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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal period ended January 30, 1999 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period to__________
Commission File number 0-16309
FACTORY 2-U STORES, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 51-0299573
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
incorporation or Organization)
4000 Ruffin Road 92123
San Diego, California
(Address of Principal Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (619) 627-1800
Securities registered pursuant to Section 12(b)
of the Act:
Title of each class Name of each exchange on which registered
_______________________________________________________________________________
Common Stock, $0.01 par value None
Securities registered pursuant to Section 12(g)
of the Act:
Common Stock, $0.01 par value
(Title of Class)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or fore such shorter period that
the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
YES X NO ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained,
to be best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [X]
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a
plan confirmed by a court.
YES X NO ___
At April 3, 1999 the aggregate market value of the voting stock of the
Registrant held by non-affiliates was approximately $85,510,683.
At April 3, 1999 the Registrant had outstanding 12,106,348 shares of
Common Stock, $0.01 par value per share.
________________________________________________________________________________
________________________________________________________________________________
FORM 10-K INDEX
PART I
Item 1. Business 3
Item 2. Properties 7
Item 3. Legal Proceedings 7
Item 4. Submission of Matters to a Vote of Security Holders 8
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 8
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10
Item 8. Financial Statements and Supplementary Data 18
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 19
PART III
Item 10. Directors and Executive Officers of the Registrant 19
Item 11. Executive Compensation 19
Item 12. Security Ownership of Certain Beneficial Owners and Management 19
Item 13. Certain Relationships and Related Transactions 19
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. 19
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PART I
Item 1. BUSINESS
THE COMPANY
Factory 2-U Stores, Inc., which was previously named Family Bargain
Corporation (the "Company"), at January 30, 1999 operated 168 off-price retail
apparel and housewares stores under the names Family Bargain Center and Factory
2-U in Arizona, California, Nevada, New Mexico, Oregon, Texas and Washington.
Prior to July 31, 1998, the Company operated through its wholly-owned
subsidiaries, General Textiles and Factory 2-U, Inc. The Company acquired
General Textiles in 1993, while General Textiles was operating under Chapter 11
of the U.S. Bankruptcy Code and acquired Factory 2-U, Inc. in November 1995.
On July 31, 1998, the Company merged General Textiles and Factory 2-U, Inc.
into General Textiles, Inc. On November 23, 1998, the Company merged General
Textiles, Inc. into itself in a transaction in which (i) the previous three
classes of the Company's stock were converted into a single class of Common
Stock and (ii) the Company's name was changed from Family Bargain Corporation to
Factory 2-U Stores, Inc. (the "Recapitalization").
The Company's 168 stores average 13,300 total square feet and are located
mostly in strip centers. Products include a broad range of family apparel,
domestic goods and housewares. Typical customers of the Company are families
with below average income, who generally are profiled as discount store
shoppers. The Company's merchandising strategy is to offer first quality
recognizable national and discount store brands at a substantial discount,
generally 20% to 50% below that offered by the national discount chains. The
stores are well-lit and present the merchandise primarily on hanging fixtures.
In-store signage emphasizing the savings is strategically placed throughout the
stores, creating increased customer awareness.
OPERATIONS
OPERATING STRATEGY
The Company seeks to be the leading off-price apparel, domestic goods and
housewares retailer to families with below average incomes in the markets it
serves. The major elements of its operating strategy include:
Provide Value to Customers on National and Discount Brand Merchandise: The
Company emphasizes providing value to its customers by providing merchandise
found in national discount chains at savings between 20% and 50% from prices
offered by the national discount chains. The Company buys excess supplies of
recognized brands at bargain prices and passes along the savings to the
customer.
Target Under-Served Market Segments: The Company's stores target customers
who are under-served in their markets. Typical customers are young families with
below average incomes.
Maximize Inventory Turns: The Company emphasizes inventory turn in its
merchandise and marketing strategies. Merchandise presentation, an everyday low
price strategy, frequent store deliveries and advertising programs all target
rapid inventory turn, which management believes leads to increased profits and
efficient use of capital.
3
EXPANSION PLANS
Opening of New Stores: The Company plans to increase its store count by 20 to 25
stores in the fiscal year ending January 29, 2000 (fiscal 1999). The new stores
are planned for markets in which the Company currently operates. During fiscal
1998, the Company opened 7 new stores and closed 5 stores. During the period
from January 30, 1999 through April 3, 1999, 3 stores closed and 3 new stores
were opened. Average store opening costs for equipment, fixtures, leasehold
improvements and preopening expenses are approximately $215,000. Average initial
inventory for a new store is approximately $300,000. Generally, during the two
to three month grand opening period, a new store achieves sales in excess of
sales of an average comparable mature store and, within six months, generates
sales consistent with comparable mature store levels.
Renovation and Relocation Program: The Company plans to renovate and relocate
stores; relocation will be considered as superior sites become available in
their markets. Store renovations generally include installing new fixtures,
redesigning layouts and refurbishing floors and walls. The cost to renovate or
relocate a store is approximately $50,000 and $175,000, respectively. During
fiscal 1998, the Company renovated 51 stores and relocated 1 store. The Company
plans to change the name of all stores to Factory 2-U by the end of the first
quarter of fiscal 2000.
BUYING AND DISTRIBUTION
The Company purchases merchandise from domestic manufacturers, jobbers,
importers and other vendors. Payment terms are typically net 30 days. The
Company continually adds new vendors and does not maintain long-term or
exclusive purchase commitments or agreements with any vendor. Management
believes that there are a substantial number of additional sources of supply of
first quality, national and discount brand merchandise that will meet its
increased inventory needs as the Company grows.
In-Season Goods. Unlike traditional department stores and discount retailers,
which primarily purchase merchandise in advance of the selling season (for
example, back-to-school clothing is purchased by March), the Company purchases
approximately 70% of its merchandise in-season (i.e., during the selling
season). In-season purchases generally represent closeouts of vendors' excess
inventories remaining after the traditional wholesale selling season and are
often created by other retailers' order cancellations. Sometimes vendors
manufacture to meet anticipated demand rather than known demand, knowing the
Company is a potential buyer of the excess. Such merchandise is typically
available at prices below wholesale. Management believes that such in-season
buying practices are well suited to the Company's customers, who tend to make
purchases on an as-needed basis later into a season. The Company's in-season
buying practice is facilitated by its ability to process and ship merchandise
through its distribution center to its stores, usually within two or three days
of receipt from the vendor, and to process a large number of relatively small
purchase orders. Management believes that the Company is a desirable customer
for vendors seeking to liquidate inventory because it can take immediate
delivery of large quantities of in-season goods. Furthermore, the Company rarely
requests markdown concessions, advertising allowances or special shipping and
packing procedures, insisting instead on the lowest possible price. It passes
these low prices on to its customers.
Manufacturers ship goods directly to the Company's San Diego distribution center
or, in the case of East Coast vendors, to the Company through its East Coast
freight consolidator. Goods received at the Company's warehouse are generally
shipped to its stores using independent trucking companies within two to three
days of their arrival. The Company generally does not store goods from season to
season at its warehouse. An auxiliary warehouse is scheduled to go into service
in the summer of 1999. That warehouse will be used in conjunction with the
current facility to ticket all merchandise prior to
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shipment to the stores.Ticketing is now done at each store and the change
in ticketing procedure is expected to create greater efficiency.
MERCHANDISING AND MARKETING
The Company's merchandise selection, pricing practices and store formats are
designed to reinforce the concept of value and maximize customer enjoyment of
the shopping experience. The Company's stores offer their customers a diverse
selection of primarily first quality, in-season merchandise at prices which
generally are lower than those of competing discount and off-price stores in
their local markets. Nearly all of their merchandise carries brand name labels,
including nationally recognized brands.
The Company delivers new merchandise to its stores at least once per week to
encourage frequent shopping trips by its customers and to maximize the rate of
inventory turn. As a result of its purchasing practices, store inventory may not
always include a full range of colors, sizes and styles in a particular item.
Management believes, however, that price, quality and product mix is more
important to the Company's customers than the availability of a specific item at
a given time.
The Company emphasizes inventory turn in its merchandising and marketing
strategy. Merchandise presentation, pricing below discounters, frequent store
deliveries, staggered vendor shipments, promotional advertising, store-tailored
distribution and prompt price reductions on slow moving items all target rapid
inventory turn. The Company believes that the pace of its inventory turn leads
to increased profits, reduced inventory markdowns, efficient use of capital and
customer urgency to make purchase decisions.
The Company's administrative headquarters receives daily store sales and
inventory information from point-of-sale computers located at each of its
stores. This data is reported by stock keeping unit (or "SKU"), permitting
management to tailor purchasing and distribution decisions. A chain-wide
computer network also facilitates communications between the administrative
headquarters and stores, enabling management to provide store management with
immediate pricing and distribution information.
The Company's stores are characterized by easily accessible merchandise
displayed on hanging fixtures and open shelves in well-lighted stores. Prices
are clearly marked, usually displayed in whole dollars. A comparative
retail-selling price is often noted on price tags. The Company's major
advertising vehicle is the use of a full-color print tab showing actual photos
of its merchandise. Print media is delivered to the consumers in newspaper
inserts and marriage-mail drops. Other advertising programs include radio and
outdoor promotional activities.
The Company's stores emphasize customer satisfaction to develop customer loyalty
and generate repeat sales. If a customer is not completely satisfied with any
purchase, the Company's stores will make a full refund or exchange. Most sales
are for cash, although checks, debit and credit cards are accepted. The Company
does not issue its own credit card, but does offer a layaway program. The
layaway program is an important means for the Company's customers, many of whom
do not possess credit cards, to purchase goods over time.
Approximately 60% of the Company's sales occur in its third and fourth
quarters, during the back-to-school (August and September) and Christmas
(November and December) seasons. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations -- Seasonality and Quarterly
Fluctuations."
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THE STORES
As of April 3, 1999 the Company operated 168 stores located in seven western
states. Stores are primarily located in rural and lower income suburban
communities and, to a lesser extent, in metropolitan areas. Most stores are
located in strip shopping centers, where occupancy costs are most favorable. As
of January 30, 1999, the number of store locations was as follows:
STRIP
STATE CENTER DOWNTOWN OTHER TOTAL
California 74 13 6 93
Arizona 27 4 0 31
Washington 12 2 2 16
New Mexico 8 0 1 9
Nevada 7 0 0 7
Oregon 7 0 1 8
Texas 3 1 0 4
138 20 10 168
The stores range in size from 5,000 square feet to 35,000 square feet, averaging
13,300 square feet. Management continually reviews the ability of stores to
provide positive contributions to the Company's operating results and may elect
to close stores that do not meet performance criteria. Costs associated with
closing stores, consisting primarily of the recognition of remaining lease
obligations and provisions to re-value assets to net realizable value, are
charged to operations during the fiscal year in which the commitment is made to
close a store.
The Company's stores typically employ one store manager, two assistant store
managers, and seven to ten sales associates, most of whom are part-time
employees. New store managers are trained in all aspects of store operations
through a management-training program. Other store personnel are trained on
site. The Company often promotes experienced assistant store managers to fill
open manager positions.
The Company's store management team participates in a bonus plan in which they
are awarded bonuses upon achieving plan objectives. The Company believes that
the bonus program is an important incentive for its key employees, helps reduce
employee turnover and lowers costs.
The Company generally leases previously occupied store sites on terms that it
believes are more favorable than those available for newly constructed
facilities. After the Company signs a store lease, a store opening team prepares
the store for opening by installing fixtures, signs, racks, dressing rooms,
checkout counters, cash register systems and other items. The district manager
and store manager arrange the merchandise according to the standard store layout
and train new personnel before and after the store is opened. The Company
selects store sites based on demographic analysis of the market area, sales
potential, local competition, occupancy expense, operational fit and proximity
to existing store locations. Store opening preparations generally take up to
three weeks.
The Company maintains commercial liability, fire, theft, business interruption
and other insurance policies.
COMPETITION
The Company operates in a highly competitive marketplace. The Company's stores
compete with large discount retail chains such as Wal-Mart, K-Mart, Target and
Mervyn's, and with regional off-price chains, such as MacFrugal's, some of which
have substantially greater resources than the Company. They also compete with
independent and small chain retailers and flea markets (also known as "swap
6
meets") which serve the same low and low-middle income market as the Company.
Management believes that the principal competitive factors in the Company's
markets are price, quality and site location and that the Company is well
positioned to compete on the basis of these factors.
EMPLOYEES
As of April 3, 1999 the Company employed 3,222 people, of whom 2,916 were store
employees and store field management (1,014 of whom were part-time), 228 were
executives and administrative employees and 78 were warehouse employees. None of
the Company's employees is subject to collective bargaining agreements and
management considers its relations with its employees to be good.
TRADEMARKS
Except for the trade names "Family Bargain Center" and "Factory 2-U", which are
federally registered trademarks, the Company does not have any material
trademarks.
GOVERNMENT REGULATION
The Company's operations are subject to various federal, state and local laws,
regulations and administrative practices affecting its business, including laws
and regulations relating to equal employment and minimum wages. The Company
believes it is in substantial compliance with all federal, state and local laws
and regulations governing its operations and has obtained all material licenses
and permits required for the operation of its business. The Company believes
that the compliance burdens and risks relating to such laws and regulations do
not have a material adverse effect on the Company.
ITEM 2. PROPERTIES
As of April 3, 1999 the Company operated 168 retail stores located in Arizona,
California, Nevada, New Mexico, Oregon, Texas and Washington, under various
operating leases with third parties. The leases are separately negotiated and
are generally not uniform. The store locations include strip centers, downtown
business districts, and stand alone sites. Typical lease terms are for five
years with renewal options in five year increments. Approximately two-thirds of
the leases are "triple net leases" under which the Company is required to
reimburse landlords for insurance, real estate taxes and common area maintenance
costs. Some leases require the Company to pay a minimum monthly rent and a
percentage of sales in excess of a specified sales level. The current annual
rent expense for the 168 stores open at January 30, 1999 is approximately $18.2
million.
The Company's headquarters are located in a 269,000 square foot multi-use
facility at 4000 Ruffin Road, San Diego, California. This facility consists of
37,000 square feet of office space, an 8,000 square foot retail store and a
224,000 square foot warehouse and distribution center. This facility is leased
for a term expiring in September 2005. The lease provides for annual base rent
at an average of approximately $1.5 million over the lease term.
ITEM 3. LEGAL PROCEEDINGS
The Company is at all times subject to pending and threatened legal actions that
arise in the normal course of business. In the opinion of management, based in
part on the advice of legal counsel, the
7
ultimate disposition of these matters will not have a material adverse
effect on the financial position or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
a. The Company's Annual Meeting of stockholders was held on November 23, 1998.
b. The directors elected at the meeting were as follows:
VOTES VOTES
FOR AGAINST WITHHELD
DIRECTOR
Peter V. Handal 17,307,936 0 80,028
Ronald Rashkow 17,307,936 0 80,028
Wm. Robert Wright II 17,307,936 0 80,028
Michael Searles 17,307,936 0 80,028
Other directors whose terms of office continued after the meeting are as
follows: James D. Somerville, John J. Borer III, Ira Neimark, H. Whitney Wagner,
and Thomas G. Weld. Mr. Weld resigned as a director effective November 29, 1998.
c. Other matters voted on at the meeting and the results of those votes were as
follows:
Approval of the merger of General Textiles, Inc. into Family Bargain
Corporation
VOTES FOR: 17,525,212
VOTES AGAINST: 427,924
ABSTENTIONS: 28,103
Approval of the Amended and Restated Family Bargain Corporation 1997 Stock
Option Plan
VOTES FOR: 15,230,843
VOTES AGAINST: 413,516
ABSTENTIONS: 38,858
Ratification of Arthur Andersen LLP as independent accountants
VOTES FOR: 17,149,751
VOTES AGAINST: 25,423
ABSTENTIONS: 9,355
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Pursuant to the plan of recapitalization approved by the Company's stockholders
on November 23, 1998 (the "Plan of Recapitalization"), the Company's stock was
converted into a single class of Common Stock. Each share of common stock prior
to the Recapitalization ("Pre-Recapitalization Common Stock") was converted into
.30133 shares of Post-Recapitalization Common Stock, each share of Series A
Cumulative Convertible Preferred Stock (the "Series A Preferred Stock") was
8
converted into one share of Post-Recapitalization Common Stock and each share of
Series B Junior Convertible, Exchangeable Preferred Stock (the "Series B
Preferred Stock") was converted into 173.33 shares of Post-Recapitalization
Common Stock. Immediately following the Recapitalization, the Company had
11,306,000 shares of Common Stock outstanding.
Prior to the Recapitalization, the Company's then Common Stock and its Series A
Preferred Stock were quoted on the Nasdaq SmallCap Market. The table below sets
forth certain information with respect to the high and low closing bid prices
(rounded to the nearest hundredth) of the Company's Common Stock and Series A
Preferred Stock during the years ended January 31, 1998 (fiscal 1997) and
January 30, 1999 (fiscal 1998), and the subsequent interim period, as quoted by
Nasdaq. The market prices of the Common Stock have been adjusted to give
retroactive effect to the conversion of Pre-Recapitalization Common Stock into
Common Stock, i.e., the prices are per share of Post-Recapitalization Common
Stock. The market prices after November 23, 1998 are the actual prices of the
current Common Stock. The quotations below represent inter-dealer prices without
retail markups, markdowns or commissions and may not be representative of actual
transactions.
SERIES A
COMMON STOCK PREFERRED STOCK
HIGH LOW HIGH LOW
FISCAL 1997
First Quarter $10.25 $ 6.64 $ 9.38 $ 7.75
Second Quarter $ 9.13 $ 5.41 $ 9.00 $ 8.00
Third Quarter $ 6.44 $ 1.66 $ 8.44 $ 6.69
Fourth Quarter $ 5.81 $ 3.32 $ 7.94 $ 6.25
FISCAL 1998
First Quarter $10.58 $ 4.25 $ 9.62 $ 7.13
Second Quarter $11.10 $ 7.47 $10.13 $ 8.13
Third Quarter $ 9.54 $ 5.39 $ 8.50 $ 5.50
Fourth Quarter (to November 23, 1998) $ 7.16 $ 5.60 $ 7.38 $ 5.56
Fourth Quarter (after November 23, 1998) $12.63 $ 6.81 Not Not
Applicable Applicable
FISCAL YEAR ENDING JANUARY 29, 2000
FIRST QUARTER (THROUGH APRIL 3, 1999) $12.50 $11.38 Not Not
Applicable Applicable
As of January 30, 1999, the number of record holders of Common Stock was
approximately 303. This number does not include an indeterminate number of
stockholders whose shares are held by financial institutions in "street name."
The Company has estimated beneficial holders of its Common Stock to be more than
2000.
Until the Recapitalization, the Company paid quarterly dividends of $0.2375 per
share on its Series A Preferred Stock (aggregating $2,593,000 for fiscal 1998).
The Company did not pay cash dividends on its Pre-Recapitalization Common Stock
and does not anticipate paying cash dividends on its Common Stock in the
foreseeable future. The declaration and payment of any cash dividends on its
Common Stock in the future will be determined by the Board of Directors in light
of conditions then existing, including the Company's earnings, financial
condition and cash requirements.
The Company recorded non-cash dividends on the Series B Preferred Stock using
the effective interest method to recognize the dividend ratably over the
estimated period in which the Series B Preferred
9
Stock was to be outstanding. For fiscal 1998, such accreted dividends
totaled approximately $2,210,000. See Note 11 to Financial Statements.
ITEM 6. SELECTED FINANCIAL DATA
Set forth below is selected financial data for the Company. All of the selected
financial data, except for Operating Data, is derived from audited financial
information. The selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Financial Statements and Supplementary Data."
(in thousands, except per share and operating data)
FISCAL YEAR ENDED
JANUARY 30, JANUARY 31, FEBRUARY, JANUARY 27, JANUARY 28,
1999 1998 1997(1) 1996 1995
Statement of Operations Data
Net sales $ 338,223 $ 300,592 $ 252,165 $ 179,820 $ 146,520
Operating income (loss) 10,464 5,097 (27,939) 5,153 2,608
Income (loss) from continuing operations 5,019 (129) (36,564) 1,478 (354)
Net income (loss) 2,269 (129) (37,390) 978 2,656
Dividends on series A preferred stock 2,593 3,456 3,509 3,040 2,030
Dividends on series B preferred stock 2,210 2,661 - - -
Inducement to convert preferred stock to
common stock 2,804 - - - -
Net income (loss) applicable to common stock (5,338) (6,246) (40,899) (2,062) 626
Weighted average shares outstanding 3,381 1,479 1,358 1,207 1,208
Loss before extraordinary loss and
discontinued operations applicable to
common stock (0.77) (4.23) (29.50) (1.29) (1.96)
Net income (loss) per common share(2) (1.58) (4.23) (30.12) (1.71) 0.52
Diluted net income (loss) per common share(2) (1.58) (4.23) (30.12) (1.71) 0.23
Operating Data
Number of stores 168 166 150 131 97
Total selling square footage 1,804,000 1,788,000 1,567,000 1,367,000 867,000
Sales per selling square foot 192 180 172 161 187
Comparable store sales growth 10.9% 3.4% 5.3% 2.8% 0.9%
Balance Sheet Data
Working capital (deficit) $ (7,430) $ (2,749) $ 248 $ 4,314 $ 10,098
Total assets 90,167 84,817 80,669 87,152 59,905
Long-term debt and revolving credit notes,
including current portion 13,773 29,076 37,894 30,120 17,267
Stockholders' equity 27,765 17,218 11,208 27,717 29,812
Notes to Selected Financial Data
(1) 53 weeks.
(2) In December 1997, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 128, "Earnings Per Share". The statement specifies the
computation, presentation, and disclosure requirements for earnings per share
(EPS) and diluted earnings per share (DEPS). The statement requires retroactive
adoption for all prior periods presented. Additionally, all prior periods
presented have been restated giving effect to the reverse stock split that was
authorized during the fourth quarter of fiscal 1998.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
information set forth under "Selected Financial Data" and "Financial Statements
and Supplementary Data."
10
GENERAL
During the past three fiscal years, a number of events occurred which have had a
significant impact on the financial condition of the Company and its
subsidiaries.
On July 31, 1998, the Company's two operating subsidiaries, General Textiles and
Factory 2-U, Inc., merged to form General Textiles, Inc.
On November 23, 1998, the Company carried out a Recapitalization in which all of
the Company's stock was converted into a single class of Common Stock. Under the
Plan of Recapitalization, each share of Pre-Recapitalization Common Stock was
converted into .30133 shares of Common Stock, each share of Series A Preferred
Stock was converted into one share of Common Stock and each share of Series B
Preferred Stock was converted into 173.33 shares of Common Stock. In connection
with the Recapitalization, General Textiles, Inc. was merged into Family Bargain
Corporation (the "Family Bargain Merger") and the Company's name was changed to
Factory 2-U Stores, Inc.
Immediately after the Recapitalization, the Company had 11,306,000 shares of
Common Stock outstanding. An investment group (the "TCR Investors") advised by
Three Cities Research, Inc. ("TCR") owned approximately 50% of these shares.
Immediately after the Recapitalization, the Company undertook a rights offering
under which it issued to its stockholders transferable rights to purchase an
additional 800,000 shares of Common Stock for $13.00 per share. Three TCR
Investors agreed to purchase any shares as to which rights were not exercised.
In total, the TCR Investors purchased 798,075 shares as a result of the rights
offering, increasing their ownership to 53%.
In January 1997, the TCR Investors advised by TCR purchased a controlling equity
interest in the Company by acquiring all of the Common and Series A Preferred
Stock held by the former chairman, vice chairman and chief executive officer of
the Company (the "Former Executives") and purchasing from the Company 22,000
shares of newly authorized Series B Preferred Stock. Subsequent to the close of
fiscal 1996, the Company sold an additional 11,715 shares of the Series B
Preferred Stock to TCR Investors, directors and management of the Company.
In connection with the change in control, three former directors resigned from
the Board of Directors and three managing directors of TCR were appointed to
serve on the Company's Board. The person then serving as President and Chief
Executive Officer of the Company's two operating subsidiaries, who was a
director of the Company, was appointed President and Chief Executive Officer of
the Company. In February 1997, the Company's Board of Directors elected three
new directors, one of whom was elected Chairman of the Board of Directors. In
August 1997, the President and Chief Executive Officer of the Company resigned
from all positions with the Company. In March 1998, the Company appointed a new
President and Chief Executive Officer of its operating subsidiaries. He was
elected a member of the Board of Directors of the Company in March 1998.
During fiscal 1998 and 1997, the Company's operational focus was on improving
the operating performance of existing stores.
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RESULTS OF OPERATIONS
The Company defines its fiscal year by the calendar year in which most of the
activity occurs (e.g. the year ended January 30, 1999 is referred to as fiscal
1998). The following table sets forth selected statement of operations data
expressed as a percentage of net sales for the periods indicated:
FISCAL YEAR 1998 1997 1996
--------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------
Net sales 100.0% 100.0% 100.0%
Cost of sales 65.7 67.7 70.6
-------------------------------------------
Gross profit 34.3 32.3 29.4
Selling and administrative expenses 29.5 29.3 32.0
Amortization of intangibles 0.7 0.7 0.8
Special charges 0.7 0.6 3.6
Merger costs 0.3 - -
Provision for goodwill impairment - - 3.3
Write off of deferred offering costs - - 0.8
-------------------------------------------
Operating income (loss) 3.1 1.7 (11.1)
Interest expense 1.2 1.7 3.4
-------------------------------------------
Income (loss) from continuing operations
before income taxes 1.9 (0.0) (14.5)
Income taxes (0.4) - -
Discontinued operations, net of income tax benefit - - (0.3)
Extraordinary loss, net of income tax benefit (0.8) - -
--------------------------------------------
Net income (loss) 0.7 0.0 (14.8)
Inducement to convert preferred stock to
Common Stock (0.9) - -
Preferred dividends (1.4) (2.1) (1.4)
Net loss applicable to common stock (1.6%) (2.1%) (16.2%)
--------------------------------------------
12
FISCAL 1998 COMPARED TO FISCAL 1997
As of January 30, 1999, the Company operated 168 stores compared to 166 as of
January 31, 1998.
Net sales were $338.2 million for fiscal 1998 compared to $300.6 million for
fiscal 1997, an increase of $37.6 million or 12.5%. Comparable store sales
increased 10.9% in fiscal 1998 over the same period of the prior year.
Gross profit was $ 115.9 million for fiscal 1998 compared to $97.1 million for
fiscal 1997, an increase of $18.8 million. As a percentage of sales, gross
profit was 34.3% in fiscal 1998 compared to 32.3% in fiscal 1997. The increase
in gross profit as a percentage of sales was primarily attributable to a lower
inventory shrinkage and higher markups, partially offset by higher markdowns in
fiscal 1998 compared to fiscal 1997.
Selling and administrative expenses were $99.7 million for fiscal 1998 compared
to $88.0 million for fiscal 1997, an increase of $11.7 million. As a percentage
of sales, selling and administrative expenses were 29.5% for fiscal 1998
compared to 29.3% in fiscal 1997. The increase in selling and administrative
expenses as a percentage of sales was primarily a result of higher store wage
rates, due in part to an increase in the minimum wage, and increased
administrative support expenses.
Amortization of intangibles was $2.4 million for fiscal 1998 compared to $2.2
million for fiscal 1997, an increase of $0.2 million. The increase is
attributable to a non-compete agreement with the former President and CEO. In
January 1997, the Company's principal executive officers, who were its largest
stockholders, sold their stock interest, resigned from their positions as
officers and directors and, among other things, entered into an agreement not to
compete with the Company until June 2000 in return for $1.8 million in secured
promissory notes, that were paid in January 1998. In August 1997, the former
President and CEO entered into an agreement not to compete with the Company
until January 2001 in return for payments totaling $970,000.
The special charge of $2.4 million in fiscal 1998 represents various expenses
incurred in connection with hiring the current President and CEO of the Company.
In fiscal 1997, a charge of $1.8 million was incurred when the Former President
and CEO resigned. At the end of fiscal 1998, future payments totaling $1.2
million related to these special charges were included in accrued liabilities.
Interest expense was $4.2 million in fiscal 1998 compared to $5.2 million in
fiscal 1997, a decrease of $1.0 million. The decrease was attributable to
decreases in the amortization of debt discount related to the exchange of the
subordinated and junior subordinated notes for new notes (see Liquidity and
Capital Resources).
Federal and state income taxes of $1.3 million were accrued in fiscal 1998,
representing the tax provision as calculated in accordance with SFAS No. 109. In
1997, no provision was required due to net operating losses. The Company
anticipates that operations in 1999 will also create taxable income.
An extraordinary charge of $2.8 million was incurred in fiscal 1998 because
notes payable associated with the General Textiles bankruptcy were extinguished
and new notes were issued with terms that the Company believes are more
favorable to it which had lower discounts than had previously been recorded (see
Liquidity and Capital Resources - Bankruptcy Debt of General Textiles).
Net income before dividends was $2.3 million in fiscal 1998 compared to a net
loss before dividends of $0.1 million in fiscal 1997. Total dividends were $4.8
million in fiscal 1998 and $6.1 million in fiscal 1997. That included fiscal
1998 non-cash dividends on the Series B Preferred Stock of $2.2 million compared
to $2.6 million in fiscal 1997. Additionally, in fiscal 1998, the Company
recognized an inducement charge of $2.8 million in connection with conversion of
Series A Preferred Stock to Post-Recapitalization Common Stock. The lower
dividends in 1998 were due to the Recapitalization
13
discussed above (see also Liquidity and Capital Resources). The net loss
applicable to common stock was $5.3 million in fiscal 1998 compared to a net
loss applicable to common stock of $6.2 million in fiscal 1997.
FISCAL 1997 COMPARED TO FISCAL 1996
Fiscal 1997 was a 52 week year and fiscal 1996 was a 53 week year. For purposes
of determining comparable store sales, fiscal 1996 was adjusted to reflect a
comparable 52 week year. As of January 31, 1998, the Company operated 166 stores
compared to 150 as of February 1, 1997.
Net sales were $300.6 million for fiscal 1997 compared to $252.2 million for
fiscal 1996, an increase of $48.4 million. Comparable store sales increased $7.7
million, or 3.4%, in fiscal 1997.
Gross profit was $97.1 million for fiscal 1997 compared to $74.1 million in
fiscal 1996, an increase of $23.0 million. The increase in gross profit was due
to the opening of new stores, an increase in comparable store sales and an
increase in gross profit as a percentage of sales. As a percentage of sales,
gross profit was 32.3% in fiscal 1997 compared to 29.4% in fiscal 1996. The
increase in gross profit as a percentage of sales was a result of a lower
inventory shrinkage and higher initial markups in fiscal 1997 compared to fiscal
1996.
Selling and administrative expenses were $88.0 million for fiscal 1997 compared
to $80.6 million for fiscal 1996, an increase of $7.4 million. As a percentage
of sales, selling and administrative expenses were 29.3% for fiscal 1997
compared to 32.0% in fiscal 1996. The decrease in selling and administrative
expenses as a percentage of sales was primarily attributable to moving the
Company's executive offices from New York City to San Diego and economies
associated with increased sales volume.
Amortization of intangibles consists of amortization of excess of cost over net
assets acquired and agreements not to compete. The noncompete agreements are the
result of two transactions discussed in the comparison of fiscal 1998 to fiscal
1997.
The Company recognized special charges to operations in the aggregate amount of
$1.8 million in fiscal 1997 and $9.2 million during fiscal 1996. The fiscal 1997
amount pertains to the separation from the Company of the then President and
CEO, whereas the fiscal 1996 charges relate to terminating contracts with the
former principal executive officers and closure of the former executive offices
in New York City in connection with the change in control. At the end of fiscal
1997, future payments totaling $1.6 million related to these special charges
were included in accrued liabilities.
Interest expense was $5.2 million in fiscal 1997 compared to $8.6 million for
fiscal 1996, a decrease of $3.4 million. The decrease was attributable to
decreases in the amortization of debt discount related to the Bankruptcy Debt of
General Textiles (see Liquidity and Capital Resources).
There were no discontinued operations in fiscal 1997 compared to a loss from
discontinued operations of $0.8 million in fiscal 1996.
The net loss before dividends was $0.1 million in fiscal 1997 compared to a net
loss before dividends of $37.4 million in fiscal 1996. Total dividends were $6.1
million in fiscal 1997 and $3.5 million in fiscal 1996. This included non-cash
dividends on the Series B Preferred Stock in fiscal 1997 of $2.6 million. There
were no Series B Preferred Stock dividends in fiscal 1996. The net loss
applicable to common stock was $6.2 million in fiscal 1997 compared to a net
loss applicable to common stock of $40.9 million in fiscal 1996.
14
LIQUIDITY AND CAPITAL RESOURCES
GENERAL
As of January 30, 1999, the Company had outstanding indebtedness in the
principal amount of $13.8 million.
The Company finances its operations through credit provided by vendors and other
suppliers, amounts borrowed under its $50.0 million revolving credit facility
and internally generated cash flow. Credit terms provided by vendors and other
suppliers are usually net 30 days. Amounts which may be borrowed under the
working capital facility are based on a percentage of eligible inventories, as
defined, outstanding from time to time, as more fully described below.
REVOLVING CREDIT FACILITY
In July 1998, the Company and its lender agreed to amend certain terms and
conditions of the revolving credit facilities between the lender and General
Textiles and Factory 2-U. As a result of the Subsidiary Merger, the covenants
and financial ratios were reset to reflect anticipated earnings, capital
expenditures and cash flow of the Company during fiscal 1998 and the facilities
were combined into one revolving credit facility (the "Facility").
At January 30, 1999 the Company could borrow up to $50,000,000 at the prime rate
plus 0.75%, subject to limitations based on inventory levels. At January 30,
1999, the Company owed $1.8 million under the Facility and had $27,700,000
available to borrow under the Facility. The Facility expires in March 2000 but
is subject to one year automatic renewal periods, unless terminated by the
Company or its lender. The balance owed under the Facility fluctuates based on
working capital requirements. Because of the seasonal nature of the Company's
business, borrowings are usually greatest between August and December. The
Company pays fees of 0.25% on the unused portion of the Facility. The Facility
is secured by all the assets of the Company.
The Company was not in compliance with the current ratio covenant in the
Facility as of January 30, 1999. The lender has waived that requirement at
January 30, 1999.
SUBORDINATED NOTES
At January 31, 1998, the Company had outstanding $22,945,000 face value of Trade
Subordinated Notes, Subordinated Reorganization Notes and Junior Subordinated
Reorganization Notes. These notes were non-interest bearing, except for certain
contingent interest payments and were subject to minimum principal payment
requirements based on the annual excess cash flows of General Textiles.
Accordingly, they were discounted to carrying values based on estimated future
cash flows of General Textiles at discount rates ranging from 6% to 25%.
Effective April 30, 1998, the Company exchanged the Subordinated
Reorganization Notes and the Junior Subordinated Reorganization Notes (the "Old
Notes") for new notes (the "New Subordinated Notes" and the "New Junior
Subordinated Notes", collectively, the "New Notes"). The New Notes removed an
estimated excess cash flow calculation previously used to determine the timing
and amount of payments. Further, the New Notes provide a fixed schedule for debt
principal payments. In accordance with EITF 96-19, the Company recorded the
exchange of the Old Notes as an extinguishment of debt, and in connection
15
therewith, recorded an extraordinary loss, net of taxes, of $2,750,000.
This loss represents the amount by which the present value of the New Notes
exceeds the present value of the Old Notes for which they were exchanged and
fees paid to the lenders. The fees included the issuance of 22,600 shares of
pre-Recapitalization common stock and warrants to purchase 82,690 shares of
pre-Recapitalization common stock, both stated at fair market value when they
were issued.
The New Subordinated Notes totaled $3,250,000 and bore interest at 9.2% per
annum through March 31, 1999, after which the interest rate would increase by
one percent per annum each year up to a maximum of 13.2%. Principal was due in
annual payments ranging from $200,000 to $400,000 with a balloon payment of
$2,050,000 due May 28, 2003. The entire balance of $3,250,000 was paid on
December 8, 1998.
The New Junior Subordinated Notes have a face value of $17,335,000, are
non-interest bearing and are reflected on the accompanying balance sheets at the
present value using a discount rate of 10%. The unamortized discount related to
the New Junior Subordinated Notes was $6,404,000 at January 30, 1999, resulting
in a net carrying value of $10,931,000, as reflected in the January 30, 1999
balance sheet (see Financial Statements). The discount is amortized to interest
expense as a non-cash charge until the notes are paid in full. Further, the New
Junior Subordinated Notes require principal payments at December 31, 1999 and
December 31, 2000 of $1,000,000, at December 31, 2001 and December 31, 2002 of
$2,000,000, at December 31, 2003 and December 31, 2004 of $3,000,000 and a final
payment at May 28, 2005 of $5,335,000.
Management believes that the Company's sources of cash, including the Facility,
will be adequate to finance its operations and meet obligations under its
existing indebtedness as they become due for at least the next twelve months.
CAPITAL EXPENDITURES
The Company anticipates spending approximately $15 million on capital
expenditures in fiscal 1999 which includes costs to open new stores, to renovate
and/or relocate existing stores and to upgrade information systems. Management
believes that future expenditures will be financed from internal cash flow and
the Facility.
INFLATION
In general, the Company believes that inflation has had no recent material
impact on operations and none is anticipated in the next fiscal year.
MINIMUM WAGE INCREASES
The Company employs, both in its stores and in its corporate headquarters, a
substantial number of employees who earn hourly wages near or at the minimum
wage. Actions by both the federal and certain state governments have increased
the hourly wages payable by the Company to such employees. To mitigate the
impact of this wage increase, the Company has instituted policies to manage its
ratio of wages to sales. Management believes that these measures will be
adequate to control the impact of hourly wage increases on the overall
profitability of its operations.
SEASONALITY AND QUARTERLY FLUCTUATIONS
The Company historically has realized its highest level of sales and income
during the third and fourth quarters of its fiscal year (the quarters ending in
October and January) as a result of the "Back to School" (August and September)
and Christmas (November and December) seasons. The seasonally
16
lower sales in the Company's first two quarters (February through July),
can result in the Company's incurring losses during those quarters even in years
in which it will have full year profits.
YEAR 2000 ISSUE
Many currently installed computer systems and software products are coded to
accept only 2 digit entries in the date code field. Beginning in the year 2000,
these date code fields will need to accept 4 digit entries to distinguish 21st
century dates from 20th century dates. Systems that do not properly recognize
such information could generate erroneous data or fail. As a result, computer
systems and/or software used by many companies may need to be upgraded to comply
with Year 2000 requirements.
The Company is utilizing both internal and external resources as applicable, to
identify, correct or reprogram its internal systems for Year 2000 compliance.
The effect on the Company's future results of operations is being determined as
part of the detailed conversion process. In February 1999, the Company
implemented a new integrated software package to support future growth and to
address the issues associated with the year 2000. This system implementation
substantially completed the Company's internal program to address the Company's
Year 2000 issues. The new software installation cost $2.8 million.
The Company is currently seeking to insure that the software and operating
systems included in its new integrated software package are Year 2000 compliant.
The Company is also in the process of requesting information and assurances from
its major vendors, service providers and customers about their state of Year
2000 compliance and readiness. In the event that significant Year 2000 issues
are identified with such parties, the Company will develop contingency plans
such as the use of alternate vendors or manual systems.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS NO. 133
"Accounting for Derivative Instruments and Hedging Activities." This Statement
established accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. SFAS No. 133 is effective for fiscal quarters beginning after
June 15, 1999. The Company anticipates that the adoption of SFAS No. 133 will
not have a material impact on the Company's financial position or results of
operations.
The Accounting Standards Executive Committee (the "AcSEC") issued AICPA
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities," and SOP 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use," in April 1998 and March 1998,
respectively. SOP 98-5 provides guidance on the financial reporting of start-up
costs and organization costs and requires that such costs of start-up activities
be expensed as incurred. SOP 98-1 provides guidance on accounting for the costs
of computer software developed or obtained for internal use and identifies
characteristics to be used in determining when computer software is for internal
use. SOP 98-5 and 98-1 are effective for fiscal years beginning after December
15, 1998, with earlier applications permitted. The Company anticipates that the
adoption of SOP 98-1 and SOP 98-5 will not have a material impact on the
Company's financial position or results of operations.
On February 1, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," which requires reporting
certain information about operating segments in condensed financial statements
of interim periods issued to shareholders. The Company
17
did not operate multiple business segments as identified in SFAS No. 131
for the periods presented in the accompanying financial statements.
On February 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income," which requires companies to report as comprehensive income all changes
in equity during a period except those resulting from investments by owners and
distributions to owners. The Company had no other comprehensive income as
identified in SFAS No. 130 for the periods presented in the accompanying
financial statements.
In December 1997, the Company adopted SFAS No. 129, "Disclosure of Information
about Capital Structure". This Statement establishes standards for disclosing
information about an entity's capital structure. This Statement is effective for
financial statements for periods ending after December 15, 1997. The adoption of
SFAS No. 129, in fiscal 1997 did not have a material effect on the Company's
financial position or results of operations.
CAUTIONARY STATEMENT FOR PURPOSES OF "SAFE HARBOR PROVISIONS" OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements contained in this Management's Discussion and Analysis of
Financial Condition and Results of Operations that are not related to historical
results are forward-looking statements. Actual results may differ materially
from those projected or implied in the forward-looking statements. Risks and
uncertainties which could effect the Company include increased competition from
large national and regional discount store chains, inability to purchase
adequate quantities of merchandise at below wholesale prices and changes in laws
and regulations relating to wages, as well as other risks which are more fully
described in Part I, Item 1 of this Form 10-K.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
FACTORY 2-U STORES, INC.
Reports of Independent Public Accountants F-1
Factory 2-U Stores, Inc. Balance Sheets as of January 30, 1999 and January 31, 1998 F-3
Factory 2-U Stores, Inc. Statements of Operations for fiscal years ended January 30, 1999,
January 31, 1998 and February 1, 1997 F-4
Factory 2-U Stores, Inc. Statements of Stockholders' Equity for fiscal years ended January 30, 1999,
January 31, 1998 and February 1, 1997 F-5
Factory 2-U Stores, Inc. Statements of Cash Flows for fiscal years ended January 30, 1999,
January 31, 1998 and February 1, 1997 F-6
Factory 2-U Stores, Inc. Notes to Financial Statements F-7
All other schedules are omitted because of the absence of conditions under which
they are required or because the required information is set forth in the
consolidated financial statements and notes thereto.
18
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference to the
Registrant's definitive proxy statement to be filed with the Commission pursuant
to Regulation 14A in connection with the 1999 Annual Meeting of Shareholders
(the "Proxy Statement") under the headings "Proposal 1 "Election of Directors"
and "Executive Officers."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
Registrant's Proxy Statement under the heading "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
Registrant's Proxy Statement under the heading "Security Ownership of Certain
Beneficial Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
Registrant's Proxy Statement under the heading "Certain Relationships and
Related Transactions."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report:
The following is an index of the financial statements and exhibits included in
this report or incorporated herein by reference.
1) Financial Statements; the financial statements filed as part of this
report are listed in the index to financial statements on page 18.
19
2) Exhibits:
Exhibit
No. Description
- -----------
2.1 Plan and Agreement of Merger dated June 18, 1998 between Family Bargain Corporation and General
Textiles, Inc. (2-Exhibit 2.1)
10.6 Subordinated Promissory Note ($6.35 MM), dated as of April 30, 1997 between General Textiles and Family
Bargain Corporation (1-Exhibit 10.5)
10.7 Subordination and Standstill Agreement (RE: $6.35 MM Debt), dated as
of May 30, 1997, between Family Bargain Corporation and Finova
Capital Corporation (1-Exhibit 10.4)
10.9 Note Exchange Agreement dated April 27, 1998 among General Textiles, Family Bargain Corporation,
American Endeavour Fund Limited and London Pacific Life & Annuity Company (2-Exhibit 10.9)
10.10 Junior Subordinated Note Agreement dated April 30, 1998 among General Textiles, American Endeavour Fund
Limited and London Pacific Life & Annuity Company (2-Exhibit 10.10)
10.11 Subordinated Note Agreement dated April 30, 1998 among General Textiles, American Endeavour Fund Limited
and London Pacific Life & Annuity Company (2-Exhibit 10.11)
10.12 Form of Warrant dated April 30, 1998 (2-Exhibit 10.2)
10.14 Agreement dated July 18, 1998 of Three Cities Fund II L.P., Three Cities Offshore II C.V. and Quilvest
American Equity Ltd. to exercise Rights and vote for merger (2-Exhibit 10.14)
11.1 Computation of per share earnings
23 Consents
(b) Arthur Andersen LLP (accountants)
(c) KPMG LLP (accountants)
27 Financial Data Schedule
(1) Incorporated by reference to the Registrant's Form 10-Q for the 13
weeks ended August 2, 1997.
(2) Incorporated by reference to Registration Statement on Form S-2, No.
333-58797 filed with the Commission on October 14, 1998.
20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed
on its behalf by the undersigned, hereunto duly authorized.
FACTORY 2-U STORES, INC.
By: /s/ Michael M. Searles
Michael M. Searles
Chairman
Dated: April 29, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of
this Company and in the capacities and on the date indicated.
Signature Title Date
/s/ Michael M. Searles Chairman and Director April 29, 1999
Michael M. Searles
/s/ Jonathan W. Spatz Executive Vice President, April 29, 1999
Jonathan W. Spatz Chief Financial Officer
(Principal Financial
and Accounting Officer)
/s/ John J. Borer III Director April 26, 1999
John J. Borer III
/s/ Peter V. Handal Director April 26, 1999
Peter V. Handal
/s/ Ira Neimark Director April 28, 1999
Ira Neimark
/s/ Ronald Rashkow Director April 26, 1999
Ronald Rashkow
/s/ James D. Somerville Director April 26, 1999
James D. Somerville
/s/ H. Whitney Wagner Director April 29, 1999
H. Whitney Wagner
/s/ Wm. Robert Wright II Director April 29, 1999
Wm. Robert Wright II
21
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Factory 2-U Stores, Inc.:
We have audited the accompanying balance sheets of Factory 2-U Stores,
Inc. (a Delaware corporation) as of January 30, 1999 and January 31,
1998, and the related statements of operations, stockholders' equity
and cash flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is
to express an opinion on these financial statements based on our audit.
The financial statements of Factory 2-U Stores, Inc. for the year ended
February 1, 1997 were audited by other auditors whose report dated
April 11, 1997 expressed an unqualified opinion on those statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Factory 2-U
Stores, Inc. as of January 30, 1999 and January 31, 1998, and the
results of its operations and its cash flows for the years then ended
in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
San Diego, California
March 19, 1999
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Factory 2-U Stores, Inc. (formerly Family Bargain Corporation):
We have audited the accompanying consolidated statements of operations,
stockholders' equity, and cash flows of Family Bargain Corporation and
subsidiaries for the year ended February 1, 1997. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of Family Bargain Corporation and subsidiaries for the year ended February
1, 1997, in conformity with generally accepted accounting principles.
KPMG LLP
San Diego, California
April 11, 1997
F-2
FACTORY 2-U STORES, INC.
BALANCE SHEETS
(IN THOUSANDS)
JANUARY 30, JANUARY 31,
1999 1998
ASSETS
Current assets:
Cash $ 3,124 $ 3,167
Merchandise inventory 31,353 29,820
Prepaid expenses and other assets 1,137 727
Deferred income taxes 1,690 -
Total current assets 37,304 33,714
Leasehold improvements and equipment,
net of accumulated depreciation and amortization (Note 5) 18,187 15,066
Deferred income taxes (Note 9) 1,149 -
Other assets (Note 6) 2,419 3,326
Excess of cost over net assets acquired, less accumulated
amortization of $8,537 and $6,935, respectively (Note 2) 31,108 32,711
Total assets $90,167 $84,817
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt and capital leases
(Notes 8 and 10) $ 1,818 $ 4,873
Accounts payable 21,258 19,003
Income taxes payable 2,656 -
Accrued expenses (Note 7) 20,151 12,587
Total current liabilities 45,883 36,463
Revolving credit notes (Note 8) 1,843 12,657
Long-term debt (Note 8) 10,530 12,922
Capital lease and other long-term obligations (Note 10) 2,257 3,306
Deferred rent (Note 10) 1,889 2,251
Total liabilities $62,402 $67,599
Commitments and contingencies
(Notes 3, 8, 10, 11 and 15)
Stockholders' equity (Notes 11 and 12):
Series A convertible preferred stock, $0.01 par value; 0 and
4,500,000 shares authorized, 0 and 3,638,690 shares
issued and outstanding (aggregate liquidation preference of
$0 and $36,387), respectively - 36
Series B junior convertible, exchangeable preferred stock,
$0.01 par value; 0 and 40,000 shares authorized,
0 and 33,714 shares issued and outstanding (aggregate
liquidation preference of $0 and $33,714), respectively - -
Common stock, $0.01 par value, 80,000,000 shares authorized;
12,106,175 shares and 1,485,291 shares issued and
outstanding, respectively 121 15
Stock subscription notes receivable (4,087) (2,115)
Additional paid-in capital 103,248 85,461
Accumulated deficit (71,517) (66,179)
Total stockholders' equity 27,765 17,218
Total liabilities and stockholders' equity $90,167 $84,817
The accompanying notes are an integral part to these financial statements.
F-3
FACTORY 2-U STORES, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FISCAL YEAR ENDED
JANUARY 30, JANUARY 31, FEBRUARY 1,
1999 1998 1997
Net sales $338,223 $300,592 $252,165
Cost of sales 222,332 203,528 178,029
Gross profit 115,891 97,064 74,136
Selling and administrative expenses 99,719 87,979 80,634
Amortization of intangibles 2,358 2,238 1,966
Special charges (Note 2) 2,350 1,750 9,172
Merger costs (Note 4) 1,000 - -
Provision for goodwill impairment (Note 2) - - 8,380
Write off of deferred offering costs (Note 2) - - 1,923
Operating income (loss) 10,464 5,097 (27,939)
Interest expense (Note 8) 4,189 5,226 8,625
Income (loss) from continuing operations
before income taxes, discontinued operations
and extraordinary loss 6,275 (129) (36,564)
Income taxes (Note 9) 1,256 - -
Income (loss) from continuing operations
before discontinued operations and
extraordinary loss 5,019 (129) (36,564)
Discontinued operations (Notes 3 and 15):
Loss on disposal, net of income tax benefit - - (826)
Net income (loss) before extraordinary loss 5,019 (129) (37,390)
Extraordinary loss - debt extinguishment, net of
income tax benefit (Note 10) (2,750) - -
Net income (loss) 2,269 (129) (37,390)
Inducement to convert preferred stock to
common stock (Note 4) (2,804) - -
Preferred stock dividends:
Series A (Note 11) (2,593) (3,456) (3,509)
Series B (Note 11) (2,210) (2,661) -
Net loss applicable to common stock $(5,338) $(6,246) $(40,899)
Loss per common share (basic and diluted):
Loss before extraordinary loss and
discontinued operations $ (0.77) $ (4.23) $ (29.51)
Net loss applicable to common stock (1.58) (4.23) (30.12)
Weighted average common shares outstanding
(basic and diluted) 3,381 1,477 1,358
The accompanying notes are an integral part to these financial statements.
F-4
FACTORY 2-U STORES, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
PREFERRED STOCK
SERIES A SERIES B COMMON STOCK
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
Balance at January 27, 1996 3,200,000 $32 - $ - 1,200,918 $ 12
Series A Preferred
stock dividends (Note 11) - - - - - -
Issuance of preferred stock
in settlement of lawsuit
(Notes 3 and 11) 60,000 1 - - - -
Issuance of preferred stock
in a private placement
(Note 11) 726,000 7 - - - -
Conversion of preferred stock
to common stock (258,585) (3) - - 214,138 2
Issuance of preferred stock
in a private placement
(Note 11) - - 22,000 - - -
Correction of unsplit units - - - - (814) -
Net loss - - - - - -
Balance at February 1, 1997 3,727,415 $37 22,000 $ - 1,414,242 $ 14
Series A preferred
stock dividends (Note 11) - - - - - -
Series B preferred
stock dividend accretion
(Note 11) - - - - - -
Conversion of preferred
stock to common stock (88,725) (1) - - 71,049 1
Issuance of preferred stock
in a private placement
(Note 11) - - 9,599 - - -
Issuance of preferred stock
to management for notes
(Note 11) - - 2,115 - - -
Common stock
rights redemption - - - - - -
Net loss - - - - - -
Balance at January 31, 1998 3,638,690 $ 36 33,714 $ - 1,485,291 $ 15
Series A preferred
stock dividends (Note 11) - - - - - -
Series B preferred
stock dividend accretion
(Note 11) - - - - - -
Issuance of preferred stock
to management for notes
(Note 11) - - 1,824 - - -
Issuance of common stock
in debt restructuring
(Note 8) - - - - 22,600 -
Issuance of common stock
in rights offering (Note 11) - - - - 800,000 8
Conversion of preferred
stock to common stock
(Note 4) (3,638,690) (36) (35,538) - 9,798,468 98
Correction for unsplit units - - - - (184) -
Inducement to convert
preferred stock to common
stock (Note 4) - - - - - -
Compensation expense - - - - - -
Net income - - - - - -
Balance at January 30, 1999 - $ - - $ - 12,106,175 $ 121
STOCK
SUBSCRIPTION ADDITIONAL
NOTES PAID-IN ACCUMULATED
RECEIVABLE CAPITAL DEFICIT TOTAL
Balance at January 27, 1996 $ - $46,707 $(19,034) $27,717
Series A Preferred
stock dividends (Note 11) - - (3,509) (3,509)
Issuance of preferred stock
in settlement of lawsuit
(Notes 3 and 11) - 359 - 360
Issuance of preferred stock
in a private placement
(Note 11) - 2,849 - 2,856
Conversion of preferred stock
to common stock - 1 - -
Issuance of preferred stock
in a private placement
(Note 11) - 21,174 - 21,174
Correction of unsplit units - - - -
Net loss - - (37,390) (37,390)
Balance at February 1, 1997 - $71,090 $(59,933) $11,208
Series A preferred
stock dividends (Note 11) - - (3,456) (3,456)
Series B preferred
stock dividend accretion (Note 11) - 2,661 (2,661) -
Conversion of preferred
stock to common stock - - - -
Issuance of preferred stock
in a private placement
(Note 11) - 9,600 - 9,600
Issuance of preferred stock
to management for notes
(Note 11) (2,115) 2,115 - -
Common stock
rights redemption - (5) - (5)
Net loss - - (129) (129)
Balance at January 31, 1998 (2,115) $85,461 $(66,179) $17,218
Series A preferred
stock dividends (Note 11) - - (2,593) (2,593)
Series B preferred
stock dividend accretion
(Note 11) - 2,210 (2,210) -
Issuance of preferred stock
to management for notes
(Note 11) (1,972) 1,972 - -
Issuance of common stock
in debt restructuring
(Note 8) - 789 - 789
Issuance of common stock
in rights offering (Note 11) - 9,992 - 10,000
Conversion of preferred
stock to common stock
(Note 4) - (62) - -
Correction for unsplit units - - - -
Inducement to convert
preferred stock to common
stock (Note 4) - 2,804 (2,804) -
Compensation expense - 82 - 82
Net income - - 2,269 2,269
Balance at January 30, 1999 $(4,087) $103,248 $(71,517) $27,765
The accompanying notes are an integral part to these financial statements.
F-5
FACTORY 2-U STORES, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FISCAL YEAR ENDED
JANUARY 30, JANUARY 31, FEBRUARY 1,
1999 1998 1997
Cash flows from operating activities:
Income (loss) from continuing operations $ 5,019 $ (129) $(36,564)
Adjustments to reconcile income (loss) to net cash
provided by (used in) continuing operations:
Depreciation 4,484 3,505 2,253
Amortization of intangibles 2,359 2,238 1,966
Amortization of debt discount 1,430 2,168 4,376
Provision for goodwill impairment - - 8,380
(Increase) decrease in assets:
Merchandise inventory (1,533) (702) (3,244)
Prepaid expenses and other (3,954) (1,359) 924
Increase (decrease) in liabilities:
Accounts payable 2,255 1,512 (1,269)
Accrued expenses 9,608 3,655 2,282
Other 150 587 1,827
Net cash provided by (used in) continuing operations: 19,818 11,475 (19,069)
Discontinued operations:
Loss from discontinued operations - - (826)
Decrease in net liabilities - - (581)
Net cash used in discontinued operations - - (1,407)
Cash flows from investing activities:
Purchase of leasehold improvements and equipment (6,798) (5,865) (4,635)
Investment in Factory 2-U, net of cash acquired - - (230)
Proceeds from sale of real property and equipment - - 4,570
Net cash used in investing activities: (6,798) (5,865) (295)
Cash flows from financing activities:
Borrowings on revolving credit facility (Note 8) 354,816 335,053 315,156
Payments on revolving credit facility (Note 8) (365,630) (340,283) (312,428)
Payments of long-term debt and capital
lease obligations (9,445) (6,218) (3,945)
Cash payments of preferred stock dividends (2,593) (3,456) (3,509)
Proceeds from issuance of common stock, net (Note 4) 10,000 - -
Proceeds from issuance of Series B Preferred Stock - 9,595 -
Proceeds from issuance of preferred stock, net - - 24,030
Proceeds from issuance of notes payable - - 3,100
Payment of deferred debt issuance costs (211) (320) (330)
Purchase of subordinated notes, stock and warrants - (75) -
Net cash (used in) provided by financing activities (13,063) (5,704) 22,074
Net (decrease) increase in cash (43) (94) 1,303
Cash at the beginning of the period 3,167 3,261 1,958
Cash at the end of the period $ 3,124 $ 3,167 $ 3,261
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 2,679 $ 2,948 $ 3,299
Income taxes $ 111 $ - $ -
Supplemental disclosures of non-cash investing and financing activities:
Acquisition of equipment financed by capital
leases (Note 10) $ 970 $ 2,173 $ 125
Issuance of Series B preferred stock for notes $ 1,972 $ 2,115 $ -
Series B preferred stock dividend accretion $ 2,210 $ 2,661 $ -
Conversion of preferred stock to common stock
inducement charge (Note 4) $ 2,804 $ - $ -
Compensation expense $ 82 $ - $ -
Issuance of notes payable for non-compete
agreement (Note 2) $ - $ - $ 1,750
Issuance of preferred stock in return for
consulting agreement (Notes 3 and 11) $ - $ - $ 360
Issuance of and adjustments to notes payable to
former stockholders of Factory 2-U (Notes 2 and 8) $ - $ - $ 600
The accompanying notes are an integral part to these financial statements.
F-6
FACTORY 2-U STORES, INC.
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Factory 2-U Stores, Inc. ("the Company") operates off-price retail
apparel and home goods stores in the western United States. At January
30, 1999, the Company operated 168 stores in seven states under the
names Factory 2-U and Family Bargain Center.
PRINCIPLES OF CONSOLIDATION
Fiscal years ending February 1, 1997 and January 31, 1998 reflect
consolidated financial statements which include the accounts of Family
Bargain Corporation and its wholly-owned subsidiaries, General Textiles
and Factory 2-U, Inc. All significant intercompany accounts were
eliminated in consolidation. On July 31, 1998, General Textiles and
Factory 2-U, Inc. merged to form a new Delaware corporation named
General Textiles, Inc. On November 23, 1998, General Textiles, Inc.
merged into Family Bargain Corporation which simultaneously changed its
name to Factory 2-U Stores, Inc. The financial statements as of and for
the period ending January 30, 1999, reflect the mergers (Note 4).
FISCAL YEAR
The Company's fiscal year is based on a 52/53 week year ending on the
Saturday nearest January 31. Fiscal years ended January 30, 1999 and
January 31, 1998 included 52 weeks and the fiscal year ended February
1, 1997 included 53 weeks. The Company defines its fiscal year by the
calendar year in which most of the activity occurs (e.g. the year ended
January 30, 1999 is referred to as fiscal 1998).
MERCHANDISE INVENTORY
Merchandise inventory is stated at the lower of cost or market
determined using the retail inventory method on a first-in, first-out
flow assumption. In addition, consistent with industry practice, the
Company capitalizes certain buying, warehousing, storage and
transportation costs. At January 30, 1999 and January 31, 1998, such
costs included in inventory were approximately $2,408,000 and
$1,300,000, respectively.
LEASEHOLD IMPROVEMENTS AND EQUIPMENT
Leasehold improvements and equipment are stated at cost. Equipment
under capital leases is stated at the present value of minimum lease
payments at the date of acquisition. Depreciation and amortization are
calculated using the straight-line method over the shorter of the
estimated useful lives of the related asset or the lease term,
generally five to seven years.
OTHER ASSETS
Other assets consist principally of rental deposits on leased stores,
deferred debt issuance costs and covenants not to compete. Deferred
debt issuance costs are amortized using the effective interest method
over the terms of the related debt. Noncompete agreements are amortized
ratably over the life of the agreements (Note 6).
EXCESS OF COST OVER NET ASSETS ACQUIRED
Excess of cost over net assets acquired (goodwill) is amortized on a
straight-line basis over the expected periods to be benefited,
generally 25 years. The Company assesses the recoverability of this
intangible asset by determining whether the goodwill balance can be
recovered from
F-7
undiscounted future operating cash flows. The
impairment, if any, is measured based on estimated fair values.
Goodwill recovery may be impacted if estimated future operating cash
flows are not achieved (Note 2).
ASSET IMPAIRMENT
The Company assesses potential asset impairment using Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This
statement requires that long-lived assets and certain identifiable
intangibles be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured
by a comparison of the carrying amount of an asset to future net cash
flows expected to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is measured
by the amount by which the carrying amount of the assets exceeds the
fair value of the assets (Note 2).
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of all receivables, payables and accrued balances
approximate fair value due to the short-term nature of such
instruments. The carrying amount of the revolving credit notes
approximates fair value due to the floating rate on such instruments.
The carrying value of long-term debt with fixed payment terms
approximates fair value.
ADVERTISING COSTS
Advertising costs are charged to expense as incurred. Advertising
expense for the fiscal years ended January 30, 1999, January 31, 1998
and February 1, 1997 was $9,854,000, $9,289,000 and $8,633,000,
respectively.
LEASES
Rent expense is recorded on a straight-line basis over the life of the
lease. Deferred rent represents the difference between base rentals
paid under operating lease agreements and rent expense recognized (Note
10).
STORE PREOPENING AND CLOSING COSTS
Preopening costs (costs of opening new stores including grand opening
promotions, training, store set-up and other direct incremental store
opening costs) are charged to expense as incurred.
Costs associated with closing stores, consisting primarily of lease
obligations and provisions to reduce assets to net realizable value,
are charged to operations upon the commitment to close a store.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating losses and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date
(Note 9).
F-8
STOCK BASED COMPENSATION
On January 28, 1996, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock Based
Compensation, which permits entities to measure compensation expense
related to stock options using either the intrinsic value method or a
fair value method. 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. The Company
has elected to apply the intrinsic value method of measuring stock
based compensation and provide the pro forma disclosure requirements of
SFAS No. 123 (Note 12).
The Company has only issued options with exercise prices above or
equivalent to market price on the grant date. Accordingly, the Company
has recognized no compensation expense related to stock options in the
accompanying financial statements as of the grant date. However, refer
to Note 12 regarding potential future compensation expense on certain
stock options.
DIVIDEND ACCRETION
The Company's Series B preferred stock had an increasing rate dividend
feature (Note 11). Accordingly, dividends on Series B preferred stock
were recorded using the effective interest method to recognize the
dividends ratably over the estimated period in which the stock would
have been outstanding. As of November 23, 1998, the Series B Preferred
Stock has been converted to common stock and, therefore, no additional
dividends will be accreted (Note 4).
EARNINGS (LOSS) PER COMMON SHARE
In December 1997, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 128, "Earnings Per Share" (EPS). The statement
specifies the computation, presentation, and disclosure requirements
for earnings per share and diluted earnings per share. The statement
requires retroactive adoption for all prior periods presented.
Some of the changes made to simplify the EPS computations include: (a)
eliminating the presentation of primary EPS and replacing it with basic
EPS, with the principal difference being that common stock equivalents
are not considered in computing basic EPS (1,776,225, 1,030,189, and
237,128 common stock equivalents were excluded from the calculation for
the fiscal years ended January 30, 1999, January 31, 1998 and February
1, 1997, respectively); (b) eliminating the modified treasury stock
method and the three percent materiality provision; and (c) revising
the contingent share provisions and the supplemental EPS data
requirements.
The computation of diluted EPS is similar to the computation of basic
EPS except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the
dilutive potential common shares had been issued, except for
contingently issuable shares which are omitted from the calculation. In
addition, in computing the dilutive effect of convertible securities,
the numerator is adjusted to add back (a) any convertible preferred
dividends and (b) the after-tax amount of interest recognized in the
period associated with any convertible debt.
For fiscal years 1998, 1997 and 1996 potential dilutive securities
include certain stock options and warrants, and fiscal years 1997 and
1996 also include convertible preferred stock. Due to the net loss
applicable to common shares recorded in each year, had such potential
common shares been outstanding, the effect on earnings per share would
have been anti-dilutive. Therefore, the exercise or conversion of such
securities is not assumed for purposes of calculating diluted earnings
per share and basic and diluted are equal in each period presented.
F-9
USE OF ESTIMATES
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period to prepare these financial statements in
conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform their
presentation to fiscal 1998 financial statements.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS NO.
133 "Accounting for Derivative Instruments and Hedging Activities."
This Statement established accounting and reporting standards for
derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives)
and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. SFAS
No. 133 is effective for fiscal quarters beginning after June 15, 1999.
The Company anticipates that the adoption of SFAS No. 133 will not have
a material impact on the Company's financial position or results of
operations.
The Accounting Standards Executive Committee (the "AcSEC") issued AICPA
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities," and SOP 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," in April 1998 and
March 1998, respectively. SOP 98-5 provides guidance on the financial
reporting of start-up costs and organization costs and requires that
such costs of start-up activities be expensed as incurred. SOP 98-1
provides guidance on accounting for the costs of computer software
developed or obtained for internal use and identifies characteristics
to be used in determining when computer software is for internal use.
SOP 98-5 and 98-1 are effective for fiscal years beginning after
December 15, 1998, with earlier applications permitted. The Company
anticipates that the adoption of SOP 98-1 and SOP 98-5 will not have a
material impact on the Company's financial position or results of
operations.
On February 1, 1998, the Company adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information," which
requires reporting certain information about operating segments in
condensed financial statements of interim periods issued to
shareholders. The Company did not operate multiple business segments as
identified in SFAS No. 131 for the periods presented in the
accompanying financial statements.
On February 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income," which requires companies to report as
comprehensive income all changes in equity during a period except those
resulting from investments by owners and distributions to owners. The
Company had no other comprehensive income as identified in SFAS No. 130
for the periods presented in the accompanying financial statements.
In December 1997, the Company adopted SFAS No. 129, "Disclosure of
Information about Capital Structure". This Statement establishes
standards for disclosing information about an entity's capital
structure. This Statement is effective for financial statements for
periods ending after December 15, 1997. The adoption of SFAS No. 129,
in fiscal 1997 did not have a material effect on the Company's
financial position or results of operations.
F-10
2. SPECIAL CHARGES
During fiscal 1998, the Company recorded charges to operations in the
amount of $1,000,000 for costs related to the merger of its
wholly-owned subsidiary, General Textiles, Inc. into the Company and
the Recapitalization (Note 4).
In fiscal 1998, the Company recorded special charges in the amount of
$2,350,000 in connection with hiring the current President and CEO of
the Company. In August 1997, the Company recorded special charges to
operations in the amount of $1,750,000 pertaining to the separation
from the Company of the former President and CEO.
In connection with the sale of a controlling interest in the Company to
a new investor group in January 1997 (Note 11), the Company moved its
executive offices from New York City to San Diego, CA and entered into
a separation agreement with three former executives (the Former
Executives). As a result of these actions, the Company recognized
special charges in the amount of $9,172,000 in fiscal 1996. The special
charges included $7,081,000 to settle the existing employment and
benefit agreements of the Former Executives and $2,091,000 to cancel
certain contracts and expenses related to the separation of the Former
Executives and closure of the New York office.
On November 13, 1995, the Company acquired all of the common stock of
Factory 2-U, Inc. The acquisition was accounted for under the purchase
method of accounting. The operating results of Factory 2-U during the
year after acquisition were significantly below the projections the
Company had used when Factory 2-U was acquired. As a result, the
Company adjusted its estimate of future cash flows for Factory 2-U. The
revised estimated cash flows were insufficient to recover the recorded
value of goodwill and accordingly, the Company recorded an asset
impairment charge of $8,380,000 to reduce goodwill arising from the
Factory 2-U acquisition.
The Company withdrew a securities offering in January 1997. In
conjunction with this withdrawal, the Company wrote-off $1,923,000 in
deferred offering costs.
3. DISCONTINUED OPERATIONS
The Company divested its distribution business (the "Former
Distribution Business"), which was comprised of the operations of MKI
Acquisition, Mandel-Kahn, CB/Camelot and CB/Murray, prior to April 30,
1993. The estimation and settlement of the residual net liabilities of
the Former Distribution Business have been accounted for as
discontinued operations in these financial statements. The Company
recognized a loss, net of taxes, on disposal of discontinued operations
in the amount of $826,000 in fiscal 1996 to reflect the costs to
litigate and settle claims and the cost of consulting services that it
does not intend to use. The Company does not anticipate any future
expenses related to the Former Distribution Business.
4. RECAPITALIZATION
In fiscal year 1998, the Company initiated a multi-phased plan to
restructure its capitalization (the "Recapitalization"), which included
restructuring the subordinated and junior subordinated debt in a manner
that removed an estimated excess cash flow calculation previously used
to determine the timing and amounts of payments and replaced that
feature with a fixed schedule for debt payments. The debt restructuring
resulted in an extraordinary charge of $2,750,000, net of taxes, in the
first quarter ending April 30, 1998 (Note 9).
On July 31, 1998, the Company's two operating subsidiaries, General
Textiles and Factory 2-U, Inc., merged to form General Textiles, Inc.
F-11
On November 23, 1998, the Company carried out a Recapitalization in
which all of the Company's stock was converted into a single class of
Common Stock. Under the Plan of Recapitalization, each share of
Pre-Recapitalization Common Stock was converted into .30133 shares of
Common Stock, each share of Series A Preferred Stock was converted into
one share of Common Stock and each share of Series B Preferred Stock
was converted into 173.33 shares of Common Stock. In connection with
the Recapitalization, General Textiles, Inc. was merged into Family
Bargain Corporation (the "Family Bargain Merger") and the Company's
name was changed to Factory 2-U Stores, Inc.
The last phase of the Recapitalization was a rights offering in which
800,000 shares of Post-Recapitalization Common Stock were sold to
existing shareholders at $13 per share. The Company received proceeds
of $10,00,000, net of $400,000 of related expenses.
In November 1998, the Company recorded a reduction to net income
available to common stockholders in the amount of $2,804,000 pertaining
to the conversion of Series A and Series B Preferred Stock to Common
Stock pursuant to the Plan of Recapitalization, in accordance with SFAS
No. 84, "Induced Conversions of Convertible Debt." The amount of the
reduction represents the fair value of Post-Recapitalization Common
Stock transferred in excess of the fair value of common stock issuable
pursuant to the original conversion terms of the Preferred Stock.
5. LEASEHOLD IMPROVEMENTS AND EQUIPMENT
Leasehold improvements and equipment consist of the following:
JANUARY 30, JANUARY 31,
1999 1998
IN THOUSANDS
Furniture, fixtures and equipment $20,367 $15,272
Leasehold improvements 5,820 4,797
Transportation and equipment 460 114
Equipment under capital leases 3,800 2,883
30,447 23,066
Less accumulated depreciation and amortization (12,260) (8,000)
$18,187 $15,066
6. OTHER ASSETS
Other assets consist of the following:
JANUARY 30, JANUARY 31,
1999 1998
IN THOUSANDS
Deferred debt issuance costs $ 201 $ 257
Rent and other deposits 893 989
Noncompete agreements 2,756 2,756
3,850 4,002
Less accumulated amortization (1,431) (676)
$ 2,419 $ 3,326
In August 1997, the former President and CEO entered into an agreement
not to compete with the Company until January 2001 in return for
payments totaling $970,000. In January 1997, the Company entered into
an agreement not to compete with certain former executives in favor of
the Company until June 2000 in return for $1,750,000 in secured
promissory notes that were paid in January 1998.
F-12
7. ACCRUED EXPENSES
Accrued expenses consist of the following:
JANUARY 30, JANUARY 31,
1999 1998
IN THOUSANDS
Accrued compensation and related costs $ 5,925 $ 3,153
Sales tax payable 4,094 3,432
Other accrued expenses 10,132 6,002
$20,151 $12,587
8. LONG-TERM DEBT AND REVOLVING CREDIT NOTES
Long-term debt and revolving credit notes consist of the following:
JANUARY 30, JANUARY 31,
1999 1998
IN THOUSANDS
Revolving credit note, interest at prime plus 2.0%
till June 1997 then prime plus 0.75%
(8.5% at January 30, 1999 and 9.25% at
January 31, 1998) payable monthly, principal
due in November 1999 $ 1,843 $ 9,473
Revolving credit note, interest at prime plus 2%
till June 1997 then prime plus 0.75%
(9.25% at January 31, 1998 payable monthly, principal
paid in August 1998 -- 3,184
Installment note payable to a finance company, interest
at prime plus 2% (10.5% at January 31, 1998) payable
monthly, principal payable in monthly in installments
of $37,750, final balloon payment of $216,500
paid in April 1998 -- 292
Installment note payable to a finance company, interest
at prime plus 2% (10.5% at January 31, 1998) payable
monthly, principal payable monthly in installments of
$30,556, final payment paid in January 1999. -- 489
Installment note payable to a finance company, interest
at prime plus 3% (10.75% at January 30, 1999) payable
monthly, principal payable monthly in installments of
$33,333, final payment due in July 2001. 1,000 1,400
(This note was paid in its entirety in February 1999.)
Junior subordinated notes, discounted at a rate of 10.0%,
principal payments in annual installments ranging from
$1,000,000 to $3,000,000, final balloon payment of
$5,335,000 due May 2005 10,930 --
Subordinated notes, non-interest bearing, discounted
at rates ranging from 6.0% to 25%, principal
payments based on excess cash flow, as defined -- 13,042
F-13
Installment note payable to a finance company,
interest at 8%, principal and interest payable in
installments of $13,648,final balloon payment of
$304,000 paid in December 1998 -- 414
Installment note payable to former stockholders of
Factory 2-U, interest at 8.75%, principal payments
of $45,455 plus accrued interest payable quarterly
beginning in May 1996, final payment paid in
October 1998 (Note 3) -- 182
Note payable to former stockholders of Factory 2-U,
interest at 8.75%, principal and accrued interest
paid in October 1998 (Note 3) -- 600
Total long-term debt 13,773 29,076
Less current maturities (1,400) (3,497)
Long-term debt and revolving credit notes,
net of current maturities $ 12,373 $ 25,579
REVOLVING CREDIT FACILITY
In July 1998, the Company and its lender agreed to amend certain terms
and conditions of the revolving credit facilities between the lender
and General Textiles and Factory 2-U. As a result of the Subsidiary
Merger, the covenants and financial ratios were reset to reflect
anticipated earnings, capital expenditures and cash flow of the Company
during fiscal 1998 and the facilities were combined into one revolving
credit facility (the "Facility").
At January 30, 1999 the Company had a revolving credit facility (the
"Facility") under which it could borrow up to $50,000,000 under the
Facility at the prime rate plus 0.75%, subject to limitations based on
inventory levels. At January 30, 1999, the Company owed $1.8 million
under the Facility and had $27,700,000 available to borrow under the
Facility. The Facility expires in March 2000 but is subject to one year
automatic renewal periods, unless terminated by the Company or its
lender. The balance owed under the Facility fluctuates based on working
capital requirements. Because of the seasonal nature of the Company's
business, borrowings are usually greatest between August and December.
The Company pays fees of 0.25% on the unused portion of the Facility.
The Facility is secured by all the assets of the Company.
The Company was not in compliance with the current ratio covenant in
the Facility as of January 30, 1999. The lender has waived that
requirement at January 30, 1999.
SUBORDINATED NOTES
At January 31, 1998, the Company had outstanding $22,945,000 face value
of subordinated notes issued in settlement of certain pre-bankruptcy
claims of General Textiles. In 1997 and previously, the subordinated
notes were referred to as the "Sub Notes" and were comprised, in order
of seniority, of Trade Subordinated Notes (due no later than April
2003), Subordinated Reorganization Notes (due no later than November
2003) and Junior Subordinated Reorganization Notes (due no later than
May 2005). The Sub Notes were non-interest bearing, except for certain
contingent interest payments and were subject to minimum principal
payment requirements based on the annual excess cash flows of General
Textiles. Accordingly, the Sub
F-14
Notes were discounted to carrying values based on estimated future cash
flows of General Textiles at discount rates ranging from 6% to 25%.
Effective April 30, 1998, the Company entered into agreements to
exchange the Subordinated Reorganization Notes and the Junior
Subordinated Reorganization Notes (the "Old Notes") for new notes (the
"New Subordinated Notes" and the "New Junior Subordinated Notes",
collectively, the "New Notes"). The New Notes removed an estimated
excess cash flow calculation previously used to determine the timing
and amount of payments. Further, the New Notes provide a fixed schedule
for debt principal payments. In accordance with EITF 96-19, the Company
recorded the exchange of the Old Notes as an extinguishment of debt,
and in connection therewith, recorded an extraordinary loss, net of
taxes, of $2,750,000. This loss represents increases in the present
value of the principal amount of the Old Notes and fees paid to the
lenders. The fees included the issuance of 22,600 shares of
pre-Recapitalization common stock and warrants to purchase 82,690
shares of pre-Recapitalization common stock, both stated at fair market
value when they were issued.
The New Subordinated Notes totaled $3,250,000 and bore interest at 9.2%
per annum through March 31, 1999, after which the interest rate would
increase by one percent per annum each year up to a maximum of 13.2%.
Principal was due in annual payments ranging from $200,000 to $400,000
with a balloon payment of $2,050,000 due May 28, 2003. The entire
balance of $3,250,000 was paid on December 8, 1998.
The New Junior Subordinated Notes have a face value of $17,335,000, are
non-interest bearing and are reflected on the accompanying balance
sheets at the present value using a discount rate of 10%. The
unamortized discount related to the New Junior Subordinated Notes was
$6,404,000 at January 30, 1999, resulting in a net carrying value of
$10,931,000, as reflected in the January 30, 1999 balance sheet (see
Financial Statements). The discount is amortized to interest expense as
a non-cash charge until the notes are paid in full. Further, the New
Junior Subordinated Notes require principal payments at December 31,
1999 and December 31, 2000 of $1,000,000, at December 31, 2001 and
December 31, 2002 of $2,000,000, at December 31, 2003 and December 31,
2004 of $3,000,000 and a final payment at May 28, 2005 of $5,335,000.
The Plan required that certain events, such as the Subsidiary Merger of
July 31, 1998, result in the acceleration of payment of the Trade
Subordinated Notes. Accordingly, the outstanding balance of $1,760,000
of the Trade Subordinated Notes was paid in October 1998.
F-15
9. INCOME TAXES
Significant components of the provision (benefit) for income taxes are
as follows:
JANUARY 30, JANUARY 31,
1999 1998
IN THOUSANDS
Federal Income Tax Provision
Current $ 2,857 $ -
Deferred (1,914) -
Total federal income tax provision 943 -
State Income Tax Provision (Benefit)
Current $ 698 $ -
Deferred (385) -
Total state income tax provision (benefit) 313 -
Total $ 1,256 $ -
The principal temporary differences that give rise to significant
portions of the consolidated deferred tax assets and liabilities are
presented below:
JANUARY 30, JANUARY 31,
1999 98
IN THOUSANDS
Deferred tax assets
Net operating loss carryforwards $ 6,948 $ 7,562
Compensated absences and bonuses 463 1,184
Deferred rent 1,126 1,118
Closed store accrual 1,141 1,158
Excess of tax over book inventory 506 341
Restructuring costs - 121
Other 330 497
Discontinued operations accruals - 48
Accrued expenses 1,009 -
Total gross deferred tax assets 11,523 12,029
Less valuation allowance (7,884) (9,901)
Net deferred tax assets 3,639 2,128
Deferred tax liabilities
Subordinated notes - 481
Inventory reserves and prepaid expenses - 151
Leasehold improvements and equipment,
principally due to differences in depreciation
recognized on fixed assets 800 598
Other - 898
Deferred tax liabilities 800 2,128
Net deferred taxes $ 2,839 $ -
F-16
The Company has established a valuation allowance due to lack of
historical earnings and annual limitations on the usage of net
operating loss carryforwards.
The difference between the expected income tax expense (benefit)
computed by applying the U.S. federal income tax rate of 34% to net
income from continuing operations for fiscal 1998, 1997 and 1996 and
actual expense is a result of the following:
JANUARY 30, JANUARY 31, FEBRUARY 1,
1999 1998 1997
IN THOUSANDS
Computed "expected" tax expense (benefit) $ 2,180 $ (44) $(12,432)
Amortization of goodwill 658 638 668
Change in valuation allowance (2,017) (1,551) 5,950
Provision for goodwill impairment - - 2,849
Merger costs 410 - -
Business credits (150) - -
State income taxes, net of federal
income tax benefit 374 - -
Limitation of net losses due to
change in control - - 2,988
Other, net (199) 957 (23)
$ 1,256 $ - $ -
At January 30, 1999, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $18.2 million that
expire starting in 2012.
10. LEASE COMMITMENTS
The Company operates retail stores, warehouse facilities and
administrative offices under various operating leases. Total rent
expense was $17,977,000, $17,313,000 and $14,987,000, including
contingent rent expense of $240,000, $128,000 and $89,000, for fiscal
years ended January 30, 1999, January 31, 1998 and February 1, 1997,
respectively.
For financial statement purposes, rent expense is recorded on a
straight-line basis over the life of the lease. For fiscal year 1998,
cash payment requirements exceeded rent expense charged to operations
by $362,000, resulting in a decrease to the deferred rent liability for
the same amount. For fiscal 1997 and 1996, rent expense charged to
operations exceeded cash payment requirements by $153,000 and $452,000,
respectively, and resulted in an increase to the deferred rent
liability for the same amounts.
The Company is also obligated under various capital leases for
leasehold improvements and equipment that expire at various dates
during the next three years. Leasehold improvements and equipment and
related accumulated amortization recorded under capital leases are as
follows:
F-17
JANUARY 30, JANUARY 31,
1999 1998
IN THOUSANDS
Leasehold improvements $ 344 $ 340
Equipment 3,456 2,543
3,800 2,883
Less accumulated amortization (1,172) (531)
$ 2,628 $ 2,352
At January 30, 1999, the future minimum lease payments under capital
leases and operating leases with remaining noncancelable terms are as
follows:
CAPITAL OPERATING
LEASES LEASES
IN THOUSANDS
Fiscal year:
1999 $ 466 $14,001
2000 289 11,143
2001 185 9,508
2002 20 6,979
2003 -- 5,416
Thereafter -- 8,245
Total minimum lease payments 960 $55,292
Less amount representing interest (rates ranging
from 9.0% to 14.8%) (100)
Present value of capital lease obligation 860
Less current maturities (418)
Long-term capital lease obligation $ 442
11. STOCKHOLDERS' EQUITY
Prior to the Recapitalization, the Company was authorized to issue
Series A 9-1/2% Cumulative Convertible Preferred Stock (the "Series A
Preferred Stock"), Series B Junior Convertible, Exchangeable Preferred
Stock (the "Series B Preferred Stock") and Common Stock. As a result of
the Plan of Recapitalization approved by the stockholders, the Company
converted all shares of its Series A and Series B Preferred Stock into
Post-Recapitalization Common Stock and issued a reverse stock split
which converted all shares of its Pre-Recapitalization Common Stock
into .30133 shares of Post-Recapitalization Common Stock (Note 4).
SERIES A AND SERIES B PREFERRED STOCK
Prior to the Recapitalization, the Company had 7,500,000 shares of
preferred stock authorized, of which 4,500,000 were allocated to Series
A Preferred Stock and 40,000 were allocated Series B Preferred Stock.
The Series A Preferred Stock ranked senior to the Series B Preferred
Stock and the common stock with respect to the payment of dividends and
distribution of net assets upon liquidation, dissolution or winding up.
Cumulative dividends were payable quarterly at the rate of $.95 per
F-18
year on April 30, July 31, October 31, and the last Friday in January
if, as and when declared by the Board of Directors. Series A Preferred
Stock was convertible, prior to redemption, at the option of the
holder, into shares of common stock at a conversion price subject to
adjustment under certain circumstances pursuant to anti-dilution
provisions.
The Series B Preferred Stock ranked junior to the Series A Preferred
Stock and senior to the common stock with respect to the payment of
dividends and the distribution of assets upon liquidation, dissolution
or winding up. The Series B Preferred Stock was convertible, at the
option of the holder, only after all the Series A Preferred Stock was
converted or redeemed. The conversion price per share was subject to
adjustment under certain circumstances pursuant to anti-dilution
provisions. Each share of Series B Preferred Stock was entitled to
voting rights equivalent to the number of common shares into which it
is convertible. The Series B Preferred Stock was to pay no dividend
until January 2002.
During fiscal 1997, the Company placed 11,715 shares of its Series B
Preferred Stock for aggregate cash proceeds of $9,600,000 with private
investors and notes receivable in the amount of $2,115,000 from
management of the Company. Additionally, during fiscal 1998, the
Company placed 1,824 shares of its Series B Preferred Stock for notes
receivable in the amount of $1,972,000 from management of the Company.
The notes receivable from management of the Company for the purchase of
Series B Preferred Stock are due in 2002 and 2003, accrue interest at
8% per annum and require annual principal payments equivalent to 16.25%
of the annual bonus of each purchaser and a balloon payment of the
unpaid principal and accrued interest at maturity. The notes are
full-recourse notes and were secured by the Series B Preferred Stock
issued in return for the notes. The notes are now secured by the
Post-Recapitalization Common Stock into which the underlying Series B
Preferred Stock was converted.
In April 1997, concurrent with the Series B issuance, the Company
effectively redeemed all rights outstanding under its Shareholders'
Rights Agreement. The Company paid each holder of common stock $0.001
per share totaling $4,930.
12. STOCK OPTIONS AND WARRANTS
At January 30, 1999, warrants to purchase 452,459 common shares were
outstanding. Of these warrants, 82,690 have an exercise price of $19.91
and expire in May 2005, 320,000 have an exercise price of $16.50 and
expire in July 1999, and 49,769 have an exercise price of $6.22 and
expire in March 2001 (the "$6.22 Warrants"). The $6.22 Warrants were
issued in March 1996 in connection with a private placement of Series A
Preferred Stock (Note 11). Had the Company measured the estimated fair
value of the warrants issued in March 1996, there would have been no
impact on the consolidated financial statements due their being treated
as an expense of the private placement.
The Company has one stock option plan, the Amended and Restated Family
Bargain Corporation 1997 Stock Option Plan. Options may be granted as
incentive or nonqualified stock options. The Company accounts for its
stock option plan under APB Opinion No. 25, under which no compensation
cost has been recognized in fiscal 1998 and fiscal 1999 respectfully.
FASB Statement No. 123 "Accounting for Stock-Based Compensation" was
issued by the FASB in 1995 and, if fully adopted, changes the methods
for recognition of cost on plans similar to those of the Company.
Adoption of FASB Statement No. 123 is optional, however pro forma
disclosures as if the Company had adopted the cost recognition method
are required. Had compensation cost for stock options awarded under
this plan been determined consistent with FASB Statement No. 123, the
Company's net income and earnings per share would have reflected the
following pro forma amounts:
F-19
JANUARY 30, JANUARY 31, 1998
1999 1999
IN THOUSANDS
Net Income (Loss): As Reported (5,338) (6,246)
Pro Forma (6,249) (7,114)
Primary EPS: As Reported (1.58) (1.27)
Pro Forma (1.85) (1.45)
The Company may grant up to 1,807,980 options under this Plan. The
Company has granted 1,323,766 through January 30, 1999. The options are
issued at fair market value with exercise prices equal to Company's
stock price at the date of grant. Options vest over three to five
years; are exercisable in whole or in installments; and expire from
five to ten years from date of grant.
The Company's Board of Directors has granted stock options to members
of the Board and to Company management. A summary of the status of the
Company's stock option plan at February 1, 1997, January 31, 1998, and
January 30, 1999 and changes during the years then ended is presented
in the table and narrative below:
NUMBER OF WEIGHTED AVERAGE
SHARES * OF EXERCISE PRICES *
Outstanding at January 27, 1996 257,512 7.10
Granted 11,275 4.58
Canceled (151,519) 4.58
Outstanding February 1, 1997 117,268 10.12
Granted 908,947 7.14
Canceled (95,798) 11.38
Outstanding January 31, 1998 930,417 7.07
Granted 451,016 6.78
Canceled (57,667) 7.27
Outstanding January 30, 1999 1,323,766 6.96
Exercisable at January 30, 1999 352,115 6.45
Exercisable at January 31, 1998 24,863 4.69
* Options for January 31, 1998, February 1, 1997 and January 26, 1996 have been
converted at .30133 per option under the Recapitalization.
Of the options outstanding at January 30, 1999, 213,233 have exercises
prices of $4.15 to $5.81 with a weighted average exercise price of
$5.09, a weighted average remaining contractual life of 3.72 years and
104,895 of these options are exercisable. The remaining 1,110,533
options outstanding at January 30, 1999 have exercise prices of $6.01
to $8.50, a weighted average exercise price of $7.32, a weighted
average remaining contractual life of 3.51 years and 247,220 of these
options are exercisable.
At January 30, 1999, there were 585,520 options outstanding which,
subject to vesting conditions, originally became exercisable in 25%
installments when the Common Stock price reaches the following market
price hurdles: $19.91, $24.89, $33.19 and $49.78. In December 1998, the
Board of Directors removed the first two market price hurdles for
employees with options, making one-half of those options granted
exercisable, subject to vesting conditions. As a result of the removal
of the first two market price hurdles, the Company recorded
compensation expense in the amount of $82,000. Assuming all shares are
fully vested and all market price hurdles are met, then the Company
would be required to record an aggregate non-cash compensation expense
in the amount of $9,564,000 in varying amounts as the market price
hurdles are achieved.
The weighted-average fair values at date of grant for options granted
during fiscal 1998 and 1997 were between $0.90 and $4.14 and were
estimated using the Black-Scholes option pricing model
F-20
with the following assumptions: (i) weighted average dividend yield of 0.00%,
(ii) weighted average volatility of 106.89% and 138.88% for fiscal
years 1998 and 1997, respectively, (iii) expected life of three to five
years, and (iv) weighted average risk-free interest rate of 5.55% and a
range from 5.45% to 6.88%, for fiscal years 1998 and 1997,
respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. Option valuation models also
require the input of highly subjective assumptions such as expected
option life and expected stock price volatility. Because the Company's
employee stock-based compensation plan has characteristics
significantly different from those of traded options and because
changes in the subjective input assumptions can materially affect the
fair value estimate, the Company believes that the existing option
valuation models do not necessarily provide a reliable single measure
of the fair value of awards from those plans.
13. EMPLOYEE BENEFITS
The Company sponsors a defined contribution plan, qualified under
Internal Revenue Code Section 401(k), for the benefit of employees who
have completed twelve months of service and who work a minimum of 1,000
hours during that twelve month period. The Company makes a matching
contribution equal to 20% of participating employees' voluntary
contributions. Participants may contribute from 1% to 15% of their
compensation annually, subject to IRS limitations. The Company
contributed $134,000, $132,000 and $111,000 in fiscal 1998, 1997 and
1996, respectively.
14. RELATED PARTY TRANSACTIONS
During fiscal 1996, the Company paid $1,100,000 in fees and expense
reimbursements related to its withdrawn securities offering and
advisory fees related to the private placement of Series B Preferred
Stock to an investment banking firm for which a director of the Company
served as a managing director (Notes 2 and 11). This same director was
appointed to the Board of Directors following the successful completion
of the initial public offering of Series A Preferred Stock in July
1994.
The Company also paid a $250,000 finder's fee to a newly appointed
director in respect of advisory services rendered to the Company in
connection with the private placements of Series B Preferred Stock
(Note 11).
In January 1997, the Company paid $96,000 to former directors of the
Company pursuant to the cancellation of their stock options and
warrants.
In March 1996, a director of the Company was a managing director of the
investment-banking firm that served as the placement agent for the
Company's private placement of 726,000 shares of Series A Preferred
Stock (Note 11).
At January 27, 1996, an accounts receivable balance of approximately
$170,000 was outstanding from an affiliate of the Former Executives.
This receivable was forgiven in connection with the settlements with
the Former Executives and is included in the special charges recorded
in fiscal 1996 (Note 2).
15. COMMITMENTS AND CONTINGENCIES
The Company is at all times subject to pending and threatened legal
actions that arise out of the normal course of business. In the opinion
of management, based in part on the advice of legal counsel, the
ultimate disposition of these matters will not have a material adverse
effect on the financial position or results of operations of the
Company.
F-21
The Company has entered into an employment contract with its President
and CEO, which defines his duties, compensation and severance in the
event of his termination of employment with the Company.
16. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The results of operations for fiscal 1998, 1997 and 1996 were as
follows:
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
IN THOUSANDS, EXCEPT PER SHARE DATA
Fiscal 1998
Net Sales $ 66,495 $ 73,456 $ 84,978 $113,294
Gross profit 21,846 24,962 28,785 40,298
Operating income (loss) (1,437) 42 3,382 8,477
Income (loss) before extraordinary loss (2,789) (1,077) 2,251 6,634
Extraordinary loss (2,750) - - -
Net income (loss) (5,539) (1,077) 2,251 6,634
Net income (loss) applicable to
common stock (7,106) (2,669) 607 3,830
Basic earnings per share:
Income (loss) before extraordinary loss (2.92) (1.76) 1.33 0.42
Extraordinary loss (1.86) - - -
Net loss applicable to common stock (4.78) (1.76) 1.33 0.42
Diluted earnings per share:
Income (loss) before extraordinary loss (2.92) (1.76) 0.76 0.34
Extraordinary loss (1.86) - - -
Net loss applicable to common stock (4.78) (1.76) 0.76 0.34
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
IN THOUSANDS, EXCEPT PER SHARE DATA
Fiscal 1997
Net Sales $60,436 69,375 77,263 93,518
Gross profit 19,005 21,220 26,461 30,378
Operating income (loss) (83) (2,841) 2,964 5,057
Net income (loss) (1,360) (4,170) 1,606 3,795
Net income (loss) applicable to (2,881) (5,669) 71 2,233
common stock
Earnings (loss) per share:
Basic (1.99) (3.82) 0.17 1.50
Diluted (1.99) (3.82) 0.17 0.39
F-22
EXHIBIT INDEX
EXHIBIT NUMBER
11.1 Calculation of per share income (loss)
23 Consents
(b) Arthur Andersen LLP (accountants)
(c) KPMG Peat Marwick LLP (accountants)
27 Financial Data Schedule (submitted for SEC use only)
EXHIBIT 11.1
FACTORY 2-U STORES, INC.
COMPUTATION OF NET INCOME (LOSS) PER COMMON SHARE (BASIC AND DILUTED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FISCAL YEAR ENDED
JANUARY 30, JANUARY 31, FEBRUARY 1,
1999 1998 1997
The computation of net (loss) available & adjusted
shares outstanding follows:
Income income (loss) from continuing operations $ 5,019 $ (129) $ (36,564)
Discontinued operations
Loss on disposal, net of income tax benefit - - (826)
Extraordinary item
Debt extinguishment, net of income tax benefit (2,750) - -
Net income (loss) $ 2,269 $ (129) $ (37,390)
Less:
Inducement to convert preferred stock to $ (2,804) $ - $ -
Preferred stock dividends $ (4,803) $ (6,117) $ (3,509)
Net (loss) used for basic and diluted computation $ (5,338) $ (6,246) $ (40,899)
Weighted average number of common shares
outstanding 3,381 1,477 1,358
Add:
Assumed exercise of those options that are - - -
common stock equivalents
Assumed exercise of convertible preferred stock - - -
Adjusted shares outstanding, used for basic &
diluted computation 3,381 1,477 1,358
Loss before extraordinary loss and
discontinued operations (0.77) (4.23) (29.51)
Net loss applicable to common stock per share (1.58) (4.23) (30.12)
EXHIBIT 23(b)
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our report included in this Form 10-K, into the Company's previously filed
Registration Statement File No. 333-76011.
ARTHUR ANDERSEN LLP
San Diego, California
April 28, 1999
EXHIBIT 23(c)
INDEPENDENT AUDITOR'S CONSENT
The Board of Directors
Factory 2-U Stores, Inc. (formerly Family Bargain Corporation)
We consent to the incorporation by reference in the registration statement
(No. 333-76011) on Form S-8 of Factory 2-U Stores, Inc. of our report dated
April 11, 1997, relating to the consolidated statements of operations,
stockholders' equity, and cash flows of Family Bargain Corporation and
subsidiaries for the year ended February 1, 1997, which report appears in the
January 30, 1999 annual report on Form 10-K of Factory 2-U Stores, Inc.
KPMG LLP
San Diego, California
April 28, 1999