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 August 2, 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
September 10, 2003 was 18,046,132 shares.
FACTORY 2-U STORES, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED AUGUST 2, 2003
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets as of August 2, 2003 (Unaudited), August 3, 2002
(Unaudited) and February 1, 2003 ..................................F-1
Statements of Operations (Unaudited) for the 13 and 26 weeks ended
August 2, 2003 and August 3, 2002 .................................F-3
Statements of Cash Flows (Unaudited) for the 26 weeks ended
August 2, 2003 and August 3, 2002 .................................F-4
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..........11
Item 4. Controls and Procedures ............................................12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................. 13
Item 2. Changes in Securities and Use of Proceeds...........................13
Item 3. Defaults Upon Senior Securities.....................................13
Item 4. Submission of Matters to a Vote of Security Holders.................13
Item 5. Other Information ..................................................13
Item 6. Exhibits and Reports on Form 8-K ...................................14
Signatures ...............................................................15
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
FACTORY 2-U STORES, INC.
Balance Sheets
(in thousands, except share and per share data)
August 2, August 3, February 1,
2003 2002 2003
--------- --------- -----------
(Unaudited) (Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 6,384 $ 7,446 $ 3,465
Merchandise inventory 65,692 76,824 32,171
Accounts receivable, net 350 2,476 884
Income taxes receivable - 5,913 8,200
Prepaid expenses 6,862 6,909 5,436
Deferred income taxes 9,753 3,553 9,732
-------- -------- --------
Total current assets 89,041 103,121 59,888
Leasehold improvements and equipment, net 25,388 36,957 28,602
Deferred income taxes 15,813 7,182 10,750
Other assets 815 959 963
Goodwill 26,301 26,301 26,301
-------- -------- --------
Total assets $157,358 $174,520 $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)
August 2, August 3, February 1,
2003 2002 2003
--------- -------- -----------
(Unaudited) (Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 3,030 $ 2,001 $ 3,000
Junior secured term loans 7,500 - -
Accounts payable 47,767 52,714 27,961
Taxes payable 2,840 3,150 5,840
Accrued expenses 25,223 32,875 27,831
-------- -------- ---------
Total current liabilities 86,360 90,740 64,632
Revolving credit facility 17,949 5,386 6,300
Long-term debt 7,023 8,906 6,445
Accrued restructuring charges 1,747 3,578 1,747
Deferred rent 2,931 3,295 3,061
-------- -------- ---------
Total liabilities 116,010 111,905 82,185
-------- -------- ---------
Stockholders' equity:
Common stock, $0.01 par value;
35,000,000 shares authorized
and 15,670,382 shares, 12,968,910
shares and 13,475,705 shares
issued and outstanding, respectively 157 130 135
Stock subscription notes receivable - (2,149) (1,116)
Additional paid-in capital 126,518 122,319 122,516
Accumulated deficit (85,327) (57,685) (77,216)
-------- -------- ---------
Total stockholders' equity 41,348 62,615 44,319
-------- -------- ---------
Total liabilities and
stockholders' equity $157,358 $174,520 $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 26 Weeks Ended
-------------- --------------
August 2, August 3, August 2, August 3,
2003 2002 2003 2002
--------- --------- --------- ---------
Net sales $ 123,659 $ 128,088 $ 228,006 $ 245,039
Cost of sales 85,090 87,059 151,802 162,852
--------- --------- --------- ---------
Gross profit 38,569 41,029 76,204 82,187
Selling and administrative expenses 46,248 50,181 87,503 95,879
Pre-opening and closing expenses 83 266 221 703
--------- --------- --------- ---------
Operating loss (7,762) (9,418) (11,520) (14,395)
Interest expense, net 935 310 1,569 568
--------- --------- --------- ---------
Loss before income taxes (8,697) (9,728) (13,089) (14,963)
Income tax benefit (3,307) (3,891) (4,978) (5,985)
--------- --------- --------- ---------
Net loss $ (5,390) $ (5,837) $ (8,111) $ (8,978)
========= ========= ========= =========
Loss per share
Basic $ (0.35) $ (0.45) $ (0.54) $ (0.69)
Diluted $ (0.35) $ (0.45) $ (0.54) $ (0.69)
Weighted average common shares outstanding
Basic 15,197 12,957 14,909 12,930
Diluted 15,197 12,957 14,909 12,930
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)
26 Weeks Ended
--------------
August 2, 2003 August 3, 2002
-------------- --------------
Cash flows from operating activities
Net loss $ (8,111) $ (8,978)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 6,667 7,466
Loss on disposal of equipment 24 51
Deferred income tax (4,978) -
Deferred rent 277 (354)
Stock subscription notes receivable
valuation adjustment (708) -
Changes in operating assets and liabilities
Merchandise inventory (33,521) (21,964)
Income tax receivable 8,200 (5,913)
Prepaid expenses and other assets (628) 536
Advances to vendor (16) (1,525)
Repayments from vendor 77 -
Accounts payable 19,806 16,442
Accrued expenses and other liabilities (5,572) 3,098
------------ -----------
Net cash used in operating activities (18,483) (11,141)
Cash flows from investing activities
Purchases of leasehold improvements and equipment (3,155) (5,125)
------------ -----------
Net cash used in investing activities (3,155) (5,125)
Cash flows from financing activities
Borrowings on revolving credit facility 72,792 25,760
Payments on revolving credit facility (61,143) (20,374)
Payments on long-term debt and capital
lease obligations (6) (18)
Proceeds from debt financing 7,500 -
Proceeds from issuance of common stock, net 5,713 -
Payment of deferred debt issuance costs (442) (40)
Proceeds from exercise of stock options - 918
Payments of stock subscription notes receivable 143 76
----------- -----------
Net cash provided by financing activities 24,557 6,322
Net increase (decrease) in cash 2,919 (9,944)
Cash at the beginning of the period 3,465 17,390
---------- -----------
Cash at the end of the period $ 6,384 $ 7,446
========== ===========
Supplemental disclosure of cash flow information
Cash paid during the period for
Interest $ 916 $ 97
Income taxes $ 88 $ 1,102
Supplemental disclosure of non-cash investing and financing activities
Acquisition of equipment under notes payable $ 132 $ -
Issuance of common stock to board members
as compensation $ 8 $ 33
Foreclosure of collateral on stock subscription
notes receivable $ 1,681 $ -
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/A as filed
with the Securities and Exchange Commission.
We believe that the unaudited financial statements as of and for the 13
weeks and 26 weeks ended August 2, 2003 and August 3, 2002 reflect all
adjustments (consisting of normal recurring 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.
Certain prior period amounts have been reclassified to conform their
presentation to the current period's financial statements.
(2) Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (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.
In April 2003, the FASB issued Statement of Financial Accounting
Standard (the "SFAS") No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement provides
clarification on the financial accounting and reporting of derivative
instruments and hedging activities and requires contracts with similar
characteristics to be accounted for on a comparable basis. We are
currently in the process of assessing the effect of SFAS No.149 and do
not expect the adoption of it, which will be effective for contracts
entered into or modified after June 30, 2003, to have a material impact
on our financial position or results of operations.
F-5
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity." This statement establishes standards on the classification and
measurement of financial instruments with characteristics of both
liabilities and equity and is effective for financial instruments
entered into or modified after May 31, 2003. We do not expect the
adoption of this statement will have a material impact on our financial
position or results of operations.
(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 September 10, 2003, we closed 16 of these 23 stores and
terminated the lease obligations of 13 of these closed stores. For the
remaining seven stores, we have decided to continue to operate four of
these stores as a result of entering into amendments to the leases with
the landlords; and we plan to close the other three stores by January
2004. In addition, we had completed the consolidation of our two former
San Diego distribution centers into the new distribution center, which
is also located in San Diego, California. We are currently seeking
disposition of the leases for these two former San Diego distribution
facilities.
The balance of the liability ($4.7 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 August 2, 2003 was as follows:
Balance at Balance at
February 1, Cash Non-cash August 2,
(in thousands) 2003 Payments Charges 2003
----------- -------- -------- ----------
Lease termination costs* $ 6,548 $ (1,632) $ 588 $ 5,504
Employee termination costs 908 (483) (115) 310
Other costs 786 (238) 115 663
------- -------- ------ -------
$ 8,242 $ (2,353) $ 588 $ 6,477
======= ======== ====== =======
* The non-cash charge portion consists primarily of the write-off of deferred
rent.
F-6
The balances of non-cash inventory liquidation costs and fixed asset
write-downs related to the fiscal 2002 restructuring charge at August
2, 2003 were as follows:
Balance at Balance at
February 1, Usage/ August 2,
(in thousands) 2003 Adjustments 2003
----------- ----------- ----------
Inventory liquation costs* $ 517 $ (103) $ 414
Fixed asset write-downs** $ 3,652 $ (656) $2,996
* The balance of inventory liquidation costs of approximately $414,000
as of August 2, 2003 was recorded as a valuation allowance for
merchandise inventory.
** The balance of fixed asset write-downs of approximately $3.0 million
as of August 2, 2003 was recorded as a valuation allowance for
leasehold improvements and equipment.
(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 September 10,
2003, we had terminated the lease obligations of 22 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.
The balance of the liability (included in the accrued expenses in the
accompanying balance sheets) related to the fiscal 2001 restructuring
charge at August 2, 2003 was as follows:
Balance at Non-cash Balance at
February 1, Cash Charges and August 2,
(in thousands) 2003 Payments Adjustments 2003
----------- -------- ----------- ----------
Lease termination costs $ 4,275 $ (1,330) $ - $ 2,945
Employee termination costs 70 (16) - 54
Other costs 277 (108) (132) 37
----------- -------- ----------- ----------
$ 4,622 $ (1,454) $ (132) $ 3,036
----------- -------- ----------- ----------
F-7
The balances of non-cash inventory liquidation costs and fixed asset
write-downs related to the fiscal 2001 restructuring charge at August
2, 2003 were as follows:
Balance at Balance at
February 1, Usage/ August 2,
(in thousands) 2003 Adjustments 2003
----------- ----------- ----------
Inventory liquation costs* $ 19 $ - $ 19
Fixed asset write-downs** $ 133 $ 35 $ 168
* The balance of inventory liquidation costs of approximately $19,000
as of August 2, 2003 was recorded as a valuation allowance for
merchandise inventory.
** The balance of fixed asset write-downs of approximately $168,000 as
of August 2, 2003 was recorded as a valuation allowance for leasehold
improvements and equipment.
(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 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,
which is related to achieving a minimum earnings before interest, tax
F-8
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, outstanding borrowings
and letters of credit cannot exceed $12.2 million under the revolving
credit facility during the period from December 22 through January 7 of
each fiscal year. These financial covenants will terminate at such time
that the $7.5 million term loans are no longer outstanding.
At August 2, 2003, we were in compliance with all financial covenants,
as defined, and had outstanding borrowings of $17.9 million and letters
of credit of $12.5 million under our revolving credit facility. In
addition, based on eligible inventory and accounts receivable, we were
eligible to borrow $49.8 million under our revolving credit facility
and had $11.9 million available for future borrowings after giving
effect for the $7.5 million availability block, as defined.
(6) Long-Term Debt
Our long-term debt primarily consists 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 August 2, 2003, the Notes had a face value of $11.3 million and a
related unamortized discount of $1.4 million, resulting in a net
carrying value of $9.9 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) Loss per Share and Comprehensive Loss
We compute loss per share in accordance with SFAS No. 128, "Earnings
Per Share." Under the provisions of SFAS No. 128, 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 274,669 and 191,553 for 13
weeks and 26 weeks ended August 2, 2003, respectively, and 121,832 and
134,391 for 13 weeks and 26 weeks ended August 3, 2002, respectively,
are not included in the computation of diluted loss per share because
the effect would be anti-dilutive.
Our comprehensive loss equaled our net loss for the 13 weeks and 26
weeks ended August 2, 2003 and August 3, 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 loss and net loss per
share if we had applied the fair value recognition provisions of SFAS
No. 148.
(in thousands, except per share data)
-------------------------------------
13 weeks ended 26 weeks ended
-------------- --------------
August 2, August 3, August 2, August 3,
2003 2002 2003 2002
--------- --------- --------- ---------
Net loss before stock-based compensation, $ (5,390) $ (5,837) $ (8,111) $ (8,978)
as reported
Stock-based compensation, using the fair (529) (782) (1,126) (1,592)
value method, net of tax
--------- --------- --------- ---------
Pro-forma net loss available to
shareholders $ (5,919) $ (6,619) $ (9,237) $(10,570)
--------- --------- --------- ---------
Pro-forma loss per share $ (0.39) $ (0.51) $ (0.62) $ (0.82)
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:
13 weeks ended 26 weeks ended
-------------- --------------
August 2, August 3, August 2, August 3,
2003 2002 2003 2002
--------- --------- --------- ---------
(i) Expected dividend yield 0.00% 0.00% 0.00% 0.00%
(ii) Expected volatility 103.63% 104.01% 103.66% 104.01%
(iii) Expected life 7 years 8 years 7 years 8 years
(iv) Risk-free interest rate 4.01% 3.55% 3.96% 3.55%
F-10
(9) Provision for Income Taxes
Based on our estimated effective tax rate for the entire fiscal year,
which is dependent on our ability to generate future taxable income and
to utilize the net operating loss carryforwards, we recorded an income
tax benefit of $3.3 million and $5.0 million for the 13 weeks and 26
weeks ended August 2, 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 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.
In August 2003, we received payment in full from Mr. Parks to repay the
outstanding balance of his note. Based on Mr. Spatz's current financial
condition, we have elected, at this time, to forbear our collection
efforts regarding the amount for which he is personally liable.
(12) Stock Options and Warrants
As of August 2, 2003, we had outstanding options to purchase 1,316,436
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 August 2, 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 (weighted average exercise price of $12.11)
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, would
provide 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.
Through August 2, 2003, we have made cash advances in the aggregate of
approximately $3.1 million to the Borrower and received cash payments
in the aggregate of approximately $866,000. We also received
approximately $1.5 million of inventory shipments to offset the
advances. The remaining balance of approximately $1.1 million was fully
reserved as of August 2, 2003.
F-12
(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
an oral agreement to employ him for one year. Under the terms of the
settlement agreement, we are obligated to pay $390,000, payable in 52
equal bi-weekly installments.
In April 2003, Lynda Bray and Masis Manougian, two of our then 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.
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 Bray Lawsuit and we are vigorously defending against
it.
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.
On May 27, 2003, we filed a lawsuit against the Borrower and the two
guarantors seeking the balance due under the temporary bridge financing
agreement (see Note 13).
15. Subsequent Event
On August 20, 2003, we sold 2,450,000 shares of common stock at $5.00
per share to accredited investors and received approximately $11.6
million in net proceeds, after deducting placement fees and other
expenses. This transaction also provides for warrants to purchase
490,000 shares at the same price as the initial shares purchased
exercisable until 90 days after the effective date of the registration
statement filed for the resale of the initial shares. In addition to
the placement fees, the placement agent received warrants to purchase
112,500 shares of our common stock at an exercise price of $6.00 per
share. These warrants will expire in August 2006. Depending on the
number of additional shares purchased by investors, the placement agent
is entitled to receive additional fees and an additional warrant to
purchase up to 22,500 shares at $6.00 per share.
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 the Annual Report for the fiscal year ended February 1, 2003 on
Form 10-K/A 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 August 2, 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 257 stores in operation as
of August 3, 2002.
3
During the 13-week period ended August 2, 2003, we opened one new store and
closed one store. For the same period last year, we opened three new stores and
closed two stores. The average numbers of stores in operation were 242 and 257
for the 13-week periods ended August 2, 2003 and August 3, 2002, respectively.
In addition, we averaged 229 and 217 comparable stores for the 13 weeks ended
August 2, 2003 and August 3, 2002, respectively.
During the 26-week period ended August 2, 2003, we opened two new stores and
closed four stores, one of which was closed on a temporary basis for structural
repairs and reopened subsequent to August 2, 2003. For the same period last
year, we opened eight new stores and closed 30 stores. The average numbers of
stores in operation were 243 and 260 for the 26-week periods ended August 2,
2003 and August 3, 2002, respectively. In addition, we averaged 226 and 211
comparable stores for the 26 weeks ended August 2, 2003 and August 3, 2002,
respectively.
We define comparable stores as follows:
o New stores are considered comparable after 18 months from date of opening.
o When a store relocates within the same market, it is considered comparable
after 6 months of operations.
o Store expansion greater than 25% of the original store size are treated
like a new store and become comparable after 18 months of operations.
Store expansion less than 25% of the original store size remains in the
comparable store base.
Operating results for the 13-week period ended August 2, 2003 were lower than
originally anticipated as a result of lower than expected sales in July,
promotional efforts during the quarter and costs associated with the start-up of
our new distribution center in San Diego, California.
Operating results for the 26-week period ended August 2, 2003 were lower than
originally anticipated as well. In addition to the factors we experienced in the
second quarter, our lower than expected operating results for the first half of
fiscal 2003 was also due to our low inventory levels for most of the first
quarter and a very soft retail environment for retailers in general,
particularly in apparel.
In an effort to improve our liquidity position, obtain more favorable 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 2,515,379 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 tax loss carry-back
benefits. 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. On August 20, 2003, we sold 2,450,000 shares of common stock at $5.00
per share to accredited investors and received approximately $11.6 million in
net proceeds, after deducting the placement fees and other expenses.
4
We continue to experience a very soft retail environment, affected by general
price deflation and heavy promotion within the retail industry, particularly in
apparel. 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 started to see a very slowly recovering economy in the second quarter,
excess inventories generally held by apparel retailers continues to drive
aggressive pricing and a deflationary retail environment. In our second quarter,
in response to a very competitive retail environment, we increased our
advertising expenditures above originally planned levels and equivalent to last
year. We also increased our in-store promotional efforts with weekly in-store
specials.
Due to the lower than anticipated August sales results, we have lowered our
third quarter's guidance for comparable store sales and operating results.
Currently, we expect comparable store sales to be flat or slightly negative and
an operating loss of approximately $0.07 per share.
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 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
August 2, 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 inventory 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.
5
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. Future
restructuring efforts, if any, will be accounted for in accordance with
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities."
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.
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 with current 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.
6
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
13 weeks ended August 2, 2003 compared to 13 weeks ended August 3, 2002
Net sales were $123.7 million for the 13 weeks ended August 2, 2003 compared to
$128.1 million for the same period last year, a decrease of $4.4 million, or
3.5%. Comparable store sales for the 13-week period ended August 2, 2003
increased 0.1% versus a decrease of 8.7% for the same period last year. The
decline in net sales was primarily due to fewer stores in operation. Though we
recorded an increase of 8.9% in comparable transaction counts and an increase of
12.2% in average purchase size in units, our average unit retail price point was
21.0% lower as compared to the same period last year.
Gross profit was $38.6 million for the 13 weeks ended August 2, 2003 compared to
$41.0 million for the same period last year, a decrease of $2.5 million or 6.0%.
As a percentage of net sales, gross profit was 31.2% for the 13 weeks ended
August 2, 2003 versus 32.0% for the same period last year. The decline in gross
profit as a percentage of net sales for the 13 weeks ended August 2, 2003 from
the comparable period last year was primarily due to lower initial mark-up as a
result of lower retail price points and higher distribution costs associated
with the start-up of our new distribution center, which opened in May 2003.
Selling and administrative expenses were $46.2 million for the 13 weeks ended
August 2, 2003 compared to $50.2 million for the same period last year, a
decrease of $3.9 million or 7.8%. Selling and administrative expenses decreased
as a result of (1) fewer stores in operation during the current quarter, (2)
reduced consulting and legal fees, and (3) a charge of $2.1 million related to a
legal settlement recorded in the second quarter last year. As a percentage of
net sales, selling and administrative expenses were 37.4% for the 13 weeks ended
August 2, 2003 as compared to 37.5%, adjusted for the legal settlement charge,
for the same period last year. The decrease in selling and administrative
expenses as a percentage of net sales was due to the items mentioned above,
partially offset by the loss of sales volume leverage.
Pre-opening and closing expenses were $83,000 for the 13 weeks ended August 2,
2003 compared to $266,000 for the same period last year, a decrease of $183,000
or 68.8%. The decrease in pre-opening and closing expenses was primarily due to
the opening of two fewer new stores during the current quarterly period versus
the same period last year.
Interest expense, net was $935,000 for the 13 weeks ended August 2, 2003
compared to $310,000 for the 13 weeks ended August 3, 2002, an increase of
$625,000 or 201.6%. The increase in interest expense for the current quarter was
due to increased borrowings and higher interest rates.
7
We recorded an income tax benefit of $3.3 million for the 13 weeks ended August
2, 2003 compared to $3.9 million for the 13 weeks ended August 3, 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 August 2, 2003, the net loss was $5.4 million as compared
to $5.8 million for the 13 weeks ended August 3, 2002. The decrease in net loss
was a result of factors cited above.
26 weeks ended August 2, 2003 compared to 26 weeks ended August 3, 2002
Net sales were $228.0 million for the 26 weeks ended August 2, 2003 compared to
$245.0 million for the same period last year, a decrease of $17.0 million, or
7.0%. Comparable store sales for the 26-week period ended August 2, 2003
decreased 3.5% versus a decrease of 10.2% for the same period last year. The
decline in net sales was due to fewer stores in operation and negative
comparable store sales. Though we recorded an increase of 5.9% in comparable
transaction counts and an increase of 12.6% in average purchase size in units,
our average unit retail price point was 19.0% lower as compared to the same
period last year.
Gross profit was $76.2 million for the 26 weeks ended August 2, 2003 compared to
$82.2 million for the same period last year, a decrease of $6.0 million or 7.3%.
As a percentage of net sales, gross profit was 33.4% for the 26 weeks ended
August 2, 2003 versus 33.5% for the same period last year. Compared to the first
six months of last year, our cumulative initial mark-up was lower by
approximately 200 basis points as a result of lower retail price points, and our
distribution costs were approximately 90 basis points higher due to the start-up
of the new distribution center. The effect of these unfavorable variances was
substantially offset by the favorable adjustment to the inventory valuation
allowance that we recorded during the first quarter.
Selling and administrative expenses were $87.5 million for the 26 weeks ended
August 2, 2003 compared to $95.9 million for the same period last year, a
decrease of $8.4 million or 8.7%. The decrease in selling and administrative
expenses was primarily a result of (1) fewer stores in operation during the
current period, (2) reduced consulting and legal fees, (3) non-recurring income
of $708,000 recorded in conjunction with the foreclosures of certain stock
subscription notes during the first quarter, and (4) a charge of $2.1 million
related to a legal settlement recorded in the second quarter last year.
Excluding the non-recurring income of $708,000 and the legal settlement charge
of $2.1 million, selling and administrative expenses, as a percentage of net
sales, were 38.7% and 38.3% for the 26 weeks ended August 2, 2003 and August 3,
2002, respectively. The increase in selling and administrative expenses as a
percentage of net sales was primarily due to the loss of sales volume leverage.
Pre-opening and closing expenses were $221,000 for the 26 weeks ended August 2,
2003 compared to $703,000 for the same period last year, a decrease of
approximately $482,000 or 68.6%. The decrease in pre-opening and closing
expenses was due to the opening of six fewer new stores during the current
26-week period versus the same period last year, and the start-up expenses
incurred for our new distribution center.
8
Interest expense, net was $1.6 million for the 26 weeks ended August 2, 2003
compared to $568,000 for the 26 weeks ended August 3, 2002, an increase of $1.0
million or 176.2%. The increase in interest expense from the same period last
year was primarily due to increased borrowings and higher interest rates.
We recorded an income tax benefit of $5.0 million for the 26 weeks ended August
2, 2003 compared to $6.0 million for the 26 weeks ended August 3, 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 26 weeks ended August 2, 2003, the net loss was $8.1 million as compared
to $9.0 million for the 26 weeks ended August 3, 2002. The decrease in net loss
was a result of 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.
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 2,515,379 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. On August 20, 2003, we sold
2,450,000 shares of common stock at $5.00 per share to accredited investors and
received approximately $11.6 million in net proceeds, after deducting the
placement fees and other expenses.
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.
9
At August 2, 2003, we were in compliance with all financial covenants, as
defined, and had outstanding borrowings of $17.9 million and letters of credit
of $12.5 million under our revolving credit facility. In addition, based on
eligible inventory and accounts receivable, we were eligible to borrow $49.8
million under our revolving credit facility and had $11.9 million available for
future borrowings after giving effect for the $7.5 million availability block,
as defined.
With respect to cash flows for the 26-week period ended August 2, 2003, we used
$18.5 million in operating activities, $3.2 million in investing activities and
generated $24.6 million from financing activities, which resulted in a net
increase in cash of $2.9 million. For the same period last year, we used $11.1
million in operating activities, $5.1 million in investing activities and
generated $6.3 million from financing activities, which resulted a net decrease
in cash of $9.9 million. The increase in cash used in operating activities was
primarily due to replenishment of inventory. The decrease in cash used in
investing activities was primarily due to fewer new store openings and
completion of our new distribution center. 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 loans.
Capital Expenditures
We anticipate capital expenditures of approximately $1.0 million for the second
half of the current fiscal year ending January 31, 2004, primarily in connection
with 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 September 10, 2003, we had closed 16 of the 23 stores identified in our
Fiscal 2002 restructuring efforts, as well as completed the consolidation of our
corporate overhead structure. For the remaining seven stores, we have decided to
continue to operate four of these stores as a result of entering into amendments
to the leases with the landlords; and we plan to close the other three stores by
January 2004. In addition, we had completed the consolidation of our two former
San Diego distribution centers into the new distribution facility, which is also
located in San Diego, California. We estimate the cash requirement for the
remainder of this current fiscal year for the Fiscal 2002 restructuring efforts
will be approximately $2.5 million, which we intend to fund from our sources of
cash, including the revolving credit facility.
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 $828,000, which we intend to fund from our sources of cash,
including the revolving credit facility.
10
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
August 2, 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 Debt" in the accompanying
unaudited financial statements, as well as our fiscal 2002 Annual Report on Form
10-K/A as filed with the Securities and Exchange Commission.
(in thousands)
--------------
Revolving Junior
Credit Subordinated Junior Secured Operating Restructuring
Facility Notes Term Loans Leases Charges* Total
--------- ------------ -------------- --------- ------------- -----
Fiscal Year:
2003 (remaining
6 months) $ - $ 3,000 $ 500 $ 15,258 $ 3,324 $ 22,082
2004 - 3,000 7,000 28,034 6,189 44,223
2005 - 5,300 - 25,103 - 30,403
2006 17,949 - - 18,942 - 36,891
2007 - - - 13,869 - 13,869
Thereafter - - - 44,484 - 44,484
-------- --------- --------- --------- ---------- ---------
$17,949 $ 11,300 $ 7,500 $ 145,690 $ 9,513 $ 191,952
-------- --------- --------- --------- ---------- ---------
* 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 August 2, 2003,
our long-term debt had a face value of $11.3 million with a net carrying value
of $9.9 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 August 2, 2003.
11
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.
12
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/A as filed with the
Securities and Exchange Commission, in April 2003, Lynda Bray and
Masis Manougian, two of our then 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.
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 Bray Lawsuit and we are vigorously
defending against it.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
13
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit
31.1 Certification pursuant to Rule 13a-14(a) and 15d-14(a) of
the Securities Exchange Act of 1934, as amended, by
William R. Fields, Chief Executive Officer.
31.2 Certification pursuant to Rule 13a-14(a) and 15d-14(a) of
the Securities Exchange Act of 1934, as amended, by
Douglas C. Felderman, Executive Vice President and
Chief Financial Officer.
32.1 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.
32.2 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.
(b) Reports on Form 8-K
Item 5:
On August 13, 2003, we filed a report on Form 8-K regarding
the termination of employment of the Company's former
Executive Vice President and General Merchandising Manager
effective August 11, 2003.
Item 9:
On August 21, 2003, we furnished a report on Form 8-K
regarding the announcement of our definitive agreement with
institutional investors to sell 2,450,000 shares of common
stock at $5.00 per share. The full text of our press release
dated August 20, 2003 was attached as exhibit to the Form 8-K.
Item 12:
On August 7, 2003, we furnished a report on Form 8-K regarding
the announcement of sales for the four-week, 13-week and
26-week periods ended August 2, 2003. The full text of our
press release dated August 6, 2003 was attached as exhibit to
the Form 8-K.
On August 14, 2003, we furnished a report on Form 8-K
regarding the announcement of operating results for the
13-week and 26-week periods ended August 2, 2003. The full
text of our press release dated August 13, 2003 was attached
as exhibit to the Form 8-K.
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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: September 16, 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)
15