<DOCUMENT>
<TYPE>10-Q
<SEQUENCE>1
<FILENAME>a20013rd10qrevised.txt
<DESCRIPTION>FORM 10-Q FOR THE QUARTERLY PERIOD ENDED 11/3/01
<TEXT>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 1O-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended November 3, 2001
----------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1932
For the transition period from...............to................
Commission File Number: 1-10089
FACTORY 2-U STORES, INC.
(Exact name of registrant as specified in its charter)
Delaware 51-0299573
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4000 Ruffin Road, San Diego, CA 92123-1866
------------------------------- ----------
(Address of principal executive office) (Zip Code)
(858) 627-1800
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[X] YES [ ] NO
The number of shares outstanding of the registrant's common stock, as of
December 17, 2001 was 12,824,370 shares.
<PAGE>
FACTORY 2-U STORES, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED NOVEMBER 3, 2001
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Factory 2-U Stores, Inc. Balance Sheets as of November 3, 2001
(Unaudited) and February 3, 2001....................................F-1
Factory 2-U Stores, Inc. Statements of Operations (Unaudited) for the
13 weeks ended November 3, 2001 and October 28, 2000; 39 weeks ended
November 3, 2001 and October 28, 2000 ..............................F-3
Factory 2-U Stores, Inc. Statements of Cash Flows (Unaudited) for the
39 weeks ended November 3, 2001 and October 28, 2000 ...............F-4
Factory 2-U Stores, Inc. Notes to Financial Statements (Unaudited) .F-5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ................................................3
Item 3. Quantitative and Qualitative Disclosures About Market Risk............8
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ....................................................9
Item 2. Changes in Securities and Use of Proceeds............................10
Item 3. Defaults Upon Senior Securities......................................10
Item 4. Submission of Matters to a Vote of Security Holders..................10
Item 5. Other Information ...................................................10
Item 6. Exhibits and Reports on Form 8-K ....................................10
Signatures ...................................................................11
2
<PAGE>
PART I
Item 1. Financial Statements
<TABLE>
<CAPTION>
FACTORY 2-U STORES, INC.
Balance Sheets
(in thousands, except share data)
November 3, February 3,
2001 2001
----------- -----------
<S> <C> <C>
(Unaudited)
ASSETS
Current assets
Cash $ 6,059 $ 4,739
Merchandise inventory 85,416 52,444
Accounts receivable 1,823 3,160
Prepaid expenses 6,393 4,716
Deferred income taxes 2,503 2,503
---------- ----------
Total current assets 102,194 67,562
Leasehold improvements and equipment,
net of accumulated depreciation and amortization 42,311 40,632
Deferred income taxes 4,992 4,992
Other assets 1,066 1,176
Excess of cost over net assets acquired, less accumulated
amortization of $12,944 and $11,742, respectively 26,701 27,903
---------- ----------
Total assets $ 177,264 $ 142,265
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
(continued)
F-1
<PAGE>
<TABLE>
<CAPTION>
FACTORY 2-U STORES, INC.
Balance Sheets
(in thousands, except share data)
(continued)
November 3, February 3,
2001 2001
----------- -----------
<S> <C> <C>
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Current maturities of long-term debt and capital leases $ 2,058 $ 2,170
Accounts payable 50,472 25,194
Taxes payable 1,821 8,144
Accrued expenses 17,711 13,158
---------- ----------
Total current liabilities 72,062 48,666
Revolving credit facility 8,143 -
Long-term debt 10,088 9,218
Deferred taxes and other long-term obligations 4,346 1,126
Deferred rent 3,706 3,518
---------- ----------
Total liabilities 98,345 62,528
---------- ----------
Stockholders' equity
Common stock, $0.01 par value; 35,000,000 shares authorized and
12,823,370 shares and 12,759,304 shares issued and outstanding,
respectively 128 127
Stock subscription notes receivable (2,225) (2,225)
Additional paid-in capital 120,794 119,646
Accumulated deficit (39,778) (37,811)
---------- ----------
Total stockholders' equity 78,919 79,737
---------- ----------
Total liabilities and stockholders' equity $ 177,264 $ 142,265
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-2
<PAGE>
<TABLE>
<CAPTION>
FACTORY 2-U STORES, INC.
Statements of Operations
(in thousands, except per share data)
(Unaudited)
13 Weeks Ended 39 Weeks Ended
-------------- --------------
November 3, October 28, November 3, October 28,
2001 2000 2001 2000
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales $ 145,568 $ 136,831 $ 410,646 $ 361,884
Cost of sales 95,308 87,874 268,807 232,567
----------- ----------- ----------- -----------
Gross profit 50,260 48,957 141,839 129,317
Selling and administrative expenses 49,065 38,759 139,503 107,717
Pre-opening and closing expenses 989 1,548 2,881 3,910
Amortization of intangibles 422 482 1,267 1,630
Condemnation award - - - (1,240)
Stock-based compensation expense - 2,056 456 4,807
----------- ----------- ----------- -----------
Operating income (loss) (216) 6,112 (2,268) 12,493
Interest expense, net 342 441 1,123 1,264
----------- ----------- ----------- -----------
Income (loss) before income taxes (558) 5,671 (3,391) 11,229
Income tax provision (benefit) (234) (165) (1,424) 2,130
----------- ----------- ----------- -----------
Net income (loss) $ (324) $ 5,836 $ (1,967) $ 9,099
=========== =========== =========== ===========
Income (loss) per share
Basic $ (0.03) $ 0.46 $ (0.15) $ 0.73
Diluted $ (0.03) $ 0.44 $ (0.15) $ 0.70
Weighted average common shares outstanding
Basic 12,823 12,686 12,780 12,530
Diluted 12,823 13,168 12,780 13,009
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
<TABLE>
<CAPTION>
FACTORY 2-U STORES, INC.
Statements of Cash Flows
(in thousands)
(Unaudited)
39 Weeks Ended
--------------
November 3, October 28,
2001 2001
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Income (loss) from operating activities $ (1,967) $ 9,099
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation 10,300 7,433
Amortization of intangibles 1,268 1,630
Amortization of debt discount 870 858
Loss on disposal of equipment 133 554
Deferred rent expense 296 596
Stock-based compensation expense 456 4,807
Changes in operating assets and liabilities:
Merchandise inventory (32,972) (42,388)
Prepaid expenses and other assets (256) (4,999)
Accounts payable 25,278 24,004
Accrued expenses and other liabilities 88 (4,624)
---------- ---------
Net cash provided by (used in) operating activities 3,494 (3,030)
---------- ---------
Cash flows from investing activities:
Purchase of leasehold improvements and equipment (10,622) (17,105)
---------- ---------
Net cash used in investing activities (10,622) (17,105)
---------- ---------
Cash flows from financing activities:
Borrowings on revolving credit facility 76,146 102,201
Payments on revolving credit facility (68,003) (89,201)
Payments on long-term debt and capital lease obligations (132) (207)
Payment of deferred debt issuance costs (40) (275)
Payments of stock subscription notes receivable - 2,389
Proceeds from exercise of stock options 477 285
---------- ---------
Net cash provided by financing activities 8,448 15,192
---------- ---------
Net increase (decrease) in cash 1,320 (4,943)
Cash at the beginning of the period 4,739 9,473
---------- ---------
Cash at the end of the perod $ 6,059 $ 4,530
========== =========
Supplemental disclosure of cash flow information:
Cash paid durng the period for:
Interest $ 320 $ 424
Income taxes $ 5,523 $ 5,628
Supplemental disclosure of non-cash financing activities:
Issuance of common stock to board members as compensation $ 90 $ 122
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
FACTORY 2-U STORES, INC.
Notes to Financial Statements
(Unaudited)
(1) Unaudited Interim Financial Statements
The accompanying unaudited financial statements do not include all of
the information and footnotes required by generally accepted accounting
principles for annual financial statements and should be read in
conjunction with the financial statements for the fiscal year ended
February 3, 2001 included in our Form 10-K as filed with the Securities
and Exchange Commission.
We believe that the unaudited financial statements as of and for the 13
weeks and 39 weeks ended November 3, 2001 and October 28, 2000 reflect
all adjustments (which include normal recurring adjustments) necessary
to present fairly our financial position, results of operations and
cash flows for the periods presented. Due to the seasonal nature of our
business, the results of operations for the interim period may not
necessarily be indicative of the results of operations for a full year.
Certain prior period amounts have been reclassified to conform their
presentation to the fiscal 2001 financial statements.
(2) New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (the "FASB")
issued two new pronouncements: Statement of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142,
"Goodwill and Other Intangible Assets." SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations
initiated after June 30, 2001 and that the use of the
pooling-of-interests method is no longer permitted. SFAS No. 142
requires that upon adoption, amortization of goodwill will cease and
instead, the carrying value of goodwill will be evaluated for
impairment at least annually using a fair value test. Identifiable
intangible assets will continue to be amortized over their useful lives
and reviewed at least annually for impairment using a method
appropriate to the nature of the intangible asset. We are required to
implement SFAS No.141 on July 1, 2001 and SFAS No. 142 at the beginning
of our next fiscal year, February 3, 2002. We are currently evaluating
the impact of the adoption of these standards and have not yet
determined the full effect that their adoption will have on our
financial position or results of operations. Goodwill amortization for
the 13 weeks and 39 weeks ended November 3, 2001 was approximately
$400,000 and $1.2 million, respectively.
F-5
<PAGE>
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement addresses financial accounting
and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs.
It applies to (a) all entities and (b) legal obligations associated
with the retirement of long-lived assets that result from the
acquisition, construction, development and/or normal operation of
long-lived assets, except for certain obligations of lessees. This
statement amends SFAS No. 19, "Financial Accounting and Reporting by
Oil and Gas Producing Companies" and is effective for financial
statements issued for fiscal years beginning after June 15, 2002. We do
not believe the adoption of this statement will have a material impact
on our consolidated financial position or results of operations.
Also in August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses
financial accounting and reporting for the impairment or disposal of
long-lived assets and supersedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of" and the accounting and reporting provisions of APB Opinion
No. 30, "Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" for the disposal of a
segment of a business (as previously defined in that Opinion). The
provisions of SFAS No. 144 are effective for financial statements
issued for fiscal years beginning after December 15, 2001. We do not
expect the adoption of this statement will have a material impact on
our consolidated financial position or results of operations.
(3) Revolving Credit Facility
We have a $50.0 million revolving credit facility, under which we may
borrow up to 70% of our eligible inventory and 85% of our eligible
accounts receivable, as defined. The credit facility includes a $5.0
million sub-facility for letters of credit. Under the terms of the
credit facility, the interest rate may increase or decrease subject to
earnings before interest, tax obligations, depreciation and
amortization expense (EBITDA), as defined, on a rolling four fiscal
quarter basis. Accordingly, prime rate borrowings could range from
prime to prime plus 0.50% and LIBOR borrowings from LIBOR plus 1.50% to
LIBOR plus 2.50%. The credit facility expires on March 3, 2003, subject
to automatic one-year renewal periods, unless terminated earlier by
either party. We are obligated to pay fees equal to 0.125% per annum on
the unused amount of the credit facility. The credit facility is
secured by a first lien on accounts receivable and inventory and
requires us to maintain specified levels of tangible net worth in the
event that our borrowing availability is less than $10.0 million.
At November 3, 2001, based on eligible inventory and accounts
receivable, we were eligible to borrow $50.0 million under the
revolving credit facility, of which $8.1 million was outstanding at a
prime rate of 5.5%.
F-6
<PAGE>
(4) Long-term Debt
---------------
Our long-term debt consists of Junior Subordinated Notes, which are
non-interest bearing and are reflected on our balance sheets at the
present value using a discount rate of 10%. As of November 3, 2001, the
Junior Subordinated Notes had a face value of $15.3 million and a
related unamortized discount of $3.2 million, resulting in a net
carrying value of $12.1 million. The discount is amortized to interest
expense as a non-cash charge until the notes are paid in full. We made
a principal payment on the Junior Subordinated Notes of $1.0 million in
December 2000. Additional principal payments are scheduled on December
31, 2001 and December 31, 2002 ($2.0 million), December 31, 2003 and
December 31, 2004 ($3.0 million) and on May 28, 2005 ($5.3 million).
(5) Earnings (loss) per Share
We compute earnings (loss) per share in accordance with SFAS No. 128,
Earnings Per Share. Under the provisions of SFAS No. 128, basic
earnings (loss) per share is computed based on the weighted average
shares outstanding. Diluted earnings per share is computed based on the
weighted average shares outstanding and potentially dilutive common
stock equivalent shares. At November 3, 2001, we had 1,452,457
anti-dilutive stock options outstanding. Common stock equivalent shares
are not included in the computation of diluted loss per share for the
13 weeks and 39 weeks ended November 3, 2001 because the effect would
be anti-dilutive.
The following table sets forth the computation of basic and diluted
earnings per share for the periods indicated.
<TABLE>
<CAPTION>
13 Weeks Ended 39 Weeks Ended
-------------- --------------
November 3, October 28, November 3, October 28,
2001 2000 2001 2000
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
(in thousands, except per share data)
Net income (loss) $ (324) $ 5,836 $ (1,967) $ 9,099
Weighted average number of common shares outstanding 12,823 12,686 12,780 12,530
Effect of dilutive securities:
Warrants that are common stock equivalents - 34 - 31
Options that are common stock equivalents - 448 - 448
Adjusted common shares outstanding used for
diluted computation 12,823 13,168 12,780 13,009
Earnings (loss) per share:
Basic $ (0.03) $ 0.46 $ (0.15) $ 0.73
Diluted $ (0.03) $ 0.44 $ (0.15) $ 0.70
</TABLE>
F-7
<PAGE>
(6) Stock Options and Warrants
As of November 3, 2001, we had outstanding options to purchase
1,369,767 shares of our common stock. Included in these outstanding
stock options are 46,144 performance-based options. These
performance-based options are designed to become exercisable when the
closing price of our common stock remains at or above the price target
of $49.78 for 60 consecutive trading days. If they become exercisable,
we will incur a minimum non-cash charge of $1.9 million. Of these
performance-based options, 36,201 will expire on April 3, 2002 and the
balance will expire on various dates through April 29, 2003.
During the second quarter, we removed the price target of $49.78 for
19,361 stock options held by a former Executive Vice President who
retired in August 2001. As a result of the removal of the price target,
we incurred a non-cash charge of $456,000 for the 13 weeks ended August
4, 2001.
At November 3, 2001, we had outstanding warrants to purchase 82,690
shares of our common stock. These warrants have an exercise price of
$19.91 and expire in May 2005.
(7) Contingencies and commitments
We have developed and from time-to-time revise financial hurdles for
each of our existing and proposed stores. Prior to a decision to locate
and open any new store, we evaluate, among other factors, the
likelihood that the store will be able to achieve then current
financial performance criteria, including initial sales volume, sales
growth, store opening and operating costs, store contribution,
cash-on-cash return and return on net assets. These financial criteria
are considered not only in connection with the decision to open a new
store but also are constantly evaluated after a store has been opened
for a reasonable period of time to determine if they continue to be
met.
As a result of our ongoing store evaluation process, we have closed 36
stores over the past three years, generally as a result of declining
financial performance due to demographic shifts in specific markets.
During this same time frame, we accelerated our store growth opening
147 new stores, including 65 stores in 9 states in which we had not
previously operated. As a result of a significantly larger and younger
store base built during this period, through our ongoing store
evaluation process, we have identified approximately 30 stores that are
not currently meeting the minimum financial performance criteria. Our
current plan is to evaluate these stores again after the Holiday
season and, at that time, make a determination as to whether we should
continue to operate some or all of these stores. The time table for
potential closing of any store is based on many factors, including the
lease expiration date, the store cash flow and lease operating
covenants. If it is determined that some or all of the stores currently
identified as "under performers" should be closed, charges for the
estimated costs to close those stores would be taken in the fourth
quarter of Fiscal 2001.
F-8
<PAGE>
The charges to close a store would principally consist of lease
termination or sublease costs, inventory liquidation expenses, a
provision for fixed asset write-offs, tear down costs, and employee
severance. Our current analysis suggests that the average cost to
close a store would be $550,000 per store.
On December 15, 2000, Pamela Jean O'Hara ("O'Hara"), a former employee
in our Alameda, California store, filed a lawsuit against us, entitled
"Pamela Jean O'Hara, Plaintiff vs. Factory 2-U Stores, Inc., et al.,
Defendants," Case No. 834123-5, in the Superior Court of the State of
California for the County of Alameda (the "O'Hara Lawsuit"). On August
2, 2001, O'Hara and four other former employees in our California
stores, filed a Second Amended Complaint in the O'Hara Lawsuit.
The Second Amended Complaint in the O'Hara Lawsuit alleges that we
violated the California Labor Code and Industrial Wage Commission
Orders, as well as the California Unfair Competition Act, by failing to
pay overtime to the plaintiffs. Plaintiffs purport to bring this action
on behalf of themselves and all other store managers, assistant store
managers and other undescribed "similarly-situated employees" in our
California stores from December 15, 1996 to present. The Second Amended
Complaint seeks compensatory damages, interest, penalties, attorneys'
fees and disgorged profits, all in unspecified amounts. The Second
Amended Complaint also seeks injunctive relief requiring payment of
overtime to "non-exempt" employees. On September 4, 2001, we filed an
answer in which we denied the material allegations of the Second
Amended Complaint.
Pursuant to an Order dated December 3, 2001, the Court in the O'Hara
Lawsuit granted Plaintiff's motion for certification of two plaintiff
clauses: (1) all persons who have been employed as assistant store
managers at one of our California stores at any time after December 15,
1996, and who worked hours which would have entitled them to overtime
had they not been exempt employees; and (2) all persons who have been
employed as store managers at one of our California stores at any time
after December 15, 1996, and who worked hours which would have entitled
them to overtime had they not been exempt employees.
The Court has scheduled the trial for July 22, 2002.
Although at this stage of the litigation is difficult to predict the
outcome of the case with certainty, we believe that we have meritorious
defenses to the O'Hara Lawsuit and are vigorously defending against it.
If the O'Hara Lawsuit is decided adversely to us, the potential
exposure could be material to our results of operations for the year in
which the case is ultimately decided.
In addition, we are at all times subject to pending and threatened
legal actions that arise in the normal course of business. In the
opinion of our management, based in part on the advice of legal
counsel, the ultimate disposition of these current matters will not
have a material adverse effect on our financial position or results of
operations.
F-9
<PAGE>
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our
Financial Statements and notes thereto, included elsewhere in this Form 10-Q.
General
As of November 3, 2001, we operated 273 stores compared to 231 stores as of
October 28, 2000, an increase of 42 stores or 18.2%. We opened 12 new stores and
closed 2 stores during the 13-week period ended November 3, 2001, and opened 20
new stores in the same period last year. For the 39 weeks ended November 3,
2001, we opened 33 new stores and closed 3 stores as compared to 56 new store
openings and 12 store closings for the comparable period last year.
Due to the Company's 53-week fiscal year last year, the Company's comparable
sales weeks are compared to an adjusted comparable sales period for last year.
Results of Operations
Net sales were $145.6 million for the 13 weeks ended November 3, 2001 compared
to $136.8 million for the 13 weeks ended October 28, 2000, an increase of $8.7
million, or 6.4%. Comparable store sales for the third quarter decreased 10.5%
versus an increase of 8.2% for the same period last year.
For the 39 weeks ended November 3, 2001, net sales were $410.6 million versus
$361.9 million the same period last year, an increase of $48.8 million or 13.5%.
Comparable store sales decreased 6.6% in the first 39 weeks of this year
compared to an increase of 5.2% for the same period last year.
The increase in sales for the 13 and 39 weeks ended November 3, 2001, compared
to the same periods in the prior year, reflected an increase in the number of
stores in operation, offset by a decrease in comparable store sales.
Gross profit was $50.3 million or 34.5% of net sales for the 13 weeks ended
November 3, 2001 compared to $49.0 million or 35.8% for the 13 weeks ended
October 28, 2000.
For the 39 weeks ended November 3, 2001 and October 28, 2000, gross profit was
$141.8 million or 34.5% of net sales and $129.3 million or 35.7% of net sales,
respectively.
The increase in gross profit dollars for the 13 and 39 weeks ended November 3,
2001 versus the comparable periods last year was due to more stores in operation
this year. The decline in gross profit as a percentage of net sales for both
periods was primarily attributable to higher markdown volume, partially offset
by a higher initial mark up on merchandise purchases.
3
<PAGE>
Selling and administrative expenses were $49.1 million or 33.7% of net sales for
the 13 weeks ended November 3, 2001 compared to $38.8 million or 28.3% of net
sales for the 13 weeks ended October 28, 2000.
For the 39 weeks ended November 3, 2001, selling and administrative expenses
were $139.5 million or 34.0% of net sales versus $107.7 million or 29.8% of net
sales for the same period last year.
The dollar increase in selling and administrative expenses for the 13 and 39
weeks ended November 3, 2001 versus the same periods last year was a result of
additional new stores, increased labor rates due to minimum wage increases,
higher advertising costs, occupancy costs and utility costs in certain operating
areas. In addition, included in the year-to-date selling and administrative
expenses was a charge of $1.2 million recorded in the second quarter related to
the retirement and replacement of a former Executive Vice President. The
increase in selling and administrative expenses as a percent of sales for both
the 13 and 39 weeks ended November 3, 2001 was due to lower sales volume from
new stores, a decline in comparable store sales and the items cited above.
Pre-opening and closing expenses were $1.0 million for the 13 weeks ended
November 3, 2001 compared to $1.5 million for the same period last year, a
decrease of approximately $559,000. The decrease was primarily attributable to 8
fewer new store openings in the current quarter.
For the 39 weeks ended November 3, 2001, the pre-opening and closing expenses
were $2.9 million versus $3.9 million the same period last year, a decrease of
approximately $1.0 million. The decrease was primarily due to 23 fewer new store
openings during the current period.
During the 39 weeks ended October 28, 2000, we recorded a non-recurring gain of
$1.2 million related to a condemnation award from the City of San Diego for a
store located in downtown San Diego, California.
Interest expense was $342,000 and $1.1 million for the 13 weeks and 39 weeks
ended November 3, 2001, respectively, versus $441,000 and $1.3 million for the
comparable periods last year. The continued decrease in interest expense for
both periods was primarily due to lower average outstanding borrowings and lower
interest rates on the revolving credit facility.
Income tax benefit was $234,000 and $1.4 million for the 13 weeks and 39 weeks
ended November 3, 2001, respectively, versus income tax benefit of $165,000 and
income tax provision of $2.1 million for the comparable periods last year.
Income tax provision/benefit is based upon our estimated effective tax rate for
the entire fiscal year. During the third quarter of last year, our $2.3 million
provision for income taxes was offset by a favorable adjustment of $2.5 million
to our income tax provision for a reduction in our tax valuation allowance.
We incurred a net loss of $324,000 and $2.0 million for the 13 weeks and 39
weeks ended November 3, 2001 compared to net income of $5.8 million and $9.1
million for the comparable periods last year. The decline in net income was a
result of the operating and other factors cited above.
4
<PAGE>
Liquidity and Capital Resources
General
We finance our operations through credit provided by vendors and other
suppliers, amounts borrowed under our $50.0 million revolving credit facility
and internally generated cash flow. Credit terms provided by vendors and other
suppliers are usually 30 days. Amounts that may be borrowed under the revolving
credit facility are based on a percentage of eligible inventory and accounts
receivable, as defined, outstanding from time to time, as more fully described
in Note 3 of Notes to Financial Statements.
We believe that our sources of cash, including the revolving credit facility,
will be adequate to finance our operations, capital requirements and debt
obligations as they become due for at least the next twelve months. See Notes 3
and 4 of Notes to Financial Statements.
Cash Flows
For the 39 weeks ended November 3, 2001, net cash generated from operating
activities was $3.5 million versus net cash of $3.0 million used in the same
period last year. The increase in cash flow from operating activities was
primarily due to the timing of vendor payments. Cash used in investing
activities for the 39 weeks ended November 3, 2001 was $10.1 million as compared
to $17.1 million in the same period last year. Investing activities relate
primarily to capital expenditures for both new and existing stores. The decrease
in capital expenditures from the prior year was a result of 23 fewer new stores
opened in fiscal 2001. Cash provided by financing activities, primarily from
borrowings on our revolving credit facility, for the 39 weeks ended November 3,
2001 was $8.4 million versus $15.2 million in the same period last year. The
decrease in borrowings was primarily due to the timing of vendor payments and
lower capital spending. For the 39 weeks ended November 3, 2001, the net
increase in cash was $1.3 million versus a decrease of $4.9 million for the same
period last year.
Capital Expenditures
We anticipate capital expenditures of approximately $2.1 million during the
remainder of the current fiscal year ending February 2, 2002, which include
primarily costs to open 6 new stores in November.
We are currently developing a plan to relocate and expand our current
distribution center in San Diego, California. We expect that the new
distribution center will be approximately 600,000 square feet and it is intended
to service our California, Washington, Oregon, Arizona, and Nevada markets. We
anticipate that it will become operational during the first quarter of fiscal
2003. We anticipate capital expenditures of approximately $5.0 million for this
facility, most of which will occur in fiscal 2002. We currently plan to finance
the development of this new distribution facility from internally generated cash
flow.
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Evaluation of Store Performance
We have developed and from time-to-time revise financial hurdles for each of our
existing and proposed stores. Prior to a decision to locate and open any new
store, we evaluate, among other factors, the likelihood that the store will be
able to achieve then current financial performance criteria, including initial
sales volume, sales growth, store opening and operating costs, store
contribution, cash-on-cash return and return on net assets. These financial
criteria are considered not only in connection with the decision to open a new
store but also are constantly evaluated after a store has been opened for a
reasonable period of time to determine if they continue to be met.
As a result of our ongoing store evaluation process, we have closed 36 stores
over the past three years, generally as a result of declining financial
performance due to demographic shifts in specific markets. During this same
time frame, we accelerated our store growth opening 147 new stores, including
65 stores in 9 states in which we had not previously operated. As a result of a
significantly larger and younger store base built during this period, through
our ongoing store evaluation process, we have identified approximately 30 stores
that are not currently meeting the minimum financial performance criteria. Our
current plan is to evaluate these stores again after the Holiday season and, at
that time, make a determination as to whether we should continue to operate some
or all of these stores. The time table for potential closing of any store is
based on many factors, including the lease expiration date, the store cash flow
and lease operating covenants. If it is determined that some or all of the
stores currently identified as "under performers" should be closed, charges for
the estimated costs to close those stores would be taken in the fourth quarter
of Fiscal 2001. The charges to close a store would principally consist of lease
termination or sublease costs, inventory liquidation expenses, a provision for
fixed asset write-offs, tear down costs, and employee severance. Our current
analysis suggests that the average cost to close a store would be $550,000 per
store.
Inflation
In general, we believe that inflation has had no recent material impact on our
operations and none is anticipated in the next fiscal year.
Minimum Wage Increases
We employ a substantial number of employees in our stores who earn hourly wages
near or at the minimum wage. Actions by both the federal and certain state
governments have increased and may continue to increase the hourly wages that we
must pay to such employees. Historically, we have attempted to partially
mitigate such increases through policies to manage our ratio of wages to sales.
However, we can make no assurances that these measures and other steps taken
will be adequate to control the impact of any hourly wage increases in the
future, which may have a negative effect on our future profitability.
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California Utility Costs
In California, where we currently operate 123 stores, representing 44% of our
total store base, utility costs for electricity and natural gas have risen
significantly over the past year. These costs may continue to increase due to
the actions of federal and state governments and agencies, as well as other
factors beyond our control. We have attempted to mitigate such increases through
energy conservation measures and other cost reduction steps. However, we can
make no assurances that these measures and other steps taken will be adequate to
control the impact of these utility cost increases in the future, nor can we
make assurances as to what impact these utility cost increases may have on our
sales related to our core customer base in California.
Seasonality and Quarterly Fluctuations
We have historically realized our highest level of sales and income during the
third and fourth quarters of our fiscal year (the quarters ending in October and
January, respectively) as a result of the "Back to School" (August and
September) and Holiday (November and December) seasons. The seasonally lower
sales in our first two quarters (February through July), can result in losses
during these quarters even in years in which we will have full year profits.
Cautionary Statement Concerning Forward-Looking Statements
In this Quarterly Report on Form 10-Q, we have made both historical and
forward-looking statements. All of our statements other than those of historical
fact are, or may be deemed to be, forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These forward-looking statements are not based on
historical facts, but rather reflect our current expectations concerning future
results and events. These forward-looking statements generally may be identified
by the use of phrases such as "believe", "expect", "anticipate", "intend",
"plan", "foresee", "likely", "will" or other similar words or phrases.
Similarly, statements that describe our objectives, plans or goals are or may be
forward-looking statements. These forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause our actual
results, performance or achievements to be different from any future results,
performance or achievements expressed or implied by these statements.
The following important factors, among others, could affect our future results,
causing these results to differ materially from those expressed in any of our
forward-looking statements: general economic and business conditions, trends in
our business and consumer preferences, especially as may be impacted by economic
weakness on consumer spending, the effects of government regulations and
legislation, litigation and other claims that may be asserted against us, the
effects of intense competition, changes in our business strategy or development
plans, including anticipated growth strategies and capital expenditures, the
costs and difficulties of attracting and retaining qualified personnel, the
effects of increasing labor, utility, fuel and other
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operating costs, our ability to obtain adequate quantities of suitable
merchandise at favorable prices and on favorable terms and conditions, the
effectiveness of our operating initiatives and advertising and promotional
strategies and other factors that may be described from time to time in our
Annual Report on Form 10-K and other filings that we may make with the
Securities and Exchange Commission.
We do not undertake to publicly update or revise any of our forward-looking
statements, whether as a result of new information, future events and
developments or otherwise, except to the extent that we may be obligated to do
so by applicable law.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to interest rate risk on our long-term debt, which is
non-interest bearing and is discounted at an annual rate of 10%. At November 3,
2001, our long-term debt had a face value of $15.3 million with a net carrying
value of $12.1 million. While generally an increase in market interest rates
will decrease the value of this debt, and decreases in interest rates will have
the opposite effect, we are unable to estimate the impact that interest rate
changes will have on the value of this debt as there is no active public market
for the debt and we are unable to determine the market interest rate at which
alternate financing would have been available at November 3, 2001. In addition,
we are exposed to interest rate risk on our revolving credit facility, with the
outstanding balance accruing interest at variable rates, based on either prime
or LIBOR. Depending upon prevailing market conditions, the base prime or LIBOR
rates at which our borrowings are charged interest could be affected.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On December 15, 2000, Pamela Jean O'Hara ("O'Hara"), a former employee in our
Alameda, California store, filed a lawsuit against us, entitled "Pamela Jean
O'Hara, Plaintiff vs. Factory 2-U Stores, Inc., et al., Defendants," Case No.
834123-5, in the Superior Court of the State of California for the County of
Alameda (the "O'Hara Lawsuit"). On August 2, 2001, O'Hara and four other former
employees in our California stores, filed a Second Amended Complaint in the
O'Hara Lawsuit.
The Second Amended Complaint in the O'Hara Lawsuit alleges that we violated the
California Labor Code and Industrial Wage Commission Orders, as well as the
California Unfair Competition Act, by failing to pay overtime to the plaintiffs.
Plaintiffs purport to bring this action on behalf of themselves and all other
store managers, assistant store managers and other undescribed
"similarly-situated employees" in our California stores from December 15, 1996
to present. The Second Amended Complaint seeks compensatory damages, interest,
penalties, attorneys' fees and disgorged profits, all in unspecified amounts.
The Second Amended Complaint also seeks injunctive relief requiring payment of
overtime to "non-exempt" employees. On September 4, 2001, we filed an answer in
which we denied the material allegations of the Second Amended Complaint.
Pursuant to an Order dated December 3, 2001, the Court in the O'Hara Lawsuit
granted Plaintiff's motion for certification of two plaintiff clauses: (1) all
persons who have been employed as assistant store managers at one of our
California stores at any time after December 15, 1996, and who worked hours
which would have entitled them to overtime had they not been exempt employees;
and (2) all persons who have been employed as store managers at one of our
California stores at any time after December 15, 1996, and who worked hours
which would have entitled them to overtime had they not been exempt employees.
The Court has scheduled the trial for July 22, 2002.
Although at this stage of the litigation is difficult to predict the outcome of
the case with certainty, we believe that we have meritorious defenses to the
O'Hara Lawsuit and are vigorously defending against it. If the O'Hara Lawsuit is
decided adversely to us, the potential exposure could be material to our results
of operations for the year in which the case is ultimately decided.
We are at all times subject to pending and threatened legal actions that arise
in the normal course of business. In our opinion, based in part on the advice of
legal counsel, the ultimate disposition of other current legal matters will not
have a material adverse effect on our financial position or results of
operations.
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Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FACTORY 2-U STORES, INC.
Date: December 18, 2001
By: /s/ Douglas C. Felderman
---------------------------------------------------
Name: Douglas C. Felderman
Title: Executive Vice President and Chief Financial Officer
(duly authorized officer and principal financial officer)
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</TEXT>
</DOCUMENT>