-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C1qV2p3vrTdxAM0AAY3lyxz6ZwPMPKK2XcBvLCQWR6ZNl8y6hEr5PuoBPTcZPPJ5 H7H7a0JWy1xUd2CHepjFiQ== 0000813775-04-000022.txt : 20040610 0000813775-04-000022.hdr.sgml : 20040610 20040610160851 ACCESSION NUMBER: 0000813775-04-000022 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20040501 FILED AS OF DATE: 20040610 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FACTORY 2 U STORES INC CENTRAL INDEX KEY: 0000813775 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-FAMILY CLOTHING STORES [5651] IRS NUMBER: 510299573 STATE OF INCORPORATION: DE FISCAL YEAR END: 0131 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-10089 FILM NUMBER: 04858463 BUSINESS ADDRESS: STREET 1: 4000 RUFFIN ROAD STREET 2: 6TH FLR CITY: SAN DIEGO STATE: CA ZIP: 92123-1866 MAIL ADDRESS: STREET 1: 4000 RUFFIN ROAD STREET 2: 6TH FLOOR CITY: SAN DIEG STATE: CA ZIP: 92123-1866 FORMER COMPANY: FORMER CONFORMED NAME: FAMILY BARGAIN CORP DATE OF NAME CHANGE: 19940202 FORMER COMPANY: FORMER CONFORMED NAME: DRS INDUSTRIES INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: LONGWOOD GROUP LTD DATE OF NAME CHANGE: 19920527 10-Q 1 aform10q050104.txt FORM 10-Q FOR THE QUARTERLY PERIOD ENDED 050104 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 1O-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended May 1, 2004 ----------- Commission File Number: 1-10089 FACTORY 2-U STORES, INC. (1) (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 Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). [X] YES [ ] NO The number of shares outstanding of the registrant's common stock, as of June 4, 2004 was 17,796,178 shares. (1) Factory 2-U Stores, Inc. has been operating as a debtor in possession under Chapter 11 of the United States Bankruptcy Code since January 13, 2004. FACTORY 2-U STORES, INC. FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MAY 1, 2004 INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements Factory 2-U Stores, Inc. Balance Sheets as of May 1, 2004 (Unaudited), May 3, 2003 (Unaudited) and January 31, 2004 ......................F-1 Factory 2-U Stores, Inc. Statements of Operations (Unaudited) for the 13 weeks ended May 1, 2004 and May 3, 2003 .........................F-3 Factory 2-U Stores, Inc. Statements of Cash Flows (Unaudited) for the 13 weeks ended May 1, 2004 and May 3, 2003 .........................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...........12 Item 4. Controls and Procedures .............................................12 PART II. OTHER INFORMATION Item 1. Legal Proceedings ...................................................12 Item 6. Exhibits and Reports on Form 8-K ....................................12 Signatures ................................................................13 2 PART I - FINANCIAL INFORMATION Item 1. Financial Statements
FACTORY 2-U STORES, INC. (Debtor-in-Possession) Balance Sheets (in thousands) May 1, May 3, January 31, 2004 2003 2004 ------ ------ ----------- (Unaudited) (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 5,487 $ 5,414 $ 9,963 Merchandise inventory 46,534 66,012 38,168 Accounts receivable, net 884 623 618 Income tax receivable - 1,756 - Prepaid expenses 3,863 6,258 2,740 Deferred income taxes - 9,753 - --------- --------- -------- Total current assets 56,768 89,816 51,489 Leasehold improvements and equipment, net 16,094 26,594 18,186 Deferred income taxes - 10,750 - Other assets 1,366 936 1,033 Goodwill - 26,301 - --------- --------- -------- $74,228 $154,397 $70,708 ========= ========= ========
The accompanying notes are an integral part of these financial statements. (continued) F-1
FACTORY 2-U STORES, INC. (Debtor-in-Possession) Balance Sheets (in thousands) (continued) May 1, May 3, January 31, 2004 2003 2004 ------ ------ ----------- (Unaudited) (Unaudited) LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: DIP financing facility $ 3,015 $ - $ - Current maturities of long-term debt 36 3,021 36 Junior secured term loans - 7,500 - Accounts payable 16,013 43,844 8,257 Income tax payable 3,492 - 3,500 Sales tax payable 4,142 2,748 5,615 Accrued expenses 14,670 27,693 12,560 --------- -------- --------- Total current liabilities 41,368 84,806 29,968 Revolving credit facility - 11,535 - Long-term debt 83 6,754 92 Accrued restructuring charges - 1,747 - Deferred rent and other liabilities 2,073 2,822 2,518 --------- --------- --------- Total liabilities not subject to compromise 43,524 107,664 32,578 --------- --------- --------- Liabilities subject to compromise 67,986 - 63,062 Stockholders' equity (deficit): Common stock, $0.01 par value; 35,000 shares authorized and 17,796 shares, 15,657 shares and 17,921 shares issued and outstanding, respectively 178 157 179 Additional paid-in capital 137,965 126,513 137,964 Accumulated deficit (175,425) (79,937) (163,075) --------- --------- ---------- Total stockholders' equity (deficit) (37,282) 46,733 (24,932) --------- --------- ---------- $ 74,228 $154,397 $ 70,708 ========= ========= ===========
The accompanying notes are an integral part of these financial statements. F-2
FACTORY 2-U STORES, INC. (Debtor-in-Possession) Statements of Operations (in thousands, except per share data) (Unaudited) 13 Weeks Ended -------------- May 1, May 3, 2004 2003 ------- ------ Net sales $ 80,326 $ 104,347 Cost of sales 52,913 66,712 ---------- ------------ Gross profit 27,413 37,635 Selling and administrative expenses 31,165 41,255 Pre-opening and closing expenses 14 138 ---------- ------------ Operating loss (3,766) (3,758) Interest expense, net 375 634 ---------- ------------ Loss before reorganization items and income tax benefit (4,141) (4,392) Reorganization items 8,210 - ---------- ------------ Loss before income tax benefit (12,351) (4,392) Income tax benefit - (1,671) ---------- ------------ Net loss $ (12,351) $ (2,721) ========== ============ Net loss per share, basic and diluted $ (0.70) $ (0.19) Weighted average common shares outstanding, basic and diluted 17,696 14,620
The accompanying notes are an integral part of these financial statements. F-3
FACTORY 2-U STORES, INC. (Debtor-in-Possession) Statements of Cash Flows (in thousands) (Unaudited) 13 Weeks Ended -------------- May 1, 2004 May 3, 2003 ----------- ----------- Cash flows from operating activities Net loss $ (12,351) $ (2,721) Adjustments to reconcile net loss to net cash used in operating activities Depreciation and amortization 2,349 3,305 Gain on disposal of equipment (4) - Deferred rent (621) (239) Reorganization items 7,874 - Stock subscription notes receivable valuation adjustment - (708) Issuance of common stock to board members as compensation - 5 Other non-cash changes (71) - Changes in operating assets and liabilities Merchandise inventory (8,366) (33,840) Prepaid expenses and other assets (2,225) 8,051 Advances to vendor - (16) Repayments from vendor 70 4 Accounts payable 7,756 15,883 Income taxes payable (8) (4,848) Accrued expenses and other liabilities (1,740) (17) Liabilities subject to compromise (94) - ------------ ------------ Net cash used in operating activities (7,431) (15,141) Cash flows from investing activities Purchases of leasehold improvements and equipment (51) (1,032) ------------ ------------- Net cash used in investing activities (51) (1,032) Cash flows from financing activities Borrowings on revolving credit facility 66,702 42,507 Payments on revolving credit facility (63,687) (37,272) Payments on long-term debt (9) - Proceeds from debt financing - 7,500 Proceeds from issuance of common stock, net - 5,672 Payment of deferred debt issuance costs - (428) Payments of stock subscription notes receivable - 143 ------------ ------------- Net cash provided by financing activities 3,006 18,122 Net increase (decrease) in cash (4,476) 1,949 Cash at the beginning of the period 9,963 3,465 ------------ ------------- Cash at the end of the period $ 5,487 $ 5,414 ============ ============= Supplemental disclosure of cash flow information Cash paid during the period for Interest $ 206 $ 347 Incomes taxes $ 9 $ 88 Supplemental disclosure of non-cash investing and financing activities Acquisition of equipment under notes payable $ - $ 92
The accompanying notes are an integral part of these financial statements. F-4 FACTORY 2-U STORES, INC. (Debtor-in-Possession) Notes to Financial Statements (Unaudited) (1) Basis of Presentation --------------------- The accompanying unaudited financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for annual financial statements and should be read in conjunction with the financial statements for the fiscal year ended January 31, 2004 included in our Form 10-K as filed with the Securities and Exchange Commission. We believe that the unaudited financial statements as of and for the 13 weeks ended May 1, 2004 and May 3, 2003 reflect all adjustments necessary to present fairly the financial position, results of operations and cash flows for the periods presented. Due to the seasonal nature of our business, the results of operations for the interim period may not necessarily be indicative of the results of operations for a full year. Certain prior period amounts have been reclassified to conform their presentation to the fiscal 2004 financial statements. On January 13, 2004 (the "Petition Date"), we filed a voluntary petition to reorganize under Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the District of Delaware (the "Court"), which is currently pending as case number 04-10111(PJW) (the "Chapter 11 filing"). We remain in possession of our properties and continue to operate our business as debtor-in-possession ("DIP") in accordance with the applicable provisions of the Bankruptcy Code. Since the Chapter 11 filing, we have applied the provisions of Statement of Position 90-7 "Financial Reporting by Entities in Reorganization under the Bankruptcy Code" ("SOP 90-7"), which does not significantly change the application of accounting principles generally accepted in the United States; however, it requires the financial statements for periods including and subsequent to filing Chapter 11 petition distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. The accompanying financial statements are prepared on a going concern basis, which assumes continuity of operations and realization of assets and satisfaction of liabilities in the ordinary course of business. In accordance with SOP 90-7, all pre-petition liabilities subject to compromise have been segregated in the Balance Sheets as of May 1, 2004 and January 31, 2004 and classified as Liabilities subject to compromise, at the estimated amount of allowable claims. Liabilities not subject to compromise are separately classified as current and non-current. Expenses, realized gains and losses, and provisions for losses resulting from the reorganization are reported separately as Reorganization items in the Statement of Operations for the 13 weeks ended May 1, 2004. F-5 (2) Accounting Policies ------------------- Use of Estimates Our management has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period to prepare these financial statements in conformity with generally accepted accounting principles in the United States. Actual results could differ from these estimates. Stock-based Compensation We have elected under the provisions of Statement of Financial Accounting Standard (the "SFAS") No. 123, "Accounting for Stock-Based Compensation" to continue using the intrinsic value method of accounting for employee stock-based compensation in accordance with APB No.25, "Accounting for Stock Issued to Employees." Under the intrinsic value method, compensation expense is recognized only in the event that the exercise price of options granted is less than the market price of the underlying stock on the date of grant. The fair value method generally requires entities to recognize compensation expense over the vesting period of options based on the estimated fair value of the options granted. We have disclosed the pro forma effect of using the fair value based method to account for our stock-based compensation as required by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." The following table illustrates the effect on net loss and net loss per common share if we had applied the fair value recognition provisions of SFAS No. 148. (in thousands, except per share data) 13 weeks ended ------------------------------------- May 1, May 3, 2004 2003 ---------- ----------- Net loss before stock-based compensation, as reported $ (12,351) $ (2,721) Stock based compensation using the fair value method, net of tax (546) (809) ----------- ---------- Pro-forma net loss $ (12,897) $ (3,530) =========== ========== Pro-forma net loss per share, basic and diluted $ $ (0.73) $ (0.27)
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option valuation models also require the input of highly subjective assumptions such as expected option life and expected stock price volatility. Because our employee stock-based compensation plan has characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, we believe that the existing option valuation models do not necessarily provide a reliable single measure of the fair value of awards from those plans. The Black-Scholes option valuation model does not take into account our status as a debtor in possession, which may have a material effect on the value of our outstanding options. F-6 The weighted-average fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model using the following weighted-average assumptions: 13 Weeks Ended -------------- May 1, May 3, 2004 2003 ------ ------ (i) Expected dividend yield 0.00% 0.00% (ii) Expected volatility 111.81% 103.68% (iii) Expected life 6 years 7 years (iv) Risk-free interest rate 3.63 % 3.45%
Income (loss) per Share and Comprehensive Income We compute loss per share in accordance with SFAS No. 128, "Earnings Per Share." Under the provisions of SFAS No. 128, basic earnings (loss) per share is computed based on the weighted average shares outstanding. Diluted income (loss) per share is computed based on the weighted average shares outstanding and potentially dilutive common stock equivalent shares. Common stock equivalent shares totaling 0 and 108,437 for the 13 weeks ended May 1, 2004 and May 3, 2003, respectively, are not included in the computation of diluted loss per share because the effect would have been anti-dilutive. Comprehensive loss for the 13 weeks ended May 1, 2004 and May 3, 2003 did not differ from net loss. Recent Accounting Pronouncements In March 2004, the Financial Accounting Standards Board (the "FASB") issued an exposure draft entitled "Share-Based Payment - an amendment of Statements No. 123 and 95 (Proposed Statements of Financial Accounting Standards)" The proposed statement would eliminate an issuer's ability to account for share-based compensation transactions using APB Opinion No. 25 and would generally require that such transactions be accounted for using a fair-value-based method of accounting. This accounting standard, if approved, will result in compensation expense charges to our future results of operations. The proposed statement, if adopted, would be applied to public entities prospectively for fiscal years beginning after December 15, 2004, as if all share-based compensation awards granted, modified or settled after December 15, 1994 had been accounted for using the fair-value method of accounting. Retrospective application of the proposed statement is not permitted. (3) Reorganization Items -------------------- Reorganization items represent amounts we incurred as a result of the Chapter 11 filing, and are recorded and presented in accordance with SOP 90-7. Reorganization items for the 13 weeks ended May 1, 2004 were $8.2 million and consisted of: (1) a non-cash charge of $5.0 million for lease rejection claims associated with 31 lease rejections in conjunction with the 44 stores closed in the quarterly period ended May 1, 2004, as part of our reorganization efforts; (2) $2.8 million of professional fees and other expenses incurred in our bankruptcy case and reorganization efforts; and (3) $366,000 of additional costs to close the 44 stores. Cash payments resulting from reorganization items during the 13 weeks ended May 1, 2004 were approximately $221,000. F-7 (4) Liabilities Subject to Compromise --------------------------------- Under the Bankruptcy Code, actions by creditors to collect indebtedness we owe prior to the Petition Date are stayed and certain other pre-petition contractual obligations may not be enforced against us. We have received approval from the Court to pay certain pre-petition liabilities including employee salaries and wages, benefits and other employee obligations. Except for secured debt, employee payroll and benefits, sales, use and other taxes, and capital lease obligations, all pre-petition liabilities have been classified as Liabilities subject to compromise in the Balance Sheets as of May 1, 2004 and January 31, 2004. Adjustments to pre-petition liabilities may result from negotiations, payments authorized by Court order, additional rejection of executory contracts including leases, or other events. Therefore, the amounts below in total may vary significantly from the stated amounts of proofs of claim that will be filed with the Court. We have mailed notices to all known creditors to inform them that the deadline for filing proofs of claim with the Court is June 15, 2004. The following table summarizes the components of Liabilities subject to compromise in our Balance Sheet as of May 1, 2004. (in thousands) May 1, January 31, 2004 2004 ------ ----------- Trade and other accounts payable $ 41,987 $ 41,734 Junior subordinated notes, net of discount 10,349 10,349 Restructuring costs, primarily lease rejection claims 5,929 6,044 Lease rejection claims 5,065 - General liability and workers compensation claims 2,273 2,283 Severance claims 1,385 1,385 Other 998 1,267 -------- ----------- Liabilities subject to compromise $ 67,986 $ 63,062 -------- -----------
F-8 (5) Store Closures -------------- On February 2, 2004, the Court authorized the closure of 44 stores. On February 11, 2004, the Court approved the agreement between the Great American Group ("Great American") and us in which Great American acted as an exclusive agent to conduct store closing sales at the 44 stores location. The store closing sales started on February 12, 2004. All 44 stores were closed by March 18, 2004 and as of April 23, 2004, we have terminated or assigned a total of 13 leases of these stores and rejected the remaining 31 leases. As a result of these lease rejections, we recorded a non-cash charge of $5.0 million (included in Reorganization items) related to lease rejection claims per the maximum amount allowed under the Bankruptcy Code. Under the terms of the agreement with Great American, we receive a percentage of the aggregate retail price of the merchandise at the 44 stores as of February 11, 2004, as defined. In addition, we receive reimbursement of sale expenses, as defined, incurred during the store closing sales. Sales proceeds, net of sales tax, received during the store closing sales goes to Great American. As of June 4, 2004, we have received $3.4 million as partial payment for the sale of inventory to Great American and are in the process of determining the remaining amount owed to us. In addition, we have received approximately $1.5 million of sale expense reimbursement. Other closing costs of approximately $366,000 not reimbursed by Great American have been included in Reorganization items for the 13 weeks ended May 1, 2004. On June 4, 2004, we filed a motion with the Court seeking authorization to close another 23 under-performing stores. Subject to the Court's approval, we currently plan to start the going-out-of-business sale process on or about July 1, 2004 and expect to close these stores by the end of August 2004. (6) Fiscal 2002 Restructuring Charge -------------------------------- In December 2002, we recorded a restructuring charge of $14.4 million in conjunction with the decision to close 23 stores as well as to consolidate both our distribution center network and corporate overhead structure. As of June 4, 2004, we have closed 20 of these 23 stores. We terminated the lease obligations on 14 of these closed stores prior to our Chapter 11 filing, and in conjunction with our Chapter 11 filing we rejected the other 6 leases. The three remaining stores have not been closed at this time due to lease concessions agreed to by the landlords. The balance of the liability of $4.6 million as of May 1, 2004 (included in "Liabilities subject to compromise" in the accompanying Balance Sheet) related to this fiscal 2002 restructuring charge was as follows: Balance at Non-cash Balance at January 31, Cash Charges and May 1, (in thousands) 2004 Payments Adjustments 2004 ----------- -------- ----------- --------- Lease termination costs $ 4,463 $ - $ - $ 4,463 Employee termination costs 65 (43) - 22 Other costs 147 (58) - 89 ----------- --------- ----------- ---------- $ 4,675 $(101) $ - $ 4,574 ----------- --------- ----------- ----------
As of May 1, 2004, the balance of non-cash inventory liquidation costs related to this fiscal 2002 restructuring charge was zero. F-9 (7) Fiscal 2001 Restructuring Charge -------------------------------- In January 2002, we recorded a restructuring charge of $21.2 million in conjunction with the decision to close 28 under-performing stores as well as the realignment of our field organization and workforce reductions. We closed all 28 stores during fiscal 2002. We had terminated the lease obligations on 23 of these stores prior to our Chapter 11 filing and rejected the remaining 5 leases during the bankruptcy proceeding. The balance of the liability of $1.4 million as of May 1, 2004 (included in "Liabilities subject to compromise" in the accompanying Balance Sheet) related to the fiscal 2001 restructuring charge was as follows: Balance at Balance at January 31, Cash May 1, (in thousands) 2004 Payments 2004 ----------- --------- ---------- Lease termination costs $ 1,249 $ - $ 1,249 Other costs 120 (14) 106 ----------- --------- ---------- $ 1,369 $ (14) $ 1,355 ----------- --------- ----------
(8) DIP Financing Facility ---------------------- In conjunction with our Chapter 11 filing, we entered into a financing agreement with The CIT Group/Business Credit, Inc. (the Tranche A Lender) and GB Retail Funding, LLC (the Tranche B Lender), (collectively the "Lenders") in which the Lenders provided us a $45.0 million revolving credit facility for working capital needs and other general corporate purposes while we operate as a debtor-in-possession (the "DIP financing facility"). This DIP financing facility with a maturity date of January 14, 2005 has since been amended three times; on January 30, 2004, March 10, 2004, and May 27, 2004, respectively. The most recent amendment is subject to the Court's approval, a hearing for which is scheduled on June 15, 2004. The DIP financing facility has a superpriority claim status in our Chapter 11 case and is collateralized by first liens on substantially all of our assets, subject to valid and unavoidable pre-petition liens and certain other permitted liens. Under the terms of the DIP financing facility, we may borrow up to 85% of our eligible accounts receivable and up to 70% of our eligible inventory, as defined. However, the DIP financing facility provides for a $5.0 million availability block against our availability calculation, as defined. The DIP financing facility also includes a $20.0 million sub-facility for letters of credit. Interest on the outstanding borrowings under the DIP financing facility is payable monthly and accrues at the rate equal to, at our option, either the prime rate (as announced by JP Morgan Chase Bank) plus 1.50% per annum or LIBOR plus 3.5% per annum. In the event that there is any outstanding borrowing provided by the Tranche B Lender, such borrowing bears interest at 14.5% per annum payable monthly. We are also obligated to pay a monthly fee equal to 0.375% per annum on the unused available line of credit and a fee equal to 2.5% per annum on the outstanding letters of credit. F-10 Under the terms of the DIP financing facility, capital expenditure for fiscal 2004 is restricted to $2.0 million. In addition, we are required to be in compliance with financial covenants and other customary covenants. As of May 1, 2004, the financial covenants included average minimum availability, cumulative four-week rolling average of cash receipts from store sales and cumulative rolling four-week average of inventory receipts, as defined. The customary covenants include certain reporting requirements and covenants that restrict our ability to incur or create liens, indebtedness and guarantees, make dividend payments, sell or dispose of assets, change the nature of our business and enter into affiliate transactions, mergers and consolidations. Failure to satisfy these covenants would (in some cases, after the expiration of a grace period) result in an event of default that could cause, absent the receipt of appropriate waivers, the funds necessary to maintain our operations to become unavailable. The DIP financing facility contains other customary events of default including certain ERISA events, a change of control and the occurrence of certain specified events in the Chapter 11 case. In addition, during the period from December 28, 2004 through January 11, 2005, we are not allowed to have any outstanding borrowings under the revolving credit facility and our outstanding letters of credit cannot exceed $11.0 million. As of May 1, 2004, we were in compliance with our covenants and had borrowings of $3.0 million outstanding under the revolving credit facility and outstanding letters of credit of $15.1 million under the sub-facility for letters for credit. As of May 1, 2004, based on our eligible inventory and accounts receivable, we were eligible to borrow $14.7 million under the revolving credit facility and had $8.5 million available after giving effect for the availability block, as defined. The May 27, 2004 amendment, still subject to the Court's approval, modified our financial covenants, whereby covenants will include minimum availability, five-day availability covenants at each month end and minimum inventory per store. The Tranche B Lender will fully fund within five business days of the Court's approval of the amendment and we may repay the Tranche B amount after October 20, 2004 subject to certain conditions. (9) Provision for Income Taxes -------------------------- Due to our significant net operating losses and our Chapter 11 filing, we provided for a 100% valuation allowance on all deferred tax assets as of January 31, 2004 because we cannot conclude that it is more likely than not that the deferred tax assets will be realized in the foreseeable future. Accordingly, for the 13 weeks ended May 1, 2004, our income tax benefit was zero as we established a 100% valuation allowance to offset such benefit. (10) Stock Options and Warrants -------------------------- As of May 1, 2004, options to purchase 950,091 shares of our common stock and warrants to purchase 270,190 shares of our common stock were outstanding. The options have exercise prices in the range of $1.61 to $42.25 and expire on various dates between May 2004 and December 2013. The warrants have exercise prices in the range of $3.50 to $19.91 and expire on various dates between May 2005 and August 2006. (11) Legal Matters, Commitments and Contingencies -------------------------------------------- On January 13, 2004, we filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code. We retain control of our assets and are authorized to operate the business as a debtor-in-possession while being subject to the jurisdiction of the Bankruptcy Court. As of the Petition Date, most pending litigation is stayed, and absent further order of the Court, substantially all pre-petition liabilitities are subject to settlement under a plan of reorganization. At this time, it is not possible to predict the outcome of the Chapter 11 case or its effect on our business. If it is determined that the liabilities subject to compromise in the Chapter 11 case exceed the fair value of the assets, unsecured claims may be satisfied at less than 100% of their fair value and the equity interests of our shareholders may have no value. F-11 On or about April 28, 2003, Lynda Bray and Masis Manougian, two of our former employees, filed a lawsuit against us entitled Lynda Bray, Masis Manougian, etc., Plaintiffs v. Factory 2-U Stores, Inc., et al., Defendants, Case No. RCV071918, in the Superior Court of the State of California for the County of San Bernardino (the "Bray Lawsuit"). The First Amended Complaint in the Bray Lawsuit alleges purported claims for: (1) "Failure to Record Hours and or Illegally Modify Recorded Hours Worked;" (2) "Failure to Pay Wages Under State Labor Code, Penal Code and IWC Wage Order 7, Injunctive and Monetary Relief;" (3) "Unfair Business Practice, Bus. & Prof. Code ss.17200 et. seq., Failure to Pay Wages and Record Hours Worked;" (4) "Equitable Conversion;" and (5) "False Advertising." The thrust of plaintiffs' claim is that the Company failed to pay wages and overtime for all hours worked, failed to document all hours worked, and failed to inform prospective or new employees of unpaid wage claims. Plaintiffs purport to bring this action on behalf of all persons who were employed in one of the California stores at anytime after April 25, 2003. Plaintiffs seek compensatory and exemplary damages, interest, penalties, attorneys' fees and disgorged profits in an amount which plaintiffs estimated to be not less than $100,000,000. Plaintiffs also seek injunctive relief requiring correction of the alleged unlawful practices. Although at this stage of the litigation it is difficult to predict the outcome of the case with certainty, we believe that we have meritorious defenses to the Bray Lawsuit. All proceedings in the Bray Lawsuit are currently stayed pursuant to the automatic stay provisions of Section 362 of the Bankruptcy Code, subject to the entry of an order by the Court lifting the automatic stay. In the event the Court enters an order lifting the automatic stay, we will continue to vigorously defend against the Bray Lawsuit. If the Bray Lawsuit is decided adversely, the potential exposure could be material to our results of operations. In November 2003, Virginia Camarena, a current employee in one of our California stores, filed a lawsuit against us entitled Virginia Camarena, Plaintiff, vs. Factory 2-U Stores Inc., etc., Defendants, Case No. BC305173 in the Superior Court of the State of California for the County of Los Angeles - Central District (the "Camarena Lawsuit"). The plaintiff alleges that we violated the California Wage Orders, California Labor Code, California Business and Profession Code and the Federal Fair Labor Standards Act by failing to pay her wages and overtime for all hours worked, by failing to provide her with statements showing the proper amount of hours worked, and by wrongfully converting her property by failing to pay overtime wages owed on the next payday after they were earned. The plaintiff purports to bring this as an action on behalf of all persons who were employed in one of our California stores or outside the state of California. Plaintiffs seek compensatory, punitive and liquidated damages, restitution, interest, penalties and attorneys' fees. In December 2003, we filed an answer to the complaint and removed the Camarena Lawsuit to the United States District Court for the Central District of California, Case No. CV-03-8880 RGK (SHx), where it is currently pending. Although at this stage of the litigation it is difficult to predict the outcome of the case with certainty, we believe that we have meritorious defenses to the Camarena Lawsuit. All proceedings in the Camarena Lawsuit are currently stayed pursuant to the automatic stay provisions of Section 362 of the Bankruptcy Code, subject to the entry of an order by the Court lifting the automatic stay. In the event the Court enters an order lifting the automatic stay, we will continue to vigorously defend against the Camarena Lawsuit. There are numerous other matters filed with the Court in our reorganization proceedings by creditors, landlords or other third parties related to our business operations or the conduct of our reorganization activities. Although none of these individual matters which have been filed to date have had or are expected to have a material adverse effect on us, our ability to successfully manage the reorganization process and develop an acceptable reorganization plan could be negatively impacted by adverse determinations by the Court on certain of these matters. F-12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Cautionary Statements for Purposes of "Safe Harbor Provisions" of the Private Securities Litigation Reform Act of 1995 Certain statements in this Quarterly Report on Form 10-Q are forward-looking statements, which are within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are not based on historical facts, but rather reflect our current expectation concerning future results and events. These forward-looking statements generally may be identified by the use of phrases such as "believe", "expect", `estimate", "anticipate", "intend", "plan", "foresee", "likely", "will" or other similar words or phrases. Similarly, statements that describe our objectives, plans or goals are or may be forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be different from any future results, performance or achievements expressed or implied by these statements. The following factors, among others, could affect our future results, performance or achievements, causing these results to differ materially from those expressed in any of our forward-looking statements: general economic and business conditions (both nationally and in regions where we operate); trends in our business and consumer preferences, especially as may be impacted by economic weakness on consumer spending; the effect of government regulations and legislation; litigation and other claims that may be asserted against us; the effects of intense competition; changes in our business strategy or development plans, including anticipated growth strategies and capital expenditures; the challenges and costs associated with maintaining and improving technology; the costs and difficulties of attracting and retaining qualified personnel; the effects of increasing labor, utility, fuel and other operating costs; our ability to obtain adequate quantities of suitable merchandise at favorable prices and on favorable terms and conditions; the effectiveness of our operating initiatives and advertising and promotional strategies and other factors described in this Quarterly Report on Form 10-Q and in our other filings with the Securities and Exchange Commission. In addition to the above general factors, the following bankruptcy related factors, among others, could also affect our future results, performance or achievements, causing these results to differ materially from those expressed in any of our forward-looking statements: our ability to continue as a going concern; our ability to operate pursuant to the terms of our debtor-in-possession financing facility; our ability to obtain approval from the Court with respect to motions in the Chapter 11 case from time to time; our ability to negotiate, confirm and consummate a plan of reorganization in a timely manner; risks associated with third parties seeking and obtaining court approval to terminate or shorten the exclusivity period that we have to propose and confirm one or more plans of reorganization, for the appointment of a Chapter 11 trustee or to convert the Chapter 11 case to a case under Chapter 7 of title 11 of the Bankruptcy Code; our ability to offset the negative effects that the filing for reorganization under Chapter 11 of the Bankruptcy Code has had on our business, including the loss in customer traffic, the impairment of vendor relations and the constraints placed on available capital; our ability to obtain and maintain normal terms with vendors and service providers; the ability of our vendors to obtain satisfactory credit terms from factors and other financing sources; our ability to maintain contracts, including leases, which are critical to our operations; the potential adverse impact of the Chapter 11 case on our liquidity or results of operations; our ability to develop a long-term strategy to revitalize our business and return to profitability; and our ability to fund and execute our business plan. 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. 3 Similarly, these and other factors, including the terms of the final plan of reorganization, if any, ultimately confirmed, can affect the value of our pre-petition liabilities and common stock. Until a plan of reorganization is confirmed by the Court, the recoveries of pre-petition claim holders are subject to change. Accordingly, no assurance can be given as to what values, if any, will be ascribed in the bankruptcy case to each of these constituencies. The final plan of reorganization, if any, confirmed by the Court may result in the cancellation of our existing common stock with holders thereof receiving no distributions under the plan of reorganization. In light of the foregoing, we consider the value of our common stock to be highly speculative and caution equity holders that the stock may ultimately be determined to have no value. Accordingly, we urge that appropriate caution be exercised with respect to existing and future investments in our common stock or any claims relating to pre-petition liabilities. General The following discussion and analysis should be read in conjunction with our financial statements and notes thereto, included elsewhere in this Form 10-Q. Despite our efforts in fiscal 2003 to improve sales and our liquidity, we were unable to improve comparable sales growth and operating margin at a rate that could generate sufficient cash flow to sustain ongoing operations. Accordingly, on January 13, 2004, we filed a voluntary petition to reorganize under Chapter 11 of the Bankruptcy Code in the Court, which is currently pending. We decided to seek judicial reorganization in order to implement a comprehensive operational and financial restructuring due to the tightening of credit extended by our vendors and the credit community and a decline in our liquidity caused by declining sales volume and deteriorating operating margin in a very soft retail environment. As the debtor, we are authorized to continue to operate as an ongoing business, but may not engage in transactions outside the ordinary course of business without the approval of the Court after notice and an opportunity for a hearing. At hearings held on January 14, 2004 concerning our first day motions, the Court entered orders granting us authority, among other things, to (1) continue our centralized cash management system, (2) pay pre-petition wages and continue our employee benefit plans and other employee programs, (3) continue customer related practices, (4) pay certain sales, use and other taxes, (5) pay suppliers and vendors in full for all goods and services provided on or after the Petition Date and (6) continue ongoing pre-petition "going out of business sales" for four store locations completed by January 31, 2004. In addition, the Court also gave interim approval for a $45.0 million DIP financing facility (DIP financing facility) that was committed by The CIT Group/Business Credit, Inc. and GB Retail Funding, LLC. On February 2, 2004, the Court granted final approval of the $45.0 million DIP financing facility. We intend to utilize this financing, in addition to cash flow from operations, to fulfill business obligations during the Chapter 11 process. Additionally, on February 2, 2004, the Court authorized the closure of 44 stores, or approximately 18% of our 239 stores. Stores were selected by evaluating their market and financial performance. On February 11, 2004, the Court approved our appointment of the Great American Group ("Great American") as exclusive agent to conduct store closing sales at these 44 store locations. The store closing sales started on February 12, 2004. All 44 stores were closed by March 18, 2004 and as of April 23, 2004, we have terminated or assigned a total of 13 leases of these stores and rejected the remaining 31 leases. On February 17, 2004, we filed with the Court our schedules of assets and liabilities and statements of financial affairs setting forth, among other things, the assets and liabilities as shown on our books and records as of the Petition Date, subject to the assumptions contained in certain notes filed in connection therewith. The schedules of assets and liabilities and statements of financial affairs remain subject to further amendment or modification. We have mailed notices to all known creditors that the deadline for filing proofs of claim with the Court is June 15, 2004. Differences between amounts we have scheduled and claims by creditors will be investigated and resolved in connection with our claims resolution process. As we are at an early stage of the bankruptcy and we do not yet have a plan of reorganization, the ultimate distribution with respect to allowed claims is not presently ascertainable. 4 The United States Trustee has appointed an unsecured creditors committee and may consider the appointment of an equity committee. There can be no assurance that the unsecured creditors committee or equity committee, if any, will support our positions in the bankruptcy case or the plan of reorganization once proposed, and any disagreements could protract the bankruptcy case, negatively impact our ability to operate during bankruptcy, and/or delay our emergence from bankruptcy. Under the Bankruptcy Code, actions to collect pre-petition indebtedness, as well as most other pending litigation, are stayed and other contractual obligations against us generally may not be enforced. Absent an order of the Court, substantially all pre-petition liabilities are subject to compromise under a plan of reorganization to be voted upon and approved by the Court. Although we expect to file a reorganization plan that provides for emergence from bankruptcy, there can be no assurance that a plan of reorganization will be proposed by us or confirmed by the Court, or that any such plan will be consummated. We also may assume or reject executory contracts and unexpired leases, including our store and distribution center leases, subject to the approval of the Court and our satisfaction of certain other requirements. In the event we choose to reject an executory contract or unexpired lease, parties affected by these rejections may file claims with the Court-appointed claims agent as prescribed by the Bankruptcy Code and/or orders of the Court. Unless otherwise agreed, the assumption of an executory contract or unexpired lease will require us to cure all prior defaults under such executory contract or lease, including all pre-petition liabilities, some of which may be significant. In addition, in this regard, we expect that liabilities that will be subject to compromise through the Chapter 11 process will arise in the future as a result of the rejection of additional executory contracts and/or unexpired leases, and from the determination by the Court (or agreement by parties in interest) of allowed claims for items that we now claim as contingent or disputed. Conversely, we would expect that the assumption of additional executory contracts may convert some liabilities shown on our financial statements as subject to compromise to post-petition liabilities. Due to the uncertain nature of many of the potential claims, we are unable to project the magnitude of such claims with any degree of certainty. We have incurred, and will continue to incur, significant costs associated with the reorganization. Under the priority scheme established by the Bankruptcy Code, certain post-petition liabilities and pre-petition liabilities need to be satisfied before shareholders are entitled to receive any distribution. The ultimate recovery to creditors and shareholders, if any, will not be determined until confirmation of a plan of reorganization. We can give no assurance as to what values, if any, will be ascribed in the bankruptcy case to each of these constituencies. A plan of reorganization could also result in holders of our common stock receiving no distribution on account of their interests and cancellation of their interests. In addition, under certain conditions specified in the Bankruptcy Code, a plan of reorganization may be confirmed notwithstanding its rejection by an impaired class of equity holders and notwithstanding the fact that equity holders do not receive or retain property on account of their equity interests under the plan. Moreover, as discussed above, there can be no assurance that a plan of reorganization will be confirmed by the Court. In light of the foregoing, we consider, as described above, the value of the common stock to be highly speculative and caution equity holders that the stock may ultimately be determined to have no value. Accordingly, we urge that appropriate caution be exercised with respect to existing and future investments in our common stock or in any claims related to pre-petition liabilities and our other securities. At this time, it is not possible to predict the effect of the Chapter 11 filing on our business, various creditors and shareholders or when we will be able to exit Chapter 11. Our future results are dependent upon our confirming and implementing a plan of reorganization. Our ability to continue as a going concern is predicated upon numerous issues, including our ability to achieve the following: - developing and implementing a long-term strategy to revitalize our business and return to profitability; - taking appropriate actions to offset the negative impact the Chapter 11 filing has had on our business and the impairment of vendor relations; - operating within the framework of our DIP financing facility, including limitations on capital expenditures and compliance with financial covenants, - generating cash flows from operations or seeking other sources of financing and the availability of projected vendor credit terms; - attracting, motivating and retaining key executives and associates; and - - developing, negotiating, and, thereafter, having a plan of reorganization confirmed by the Court. 5 These challenges are in addition to other operational and competitive challenges faced by us in connection with our business as an off-price retailer. See "Cautionary Statement for Purposes of "Safe Harbor Provisions" of the Private Securities Litigation Reform Act of 1995" immediately preceding this session. On May 5, 2004, the Court granted us authorization to adopt and implement the key employee retention, emergence and severance plans. On June 3, 2004, the Court issued an order, subject to certain conditions, extending the period in which we have the exclusive right to file a proposed plan or reorganization through December 3, 2004. On June 4, 2004, we filed a motion with the Court seeking authorization to close another 23 under-performing stores. Subject to the Court's approval, we currently plan to start the going-out-of-business sale process on or about July 1, 2004 and expect to close these stores by the end of August 2004. As in the last two fiscal years, we continue to operate our business in a very soft retail environment. Our first quarter in fiscal 2004 started shortly after we filed for bankruptcy protection under Chapter 11. Our inventory position during the earlier part of the quarter was below our preferred level due, in part, to the uncertainties surrounding our Chapter 11 filing. Additionally, the filing adversely affected our sales in the first quarter. We have significantly reduced our marketing spend, in accordance with our marketing strategy, which has also negatively impacted our top line since the beginning of fiscal 2004, but which we believe will ultimately improve profitability. As previously disclosed, we started our 44 store closings in mid-February via a going-out-of-business process conducted by Great American. All 44 stores were closed by March 18, 2004 and we have terminated the lease obligations of these store locations either through mutual agreements with landlords or through lease rejections as allowed by the Court. As a result of a thorough review of the financial performance of our entire store base after the completion of the first quarter, we have sought the Court's approval to close an additional 23 stores to further improve our overall financial performance and enable us to concentrate on growing our business at our most productive locations. Currently, we are focusing our efforts on implementing our inventory strategy, enhancing distribution and store operating efficiency, and improving store execution. All these efforts are intended to ensure that we are well prepared for the upcoming back-to-school season. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The financial statements have been prepared on a going concern basis, which assumes continuity of operations and realization of assets and satisfaction of liabilities in the ordinary course of business. Based on guidance in SOP 90-7, all pre-petition liabilities subject to compromise have been segregated in the Balance Sheet and are classified as Liabilities subject to compromise, at the estimated amount of allowable claims. Liabilities not subject to compromise are separately classified as current and non-current. Expenses, realized losses, and provision for losses resulting from the reorganization are reported separately as reorganization items. 6 We believe the following represents the areas where the most critical estimates and assumptions are used in the preparation of the financial statements: o Inventory valuation. Merchandise inventory is stated at the lower of cost or market determined using the retail inventory method ("RIM") on a first-in, first-out basis. Under the RIM, the valuation of inventory at cost and the resulting gross margin are calculated by applying a computed cost-to-retail ratio to the retail value of inventory. RIM is an averaging method that has been widely used in the retail industry due to its practicality. Also, it is recognized that the use of the RIM will result in valuing inventory at the lower of cost or market if markdowns are currently taken as a reduction of the retail value of inventory. Inherent in the RIM calculation are certain significant management judgments and estimates regarding markdowns and shrinkage, which may from time to time cause adjustments to the gross margin in the subsequent period. Factors that can lead to distortion in the calculation of the inventory balance include applying the RIM to a group of merchandise items that is not fairly uniform in terms of its cost and selling price relationship and turnover, and applying RIM to transactions over a period of time that includes different rates of gross profit, such as those relating to seasonal merchandise items. To minimize the potential of such distortions in the valuation of inventory from occurring, we utilize 82 sub-departments in which fairly homogeneous classes of merchandise items having similar gross margin are grouped. In addition, failure to take markdowns currently may result in an overstatement of cost under the lower of cost or market principle. As of May 1, 2004, we had an inventory valuation allowance of approximately $1.1 million representing our estimate of the cost in excess of the net realizable value of all clearance items. In addition, we had an allowance of approximately $921,000 representing additional inventory shrink reserve. We believe that our RIM provides an inventory valuation that reasonably approximates cost and results in carrying inventory at the lower of cost or market. o Valuation of goodwill, intangible and other long-lived assets. We use certain assumptions in establishing the carrying value and estimated lives of our long-lived assets and goodwill. The criteria used for these evaluations include management's estimate of the asset's continuing ability to generate income from operations and positive cash flows. If assets are considered to be impaired, the impairment recognized is measured by the amount that the carrying value of the assets exceeds the fair value of the assets. Useful lives and related depreciation or amortization expense are based on our estimate of the period that the assets will generate revenues or otherwise be used in operations. Factors that would influence the likelihood of a material change in our reported results include a significant decline in our stock price and market capitalization compared to our net book value, significant changes in an asset's ability to generate positive cash flows, significant changes in our strategic business objectives and utilization of the asset. In conjunction with our Chapter 11 filing, at the end of fiscal 2003, we recorded an impairment charge of $26.3 million for our goodwill and an impairment charge of $2.4 million regarding fixed assets located at the 44 closed stores. o Accrued restructuring costs. We have estimated amounts for the charges and the related liabilities regarding our fiscal 2002 and fiscal 2001 restructuring initiatives including store closures, realignment of our field organization and workforce reductions in accordance with the Emerging Issues Task Force ("EITF") Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." At the end of fiscal 2003, we evaluated our accrued restructuring costs and recorded a favorable adjustment of $1.5 million primarily related to the adjustment of lease termination costs, which is based on the maximum amount allowed by the Bankruptcy Code. o Litigation reserves. Based in part on the advice of our legal counsel, estimated amounts for litigation and claims that are probable and can be reasonably estimated are recorded as liabilities in the balance sheet. The likelihood of a material change in these estimated reserves would be dependent on new claims as they may arise and the favorable or unfavorable outcome of the particular litigation. We continuously evaluate the adequacy of these reserves and, as new facts come to light, adjust these reserves when necessary. 7 o Liabilities subject to compromise. Under the Bankruptcy Code, actions by creditors to collect indebtedness we owe prior to the Petition Date are stayed and certain other pre-petition contractual obligations may not be enforced against us. Except for secured debt, employee payroll and benefits, sales, use and other taxes, and capital lease obligations, all pre-petition liabilities per our best estimate have been classified as liabilities subject to compromise. Adjustments to pre-petition liabilities may result from negotiations, payments authorized by Court order, additional rejection of executory contracts, including leases, or other events. We have mailed notices to all known creditors that the deadline for filing proofs of claims with the Court is June 15, 2004. Differences between amounts we have scheduled and claims by creditors will be investigated and resolved in connection with our claims resolution process, and any necessary adjustments will be recorded accordingly. o Workers' compensation accrual. At the beginning of fiscal 2001, we transitioned to a partially self-insured workers' compensation program. The program for the policy year ended January 31, 2002 had both a specific and aggregate stop loss amount of $250,000 and $3.2 million, respectively. The program for the policy years ended January 31, 2004 and January 31, 2003 had a specific stop loss amount of $250,000 with no aggregate stop loss limit. We utilize internal actuarial methods, as well as an independent third-party actuary for the purpose of estimating ultimate costs for a particular policy year. Based on these actuarial methods along with current available information and insurance industry statistics, the ultimate expected losses for the policy years ended January 31, 2004, 2003 and 2002 were estimated to be approximately $3.6 million, $4.7 million and $4.3 million ($3.2 million aggregate stop loss), respectively. Our estimate is based on average claims experience in our industry and our own experience in terms of frequency and severity of claims, with no explicit provision for adverse fluctuation from year to year and is subject to inherent variability. This variability may lead to ultimate payments being either greater or less than the amounts presented above. o Valuation of deferred income taxes. Valuation allowances are established, if deemed necessary, to reduce deferred tax assets to the amount expected to be realized. The likelihood of a material change in our expected realization of these assets is dependent on future taxable income, our ability to use the net operating loss carryforwards, the effectiveness of our tax planning and strategies among the various tax jurisdictions that we operate in, and any significant changes in the tax treatment we currently receive. In light of our significant net operating losses and our Chapter 11 filing, we provided for a 100% valuation allowance on our deferred tax assets as of May 1, 2004. Results of Operations The financial statements contained herein have been prepared on a going concern basis, which assumes continuity of operations and realization of assets and satisfaction of liabilities in the ordinary course of business, and in accordance with SOP 90-7. Upon emergence from bankruptcy, the amounts reported in subsequent financial statements may materially change, due to the restructuring of our assets and liabilities as a result of the plan of reorganization, if any, and the application of "Fresh Start" accounting. We operated 195 and 242 stores as of May 1, 2004 and May 3, 2003, respectively. The average number of stores in operation during the 13-week period ended May 1, 2004 was 198 versus 243 during the same period last year. Net sales were $80.3 million for the 13 weeks ended May 1, 2004 compared to $104.3 million for the 13 weeks ended May 3, 2003, a decrease of $24.0 million, or 23.0%. Comparable store sales for the 13-week period ended May 1, 2004 decreased 11.0% versus a decrease of 7.4% for the same period last year. The decline in net sales was primarily due to fewer stores in operation and negative comparable store sales. In addition, we believe reduced marketing efforts, as provided in our strategic plan, adversely affected net sales. Gross profit was $27.4 million for the 13 weeks ended May 1, 2004 compared to $37.6 million for the 13 weeks ended May 3, 2003, a decrease of $10.2 million or 27.2%. As a percentage of net sales, gross profit was 34.1% for the 13 weeks ended May 1, 2004 versus 36.1% for the same period last year. The decrease in gross profit as a percentage of net sales for the 13 weeks ended May 1, 2004 from the comparable period last year was primarily due to higher markdowns and shrink accrual, partially offset by higher initial mark-up. 8 Selling and administrative expenses were $31.2 million for the 13 weeks ended May 1, 2004 compared to $41.3 million for the 13 weeks ended May 3, 2003, a decrease of $10.1 million or 24.5%. As a percentage of net sales, selling and administrative expenses were 38.8% and 39.5% for the 13 weeks ended May 1, 2004 and May 3, 2003, respectively. Selling and administrative expenses decreased as a result of fewer stores in operation during the current quarter, lower advertising spend and lower general and administrative costs at corporate. The lower selling and administrative expenses were in line with our plan. Pre-opening and closing expenses were $14,000 for the 13 weeks ended May 1, 2004 compared to $138,000 for the same period last year, a decrease of approximately $124,000 or 89.9%. The decrease in pre-opening and closing expenses was due to no store opening activity in the first quarter of fiscal 2004, versus one new store opening during the same period last year and preopening costs incurred for the Otay Mesa distribution center, which was opened in May 2003. Reorganization items for the 13 weeks ended May 1, 2004 were $8.2 million and consisted of: (1) a non-cash charge of $5.0 million for lease rejection claims associated with 31 lease rejections in conjunction with the 44 stores closed in the quarterly period ended May 1, 2004, as part of our reorganization efforts; (2) $2.8 million of professional fees and other expenses incurred in our bankruptcy case and reorganization efforts; and (3) $366,000 of additional costs to close the 44 stores. Interest expense, net was $375,000 for the 13 weeks ended May 1, 2004 compared to $634,000 for the 13 weeks ended May 3, 2003, a decrease of $259,000 or 40.9%. The decrease in interest expense for the current quarter was primarily due to lower borrowings as compared to the same period last year. Income tax benefit for the 13 weeks ended May 1, 2004 was zero as compared to $1.7 million for the 13 weeks ended May 3, 2003. Due to our significant net operating losses and our Chapter 11 filing, we provided for a 100% valuation allowance on all deferred tax assets as of January 31, 2004 because we cannot conclude that it is more likely than not that the deferred tax assets will be realized in the foreseeable future. Accordingly, for the 13 weeks ended May 1, 2004, our income tax benefit was zero as we established 100% valuation allowance to offset such benefit. For the 13 weeks ended May 1, 2004, the net loss was $12.4 million as compared to $2.7 million for the 13 weeks ended May 3, 2003. The increase in net loss was primarily a result of the reorganization items discussed above. 9 Liquidity and Capital Resources General We finance our operations through credit provided by vendors and other suppliers, amounts borrowed under our DIP financing facility, internally generated cash flow, and other financing resources. Credit terms provided by vendors and other suppliers have historically been approximately 30 days net, although during the pendency of the Chapter 11 case, many of our vendors have reduced the amount of time in which we must pay for goods. Amounts that may be borrowed under the DIP financing facility are based on a percentage of eligible inventory and accounts receivable, as defined. At May 1, 2004, we were in compliance with all financial covenants under our DIP financing facility, and had outstanding borrowings of $3.0 million and letters of credit of $15.1 million under our DIP financing facility. The financial covenants have since been amended in accordance with the May 27, 2004 amendment, subject to the Court's approval. This amendment modified our financial covenants, whereby covenants will include minimum availability, five-day availability covenants at each month end and minimum inventory per store. The Tranche B Lender will fully fund within five business days of the Court's approval of the amendment and we may repay the Tranche B amount after October 20, 2004 subject to certain conditions. With respect to cash flows for the quarterly period ended May 1, 2004, we used $7.4 million in operating activities, $51,000 in investing activities and generated $3.0 million from financing activities, which resulted in a net decrease in cash of $4.5 million. For the same period last year, we used $15.1 million in operating activities, $1.0 million in investing activities and generated $18.1 million from financing activities, which resulted a net increase in cash of $1.9 million. The decrease in cash used in operating activities was primarily due to the lower number of stores in operation. The decrease in cash used in investing activities was due to higher spending in the first quarter of fiscal 2003 related to the equipment acquisition for the Otay Mesa distribution facility. The decrease in cash generated from the financing activities was a result of net proceeds received from the private offering and the borrowings on the junior secured term loan in the same period last year. Our cash needs are satisfied through working capital generated by our business and funds available under our DIP financing facility. The level of cash generated by our business is dependent, to a great extent, on our level of sales and the credit extended by our vendors and the factor community. If we experience a significant shortening of payment terms with our vendors, a significant deterioration of credit terms with our factors, the DIP financing facility for any reason becomes unavailable, or actual results differ materially from those projected, our compliance with financial covenants and our cash resources could be adversely affected. Capital Expenditures We anticipate capital expenditures of approximately $800,000 during the remaining nine months of the fiscal year ending January 29, 2005, which include necessary costs for replacement capital at existing stores. We intend to fund the anticipated capital expenditures from our sources of cash, including the DIP financing facility. Store Closures and Restructuring Initiatives On February 2, 2004, the Court authorized the closure of 44 stores. On February 11, 2004, the Court approved the agreement between the Great American Group ("Great American") and us in which Great American acted as an exclusive agent to conduct store-closing sales at the 44 stores location. The store-closing sales started on February 12, 2004. All 44 stores were closed by March 18, 2004. As of June 4, 2004, we have terminated or assigned a total of 13 leases of these stores and rejected the remaining 31 leases. We do not expect any significant cash requirements relating to these 44 store closures for the remaining nine months of fiscal 2004. 10 As of June 4, 2004 we have closed 20 of the 23 stores identified in our Fiscal 2002 restructuring efforts and all 28 of the stores identified in our Fiscal 2001 restructuring efforts. In conjunction with our Chapter 11 filing, we have ceased to make cash payments for any remaining obligations regarding our Fiscal 2002 or 2001 restructuring plans except for the lease obligation of one of our former San Diego distribution centers (located in the same building as our corporate headquarters) and certain satellite communication service fee obligations. The cash requirements relating to these obligations for the remaining nine months of fiscal 2004 are expected to be approximately $991,000, which we intend to fund from our sources of cash, including the DIP financing facility. In addition, on June 4, 2004, we filed a motion with the Court seeking authorization to close another 23 under-performing stores. Subject to the Court's approval, we currently plan to start the going-out-of-business sale process on or about July 1, 2004 and expect to close these stores by the end of August 2004. We do not expect any significant cash requirements relating to these 23 store closures for the remaining nine months of fiscal 2004. Contractual Obligations and Commitments The following table summarizes, as of May 1, 2004, certain of our contractual obligations, as well as estimated cash requirements related to our fiscal 2002 and 2001 restructuring initiatives. This table should be read in conjunction with "Note 6 - Fiscal 2002 Restructuring Charge", "Note 7 - Fiscal 2001 Restructuring Charge", and "Note 8 - DIP Financing Facility" in the accompanying unaudited financial statements, as well as our fiscal 2003 Annual Report on Form 10-K as filed with the Securities and Exchange Commission. Payments due by period ---------------------- 2005 and 2007 and (in thousands) Total 2004 2006 2008 Thereafter --------- -------- -------- -------- ---------- Operating lease obligations* $ 109,393 $ 18,649 $ 37,220 $ 22,644 $ 30,880 Restructuing charges 2,000 991 1,009 - - Notes payable 132 32 86 14 - --------- -------- -------- -------- -------- $ 111,525 $ 19,672 $ 38,315 $ 22,658 $ 30,880 ========= ======== ======== ======== ======== * Operating lease obligations have changed significantly from the disclosure in our most recent annual report on Form 10-K due to lease rejections associated with the 44 store closures.
Certain amounts included in the above table are related to executory contracts or lease obligations, which we have neither assumed nor rejected as of May 1, 2004. Under the Bankruptcy Code, we may assume or reject executory contracts, including lease obligations. Therefore, the commitments shown in the above table may not reflect actual cash outlays in the future periods. Reorganization Items Reorganization items represent amounts we incurred as a result of the Chapter 11 proceedings in accordance with SOP 90-7. The amounts for Reorganization items in the Statements of Operations include: (1) a non-cash charge of $5.0 million for lease rejection claims associated with 31 lease rejections in conjunction with the 44 stores closed in the quarterly period ended May 1, 2004, as part of our reorganization efforts; (2) $2.8 million of professional fees and other expenses incurred in our bankruptcy case and reorganization efforts; and (3) $366,000 of additional costs to close the 44 stores. We project cash requirements of approximately $4.5 million of professional fees and other related expenses for the remaining nine months of fiscal 2004. We believe that our sources of cash, including the DIP financing facility, should be adequate to fund the cash requirements for our reorganization efforts. 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk Currently, our exposure to market risks results primarily from changes in interest rates, principally with respect to the DIP financing facility, which is a variable rate financing agreement. We do not use swaps or other interest rate protection agreements to hedge this risk. As of May 1, 2004, we had $3.0 million of borrowings outstanding under our DIP financing facility. Item 4. Controls and Procedures Evaluation. We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as defined under Rule 13a-14 and Rule 15d-14 of the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. This evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO). Conclusions. Based upon our evaluation, our CEO and CFO have concluded that our disclosure controls and procedures are effective to ensure that material information relating to the Company is made known to management, including the CEO and CFO, particularly during the period when our periodic reports are being prepared. Changes in Internal Controls. There have not been any significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of our last evaluation of such internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses. PART II - OTHER INFORMATION Item 1. Legal Proceedings See discussion of legal proceedings at Note 11 of the Notes to Financial Statements. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.26 Factory 2-U Stores, Inc. 2004 Key Employee Retention Plan. 10.27 Factory 2-U Stores, Inc. 2004 Key Employee Emergence Plan. 10.28 Factory 2-U Stores, Inc. 2004 Key Employee Severance Plan. 31.1 Certification of the Chief Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Norman G. Plotkin, Chief Executive Officer. 32.2 Certification pursuant to 18 U.S. C.Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Norman Dowling, Executive Vice President and Chief Financial Officer. (b) Reports on Form 8-K On June 4, 2004, we furnished a report on Form 8-K regarding the extension of our exclusive right to file a proposed Plan of Reorganization and the filing of a motion with the Court seeking authorization to close additional 23 stores. The full text of our press dated June 4, 2004 was furnished and attached as an exhibit to the Form 8-K. 12 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FACTORY 2-U STORES, INC. Date: June 10, 2004 By: /s/Norman Dowling ----------------- Name: Norman Dowling Title:Executive Vice President and Chief Financial Officer (duly authorized officer and principal financial officer) 13 EX-10 2 exhkerp.txt 2004 KEY EMPLOYEE RETENTION PLAN Exhibit 10.26 Factory 2-U Stores, Inc. 2004 Key Employee Retention Plan On January 13, 2004, in order to implement an operational and financial restructuring, Factory 2-U Stores, Inc. (the "Company") voluntarily filed a petition under chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court in the District of Delaware (the "Bankruptcy Court"). In order to maintain consistently effective, high quality management in certain critical positions during the reorganization of Company, and to reward certain employees for continuing to provide services to the Company in these uncertain times, the Board of Directors of the Company has determined that it is in the best interest of the estate to develop and implement a key employee retention plan (the "Retention Plan"). The Retention Plan is subject to Bankruptcy Court approval. 1. Potential Participants in the Retention Plan -------------------------------------------- Twenty eight (28) employees, including approximately 13 Vice Presidents and 15 Directors set forth more particularly in the attached Exhibit A, together with any successors employed by the Company to fill vacancies left by those listed employees who resign or are terminated. If the Company creates one or more new positions (not already included in Exhibit A) at the level of vice president or director, any employee hired to fill such new positions shall only be entitled to participate with the express written consent of (i) the Board of Directors of the Company and (ii) the Official Committee of Unsecured Creditors. No other employee shall participate in the Retention Plan. 2. Potential Benefits Available Under the Retention Plan ----------------------------------------------------- A. Vice Presidents 35% of salary B. Directors 35% of salary Individuals not otherwise eligible to be a participant in the Retention Plan but either newly employed to fill a vacancy in a position held currently by a participant, or to fill a newly created position that is eligible, shall only receive a pro rata share of the potential benefit under the Retention Plan based upon the length of service in the covered position. The calculation for pro rata shall be calculated based upon the percentage of service in each of the three time periods covered in the Retention Plan, as set forth below in section 5 hereof. 3. Conditions for Payments Under the Retention Plan ------------------------------------------------ A. The affected employee is employed by the Company on the date of entry of the order by the Bankruptcy Court approving the Retention Plan or thereafter fills a vacancy in an eligible position. B. Continued uninterrupted full time employment by the Company of the affected employee through the date and time of payment for each of the payments. C. Payments shall be made net of (i) any and all loans and advances from the Company to the affected employee and any and all other amounts due to the Company from the affected employee, and (ii) all required federal and state withholding taxes and similar required withholdings, as applicable. 4. Credit Against any Severance Payments ------------------------------------- To the extent an employee receives any payments under the Retention Plan, such payments shall offset dollar for dollar any payment that may be received under the Company's 2004 Key Employee Severance Plan (the "Severance Plan"). 5. Time for Payment ---------------- A. For service from January 13, 2004 through July 31, 2004, one quarter of the retention payment shall be made on August 2, 2004. B. For service from August 1, 2004 through December 1, 2004, one quarter of the retention payment shall be made on December 15, 2004. C. For service from December 1, 2004 through the date of payment, the remaining one half of the retention payment shall be made on April 30, 2005. D. Notwithstanding the foregoing, any and all payments not yet made before the effective date of a confirmed chapter 11 plan (the "Effective Date") shall be made on the Effective Date, or as soon thereafter as is practicable. 6. Priority of Payment Obligations ------------------------------- Payments to be made under this Retention Plan shall be entitled to priority under section 503(b) of the Bankruptcy Code as an administrative priority, and shall be due and owing no later than the Effective Date, except as otherwise provided for in the Retention Plan. 7. Miscellaneous ------------- All rights under the Retention Plan shall at all times be entirely unfunded, and no provision shall at any time be made with respect to segregating any assets of the Company for payment of any amounts due under the Retention Plan. Any payments under the Retention Plan shall be made from the general assets of the Company as and when due. No member of the Board of Directors of the Company, nor any officer or employee of the Company, shall be personally liable if the Company is unable to make any of the payments provided for in the Retention Plan for any reason, including, without limitation, lack of funding or financing, legal prohibition, or failure to obtain required consents. Nothing contained in this Retention Plan shall be construed to be an employment contract between a participant in the Retention Plan and the Company. No interest of any participant in the Retention Plan, or any right to receive any payment hereunder, shall be subject to any manner of sale, transfer, assignment, pledge, attachment, garnishment, or other alienation or encumbrance of any kind, nor may such interest or right to receive a payment be taken, voluntarily or involuntarily, for the satisfaction of the obligation of, or other claims against, any participant, including claims for alimony, support, separate maintenance, and claims in bankruptcy cases. The Board of Directors of the Company shall have the right to amend the Retention Plan from time to time and may terminate the Retention Plan at any time; provided, however, that no amendment may be made to the Retention Plan and no termination of the Retention Plan may be effective until after the later of (i) May 1, 2005, and (ii) the effective date of a confirmed plan of reorganization for the Company. Approved by the Board of Directors of the Company on March 16, 2004 By: /s/Susan M. Skrokov ------------------- Susan M. Skrokov, Secretary Exhibit A Department Name Title FINANCE AND ACCOUNTING 9105 FIDIRA -VP, Controller 9106 FIDRFR-Dir, Fin Anal & Rptg 9106 FINAGC - Asst Gen Counsel ITS 9107 VP of ITS 9107 ITDRSD - Dir, System Developme 9107 ITDRSA-Director, System Admin HUMAN RESOURCES 9109 HRVP- VP, Human Resources 9153 HRDRTW - Dir, Train. & WF Plan REAL ESTATE, CONSTRUCTION, STORE PLANNING 9111 REDIR1 - Director - Real Estat 9115 FCDIRC - Director - Constructi LOSS PREVENTION 9119 VPLP1 - VP - Loss Prevention 9119 LPDRRM - Dir. Risk Management 9121 LPRMG1 - RM - LP 9123 LPRMG1 - RM - LP 9125 LPRMG1 - RM - LP MARKETING 9131 ADDIRMK - Director, Marketing MERCHANDISING 9139 MEMGM1 - Vice Pres. - Merch. 9141 MEMGM1 - Vice Pres. - Merch. 9135 MEMGM1 - Vice Pres. - Merch. 9137 MEMGM1 - Vice Pres. - Merch. PLANNING 9143 VP of Planning & Allocation 9143 PLADIR - Director of Plng 9143 PLADIR - Director of Plng ALLOCATION 9144 DIRALL - Director, Allocation STORE OPERATIONS 9145 FMDRSO - VP, Store Ops 9145 Divisional VP 9161 Divisional VP DISTRIBUTION 9449 VPTDC1 - VP - Transportation/D EX-10 3 exhkeep.txt 2004 KEY EMPLOYEE EMERGENCE PLAN Exhibit 10.27 Factory 2-U Stores, Inc. 2004 Key Employee Emergence Plan On January 13, 2004, in order to implement an operational and financial restructuring, Factory 2-U Stores, Inc. (the "Company") voluntarily filed a petition under chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court in the District of Delaware (the "Bankruptcy Court"). In order to maintain consistently effective, high quality senior management during the reorganization of Company, and to reward several key employees for managing the affairs of the Company through the reorganization process, the Board of Directors of the Company has determined that it is in the best interest of the estate to develop and implement a plan for fairly compensating the members of the executive committee for the valuable services provided during the reorganization. This Key Employee Emergence Plan (the "Emergence Plan") is subject to Bankruptcy Court approval. 1. Potential Participants ---------------------- The only participants in the Emergence Plan are the four members of the executive committee and any successors: (i) Norman G. Plotkin, Chief Executive Officer (the "CEO"), (ii) the person to fill the position of Executive Vice President and Chief Operating Officer (the "COO"), if any, (iii) A.J. Nepa, Executive Vice President, Merchandising (the "EVP," and together with the COO, the "EVPs"), and (iv) Norman Dowling, Chief Financial Officer (the "CFO"). The CEO, the EVPs, the CFO and their successors are referred to collectively as the "Participants." 2. Definition of "EBITDAR" ----------------------- For the purpose of the Emergence Plan, earnings before interest, taxes, depreciation, amortization, and reorganization charges ("EBITDAR") shall be determined as set forth in this paragraph. EBITDAR shall be determined by the Company's then independent accountants as promptly as practicable after the effective date under a confirmed plan of reorganization for the Company (the "Effective Date"). The independent accountants shall use audited financial statements to determine EBITDAR, however, if the Effective Date shall be other than within the 60 day period following the end of the fiscal year, then the calculation of EBITDAR shall be subject to agreed-upon procedures performed by the auditors as applied to the internal unaudited financial statements ("Agreed Upon Procedures"). In any event, in determining EBITDAR, all costs associated with the relocation of the corporate offices in San Diego County shall not be applied as a reorganization charge. In determining EBITDAR, the reorganization charges to be applied shall include, but not be limited to, any and all of the following: (i) professional fees and expenses (to the extent related to the reorganization matters), including fees and expenses of: (a) the Company's corporate and bankruptcy attorneys, financial advisors and attorneys and advisors for the Board of Directors; (b) real estate consultants (and specifically including any commissions incurred); (c) claims management administrator; (d) expert witnesses; and (e) attorneys and financial advisors for the committee of unsecured creditors (the "Creditors Committee") and for any other committee formed by the Office of the United States Trustee; (ii) gains, losses, costs and expenses related to store closings and conducting going-out-of-business sales, including, without limitation: (a) gain or loss on the sale of inventory; (b) gain or loss on the sale, disposal or write off of fixed assets; (c) physical inventory taking service fees; (d) expenses and expense reimbursements associated with the closing stores during and after the sale period; and (e) closing store expenses in excess of reimbursed expenses; (iii) secured, unsecured and priority claims in excess of pre-petition stated balances; (iv) travel expenses incurred by the Company and its employees related to reorganization matters, including, without limitation, attendance at Bankruptcy Court hearings, committee meetings and trade meetings; (v) United States Trustee fees; (vi) fees, costs and expenses related to the Debtor In Possession financing, refinancing or emergence financing; and (vii) any other income or costs properly characterized as restructuring costs under GAAP SOP 90-7 or otherwise, including, but not limited to, any costs associated with the Severance Plan, the Retention Plan and the Emergence Plan and any costs associated with the issuance of stock options under the Emergence Plan. 3. Cash Component of Emergence Award --------------------------------- The amount of the cash component of the Emergence Award to be paid to the Participants will be dependent upon the amount of EBITDAR generated by the Company during the Company's fiscal year 2004, which fiscal year ends on January 29, 2005, but if the Effective Date were to occur on or after March 15, 2005, then the EBITDAR generated by the Company during the rolling twelve month period ending on the last day of the month in which the Effective Date occurs (the "Measurement Period"). A. If, during the Measurement Period, the Company generates EBITDAR of $6.0 million or less, but at least $1.0 million, then the CEO and the EVPs shall each receive a cash payment of $42 thousand, and the CFO shall receive a cash payment of $25 thousand. B. If, during the Measurement Period, the Company generates EBITDAR of $9.0 million or less, but at least $6.0 million, then the CEO and the EVPs shall each receive an additional cash payment of $69 thousand, and the CFO shall receive an additional cash payment of $42 thousand. In that circumstance, the CEO and the EVPs will each have received cash totaling $111 thousand, and the CFO will have received cash totaling $67 thousand. C. If, during the Measurement Period, the Company generates EBITDAR of more than $9.0 million, then the CEO and the EVPs shall each receive (i) an additional cash payment of $97 thousand, and (ii) an additional sum equal to 2.25% of the amount by which EBITDAR exceeds $9.0 million, and the CFO shall receive (i) an additional cash payment of $58 thousand and (ii) an additional sum equal to 1.25% of the amount by which EBITDAR exceeds $9.0 million. If EBITDAR were to be $9.0 million, the CEO and the EVPs will each have received cash totaling $208 thousand, and the CFO will have received cash totaling $125 thousand. 4. Non-cash Component of Emergence Award ------------------------------------- A. If, on the Effective Date, the Company emerges from the reorganization process with publicly traded common stock, or common stock the majority of which is subject to registration rights, then the CEO and the EVPs shall each receive, in addition to the cash component, the "Option Alternative" consisting of options to acquire shares in the reorganized Company equal to 1.4% of the issued and outstanding stock and the CFO shall receive options to acquire shares in the reorganized Company equal to 0.8% of the issued and outstanding stock (collectively, the "Issuance Allocation"), each on a fully diluted basis, assuming the exercise of all options, warrants and other securities convertible into or exchangeable for common stock. If the Equity Threshold (as defined below) is met, as an alternative to the Option Alternative, each Participant may, at any time before the Effective Date and at such Participant's sole election, choose the "Stock and Option Alternative" consisting of a grant of (i) unrestricted fully vested common stock in the same percentages and proportion as the Issuance Allocation, and (ii) options to acquire additional shares of stock equal to 40% of the Issuance Allocation granted to the selecting Participant (i.e., an additional 2% of the authorized stock of the reorganized Company if each Participant were to select the Stock and Option Alternative) on a fully diluted basis, assuming the exercise of all options, warrants and other securities convertible into or exchangeable for common stock. The "Equity Threshold" is met if the enterprise value of the Company's business (the "Enterprise Value"), as of the date of entry of the order confirming the chapter 11 plan, less (i) the outstanding balance on the DIP revolver (without including any outstanding letters of credit), and (ii) all applied-for and unpaid professional fees and costs, exceeds the lesser of: (A) $57 million; (B) such other amount as may be agreed upon by the Company and the Creditors Committee; (C) if the Company elects, the sum of all allowed and disputed claims asserted against the Company as of the Effective Date; and (D) if the Company so elects, the sum of all allowed claims and the amount of all disputed claims as determined by the Bankruptcy Court in an order entered after estimation of such claims for such purpose only. The Enterprise Value shall be (i) agreed to between the Company and the Creditors Committee and filed with the Bankruptcy Court on or before the Effective Date, or (ii) determined by a suitable expert in business valuation acceptable to both the Company and the Creditors Committee, or, if no such expert is mutually acceptable, then the Company and the Creditors Committee shall each select a suitable expert and those two experts shall select a third business valuation expert who shall make the determination of Enterprise Value without consulting the other two experts. If the business valuation expert shall state his or her opinion of Enterprise Value in the form of a range, the midpoint of that range shall be used as the Enterprise Value. Whether the options are granted under the Option Alternative or the Stock and Option Alternative, upon exercise of the options by, and upon grant of any common stock to, one or more of the Participants, the Company shall use commercially reasonable efforts to assure that the common stock acquired shall be exempt from the registration requirements of Section 5 of the Securities Act of 1933, as amended, and any state or local laws requiring registration pursuant the provisions of section 1145 of the Bankruptcy Code (11 U.S.C. ss.1145) such that the securities shall be freely tradable without any restrictions. All options granted under this Emergence Plan shall be (i) fully vested as of the date of the grant, (ii) exercisable at the Exercise Price (as defined below) for a term of 10 years from the date of the grant, and (iii) contain such other terms and conditions as are usual and customary in the circumstances. If, at the time of confirmation of the chapter 11 plan, the Bankruptcy Court determines the "fair market value" of the common stock of the reorganized Company, then the term "Exercise Price" for the options shall mean that fair market value of the common stock of the reorganized Company. If, however, the Bankruptcy Court does not make such a finding, then "Exercise Price" shall mean the fair market value of the common stock of the reorganized Company as determined by the Board of Directors, giving due consideration to all relevant factors, including, without limitation, (i) any evidence considered by the Bankruptcy Court that reflects the value of the Company's business, (ii) valuations, if any, from the Company's advisors related to the value of the business of the Company, whether or not taken into evidence by the Bankruptcy Court, provided that the Company shall not be required to obtain any such valuations, (iii) the average of the closing prices for the common stock of the reorganized Company for the last 20 trading days (or such other period as the Board of Directors may deem reasonable) if, after the Effective Date, the reorganized Company's common stock is publicly traded on a nationally recognized exchange or market, and (iv) any other relevant information reasonably available to the Board of Directors. B. If, on the Effective Date, the Company emerges from reorganization as a privately-held business (whether a stock corporation, limited liability company, limited partnership, or otherwise) each of the Participants shall receive, in addition to the cash component of the Emergence Award, options to acquire shares of stock in the reorganized Company or comparable evidence of ownership in the reorganized business in the Issuance Allocation and at the same price as if the reorganized Company were a publicly traded company and section 4A were to apply. In that event, the options shall provide that, at any time before the exercise of the options, each Participant shall have the right to cause the reorganized Company to repurchase such Participant's options at a price equal to the Exercise Price for the options and the reorganized Company shall have the right to repurchase all of the options from any or all of the Participants at a price equal to 150% of the Exercise Price for such options and in any event, upon such other terms and conditions as are usual and customary in the circumstances. The Company shall use its best efforts to assure that the common stock acquired by any Participant of such options shall enjoy (i) "drag along," and "tag along" rights, and (ii) "piggy back" registration rights under any registration rights or similar agreement entered into by the Company, and in each such event, upon such terms and conditions as are usual and customary in the circumstances. C. If, on or before the Effective Date, all or substantially all of the Company's assets are sold, whether pursuant to section 363 of the Bankruptcy Code or under a chapter 11 plan (a "Sale"), then, in lieu of the non-cash component of the Emergence Award, the Participants shall receive cash in an amount determined by applying the formula set forth, and in the same proportions specified, in paragraphs 3A, 3B and 3C; provided, however, that instead of calculating EBITDAR during the Measurement Period, it shall be conclusively assumed that the gross Sale price was based upon a multiple of five times EBITDAR. By way of example, if the Sale were at a gross price of $35 million, then each of the Participants will receive cash payments in the amounts that would have been paid had the actual EBITDAR during the Measurement Period been $7.0 million, meaning the payment amounts set forth in paragraph 3B. In addition, if the net proceeds realized from a Sale are greater than is necessary to pay or otherwise satisfy in full all allowed claims against the Company ("Excess Cash"), then the Participants shall receive additional cash payments equal to five percent (5%) of the Excess Cash that would otherwise be available for distribution to holders of allowed pre-petition common stock interests of the Company. Each of the CEO and the EVPs shall receive cash equal to 1.4% of the Excess Cash, and the CFO shall receive 0.8% of the Excess Cash. 5. Conditions for Emergence Payments --------------------------------- A. The affected employee is employed by the Company on the date of entry of the order by the Bankruptcy Court approving the Emergence Plan or thereafter fills a vacancy in an eligible position. B. Continued uninterrupted full time employment by the Company of the affected employee through the date and time of payment for each of the payments. C. Payments shall be made net of all required federal and state withholding taxes and similar required withholdings, as applicable. D. Confirmation of a chapter 11 plan for the Company and the occurrence of the Effective Date, except for any Emergence Award under paragraph 4C. 6. Time for Payment ---------------- On the Effective Date, the Participants shall each receive cash in the amount equal to 60% of the total cash component in paragraph 3 based upon the internal unaudited financial statements. The remaining 40% of the cash component shall be paid within 5 business days of the completion by the auditors of the Agreed Upon Procedures. Any payment set forth under paragraph 4C shall be paid in full within five (5) business days after the close of the Sale. 7. Priority of Payment Obligations ------------------------------- Payments to be made under the Emergence Plan shall be entitled to priority under section 503(b) of the Bankruptcy Code as an administrative priority, and shall be due and owing no later than the Effective Date, except as otherwise provided for in the Emergence Plan. If any payment under the Emergence Plan to be made after the Effective Date is not made as and when due, and the affected employee employs counsel in order to assert his or her rights with respect to the payment, then, in addition to the payment under the Emergence Plan, the Company, and any successor obligated to perform under the Emergence Plan, shall reimburse the affected employee all reasonable attorneys fees and costs incurred in successfully asserting such rights. 8. Miscellaneous ------------- All rights under the Emergence Plan shall at all times be entirely unfunded, and no provision shall at any time be made with respect to segregating any assets of the Company for payment of any amounts due under the Emergence Plan. Any payments under the Emergence Plan shall be made from the general assets of the Company as and when due. If, on the date a payment is due under the Emergence Plan, one or more of the Participants is no longer employed by the Company, than the Board of Directors may, after consultation with the Creditors Committee, and without any further court approval, reallocate to the remaining Participants, that portion of the cash and non-cash components of the Emergence Award that would otherwise have been allocated to the former Participant. No member of the Board of Directors of the Company, nor any officer or employee of the Company shall be personally liable if the Company is unable to make any of the payments provided for in the Emergence Plan for any reason, including, without limitation, lack of funding or financing, legal prohibition, or failure to obtain required consents. Nothing contained in the Emergence Plan shall be construed to be an employment contract between a Participant in the Emergence Plan and the Company. No interest of any Participant in the Emergence Plan, or any right to receive any payment hereunder, shall be subject to any manner of sale, transfer, assignment, pledge, attachment, garnishment, or other alienation or encumbrance of any kind, nor may such interest or right to receive a payment be taken, voluntarily or involuntarily, for the satisfaction of the obligation of, or other claims against, any Participant, including claims for alimony, support, separate maintenance, and claims in bankruptcy cases. The Board of Directors of the Company shall have the right to amend the Emergence Plan from time to time and may terminate the Emergence Plan at any time; provided, however, that no amendment may be made to the Emergence Plan and no termination of the Emergence Plan may be effective until the later of (i) one year after the Effective Date, and (ii) delivery of written notice of intent to amend or terminate the Emergence Plan has been given to all Participants and one year has elapsed from the time that notice was provided. Approved by the Board of Directors of the Company on March 16, 2004 By: /s/Susan M. Skrokov ------------------- Susan M. Skrokov, Secretary EX-10 4 exhkesp.txt 2004 KEY EMPLOYEE SEVERANCE PLAN Exhibit 10.28 Factory 2-U Stores, Inc. 2004 Key Employee Severance Plan On January 13, 2004, in order to implement an operational and financial restructuring, Factory 2-U Stores, Inc. (the "Company") voluntarily filed a petition under chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court in the District of Delaware (the "Bankruptcy Court"). In order to maintain consistently effective, high quality management at a number of critical levels during the reorganization of the Company, the Board of Directors of the Company has determined that it is in the best interest of the estate to develop and implement a key employee severance plan (the "Severance Plan"). The Severance Plan is in lieu of any severance benefits that may be available under any pre-petition agreement between any participating employee and the Company. The Severance Plan is subject to Bankruptcy Court approval. 1. Potential Participants in the Severance Plan -------------------------------------------- Approximately 150 employees, including the following, or their successors: (i) the members of the Company's Executive Committee, comprised of (a) Norman G. Plotkin, Chief Executive Officer (the "CEO"), (b) the person to fill the position of Executive Vice President and Chief Operating Officer (the "COO"), if any, (c) A.J. Nepa, Executive Vice President, Merchandising (the "EVP," and together with the COO, the "EVPs"), and (d) Norman Dowling, Chief Financial Officer (the "CFO"); (ii) the vice presidents set forth in the attached Exhibit A; (iii) the directors set forth in the attached Exhibit A; and (iv) all other exempt employees (other than Store Managers), as more particularly set forth in the attached Exhibit A. The members of the Executive Committee and the vice presidents shall be referred to collectively as "Company Officers." 2. Potential Benefits Available Under the Severance Plan ----------------------------------------------------- A. Members of the Executive Committee One year's salary B. Vice Presidents Four month's salary C. Directors Three month's salary D. Other Exempt Employees One week's salary for each year of employment (in any capacity) with the Company, with a two week minimum and an eight week maximum. 3. Conditions for Payments Under the Severance Plan ------------------------------------------------ The affected employee shall not receive payments under the Severance Plan unless each of the following conditions have been satisfied. A. The affected employee is employed by the Company on the date of entry of the order by the Bankruptcy Court approving the Severance Plan or thereafter fills a vacancy in an eligible position. B. If the affected employee is not a Company Officer, the affected employee is employed by the Company on a continued uninterrupted full time basis through the date of termination. C. If the affected employee is a Company Officer, the affected employee is employed by the Company on a continued uninterrupted full time basis through the date of termination, unless the Company Officer resigns for Good Reason (as defined below). D. The employment of the affected employee has been terminated without Good Cause (as defined below), or the affected employee is a Company Officer who has resigned for Good Reason. E. The affected employee has executed and delivered the "Release of All Claims" substantially in the form attached hereto as Exhibit B (the "Release"). F. The affected employee has executed and delivered the "Non-Competition, Non-Solicitation, Confidentiality and Non-Disparagement Agreement" substantially in the form attached hereto as Exhibit C (the "Non-compete Agreement"). G. Payments shall be made net of (i) any and all loans and advances from the Company to the affected employee and any and all other amounts due to the Company from the affected employee, and (ii) all required federal and state withholding taxes and similar required withholdings, as applicable. 4. Definition of "Good Reason" --------------------------- For the purpose of the Severance Plan, "Good Reason" shall mean that without the affected employee's written consent, the occurrence of one or more of the following: (i) a material and permanent diminution of the affected employee's title, authority, duties or responsibilities; (ii) the affected employee's rate of base salary is reduced; (iii) the affected employee is required to relocate permanently to any office or location other than one within a 30 mile radius of the location at which the affected employee is based at the time the change is required; (iv) a Change in Control (as defined below) of the Company or its business operations that (A) is solely as a result of the occurrence of the effective date of a confirmed chapter 11 plan (the "Effective Date") that includes, among its provisions, the issuance of voting securities of the Company to holders of pre-petition general unsecured claims, which securities evidence more than fifty percent of the voting securities of the Company immediately after the Effective Date, with or without any change in the composition of the Board of Directors as a result thereof (a "Creditor Stock Change"), and (B) the termination of the affected employee within one year following that Change in Control; or (v) a Change in Control of the Company or its business operations other than a Creditor Stock Change. 5. Definition of "Good Cause" -------------------------- For the purpose of the Severance Plan, "Good Cause" shall mean the occurrence of one or more of the following: (i) commission by the employee of any act of willful fraud or gross misconduct in the course of his or her employment, which, in the case of gross misconduct, has a material adverse effect on the business or financial condition of the Company; (ii) willful or deliberate failure by the employee to perform the duties of his or her position, other than on account of a disability; (iii) the employee's conviction or entering a plea of guilty (or nolo contendere) to any felony under the laws of the United States or any state thereof or any foreign country to which the affected employee may be subject; (iv) the engagement by the employee in gross misconduct, such as theft or embezzlement, or a comparable crime involving moral turpitude, which crime reflects poorly on the image or reputation of the Company; (v) a material misrepresentation by the employee at any time to the Company; or (vi) failure by the employee to comply with a reasonable and lawful instruction of the Chief Executive Officer (or the Board of Directors if the affected employee is the Chief Executive Officer) of the Company, which continues for a period of five days after the employee's receipt of written notice from the Chief Executive Officer (or the Board of Directors if the affected employee is the Chief Executive Officer) of the Company identifying the objectionable action or inaction by the employee. 6. Definition of Change of Control ------------------------------- For the purpose of the Severance Plan, "Change of Control" shall mean the occurrence of one or more of the following: (i) a sale of all or substantially all of the Company's assets, whether under section 363 of the Bankruptcy Code or pursuant to confirmation of a chapter 11 plan; (ii) the consummation of a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately before the merger or consolidation continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) more than fifty percent (50%) of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation; (iii) at any time the current members of the Company's Board of Directors or members appointed by a majority of the current members of the Board of Directors cease to comprise a majority of the Board of Directors; and (iv) the occurrence of the Effective Date of a confirmed chapter 11 plan that provides, among other things, for the issuance and distribution (other than to holders of the pre-petition equity interests in the Company of record as of the petition date) of voting securities of the Company that evidence more than fifty percent (50%) of the voting securities of the Company immediately after the Effective Date. 7. Credit for Retention Payments ----------------------------- To the extent a participant receives any payments under the Company's 2004 Key Employee Retention Plan, such payments shall offset dollar for dollar any payment to be received under the Severance Plan. 8. Time of Payment --------------- All severance payments made pursuant to the Severance Plan are to be made in full on the later of: (i) the last day of employment for the affected employee; and (ii) seven days after delivery by the affected employee to the Company of (a) the Release, and (b) the Non-compete Agreement, provided that the affected employee has not revoked either the Release or the Non-compete Agreement during that seven-day period. 9. Priority of Payment Obligations ------------------------------- Payments to be made under this Severance Plan shall be entitled to priority under section 503(b) of the Bankruptcy Code as an administrative priority, and shall be due and owing no later than the Effective Date, except as otherwise provided for in the Severance Plan. If any payment under the Severance Plan to be made after the Effective Date is not made as and when due, and the affected employee employs counsel in order to assert his or her rights with respect to the payment, then, in addition to the payment under the Severance Plan, the Company, and any successor obligated to perform under the Severance Plan, shall reimburse the affected employee all reasonable attorneys fees and costs incurred in successfully asserting any such rights. 10. Miscellaneous ------------- All rights under the Severance Plan shall at all times be entirely unfunded, and no provision shall at any time be made with respect to segregating any assets of the Company for payment of any amounts due under the Severance Plan. Any payments under the Severance Plan shall be made from the general assets of the Company as and when due. No member of the Board of Directors of the Company, nor any officer or employee of the Company, shall be personally liable if the Company is unable to make any of the payments provided for in the Severance Plan for any reason, including, without limitation, lack of funding or financing, legal prohibition, or failure to obtain required consents. Nothing contained in this Severance Plan shall be construed to be an employment contract between a participant in the Severance Plan and the Company. No interest of any participant in the Severance Plan, or any right to receive any payment hereunder, shall be subject to any manner of sale, transfer, assignment, pledge, attachment, garnishment, or other alienation or encumbrance of any kind, nor may such interest or right to receive a payment be taken, voluntarily or involuntarily, for the satisfaction of the obligation of, or other claims against, any participant, including claims for alimony, support, separate maintenance, and claims in bankruptcy cases. The Board of Directors of the Company shall have the right to amend the Severance Plan from time to time and may terminate the Severance Plan at any time; provided, however, that no amendment may be made to the Severance Plan and no termination of the Severance Plan may be effective until after (i) the effective date of a confirmed plan of reorganization for the Company, and (ii) fifteen (15) months after that effective date as to Company Officers, if there is a Change in Control. Approved by the Board of Directors of the Company on March 16, 2004 By: /s/Susan M. Skrokov ------------------- Susan M. Skrokov, Secretary Assumptions: 1. Executive Commmittee: 1 year of severance 2. Vice-Presidents: 4 months of severance 3. Directors: 3 months of severance 4. All other Exempt level Store Support Center Employees: 1 week per each full year of service to a maximum of 8 weeks, 2 week minimum Tenure Rounded Down to Months DEPT Full of EMP NO. NO. DOH TITLE DATE Year Severance - ------ ---- --- ----- ---- ------- --------- EXECUTIVE COMMITTEE: 1 YEAR 9145 01/06/03 EVPSTD - Exec-VP Store Operati 3/25/04 1 12 213717 9103 07/27/98 XCEO - CEO 3/25/04 5 12 253298 9106 03/22/04 XVPCFO - EVP,CFO 3/25/04 0 12 251005 9133 11/10/03 EVPGMM - EVP, Gen Merch Mgr 3/25/04 0 12 VICE-PRESIDENTS: 4 MONTHS 253144 9137 02/21/04 Vice-President Merchandising 3/25/04 0 4 246589 9139 02/17/03 Vice-President Merchandising 3/25/04 1 4 253277 9135 03/15/04 Vice-President Merchandising 3/25/04 0 4 211014 9141 10/29/97 Vice-President Merchandising 3/25/04 6 4 222394 9105 12/13/99 VP, Controller 3/25/04 4 4 9107 03/22/04 VP, ITS 3/25/04 0 4 9143 03/22/04 VP, Planning/Allocation 3/25/04 0 4 247678 9159 05/12/03 Vice-President Division 2 3/25/04 0 4 246588 9161 02/17/03 Vice-President Division 1 3/25/04 1 4 224937 9449 05/15/00 VPTDC1 - VP - Transportation/D 3/25/04 3 4 212540 9119 04/06/98 VPLP1 - VP - Loss Prevention 3/25/04 5 4 201402 9145 03/04/94 FMDRSO -VP, Store Ops 3/25/04 10 4 222728 9109 01/05/00 HRDRCB - VP, Human Resources 3/25/04 4 4 DIRECTORS: 3 MONTHS 225204 9106 05/29/00 FIDRFR-Dir, Fin Anal & Rptg 3/25/04 3 3 247538 9107 05/12/03 ITDRSD - Dir, System Developme 3/25/04 0 3 216500 9111 02/01/99 REDIR1 - Director - Real Estat 3/25/04 5 3 115322 9131 04/27/92 ADDIRMK - Director, Marketing 3/25/04 11 3 113799 9115 09/03/91 FCDIRC - Director - Constructi 3/25/04 12 3 209938 9143 08/18/97 PLADIR - Director of Plng 3/25/04 6 3 239427 9143 11/30/01 PLADIR - Director of Plng 3/25/04 2 3 216572 9106 02/16/99 FINAGC - Asst Gen Counsel 3/25/04 5 3 222927 9119 02/07/00 LPDRRM - Dir. Risk Management 3/25/04 4 3 215923 9153 04/17/00 HRDRTW - Dir, Train. & WF Plan 3/25/04 3 3 205825 9144 11/23/96 DIRALL - Director, Allocation 3/25/04 7 3 212925 9107 05/11/98 ITDRSA-Director, System Admin 3/25/04 5 3 225815 9119 07/05/00 LPRMG1 - RM - LP 3/25/04 3 3 116776 9121 01/27/97 LPRMG1 - RM - LP 3/25/04 7 3 217312 9123 04/12/99 LPRMG1 - RM - LP 3/25/04 4 3 Weeks of Severance --------- ALL OTHER EXEMPT LEVEL: 1 WEEK PER YEAR TO A MAXIMUM OF 8 WEEKS, 2 WEEK MINIMUM 247716 9103 05/19/03 XEXAST - Executive Assistant 3/25/04 0 2 250336 9105 09/22/03 FIAMFR-Mgr, Financial Reportin 3/25/04 0 2 248382 9105 06/23/03 FIASR1 - Senior Accountant 3/25/04 0 2 216370 9105 01/04/99 FISUP1 - Supervisor - Accts Pa 3/25/04 5 5 202519 9105 04/01/96 FISUC1 - Supervisor - Cash Mgm 3/25/04 7 7 207953 9105 04/28/97 FISUP1 - Supervisor - Accts Pa 3/25/04 6 6 120151 9105 08/29/94 FIMGI1 - Manager - Inv Control 3/25/04 9 8 249982 9105 09/03/03 FIASTA-Staff Accountant 3/25/04 0 2 237511 9105 09/24/01 FIACPA - Accountant - P/A 3/25/04 2 2 237831 9105 06/09/03 FILSPA - Lease Acctg Spec 3/25/04 0 2 207809 9105 04/21/97 FISUA1 - Supervisor - Sales Au 3/25/04 6 6 223468 9106 03/13/00 FIMGP1 - Manager - Financial P 3/25/04 4 4 218229 9107 06/06/99 MISPM1 - Sr Project Manager 3/25/04 4 4 250067 9107 09/08/03 ITSODB-Sr Oracle DBA 3/25/04 0 2 208329 9107 05/12/97 MISPM1 - Sr Project Manager 3/25/04 6 6 211282 9107 11/16/97 ITMPOS - Manager, POS Systems 3/25/04 6 6 251823 9107 11/17/03 MINAP2 - Sr Program Analyst 3/25/04 0 2 224730 9107 05/08/00 MISPC1 - Programmer - Analyst 3/25/04 3 3 225509 9109 06/15/00 HRSRAN - Senior HR Analyst 3/25/04 3 3 251152 9109 10/31/03 HRREPR - HR Representative 3/25/04 0 2 219836 9111 01/07/03 RELEMG - Manager - Lease Admin 3/25/04 1 2 232499 9113 02/05/01 PMMGR1 - Manager - Property Mg 3/25/04 3 3 230042 9113 10/23/00 PMAMG1 - Asst Property Manager 3/25/04 3 3 102611 9115 04/12/88 FCCLD1 - Crew Leader 3/25/04 15 8 200618 9115 09/03/95 FPRJC1 - Coordinator-Field Pro 3/25/04 8 8 253037 9119 01/28/04 LPWCGL - WC & GL Analyst 3/25/04 0 2 247069 9119 04/16/03 LPMGC - Manager - Loss Prevent 3/25/04 0 2 218154 9121 02/25/02 LPDMR1 - DM - LP 3/25/04 2 2 206827 9121 11/06/03 LPDMR1 - DM - LP 3/25/04 0 2 207052 9121 03/04/97 LPDMR1 - DM - LP 3/25/04 7 7 253111 9121 02/29/04 LPDMR1 - DM - LP 3/25/04 0 2 243965 9121 09/17/02 LPDMR1 - DM - LP 3/25/04 1 2 225326 9123 08/19/02 LPDMR1 - DM - LP 3/25/04 1 2 230043 9123 10/23/00 LPDMR1 - DM - LP 3/25/04 3 3 234764 9123 06/05/01 LPDMR1 - DM - LP 3/25/04 2 2 251395 9123 11/10/03 LPDMR1 - DM - LP 3/25/04 0 2 213198 9123 06/08/98 LPDMR1 - DM - LP 3/25/04 5 5 243925 9123 09/09/02 LPDMR1 - DM - LP 3/25/04 1 2 113716 9131 04/07/03 ADMMGR - Marketing Manager 3/25/04 0 2 217018 9131 12/15/03 ADMGP1 - Manager - Print Produ 3/25/04 0 2 252927 9135 01/07/04 MEBUY1 - Buyer - Merchandising 3/25/04 0 2 120825 9135 08/15/94 MEBUY1 - Buyer - Merchandising 3/25/04 9 8 214562 9135 09/28/98 MEBUY1 - Buyer - Merchandising 3/25/04 5 5 246394 9135 12/30/02 MEASB1 - Assistant Buyer 3/25/04 1 2 244403 9135 10/14/02 MEASB1 - Assistant Buyer 3/25/04 1 2 248917 9135 07/21/03 MEASB1 - Assistant Buyer 3/25/04 0 2 231164 9135 11/27/00 MEASB1 - Assistant Buyer 3/25/04 3 3 253257 9137 03/03/04 MEBUY1 - Buyer - Merchandising 3/25/04 0 2 238502 9137 11/12/01 MEBUY1 - Buyer - Merchandising 3/25/04 2 2 220659 9137 10/11/99 MEBUY1 - Buyer - Merchandising 3/25/04 4 4 249093 9137 07/28/03 MEABY1 - Associate Buyer 3/25/04 0 2 234889 9137 06/11/01 MEABY1 - Associate Buyer 3/25/04 2 2 240386 9137 02/20/02 MEASB1 - Assistant Buyer 3/25/04 2 2 236151 9137 08/06/01 MEASB1 - Assistant Buyer 3/25/04 2 2 118763 9137 06/30/89 MEASB1 - Assistant Buyer 3/25/04 14 8 222766 9139 01/12/00 MEBUY1 - Buyer - Merchandising 3/25/04 4 4 204732 9139 09/23/96 MEBUY1 - Buyer - Merchandising 3/25/04 7 7 107115 9139 10/04/93 MEBUY1 - Buyer - Merchandising 3/25/04 10 8 201155 9139 11/06/95 MEASB1 - Assistant Buyer 3/25/04 8 8 240485 9139 02/27/02 MEABY1 - Associate Buyer 3/25/04 2 2 223834 9139 03/27/00 MEASB1 - Assistant Buyer 3/25/04 3 3 249680 9141 08/18/03 MEBUY1 - Buyer - Merchandising 3/25/04 0 2 241276 9141 05/06/02 MEBUY1 - Buyer - Merchandising 3/25/04 1 2 233503 9141 04/09/01 MEBUY1 - Buyer - Merchandising 3/25/04 2 2 212729 9141 04/27/98 MEASB1 - Assistant Buyer 3/25/04 5 5 246889 9141 03/24/03 MEASB1 - Assistant Buyer 3/25/04 1 2 251771 9141 11/17/03 MEASB1 - Assistant Buyer 3/25/04 0 2 203193 9141 06/03/96 MEASB1 - Assistant Buyer 3/25/04 7 7 239104 9143 11/26/01 PLSRMG - Senior Planning Mgr 3/25/04 2 2 202244 9143 03/14/96 PLSRMG - Senior Planning Mgr 3/25/04 8 8 242397 9143 06/25/02 PLMPSR - Senior Planner 3/25/04 1 2 224594 9143 05/03/00 PLMGP1 - Manager - Planning 3/25/04 3 3 212268 9143 03/09/98 PLPMA - Price Management Analy 3/25/04 6 6 216392 9144 01/11/99 PLALMGR - Allocation Manager 3/25/04 5 5 218441 9144 06/21/99 PLMALL1 - Allocator 3/25/04 4 4 108969 9144 12/18/89 PLMALL1 - Allocator 3/25/04 14 8 118481 9144 01/03/94 PLMALL1 - Allocator 3/25/04 10 8 109742 9144 10/06/03 PLMALL1 - Allocator 3/25/04 0 2 208017 9144 04/03/00 PLMALL1 - Allocator 3/25/04 3 3 213317 9144 06/15/98 PLMALL1 - Allocator 3/25/04 5 5 109139 9144 02/26/90 PLMALL1 - Allocator 3/25/04 14 8 224090 9145 04/14/00 FMMSP - Mgr, Special Projects 3/25/04 3 3 250811 9145 11/03/03 OPSAST - Asst. to EVP, Ops 3/25/04 0 2 232004 9145 12/18/00 FMSPSS-Supervisor,Store Suppor 3/25/04 3 3 222926 9153 02/07/00 HRDMF - Divisional HR Manager 3/25/04 4 4 230138 9153 10/30/00 HRDMF - Divisional HR Manager 3/25/04 3 3 225492 9153 06/14/00 HRARTR - Area Trainer 3/25/04 3 3 217311 9153 04/12/99 HRTCRP - Trng & Comm Rep 3/25/04 4 4 246888 9158 03/25/03 FMDMF1 - District Manager 3/25/04 1 2 201400 9158 04/11/94 FMDMF1 - District Manager 3/25/04 9 8 247493 9158 05/06/03 FMDMF1 - District Manager 3/25/04 0 2 205313 9158 10/27/96 FMDMF1 - District Manager 3/25/04 7 7 214177 9158 08/17/98 FMDMF1 - District Manager 3/25/04 5 5 248913 9158 07/21/03 FMDMF1 - District Manager 3/25/04 0 2 227399 9158 08/31/00 FMDMF1 - District Manager 3/25/04 3 3 115385 9158 05/03/92 FMDMF1 - District Manager 3/25/04 11 8 101455 9158 11/07/88 FMDMF1 - District Manager 3/25/04 15 8 249257 9158 08/04/03 FMDMF1 - District Manager 3/25/04 0 2 125032 9160 02/18/85 FMDMF1 - District Manager 3/25/04 19 8 112529 9160 10/10/90 FMDMF1 - District Manager 3/25/04 13 8 246412 9160 01/06/03 FMDMF1 - District Manager 3/25/04 1 2 237755 9160 10/09/01 FMDMF1 - District Manager 3/25/04 2 2 236873 9160 08/27/01 FMDMF1 - District Manager 3/25/04 2 2 217592 9160 05/03/99 FMDMF1 - District Manager 3/25/04 4 4 215573 9160 11/15/98 FMDMF1 - District Manager 3/25/04 5 5 227234 9160 09/05/00 FMDMF1 - District Manager 3/25/04 3 3 235323 9160 06/26/01 FMDMF1 - District Manager 3/25/04 2 2 119231 9160 05/03/96 FMDMF1 - District Manager 3/25/04 7 7 197902 9449 05/20/85 WHMG1 - Manager - Warehouse 3/25/04 18 8 119429 9449 06/13/94 RDCSUP - DC Supervisor 3/25/04 9 8 142528 9449 10/07/85 RDCSM - Marking Supervisor 3/25/04 18 8 234404 9449 05/21/01 RDCSR - Rec'ing Supervisor 3/25/04 2 2 218305 9449 06/14/99 MDCSR - Rec'ing Supervisor 3/25/04 4 4 209940 9449 08/18/97 MDCSS - Shipping Supervisor 3/25/04 6 6 100128 9449 06/03/87 RDCSR - Rec'ing Supervisor 3/25/04 16 8 209915 9449 08/18/97 RDCSM - Marking Supervisor 3/25/04 6 6 100226 9449 10/03/88 RDCSM - Marking Supervisor 3/25/04 15 8 211104 9449 11/03/97 RDCSH - Hanging Supervisor 3/25/04 6 6 124839 9449 03/17/86 RDCSH - Hanging Supervisor 3/25/04 18 8 203453 9451 02/07/94 WHMGTR - Manager - Traffic 3/25/04 10 8 207585 9451 04/02/97 RDCSIC - Supervisor DC Inv Con 3/25/04 6 6 216996 9451 03/22/99 RDCSRT - Routing Supervisor 3/25/04 5 5 EX-31 5 exhnp302.txt 302 CERTIFICATE FROM CEO NP EXHIBIT 31.1 I, Norman G. Plotkin, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Factory 2-U Stores, Inc. (the "registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented b in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluations; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the Audit Committee of the registrant's Board of Directors: a) All significant deficiencies and material weaknesses in the design or operation of internal a control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control. Date: June 10, 2004 /s/ Norman G. Plotkin --------------------- Norman G. Plotkin Chief Executive Officer EX-31 6 exhnd302.txt 302 CERTIFICATE FROM CFO ND EXHIBIT 31.2 I, Norman Dowling, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Factory 2-U Stores, Inc. (the "registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the tatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented b in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluations; c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the Audit Committee of the registrant's Board of Directors: a) All significant deficiencies and material weaknesses in the design or operation of internal a control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control. Date: June 10, 2004 /s/ Norman Dowling ------------------ Norman Dowling Executive Vice President and Chief Financial Officer EX-32 7 exhnp906.txt 906 CERTIFICATE FROM CEO NP EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 (AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002) In connection with the Quarterly Report of Factory 2-U Stores, Inc. (the "Company") on Form 10-Q for the period ended May 1, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Norman G. Plotkin, Chief Executive Officer of the Company, certify to my knowledge and in my capacity as an officer of the Company, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods expressed in the Report. IN WITNESS WHEREOF, the undersigned has executed this Certificate, effective as of June 10, 2004. /s/ Norman G. Plotkin --------------------- Norman G. Plotkin Chief Executive Officer A signed original of this written statement required by Section 906 has been provided to Factory 2-U Stores, Inc. and will be retained by Factory 2-U Stores, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. EX-32 8 exhnd906.txt 906 CERTIFICATE FROM CFO ND EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 (AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002) In connection with the Quarterly Report of Factory 2-U Stores, Inc. (the "Company") on Form 10-Q for the period ended May 1, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Norman Dowling, Executive Vice President and Chief Financial Officer of the Company, certify to my knowledge and in my capacity as an officer of the Company, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods expressed in the Report. IN WITNESS WHEREOF, the undersigned has executed this Certificate, effective as of June 10, 2004. /s/ Norman Dowling ------------------ Norman Dowling Executive Vice President and Chief Financial Officer A signed original of this written statement required by Section 906 has been provided to Factory 2-U Stores, Inc. and will be retained by Factory 2-U Stores, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----