 million.
At February 2, 2002, we were in compliance with all financial and tangible
net worth covenants, as defined. At February 2, 2002, based on eligible
inventory and accounts receivable, we were eligible to borrow $40.1 million
under the credit facility with no outstanding borrowings; and we had a $1.0
million standby letter of credit outstanding.
The interest rates on the revolving credit facility range from 4.75% to
8.00% for the fiscal year ended February 2, 2002 and from 7.90% to 9.50%
for the fiscal year ended February 3, 2001.
F-13
Junior Subordinated Notes
The 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, 2002, the Junior Subordinated Notes had a face value of $13.3
million and a related unamortized discount of $2.9 million, resulting in a
net carrying value of $10.4 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 Junior Subordinated Notes of $2.0 million in
December 2001. Additional principal payments are scheduled on 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).
6. INCOME TAXES
Significant components of income taxes (benefit) are as follows:
(in thousands)
--------------
Fiscal Year
-----------
2002 2001 2000
---------- ---------- ----------
Federal income taxes (benefit)
Current $ (3,069) $ 11,249 $ 6,592
Deferred (2,754) (3,596) (302)
---------- ---------- ----------
(5,823) 7,653 6,290
---------- ---------- ----------
State income taxes (benefit)
Current (541) 2,088 1,822
Deferred (486) (683) (73)
---------- ---------- ----------
(1,027) 1,405 1,749
---------- ---------- ----------
$ (6,850) $ 9,058 $ 8,039
========== ========== ==========
F-14
The principal temporary differences that give rise to significant portions
of the deferred tax assets and liabilities are presented below:
(in thousands)
--------------
February 2, February 3,
2002 2001
----------- -----------
Deferred tax assets
Net operating loss carryforwards $ 7,644 $ 8,409
Compensated absences and bonuses 2,719 2,696
Deferred rent 1,807 1,695
Closed store accrual 299 229
Excess of tax over book inventory 1,649 875
Accrued expenses 7,552 762
Fixed assets 313 -
Other 748 1,080
----------- -----------
Total gross deferred tax assets 22,731 15,746
Less: valuation allowance (7,647) (7,647)
----------- -----------
Net deferred tax assets 15,084 8,099
----------- -----------
Deferred tax liabilities
Leasehold improvements and equipment, - 604
principally due to differences in
depreciation recognized on fixed assets
Tax basis difference 4,349 -
----------- -----------
Deferred tax liabilities 4,349 604
----------- -----------
Net deferred tax asset $ 10,735 $ 7,495
=========== ===========
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.
The difference between the expected income taxes (benefit) computed by
applying the U.S. federal income tax rate of 35% to net income (loss)
from continuing operations for each of the fiscal years 2001, 2000 and
1999, and actual taxes (benefit) is a result of the following:
(in thousands)
--------------
2001 2000 1999
--------- --------- --------
Computed "expected" taxes (benefit) $ (6,211) $ 10,612 $ 7,168
Amortization of goodwill 656 656 657
Change in valuation allowance - (3,064) (784)
Business credits (238) (86) (52)
State income taxes, net of federal income (1,064) 1,819 1,059
tax credit
Refund of taxes - (900) -
Other, net 7 21 (9)
--------- --------- ---------
$ (6,850) $ 9,058 $ 8,039
========= ========= =========
F-15
At February 2, 2002, we had net operating loss carryforwards for federal
income tax purposes of approximately $21.8 million that expire starting in
fiscal 2012. These losses are limited under Section 382 of the Internal
Revenue Code due to prior ownership changes.
7. LEASE COMMITMENTS
We operate retail stores, distribution centers and administrative offices
under various operating leases. Total rent expense was approximately
$40.7 million, $29.9 million and $22.0 million, including contingent rent
expense of approximately $228,000, $435,000 and $447,000, for fiscal years
ended February 2, 2002, February 3, 2001 and January 29, 1999,
respectively.
Rent expense is recorded on a straight-line basis over the life of the
lease. For fiscal 2001, 2000 and 1999, rent expense charged to operations
exceeded cash payment requirements by approximately $264,000, $1.1 million
and $364,000, respectively, and resulted in an increase 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 depreciation recorded under capital leases are as follows:
(in thousands)
--------------
February 2, February 3,
2002 2001
----------- -----------
Equipment $ 584 $ 678
Less: accumulated depreciation (575) (508)
----------- -----------
$ 9 $ 170
=========== ===========
At February 2, 2002, the future minimum lease payments under capital
leases and operating leases with remaining non-cancelable terms are as
follows:
(in thousands)
--------------
Capital Operating
Leases Leases
-------- ---------
Fiscal year:
2002 $ 20 $ 32,285
2003 - 30,792
2004 - 27,187
2005 - 20,325
2006 - 13,905
Thereafter - 27,065
-------- ---------
Total minimum lease payments 20 $ 151,559
=========
Less: amount representing interest
at 9.5% (1)
--------
Present value of capital lease
obligation 19
Less: current maturities (19)
--------
Long-term capital lease obligation $ -
========
F-16
8. STOCKHOLDERS' EQUITY
We have 35,000,000 shares of common stock authorized for issuance at a par
value of $0.01 per share. At February 2, 2002, we have reserved 1,491,950
shares of common stock for issuance in connection with our stock option
plan and 330,438 shares for issuance under the employee stock purchase
plan.
We have never paid cash dividends on our common stock and do not anticipate
paying cash dividends in the foreseeable future. Currently, we are
contractually prohibited from paying cash dividends on the common stock
under the terms of our existing revolving credit facility without the
consent of the lender.
At February 2, 2002, the outstanding stock subscription notes receivable
balance was $2.2 million. All outstanding stock subscription notes
receivable are due from members of our management with a five-year term
maturing in different dates and have an interest rate of 8%.
9. STOCK OPTIONS AND WARRANTS
At February 2, 2002, 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 Factory 2-U Stores,
Inc. 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.
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 Weighed average
options exercise price
----------- -----------------
Balance at January 30, 1999 1,324,897 $ 7.00
Granted 454,232 17.93
Exercised (257,482) 6.90
Canceled (141,209) 7.86
----------- -----------------
Balance at January 29, 2000 1,380,438 10.53
Granted 335,584 28.35
Exercised (341,932) 7.60
Canceled (88,658) 16.85
----------- -----------------
Balance at February 3, 2001 1,285,432 15.52
Granted 238,323 20.64
Exercised (66,456) 7.90
Canceled (41,141) 24.38
----------- -----------------
Balance at February 2, 2002 1,416,158 $ 16.49
=========== =================
Exercisable at February 2, 2002 676,297 $ 12.25
F-17
The following table summarizes information about the stock options
outstanding at February 2, 2002:
Weighted -
average Weighted- Weighted-
Number of contractual average Number of average
Range of options life exercise options exercise
exercise prices outstanding (Years) price exercisable price
- ---------------------------------------------------------------------------------------------------
$ 0.00 - $ 4.23 754 0.8 $ 4.15 754 $ 4.15
$ 4.23 - $ 8.45 519,113 2.5 $ 6.95 437,035 $ 6.94
$ 8.45 - $12.68 149,184 7.0 $ 12.08 55,297 $ 12.05
$12.68 - $16.90 119,560 8.0 $ 15.04 28,500 $ 15.16
$16.90 - $21.13 148,410 7.7 $ 20.60 10,500 $ 19.51
$21.13 - $25.35 169,158 7.7 $ 24.23 40,279 $ 24.05
$25.35 - $29.58 249,736 5.8 $ 27.29 83,886 $ 26.72
$29.58 - $33.80 18,993 6.0 $ 32.12 5,396 $ 31.98
$33.80 - $38.03 31,750 6.5 $ 36.79 9,950 $ 37.06
$38.03 - $42.25 9,500 5.1 $ 40.62 4,700 $ 41.32
----------------------------------------------------------------------------
1,416,158 5.3 $ 16.49 676,297 $ 12.25
========= =======
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.
In May 2001, we removed the market price hurdle of $49.78 for 19,361 stock
options held by a former Executive Vice President who retired in August
2001. As a result of the removal of the market price hurdle, we recorded
non-cash stock-based compensation expense of $456,000. As of February 2,
2002, there were 45,918 stock options outstanding that would have become
exercisable if our Common Stock had achieved and maintained a price of
$49.78 for 60 consecutive trading days. Of these 45,918 stock options,
36,125 will expire in April 2002; and based on historical and current
market price there are only 9,793 stock options remaining that may cause
us to record non-cash compensation expense in the minimum amount of
$410,000 if the market price hurdle of $49.78 has been achieved and
maintained for 60 consecutive trading days.
F-18
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:
(in thousands, except per share data)
-------------------------------------
Fiscal Year
-----------
2001 2000 1999
---- ---- ----
Net income (loss) As reported $ (10,896) $ 21,264 $ 12,442
Pro forma $ (16,773) $ 18,759 $ 11,485
Basic earnings (loss) per share As reported $ (0.85) $ 1.69 $ 1.02
Pro forma $ (1.31) $ 1.49 $ 0.94
Diluted earnings (loss) per share As reported $ (0.85) $ 1.63 $ 0.97
Pro forma $ (1.31) $ 1.44 $ 0.89
The Black-Scholes option valuation model was developed for use inestimating
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 96.86%, 98.75% and 103.33% for fiscal
2001, 2000 and 1999, respectively, (iii) expected life of nine years for
fiscal 2001, seven years for fiscal 2000 and three to five years for fiscal
1999, and (iv) risk-free interest rate of 5.71%, 5.01% and 6.68% for fiscal
2001, 2000 and 1999, respectively.
9. 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 $232,000, $208,000 and $199,000
in fiscal 2001, 2000 and 1999, 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. 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 2, 2002,
eligible employees had purchased 19,562 shares of our Common Stock under
the Plan.
F-19
11. LEGAL MATTERS, COMMITMENTS AND CONTINGENCIES
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 August 2,
2001, O'Hara and four other former employees in our Alameda store, filed a
Second Amended Complaint in the O'Hara Lawsuit.
The Second Amended Complaint in the O'Hara Lawsuit alleges that we violate
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 Second Amended Complaint seeks
compensatory damages, interest, penalties, attorneys' fees, and disgorged
profits, all in unspecified amounts. The Second Amended Complaint also
seeks injunctive relief requiring payment of overtime to "non-exempt"
employees. On September 4, 2001, we filed an answer in which we denied the
material allegations of the Second Amended Complaint.
Pursuant to an Order dated December 3, 2001, the Court in the O'Hara
Lawsuit granted Plaintiff's motion for certification of two plaintiff
classes: (1) all person who have been employed as assistant store managers
at one of our California stores at any time after December 15, 1996, and
who worked hours which would have entitled them to overtime had they not
been exempt employees; and (2) all persons who have been employed as store
managers at one of our California stores at any time after December 15,
1995, and who worked hours which would have entitled them to overtime had
they not been exempt employees. We have made a settlement offer to each
member of the two plaintiffs classes, pursuant to which we offered to pay
$1,000 for each year of service (or a pro rata portion of each partial
year) after December 15, 1996 and between February 1, 2002 in exchange for
a release of all overtime claims. Approximately 264 members of the
plaintiff classes who received notice of the settlement offer in the mail
have accepted this offer. The settlement offer has been mailed again to
approximately 129 members of the plaintiff classes whose first mailing
notices of the settlement offer were returned as undeliverable. Those
individuals have until April 26, 2002, to accept the settlement offer.
The Court has scheduled the trial for July 22, 2002.
Although at this stage of the litigation it is difficult to predict the
outcome of the case with certainty, we believe that we have meritorious
defenses to the O'Hara Lawsuit and we are vigorously defending against it.
If the O'Hara Lawsuit is decided adversely, the potential exposure could be
material to our results of operations for the year in which the case is
ultimately decided.
We are 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.
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12. 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 $34,000, $37,000 and $46,000 during fiscal
2001, 2000 and 1999, respectively. TCR controls approximately 24% of our
outstanding common stock and certain principals of TCR are members of our
Board of Directors.
13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The results of operations for fiscal 2001 and 2000 were as follows:
(in thousands, except per share data)
------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
Fiscal 2001
-----------
Net sales $125,824 $139,254 $145,568 $169,814
Gross profit 41,759 49,820 50,260 53,231
Operating income (loss) (2,165) 113 (216) (14,518)
Net loss (1,448) (195) (324) (8,929)
Earnings (loss) per share
Basic $ (0.11) $ (0.02) $ (0.03) $ (0.70)
Diluted $ (0.11) $ (0.02) $ (0.03) $ (0.70)
(in thousands, except per share data)
-------------------------------------
First Second Third Fourth
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
* 14-week fiscal quarter
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.
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