UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 1O-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 3, 2003
-----------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1932
For the transition period from...............to................
Commission File Number: 1-10089
FACTORY 2-U STORES, INC.
(Exact name of registrant as specified in its charter)
Delaware 51-0299573
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4000 Ruffin Road, San Diego, CA 92123-1866
------------------------------- ----------
(Address of principal executive office) (Zip Code)
(858) 627-1800
(Registrant's telephone number, including area code)
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 for 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. [X] YES [ ] NO
The number of shares outstanding of the registrant's common stock, as of June
13, 2003 was 15,658,137 shares.
FACTORY 2-U STORES, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MAY 3, 2003
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Factory 2-U Stores, Inc. Balance Sheets as of May 3, 2003 (Unaudited),
May 4, 2002 (Unaudited) and February 1, 2003 .......................F-1
Factory 2-U Stores, Inc. Statements of Operations (Unaudited) for the
13 weeks ended May 3, 2003 and May 4, 2002 .........................F-3
Factory 2-U Stores, Inc. Statements of Cash Flows (Unaudited) for the
13 weeks ended May 3, 2003 and May 4, 2002 .........................F-4
Factory 2-U Stores, Inc. Notes to Financial Statements (Unaudited)..F-5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ................................................3
Item 3. Quantitative and Qualitative Disclosures About Market Risk............9
Item 4. Controls and Procedures...............................................9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................11
Item 2. Changes in Securities and Use of Proceeds............................11
Item 3. Defaults Upon Senior Securities......................................11
Item 4. Submission of Matters to a Vote of Security Holders..................11
Item 5. Other Information ...................................................11
Item 6. Exhibits and Reports on Form 8-K ....................................12
Signatures ................................................................13
Certifications ...............................................................14
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
FACTORY 2-U STORES, INC.
Balance Sheets
(in thousands, except share and per share data)
May 3, 2003 May 4, 2002 February 1, 2003
----------- ----------- ----------------
(Unaudtied) (Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 5,414 $ 8,360 $ 3,465
Merchandise inventory 66,012 64,369 32,171
Accounts receivable, net 623 1,014 884
Income taxes receivable - - 8,200
Prepaid expenses 6,258 6,832 5,436
Deferred income taxes 9,753 3,553 9,732
----------- ----------- ----------------
Total current assets 88,060 84,128 59,888
Leasehold improvements and equipment, net 26,594 34,771 28,602
Deferred income taxes 10,750 7,182 10,750
Other assets 936 1,006 963
Goodwill, less accumulated amortization of $13,344 26,301 26,301 26,301
----------- ----------- ----------------
Total assets $ 152,641 $ 153,388 $ 126,504
=========== =========== ================
The accompanying notes are an integral part of these financial statements.
(continued)
F-1
FACTORY 2-U STORES, INC.
Balance Sheets
(in thousands, except share and per share data)
(continued)
May 3, 2003 May 4, 2002 February 1, 2003
----------- ----------- ----------------
(Unaudited) (Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debts $ 3,021 $ 2,004 $ 3,000
Junior secured term loans 7,500 - -
Accounts payable 43,844 37,230 27,961
Taxes payable 992 690 5,840
Accrued expenses 27,693 29,729 27,831
----------- ----------- -----------------
Total current liabilities 83,050 69,653 64,632
Revolving credit facility 11,535 - 6,300
Long-term debts 6,754 8,638 6,445
Accrued restructuring charges 1,747 3,578 1,747
Deferred rent 2,822 3,263 3,061
----------- ----------- -----------------
Total liabilities 105,908 85,132 82,185
----------- ----------- -----------------
Stockholders' equity:
Common stock, $0.01 par value; 35,000,000 shares authorized
and 15,657,387 shares, 12,943,137 shares and 13,475,705 shares
issued and outstanding, respectively 157 129 135
Stock subscription notes receivable - (2,149) (1,116)
Additional paid-in capital 126,513 122,124 122,516
Accumulated deficit (79,937) (51,848) (77,216)
------------ ----------- -----------------
Total stockholders' equity 46,733 68,256 44,319
------------ ----------- -----------------
Total liabilities and stockholders' equity $ 152,641 $ 153,388 $ 126,504
============ =========== =================
The accompanying notes are an integral part of these financial statements.
F-2
FACTORY 2-U STORES, INC.
Statements of Operations
(in thousands, except per share data)
(Unaudited)
13 Weeks Ended
--------------
May 3, 2003 May 4, 2002
----------- -----------
Net sales $ 104,347 $ 116,951
Cost of sales 66,712 75,793
----------- -----------
Gross profit 37,635 41,158
Selling and administrative expenses 41,255 45,698
Pre-opening and closing expenses 138 437
----------- -----------
Operating loss (3,758) (4,977)
Interest expense, net 634 258
------------ -----------
Loss before income taxes (4,392) (5,235)
Income tax benefit (1,671) (2,094)
------------ -----------
Net loss $ (2,721) $ (3,141)
============ ===========
Loss per share
Basic $ (0.19) $ (0.24)
Diluted $ (0.19) $ (0.24)
Weighted average common shares outstanding
Basic 14,620 12,903
Diluted 14,620 12,903
The accompanying notes are an integral part of these financial statements.
F-3
FACTORY 2-U STORES, INC.
Statements of Cash Flows
(in thousands)
(Unaudited)
13 Weeks Ended
--------------
May 3, 2003 May 4, 2002
----------- -----------
Cash flows from operating activities
Net loss $ (2,721) $ (3,141)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 3,305 3,757
Loss on disposal of equipment - 41
Deferred rent (239) (386)
Stock subscription notes receivable
valuation adjustment (708) -
Changes in operating assets and liabilities
Merchandise inventory (33,840) (9,509)
Prepaid expenses and other assets 8,039 536
Accounts payable 15,883 958
Accrued expenses and other liabilities (4,860) (1,506)
--------- ----------
Net cash used in operating activities (15,141) (9,250)
Cash flows from investing activities
Purchases of leasehold improvements and equipment (1,032) (538)
--------- ----------
Net cash used in investing activities (1,032) (538)
Cash flows from financing activities
Borrowings on revolving credit facility 42,507 -
Payments on revolving credit facility (37,272) -
Payments on long-term debt and
capital lease obligations - (15)
Proceeds from debt financing 7,500 -
Proceeds from issuance of common stock, net 5,672 -
Payment of deferred debt issuance costs (428) (40)
Proceeds from exercise of stock options - 737
Payments of stock subscription notes receivable 143 76
--------- ----------
Net cash provided by financing activities 18,122 758
Net increase (decrease) in cash 1,949 (9,030)
Cash at the beginning of the period 3,465 17,390
--------- ----------
Cash at the end of the period $ 5,414 $ 8,360
========= ==========
Supplemental disclosure of cash flow information
Cash paid during the period for
Interest $ 347 $ 38
Income taxes $ 88 $ 1,102
Supplemental disclosure of non-cash investing and financing activities
Acquisition of equipment under notes payable $ 92 $ -
Issuance of common stock to board members
as compensation $ 5 $ 17
The accompanying notes are an integral part of these financial statements.
F-4
FACTORY 2-U STORES, INC.
Notes to Financial Statements
(Unaudited)
(1) Unaudited Interim Financial Statements
The accompanying unaudited financial statements do not include all of
the information and footnotes required by accounting principles
generally accepted in the United States for annual financial statements
and should be read in conjunction with the financial statements for the
fiscal year ended February 1, 2003 included in our Form 10-K as filed
with the Securities and Exchange Commission.
We believe that the unaudited financial statements as of and for the 13
weeks ended May 3, 2003 and May 4, 2002 reflect all adjustments
necessary to present fairly the financial position, results of
operations and cash flows for the periods presented. Due to the
seasonal nature of our business, the results of operations for the
interim period may not necessarily be indicative of the results of
operations for a full year.
(2) Recent Accounting Pronouncements
In April 2002, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections", which
rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment
of Debt" and an amendment of that Statement, and SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements."
SFAS No. 145 also rescinds SFAS No. 44, "Accounting for Intangible
Assets of Motor Carriers." SFAS No. 145 amends SFAS No. 13,
"Accounting for Leases", to eliminate an inconsistency between the
required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects
that are similar to sale-leaseback transactions. SFAS No. 145 also
amends other existing authoritative pronouncements to make various
technical corrections, clarify meanings, or describe their
applicability under changed conditions. SFAS No. 145 is effective for
fiscal years beginning after May 15, 2002. We do not expect the
adoption of this statement will have a material impact on our financial
position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which addresses
significant issues regarding the recognition, measurement, and
reporting of costs associated with exit and disposal activities,
including restructuring activities. This statement requires that costs
associated with exit or disposal activities be recognized when they are
incurred rather than at the date of a commitment to an exit or disposal
plan. SFAS No. 146 is effective for all exit or disposal activities
initiated after December 31, 2002. We do not expect the adoption of
this statement will have a material impact on our financial position or
results of operations.
F-5
In November 2002, the FASB issued Interpretation No. ("FIN") 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"),
which requires elaborating on the disclosures that must be made by a
guarantor in financial statements about its obligations under certain
guarantees. It also requires that a guarantor recognize, at the
inception of certain types of guarantees, a liability for the fair
value of the obligation undertaken in issuing the guarantee. The
disclosure requirements of FIN 45 are effective for financial
statements issued after December 15, 2002, and have been applied in the
presentation of the accompanying consolidated financial statements. The
recognition requirements of FIN 45 are applicable for guarantees issued
or modified after December 31, 2002. We have not yet determined the
effect, if any, the recognition requirement for guarantees issued or
modified after December 31, 2002 will have on our business, results of
operations and financial condition.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure." This statement
amends SFAS No. 123, "Accounting for Stock-Based Compensation" to
provide alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. SFAS No. 148 also amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for
stock-based compensation and the effect of the method used on reported
results. Certain of the disclosure modifications are required for
fiscal years ending after December 15, 2002. We have not yet completed
the final evaluation of the transitioning options presented by SFAS No.
148. However, during fiscal 2003, we expect to reach a determination of
whether and, if so, when to change our existing accounting for
stock-based compensation to the fair value method in accordance with
the transition alternatives of SFAS No. 148.
In January 2003, the FASB issued FIN 46 - "Consolidation of Variable
Interest Entities." FIN 46 clarifies the application of Accounting
Research Bulletin No. 51 - Consolidated Financial Statements to those
entities defined as "Variable Interest Entities" (more commonly
referred to as special purpose entities) in which equity investors do
not have the characteristics of a "controlling financial interest" or
do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other
parties. FIN 46 applies immediately to all Variable Interest Entities
created after January 31, 2003, and by the beginning of the first
interim or annual reporting period commencing after June 15, 2003 for
Variable Interest Entities created prior to February 1, 2003. We do not
expect the adoption of this statement will have a material impact on
our financial position or results of operations.
F-6
(3) Fiscal 2002 Restructuring Charge
In December 2002, we recorded a restructuring charge of $14.4 million
in conjunction with the decision to close 23 stores as well as to
consolidate both our distribution center network and corporate overhead
structure. The purpose of these restructuring initiatives was to
improve store profitability, reduce costs and improve efficiency.
As of June 13, 2003, we had closed 15 of these 23 stores and terminated
the lease obligations of 12 of these closed stores. In addition, we had
completed the consolidation of our two former San Diego distribution
centers into the new Otay Mesa distribution center. We are currently
seeking disposition of the leases for these two former San Diego
distribution facilities.
The balance of the liability ($5.4 million was included in the accrued
expenses and $1.7 million was included in the accrued restructuring
charges in the accompanying balance sheets) related to the fiscal 2002
restructuring charge at May 3, 2003 was as follows:
Balance at
Restructuring Cash Non-cash May 3,
(in thousands) Charge Payments Charges 2003
------------- -------- --------- ----------
Lease termination costs* $ 6,513 $ (817) $ 226 $ 5,922
Employee termination costs 1,027 (405) - 622
Other costs 807 (235) - 572
------------- -------- --------- ----------
$ 8,347 $(1,457) $ 226 $ 7,116
============= ======== ========= ==========
* The non-cash charge portion consists primarily of the write-off of
deferred rent.
(4) Fiscal 2001 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 the restructuring was to improve store
profitability, streamline field operations, reduce costs and improve
efficiency.
We closed 24 of these 28 stores during the first quarter of fiscal 2002
and the remaining four stores in January 2003. As of June 13, 2003, we
had terminated the lease obligations of 21 of these closed stores. In
light of the favorable experience related to the costs of closing these
stores, we recorded a non-cash adjustment to reduce the reserve for the
fiscal 2001 restructuring initiatives by approximately $5.0 million
during the fourth quarter of fiscal 2002. The adjustment included (1)
reduction of reserve for lease termination costs by $3.8 million, (2)
reduction of reserve for inventory liquidation costs by $1.3 million,
offset by (3) an additional reserve for fixed asset write-downs of
$94,000.
F-7
The balance of the liability (included in the accrued expenses in the
accompanying balance sheets) related to the fiscal 2001 restructuring
charge at May 3, 2003 was as follows:
Non-cash Balance at
Restructuring Cash Charges and May 3,
(in thousands) Charge Payments Adjustment 2003
------------- -------- ----------- ----------
Lease termination costs $ 13,724 $ (6,972) $ (3,496) $ 3,256
Employee termination costs 1,206 (1,152) - 54
Other costs 1,379 (1,199) - 180
------------- --------- ----------- ----------
$ 16,309 $ (9,323) $ (3,496) $ 3,490
============= ========= =========== ==========
(5) 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 revolving credit
facility provides for a $7.5 million availability block against our
availability calculation as defined. The credit facility also includes
a $15.0 million sub-facility for letters of credit. 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 1.0 % and LIBOR borrowings from LIBOR plus 1.5% to
LIBOR plus 3.0%. The credit facility expires on March 3, 2006. 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. We are contractually prohibited from
paying cash dividends on our common stock under the terms of the
revolving credit facility without the consent of the lender.
On February 14, 2003, we obtained the approval from the lender to
expand the scope of the collateral securing the obligations under our
revolving credit facility and increased the sub-facility for letters of
credit to $15.0 million. In addition, we obtained the lender's consent
to the incurrence by us of up to $10.0 million in additional
indebtedness, which may be secured by a junior lien on the collateral.
On April 10, 2003, we amended the terms of our revolving credit
facility to add $7.5 million of term loans, to add financial covenants,
and to amend certain reporting provisions and other terms. The term
loans consist of a $6.5 million junior term note secured primarily by
inventory and accounts receivable and a $1.0 million junior term note
secured primarily by equipment and other assets. These notes bear
interest at the rate of 14.5% per annum on the then current outstanding
balance, and mature on April 10, 2004. The $6.5 million junior term
note can be extended for one additional year. The financial covenant,
F-8
which is related to achieving a minimum earnings before interest, tax
obligations, depreciation and amortization expense (EBITDA), as
defined, is subject to testing only if the Triggering Availability, as
defined, is less than $10.0 million on the last three days of each
month commencing on May 3, 2003. In addition, there shall not be any
outstanding borrowings and outstanding letters of credit cannot exceed
$12.2 million under the revolving credit facility during the period
from December 22 through January 7 of each year. These financial
covenants will terminate at such time that the $7.5 million term loans
are no longer outstanding.
At May 3, 2003, we were in compliance with all financial covenants, as
defined, and had outstanding borrowings of $11.5 million and letters of
credit of $12.3 million under our revolving credit facility. In
addition, based on eligible inventory and accounts receivable, we were
eligible to borrow $48.0 million under our revolving credit facility
and had $16.4 million available for future borrowings after giving
effect for the $7.5 million availability block, as defined.
(6) Long-Term Debts
Our long-term debts primarily consist of Junior Subordinated Notes (the
"Notes"), which are non-interest bearing and are reflected on our
balance sheets at the present value using a discount rate of 10%. We
are prohibited from paying cash dividends on our common stock under the
terms of the Notes without the consent of the note holders.
As of May 3, 2003, the Notes had a face value of $11.3 million and a
related unamortized discount of $1.7 million, resulting in a net
carrying value of $9.6 million. The discount is amortized to interest
expense as a non-cash charge over the term of the Notes. We made a
principal payment on the Notes of $2.0 million in January 2003.
Additional principal payments are scheduled on December 31, 2003 ($3.0
million), December 31, 2004 ($3.0 million) and a final payment on May
28, 2005 ($5.3 million).
(7) Income (loss) per Share and Comprehensive Income
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 earnings per share is computed based on the
weighted average shares outstanding and potentially dilutive common
equivalent shares.
Common stock equivalent shares totaling 108,437 and 146,950,
respectively, are not included in the computation of diluted loss per
share for the 13 weeks ended May 3, 2003 and May 4, 2002 because the
effect would be anti-dilutive.
We had no items of comprehensive income for the 13 weeks ended May 3,
2003 and May 4, 2002.
F-9
(8) 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 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. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure."
The following table illustrates the effect on net income (loss) and net
income (loss) per common share if we had applied the fair value
recognition provisions of SFAS No. 148.
-----(in thousands)-----
13 Weeks Ended
--------------
May 3, 2003 May 4, 2002
----------- -----------
Net loss before stock-based compensation,
as reported $ (2,721) $ (3,141)
Stock-based compensation, using the fair
value method, net of tax (809) (599)
--------- ---------
Pro-forma net loss available to common shareholders $ (3,530) $ (3,740)
--------- ---------
Pro-forma loss per common share $ (0.27) $ (0.26)
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. Option valuation models also
require the input of highly subjective assumptions such as expected
option life and expected stock price volatility. Because our employee
stock-based compensation plan has characteristics significantly
different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value
estimate, we believe that the existing option valuation models do not
necessarily provide a reliable single measure of the fair value of
awards from those plans.
The weighted-average fair value of each option grant is estimated on
the date of grant using the Black-Scholes option pricing model using
the following weighted-average assumptions: (i) expected dividend yield
of 0.00%, (ii) expected volatility of 103.68% and 104.01% for 13 weeks
ended May 3, 2003 and May 4, 2002, respectively, (iii) expected life of
7years for 13 weeks ended May 3, 2003 and 8 years for 13 weeks ended
May 4, 2002, and (iv) risk-free interest rate of 3.45% and 3.55% for 13
weeks ended May 3, 2003 and May 4, 2002, respectively.
F-10
(9) Provision for Income Taxes
Based on our estimated effective tax rate for the entire fiscal year,
which is subject to ongoing review and evaluation, we recorded an
income tax benefit of $1.7 million for the 13 weeks ended May 3, 2003.
(10) Private Offering
On March 6, 2003, we completed a private offering of 2,532,679 shares
of our common stock for net proceeds of approximately $5.7 million,
after deducting the placement fees and other offering expenses. We used
the net proceeds of this private offering for working capital purposes.
In addition to the placement fees, the placement agent received
warrants to purchase 75,000 shares of our common stock at an exercise
price of $3.50 per share, a 30% premium over the closing price of $2.68
on March 6, 2003. These warrants will expire in March 2006.
(11) Stock Subscription Notes Receivable
As of February 1, 2003, the outstanding stock subscription notes
receivable balance was $1.1 million, net of a valuation allowance. All
outstanding stock subscription notes receivable, which are secured by
the underlying common stock of the Company, at that time were either
due from current or former members of management with a five-year term
and had maturity dates from April 29, 2003 to July 29, 2003 and an
interest rate of 8.0% per annum.
On March 21, 2003, two stock subscription notes in the principal amount
of $99,548 and $50,000, respectively, plus accrued interest, were paid
in full by current members of management.
On April 29, 2003, the remaining stock subscription notes matured and
we foreclosed on the shares of our common stock that served as
collateral as of the close of business. The principal and accrued
interest on the note due from Michael M. Searles, our former President
and Chief Executive Officer, was $1,458,608 and the collateral's market
value on April 29, 2003 was $1,198,750, resulting in a deficiency of
$259,858, for which Mr. Searles is not personally liable under the
terms of the note. In addition, the principal and accrued interest on
two notes due from Jonathan W. Spatz, our former Chief Financial
Officer, were $688,197 and the collateral's market value on April 29,
2003 was $376,744, resulting in a deficiency of $311,453, for which
Mr. Spatz is personally liable for $136,614 of the deficiency under the
terms of his notes. Additionally, on April 29, 2003, the principal and
accrued interest on the notes due from Tracy W. Parks, our former Chief
Operating Officer, was $117,042 and the collateral had a market value
of $82,197, resulting in a deficiency of $34,845, for which he is
personally liable under the terms of his notes.
F-11
In conjunction with the foreclosures as discussed above, we recorded
income of approximately $708,000 to adjust the valuation allowance
established as of February 1, 2003 as a result of the increase in the
market value of our common stock on April 29, 2003 as compared to
February 1, 2003.
We are currently pursuing collection efforts for the remaining amounts
due from Mr. Parks and Mr. Spatz.
(12) Stock Options and Warrants
As of May 3, 2003, we had outstanding options to purchase 1,216,365
shares of our common stock. Included in these outstanding stock options
are 450,000 stock options granted to certain of our new senior
management members as an inducement to accept employment at the time
they were hired, subject to shareholder approval of an appropriate
amendment to our stock option plan. In the event that such an amendment
is not approved, we are nevertheless contractually obligated to grant
such options, which would not be granted under our stock option plan.
At May 3, 2003, warrants to purchase 157,690 shares of our common stock
were outstanding. These warrants have exercise prices in the range of
$3.50 to $19.91 and expire on various dates between May 2005 and March
2006.
(13) Note Receivable
In July 2002, we entered into a temporary bridge financing agreement
(the "Agreement") with one of our trade vendors (the "Borrower") in
which we, subject to the terms and conditions of the Agreement,
provided a $4.0 million revolving line of credit facility to the
Borrower. Advances made to the Borrower under this Agreement are
secured by the Borrower's accounts receivable, inventory, personal
property and other assets including cash. Borrowings under this
facility are also secured by personal guarantees from the principals of
the Borrower. This Agreement expired on October 11, 2002, and we have
not made any direct advances to the Borrower thereafter.
As of May 3, 2003, the outstanding borrowings plus accrued interest
under this Agreement were approximately $1.2 million, which was fully
reserved. On May 27, 2003, we initiated legal action against the
Borrower and guarantors to collect the outstanding sums due under this
Agreement.
(14) Legal Matters, Commitments and Contingencies
On March 19, 2003, we entered into a settlement agreement with a former
candidate for an executive level position who alleged that we breached
oral agreement to employ him. Under the terms of the settlement
agreement, we are obligated to pay $390,000, payable in 52 equal
bi-weekly installments.
F-12
In April 2003, Lynda Bray and Masis Manougian, two of our current
employees, filed a lawsuit against us entitled "Lynda Bray, Masis
Manougian, etc., Plaintiffs, vs. Factory 2-U Stores, Inc., etc.,
Defendants", Case No. RCV071918 in the Superior Court of the State of
San Bernardino (the "Bray Lawsuit"). The First Amended Complaint in the
Bray Lawsuit alleges that we violated the California Labor Code,
Industrial Wage Commission Orders and the California Unfair Competition
Act by failing to pay wages and overtime for all hours worked, by
failing to document all hours worked, by threatening to retaliate
against employees who sought to participate in the settlement of the
O'Hara Lawsuit and by failing to inform prospective employees of unpaid
wage claims. Plaintiffs purport to bring this action on behalf of all
persons who were employed in one of our California stores at any time
after April 25, 2003. Plaintiffs seek compensatory and exemplary
damages, interest, penalties, attorneys' fees and disgorged profits in
an amount which plaintiffs estimated to be not less than $100,000,000.
Plaintiffs also seek injunctive relief requiring correction of the
alleged unlawful practices.
We believe that the material allegations of the complaint in the Bray
Lawsuit are false and that each of the claims asserted in the Bray
Lawsuit is meritless. We intend to vigorously defend against the Bray
Lawsuit.
We are at all times subject to pending and threatened legal actions
that arise in the normal course of business. In the opinion of our
management, based in part on the assessment 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.
F-13
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
Forward-Looking Statements
Certain statements in this Quarterly Report on Form 10-Q 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, but 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", `estimate", "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,
performance or achievements, 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 regions where 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
challenges and costs associated with maintaining and improving technology; 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.
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.
General
The following discussion and analysis should be read in conjunction with our
Financial Statements and notes thereto, included elsewhere in this Form 10-Q.
As of May 3, 2003, we operated 242 "Factory 2-U" off-price retail stores which
sell branded casual apparel for the family, as well as selected domestics and
household merchandise at prices which generally are significantly lower than the
prices offered by other discount chains. We had 256 stores in operation as of
May 4, 2002.
3
During the 13-week period ended May 3, 2003, we opened one new store and closed
three stores, one of which was closed on a temporary basis for structural
repairs. For the same period last year, we opened five new stores and closed 28
stores. The average numbers of stores in operation were 243 and 264 for the
13-week periods ended May 3, 2003 and May 4, 2002, respectively. In addition, we
averaged 223 and 205 comparable stores for the 13 weeks ended May 3, 2003 and
May 4, 2002, respectively. We define comparable stores as follows:
* New stores are considered comparable after 18 months from date of opening.
* When a store relocates within the same market, it is considered comparable
after 6 months of operations.
* Store expansion greater than 25% of the original store size are treated like
a new store and become comparable after 18 monhts of operations. Store
expansion less than 25% fo the original store size remains in the comparable
store base.
Operating results for the 13-week period ended May 3, 2003 were lower than
originally anticipated due to our low inventory levels for most of the 13-week
period and a very soft retail environment for retailers in general, particularly
in apparel. We ended the quarter in a much stronger inventory position than we
began.
In an effort to improve our liquidity position, obtain more reasonable credit
terms and provide for a consistent flow of merchandise, we initiated a series of
financing transactions, as well as initiated steps to accelerate the recognition
of tax loss carry-back benefits. On March 6, 2003, we completed the private
offering of approximately 2.5 million shares of our common stock for net
proceeds of approximately $5.7 million, after deducting the placement fees and
other offering expenses. In addition, during March of 2003, we received an $8.2
million federal tax refund as a result of utilizing a tax loss carry-back
benefit. On April 10, 2003, we completed a $7.5 million debt financing
transaction consisting of a $6.5 million junior term note secured primarily by
inventory and a $1.0 million term note secured primarily by equipment and other
assets.
We continue to experience a very soft retail environment, affected by general
price deflation and heavy promotion within the retail industry. This has been a
very difficult environment for us, especially during the first quarter, when we
experienced lower than normal inventory levels due to the tightening of credit
terms from vendors and factors. Though we experienced a significant improvement
in inventory levels near the end of the first quarter and expect this to
continue for our second quarter, excess inventories generally held by retailers
and the continuing soft economy will likely contribute to a continuation of
aggressive pricing and soft retail sales for the industry. For our second
quarter, in response to a very competitive retail environment, we have increased
our advertising expenditures above originally planned levels and equivalent to
last year. We also anticipate increasing our in-store promotional efforts with
weekly in-store specials. Our current outlook for the second quarter is for
comparable store sales to range from a negative 2% to a positive 2% and a net
loss per share in the range of $0.19 to $0.25.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make
estimates, assumptions and judgments 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
4
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 83 sub-departments in which fairly homogeneous classes of
merchandise items having similar gross margin are grouped. In addition,
failure to take markdowns currently may result in an overstatement of cost
under the lower of cost or market principle. As of May 3, 2003, we had an
inventory valuation allowance of approximately $1.3 million, which
represents our estimate of the cost in excess of the net realizable value
of slow-moving items. 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 amounts for the charges and
the related liabilities regarding our fiscal 2002 and fiscal 2001
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)." Depending on our
ability to dispose of the remaining lease obligations for the store and
distribution center closures, the actual costs to complete the
restructuring initiatives may be different from our estimated costs.
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 continuously evaluate the adequacy
of these reserves and, as new facts come to light, adjust these reserves
when necessary.
5
o Workers' compensation accrual. At the beginning of fiscal 2001, we
transitioned to a partially self-insured workers' compensation
program. The program for the policy year ended January 31, 2002 had both
a specific and aggregate stop loss amount of $250,000 and $3.2 million,
respectively. The program for the policy year ended January 31, 2003 had
a specific stop loss amount of $250,000 with no aggregate stop loss
limit. 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
withcurrent available information and insurance industry statistics,
the ultimate expected losses for the policy year ended January 31, 2003 and
2002 were estimated to be approximately $3.4 million and $3.7 million
($3.2 million aggregate stop loss), respectively. 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
Net sales were $104.3 million for the 13 weeks ended May 3, 2003 compared to
$117.0 million for the 13 weeks ended May 4, 2002, a decrease of $12.6 million,
or 10.8%. Comparable store sales for the 13-week period ended May 3, 2003
decreased 7.4% versus a decrease of 11.8% for the same period last year. The
decline in net sales was primarily due to fewer stores in operation and negative
comparable store sales.
Gross profit was $37.6 million for the 13 weeks ended May 3, 2003 compared to
$41.2 million for the 13 weeks ended May 4, 2002, a decrease of $3.5 million or
8.6%. As a percentage of net sales, gross profit was 36.1% for the 13 weeks
ended May 3, 2003 versus 35.2% for the same period last year. The improvement in
gross profit as a percentage of net sales for the 13 weeks ended May 3, 2003
from the comparable period last year was primarily due to (1) lower markdowns
taken during the current quarterly period, (2) higher purchase discounts, (3) a
favorable adjustment to the inventory valuation allowance established at the end
of fiscal 2002, partially offset by (4) lower initial mark-up as a result of
lower retail price points.
Selling and administrative expenses were $41.3 million for the 13 weeks ended
May 3, 2003 compared to $45.7 million for the 13 weeks ended May 4, 2002, a
decrease of $4.4 million or 9.7%. Selling and administrative expenses decreased
as a result of (1) fewer stores in operation
6
during the current quarter, (2) reduced consulting and legal fees, and (3)
non-recurring income of $708,000 recorded in conjunction with the foreclosures
of certain stock subscription notes. As a percentage of net sales, selling and
administrative expenses were 39.5% and 39.1% for the 13 weeks ended May 3, 2003
and May 4, 2002, respectively. The increase in selling and administrative
expenses ratio was due to lower sales volume, partially offset by the decrease
in consulting and legal fees and the non-recurring income as mentioned above.
Pre-opening and closing expenses were $138,000 for the 13 weeks ended May 3,
2003 compared to $437,000 for the same period last year, a decrease of
approximately $299,000 or 68.4%. The decrease in pre-opening and closing
expenses was due to the opening of four fewer new stores during the current
quarterly period versus the same period last year.
Interest expense, net was $634,000 for the 13 weeks ended May 3, 2003 compared
to $258,000 for the 13 weeks ended May 4, 2002, an increase of $376,000 or
145.7%. The increase in interest expense for the current quarter was primarily
due to higher average outstanding borrowings on the revolving credit facility
and interest related to the junior secured term loan.
We recorded an income tax benefit of $1.7 million for the 13 weeks ended May 3,
2003 compared to $2.1 million for the 13 weeks ended May 4, 2002. The decrease
in income tax benefit was the result of decreased pre-tax loss compared to the
same period a year ago.
For the 13 weeks ended May 3, 2003, the net loss was $2.7 million as compared to
$3.1 million for the 13 weeks ended May 4, 2002. The decrease in net loss was a
result of the operating and other factors cited above.
Liquidity and Capital Resources
General
We finance our operations through credit provided by vendors and other
suppliers, amounts borrowed under our $50.0 million revolving credit facility,
internally generated cash flow, and other financing resources. Credit terms
provided by vendors and other suppliers are generally net 30 days. Amounts that
may be borrowed under the revolving credit facility are based on a percentage of
eligible inventory and accounts receivable, as defined, outstanding from time to
time, as more fully described in Note 5 of Notes to Financial Statements.
Since February 1, 2003, we have completed a series of financing transactions
designed to add liquidity and strengthen our financial position. On March 6,
2003, we completed the private offering of approximately 2.5 million shares of
our common stock for net proceeds of approximately $5.7 million, after deducting
the placement fees and other offering expenses. On April 10, 2003, we completed
a $7.5 million debt financing transaction, which consists of a $6.5 million
junior term note secured primarily by inventory and accounts receivable and a
$1.0 million term note secured primarily by equipment and other assets. In
addition, we received a federal tax refund of $8.2 million in March 2003.
7
Since the completion of our private equity offering and debt financing
transaction, and receipt of the federal tax refund, the vendor and credit
community have begun to provide support and extend credit terms for merchandise
shipments. Based on the current credit support being provided by our vendors
and the credit community, we expect to receive merchandise receipts on credit
terms necessary to meet our desired inventory levels. While we have experienced
an improvement in support from the credit community, any further improvement in
credit will be contingent upon improved operating results and liquidity.
Provided we do not experience comparable store sales declines and a
tightening of credit from our vendors and/or the credit community in the future,
we believe our $50.0 million revolving credit facility and internal cash flow
should provide sufficient funds to finance our operations and capital
expenditures, pay our debt obligations, and complete the closing of stores and
distribution centers included in our fiscal 2002 restructuring and fiscal 2001
restructuring efforts over the next twelve months. In the event we experience a
shortage of cash, we anticipate raising equity capital in one or more
transactions.
At May 3, 2003, we were in compliance with all financial covenants, as defined,
and had outstanding borrowings of $11.5 million and letters of credit of $12.3
million under our revolving credit facility. In addition, based on eligible
inventory and accounts receivable, we were eligible to borrow $48.0 million
under our revolving credit facility and had $16.4 million available for future
borrowings after giving effect for the $7.5 million availability block, as
defined.
With respect to cash flows for the quarterly period ended May 3, 2003, we used
$15.1 million in operating activities, $1.0 million in investing activities and
generated $18.1 million from financing activities, which resulted in a net
increase in cash of $1.9 million. For the same period last year, we used $9.3
million in operating activities, $538,000 in investing activities and generated
$758,000 from financing activities, which resulted a net decrease in cash of
$9.0 million. The increase in cash used in operating activities was primarily
due to replenishment of inventory. The increase in cash used in investing
activities was related to the equipment acquisition for our new Otay Mesa
distribution facility. The increase in cash generated from the financing
activities was a result of borrowings against the revolving credit facility, net
proceeds received from the private offering and the borrowings on the junior
secured term loan.
Capital Expenditures
We anticipate capital expenditures of approximately $3.1 million for the
remainder of the current fiscal year ending January 31, 2004, primarily in
connection with equipment purchases in our new Otay Mesa distribution center and
information systems replacement at our corporate office. We believe the capital
expenditures will be financed from internal cash flow and borrowings under our
revolving credit facility.
Store Closures and Restructuring Initiatives
As of June 9, 2003, we had closed 15 of the 23 stores identified in our Fiscal
2002 restructuring efforts, as well as completed the consolidation of our
corporate overhead structure. In addition, in May 2003, we completed the
consolidation of our two former San Diego distribution centers into our new Otay
Mesa distribution facility. We estimate the cash requirement for the remainder
of this current fiscal year for the Fiscal 2002 restructuring efforts will be
approximately $5.4 million, which we intend to fund from our sources of cash,
including the revolving credit facility.
8
In regards to our Fiscal 2001 restructuring efforts, we closed 24 of 28
under-performing stores in the first quarter of fiscal 2002 and the remaining
four stores in January 2003. We estimate the cash requirement for the remainder
of this current fiscal year for the Fiscal 2001 restructuring efforts will be
approximately $3.5 million, which we intend to fund from our sources of cash,
including the revolving credit facility.
Contractual Obligations and Commitments
The following table summarizes our significant contractual obligations, as well
as estimated cash requirements related to our restructuring initiatives, as of
May 3, 2003. These should be read in conjunction with "Note 3 - Fiscal 2002
Restructuring Charge", "Note 4 - Fiscal 2001 Restructuring Charge", "Note 5 -
Revolving Credit Facility", and "Note 6 - Long-Term Debts" in the accompanying
unaudited financial statements, as well as our fiscal 2002 Annual Report on Form
10-K as filed with the Securities and Exchange Commission.
-----------------------------------(in thousands)------------------------------------
Revolving Junior
Credit Subordinated Junior Secured Operating Restructuring
Facility Notes Term Loan Leases Charges* Total
---------- ------------ --------------- --------- ------------- -----
Fiscal Year:
2003 (for remaining 9 months) $ - $ 3,000 $ 500 $ 22,301 $ 8,859 $ 34,660
2004 - 3,000 7,000 27,328 1,747 39,075
2005 - 5,300 - 24,372 - 29,672
2006 11,535 - - 18,335 - 29,870
2007 - - - 13,256 - 13,256
Thereafter - - - 44,713 - 44,713
---------- ------------ ------------ ---------- ------------- --------
$ 11,535 $ 11,300 $ 7,500 $ 150,305 $ 10,606 $191,246
---------- ------------ ------------ ---------- ------------- --------
* Amounts reflect management's best estimate to complete store closures and
other restructuring initiatives.
We believe our internal cash flow and borrowings under our revolving credit
facility provide sufficient funds to service the above contractual obligations
over the next twelve months.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to interest rate risk on our Junior Subordinated Notes, which are
non-interest bearing and discounted at an annual rate of 10%. At May 3, 2003,
our long-term debt had a face value of $11.3 million with a net carrying value
of $9.6 million. While generally an increase in market interest rates will
decrease the value of this debt, and decreases in interest 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 May 3, 2003.
9
Item 4. Controls and Procedures
Evaluation. Within 90 days prior to the date of this Quarterly Report on Form
10-Q, we have evaluated the effectiveness of the design and operation of our
disclosure controls and procedures as defined under Rule 13a-14 and Rule 15d-14
of the Securities Exchange Act of 1934, as amended. This evaluation was done
under the supervision and with the participation of management, including our
Chief Executive Officer (CEO) and Chief Financial Officer (CFO).
Conclusions. Based upon our evaluation, the CEO and CFO have concluded that our
disclosure controls and procedures are effective to ensure that material
information relating to the Company is made known to management, including the
CEO and CFO, particularly during the period when our periodic reports are being
prepared.
Changes in Internal Controls. There have not been any significant changes in our
internal controls or in other factors that could significantly affect these
controls subsequent to the date of our last evaluation of such internal
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
As disclosed in our financial statements for the fiscal year ended
February 1, 2003 included in our Form 10-K as filed with the
Securities and Exchange Commission, in April 2003, Lynda Bray and
Masis Manougian, two of our current employees, filed a lawsuit
against us entitled "Lynda Bray, Masis Manougian, etc., Plaintiffs,
vs. Factory 2-U Stores, Inc., etc., Defendants", Case No. RCV071918
in the Superior Court of the State of San Bernardino (the "Bray
Lawsuit"). The First Amended Complaint in the Bray Lawsuit alleges
that we violated the California Labor Code, Industrial Wage
Commission Orders and the California Unfair Competition Act by
failing to pay wages and overtime for all hours worked, by failing to
document all hours worked, by threatening to retaliate against
employees who sought to participate in the settlement of the O'Hara
Lawsuit and by failing to inform prospective employees of unpaid wage
claims. Plaintiffs purport to bring this action on behalf of all
persons who were employed in one of our California stores at any time
after April 25, 2003. Plaintiffs seek compensatory and exemplary
damages, interest, penalties, attorneys' fees and disgorged profits
in an amount which plaintiffs estimated to be not less than
$100,000,000. Plaintiffs also seek injunctive relief requiring
correction of the alleged unlawful practices.
We believe that the material allegations of the First Amended
Complaint in the Bray Lawsuit are false and that each of the claims
asserted in the Bray Lawsuit is meritless. We intend to vigorously
defend against the Bray Lawsuit.
10
Item 2. Changes in Securities and Use of Proceeds
On March 6, 2003, we completed the private offering of 2,515,379
shares of our common stock to accredited investors for aggregate
proceeds of $5,712,804 (net of placement agent fees of $217,415),
together with a warrant to purchase an additional 75,000 shares of
our common stock. The warrant, issued to the placement agent, is
exercisable at a purchase price of $3.50 per share and expires on
March 6, 2006. This offering was exempt from registration under Rule
506 of Regulation D of the Securities Act of 1933.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit
10.17 Employment Agreement, dated as of May 20, 2003, by and
between Factory 2-U Stores, Inc. and Douglas C.
Felderman.
10.18 Employment Agreement, dated as of May 20, 2003 by and
between Factory 2-U Stores, Inc. and Norman G. Plotkin.
99.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 by William R. Fields, Chief Executive
Officer.
99.2 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 by Douglas C. Felderman, Executive Vice
President and Chief Financial Officer.
11
(b) Reports on Form 8-K
Items 7 and 12:
On May 9, 2003, we filed a report on Form 8-K regarding the
announcement of sales for the four-week and 13-week periods
ended May 3, 2003. The full text of our press release dated
May 7, 2003 was attached as exhibit to the Form 8-K.
On May 15, 2003, we filed a report on Form 8-K regarding the
announcement of operating results for the 13-week period ended
May 3, 2003. The full text of our press release dated May 14,
2003 was attached as exhibit to the Form 8-K.
12
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FACTORY 2-U STORES, INC.
Date: June 17, 2003
By: /s/Douglas C. Felderman
-----------------------
Name: Douglas C. Felderman
Title: Executive Vice President and Chief Financial Officer
(duly authorized officer and principal financial officer)
13
CERTIFICATION
I, William R. Fields, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Factory 2-U Stores,
Inc. (the "Registrant").
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report.
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Registrant as of, and for, the periods presented in this
quarterly report.
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
14
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: June 17, 2003 /s/ William R. Fields
---------------------
Name: William R. Fields
Title: Chief Executive Officer
15
CERTIFICATION
I, Douglas C. Felderman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Factory 2-U Stores,
Inc. (the "Registrant").
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report.
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Registrant as of, and for, the periods presented in this
quarterly report.
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
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(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: June 17, 2003 /s/ Douglas C. Felderman
------------------------
Name: Douglas C. Felderman
Title: Executive Vice President and
Chief Financial Officer
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