-----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, OSA+Uj169j6YceIvtIAwcrD5lNHcuvzjMusP5FNXjEXyWjXsQ46BvGTXkFOymTSH HDZUYR7/VXitKJHWx5cyTQ== 0000813775-02-000015.txt : 20020917 0000813775-02-000015.hdr.sgml : 20020917 20020917125023 ACCESSION NUMBER: 0000813775-02-000015 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20020803 FILED AS OF DATE: 20020917 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: 02765638 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: DRS INDUSTRIES INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: LONGWOOD GROUP LTD DATE OF NAME CHANGE: 19920527 FORMER COMPANY: FORMER CONFORMED NAME: FAMILY BARGAIN CORP DATE OF NAME CHANGE: 19940202 10-Q 1 a20022nd10q.txt FORM 10-Q FOR QUARTERLY PERIOD ENDED 080302 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 1O-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended August 3, 2002 -------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1932 For the transition period from...............to................ Commission File Number: 1-10089 FACTORY 2-U STORES, INC. (Exact name of registrant as specified in its charter) Delaware 51-0299573 - -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4000 Ruffin Road, San Diego, CA 92123-1866 - ------------------------------- ---------- (Address of principal executive office) (Zip Code) (858) 627-1800 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] YES [ ] NO The number of shares outstanding of the registrant's common stock, as of September 13, 2002 was 12,969,910 shares. FACTORY 2-U STORES, INC. FORM 10-Q FOR THE QUARTERLY PERIOD ENDED AUGUST 3, 2002 INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements Factory 2-U Stores, Inc. Balance Sheets as of August 3, 2002, August 4, 2001 (Unaudited) and February 2, 2002....................F-1 Factory 2-U Stores, Inc. Statements of Operations (Unaudited) for the 13 weeks and 26 weeks ended August 3, 2002 and August 4, 2001 .....F-3 Factory 2-U Stores, Inc. Statements of Cash Flows (Unaudited) for the 26 weeks ended August 3, 2002 and August 4, 2001 ..................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..........10 Item 4. Controls and Procedures.............................................10 PART II. OTHER INFORMATION Item 1. Legal Proceedings ..................................................11 Item 2. Changes in Securities and Use of Proceeds...........................11 Item 3. Defaults Upon Senior Securities.....................................11 Item 4. Submission of Matters to a Vote of Security Holders.................11 Item 5. Other Information ..................................................12 Item 6. Exhibits and Reports on Form 8-K ...................................12 Signatures ...............................................................13 Certifications ..............................................................14 2 PART I - FINANCIAL INFORMATION Item 1. Financial Statements
FACTORY 2-U STORES, INC. Balance Sheets (in thousands, except share and per share data) August 3, August 4, February 2, 2002 2001 2002 ------------ ------------ -------------- (Unaudited) (Unaudited) ASSETS Current assets: Cash $ 7,446 $ 8,229 $ 17,390 Merchandise inventory 76,824 76,558 54,860 Accounts receivable 2,476 3,038 2,013 Income taxes receivable 5,913 1,253 - Prepaid expenses 6,909 7,246 6,357 Deferred income taxes 3,553 2,503 3,553 --------- --------- ---------- Total current assets $ 103,121 $ 98,827 $ 84,173 Leasehold improvements and equipment, net 36,957 42,265 37,042 Deferred income taxes 7,182 4,992 7,182 Other assets 959 1,096 1,011 Excess of cost over net assets acquired, less accumulated amortization of $13,344, $12,543 and $13,344, respectively 26,301 27,102 26,301 --------- --------- ---------- Total assets $ 174,520 $ 174,282 $ 155,709 ========= ========= ==========
The accompanying notes are an integral part of these financial statements. (continued) F-1
FACTORY 2-U STORES, INC. Balance Sheets (in thousands, except share and per share data) (continued) August 3, August 4, February 2, 2002 2001 2002 ------------ ------------- -------------- (Unaudited) (Unaudited) LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt $ 2,001 $ 2,099 $ 2,019 Accounts payable 52,714 48,218 36,271 Taxes payable 3,150 3,262 3,332 Accrued expenses 32,875 15,378 27,918 ---------- --------- ---------- Total current liabilities 90,740 68,957 69,540 Revolving credit facility 5,386 11,600 - Long-term debt 8,906 9,791 8,376 Other long-term obligations 3,578 1,064 3,578 Deferred rent 3,295 3,654 3,649 ---------- --------- ---------- Total liabilities 111,905 95,066 85,143 ---------- --------- ---------- Stockholders' equity: Common stock, $0.01 par value; 35,000,000 shares authorized and 12,968,910 shares, 12,821,779 shares and 12,842,146 shares issued and outstanding, respectively 130 128 128 Stock subscription notes receivable (2,149) (2,225) (2,225) Additional paid-in capital 122,319 120,767 121,370 Accumulated deficit (57,685) (39,454) (48,707) ---------- ---------- ----------- Total stockholders' equity 62,615 79,216 70,566 ---------- ---------- ----------- Total liabilities and stockholders' equity $ 174,520 $ 174,282 $ 155,709 ========== ========== ===========
The accompanying notes are an integral part of these financial statements. F-2
FACTORY 2-U STORES, INC. Statements of Operations (in thousands, except per share data) (Unaudited) 13 Weeks Ended 26 Weeks Ended -------------- -------------- August 3, August 4, August 3, August 4, 2002 2001 2002 2001 ---------- ---------- ---------- ---------- Net sales $ 128,088 $ 139,254 $ 245,039 $ 265,078 Cost of sales 87,059 89,434 162,852 173,499 ---------- ---------- ---------- ---------- Gross profit 41,029 49,820 82,187 91,579 Selling and administrative expenses 50,181 47,791 95,879 90,438 Pre-opening and closing expenses 266 1,038 703 1,892 Amortization of intangibles - 422 - 845 Stock-based compensation expense - 456 - 456 ---------- ---------- ---------- ---------- Operating income (loss) (9,418) 113 (14,395) (2,052) Interest expense, net 310 450 568 781 ---------- ---------- ---------- ---------- Loss before income taxes (9,728) (337) (14,963) (2,833) Income tax benefit (3,891) (142) (5,985) (1,190) ---------- ---------- ---------- ---------- Net loss $ (5,837) $ (195) $ (8,978) $ (1,643) ========== ========== ========== ========== Loss per share Basic $ (0.45) $ (0.02) $ (0.69) $ (0.13) Diluted $ (0.45) $ (0.02) $ (0.69) $ (0.13) Weighted average common shares outstanding Basic 12,957 12,806 12,930 12,788 Diluted 12,957 12,806 12,930 12,788
The accompanying notes are an integral part of these financial statements. F-3
FACTORY 2-U STORES, INC. Statements of Cash Flows (in thousands) (Unaudited) 26 Weeks ended -------------- August 3, August 4, 2002 2001 ---------- ---------- Cash flows from operating activities Net Loss $ (8,978) $ (1,643) Adjustments to reconcile net loss to net cash used in operating activities Depreciation and amortization 7,466 8,109 Loss on disposal of equipment 51 125 Deferred rent (354) 214 Stock-based compensation expense - 456 Changes in operating assets and liabilities Merchandise inventory (21,964) (24,114) Prepaid expenses and other assets (6,902) (2,398) Accounts payable 16,442 23,024 Accrued expenses and other liabilities 3,098 (4,635) ---------- ---------- Net cash used in operating activities (11,141) (862) ---------- ---------- Cash flows from investing activities Purchases of leasehold improvements and equipment (5,125) (7,589) ---------- ---------- Net cash used in investing activities (5,125) (7,589) ---------- ---------- Cash flows from financing activities Borrowings on revolving credit facility 25,760 59,872 Payments on revolving credit facility (20,374) (48,272) Payments on long-term debt and capital lease obligations (18) (90) Payment of deferred debt issuance costs (40) (40) Proceeds from exercise of stock options 918 471 Payments of stock subscription notes receivable 76 - ---------- ---------- Net cash provided by financing activities 6,322 11,941 ---------- ---------- Net increase (decrease) in cash (9,944) 3,490 Cash at the beginning of the period 17,390 4,739 ---------- ---------- Cash at the end of the period $ 7,446 $ 8,229 ========== ========== Supplemental disclosure of cash flow information Cash paid during the period for Interest $ 97 $ 572 Income taxes $ 1,102 $ 5,521 Supplemental disclosure of non-cash financing activities Issuance of common stock to board members as compensation $ 33 $ 69
The accompanying notes are an integral part of these financial statements. F-4 FACTORY 2-U STORES, INC. Notes to Financial Statements (Unaudited) (1) Unaudited Interim Financial Statements The accompanying unaudited financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for annual financial statements and should be read in conjunction with the financial statements for the fiscal year ended February 2, 2002 included in our Form 10-K as filed with the Securities and Exchange Commission. We believe that the unaudited financial statements as of and for the 13 weeks and 26 weeks ended August 3, 2002 and August 4, 2001 reflect all adjustments (which include normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for the periods presented. Due to the seasonal nature of our business, the results of operations for the interim period may not necessarily be indicative of the results of operations for a full year. Certain prior period amounts have been reclassified to conform their presentation to the current period financial statements. (2) Recent Accounting Pronouncements In August 2001, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations." This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to (a) all entities and (b) legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or normal operation of long-lived assets, except for certain obligations of lessees. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. We do not expect the adoption of this statement will have a material impact on our financial position or results of operations. Also in August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which establishes one accounting model to be used for long-lived assets to be disposed of by sale and broadens the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" for the disposal of a segment of a business (as previously defined in that Opinion). The provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 144 had no impact on our financial position or results of operations. F-5 In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections", which rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt" and an amendment of that Statement, and SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS No. 145 also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers." SFAS No. 145 amends SFAS No. 13, "Accounting for Leases", to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. We do not expect the adoption of this statement will have a material impact on our financial position or results of operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities", which addresses significant issues regarding the recognition, measurement, and reporting of costs associated with exit and disposal activities, including restructuring activities. This statement requires that costs associated with exit or disposal activities be recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 is effective for all exit or disposal activities initiated after December 31, 2002. We do not expect the adoption of this statement will have a material impact on our financial position or results of operations. (3) Restructuring Charge In January 2002, we recorded a restructuring charge of $21.2 million in conjunction with the decision to close 28 under-performing stores, as well as the realignment of our field organization and workforce reductions. The purpose of these restructuring initiatives is to improve store profitability, streamline field operations, reduce costs and improve efficiency. As of September 17, 2002, we have closed 24 of the 28 under-performing stores and have completed the realignment of our field organization and workforce reductions. The balance of the liability related to the restructuring charge at August 3, 2002 was as follows: F-6
Balance at Balance at February 2, Cash Non-cash August 3, 2002 Payments Charges 2002 (in thousands) ----------- -------- -------- ---------- Lease termination costs* $ 13,724 $ (1,540) $ 304 $ 12,488 Inventory liquidation costs 2,870 - (1,289) 1,581 Fixed asset write-downs 2,052 - (1,390) 662 Employee termination costs 1,159 (930) - 229 Other costs 1,349 (849) - 500 ----------- --------- --------- ---------- $ 21,154 $ (3,319) $ (2,375) $ 15,460 ----------- --------- --------- ---------- * The non-cash charge portion consists primarily of the write-off of deferred rent.
(4) Adoption of SFAS No. 142, "Goodwill and Other Intangible Assets" ---------------------------------------------------------------- In June 2001, the FASB issued SFAS No. 142 "Goodwill and Other Intangible Assets", which requires that upon adoption, amortization of goodwill will cease and instead, the carrying value of goodwill be evaluated for impairment at least annually using a fair value test. Identifiable intangible assets will continue to be amortized over their useful lives and reviewed at least annually for impairment using a method appropriate to the nature of the intangible asset. As required, we adopted SFAS No. 142 on February 3, 2002 and ceased the amortization of goodwill accordingly. The following table presents the reconciliation of net income and per share data to what we would have reported had the new rules been in effect during the 13-week and 26-week periods ended August 4, 2001 (in thousands, except per share data):
13 Weeks Ended 26 Weeks Ended -------------- -------------- August 3, August 4, August 3, August 4, 2002 2001 2002 2001 --------- --------- --------- --------- Reported net loss $ (5,837) $ (195) $ (8,978) $ (1,643) Add back goodwill amortization, net of tax - 233 - 465 ---------- --------- ---------- --------- Adjusted net income (loss) $ (5,837) $ 38 $ (8,978) $ (1,178) ---------- --------- ---------- --------- Basic and diluted net income (loss) per common share: Reported net loss $ (0.45) $ (0.02) $ (0.69) $ (0.13) Goodwill amortization, net of tax $ - $ 0.02 $ - $ 0.04 Adjusted net income (loss) $ (0.45) $ 0.00 $ (0.69) $ (0.09)
F-7 (5) Revolving Credit Facility We have a $50.0 million revolving credit facility, under which generally we may borrow up to 70% of our eligible inventory and 85% of our eligible accounts receivable, as defined. Under the terms of the credit facility, the interest rate may increase or decrease subject to earnings before interest, tax obligations, depreciation and amortization expense (EBITDA), as defined, on a rolling four fiscal quarter basis. Accordingly, prime rate borrowings could range from prime to prime plus 0.5% and LIBOR borrowings from LIBOR plus 1.5% to LIBOR plus 2.5%. The credit facility expires on March 3, 2003, subject to automatic one-year renewal periods, unless terminated earlier by either party. We are obligated to pay fees equal to 0.125% per annum on the unused amount of the credit facility. The credit facility is secured by a first lien on accounts receivable and inventory and requires us to maintain specific levels of tangible net worth in the event that our borrowing availability is less than $7.5 million. On September 16, 2002, the credit facility was amended to extend the term until March 3, 2006. The amendment also amended the interest rate ranges on borrowings from prime to prime plus 1.0% or LIBOR plus 1.5% to LIBOR plus 3.0%. In addition, the amendment eliminated all financial covenants and provided for a $7.5 million availability block. Under the availability block, all borrowings require lender's authorization while availability under the facility is $7.5 million or less. At August 3, 2002, based on eligible inventory and accounts receivable, we were eligible to borrow $50.0 million under the revolving credit facility; and we were in compliance with all financial and tangible net worth covenants, as defined. At August 3, 2002, we had outstanding borrowings of $5.4 million; and we had a $4.4 million standby letter of credit outstanding. (6) Long-Term Debt Our long-term debt consists of Junior Subordinated Notes (the "Notes"), which are non-interest bearing and are reflected on our balance sheets at the present value using a discount rate of 10%. As of August 3, 2002, the Notes had a face value of $13.3 million and a related unamortized discount of $2.4 million, resulting in a net carrying value of $10.9 million. The discount is amortized to interest expense as a non-cash charge over the term of the Notes. We made a principal payment on the Notes of $2.0 million in December 2001. Additional principal payments are scheduled on December 31, 2002 ($2.0 million), December 31, 2003 and December 31, 2004 ($3.0 million) and on May 28, 2005 ($5.3 million). F-8 (7) Income (loss) per Share We compute income (loss) per share in accordance with SFAS No. 128, Earnings Per Share. Under the provisions of SFAS No. 128, basic earnings (loss) per share is computed based on the weighted average shares outstanding. Diluted earnings per share is computed based on the weighted average shares outstanding and potentially dilutive common equivalent shares. Common equivalent shares totaaling 13,078,881, 12,997,111, 13,183,665 and 12,976,516, respectively, are not included in the computation of diluted loss per share for the 13 weeks and 26 weeks ended August 3, 2002 and August 4, 2001 because the effect would be anti-dilutive. (8) Provision for Income Taxes Based on our estimated effective tax rate for the entire fiscal year, which is subject to ongoing review and evaluation, we recorded an income tax benefit of $3.9 million and $6.0 million for the 13 weeks and 26 weeks ended August 3, 2002, respectively. (9) Stock Options and Warrants As of August 3, 2002, we had outstanding options to purchase 1,254,275 shares of our common stock. Included in these outstanding stock options are 4,520 performance-based options, which will become exercisable if the market price hurdle of $49.78 has been achieved and maintained for 60 consecutive trading days. Should this occur, we will incur a non-cash compensation expense in the minimum amount of $187,000. These performance-based options will expire on or before April 29, 2003. During the 13 weeks ended August 4, 2001, we recorded a non-cash charge of $456,000 in conjunction with the removal of the price target of $49.78 for 19,361 stock options held by an executive officer who retired in August 2001. At August 3, 2002, warrants to purchase 82,690 shares of our common stock were outstanding. These warrants have an exercise price of $19.91 and expire May 2005. (10) Other Receivable In July 2002, we entered into a temporary bridge financing agreement (the "Agreement") with one of our trade vendors (the "Borrower") in which we, subject to the terms and conditions of the Agreement, will provide a $4.0 million revolving line of credit facility to the Borrower. Advances made to the Borrower under this Agreement are secured by the Borrower's accounts receivable, inventory, personal property and other assets including cash. Borrowings under this facility are also secured by personal guarantees from the principals of the Borrower. This agreement will terminate on September 27, 2002. As of August 3, 2002, there were direct borrowings of approximately $1.2 million under this Agreement. F-9 (11) Legal Matters, Commitments and Contingencies As disclosed in our financial statements for the fiscal year ended February 2, 2002 included in our Form 10-K as filed with the Securities and Exchange Commission, in December 2000, a former employee in our Alameda, California store filed a lawsuit against us (the "O'Hara Lawsuit"). This lawsuit alleged that we violated the California Labor Code and Internal Wage Commission Orders, by classifying store managers and assistant managers as exempt salaried employees and thereby failing to pay them overtime. In August 2002, we reached a tentative settlement, subject to court approval, to settle the O'Hara Lawsuit. On September 3, 2002, the court gave preliminary approval to the settlement and has scheduled a hearing on November 7, 2002 to consider final approval of the settlement. In conjunction with this tentative settlement, we recorded a charge of $2.1 million during the 13 weeks ended August 3, 2002. We are at all times subject to pending and threatened legal actions that arise in the normal course of business. In the opinion of our management, based in part on the assessment of legal counsel, the ultimate disposition of these current matters will not have a material adverse effect on our financial position or results of operations. F-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis should be read in conjunction with our Financial Statements and notes thereto, included elsewhere in this Form 10-Q. General As of August 3, 2002, we operated 257 stores compared to 263 stores as of August 4, 2001. We opened 3 new stores and closed 2 stores during the 13-week period ended August 3, 2002, and opened 12 new stores during the same period last year. For the 26-week period ended August 3, 2002, we opened 8 new stores and closed 30 stores as compared to 21 new store openings and 1 store closing for the comparable period last year. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Specifically, we must make estimates in the following areas: o Inventory valuation. Merchandise inventory is stated at the lower of cost or market determined using the retail inventory method ("RIM") on a first-in, first-out basis. Under the RIM, the valuation of inventory at cost and the resulting gross margin are calculated by applying a computed cost-to-retail ratio to the retail value of inventory. RIM is an averaging method that has been widely used in the retail industry due to its practicality. Also, it is recognized that the use of the RIM will result in valuing inventory at the lower of cost or market if markdowns are currently taken as a reduction of the retail value of inventory. Inherent in the RIM calculation are certain significant management judgments and estimates regarding markdowns and shrinkage, which may from time to time cause adjustments to the gross margin in the subsequent period. Factors that can lead to distortion in the calculation of the inventory balance include applying the RIM to a group of merchandise items that is not fairly uniform in terms of its cost and selling price relationship and turnover, and applying RIM to transactions over a period of time that includes different rates of gross profit, such as those relating to seasonal merchandise items. To minimize the potential of such distortions in the valuation of inventory from occurring, we utilize 83 subdepartments in which fairly homogeneous classes of merchandise items having similar gross margin are grouped. In addition, failure to take timely markdowns may result in an overstatement of cost under the lower of cost or market principle. 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. 3 o Valuation of goodwill, intangible and other long-lived assets. We use certain assumptions in establishing the carrying value and estimated lives of our long-lived assets and goodwill. The criteria used for these evaluations include management's estimate of the asset's continuing ability to generate income from operations and positive cash flows. If assets are considered to be impaired, the impairment recognized is measured by the amount that the carrying value of the assets exceeds the fair value of the assets. Useful lives and related depreciation or amortization expense are based on our estimate of the period that the assets will generate revenues or otherwise be used in operations. Factors that would influence the likelihood of a material change in our reported results include a significant decline in our stock price and market capitalization compared to our net book value, significant changes in an asset's ability to generate positive cash flows, significant changes in our strategic business objectives and utilization of the asset. o Accrued restructuring costs. We have estimated an amount for the charge and the related liability regarding our 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)." Materially different reported results would be likely if the timing and extent of the adopted restructuring plan were changed. o Litigation reserves. Based in part on the assessment 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 anticipate these reserves will be re-evaluated as new facts come to light in any particular case. o Worker's compensation accrual. At the beginning of fiscal 2001, we transitioned to a self-insured worker's compensation program. This new program has both specific and aggregate stop-loss amounts. The maximum specific stop-loss is $250,000 per occurrence and the deductible aggregate stop-loss is $3.2 million for the policy year ended January 31, 2002. We utilize internal actuarial methods, as well as an independent third-party actuary for the purpose of estimating ultimate costs for a particular policy year. Based on these actuarial methods along with current available information and insurance industry statistics, the ultimate expected losses for the policy year ended January 31, 2002 were estimated to be approximately $2.6 million. 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. For the policy year ending January 31, 2003, our self-insured worker's compensation program includes a maximum specific stop-loss amount of $250,000 per occurrence with no deductible aggregate stop-loss amount. 4 o Valuation of deferred income taxes. Valuation allowances are established, if deemed necessary, to reduce deferred tax assets to the amount expected to be realized. The likelihood of a material change in our expected realization of these assets is dependent on future taxable income, our ability to use the net operating loss carryforwards, the effectiveness of our tax planning and strategies among the various tax jurisdictions that we operate in, and any significant changes in the tax treatment we currently receive. Results of Operations Net sales were $128.1 million for the 13 weeks ended August 3, 2002 compared to $139.3 million for the 13 weeks ended August 4, 2001, a decrease of $11.2 million, or 8.0%. Comparable store sales for the 13-week period ended August 4, 2002 decreased 8.7% versus a decrease of 2.4% for the same period last year. For the 26 weeks ended August 3, 2002, net sales were $245.0 million versus $265.1 million the same period last year, a decrease of $20.0 million or 7.6%. Comparable store sales decreased 10.2% in the first 26 weeks of this year compared to a decrease of 4.2% for the same period last year. The decline in net sales for the 13 and 26 weeks ended August 3, 2002 from the comparable periods last year was primarily due to reduced customer traffic and lower average size in customer purchases. Gross profit was $41.0 million or 32.0% of net sales for the 13 weeks ended August 3, 2002 compared to $49.8 million or 35.8% of net sales for the 13 weeks ended August 4, 2001. For the 26 weeks ended August 3, 2002 and August 4, 2001, gross profit was $82.2 million or 33.5% of net sales and $91.6 million or 34.5% of net sales, respectively. The decline in gross profit as a percentage of net sales for the 13 and 26 weeks ended August 3, 2002 from the comparable periods last year was primarily related to higher markdown volume, lower initial mark-up, partially offset by improving efficiency in distribution operations. The higher markdown volume was primarily a result of increased promotional activity this year, which included our July chain-wide grand re-opening event, and clearing of slow-moving inventory. Included in selling and administrative expenses for the 13 and 26 weeks ended August 3, 2002 was a charge of $2.1 million related to the tentative settlement, subject to court approval, of the O'Hara Lawsuit, as previously discussed in this document. For the 13 and 26 weeks ended August 4, 2001, selling and administrative expenses included a charge of $1.2 million related to the retirement and replacement of an executive officer. 5 Excluding these charges, selling and administrative expenses were $48.1 million or 37.5% of net sales and $46.6 million or 33.5% of net sales for the 13 weeks ended August 3, 2002 and August 4, 2001, respectively. For the 26 weeks ended August 3, 2002 and August 4, 2001, selling and administrative expenses, excluding the charges, were $93.8 million or 38.3% of net sales and $89.3 million or 33.7% of net sales, respectively. The dollar increase in selling and administrative expenses was primarily a result of increased spending for advertising, store occupancy and consulting services. Selling and administrative expenses increased as a percent of net sales due to lower average sales volume per store and increased spending related to the items cited above. Pre-opening and closing expenses were $266,000 for the 13 weeks ended August 3, 2002 compared to $1.0 million for the same period last year, a decrease of approximately $772,000 or 74.3%. For the 26 weeks ended August 3, 2002, pre-opening and closing expenses were $703,000 versus $1.9 million for the same period last year, a decrease of approximately $1.2 million. The decrease in pre-opening and closing expenses for the 13 and 26 weeks ended August 3, 2002 from the comparable periods last year was due to the opening of fewer new stores during the current periods versus the same periods last year. We did not record any amortization of intangibles for the 13 weeks and 26 weeks ended August 3, 2002 versus $422,000 and $845,000, respectively, recorded during the same periods last year. This change was due to the elimination of goodwill amortization in conjunction with the adoption of SFAS No. 142 and cessation of amortization associated with prior business acquisitions. Interest expense, net was $310,000 and $568,000 for the 13 weeks and 26 weeks ended August 3, 2002, respectively, compared to $450,000 and $781,000 for the comparable periods last year. The decrease in both periods was due to lower average outstanding borrowings on the revolving credit facility. We recorded an income tax benefit of $3.9 million and $6.0 million for the 13 weeks and 26 weeks ended August 3, 2002, respectively, compared to $142,000 and $1.2 million for the 13 weeks and 26 weeks ended August 4, 2001. The increase in income tax benefit was the result of an increased pre-tax loss versus the same periods a year ago. For the 13 weeks and 26 weeks ended August 3, 2002, the net loss was $5.8 million and $9.0 million as compared to $195,000 and $1.6 million for the 13 weeks and 26 weeks ended August 3, 2001. The increase in net loss was a result of the operating and other factors cited above. 6 Liquidity and Capital Resources General We finance our operations through credit provided by vendors and other suppliers, amounts borrowed under our $50.0 million revolving credit facility and internally generated cash flow. Credit terms provided by vendors and other suppliers are usually net 30 days. Amounts which may be borrowed under the revolving credit facility are based on a percentage of eligible inventory and accounts receivable, as defined, outstanding from time to time, as more fully described in Note 5 of Notes to Financial Statements. At August 3, 2002, we had $5.4 million of outstanding borrowings under our revolving credit facility versus $11.6 million as of August 4, 2001. During the 26 weeks ended August 3, 2002, we used $11.1 million in operating activities, $5.1 million in investing activities and generated $6.3 million from financing activities. As a result, we had a net decrease in cash of $9.9 million during the 26 weeks ended August 3, 2002 compared to a net increase in cash of $3.5 million during the same period last year. We believe that our sources of cash, including the revolving credit facility, will be adequate to finance our operations, capital requirements and debt obligations as they become due for at least the next twelve months. Capital Expenditures We anticipate capital expenditures of approximately $8.6 million for the remainder of the current fiscal year ending February 1, 2003, which includes costs to open new stores, to renovate and relocate existing stores, to upgrade information systems and to develop a distribution center in San Diego, California. This new distribution center will be approximately 600,000 square feet and service store operations on the west coast, Arizona, Nevada, and parts of New Mexico. We anticipate that it will become operational in our second quarter of fiscal 2003. We anticipate capital expenditures of approximately $6.5 million for this facility, approximately $4.0 million of which will occur in fiscal 2002. We believe the capital expenditures for this facility and other capital requirements will be financed from internal cash flow. Store Closures and Restructuring Initiatives As previously discussed, we have closed 24 of the 28 under-performing stores as part of our restructuring plan. In addition, we have closed six other stores which were either due to non-renewable leases or relocation opportunities. The majority of the store closures were part of our restructuring initiatives intended to improve future financial performance. The cash charges to close a store principally consisted of lease termination or sublease costs, employee severance and tear-down costs. In addition to the closing of under-performing stores, we also included the realignment of field organization and workforce reductions as part of our restructuring initiatives. We estimate the cash requirement during the remainder of fiscal 2002 for the restructuring will be approximately $5.7 million. We believe that our sources of cash, including the revolving credit facility, will be adequate to fund our restructuring efforts. 7 Contractual Obligations and Commitments The following table summarizes our significant contractual obligations, as well as estimated cash requirements related to our restructuring initiatives, as of August 3, 2002. These should be read in conjunction with "Note 3 - Restructuring Charge" and "Note 6 - Long-Term Debt" in the accompanying unaudited financial statements, as well as our fiscal 2001 Annual Report on Form 10-K as filed with the Securities and Exchange Commission.
(in thousands) Junior Accenture Subordinated Operating Capital Restructuring Consulting Notes Leases Leases Charge Agreement Total ------------ ---------- ------- ------------- ----------- ----------- Fiscal Year: 2002 (remaining 6 months) $ 2,000 $ 15,822 $ 1 $ 5,702 $ 1,200 $ 24,725 2003 3,000 30,444 - 7,515 - 40,959 2004 3,000 26,865 - - - 29,865 2005 5,300 20,159 - - - 25,459 2006 - 13,836 - - - 13,836 Thereafter - 26,310 - - - 26,310 ------------ ---------- ------ ------------- --------- ----------- $ 13,300 $ 133,436 $ 1 $ 13,217 $ 1,200 $ 161,154 ------------ ---------- ------ ------------- --------- -----------
In the first quarter of fiscal 2002, we entered into a master Consulting Services Agreement and a statement of work thereunder (the "Agreement") with Accenture LLP ("Accenture") to provide consulting services on merchandise assortment planning and in-season management, advertising effectiveness and brand development. The consulting services include (1) identification of high impact opportunities, (2) development of an approach plan to realize and sustain the associated benefits of the identified opportunities, (3) assistance in the execution of the approach plan and (4) development of procedures for the company's management to ensure the continuation of the program on a long-term basis. Under the Agreement, Accenture would receive approximately $3.9 million for services scheduled to be completed by January 2003. In addition, Accenture may become entitled to additional fees of up to $1.3 million for fiscal 2002 and $1.0 million for fiscal 2003 if we achieve specified financial targets for fiscal 2002 and fiscal 2003. The Agreement is generally terminable on 30-day notice. If we terminate without cause, we may be obligated to reimburse Accenture for specified termination fees. Through August 31, 2002, we paid Accenture approximately $2.0 million under the Agreement. Effective August 30, 2002, the Agreement was amended to reflect a reduction in the scope of services to be provided by Accenture. Under the amended Agreement, Accenture will receive approximately $1.2 million in fees and expenses for services provided for the period from September 30, 2002 to January 31, 2003. 8 Forward-Looking Statements In this Quarterly Report on Form 10-Q, we have made both historical and forward-looking statements. All of our statements other than those of historical fact are, or may be deemed to be, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are not based on historical facts, but rather reflect our current expectations concerning future results and events. These forward-looking statements generally may be identified by the use of phrases such as "believe", "expect", "anticipate", "intend", "plan", "foresee", "likely", "will" or other similar words or phrases. Similarly, statements that describe our objectives, plans or goals are or may be forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be different from any future results, performance or achievements expressed or implied by these statements. The following important factors, among others, could affect our future results, causing these results to differ materially from those expressed in any of our forward-looking statements: general economic and business conditions, trends in our business and consumer preferences, especially as may be impacted by economic weakness on consumer spending, the effects of government regulations and legislation, litigation and other claims that may be asserted against us, the effects of intense competition, changes in our business strategy or development plans, including anticipated growth strategies and capital expenditures, the costs and difficulties of attracting and retaining qualified personnel, the effects of increasing labor, utility, fuel and other 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 risk factors described in our fiscal 2001 Annual Report on Form 10-K and in our other filings with the Securities and Exchange Commission. We do not undertake to publicly update or revise any of our forward-looking statements, whether as a result of new information, future events and developments or otherwise, except to the extent that we may be obligated to do so by applicable law. 9 Item 3. Quantitative and Qualitative Disclosures About Market Risk We are exposed to interest rate risk on our Junior Subordinated Notes, which are non-interest bearing and discounted at an annual rate of 10%. At August 3, 2002, our long-term debt had a face value of $13.3 million with a net carrying value of $10.9 million. While generally an increase in market interest rates will decrease the value of this debt, and decreases in interest rates will have the opposite effect, we are unable to estimate the impact that interest rate changes will have on the value of this debt as there is no active public market for the debt and we are unable to determine the market interest rate at which alternate financing would have been available at August 3, 2002. Item 4. Controls and Procedures There have not been any significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to their evaluation in connection with our last annual audit, including any corrective actions with regard to significant deficiencies and material weaknesses. 10 PART II - OTHER INFORMATION Item 1. Legal Proceedings As disclosed in our financial statements for the fiscal year ended February 2, 2002 included in our Form 10-K as filed with the Securities and Exchange Commission, in December 2000, a former employee in our Alameda, California store filed a lawsuit against us (the "O'Hara Lawsuit"). This Lawsuit alelged that we violated the California Labor Code and Internal Wage Commission Orders, by classifying store managers and assistant managers as exempt salaries employees and thereby failing to pay them overtime. In August 2002, we reached a tentative settlement, subject to court approval, to settle the O'Hara Lawsuit. On September 3, 2002, the court gave preliminary approval to the settlement and has scheduled a hearing on November 7, 2002 to consider final approval of the settlement. Item 2. Changes in Securities and Use of Proceeds None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders Our annual meeting of stockholders was held on June 19, 2002. Michael M. Searles was re-elected at the meeting to hold the office of director and to serve until the annual meeting of stockholders in 2005 or until his successor is elected. The number of votes cast were as follows: Votes for: 8,320,831 Votes withheld: 0 Other directors whose terms of office continued after the meeting were Willem de Vogel, Peter V. Handal, Ronald Rashkow and Wm. Robert Wright II. The other matter voted on and approved at the meeting was the ratification of Ernst & Young LLP as independent accountants and the results of that vote were as follows: Votes for: 11,813,691 Votes against: 240,253 Votes withheld: 26,629 11 Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K (a) Exhibit 10.9 Fourth Amendment to the Financing Agreement between the CIT Group/Business Credit, Inc. (as Agent and a Lender) and Factory 2-U Stores, Inc. (as Borrower) dated as of September 16, 2002. 99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Michael M. Searles, President and Chief Executive Officer. 99.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Douglas C. Felderman, Executive Vice President and Chief Financial Officer. (b) Reports on Form 8-K Item 5 - On August 20, 2002, we filed a report on Form 8-K regarding the resignation of Michael M. Searles, the Company's President and Chief Executive Officer. 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: September 17, 2002 By: /s/Douglas C. Felderman ------------------------- Name: Douglas C. Felderman Title: Executive Vice President and Chief Financial Officer (duly authorized officer and principal financial officer) 13 CERTIFICATIONS I, Michael M. Searles, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Factory 2-U Stores, Inc. (the "Registrant"). 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report. 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report. Date: September 17, 2002 /s/Michael M. Searles --------------------- Name: Michael M. Searles Title: President and Chief Executive Officer I, Douglas C. Felderman, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Factory 2-U Stores, Inc. (the "Registrant"). 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report. 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report. Date: September 17, 2002 /s/Douglas C. Felderman ----------------------- Name: Douglas C. Felderman Title: Executive Vice President and Chief Financial Officer 14 EX-99 2 exhcert2df.txt CERTIFICATION BY DF Exhibit 99.2 CERTIFICATE 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 on Form 10-Q of Factory 2-U Stores, Inc. (the "Company") for the quarter ended August 3, 2002, as filed with the Securities Exchange Commission on the date hereof (the "Report"), I, Douglas C. Felderman, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to and for purposes of 18 U.S.C. Section 1350, as adopted 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; and (2) The information contained in the Report fairly presents, in all material aspects, the financial condition of the Company as of the dates indicated and result of operations of the Company for the periods indicated. /s/ Douglas C. Felderman ------------------------ Douglas C. Felderman Executive Vice President and Chief Financial Officer September 17, 2002 EX-99 3 exhcert1ms.txt CERTIFICATION BY MS Exhibit 99.1 CERTIFICATE 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 on Form 10-Q of Factory 2-U Stores, Inc. (the "Company") for the quarter ended August 3, 2002, as filed with the Securities Exchange Commission on the date hereof (the "Report"), I, Michael M. Searles, President and Chief Executive Officer of the Company, certify, pursuant to and for purposes of 18 U.S.C. Section 1350, as adopted 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; and (2) The information contained in the Report fairly presents, in all material aspects, the financial condition of the Company as of the dates indicated and result of operations of the Company for the periods indicated. /s/ Michael M. Searles ---------------------- Michael M. Searles President and Chief Executive Officer September 17, 2002 EX-10 4 exh4thamend.txt 4TH AMENDMENT TO THE FINANCING AGREEMENT Exhibit 10.9 FOURTH AMENDMENT TO FINANCING AGREEMENT This Fourth Amendment to Financing Agreement (this "Amendment") is entered into as of this 16th day of September, 2002 among FACTORY 2-U STORES, INC., a Delaware corporation ("Company"), the Lenders who are a party to the Financing Agreement referred to below (collectively, "Lenders") and THE CIT GROUP/BUSINESS CREDIT, INC., a New York corporation ("Agent"), in its capacity as Agent for the Lenders, with reference to the following facts: A. Agent, Company and Lenders previously entered into that certain Financing Agreement dated as of March 3, 2000, as amended by that certain First Amendment to Financing Agreement dated as of April 13, 2000, that certain Second Amendment to Financing Agreement dated as of April 10, 2001 and that certain Third Amendment to Financing Agreement dated as of April 9, 2002 (collectively, the "Financing Agreement"), pursuant to which Lenders have provided Company with certain loans and other financial accommodations. B. Company has requested that Agent and Lenders amend the Financing Agreement to, among other things, extend the term of the Financing Agreement until March 3, 2006. C. Agent and Lenders are willing to amend the Financing Agreement on the terms and subject to the conditions set forth in this Amendment. NOW THEREFORE, in consideration of the foregoing and the terms and conditions hereof, the parties do hereby agree as follows, effective as of the date set forth above: 1. Definitions. Terms used herein, unless otherwise defined herein, shall have the meanings set forth in the Financing Agreement. 2. Amendments to Financing Agreement. (a) The definition of "Availability" set forth in Section 1 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "Availability shall mean at any time the lesser of: (a) the excess of the Borrowing Base over the sum of (x) the outstanding aggregate amount of all Obligations, including, without limitation, all Obligations with respect to Revolving Loans and Letters of Credit, (y) the Availability Reserve and (z) $7,500,000; or (b) the excess of $50,000,000, over the sum of (x) the outstanding aggregate amount of all Obligations, including, without limitation, all Obligations with respect to Revolving Loans and Letters of Credit and (y) the Availability Reserve." 1 (b) The definition of "Borrowing Base" set forth in Section 1 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "Borrowing Base shall mean (calculated without regard to the $50,000,000 line of credit maximum) the sum of (a) eighty-five percent (85%) of the outstanding Eligible Accounts Receivable of the Company plus (b) the aggregate value of Eligible Inventory (including Eligible In-Transit Inventory) determined at the lower of cost or market on a first-in, first-out basis multiplied by the Inventory Advance Percentage; provided that, in no event shall advances against Eligible In-Transit Inventory exceed the lesser of (A) $5,000,000 or (B) forty percent (40%) of the aggregate value of Eligible Inventory." (c) The definition of "Chase Manhattan Rate" set forth in Section 1 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "Chase Manhattan Rate shall mean the rate of interest per annum announced by JPMorgan Chase Bank from time to time as its prime rate in effect at its principal office in New York City. (The prime rate is not intended to be the lowest rate of interest charged by JPMorgan Chase Bank to its borrowers.)" (d) The definition of "Early Termination Fee" set forth in Section 1 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "Early Termination Fee shall: (a) mean the fee the Agent is entitled to charge the Company in the event the Line of Credit (including the Letter of Credit Sub-Line) or this Financing Agreement is terminated on a date prior to an Anniversary Date; and (b) be determined by multiplying the Line of Credit (including the Letter of Credit Sub-Line) by (i) one percent (1%) if the Early Termination Date occurs on or prior to March 2, 2004, and (ii) one-half of one percent (0.5%) if the Early Termination Date occurs after March 2, 2004, but on or prior to March 2, 2005." (e) The definition of "Inventory Advance Percentage" set forth in Section 1 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "Inventory Advance Percentage shall mean the lower of: (a) seventy percent (70%) of the aggregate value of Eligible Inventory, or (b) eighty-five percent (85%) of the Net Orderly Liquidation Value of the Inventory as a percentage of the total Inventory as determined by the most recent Inventory appraisal, a provided for in Section 7.13 hereof." 2 (f) The following definition of "Triggering Availability" is hereby added to Section 1 of the Financing Agreement in proper alphabetical order: "Triggering Availability shall mean at any time the excess of the Borrowing Base, over the sum of (x) the outstanding aggregate amount of all Obligations, including, without limitation, all Obligations with respect to Revolving Loans and Letters of Credit, and (y) the Availability Reserve." (g) The second paragraph of Section 3.4 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "The Company may and will enforce, collect and receive all amounts owing on the Accounts and/or received from sales or other dispositions of Inventory at the Company's expense, and may manage and direct its Depository Accounts; however such privilege shall terminate automatically upon the institution by or against the Company of any proceeding under any bankruptcy or insolvency law or, at the election of the Agent in its sole discretion: (x) if Triggering Availability is at any time less than $10,000,000 and at all times thereafter until such time the Company maintains minimum Triggering Availability of $10,000,000 for a period of ninety (90) consecutive days, or (y) upon the occurrence of any other Event of Default and until such Event of Default is waived in writing by Agent or cured to Agent's satisfaction." (h) The second sentence of Section 7.2 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "The Company agrees that the Agent or its agents may enter upon the Company's premises with reasonable notice (such notice not being required if an Event of Default has occurred and is continuing) at any time during normal business hours, and from time to time, but not more than twice in any twelve (12) month period, for the purpose of inspecting the Collateral, and any and all records pertaining thereto; provided however, (x) if at any time Triggering Availability is less than $20,000,000 and at all times thereafter until such time the Company maintains minimum Triggering Availability of $20,000,000 for a period of ninety (90) consecutive days or (y) upon the occurrence of any Event of Default and while it is continuing, Agent shall not be limited in the number of times it or its agent may enter upon the Company's premises." (i) The last sentence of Section 7.3 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "At any time the Triggering Availability is less than $10,000,000 or upon the occurrence and during the continuance of any Event of Default, the Company shall, upon demand by Agent, provide the reports listed above as (a) and (b) on a weekly basis." 3 (j) Clause (3) of Section 7.9(i) of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "(3) notwithstanding clauses (1) and (2) above, the Company may prepay Subordinated Debt to the extent Triggering Availability after giving effect to such prepayment exceeds $15,000,000, provided that the Company has maintained a trailing twelve(12) month EBITDA of not less than $30,000,000." (k) The financial covenant relating to the Company's Tangible Net Worth is hereby eliminated and accordingly, Section 7.10 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "7.10 Reserved." (l) The first sentence of Section 7.13 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "The Company has provided to the Agent, and agrees to provide to the Agent on an annual basis commencing with the first anniversary of the Closing Date, an appraisal indicating the Net Orderly Liquidation Value of the Inventory; provided however, if at any time Triggering Availability is less than $20,000,000 and at all times thereafter until such time the Company maintains minimum Triggering Availability of $20,000,000 for a period of ninety (90) consecutive days, such appraisals shall be provided on a semi-annual basis; provided further however, upon the occurrence and continuance of an Event of Default, such appraisals shall be provided as frequently as Agent may reasonably request." (m) The grid set forth in Section 8.1 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: Libor Rate Chase Level EBITDA plus Or Manhattan Rate plus ------ ---------------------------------- ------------- ------ ------------ I Greater than $28,000,000 1.50% or 0.00% ------ ---------------------------------- ------------- ------ ------------ II Greater than $20,000,000 but less than or equal to $28,000,000 1.75% or 0.00% ------ ---------------------------------- ------------- ------ ------------ III Greater than $15,000,000 but less than or equal to $20,000,000 2.00% or 0.00% ------ ---------------------------------- ------------- ------ ------------ IV Greater than $10,000,000 but less than or equal to $15,000,000 2.25% or 0.25% ------ ---------------------------------- ------------- ------ ------------ V Greater than $5,000,000 but less than or equal to $10,000,000 2.50% or 0.50% ------ ---------------------------------- ------------- ------ ------------ VI Less than or equal to $5,000,000 3.00% or 1.00% ------ ---------------------------------- ------------- ------ ------------ 4 (n) The last sentence of Section 8.1 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "Notwithstanding anything to the contrary contained herein, (x) in no event shall the interest rate applicable hereunder decrease by more than one-quarter percent (0.25%) within any six (6) month period and (y) if Triggering Availability exceeds $30,000,000 at all times during any fiscal quarter and no Event of Default shall have occurred and be continuing as at the end of such fiscal quarter, the interest rate applicable hereunder for the three-month period commencing immediately after such quarter shall be decreased by one-quarter of one percent (0.25%)." (o) The grid set forth in Section 8.8 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: Date of Payment Amount of Payment ------------------------------------------- ---------------------------- On the Closing Date $25,000 ------------------------------------------- ----------------------------- On each of the first, second, third, fourth $40,000 per year and fifth anniversaries of the Closing Date ------------------------------------------- ----------------------------- (p) Section 11.1 of the Financing Agreement is hereby amended and restated in its entirety to read as follows: "11.1 This Financing Agreement shall become effective as of the date set forth on the first page hereof and shall continue in full force and effect for the initial term ending six (6) years from the Closing Date (the "Anniversary Date") and from year to year thereafter (each, an "Anniversary Date"), unless sooner terminated pursuant to the terms hereof." 3. Fee. In consideration of the foregoing amendment, Company shall pay to Agent, for the pro-rata benefit of Lenders, an amendment fee of $162,500 (the "Amendment Fee"). The Amendment Fee shall be fully earned by Lenders as of the date hereof and shall be payable and charged to Company's Revolving Loan Account as follows: $81,250 upon execution of this Amendment by Company and $81,250 upon the earlier of March 3, 2003 or the termination of the Financing Agreement. 4. Conditions Precedent. The effectiveness of the foregoing amendment shall be, and hereby is, subject to the fulfillment to Agent's satisfaction of the Conditions Precedent. The "Conditions Precedent" shall mean each of the following: (a) Receipt by Agent of this Amendment duly executed by each of the parties hereto; (b) Receipt by Agent of a fully executed Assignment and Transfer Agreement whereby Fleet Retail Finance Inc. shall reassign its rights and obligations as a Lender under the Financing Agreement to The CIT Group/Business Credit, Inc.; 5 (c) Company shall have paid to Agent the portion of the Amendment Fee that is due upon execution of this Amendment by Company; and (d) As of the date hereof, the representations and warranties contained in Section 7 of the Financing Agreement are (before and after giving effect to this Amendment) true and correct in all material respects (except to the extent any such representation and warranty is expressly stated to have been made as of a specific date, in which case it shall be true and correct as of such specific date) and no Default or Event of Default shall be existing or have occurred and be continuing. 5. Miscellaneous. (a) Reference to and Effect on the Financing Agreement. (i) Except as specifically amended by this Amendment and the documents executed and delivered in connection herewith, the Financing Agreement shall remain in full force and effect and is hereby ratified and confirmed. (ii) The execution and delivery of this Amendment shall not, except as expressly provided herein, constitute a waiver of any provision of, or operate as a waiver of any right, power or remedy of Agent or any Lender under the Financing Agreement or any agreement or document executed in connection therewith. (iii) Upon the Conditions Precedent being satisfied, this Amendment shall be construed as one with the existing Financing Agreement, and the existing Financing Agreement shall, where the context requires, be read and construed throughout so as to incorporate this Amendment. (b) Fees and Expenses. The Borrower acknowledges that all costs, fees and expenses incurred in connection with this Amendment will be paid in accordance with Section 8.5 of the Financing Agreement. (c) Headings. Section and subsection headings in this Amendment are included for convenience of reference only and shall not constitute a part of this Amendment for any other purpose or be given any substantive effect. (d) Counterparts. This Amendment may be executed in one or more counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument. (e) Governing Law. This Amendment shall be governed by and construed according to the laws of the State of California. 6 IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first above written. Company: FACTORY 2-U STORES, INC. /s/Douglas C. Felderman ----------------------- Name: Douglas C. Felderman Title: Executive Vice President and Chief Financial Officer Agent and Lender: THE CIT GROUP/BUSINESS CREDIT, INC. /s/James J. Karnowski ------------------------ Name: James J. Karnowski Title: Vice President 7 -----END PRIVACY-ENHANCED MESSAGE-----