<PAGE>
Filed Pursuant to Rule 424(b)(4)
Registration No. 333-13827
2,627,000 SHARES
[LOGO]
COMMON STOCK
-----------
Of the 2,627,000 shares of Common Stock of Factory Card Outlet Corp.
("Factory Card" or the "Company") offered hereby, 2,550,000 shares are being
offered by the Company and 77,000 shares are being offered by certain
stockholders of the Company (the "Selling Stockholders"). The Company will not
receive any proceeds from the sale of shares by the Selling Stockholders. See
"Principal and Selling Stockholders." Prior to this offering, there has been no
public market for the Common Stock of the Company. See "Underwriting" for the
factors to be considered in determining the initial public offering price. The
Common Stock has been approved, subject to notice of issuance, for quotation on
the Nasdaq National Market under the symbol "FCPY."
--------------
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" COMMENCING ON PAGE 6.
-------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE UNDERWRITING PROCEEDS PROCEEDS TO
TO DISCOUNTS AND TO SELLING
PUBLIC COMMISSIONS COMPANY(1) STOCKHOLDERS
<S> <C> <C> <C> <C>
Per Share................................. $9.00 $0.63 $8.37 $8.37
Total(2).................................. $23,643,000 $1,655,010 $21,343,500 $644,490
</TABLE>
(1) Before deducting expenses of this offering payable by the Company, estimated
at $800,000.
(2) The Company and the Selling Stockholders have granted to the Underwriters a
30-day option to purchase up to 394,050 additional shares of Common Stock
solely to cover over-allotments, if any. To the extent that the option is
exercised, the Underwriters will offer the additional shares at the Price to
Public shown above. If the option is exercised in full, the total Price to
Public, Underwriting Discounts and Commissions, Proceeds to Company and
Proceeds to Selling Stockholders will be $27,189,450, $1,903,261,
$24,641,699 and $644,490, respectively. See "Underwriting."
--------------
The shares of Common Stock are offered by the several Underwriters, subject
to prior sale, when, as and if delivered to and accepted by them, and subject to
the right of the Underwriters to reject any order in whole or in part. It is
expected that delivery of the shares of Common Stock will be made at the offices
of Alex. Brown & Sons Incorporated, Baltimore, Maryland, on or about December
18, 1996.
ALEX. BROWN & SONS PIPER JAFFRAY INC.
INCORPORATED
THE DATE OF THIS PROSPECTUS IS DECEMBER 12, 1996.
<PAGE>
[PHOTOS SHOWING THE EXTERIOR AND INTERIOR OF FACTORY CARD STORES FROM VARIOUS
ANGLES]
[MAP OF THE CONTINENTAL UNITED STATES SHOWING LOCATIONS OF FACTORY CARD STORES]
--------------
The Company intends to furnish its stockholders with annual reports
containing audited financial statements certified by an independent public
accounting firm and unaudited quarterly reports for the first three quarters of
each fiscal year.
--------------
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT
A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE
OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
2
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND THE CONSOLIDATED FINANCIAL STATEMENTS, INCLUDING THE NOTES
THERETO, APPEARING ELSEWHERE IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED, ALL
INFORMATION IN THIS PROSPECTUS (I) ASSUMES NO EXERCISE OF THE UNDERWRITERS'
OVER-ALLOTMENT OPTION, (II) REFLECTS A 4.016-FOR-1 STOCK SPLIT EFFECTIVE
IMMEDIATELY PRIOR TO THE CLOSING OF THIS OFFERING AND (III) REFLECTS THE
CONVERSION OF ALL OUTSTANDING SHARES OF THE COMPANY'S SERIES A PREFERRED STOCK
("SERIES A PREFERRED"), SERIES B PREFERRED STOCK ("SERIES B PREFERRED"), AND
SERIES C PREFERRED STOCK ("SERIES C PREFERRED"), EACH WITH A PAR VALUE OF $0.01
PER SHARE (COLLECTIVELY, THE "CONVERTIBLE PREFERRED STOCK"), INTO AN AGGREGATE
OF 3,134,674 SHARES OF THE COMPANY'S COMMON STOCK, NO PAR VALUE (WHICH PAR VALUE
WILL BE REDESIGNATED AS $0.01 PER SHARE IN CONNECTION WITH THIS OFFERING) (THE
"COMMON STOCK"), WHICH WILL OCCUR UPON THE EFFECTIVENESS OF THE REGISTRATION
STATEMENT OF WHICH THIS PROSPECTUS IS A PART. IN THIS PROSPECTUS, WHERE A
REFERENCE IS MADE TO A PARTICULAR FISCAL YEAR, IT IS A REFERENCE TO THE
COMPANY'S 52-WEEK FISCAL YEAR, WHICH ENDS ON THE SATURDAY CLOSEST TO JUNE 30 OF
THAT YEAR, EXCEPT FOR YEARS PRIOR TO FISCAL 1995, ALL OF WHICH ENDED ON JUNE 30.
THE COMPANY
Factory Card Outlet Corp. is a rapidly growing chain of company-owned
superstores offering a vast assortment of party supplies, greeting cards, gift
wrap and other special occasion merchandise at everyday value prices. As of
November 15, 1996, the Company operated 122 stores in 14 states, primarily in
the Midwest and mid-Atlantic regions of the United States. To maintain the
quality and consistency of its retail presentation, the Company operates all of
its stores, which comprise the largest chain of company-operated superstores
within the party supply and special occasion merchandise category. The Company
opened 15, 25 and 32 superstores in fiscal 1994, 1995 and 1996, respectively,
and plans to open 30 to 35 superstores in fiscal 1997, including 15 opened
through November 15, 1996, and at least 40 superstores in fiscal 1998.
The Company's superstores provide customers with a value-oriented,
"one-stop" shopping destination for party and special occasion merchandise for
all major holidays and celebratory events, including birthdays, graduations,
weddings, baby showers and other family, religious and special occasions. The
Company's superstore prototype ranges in size from 10,000 to 12,000 square feet,
with approximately 80% devoted to selling space, and is designed to provide ease
of shopping within an attractive, spacious and festive environment. To enhance
the look of its superstores and encourage multiple purchases, merchandise is
displayed in assortments that emphasize themes and colors associated with
holidays, special occasions and other seasonal events. To reinforce its emphasis
on providing value, the Company since fiscal 1993 has offered multiple lines of
high quality greeting cards, all at the everyday low price of 39 CENTS.
According to the PARTY AND PAPER SOURCEBOOK, an industry trade publication,
the United States market for party and special occasion merchandise, comprised
of party supplies, greeting cards, gift wrap and related items, has estimated
annual retail sales of approximately $8.8 billion. Historically, this market has
been served by traditional retail channels such as card shops, mass
merchandisers, discount retailers, drugstores and supermarkets, which generally
offer a limited selection of party supply and special occasion products.
Superstores have become the fastest growing retail format within this category.
The Company believes that, through the expansion of its superstore base, it is
well-positioned to capture an increasing share of this large and fragmented
market and to capitalize on the increasing amount of products available within
this industry.
The key elements of the Company's business strategy are outlined below:
EXTENSIVE MERCHANDISE OFFERING. The Company believes its everyday and
seasonal merchandise offering, which includes approximately 23,000 stock keeping
units ("SKUs") at its superstores, provides the solution, in a single
destination, for a customer's complete product needs to create, enhance and
celebrate special occasions. The Company offers a full line of party supplies in
a wide variety of festive and distinctive patterns, colors and styles, including
tableware, tablecovers, invitations, party favors, pinatas, banners and other
decor items. The Company also offers a broad selection of high quality greeting
cards for all occasions, consisting of approximately 4,000 everyday and seasonal
titles. The Company carries an extensive selection of gift wrap, including a
broad array of gift bags, gift boxes, ribbons, bows and related
3
<PAGE>
items in coordinated and complementary displays. In addition, the Company offers
many other special occasion items such as balloons, stationery, gifts, novelty
items and seasonal products.
EVERYDAY VALUE PRICING. The Company's strategy of everyday value pricing is
designed to provide customers with consistent value on all purchases. The
Company typically sells its merchandise at discounts of 20% to 60% off
manufacturers' suggested retail prices. In addition, the Company's superstores
feature a "power aisle" offering a wide selection of opportunistic buys and
manufacturers' seasonal over-runs, all priced at deep discounts and frequently
changed to create continued customer interest. To build customer traffic and
loyalty, the Company's high quality greeting cards are all sold for 39 CENTS
each.
ATTRACTIVE, SPACIOUS AND FESTIVE SUPERSTORE FORMAT. The Company creates an
attractive and festive atmosphere within a spacious "easy to shop" superstore,
encouraging browsing and repeat visits by customers. The Company's superstores
are designed to provide a comfortable shopping experience, with bright lighting,
wide carpeted aisles and fixtures that offer customers easy access to
merchandise. The interiors of the Company's superstores are festively decorated
with arrays of colorful merchandise to emphasize everyday and seasonal themes.
The size of the Company's superstore prototype enables the Company to offer an
extensive selection of merchandise and increase store-level efficiencies.
TARGETED ADVERTISING. In the spring of 1996, the Company broadened its
advertising program to include a Company-wide direct mail campaign designed to
educate targeted consumers about the breadth and value of the Company's product
offerings. The Company intends to support major holiday selling seasons with
direct mail marketing and to continue radio advertising in order to complement
its direct mail program and increase its name recognition within new and
existing markets.
DEVELOPMENT OF MANAGEMENT TEAM AND INFRASTRUCTURE. The Company has
recruited a management team whose members have an average of 21 years of retail
experience. The Company believes it benefits from operating its own distribution
facilities, which enable it to make opportunistic purchases, import products
directly and achieve operating efficiencies. In fiscal 1996, the Company
completed installation of a fully integrated retail management software package
that automated the areas of finance, merchandising and distribution and
successfully tested a point of sale ("POS") system that is expected to be
operational in all stores by the end of fiscal 1997.
The Company has developed a rapid expansion plan designed to build on its
position as the largest chain of company-owned superstores in the party supply
and special occasion industry. The Company plans to open 30 to 35 superstores in
fiscal 1997, including 15 opened through November 15, 1996, and at least 40
superstores in fiscal 1998. The Company plans to focus its expansion in existing
and contiguous markets. The Company may also consider acquisitions of other
retail chains in the industry.
The Company's executive offices are located at 745 Birginal Drive,
Bensenville, Illinois 60106-1212 and its telephone number is (630) 238-0010. The
Company was incorporated in 1989 in Delaware. As used in this Prospectus, the
"Company" and "Factory Card" refer to Factory Card Outlet Corp., a Delaware
corporation, as well as Factory Card Outlet of America Ltd., an Illinois
corporation, the Company's wholly-owned operating subsidiary.
THE OFFERING
<TABLE>
<S> <C> <C>
Common Stock offered by the Company..... 2,550,000 shares
Common Stock offered by the Selling
Stockholders.......................... 77,000 shares
Common Stock to be outstanding after the
offering.............................. 6,618,394 shares (1)
Use of proceeds......................... Repayment of debt. See "Use of Proceeds."
Nasdaq National Market Symbol........... FCPY
</TABLE>
- ------------------------
(1) Excludes (i) 1,064,641 shares issuable upon the exercise of outstanding
options under the Company's 1989 Stock Option Plan, with a weighted average
exercise price of $2.36, (ii) 195,594 shares issuable upon exercise of
outstanding warrants, with a nominal exercise price, and (iii) 191,601
shares reserved for future option grants under the Company's 1989 Stock
Option Plan. The options under the Company's 1989 Stock Option Plan vest
generally on an annual basis over three or four years and must be exercised
within ten years from the date of grant. The warrants described above are
immediately exercisable. See "Management--Incentive Stock Program--1989
Stock Option Plan."
4
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
<TABLE>
<CAPTION>
13 WEEKS ENDED
FISCAL YEAR --------------------------
----------------------------------------------------- SEPT. 30, SEPT. 28,
1992 1993 1994 1995 1996 1995 1996
--------- --------- --------- --------- --------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales......................... $17,330 $24,333 $37,341 $63,174 $94,589 $16,817 $25,032
Gross profit...................... 6,215 9,174 14,114 23,417 35,450 5,792 8,036
Net store contribution(1)......... 1,965 3,165 4,609 7,922 11,772 995 1,345
Income (loss) from
operations(2)................... 716 1,108 1,238 1,101 1,717 (1,808 ) (1,629 )
Interest expense.................. 340 311 497 411 1,529 190 597
Net income (loss)................. 368 865 449 368 70 (1,238 ) (1,291 )
Net income (loss) per common and
common equivalent share......... $ 0.11 $ 0.26 $ 0.13 $ 0.08 $ 0.01 $ (0.25 ) $ (0.26 )
Weighted average common and common
equivalent shares outstanding... 3,289 3,383 3,397 4,839 5,050 5,050 5,050
Supplementary net income (loss)
per common and common equivalent
share(3)........................ $ 0.14 $ (0.15 )
OPERATING DATA:
Number of stores:
Opened during period............ 5 11 15 25 32 10 5
Closed/relocated during
period........................ 1 2 0 2 3 0 0
Open at end of period........... 31 40 55 78 107 88 112
Average sales per selling square
foot(4)......................... $ 133 $ 130 $ 139 $ 146 $ 133 $ 28 $ 29
Comparable store sales
increase(5)..................... 22.2% 9.6% 12.3% 22.2% 6.0% 7.4% 14.1%
Average sales per store(4)........ $589,000 $645,000 $734,000 $941,000 $997,000 $204,000 $229,000
<CAPTION>
SEPT. 28, 1996
--------------------------
ACTUAL PRO FORMA(6)
----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital.......................................................................... $ 30,019 $ 32,835
Total assets............................................................................. 70,570 72,848
Total debt(7)............................................................................ 18,164 300
Total stockholders' equity............................................................... 26,033 46,174
</TABLE>
- ------------------------------
(1) Represents gross profit less store operating expenses, which include labor,
advertising, depreciation and other store expenses. This computation
excludes store preopening and general and administrative expenses.
(2) Income (loss) from operations for the 13 weeks ended September 28, 1996
includes nonrecurring compensation expense of approximately $146,000 related
to stock options granted to directors, one of whom is an employee.
(3) Assumes the line of credit, term loan and subordinated debentures have been
repaid in full as of the beginning of the period (if the balances of such
debt were higher later in the period, then the higher balances were assumed
to have been repaid) using proceeds from the sale of shares of Common Stock
in this offering.
(4) Includes only stores open during the entire period.
(5) Includes stores open 13 or 14 months after their opening date. If the
opening date of a store falls in the first 14 days of a period, it is
included in the comparable store calculation in its 13th month of operation;
otherwise, a store is included in the comparable store calculation in its
14th month of operation.
(6) Adjusted to reflect the sale by the Company of the 2,550,000 shares of
Common Stock offered hereby at an initial public offering price of $9.00 per
share and the application of the net proceeds therefrom. See "Use of
Proceeds."
(7) Total debt is defined as total current and long-term debt. See
"Capitalization."
5
<PAGE>
RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, THE
FOLLOWING FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING AN INVESTMENT IN
SHARES OF THE COMMON STOCK OFFERED BY THIS PROSPECTUS. THIS PROSPECTUS CONTAINS
CERTAIN FORWARD-LOOKING STATEMENTS WHICH INVOLVE RISKS AND UNCERTAINTIES. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN
SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH
A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE SET FORTH BELOW AND
ELSEWHERE IN THIS PROSPECTUS.
RISKS ASSOCIATED WITH EXPANSION. The Company's ability to increase its net
sales and earnings will depend in part on its ability to open new superstores
and to operate such superstores on a profitable basis. The Company's continued
growth will also depend on its ability to increase sales in its existing stores.
The Company opened 32 superstores (and relocated one store and closed two other
stores) in fiscal 1996 and presently anticipates opening 30 to 35 superstores
(and closing one store) in fiscal 1997 in both existing and new geographic
markets. The opening of additional stores in an existing market could result in
lower net sales from the Company's existing stores in that market. Opening
superstores in new geographic markets may present competitive and merchandising
challenges that are different from those currently faced by the Company in its
existing geographic markets. The Company may incur higher costs related to
advertising and distribution in connection with entering new markets. If the
Company opens superstores that do not perform to the Company's expectations or
if superstore openings are delayed, the Company's financial condition and
results of operations could be materially adversely affected. The success of the
Company's planned expansion will be dependent upon many factors, including the
identification of suitable markets, the availability and leasing of suitable
sites on acceptable terms, the availability of acceptable financing, the hiring,
training and retention of qualified management and other store personnel and
general economic conditions. In addition, the Company must ensure the continuing
adequacy of its existing systems and procedures, including its distribution
facilities, store management, financial controls and information systems, which
may place significant demands on the Company's management, resources, operations
and information systems. There can be no assurance that the Company will be
successful in any of these areas, and, as a result, there can be no assurance
that the Company will achieve its planned expansion, or that new superstores
will be effectively integrated into the Company's existing operations or be
profitable. See "Business--Growth Strategy."
QUARTERLY FLUCTUATIONS. Due to the importance of the spring selling season,
which includes Easter, graduation and Mother's Day, and the fall selling season,
which includes Halloween, Thanksgiving, Hanukkah, Kwanzaa and Christmas, the
second and fourth fiscal quarters have historically contributed, and the Company
expects they will continue to contribute, disproportionately to the Company's
profitability for the entire fiscal year. As a result, any factors negatively
affecting the Company during the second and fourth fiscal quarters of any year,
including adverse weather and unfavorable economic conditions, could have a
material adverse effect on the Company's financial condition and results of
operations for the entire year. The Company's quarterly results of operations
also may fluctuate based upon such factors as the timing of certain holiday
seasons, the number and timing of new superstore openings, the amount of store
preopening expenses, the amount of net sales contributed by new and existing
stores, the mix of products sold, the timing and level of markdowns, store
closings, refurbishments and relocations, competitive factors and weather and
general economic conditions. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Quarterly Results and
Seasonality."
DEPENDENCE ON KEY PERSONNEL; NEW MANAGEMENT TEAM; TURNOVER OF STORE
MANAGERS. The success of the Company and its growth strategy is dependent upon
the active involvement of senior management personnel, particularly William E.
Freeman, Chairman of the Board of Directors of the Company, and Charles R.
Cumello, the President of the Company. The loss of the services of any of these
persons could have a material adverse effect on the Company. The Company
maintains key-person life insurance on Mr. Cumello. Many of the individuals in
key management positions, including Mr. Cumello, joined the
6
<PAGE>
Company during the past 18 months. Certain members of the management team have
been with the Company for six months or less. Accordingly, there can be no
assurance that these individuals will function effectively together as a
management team, and the failure of these individuals to so function effectively
could have a material adverse effect on the Company's results of operations and
its financial condition. From May to August 1996, the Company experienced an
unusually high rate of turnover of its store managers. A continued high rate of
turnover among the Company's store managers could significantly increase the
cost of the Company's recruiting and training efforts and may result in a
material adverse effect on the Company's results of operations and its financial
condition. The Company's success in the future will be dependent upon its
ability to attract and retain quality personnel, including store managers. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Management."
COMPETITION. The party supplies and greeting cards retailing business is
highly competitive. The Company currently competes against a diverse group of
retailers, ranging from other party supply and greeting card retailers
(including Party City Corporation) to designated departments in drug stores,
general mass merchandisers, supermarkets and department stores of local,
regional and national chains. In addition, a trend toward discounting party
supplies and greeting cards is developing and the Company may encounter
additional competition from new entrants in the future. Some of the Company's
competitors have substantially greater financial resources and experience than
the Company. See "Business-- Competition."
RISKS ASSOCIATED WITH ACQUISITIONS. The Company will consider strategic
acquisitions of other retail chains in the party supply and special occasion
industry. The Company has no experience in acquiring other businesses and there
can be no assurance that suitable acquisition candidates will be identified,
that acquisitions can be consummated or that new stores acquired through such
acquisitions can be operated profitably or integrated successfully into the
Company's operations. Further, growth through acquisition entails certain risks
in that the acquired stores could be subject to unanticipated business
uncertainties or legal liabilities. The Company intends to minimize these risks
through an appropriate due diligence process. Nevertheless, there can be no
assurance that such liabilities will not have a material adverse effect on the
Company.
RISKS ASSOCIATED WITH MERCHANDISING. The Company's success depends, in
part, on its ability to anticipate and respond, in a timely manner, to changing
merchandise trends and consumer demands. Accordingly, any delay or failure by
the Company in identifying and responding to emerging trends could adversely
affect consumer acceptance of the merchandise in the Company's stores. In
addition, the Company makes decisions regarding merchandise well in advance of
each of the seasons in which such merchandise will be sold. Significant
deviations from projected demand for products could have a material adverse
effect on the Company's financial condition and results of operations, either
from lost sales due to insufficient inventory or lost margin due to the need to
mark down excess inventory. See "Business-- Merchandising."
RISKS ASSOCIATED WITH PRODUCT SOURCING. The Company purchases its
merchandise from more than 300 suppliers. No supplier represents more than 14%
of the Company's purchases and ten suppliers account for approximately 46% of
the Company's purchases. The Company purchases its greeting cards from
approximately ten publishers, all but one of which are located in the United
States. The Company recently entered into a supply agreement (the "Fine Art
Agreement") expiring on December 1, 1998 (with automatic one-year renewals
unless the parties are unable to agree on price or certain other terms) with
Fine Art Developments, p.l.c., a publicly-owned United Kingdom company and a
stockholder of the Company ("Fine Art"). The Fine Art Agreement requires that
the Company purchase a minimum of 42% of its greeting card purchases from Fine
Art each year. During fiscal 1995 and 1996, the Company purchased 64% and 52%,
respectively, of its aggregate greeting card purchases from Fine Art. The
Company's future success is dependent upon its ability to maintain good
relationships with its principal
7
<PAGE>
suppliers, including Fine Art. There can be no assurance that the Company will
in the future be able to negotiate successfully extensions of the Fine Art
Agreement or maintain good relationships with its other suppliers. The failure
by the Company to extend the term of the Fine Art Agreement beyond December 1,
1998 or maintain good relationships with its other principal suppliers could
have a material adverse effect on the Company's financial condition and results
of operations. See "Business--Product Sourcing and Distribution."
MANAGEMENT INFORMATION SYSTEMS. In late fiscal 1996, the Company completed
the testing phase and began the implementation of its point of sale ("POS")
system. Each store operating on the Company's POS system transmits daily SKU
level sales to the corporate office. Management believes that the POS system
will result in improvements in central office operations, particulary in the
areas of merchandise planning and automated replenishment, inventory control and
performance measurement. In fiscal 1996, the Company completed installation of a
fully integrated retail management software package that automated the areas of
finance, marketing and distribution and successfully implemented a POS system
that is expected to be operational in all of the Company's stores by the end of
fiscal 1997. The implementation of the POS system is dependent on various
factors, including acceptance by store personnel and technological
contingencies, and there can be no assurance that the POS system will be
implemented effectively on a Company-wide basis by the end of fiscal 1997, if at
all. The failure to complete, or delays or problems in completing, the
implementation of the POS system could have a material adverse effect on the
Company's financial condition and results of operations. See "Business-- The
Company--Development of Management Team and Infrastructure" and
"Business--Management Information Systems."
CONSOLIDATION AND EXPANSION OF DISTRIBUTION FACILITIES. The Company has
determined that larger distribution facilities will be required by the end of
fiscal 1998 in order to serve efficiently all of its superstores planned to be
in operation at that time. Consequently, the Company has entered into a lease
for a new and larger distribution center near its current Bensenville, Illinois
location, into which the Company plans to consolidate its two existing
distribution facilities by April 1998. Upon completion of such proposed
consolidation and relocation, the Company's distribution functions for all of
its existing and currently proposed new stores will be handled from a single
location. There can be no assurance that the Company will be able to integrate
successfully a new distribution center into the Company's operations. The
failure to do so, or any significant delays in the consolidation and relocation
of the Company's distribution facilities, or interruption in the operation of
the new facility during or after consolidation, would have a material adverse
effect on the Company's financial condition and results of operations. See
"Business--Product Sourcing and Distribution" and "Business--Properties."
INVENTORY SHRINKAGE. The Company experienced a high level of inventory
shrinkage in fiscal 1995 (6.9% at retail value compared to 1.7% at retail value
in fiscal 1994), resulting from a lack of consistent store-level compliance with
price markdown and receiving procedures at certain stores, and the lack of a
loss prevention department. The Company implemented measures to address this
problem and inventory shrinkage in fiscal 1996 returned to historic levels.
However, there can be no assurance that the Company will not experience higher
shrinkage in the future, which would have a corresponding material adverse
effect on the Company's financial condition and results of operations. In
addition, in accordance with generally accepted accounting principles, quarterly
results are based on an accrual for estimated shrinkage and, therefore, fourth
quarter results may be subject to adjustment based on actual physical
inventories. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
FUTURE CAPITAL NEEDS. The Company currently intends to finance new
superstores with cash from operations and borrowings under its Line of Credit
(see "Use of Proceeds" for the definition of "Line of Credit"). The Company
plans to open 30 to 35 superstores in fiscal 1997, including 15 opened through
November 15, 1996, and at least 40 superstores in fiscal 1998. The Company
expects that the average cash investment required to open one of the Company's
prototype superstores will be approximately $413,000.
8
<PAGE>
There can be no assurance that the actual cost of opening the Company's
prototype superstores will not be significantly greater than that expected by
the Company. The Company may be required to seek additional debt and/or equity
financing in order to fund its continued expansion, which may include
acquisitions. There can be no assurance that such additional financing will be
available on terms acceptable to the Company, if at all. In addition, the
Company's ability to incur additional indebtedness or issue equity or debt
securities could be limited by covenants in present and future loan agreements
and debt instruments. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
GOVERNMENT REGULATION. Each of the Company's stores must comply with
regulations adopted by federal agencies and with licensing and other regulations
enforced by state and local health, sanitation, safety, fire and other
departments. More stringent and varied requirements of local governmental bodies
with respect to zoning, land use and environmental factors, and difficulties or
failures in obtaining the required licenses or approvals, can delay and
sometimes prevent, the opening of a new store. In addition, the Company must
comply with the federal Fair Labor Standards Act of 1938, as amended (the "Fair
Labor Standards Act") and various state laws governing various matters such as
the minimum wage, overtime and other working conditions. The Company also must
comply with the federal Americans with Disabilities Act of 1990, as amended (the
"ADA"), which generally requires that employers provide reasonable accommodation
for employees with disabilities and that stores be accessible to customers with
disabilities. Material increases in the cost of compliance with any applicable
law or regulation and similar matters could have a material adverse effect on
the Company's financial condition and results of operations. See
"Business--Government Regulation."
CONTROL BY CERTAIN EXISTING STOCKHOLDERS. Upon completion of the offering,
the Company's current stockholders will own or have the right to vote and
control the disposition of approximately 60.3% of the Company's outstanding
shares of Common Stock. As a result, those stockholders, if acting together,
will have the ability to elect the Company's directors and to determine the
outcome of corporate actions requiring stockholder approval, irrespective of the
vote of other stockholders of the Company. See "Principal and Selling
Stockholders."
NO PRIOR PUBLIC TRADING MARKET; VOLATILITY. Prior to this offering, there
has been no public market for the Common Stock, and there can be no assurance
that an active public market for the Common Stock will develop or be sustained
after the offering. The initial public offering price of the Common Stock will
be determined by negotiations between the Company and the representatives of the
Underwriters. The initial public offering price may not necessarily be
indicative of the market price of the Common Stock after the offering, which may
be highly volatile. Factors including, without limitation, announcements of
fluctuations in the Company's or its competitors' operating results, and market
conditions for retail industry stocks in general, could have a significant
impact on the future price of the Common Stock. See "Underwriting."
DILUTION. Investors purchasing shares of Common Stock in this offering will
incur immediate and substantial dilution in the net tangible book value per
share of the Common Stock from the initial public offering price as compared to
the increase in net tangible book value per share that will accrue to existing
stockholders of the Company. See "Dilution."
EFFECT OF CERTAIN CHARTER AND BY-LAW PROVISIONS; ANTI-TAKEOVER
MATTERS. Certain provisions of the Amended and Restated Certificate of
Incorporation (the "Restated Certificate of Incorporation") and the Amended and
Restated By-Laws (the "By-Laws") of the Company, as well as Delaware corporate
law, may delay, defer or prevent a tender offer or takeover attempt that a
stockholder of the Company might consider in the best interest of such
stockholder, including an attempt that might result in the receipt of a premium
over the then-current market price for the Common Stock. Certain of these
provisions allow the Company to issue, without stockholder approval, preferred
stock, par value $0.01 per share (the "Preferred Stock"), of which 10.0 million
shares have been authorized, having rights senior to those of the Common Stock.
Other provisions impose various procedural and other requirements that could
make it more
9
<PAGE>
difficult for stockholders to effect corporate actions. In addition, the Company
is subject to Section 203 of the Delaware General Corporation Law (the "DGCL")
which under certain circumstances can make it more difficult for a third party
to gain control of the Company without the approval of the Board of Directors.
See "Description of Capital Stock."
SHARES ELIGIBLE FOR FUTURE SALE. The Company and each of its directors,
executive officers and consultants and certain stockholders have agreed with the
Underwriters not to offer, sell, contract to sell or otherwise dispose of any
shares of Common Stock for a period of 180 days after the date of this
Prospectus (the "Lock-Up Period"), without the prior written consent of Alex.
Brown & Sons Incorporated. Holders of warrants and options to purchase an
aggregate of 998,794 shares of Common Stock have also agreed to enter into a
similar arrangement. Following this offering, the Company will have outstanding
6,618,394 shares of Common Stock. Of such shares, the 2,627,000 shares of Common
Stock offered hereby will be freely tradable by persons who are not affiliates
of the Company and 3,828,234 shares of Common Stock will be subject to 180-day
lock-up agreements with the Underwriters. Following the expiration of the Lock-
Up Period, such 3,828,234 shares may be sold pursuant to a registration
statement or an exemption from registration, including under Rule 144 under the
Securities Act of 1933, as amended (the "Securities Act"). The Company, its
stockholders and holders of warrants to purchase Common Stock (the "Registration
Rights Holders") have entered into registration rights agreements under which
each of the Registration Rights Holders has certain rights to have the shares of
Common Stock owned by such Registration Rights Holder (or the shares of Common
Stock into which such warrant is exercisable, as the case may be) registered by
the Company under the Securities Act in order to permit the public sale of such
shares. Sales of substantial amounts of Common Stock in the public market
following the offering, or the perception that such sales could occur, could
have a material adverse effect on the price of the Common Stock. See
"Description of Capital Stock" and "Shares Eligible for Future Sale."
10
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 2,550,000 shares of
Common Stock offered hereby by the Company are estimated to be $20.5 million,
after deduction of the underwriting discounts and commissions and estimated
expenses payable by the Company. The Company intends to use approximately $20.5
million of the net proceeds from this offering to repay approximately $12.5
million of outstanding indebtedness under the Business Loan Agreement between
the Company and Bank One, Chicago, NA ("Bank One"), dated as of November 1, 1996
(the "Business Loan Agreement"), and $8.0 million outstanding under its secured
subordinated debentures (collectively the "Subordinated Debentures"). Pending
such use by the Company, the net proceeds of this offering will be invested in
short-term investment grade, interest bearing instruments. The Company will not
receive any proceeds from the sale of Common Stock by the Selling Stockholders.
The Business Loan Agreement provides for a term loan (the "Term Loan") in
the principal amount of up to $1.5 million and a revolving line of credit (the
"Line of Credit") not to exceed the lesser of $25.0 million or 50% of
merchandise inventories. The Term Loan, which matures on June 30, 1998, bears
interest at the rate of 8.08% per annum. The Line of Credit, which expires on
October 1, 1998, bears interest at Bank One's prime rate or, at the Company's
option, 2.75% over the London Interbank Offered Rate ("LIBOR"). The Subordinated
Debentures may be prepaid at any time, with $4.0 million maturing in November
2000, $1.0 million maturing in June 2001 and $3.0 million maturing in July 2001.
The Subordinated Debentures bear interest at the rate of 12.5% per annum, $7.0
million of which has interest that is currently payable at a rate of 7.5%, with
the remaining 5.0% interest accruing until February 1, 1997 and May 1, 1997, on
$3.0 million and $4.0 million, respectively.
DIVIDEND POLICY
The Company has never paid cash dividends on its capital stock and does not
intend to pay cash dividends for the foreseeable future. The Company expects
that earnings will be retained for the continued growth and development of the
Company's business. In addition, the Business Loan Agreement restricts the
ability of the Company to pay cash dividends on its capital stock.
11
<PAGE>
CAPITALIZATION
The following table sets forth, as of September 28, 1996, (i) the pro forma
capitalization of the Company to reflect the conversion of the Convertible
Preferred Stock and (ii) the pro forma capitalization of the Company further
adjusted to reflect the sale of 2,550,000 shares of Common Stock offered by the
Company hereby at an initial public offering price of $9.00 per share and the
application of the net proceeds therefrom.
<TABLE>
<CAPTION>
SEPTEMBER 28, 1996
------------------------
<S> <C> <C>
PRO FORMA
PRO FORMA AS ADJUSTED
----------- -----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
Current debt......................................................................... $ 702 $ 133
----------- -----------
----------- -----------
Long-term debt, less current portion:
Line of credit..................................................................... 9,200 --
Subordinated debt, net of discount................................................. 7,567 --
Term loan.......................................................................... 477 --
Capital lease obligation and notes payable......................................... 218 167
----------- -----------
Total long-term debt, less current portion....................................... 17,462 167
----------- -----------
Stockholders' equity:
Preferred Stock, par value $0.01 per share, 10,000,000 shares authorized; no shares
issued and outstanding...........................................................
Common Stock, par value $0.01 per share(1), 50,000,000 shares authorized; 4,068,394
shares issued and outstanding pro forma; 6,618,394 shares issued and outstanding
pro forma as adjusted............................................................ 41 66
Additional paid-in capital......................................................... 27,666 48,185
Accumulated deficit................................................................ (1,674) (2,077)(2)
----------- -----------
Total stockholders' equity....................................................... 26,033 46,174
----------- -----------
Total capitalization........................................................... $ 43,495 $ 46,341
----------- -----------
----------- -----------
</TABLE>
- ------------------------
(1) Assumes redesignation of the Common Stock from no par value per share to
$0.01 par value per share in connection with this offering.
(2) Includes $403,087 (net of income taxes) for the write-off of deferred
financing costs and unamortized discounts related to the Subordinated
Debentures.
12
<PAGE>
DILUTION
The net tangible book value of the Company's Common Stock as of September
28, 1996 was $26,033,000 or approximately $6.40 per share. Net tangible book
value per share represents the amount of the Company's stockholders' equity,
less intangible assets, divided by 4,068,394 shares of Common Stock outstanding
as of the date of this Prospectus.
Net tangible book value dilution per share represents the difference between
the amount per share paid by purchasers of shares of Common Stock in this
offering and the pro forma net tangible book value per share of Common Stock
immediately after completion of this offering. After giving effect to the sale
of 2,550,000 shares of Common Stock in this offering at an offering price of
$9.00 per share and the application of the estimated net proceeds therefrom, the
pro forma net tangible book value of the Company as of September 28, 1996 would
have been $46,174,000 or $6.98 per share. This represents an immediate increase
in net tangible book value of $0.58 per share to existing stockholders and an
immediate dilution in net tangible book value of $2.02 per share to purchasers
of Common Stock in this offering, as illustrated in the following table:
<TABLE>
<S> <C> <C>
Initial public offering price per share................................................. $ 9.00
Net tangible book value per share at September 28, 1996, as adjusted....... $ 6.40
Increase per share attributable to new investors........................... 0.58
Pro forma net tangible book value per share after the offering.......................... 6.98
---------
Dilution per share to new investors..................................................... $ 2.02
---------
---------
</TABLE>
The following table sets forth as of September 28, 1996 the difference
between the existing stockholders and the purchasers of shares of Common Stock
in this offering (at an offering price of $9.00 per share) with respect to the
number of shares purchased from the Company, the total consideration paid and
the average price per share paid:
<TABLE>
<CAPTION>
SHARES OWNED TOTAL CONSIDERATION
----------------------- -------------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders............................... 4,068,394 61.5% $ 26,631,349 53.7% $ 6.55
New investors....................................... 2,550,000 38.5 22,950,000 46.3 9.00
---------- ----- ------------- -----
Total........................................... 6,618,394 100.0% $ 49,581,349 100.0%
---------- ----- ------------- -----
---------- ----- ------------- -----
</TABLE>
The foregoing assumes no exercise of the Underwriters' over-allotment option
or stock options or warrants outstanding as of September 28, 1996. As of
September 28, 1996, there were 1,064,641 shares of Common Stock issuable upon
exercise of outstanding stock options under the Company's 1989 Stock Option Plan
at a weighted average exercise price of $2.36 per share and 195,594 shares
issuable upon the exercise of outstanding warrants, at a nominal exercise price.
If all of the shares available for issuance upon exercise of outstanding options
and warrants were issued at September 28, 1996, dilution per share to new
investors would have been $2.82 per share. See "Management--Incentive Stock
Program" and Note (7) to Consolidated Financial Statements.
13
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
The selected consolidated financial and operating data presented below under
the captions "Statement of Operations Data" and "Balance Sheet Data" for, and as
of the end of, each of the years in the five-year period ended June 29, 1996 are
derived from consolidated financial statements of the Company, which financial
statements have been audited by KPMG Peat Marwick LLP, independent certified
public accountants. The consolidated financial statements as of July 1, 1995 and
June 29, 1996, and for each of the years in the three-year period ended June 29,
1996, and the report thereon, are included elsewhere in this Prospectus. The
consolidated financial data for the 13 week periods ended September 30, 1995 and
September 28, 1996 are derived from unaudited consolidated financial statements
of the Company and reflect all adjustments that the Company considers necessary
for a fair presentation of the consolidated financial position and consolidated
results of operations for these periods. The information set forth below should
be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Company's consolidated financial
statements and the notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
FISCAL YEAR
---------------------------------------------------------------------
1992 1993 1994 1995 1996
------------ ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales.............................................. $17,330 $24,333 $37,341 $63,174 $94,589
Cost of sales and occupancy.......................... 11,115 15,159 23,227 39,757 59,139
------------ ------------ ------------ ------------ -------------
Gross profit........................................... 6,215 9,174 14,114 23,417 35,450
Selling, general and administrative expenses........... 5,499 8,066 12,876 22,316 33,733
------------ ------------ ------------ ------------ -------------
Income (loss) from operations........................ 716 1,108 1,238 1,101 1,717
Interest expense....................................... 340 311 497 411 1,529
------------ ------------ ------------ ------------ -------------
Income (loss) before taxes........................... 376 797 741 690 188
Income tax (benefit)................................... 8 (68) 292 322 118
------------ ------------ ------------ ------------ -------------
Net income (loss).................................... $ 368 $ 865 $ 449 $ 368 $ 70
------------ ------------ ------------ ------------ -------------
------------ ------------ ------------ ------------ -------------
Net income (loss) per common
and common equivalent share.......................... $ 0.11 $ 0.26 $ 0.13 $ 0.08 $ 0.01
------------ ------------ ------------ ------------ -------------
------------ ------------ ------------ ------------ -------------
Weighted average common and common equivalent shares
outstanding.......................................... 3,289 3,383 3,397 4,839 5,050
------------ ------------ ------------ ------------ -------------
------------ ------------ ------------ ------------ -------------
Supplementary net income (loss) per common and common
equivalent share(2).................................. $0.14
-------------
-------------
OPERATING DATA:
Number of stores:
Opened during period................................. 5 11 15 25 32
Closed/relocated during period....................... 1 2 0 2 3
Open at end of period................................ 31 40 55 78 107
Average sales per selling square foot(3)............... $ 133 $ 130 $ 139 $ 146 $ 133
Comparable store sales increase(4)..................... 22.2% 9.6% 12.3% 22.2% 6.0%
Net store contribution(5).............................. $ 1,965,000 $ 3,165,000 $ 4,609,000 $ 7,922,000 $ 11,772,000
Average sales per store(3)............................. $ 589,000 $ 645,000 $ 734,000 $ 941,000 $ 997,000
BALANCE SHEET DATA (AT END OF PERIOD):
Working capital........................................ $ 2,399 $ 2,479 $ 6,704 $ 15,625 $ 23,605
Total assets........................................... 9,239 15,029 21,888 36,801 59,080
Total debt(6).......................................... 3,145 3,587 7,251 7,161 19,326
Total stockholders' equity............................. 2,942 3,807 4,257 16,640 17,124
<CAPTION>
13 WEEKS ENDED
------------------------
SEPT. 30, SEPT. 28,
1995 1996
---------- ------------
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales.............................................. $16,817 $25,032
Cost of sales and occupancy.......................... 11,025 16,996
---------- ------------
Gross profit........................................... 5,792 8,036
Selling, general and administrative expenses........... 7,600 9,665(1)
---------- ------------
Income (loss) from operations........................ (1,808) (1,629)
Interest expense....................................... 190 597
---------- ------------
Income (loss) before taxes........................... (1,998) (2,226)
Income tax (benefit)................................... (760) (935)
---------- ------------
Net income (loss).................................... $(1,238) $(1,291)
---------- ------------
---------- ------------
Net income (loss) per common
and common equivalent share.......................... $ (0.25) $ (0.26)
---------- ------------
---------- ------------
Weighted average common and common equivalent shares
outstanding.......................................... 5,050 5,050
---------- ------------
---------- ------------
Supplementary net income (loss) per common and common
equivalent share(2).................................. $(0.15)
------------
------------
OPERATING DATA:
Number of stores:
Opened during period................................. 10 5
Closed/relocated during period....................... 0 0
Open at end of period................................ 88 112
Average sales per selling square foot(3)............... $ 28 $ 29
Comparable store sales increase(4)..................... 7.4% 14.1%
Net store contribution(5).............................. $ 995,000 $1,345,000
Average sales per store(3)............................. $ 204,000 $ 229,000
BALANCE SHEET DATA (AT END OF PERIOD):
Working capital........................................ $ 16,203 $ 30,019
Total assets........................................... 44,431 70,570
Total debt(6).......................................... 10,334 18,164
Total stockholders' equity............................. 15,402 26,033
</TABLE>
- ------------------------
(1) Selling, general and administrative expenses for the 13 weeks ended
September 28, 1996 includes nonrecurring compensation expense of
approximately $146,000 related to stock options granted to directors, one of
whom is an employee.
(2) Assumes the line of credit, term loan and subordinated debentures have been
repaid in full as of the beginning of the period (if the balances of such
debt were higher later in the period, then the higher balances were assumed
to have been repaid) using proceeds from the sale of shares of Common Stock
in this offering.
(3) Includes only stores open during the entire period.
(4) Includes stores open 13 or 14 months after their opening date. If the
opening date of a store falls in the first 14 days of a period, then it will
be included in the comparable store calculation in its 13th month of
operation; otherwise, a store is included in the comparable store
calculation in its 14th month of operation.
(5) Represents gross profit less store operating expenses, which include labor,
advertising, depreciation and other store expenses. This computation
excludes store preopening and general and administrative expenses.
(6) Total debt is defined as total current and long-term debt. See
"Capitalization."
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS CONTAINS CERTAIN FORWARD-LOOKING
STATEMENTS. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE REFERRED TO IN THE
FORWARD-LOOKING STATEMENTS DUE TO A NUMBER OF FACTORS, INCLUDING THOSE SET FORTH
BELOW AND ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
Factory Card is a rapidly growing chain of company-owned superstores
offering a vast assortment of party supplies, greeting cards, gift wrap and
other special occasion merchandise at everyday value prices. The Company's first
store was opened in 1985 in the Chicago area by its prior owner, Viking
Enterprises, Inc. ("Viking"), as a showroom for greeting cards produced by
Viking's subsidiary, Gallant Greetings Corporation ("Gallant"). Mr. J. Bayard
Kelly, a current Director of the Company and President of the Company's
operating subsidiary until September 1995, served as President of Gallant until
1989, when the Company's current Chairman of the Board of Directors, Mr. William
E. Freeman, formed and led an investor group in the acquisition of the Company
from Viking. The Company, under Mr. Kelly's direction, had grown by 1989 to a
chain of ten stores in the greater Chicago area offering a broad assortment of
greeting cards at 50% off manufacturers' suggested retail prices, as well as a
limited selection of party supplies, gift wrap and other special occasion
products at discounted prices, in stores averaging approximately 5,000 square
feet. While serving as the President of the Company from 1989 to 1994, and later
as its Chief Executive Officer from 1994 to September 1996, Mr. Freeman, along
with Mr. Kelly, led the Company through a strategic phase of its development.
Between fiscal years 1990 and 1993, the Company increased its store
prototype to 6,000 to 8,000 square feet, began to broaden its merchandise
offering to include a wider selection of party supplies, gift wrap and other
special occasion products and implemented its current 39 CENTS everyday price
for all greeting cards. During fiscal 1994, the Company began to implement a
strategic plan to build upon its position as the largest chain of company-owned
superstores in the industry. The key components of the plan included: (i) the
recruitment of a team of senior retail executives to effect a management
transition from the Company's founder; (ii) the enlargement of its merchandise
offering to include a wider selection of party supplies, gift wrap and other
special occasion products; (iii) the expansion of the size of the Company's
superstore prototype to 10,000 to 12,000 square feet; and (iv) the development
of systems and infrastructure to support the Company's growth strategy.
In April 1995, the Company hired as its President Mr. Charles R. Cumello, a
senior retail executive with over 26 years of experience and the Chief Executive
Officer of Waldenbooks since 1991. Since that time, Mr. Cumello has led the
recruitment of key senior management personnel in the areas of merchandising,
store operations, marketing, finance, real estate, distribution, human resources
and loss prevention, many of whom have experience in rapidly growing retail
companies. Since his hiring, Mr. Cumello has also led an expansion of the
Company's merchandise offering and significant enhancements to the Company's
systems and corporate infrastructure.
In fiscal 1996, the Company completed installation of a fully integrated
retail management software package which automated the areas of finance,
merchandising and distribution. The Company is currently implementing a POS
system which was successfully tested in late fiscal 1996 and is expected to be
implemented in all stores by the end of fiscal 1997. The Company has entered
into a lease for an approximately 440,000 square foot distribution center and
home office facility, which the Company expects to occupy by April 1998. This
new facility will allow the Company to consolidate its two existing distribution
centers into a single, larger facility, which will substantially increase the
Company's distribution capacity and result in greater operating efficiencies.
See "Business--Product Sourcing and Distribution" and "Business--Properties."
15
<PAGE>
The Company increased the number of superstores opened in each of the last
three fiscal years and plans to open 30 to 35 superstores in fiscal 1997,
including 15 opened through November 15, 1996, and at least 40 superstores in
fiscal 1998. The Company has 13 signed store leases and has capital leases
related to POS equipment for future store openings as of November 15, 1996. The
Company will focus its expansion on the opening of prototype superstores. The
Company intends to continue its strategy of opening Company-owned superstores
and does not anticipate opening any franchised units.
Since fiscal 1993, the Company has experienced declining net income. In
fiscal 1994, 1995 and 1996, general and administrative expenses increased
related to the hiring of management personnel and to enhancements to corporate
infrastructure and systems. Due to the new store expansion strategy, aggregate
new store preopening costs also increased each year, although such costs on a
per-store basis declined from fiscal 1995 to fiscal 1996. In fiscal 1995, the
Company experienced a high level of inventory shrinkage compared to prior years,
resulting from a lack of consistent store-level compliance with price markdown
and receiving procedures at certain stores, and the lack of a loss prevention
department. During fiscal 1996, inventory shrinkage returned to near historical
levels as store compliance with markdown procedures improved and a loss
prevention department was established. Finally, interest expense increased in
fiscal 1996 in connection with the incurrence of debt to fund new superstores.
The Company's objective is to increase operating leverage through the continued
expansion and maturation of its superstore base (62 superstores were less than
two years old as of November 15, 1996).
The Company's 46 superstores open for all of fiscal 1996 averaged net sales
of $1,082,000 and store-level contribution (before pre-opening expenses,
depreciation and amortization and allocated corporate overhead and interest, but
including advertising) of $151,000, or 14.0% of net sales. The Company expects
that its new superstores will require a cash investment of approximately
$413,000, including $63,000 in preopening expenses (consisting of $38,000
primarily for labor and $25,000 for preopening advertising expenses), $175,000
in leasehold improvements and equipment (including implementation of the POS
system) and $175,000 in inventory net of payables.
The Company intends to use approximately $8.0 million of net proceeds from
this offering to repay the Subordinated Debentures. In connection with such
repayment, deferred financing costs and discounts related to the Subordinated
Debentures will be written off, resulting in an expected extraordinary charge to
net income of approximately $313,000 in the second fiscal quarter of fiscal
1997.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, selected
statement of operations data expressed as a percentage of net sales and the
number of stores open at the end of each such period:
<TABLE>
<CAPTION>
FISCAL YEAR 13 WEEKS ENDED
------------------------------- ------------------------
<S> <C> <C> <C> <C> <C>
SEPT. 30, SEPT. 28,
1994 1995 1996 1995 1996
--------- --------- --------- ----------- -----------
Net sales............................................................. 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales and occupancy........................................... 62.2 62.9 62.5 65.6 67.9
--------- --------- --------- ----- -----
Gross profit........................................................ 37.8 37.1 37.5 34.4 32.1
Selling, general and administrative expenses.......................... 34.5 35.3 35.7 45.2 38.6
--------- --------- --------- ----- -----
Income (loss) from operations....................................... 3.3 1.8 1.8 (10.8) (6.5)
Interest expense...................................................... 1.3 0.7 1.6 1.1 2.4
--------- --------- --------- ----- -----
Income (loss) before taxes.......................................... 2.0 1.1 0.2 (11.9) (8.9)
Income tax (benefit).................................................. 0.8 0.6 0.1 (4.5) (3.7)
--------- --------- --------- ----- -----
Net income (loss)................................................... 1.2% 0.5% 0.1% (7.4)% (5.2 )%
--------- --------- --------- ----- -----
--------- --------- --------- ----- -----
Number of stores open at end of period................................ 55 78 107 88 112
</TABLE>
16
<PAGE>
THIRTEEN WEEKS ENDED SEPTEMBER 28, 1996 COMPARED TO THIRTEEN WEEKS ENDED
SEPTEMBER 30, 1995
NET SALES. Net sales increased $8.2 million, or 48.8%, to $25.0 million for
the 13-week period ended September 28, 1996 from $16.8 million for the 13-week
period ended September 30, 1995. The increase resulted from (i) net sales of
approximately $547,000 from five new stores opened during the 13-week period,
(ii) net sales of $5.5 million from stores opened prior to fiscal 1997 not
included in the comparable store base and (iii) a comparable store sales
increase of $2.2 million, or 14.1%. The Company includes stores opened 13 or 14
months after their opening date in the calculation of comparable sales. If the
opening date of a store falls in the first 14 days of a period, the store is
included in the comparable store calculation on its 13th month of operation;
otherwise, a store is included in the comparable store calculation in its 14th
month of operation.
GROSS PROFIT. Cost of sales and occupancy includes merchandise, store
occupancy, purchasing and distribution costs. Gross profit increased $2.2
million, or 37.9%, to $8.0 million for the 13-week period ended September 28,
1996 from $5.8 million for the 13-week period ended September 30, 1995,
primarily as a result of operating 24 more stores. As a percentage of net sales,
gross profit was 32.1% for the 13-week period ended September 28, 1996 compared
to 34.4% for the same period in the prior year. Gross profit as a percentage of
net sales decreased resulting from a reduction in inventory overhead costs that
were capitalized (115 basis points) and a higher shrinkage allowance (82 basis
points at cost) compared to actual fiscal 1996 results. The 1997 shrinkage
allowance approximates the average shrinkage results experienced by the Company
over the last three years. In addition, gross profit as a percentage of net
sales decreased as a result of higher distribution costs (52 basis points)
resulting from the operation of a second distribution facility for the entire
13-week period ended September 28, 1996, compared to approximately six weeks
during the same period last year.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses include labor, advertising, depreciation and other store
operating and corporate administrative expenses. Selling, general and
administrative expenses increased $2.1 million, or 27.2%, to 9.7 million for the
13-week period ended September 28, 1996 from $7.6 million for the 13-week period
ended September 30, 1995. Approximately $1.4 million of this increase resulted
from the operation of 24 additional new superstores. The remainder of the
increase in selling, general and administrative expenses resulted from higher
salaries and benefits for additional corporate management and administrative
personnel, including approximately $146,000 from nonrecurring compensation
expense. Compensation expense of approximately $15,000 will be recognized each
quarter until certain options granted under the 1989 Stock Option Plan fully
vest in August 2000. As a percentage of net sales, selling, general and
administrative expenses decreased to 38.6% in the 13-weeks ended September 28,
1996 from 45.2% in the 13 weeks ended September 30, 1995, primarily due to the
leveraging of store and other general and administrative expenses against the
increase in comparable store sales.
INTEREST EXPENSE. Interest expense was approximately $597,000 in the 13
weeks ended September 28, 1996 compared to approximately $190,000 in the first
13 weeks ended September 30, 1995. This increase resulted from increased
borrowings related to the opening of new superstores.
INCOME TAX BENEFIT. The income tax benefit recognized for the 13-week
period ended September 28, 1996 was approximately $175,000 higher than the
benefit recognized during the 13-week period ended September 30, 1995 due to a
higher net loss for the period and a higher effective tax rate estimated at 42%
for the 1997 fiscal year.
FISCAL YEAR 1996 COMPARED TO FISCAL YEAR 1995
NET SALES. Net sales increased $31.4 million, or 49.7%, to $94.6 million in
fiscal 1996 from $63.2 million in fiscal 1995. The increase resulted from (i)
net sales of $18.1 million from 32 new stores opened during the year, (ii) net
sales of $9.9 million from stores opened prior to fiscal 1996 not included in
the
17
<PAGE>
comparable store base, and (iii) a comparable store sales increase of $3.4
million, or 6.0%. Fiscal 1996 was the first year since fiscal 1993 that the
Company did not achieve double-digit comparable store sales growth. This
resulted from lower inventory levels in stores during much of the first nine
months of the fiscal year due to management transitions in the merchandising
area and late receipt of merchandise related to the Company's expansion of its
product offering during the third quarter.
GROSS PROFIT. Gross profit increased $12.0 million, or 51.3%, to $35.4
million in fiscal 1996 from $23.4 million in fiscal 1995. As a percentage of net
sales, gross profit was 37.5% in fiscal 1996 compared to 37.1% in fiscal 1995.
Gross profit as a percentage of net sales increased due to higher inventory
overhead costs that were capitalized (76 basis points) and due to a decrease to
near historical levels of inventory shrinkage in fiscal 1996 compared with
fiscal 1995 (230 basis points at cost). Partially offsetting these improvements
were increases in distribution costs (164 basis points) associated with serving
new market areas and operating a second distribution facility for most of fiscal
1996. In addition, store occupancy costs increased (82 basis points) as the rate
of new store openings increased.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $11.4 million, or 51.2%, to $33.7 million in
fiscal 1996 from $22.3 million in fiscal 1995. Approximately $8.4 million of
this increase resulted from the opening and operation of 32 new superstores in
fiscal 1996. The remaining increase resulted primarily from (i) $1.8 million to
develop the current management team (including recruitment, relocation, partial
year salaries and benefits, and other associated expenses) and (ii)
approximately $878,000 for systems improvements to support the Company's
continued expansion strategy (including consulting fees related to systems,
distribution, and improvements in store backroom operations, and increases in
depreciation related to systems). As a percentage of net sales, selling, general
and administrative expenses increased to 35.7% in fiscal 1996 from 35.3% in
fiscal 1995.
INTEREST EXPENSE. Interest expense was $1.5 million in fiscal 1996 compared
to approximately $412,000 in fiscal 1995. This increase resulted from increased
borrowings related to the opening of new superstores.
PROVISION FOR INCOME TAXES. The Company's effective tax rate in fiscal 1996
was 62.7% compared to 46.7% in fiscal 1995, resulting from increases in
nondeductible expenses relative to taxable income.
FISCAL YEAR 1995 COMPARED TO FISCAL YEAR 1994
NET SALES. Net sales increased $25.8 million, or 69.2%, to $63.2 million in
fiscal 1995 from $37.3 million in fiscal 1994. The increase resulted from (i)
net sales of $12.7 million from 25 new superstores opened during the year, (ii)
net sales of $5.0 million from stores opened prior to fiscal 1995 not included
in the comparable store base, and (iii) a comparable store sales increase of
$8.1 million, or 22.2%. The increase in comparable store sales related primarily
to the Company's expansion of its product offering in fiscal 1995.
GROSS PROFIT. Gross profit increased $9.3 million, or 66.0%, to $23.4
million in fiscal 1995 from $14.1 million in fiscal 1994. As a percentage of net
sales, gross profit was 37.1% in fiscal 1995 compared to 37.8% in fiscal 1994.
Gross profit decreased as a percentage of net sales, primarily due to higher
inventory shrinkage experienced in fiscal 1995 compared to fiscal 1994. This
increase in inventory shrinkage (230 basis points at cost) resulted from a lack
of consistent store-level compliance with price markdown and receiving
procedures at certain stores, and the lack of a loss prevention department
during fiscal 1995. Partially offsetting this increase in inventory shrinkage
was a decrease in store occupancy costs (140 basis points), resulting from more
new store openings during the first half of fiscal 1994 compared to the first
half of fiscal 1995 and the leveraging of occupancy costs against higher
comparable store sales increases during fiscal 1995 compared to fiscal 1994.
18
<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $9.4 million, or 72.9%, to $22.3 million in
fiscal 1995 from $12.9 million in fiscal 1994. Approximately $7.2 million of
this increase resulted from the opening and operation of 25 new superstores. The
remaining $2.2 million resulted from $1.0 million associated with the hiring of
regional management and new store development staff and approximately $926,000
in new administrative positions, increases in depreciation for new systems and
consulting fees. As a percentage of net sales, selling, general and
administrative expenses increased to 35.3% in fiscal 1995 from 34.5% in fiscal
1994.
INTEREST EXPENSE. Interest expense was approximately $412,000 in fiscal
1995 compared to approximately $497,000 in fiscal 1994. This decrease resulted
from a decrease in borrowings primarily as a result of proceeds received from
the issuance of the Series B Preferred on July 15, 1994.
PROVISION FOR INCOME TAXES. The Company's effective tax rate in fiscal 1995
was 46.7% compared to 39.4% in fiscal 1994, resulting from increases in
nondeductible expenses relative to taxable income.
19
<PAGE>
QUARTERLY RESULTS AND SEASONALITY
The following table sets forth the Company's unaudited quarterly operating
results for its nine most recent quarterly periods.
<TABLE>
<CAPTION>
THREE FISCAL MONTHS ENDED
---------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
SEPT. 30, DEC. 30, MAR. 30, JUNE 29, SEPT. 28,
1995 1995 1996 1996 1996
----------- ----------- ----------- ----------- -----------
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net sales........................................ $ 16,817 $ 25,109 $ 21,707 $ 30,956 $ 25,032
Cost of sales and occupancy...................... 11,025 15,599 13,988 18,527 16,996
----------- ----------- ----------- ----------- -----------
Gross profit................................... 5,792 9,510 7,719 12,429 8,036
Selling, general and administrative expenses..... 7,600 8,774 7,972 9,387 9,665(1)
----------- ----------- ----------- ----------- -----------
Income (loss) from operations.................. (1,808) 736 (253) 3,042 (1,629)
Interest expense................................. 190 300 480 559 597
----------- ----------- ----------- ----------- -----------
Income (loss) before taxes..................... (1,998) 436 (733) 2,483 (2,226)
Income tax (benefit)............................. (760) 180 (272) 970 (935)
----------- ----------- ----------- ----------- -----------
Net income (loss).............................. $ (1,238) $ 256 $ (461) $ 1,513 $ (1,291)
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Stores open at end of period..................... 88 100 104 107 112
</TABLE>
<TABLE>
<CAPTION>
THREE FISCAL MONTHS ENDED(2)
--------------------------------------------------
<S> <C> <C> <C> <C>
SEPT. 30, DEC. 31, MAR. 31, JULY 1,
1994 1994 1995 1995
----------- ----------- ----------- -----------
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Net sales..................................................... $ 10,428 $ 17,152 $ 14,208 $ 21,386
Cost of sales and occupancy................................... 6,885 10,709 9,159 13,004
----------- ----------- ----------- -----------
Gross profit................................................ 3,543 6,443 5,049 8,382
Selling, general and administrative expenses.................. 4,393 5,536 5,788 6,599
----------- ----------- ----------- -----------
Income (loss) from operations............................... (850) 907 (739) 1,783
Interest expense.............................................. 54 54 124 179
----------- ----------- ----------- -----------
Income (loss) before taxes.................................. (904) 853 (863) 1,604
Income tax (benefit).......................................... (422) 398 (403) 749
----------- ----------- ----------- -----------
Net income (loss)........................................... $ (482) $ 455 $ (460) $ 855
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Stores open at end of period.................................. 56 66 72 78
</TABLE>
- ------------------------
(1) Includes approximately $146,000 in nonrecurring compensation expense related
to certain options granted under the Company's 1989 Stock Option Plan.
(2) Fiscal 1995 was on a calendar month end quarterly reporting basis.
Due to the importance of the spring selling season, which includes Easter,
graduation and Mother's Day, and the fall selling season, which includes
Halloween, Thanksgiving, Hanukkah, Kwanzaa and Christmas, the second and fourth
fiscal quarters have historically contributed, and the Company expects they will
continue to contribute, disproportionately to the Company's profitability for
the entire fiscal year. As a result, any factors negatively affecting the
Company in any year during the second and fourth fiscal quarters, including
adverse weather and unfavorable economic conditions, could have a material
adverse effect on the Company's financial condition and results of operations
for the entire year.
The Company's quarterly results of operations also may fluctuate based upon
such factors as the timing of certain holiday seasons, the number and timing of
new superstore openings, the amount of store
20
<PAGE>
preopening expenses, the amount of net sales contributed by new and existing
stores, the mix of products sold, the timing and level of markdowns, store
closings, refurbishments and relocations, competitive factors and weather and
general economic conditions.
RECENT ACCOUNTING PRONOUNCEMENTS
During October 1995, the Financial Accounting Standards Board issued SFAS
No. 123, "Accounting for Stock-Based Compensation." The Company will adopt this
Standard during fiscal 1997, electing the disclosure method of accounting.
Additionally, the Company will adopt SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
during fiscal 1997. The adoption of these standards is not expected to
materially effect fiscal 1997 earnings.
INFLATION
Management does not believe that inflation has had a material effect on its
financial condition or results of operations during the past three fiscal years.
However, there can be no assurance that inflation will not have a material
adverse effect on the Company's future financial condition or results of
operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash needs are primarily for working capital to support its
opening of new superstores and its inventory requirements. In recent years, the
Company has financed its operations primarily with borrowings under the Business
Loan Agreement, proceeds from issuances of the Convertible Preferred Stock and
the Subordinated Debentures and internally generated funds. At September 30,
1995 and September 28, 1996, the Company's working capital was $16.2 million and
$30.0 million, respectively. Cash used in operations for the 13 weeks ended
September 30, 1995 and September 28, 1996 was $1.7 million and $5.3 million,
respectively. In these two periods, $5.5 million and $8.8 million, respectively,
of cash from operations was used to increase inventory levels to support both
new and existing stores. At the end of fiscal 1995 and 1996, the Company's
working capital was $15.6 million and $23.6 million, respectively. During fiscal
1994, 1995 and 1996, cash used in operations was $1.2 million, $4.1 million and
$5.1 million, respectively. In each of these three periods, $5.1 million, $9.1
million and $16.8 million, respectively, of cash from operations was used to
increase inventory levels to support both new and existing stores.
Net cash used in investing activities during the 13-week periods ended
September 30, 1995 and September 28, 1996 was $1.9 million and $2.0 million,
respectively. Net cash used in investing activities during fiscal 1994, 1995 and
1996, respectively, was $2.2 million, $6.9 million and $7.1 million. These costs
were primarily a result of opening new superstores and investing in systems. In
fiscal 1997, the Company expects to spend approximately $11.0 million on capital
expenditures, which includes approximately $4.6 million for new superstore
openings and approximately $3.9 million for the Company-wide implementation of
the POS system.
Net cash provided from financing activities during the 13-week periods ended
September 30, 1995 and September 28, 1996 was $3.2 million and $7.5 million,
respectively. Net cash provided by financing activities during fiscal 1994,
1995, and 1996 was $3.6 million, $11.1 million and $11.9 million, respectively.
For fiscal 1995 and 1996, the outstanding balance under the Company's business
loan agreement with Bank One (the "Prior Business Loan Agreement") at year end
was $5.8 million and $13.1 million, respectively. At October 31, 1996, $9.6
million was outstanding under the revolving credit facility of the Prior
Business Loan Agreement. At September 28, 1996, the outstanding balance under
the Prior Business Loan Agreement was $9.2 million (which included such
revolving credit facility and the Term Loan). On November 1, 1996, the Company
entered into the Business Loan Agreement, which provides for the Line of Credit
and allows for borrowings by the Company in an amount not to exceed the lesser
of $25.0 million or 50% of merchandise inventories. The Line of Credit expires
on October 1, 1998. Borrowings outstanding under the Line of Credit bear
interest on the average daily outstanding balance, paid monthly, at Bank
21
<PAGE>
One's prime rate or, at the Company's option, at 2.75% over LIBOR. The Company
is required to pay an annual commitment fee of 0.25% on the unused portion of
the Line of Credit (except that if the unused portion exceeds $20.0 million the
fee increases to 0.40% on the unused portion) and to comply with certain
covenants. The Line of Credit is secured by a senior lien on substantially all
of the Company's assets.
The Prior Business Loan Agreement provided for, and the Business Loan
Agreement currently provides for, the Term Loan in an amount up to $1.5 million
with an outstanding balance of $1.1 million at the end of fiscal 1996 and
approximately $980,000 at September 28, 1996. The Term Loan is secured by a lien
on substantially all of the Company's assets, has certain covenants and matures
on June 30, 1998.
At the end of fiscal 1996, the Company had outstanding $5.0 million of
Subordinated Debentures, which, net of the unamortized discount, totaled $4.7
million. Subsequent to fiscal 1996, the Company issued an additional $3.0
million of Subordinated Debentures. At September 28, 1996, the outstanding
balance of the Subordinated Debentures, net of the unamortized discount, totaled
$7.6 million. The Subordinated Debentures may be prepaid at any time, with $4.0
million maturing in November 2000, $1.0 million maturing in June 2001 and $3.0
million maturing in July 2001. The Subordinated Debentures bear interest at the
rate of 12.5% per annum, $7.0 million of which has interest that is currently
payable at a rate of 7.5%, with the remaining 5.0% interest accruing until
February 1, 1997 and May 1, 1997, on $3.0 million and $4.0 million,
respectively. In connection with the Subordinated Debentures, the Company issued
warrants to lenders representing the right to acquire 195,594 shares of Common
Stock at an exercise price of $0.0025 per share. The Subordinated Debentures are
secured by a lien on substantially all of the Company's assets that is junior to
the liens securing the Line of Credit and the Term Loan.
The Company has issued and outstanding Series A Preferred, Series B
Preferred and Series C Preferred, which raised net proceeds in the aggregate
amount of $2.0 million, $11.4 million and $9.7 million, respectively. The Series
C Preferred was issued in August 1996, subsequent to the end of fiscal 1996. The
Company intends to convert all outstanding shares of the Convertible Preferred
Stock into shares of Common Stock upon the effectiveness of the Registration
Statement of which this Prospectus is a part.
In October 1996, the Company entered into two capital lease agreements for
point-of-sale computer equipment and related software having a total cost of
$2.1 million. These leases have terms of four and five years.
The Company offering shares through this Prospectus is not an operating
company and, historically, has had no cash needs other than its investment in
its wholly-owned operating subsidiary, Factory Card Outlet of America Ltd. In
addition, the Company does not intend to pay cash dividends in the forseeable
future and under its current Business Loan Agreement is restricted from paying
dividends on its capital stock. See "Dividend Policy." In any event, both the
Company and the operating subsidiary are co-borrowers under the Business Loan
Agreement, the proceeds of which could fund future cash needs, if any, of the
holding company. The net proceeds of this offering will be made available to the
operating subsidiary through an intercompany transaction. The Company believes
that the net proceeds it will receive from this offering, together with cash
generated from operations and available borrowings under the Line of Credit,
will be sufficient to finance its working capital and capital expenditure
requirements for at least the next 12 months. See "Use of Proceeds."
22
<PAGE>
BUSINESS
THE COMPANY
Factory Card is a rapidly growing chain of company-owned superstores
offering a vast assortment of party supplies, greeting cards, gift wrap and
other special occasion merchandise at everyday value prices. As of November 15,
1996, the Company operated 122 stores in 14 states, primarily in the Midwest and
mid-Atlantic regions of the United States. To maintain the quality and
consistency of its retail presentation, the Company operates all of its stores.
Based on the published number of stores of the Company's competitors as compiled
by the Company from various business publications and other publicly available
information, the Company believes it is the largest chain of company-owned
stores in the party supply and special occasion industry. The Company opened 15,
25 and 32 superstores in fiscal 1994, 1995 and 1996, respectively, and plans to
open 30 to 35 superstores in fiscal 1997, including 15 opened through November
15, 1996.
The Company's superstores provide customers with a value-oriented,
"one-stop" shopping destination for party and special occasion merchandise for
all major holidays and celebratory events, including birthdays, graduations,
weddings, baby showers and other family, religious and special occasions. The
Company's superstore prototype ranges in size from 10,000 to 12,000 square feet,
with approximately 80% devoted to selling space, and is designed to provide ease
of shopping within an attractive, spacious and festive environment. To enhance
the look of its superstores and encourage multiple purchases, merchandise is
displayed in assortments that emphasize themes and colors associated with
holidays, special occasions and other seasonal events. To reinforce its emphasis
on providing value, since fiscal 1993, the Company has offered multiple lines of
high quality greeting cards, all at the everyday low price of 39 CENTS.
MARKET OVERVIEW
According to the PARTY AND PAPER RETAILER SOURCEBOOK, an industry trade
publication, the United States market for party and special occasion
merchandise, comprised of party supplies, greeting cards, gift wrap and related
items, has estimated retail sales of approximately $8.8 billion. Consumers
purchase party and special occasion merchandise frequently throughout the year
in order to create, enhance and celebrate a wide range of major holidays,
including Valentine's Day, St. Patrick's Day, Passover, Easter, Mother's Day,
Father's Day, Grandparent's Day, Secretary's Day, Fourth of July, Rosh Hashanah,
Halloween, Thanksgiving, Christmas, Hanukkah, Kwanzaa and New Year's, and
celebratory events, including birthdays, graduations, weddings, baby showers and
other family, religious and special occasions. The Company believes that the
consumable and occasion-specific nature of party supplies and special occasion
merchandise results in multiple and repeat purchases by consumers.
The Company believes the party supply and special occasion market will
continue to grow based on demographic and other factors. For example, the
Company believes that the aging of the baby boom generation, and the increasing
number of their school-age children, offers an opportunity for retailers to
further expand their sale of party supplies and greeting cards. The Company
believes this segment of the population creates an increasing demand for the
Company's products as a result of greater at-home entertaining and demand for
party supplies for children.
Larger format superstores have become the fastest growing retail format
within the fragmented market for party and special occasion merchandise.
Historically, this market has been served by traditional retail channels such as
card shops, mass merchandisers, discount retailers, drugstores and supermarkets,
which generally offer a limited selection within many of the party supply and
special occasion product categories. Industry statistics indicate that
superstores have increased their share of the market in the past two years. The
Company believes that the broader product selection, "one-stop" shopping
solution and value pricing offered by superstores will continue to make them the
preferred choice of consumers.
23
<PAGE>
BUSINESS STRATEGY
The key elements of the Company's business strategy are as follows:
EXTENSIVE MERCHANDISE OFFERING. The Company believes its everyday and
seasonal merchandise offering, which includes approximately 23,000 SKUs at its
superstores, provides the solution, in a single destination, for a customer's
complete product needs to create, enhance and celebrate special occasions. The
Company offers a full line of party supplies in a wide variety of festive and
distinctive patterns, colors and styles, including tableware, tablecovers,
invitations, party favors, pinatas, banners and other decor items. The Company
also offers a broad selection of high quality greeting cards for all occasions,
consisting of approximately 4,000 everyday and seasonal titles. The Company
carries an extensive selection of gift wrap, including a broad array of gift
bags, gift boxes, ribbons, bows and related items in coordinated and
complementary displays. In addition, the Company offers many other special
occasion items such as balloons, stationery, gifts, novelty items and seasonal
products.
EVERYDAY VALUE PRICING. The Company's strategy of everyday value pricing is
designed to provide customers with consistent value on all purchases. The
Company typically sells its merchandise at discounts of 20% to 60% off
manufacturers' suggested retail prices. In addition, the Company's superstores
feature a "power aisle" offering a wide selection of opportunistic buys and
manufacturers' seasonal over-runs, all priced at deep discounts and frequently
changed to create continued customer interest. To distinguish the Company's
superstores from those of its competitors and build customer traffic and
loyalty, the Company's high quality greeting cards are all sold for 39 CENTS
each.
ATTRACTIVE, SPACIOUS AND FESTIVE SUPERSTORE FORMAT. The Company creates an
attractive and festive atmosphere within a spacious "easy to shop" superstore,
encouraging browsing and repeat visits by customers. The Company's superstores
are designed to provide a comfortable shopping experience, with bright lighting,
wide carpeted aisles and fixtures that offer customers easy access to
merchandise. The interiors of the Company's superstores are festively decorated
with arrays of colorful merchandise to emphasize everyday and seasonal themes.
The size of the Company's superstore prototype enables the Company to offer an
extensive selection of merchandise and increase store-level efficiencies.
TARGETED ADVERTISING. In the spring of 1996, the Company broadened its
advertising program to include a Company-wide direct mail campaign designed to
educate targeted consumers about the breadth and value of the Company's product
offering. The Company intends to support major holiday selling seasons with
direct mail marketing and continue radio advertising in order to complement its
direct mail program and increase its name recognition within new and existing
markets.
DEVELOPMENT OF MANAGEMENT TEAM AND INFRASTRUCTURE. The Company has
recruited a management team whose members have an average of 21 years of retail
experience. The Company believes it benefits from operating its own distribution
facilities, which enable it to make opportunistic purchases, import products
directly and achieve operating efficiencies. In fiscal 1996, the Company
completed installation of a fully integrated retail management software package
that automated the areas of finance, merchandising and distribution and
successfully tested a POS system that is expected to be operational in all
stores by the end of fiscal 1997.
GROWTH STRATEGY
The Company has developed a rapid expansion plan designed to build on its
position as the largest chain of company-owned superstores in the party supply
and special occasion industry. The Company's growth strategy is to open stores
in existing and contiguous markets that can support multiple stores and enable
the Company to achieve operating, distribution and advertising efficiencies. The
Company may also selectively enter small and mid-size markets capable of
supporting one or more superstores that the Company believes meet its
profitability criteria. The Company plans to open 30 to 35 superstores in fiscal
1997, including 15 opened through November 15, 1996, and at least 40 superstores
in fiscal 1998. As of
24
<PAGE>
November 15, 1996, the Company entered into 13 leases for superstores and had
seven more leases under review, all of which are expected to open in fiscal
1997.
In addition to opening new stores, the Company's growth strategy involves
increasing sales in existing stores through continued expansion of its
merchandise offering, coordinated party goods presentation and advertising and
in-store marketing to encourage multiple purchases and to increase customer
awareness of its broad merchandise offering. The Company may also take advantage
of opportunities to exploit the fragmented nature of the industry by considering
the acquisition of other retail chains in the industry. See "Risk Factors--Risks
Associated with Expansion" and "Risk Factors--Risks Associated with
Acquisitions."
MERCHANDISING
The Company believes its merchandise offering provides the solution, in a
single destination, for a customer's complete product needs to create, enhance
and celebrate special occasions. The Company's stores offer a vast assortment of
party supplies, greeting cards, gift wrap and other special occasion merchandise
at everyday value prices. The Company's superstores carried approximately 23,000
SKUs of everyday and seasonal merchandise in fiscal 1996. In fiscal 1996, the
average number of transactions per store for stores open the entire fiscal year
was approximately 171,500, and the average store transaction was approximately
$5.80. In addition, the Company believes that the consumable and
occasion-specific nature of its merchandise selection results in multiple and
repeat visits by its customers.
The Company's stores offer product selections for all major holidays and
seasonal events, such as Valentine's Day, St. Patrick's Day, Passover, Easter,
Mother's Day, Father's Day, Grandparent's Day, Secretary's Day, Fourth of July,
Rosh Hashanah, Halloween, Thanksgiving, Christmas, Hanukkah, Kwanzaa and New
Year's, and celebratory events, including birthdays, graduations, weddings and
baby showers, and other family, religious and special occasions. The Company's
merchandise offering consists of four major product categories: party supplies,
greeting cards, gift wrap and other special occasion items.
PARTY SUPPLIES. The Company stocks a broad selection of party supply
merchandise for everyday and special occasions in a wide variety of attractive
patterns and distinctive colors. Party supplies include tableware, tablecovers,
cutlery, invitations, party favors, milestone birthday items, pinatas, banners,
decorations, candles, decor and other related party items. By offering a full
line of coordinated and complementary patterns and designs, the Company seeks to
meet all of a customer's party needs, from children's birthdays and holiday
celebrations to at-home entertainment.
GREETING CARDS. The Company's stores feature approximately 4,000 titles of
high quality everyday and seasonal greeting cards for all occasions, all sold at
the everyday low price of 39 CENTS each. In addition to traditional lines of
greeting cards, the Company's stores also carry an extensive selection of
contemporary and humorous greeting cards. Boxed everyday greeting cards are
regularly sold at deep discounts, and boxed holiday cards (Christmas, Hanukkah
and Kwanzaa) are sold at 50% off manufacturers' suggested retail prices.
GIFT WRAP. The Company believes that it offers one of the largest
assortments of gift wrap of any retailer in the United States. This extensive
selection of gift wrap is combined with bows, ribbons and related accessories in
a large cascading waterfall display of complementary colors and distinctive
patterns. Items included in this category are gift wrap, including glossy,
printed, solid and foil, solid and printed ribbons, bows, gift bags, gift boxes,
tissue paper, shred and gift tags. The Company believes that its stores have
become a destination for shoppers seeking a wide selection of gift wrap and gift
wrap accessories and that most of these items are sold at lower prices than the
Company's competition.
OTHER SPECIAL OCCASION MERCHANDISE. The Company complements its major
product lines by offering many other special occasion items in order to provide
a "one-stop" shopping destination for its customers. These items include
balloons, candy, bridal and wedding items (such as cake decorations, place
setting
25
<PAGE>
cards and confetti), candles and candle holders (and other related accessories),
stationery, gifts, novelty items and seasonal products.
The Company's strategy of everyday value pricing is designed to provide
customers consistent value on all purchases. The Company typically sells its
merchandise at discounts of 20% to 60% off manufacturers' suggested retail
prices. In addition, the Company's superstores feature a "power aisle" offering
a wide selection of opportunistic buys and manufacturers' seasonal over-runs,
all priced at deep discounts and frequently changed to create continued customer
interest. To build customer traffic and loyalty, the Company's high quality
greeting cards are all sold for 39 CENTS each.
The Company currently offers certain party and special occasion items under
its proprietary "Partymania-Registered Trademark-" label, including invitations,
candles and decor items. Although the Company does not maintain a significant
amount of private label merchandise at present, the Company plans to explore new
opportunities to expand its Partymania-Registered Trademark- products in order
to provide customers with additional savings while realizing higher margins
typically accompanying private label products.
The Company has a centralized purchasing department comprised of five buyers
who are responsible for establishing the assortment of inventory within the
merchandise categories each selling season. The Company's merchandising mix is
achieved by considering a number of factors including the price-value
relationship, customer demand and product availability, as well as input from
regional and store managers. The Company believes that its purchasing volume
allows it to acquire quality products at competitive prices.
FACTORY CARD'S STORES
FORMAT AND PRESENTATION. The Company's current prototype superstore, which
ranges in size from 10,000 to 12,000 square feet, with approximately 80% devoted
to selling space, allows the store to carry an extensive selection of party
supplies, greeting cards and other special occasion merchandise in an easy-to-
shop visually appealing atmosphere. Approximately 75% of the Company's store
base are superstores (stores of at least 8,000 gross square feet).
The Company believes that the presentation of its merchandise is critical to
communicating value and excitement to its customers. The Company's stores are
attractively designed with the use of vibrant colors, creative merchandise
displays and decorative signage in order to create a fun shopping experience and
encourage browsing throughout the stores. Stores have bright, wide carpeted
aisles, lined with pinatas and other colorful decorations, creating an inviting
and festive atmosphere for shoppers. The Company's balloon selection, consisting
of approximately 240 designs of everyday balloons and up to an additional 30
seasonal designs, is displayed at the store entrance, providing immediate visual
appeal as customers enter the store.
The Company uses a variety of adaptable merchandising fixtures, including
gondolas and adjustable displays, that enable the Company to shift its
merchandise mix frequently to feature new and seasonal merchandise. Such
adaptable fixtures are typically located in prominent areas in the stores to
create customer interest and encourage browsing. The Company's "power aisle" and
seasonal items are centrally located in the stores and lead the customer through
the store into different merchandise areas. Store signage, including permanent
and promotional signs, is utilized to enhance the festive appeal of stores.
STORE OPERATIONS AND TRAINING. The Company's typical store is staffed with
a store manager, one to two assistant managers and a varying number of full-time
and part-time sales associates, depending on the store size and selling season.
The Company has established bonus plans for all store managers and assistant
managers. Awards are based on meeting or exceeding quarterly sales projections
to reward individual and store performance. Store managers report to one of the
Company's district managers, each of whom is responsible for approximately 10 to
12 stores. The Company's stores are typically open from 10:00 a.m. to 9:00 p.m.
on weekdays and most Saturdays, with shorter hours on Sunday. Stores typically
extend their opening and closing hours during the Christmas season.
26
<PAGE>
The Company employs three full-time new store training managers and has
developed a complete set of employee training manuals covering aspects of
operating a specialty retail store, including product information, systems
information and cash management programs. The Company has developed a one and a
half-day in-store training program for all new store employees and a three-day
in-store training program for all new store managers covering product knowledge,
customer service and the Company's systems. In addition, the Company has an
ongoing manager-in-training program within each district in which it hires a
prospective manager or advances an assistant manager for placement in a store
and later transfers them to the new store in preparation for its opening.
Finally, the Company regularly conducts store manager meetings to review store
policies and practices and reinforce management training practices.
SITE SELECTION; STORE LOCATIONS
SITE SELECTION. The Company's stores are located primarily in regional
strip or power shopping centers with co-tenants appealing to value-oriented
female customers of various ranges of age and income. Sites are selected on the
basis of several factors, including physical location, demographics, anchor and
other tenants, location within the center, parking and available lease terms.
The Company looks for co-tenants who draw customers with similar characteristics
and generate a high rate of shopping traffic, such as specialty value-oriented
women's retailers, leading chain supermarkets, arts and crafts stores, chain
drug stores and family restaurants. The Company believes its stores are
attractive to developers because they sell non-apparel goods, offer everyday
value pricing and attract high rates of female customer traffic.
STORE LOCATIONS. As of November 15, 1996, the Company operated 122 stores
in 14 states, all of which are leased. The Company's store leases typically have
an average initial term of 10 years with two five year renewal options. As of
November 15, 1996, the average unexpired term of the Company's 122 existing
store leases was approximately seven years (not including renewal options).
27
<PAGE>
Set forth below is a list of the Company's store locations by state as of
November 15, 1996:
<TABLE>
<CAPTION>
NUMBER OF
LOCATION STORES
- -------------------------------------------- -------------
<S> <C>
DELAWARE (1)
Wilmington................................ 1
ILLINOIS (40)
Chicago Metro............................. 32
Mt. Vernon................................ 1
Bloomington............................... 1
Rockford.................................. 1
Fairview Heights.......................... 1
Moline.................................... 1
Champaign................................. 1
Kankakee.................................. 1
Springfield............................... 1
INDIANA (15)
Indianapolis.............................. 6
Highland.................................. 1
Merrillville.............................. 1
Evansville................................ 2
Ft. Wayne................................. 1
Mishawaka................................. 1
LaFayette................................. 1
Clarksville............................... 1
Bloomington............................... 1
IOWA (5)
Des Moines Metro.......................... 2
Cedar Rapids.............................. 1
Waterloo.................................. 1
Davenport................................. 1
KENTUCKY (4)
Louisville Metro.......................... 2
Florence.................................. 1
Owensboro................................. 1
MARYLAND (12)
Baltimore Metro........................... 7
Washington, D.C. Metro (Md.).............. 4
Annapolis................................. 1
<CAPTION>
NUMBER OF
LOCATION STORES
- -------------------------------------------- -------------
<S> <C>
MINNESOTA (1)
Rochester................................. 1
MISSOURI (6)
St. Louis Metro........................... 4
Springfield............................... 1
Cape Girardeau............................ 1
NEBRASKA (5)
Omaha Metro............................... 3
Lincoln................................... 1
Grand Island.............................. 1
OHIO (11)
Cincinnati Metro.......................... 4
Columbus Metro............................ 3
Cleveland Metro........................... 2
Mansfield................................. 1
Akron..................................... 1
PENNSYLVANIA (2)
Hanover................................... 1
Erie...................................... 1
TENNESSEE(1)
Chattanooga............................... 1
VIRGINIA (6)
Washington, D.C. Metro (Va.).............. 4
Fredericksburg............................ 1
Richmond.................................. 1
WISCONSIN (13)
Milwaukee Metro........................... 6
Madison Metro............................. 2
Appleton.................................. 1
Oshkosh................................... 1
Eau Claire................................ 1
Janesville................................ 1
Wausau.................................... 1
</TABLE>
ADVERTISING AND PROMOTION
In the spring of 1996, the Company broadened its advertising program to
include a Company-wide direct mail campaign designed to educate targeted
consumers about the breadth and value of the Company's product offering.
Historically, the Company's marketing efforts consisted of radio advertising on
a seasonal basis, reinforced by newspaper advertisements. The Company intends to
support major holiday selling seasons with direct mail marketing and continue
radio advertising in order to complement its direct mail program and increase
its name recognition within new and existing markets. With the expected
implementation of its POS system in all stores, the Company expects to capture
customer ZIP code information which will enable it to better target its direct
mail program. In addition, Grand Opening events will continue to be a major
element of the Company's marketing program. Grand Openings typically last four
days and consist of "4 for a $1.00" greeting card promotions, special purchases,
prize drawings and other fun events. The Company intends to supplement its
traditional Grand Opening marketing program with additional post-opening
advertising and public relations campaigns in the local trading area.
28
<PAGE>
PRODUCT SOURCING AND DISTRIBUTION
The Company purchases most of its inventory through its central purchasing
system, which allows it to take advantage of volume purchase discounts and
implement system controls over its inventory and merchandise selection. The
Company purchases its inventory from more than 300 vendors world-wide, with the
largest supplier, Creative Expressions, Inc., representing less than 14%, and
the largest ten suppliers representing approximately 46%, of the Company's
aggregate purchases in fiscal 1996. A portion of the Company's merchandise is
imported from foreign manufacturers or their agents, principally from the Far
East. See "Certain Transactions." As is customary in its industry, the Company
does not have long term contracts with any suppliers except Fine Art.
In order to ensure a consistent supply of first-run high quality greeting
cards, the Company entered into the Fine Art Agreement, which expires on
December 1, 1998 (with automatic one-year renewals after the initial 2 1/2 year
term unless the parties cannot agree on pricing and other terms). Under the Fine
Art Agreement, the Company is required to purchase from Fine Art a minimum of
42% of the Company's total annual requirement of greeting cards, which
percentage is subject to modification upon the consent of the parties. Fine Art
is a publicly-owned U.K. corporation and a stockholder of the Company. See "Risk
Factors--Risks Associated with Product Sourcing" and "Certain Transactions."
The Company believes that its well-established relationships with overseas
suppliers provide it with an advantage over many of its competitors because the
Company is able to offer an extensive selection of distinctive products at
higher gross margins. The Company also believes that it benefits from the
significant buying power resulting from its size and that, by operating its own
distribution facilities, it can make opportunistic purchases, import products
directly and achieve greater operating efficiencies.
The Company's stores are currently serviced from two distribution centers
located near the Company's headquarters which total an aggregate of 237,000
square feet. Approximately 80% of the Company's purchases are shipped through
the Company's distribution centers and the remaining 20% is drop-shipped
directly from the vendors to the stores. The distribution centers handle basic
items, seasonal items, imports and opportunistic purchases. Approximately 1,200
SKUs of basic goods are stocked in the distribution centers and distributed to
the stores weekly based upon store orders. The remaining inventory is allocated
to the stores by the Company's buying group based on sales history, size of
store, geography and demographic profiles. The Company has entered into an
agreement to lease a new distribution center and office facility, which the
Company expects to be operational by April 1998. This new facility will consist
of approximately 440,000 square feet, including office space, and will have
40-foot ceilings, compared to the 20- and 24-foot ceilings in the existing
facilities. See "--Properties."
MANAGEMENT INFORMATION SYSTEMS
The Company uses a management information and control system, which is based
on the JDA Merchandise Management System software package ("JDA") acquired by
the Company in 1994 and supports the complete range of retail cycle functions in
the areas of finance, merchandising and distribution. All stores are linked to
the Company's headquarters through personal computers which interface with an
IBM AS/400 and provide the stores with the ability to enter store orders and
payroll information and send and receive electronic mail. These personal
computers will also be tied into the Company's new POS system and will allow
managers to review their stores' merchandising performance by product category
and SKU.
The Company believes that its management information systems will be an
important factor in supporting its continued expansion and enhancing its
competitive position in the industry. In fiscal 1996, the Company began the
implementation of its new POS system. In fiscal 1996, the Company completed
installation of a fully integrated retail management software package that
automated the areas of finance, marketing and distribution and successfully
implemented a POS system that is expected to be operational in all stores by the
end of fiscal 1997. The POS system will provide critical sales information to
the Company's stores and central office and will be utilized in the Company's
business operations and controls, performance monitoring programs, decision
support and business planning. Management believes that the
29
<PAGE>
POS system will result in improvements in central office operations,
particularly in the areas of merchandise planning and automated replenishment,
inventory control and performance measurement.
COMPETITION
The party supplies and greeting cards retailing business is highly
competitive. The Company currently competes against a diverse group of
retailers, ranging from other party supply and greeting card retailers
(including Party City Corporation) to designated departments in drug stores,
general mass merchandisers, supermarkets and department stores of local,
regional and national chains. In addition, a trend toward discounting party
supplies and greeting cards is developing and the Company may encounter
additional competition from new entrants in the future. Some of the Company's
competitors have substantially greater financial resources and experience than
the Company. See "Risk Factors--Competition."
EMPLOYEES
The Company had 2,001 employees as of November 15, 1996, comprised of 475
full-time and 1,526 part-time employees. The number of store employees increases
during peak selling seasons. None of the Company's employees are covered by
collective bargaining agreements. While the Company believes its relations with
its employees are generally good, the Company has been experiencing an unusually
high rate of turnover of its store managers. The Company is implementing new
pay, incentive and hours planning programs to address the conditions which led
to this high rate of turnover. See "Risk Factors--Dependence on Key Personnel;
New Management Team; Turnover of Store Managers."
TRADEMARKS
The Company has registered a trademark under the name of
"Partymania"-Registered Trademark- and its design on the Principal Register of
the United States Patent and Trademark Office. The Company has applied for
registration of the "Factory Card Outlet"-TM- trademark on the Principal
Register of the United States Patent and Trademark Office.
PROPERTIES
In addition to the Company's stores, all of which are leased, the Company
also leases two distribution center and corporate office facilities in
Bensenville, Illinois and Elk Grove Village, Illinois, with the lease terms
expiring in September 2002 and July 1998, respectively. The Company has recently
entered into a 10-year lease for an office and distribution center in
Naperville, Illinois which will integrate and replace the Company's existing
headquarters and distribution centers. The estimated commencement date under
this lease is October 1, 1997. The Company expects to be operating this new
distribution center, which consists of approximately 440,000 square feet,
including office space, by April 1998. See "Risk Factors--Consolidation and
Expansion of Distribution Facilities."
GOVERNMENT REGULATION
Each of the Company's stores must comply with regulations adopted by federal
agencies and with licensing and other regulations enforced by state and local
health, sanitation, safety, fire and other departments. More stringent and
varied requirements of local governmental bodies with respect to zoning, land
use and environmental factors, and difficulties or failures in obtaining the
required licenses or approvals, can delay and sometimes prevent, the opening of
a new store. In addition, the Company must comply with the Fair Labor Standards
Act and various state laws governing various matters such as the minimum wage,
overtime and other working conditions. The Company also must comply with the
provisions of the ADA, which requires generally that employers provide
reasonable accommodation for employees with disabilities and that stores be
accessible to customers with disabilities. See "Risk Factors-- Government
Regulation."
LITIGATION
From time to time, the Company is involved in ordinary litigation, none of
which, in the opinion of management, is likely to have a material adverse effect
on the Company's results of operations or financial condition.
30
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION(1)
- ------------------------------------------------ --- ----------------------------------------------------------
<S> <C> <C>
William E. Freeman(2)(3)........................ 54 Chairman of the Board
Charles R. Cumello(3)........................... 52 President and Director
Glen J. Franchi................................. 43 Executive Vice President and Treasurer
Carol A. Travis................................. 45 Vice President and Secretary
Martin J. Merksamer............................. 48 Vice President and General Merchandising Manager
Leonard F. Rucker............................... 45 Vice President, Retail Store Operations
Thomas W. Stoltz................................ 35 Vice President, Finance
Robert Krentzman................................ 47 Vice President, MIS
Vincent G. Brown................................ 55 Vice President, Real Estate
Joseph M. Cabon................................. 50 Vice President, Distribution
Robert J. Kendzior.............................. 44 Vice President, Marketing
Matthew F. Ellis................................ 46 Vice President, Human Resources
J. Bayard Kelly................................. 64 Director
Dr. Robert C. Blattberg(4)...................... 54 Director
Michael I. Barach(4)............................ 38 Director
Bart A. Brown, Jr.(3)(4)........................ 64 Director
Richard A. Doppelt(2)........................... 41 Director
Stewart M. Kasen................................ 57 Director
James L. Nouss, Jr.............................. 42 Director
</TABLE>
- ------------
(1) All the Vice Presidents, other than Mr. Franchi and Ms. Travis, hold their
respective positions in the Company's operating subsidiary.
(2) Member of the Compensation Committee.
(3) Member of the Executive Committee.
(4) Member of the Audit Committee.
Mr. Freeman has been Chairman of the Board of Directors of the Company since
April 1994. From May 1994 to October 1995, Mr. Freeman was Chief Executive
Officer of the Company's operating subsidiary, and, from May 1994 to September
1996, he was Chief Executive Officer of the Company. From 1989 to 1994, Mr.
Freeman was President of the Company. Mr. Freeman has been a director of the
Company since forming the investor group that acquired it in July 1989. Since
1989, Mr. Freeman has also performed various management consulting assignments,
primarily involving the marketing and distribution of consumer products. Mr.
Freeman, as Chairman of the Executive Committee and a member of the Compensation
Committee, remains active in management of the Company.
Mr. Cumello has been President of the Company since October 1995 and has
been a director of the Company since May 1995. From April 1995 to October 1995,
Mr. Cumello was the Chief Operating Officer of the Company's operating
subsidiary. Prior to joining the Company, from 1991 to 1994, Mr. Cumello was
President and Chief Executive Officer of Waldenbooks, a division of Kmart
Corporation, and from 1986 to 1991, he was President of Reader's Market, a
division of Waldenbooks. From 1980 to 1986, Mr. Cumello served as Executive Vice
President and Chief Financial Officer of Waldenbooks. Mr. Cumello is a member of
the Executive Committee.
Mr. Franchi has been Executive Vice President and Treasurer of the Company
since March 1995. From November 1990 to March 1995, Mr. Franchi served as the
Chief Operating Officer of the Company's operating subsidiary. Prior to joining
the Company, from 1977 to 1989, Mr. Franchi held various management and senior
financial positions with Carson Pirie Scott Co., a chain of retail department
stores.
31
<PAGE>
Ms. Travis has been with the Company since it was originally founded in
1985, serving as Secretary of the Company since May 1994 and as Vice President
since June 1994.
Mr. Merksamer has been Vice President and General Merchandise Manager since
May 1996. From September 1995 to May 1996, Mr. Merksamer was the Senior Vice
President for Merchandising and Marketing for Handy Andy Home Improvement
Centers, Inc. ("Handy Andy"). From February 1995 to September 1995, Mr.
Merksamer served as Vice President, Merchandising, for Handy Andy. In November
1995, Handy Andy accepted an involuntary petition for bankruptcy under chapter
11 of the United States Bankruptcy Code ("Chapter 11"). Prior to joining Handy
Andy in 1995, from April 1993 to September 1995, Mr. Merksamer was involved in
the planning of a start-up business venture and, from 1991 to 1993, he was Vice
President of Merchandising and Marketing of The Business Super Store. From 1987
to 1991, Mr. Merksamer was Vice President, Merchandising, for The Office Club,
Inc.
Mr. Rucker has been Vice President, Store Operations since July 1996. From
1990 to 1996, Mr. Rucker served as Vice President, Director of Operations, of
Geoffrey Beene/Izod, a division of Phillips-Van Heusen Corporation.
Mr. Stoltz has been Vice President, Finance since August 1996. From 1994 to
1996, Mr. Stoltz served as Corporate Comptroller of Dollar General Corporation,
a specialty retailer. Mr. Stoltz also served as Interim Chief Financial Officer
of Dollar General from 1995 to 1996. Prior to his tenure with Dollar General,
Mr. Stoltz served as Director of Operations Accounting with Food Lion, Inc. from
1989 to 1994. Mr. Stoltz is a Certified Public Accountant.
Mr. Krentzman has been Vice President, MIS since September 1995. Prior to
that, from 1994 to September 1995, Mr. Krentzman served as Director of MIS. From
1990 to 1994, Mr. Krentzman was Director, MIS, for Reader's Market, a division
of Waldenbooks.
Mr. Vincent Brown has been Vice President, Real Estate since September 1995.
From April until September 1995, Mr. Brown was Director of Franchising for A&W
Restaurants, Inc. Prior to that, from 1989 to 1995, Mr. Brown was Vice
President, Real Estate for Fayva, a division of J. Baker, Inc. Before joining J.
Baker, Inc., Mr. Brown spent 21 years with Dunkin' Donuts, Inc., a unit of
Allied Domecq plc, in various management positions, most recently as Vice
President, Corporate Development.
Mr. Cabon has been Vice President, Distribution since April 1995. From
December 1993 to January 1995, Mr. Cabon was employed as a consultant in retail
distribution. Prior to that, from October 1992 through December 1993, Mr. Cabon
was Vice President, Logistics for One Price Clothing, a specialty retailer. From
August 1990 to April 1992, Mr. Cabon was Vice President, Logistics for
Rent-a-Center, and from April 1990 to August 1990, Mr. Cabon was Vice President,
Logistics for E&B Marine. In January 1995, Mr. Cabon filed a petition for
bankruptcy under chapter 7 of the United States Bankruptcy Code, and that same
month received a discharge from indebtedness in connection therewith.
Mr. Kendzior has been Vice President, Marketing, since November 1995. From
1978 to 1995, Mr. Kendzior was employed by Dunkin' Donuts of America, serving
from 1993 to 1995 as Vice President, Marketing and, from 1991 to 1993, as
Director of Field Marketing.
Mr. Ellis has been Vice President, Human Resources since August 1996. Prior
to that, from 1989 to 1996, Mr. Ellis was Vice President, Human Resources of
Today's Man, Inc., which, in February 1996, filed a voluntary petition for
bankruptcy under Chapter 11.
Mr. Kelly has been a director since 1989. Since October 1995, Mr. Kelly has
served as a merchandise consultant to the Company's operating subsidiary. Mr.
Kelly was the founder of the Company's operating subsidiary and its President
from 1989 to 1995. Prior to that, from 1985 to 1989, Mr. Kelly was Chief
Executive Officer and President of Gallant, a creator and publisher of greeting
cards and a subsidiary of Viking Enterprises, Inc.
32
<PAGE>
Dr. Blattberg has been a director since September 1994. Dr. Blattberg has
been a Polk Brothers Distinguished Professor of Retailing at The J.L. Kellogg
Graduate School of Management at Northwestern University since September 1991.
Dr. Blattberg is also a director of First Tennessee National Bank and Director
of The Center for Retail Management at Northwestern University, and a partner in
Blattberg, Chaney and Associates, a consulting firm that provides services to
several leading retailers primarily in the supermarket and retail drug store
industries. Dr. Blattberg is a member of the Audit Committee.
Mr. Barach has been a director since July 1994. Since October 1990, Mr.
Barach has been an associate and general partner of Bessemer Venture Partners
FCOA. Prior to that, from January 1988 to October 1990, he was President and
co-founder of Cartoon Corner Corporation and, from January 1985 to October 1987,
he was Vice President, Merchandising of Scandinavian Design. Mr. Barach is a
member of the Audit Committee.
Mr. Bart Brown has been a director since May 1996. He is a corporate
executive of Investcorp International, Inc., an international investment banking
firm. Since June 1994, he has been Chairman of the Board of Spreckels
Industries, Inc., a manufacturing and processing company, serving as its Chief
Executive Officer from June 1994 to May 1995. From August 1995 to April 1996, he
was Chairman of the Board and Chief Executive Officer of Color Tile, Inc., a
retailer of specialty flooring and wall covering. Mr. Brown led Color Tile, Inc.
through a petition for bankruptcy under Chapter 11, the plan for which was filed
in January 1996. From June 1990 to August 1995, he was Chairman of the Board of
The Circle K Corporation, an operator of convenience stores. Serving as its
Chief Executive Officer from June 1991 through July 1993, Mr. Brown successfully
led The Circle K Corporation through a restructuring under Chapter 11, the plan
for which was confirmed in 1993. Mr. Brown is also a director of Edison Brothers
Stores, Inc., Yale International, Barry's Jewelers and FirstCity Financial Corp.
Mr. Brown is a member of the Executive Committee and the Audit Committee.
Mr. Doppelt has been a director since July 1994. Mr. Doppelt has been a
member of Allstate Venture Capital, a division of Allstate Insurance Company
("Allstate"), since 1987 and is currently the Venture Group Manager of Allstate
Venture Capital. Prior to joining Allstate, Mr. Doppelt was a corporate attorney
associated with the law firm of Morrison & Foerster. Mr. Doppelt is a director
of Sunrise Assisted Living, a company providing assisted living services to the
elderly, as well as several privately held companies. Mr. Doppelt is a member of
the Compensation Committee.
Mr. Kasen became a director in September 1996. From 1989 to May 1996, Mr.
Kasen was an officer of Best Products Co., Inc., a chain of catalog showrooms,
serving as its Chairman, President and Chief Executive Officer from 1991 to 1996
and its President and Chief Operating Officer from 1989 to 1991. Mr. Kasen
assisted Best Products through a petition in bankruptcy under Chapter 11 which
was filed in January 1991. Best Products' plan of reorganization was confirmed
in June 1994, and it filed a petition for bankruptcy under Chapter 11 again on
September 24, 1996. Mr. Kasen also serves as a director of Markel Corporation,
O'Sullivan Industries Holdings Inc., The Bibb Company and Spreckels Industries,
Inc. The Bibb Company filed a petition in bankruptcy under Chapter 11 in July
1996.
Mr. Nouss became a director in September 1996. For the past five years, Mr.
Nouss has been a partner at the law firm of Bryan Cave LLP.
The Board of Directors has established a Compensation Committee, which
provides recommendations concerning salaries and incentive compensation for
employees of, and consultants to, the Company and administers the 1989 Stock
Option Plan and the 1996 Employee Stock Purchase Plan. The current members of
the Compensation Committee are Messrs. Freeman and Doppelt.
The Board of Directors has also established an Audit Committee, which
reviews the results and scope of the annual audit of the Company's financial
statements conducted by the Company's independent accountants, proposed changes
in the Company's financial and accounting standards and principles and the
Company's policies and procedures with respect to its internal accounting,
auditing and financial
33
<PAGE>
controls. The Audit Committee also makes recommendations to the Board of
Directors on the engagement of the Company's independent accountants as well as
other matters which may come before the Committee or at the direction of the
Board of Directors. The current members of the Audit Committee are Messrs.
Blattberg, Barach and Brown.
In addition, the Board of Directors has established an Executive Committee
of the Company, which reviews and provides recommendations concerning strategic
planning, acquisitions, financing and shareholder relations. The current members
of the Executive Committee are Messrs. Freeman (Chairman), Cumello and Brown.
DIRECTOR COMPENSATION
Directors who are not officers, employees or consultants of the Company
receive $1,000 cash compensation for each board of directors meeting and $500
for each committee meeting (except for committee meetings held in conjunction
with regular board meetings) at which they are present, not to exceed $2,000 per
director in any calendar year with respect to committee meetings. In addition,
all such directors are reimbursed for their reasonable expenses in connection
with the performance of their duties. Mr. Freeman receives $2,000 each month as
Chairman of the Board of Directors of the Company.
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE. The following table sets forth the compensation
earned by the Company's former Chief Executive Officer, President and each of
the other four most highly compensated officers of the Company and its operating
subsidiary (collectively, the "Named Executive Officers") for services rendered
in all capacities to the Company during fiscal 1996:
<TABLE>
<CAPTION>
ANNUAL
COMPENSATION
------------------------------------
ALL OTHER
NAME AND POSITION SALARY BONUS COMPENSATION
- ---------------------------------------------------------------------------- ---------- --------- -------------
<S> <C> <C> <C>
William E. Freeman.......................................................... -- -- $ 24,000(1)
Chairman of the Board
Chief Executive Officer until Sept. 1996
Charles R. Cumello.......................................................... $ 220,200 $ 28,000 76,969
President
J. Bayard Kelly............................................................. 189,423 10,000 6,513
Founder and President until Sept. 1995;
Consultant and Chairman Emeritus from Sept. 1995
Glen J. Franchi............................................................. 148,462 8,000 5,604
Executive Vice President and Treasurer
Michael Powell.............................................................. 123,462 -- 4,076
Vice President, Store Operations
Joseph M. Cabon............................................................. 117,539 5,000 4,524
Vice President, Distribution
Robert Krentzman............................................................ 110,154 5,000 4,744
Vice President, MIS
</TABLE>
- ------------------------
(1) Represents compensation for services rendered as a director and the Chairman
of the Board of Directors of the Company. Mr. Freeman received no
compensation for services rendered in his capacity as Chief Executive
Officer.
34
<PAGE>
OPTION GRANTS, EXERCISES AND HOLDINGS
FISCAL 1997 OPTION GRANTS. The following table sets forth certain
information regarding options granted to the Named Executive Officers from June
30, 1996 to the date of this Prospectus:
OPTION GRANTS IN CURRENT FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZED
-------------------------------------------------------- VALUE AT ASSUMED
NUMBER OF PERCENTAGE OF ANNUAL RATES OF STOCK
SECURITIES TOTAL PRICE APPRECIATION FOR
UNDERLYING OPTIONS GRANTED EXERCISE OPTION TERM
OPTIONS TO EMPLOYEES IN PRICE EXPIRATION ----------------------
NAME GRANTED FISCAL YEAR ($/SHARE) DATE 5%($) 10%($)
- ---------------------------------- ----------- ----------------- ----------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
William E. Freeman................ 40,160 11.2% $ 2.49 7/12/06 $ 585,316 $ 941,649
40,160 11.2% 2.49 8/3/06 585,316 941,649
Charles R. Cumello................ -- -- -- -- -- --
J. Bayard Kelly................... 20,080 5.6% 2.49 7/12/06 292,658 470,824
Glen J. Franchi................... 20,080 5.6% 2.49 7/12/06 292,658 470,824
Michael Powell.................... -- -- -- -- -- --
Joseph M. Cabon................... -- -- -- -- -- --
</TABLE>
FISCAL 1996 OPTION GRANTS. No options were granted to any of the Named
Executive Officers during fiscal 1996.
FISCAL 1996 OPTION EXERCISES AND HOLDINGS. The following table sets forth
certain information regarding options held at June 29, 1996. No options were
exercised during fiscal 1996 by the Named Executive Officers.
AGGREGATE OPTIONS EXERCISED IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING VALUE OF UNEXERCISED IN-
UNEXERCISED OPTIONS AT THE-MONEY OPTIONS AT
FISCAL YEAR-END FISCAL YEAR-END(1)
-------------------------- --------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---------------------------------------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
William E. Freeman........................................ 40,160(2) -- $ 107,629 --
Charles R. Cumello........................................ 35,140 105,420 28,462 $ 85,386
J. Bayard Kelly........................................... 66,866 27,510 140,102 17,077
Glen J. Franchi........................................... 33,734 18,474 19,517 9,758
Michael Powell............................................ 12,048 -- 3,253 --
Joseph M. Cabon........................................... 5,020 15,060 4,066 12,198
</TABLE>
- ------------------------
(1) Calculated based on fair market value of the Common Stock at June 29, 1996,
determined by the Board of Directors to be $3.30 per share, less the
exercise price.
(2) Members of Mr. Freeman's family also hold options to purchase an additional
40,160 shares of Common Stock, of which Mr. Freeman disclaims beneficial
ownership.
35
<PAGE>
INCENTIVE STOCK PROGRAM
The Company believes that fostering an ownership culture encourages superior
performance by the Company's management and key store employees. To that end,
the Company has adopted a program to provide to officers, employees,
consultants, sponsors and directors of the Company equity incentives that are
designed to create such an ownership culture and to encourage these officers,
employees and directors to remain with Company. The components of such program
are as follows:
1996 EMPLOYEE STOCK PURCHASE PLAN. The Company's 1996 Employee Stock
Purchase Plan (the "Purchase Plan") was adopted by the Board of Directors and
approved by the Company's stockholders in September 1996 and will be effective
as of the date of this offering. The Purchase Plan has a term of ten years and
is administered by the Compensation Committee of the Board of Directors. Not
more than 1,000,000 shares of Common Stock (subject to certain recapitalization
adjustments) shall be made available for purchase under the Purchase Plan. The
Purchase Plan is intended to qualify under Section 423 of the Internal Revenue
Code of 1986, as amended (the "Code") and is designed to be implemented through
consecutive calendar quarter offering periods during its term. Under the
Purchase Plan, any employee who is employed by the Company for at least 20 hours
per week and more than five months in any calendar year, and who has worked for
the Company for at least 1,000 hours as of the first day of the offering period,
is eligible to participate in the Purchase Plan; however, such 1,000 hour
requirement does not apply to any employee employed on the date of this
offering. An eligible employee may purchase shares of Common Stock from the
Company through payroll deductions of up to 10% of compensation (including all
base straight time, gross earnings, overtime and shift premiums, sales
commissions, incentive compensation and bonuses, but excluding other
compensation) at a price per share equal to 90% of the fair market value (as
defined in the Purchase Plan) of the Common Stock as of the last day of any
offering period. For each employee, the aggregate total of all payroll
deductions accumulated under the Purchase Plan during any offering period may
not exceed $5,500. The first offering period commences on the effective date of
this offering, and ends on the last trading day of the fiscal quarter in which
the offering occurs. Each subsequent offering period begins on the first trading
day after the end of the preceding offering period and continues until the last
trading day of that fiscal quarter. An eligible employee may withdraw from the
Purchase Plan by providing written notice of the withdrawal to the Company. Upon
written notice of withdrawal, or whenever an employee ceases to meet the
eligibility requirements for the Purchase Plan, the employee's credited payroll
deductions and other payments that have not been used to exercise options under
the Purchase Plan will be paid to the employee at the end of the offering
period. An employee's withdrawal from the Purchase Plan will not affect the
employee's eligibility to participate in the Purchase Plan in subsequent
offering periods. The Purchase Plan may be amended or terminated by the Board of
Directors, provided that approval of stockholders will be obtained to the extent
that applicable law (including, without limitation, the Securities Exchange Act
of 1934, as amended, and the Code) so requires.
1989 STOCK OPTION PLAN. The Company's 1989 Stock Option Plan (the "1989
Option Plan") was adopted by the Board of Directors and approved by the
Company's stockholders on July 7, 1989 and has been amended from time to time
solely to reserve additional shares for future awards. At September 24, 1996 a
total of 191,601 shares of Common Stock were reserved for future issuance under
the 1989 Option Plan. The 1989 Option Plan is administered by the Compensation
Committee. Under the 1989 Option Plan, options may be granted to employees,
consultants, and directors. Only employees may receive incentive stock options,
which are intended to qualify for certain favorable tax treatment. The exercise
price of incentive stock options under the 1989 Option Plan must equal the fair
market value (as defined in the 1989 Option Plan) of the Common Stock on the
date of grant. Options granted under the 1989 Option Plan generally vest on an
annual basis over three or four years, and must be exercised within ten years.
Certain outstanding options granted to directors and consultants under the 1989
Option Plan vest and become fully exercisable upon the closing of this offering.
The 1989 Option Plan will terminate on the earlier to occur of July 6, 1999 or
the date on which all shares available for issuance under the 1989 Option Plan
shall have been issued pursuant to the exercise or cancellation of options
thereunder.
36
<PAGE>
INCENTIVE SAVINGS PLAN. The Company has in effect an Incentive Savings Plan
(the "Savings Plan"), which is a tax-qualified defined contribution plan for
employees meeting certain eligibility requirements. The Savings Plan permits
employees to elect to contribute up to 13% of their compensation to the Savings
Plan. The Company makes a matching contribution of one-third of the
participant's before-tax contribution for each calendar year, up to the lesser
of 6% of such participant's compensation for such calendar year, or the
statutory maximum (adjusted annually). Participants are vested in contributions
to the Incentive Savings Plan in proportions of 20%, 40%, 60%, 80% and 100%
after completion of one, two, three, four and five years of service,
respectively. Benefits are generally distributed after termination of employment
in the form of a lump sum.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION
DECISIONS
In fiscal 1996, the Compensation Committee of the Company was comprised of
William E. Freeman and Richard A. Doppelt. During such period, Mr. Freeman also
served as Chairman of the Board of Directors and Chief Executive Officer of the
Company.
EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT
The Company has an employment agreement with Charles R. Cumello (the
"Cumello Agreement"), dated as of April 10, 1995, which provides for Mr.
Cumello's employment as President and Chief Operating Officer at an annual base
salary of $175,000 effective through December 31, 1995 and $280,000, effective
as of January 1, 1996 (which amount was subsequently increased by the Board of
Directors to $295,000). In addition, pursuant to the Cumello Agreement, Mr.
Cumello was awarded a cash bonus of $28,000 for fiscal 1996, and is eligible for
future annual cash bonuses of up to $140,000. Furthermore, Mr. Cumello has been
awarded options to purchase 140,560 shares of Common Stock exercisable at $2.49
which vest in four equal annual installments commencing on April 10, 1996. In
the event the Cumello Agreement is terminated other than for "cause" (as defined
in the Cumello Agreement), Mr. Cumello is entitled to receive his then-in-effect
base salary and any applicable bonus for the 12 calendar months following
termination. In the event the Cumello Agreement is terminated for "cause," or if
Mr. Cumello terminates the Cumello Agreement, Mr. Cumello shall be entitled to
receive any unpaid salary (and, if terminated by Mr. Cumello, any unpaid bonus)
accrued as of the date of such termination, together with reimbursements for
certain expenses. The initial term of the Cumello Agreement was automatically
renewed on March 31, 1996, and will automatically renew for successive one-year
periods thereafter without further action on the part of the Company or Mr.
Cumello unless notice of non-renewal is given by either of them to the other at
least 30 days prior to the end of the then current term. Finally, the Cumello
Agreement contains a covenant not to compete on the part of Mr. Cumello for a
period of one calendar year commencing as of the termination of Mr. Cumello's
employment.
The Company entered into an agreement with Mr. J. Bayard Kelly dated as of
July 30, 1996 (the "Kelly Agreement") pursuant to which Mr. Kelly will serve as
a consultant to the Company through March 31, 1998. Pursuant to the terms of the
Kelly Agreement, until March 31, 1997, Mr. Kelly serves the Company as a
full-time consultant, receives an annual salary of $200,000 and remains eligible
for an annual performance bonus of up to a maximum of $50,000. From April 1997
until March 31, 1998, pursuant to the Kelly Agreement, Mr. Kelly will perform
consulting services to the Company on an "as needed" basis and will receive a
$100,000 fee and receive all Company benefits for which he is currently eligible
(without bonus). In addition, Mr. Kelly was granted 5,000 stock options under
the Kelly Agreement for the successful transition of his position with the
Company.
LIMITATION ON DIRECTORS' AND OFFICERS' LIABILITY
The Company's Restated Certificate of Incorporation provides that a director
of the Company shall not be personally liable to the Company or its stockholders
for monetary damages for breach of fiduciary duty as a director, except for
liability (i) for any breach of such director's duty of loyalty to the Company
or its stockholders, (ii) for acts or omissions not taken in good faith or which
involve intentional misconduct
37
<PAGE>
or a knowing violation of law, (iii) under Section 174 of the DGCL or (iv) for
any transaction from which such director derived any improper personal benefit.
The Company's Restated Certificate of Incorporation and By-Laws also provide
that the Company shall indemnify its directors and officers to the fullest
extent permitted by Delaware law.
The Company believes that these provisions will assist it in attracting and
retaining qualified individuals to serve as directors and officers.
CERTAIN TRANSACTIONS
In October 1995, the Company made a bridge loan to Charles R. Cumello,
President of the Company, in the original principal amount of $175,000, bearing
interest per annum at the prime rate of Bank One, to assist with relocation
expenses. The full amount of the loan was paid by Mr. Cumello in August 1996.
In October 1996, the Company made a bridge loan to Thomas W. Stoltz, Vice
President, Finance of the Company in the original principal amount of $100,000,
bearing no interest, to assist with relocation expenses. The full amount of the
loan is currently outstanding and is due no later than October 25, 1997.
Since 1990, the Company has, from time to time, purchased merchandise from
overseas suppliers through TRIWEF Corporation/Triad Sales International
("Triad"), an import/export firm which operates overseas buying offices, in
which Mr. Freeman retains a beneficial interest. Mr. Freeman was an officer and
director of Triad until he resigned as an officer in 1985 and as a director in
1992. Mr. Freeman performs consulting services on occasion to Triad on matters
unrelated to the Company's business. The aggregate annual merchandise purchased
by the Company from or through Triad amounted to $3,246,000 (representing 8.6%
of total purchases) for fiscal 1995 and $3,548,000 (representing 6.2% of total
purchases) for fiscal 1996. The Board of Directors (acting without Mr. Freeman)
determined that the services provided by Triad are on terms at least as
favorable to the Company as those which could have been obtained from
unaffiliated third parties.
The Company and its stockholders are currently parties to certain
stockholder agreements, which, among other things, provide for voting
arrangements among the stockholders with respect to the election of the Board of
Directors. See "Management--Executive Officers and Directors." Upon the
conversion of the Convertible Preferred Stock into Common Stock in connection
with this offering, the voting provisions of these stockholders agreements will
terminate and the rights of the stockholders of the Company in connection
therewith shall cease.
38
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth information known to the Company with respect
to the beneficial ownership of its Common Stock as of November 19, 1996, and as
adjusted to reflect the sale of Common Stock offered hereby, by (i) each person
or entity who is known by the Company to own beneficially more than 5% of the
Common Stock, (ii) each of the Company's directors, (iii) each Named Executive
Officer, (iv) all directors and executive officers as a group and (v) each
Selling Stockholder.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO NUMBER OF OWNED AFTER
OFFERING(1)(2) SHARES OFFERING(1)(2)(3)
--------------------- BEING -----------------------
NAME AND ADDRESS NUMBER PERCENT OFFERED NUMBER PERCENT
- ---------------------------------------------------------------- ---------- --------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Garlen Investments Limited(4)................................... 1,131,708 27.8% -- 1,131,708 17.1%
c/o Jarir Investments
Post Office Box 3196
Riyadh 11471
Saudi Arabia
Allstate Insurance Company(5)................................... 873,357 21.5% -- 873,357 13.2%
3075 Sanders Road
Allstate Plaza
Northbrook, IL 60062
Jasmine Trustees Ltd. .......................................... 381,398 9.4% -- 381,398 5.8%
Post Office Box 675
Vine Street Chambers
Vine Street, St. Helier
Jersey, Channel Islands
United Kingdom
Bessemer Venture Partners FCOA.................................. 374,250 9.2% -- 374,250 5.7%
83 Walnut Street
Wellesley Hills, MA 02181
Othman M. Al Rasheed............................................ 286,501 7.0% -- 286,501 4.3%
c/o Jarir Investments
Post Office Box 3196
Riyadh 11471
Saudi Arabia
William E. Freeman(6)........................................... 221,683 5.3% -- 221,683 3.3%
J. Bayard Kelly(7).............................................. 188,109 4.6% 40,000 148,109 2.2%
Michael I. Barach(8)............................................ 20,080 * -- 20,080 *
Richard A. Doppelt(9)........................................... 20,080 * -- 20,080 *
Bart A. Brown, Jr.(9)........................................... 20,080 * -- 20,080 *
Robert C. Blattberg(9).......................................... 20,080 * -- 20,080 *
Stewart M. Kasen(9)............................................. 20,080 -- -- 20,080 *
James L. Nouss, Jr.(9).......................................... 20,080 * -- 20,080 *
Charles R. Cumello(10).......................................... 40,360 * -- 40,360 *
Glen J. Franchi(11)............................................. 33,734 * -- 33,734 *
Michael Powell(12).............................................. 12,048 * -- 12,048 *
Joseph M. Cabon(13)............................................. 5,020 * -- 5,020 *
Robert Krentzman(14)............................................ 9,236 * -- 9,236 *
All directors and officers
as a group (19 persons)(15)................................... 656,873 14.5% 40,000 616,873 8.7%
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO NUMBER OF OWNED AFTER
OFFERING(1)(2) SHARES OFFERING(1)(2)(3)
--------------------- BEING -----------------------
NAME AND ADDRESS NUMBER PERCENT OFFERED NUMBER PERCENT
- ---------------------------------------------------------------- ---------- --------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Other Selling Stockholders:
Sirrom Capital Corporation(16)................................ 119,371 2.9% 25,000 94,371 *
Richard E. Bruce.............................................. 46,786 1.1% 10,000 36,786 *
Robin C. Freeman(17).......................................... 20,080 * -- 20,080 *
Robin C. Freeman(18).......................................... 20,080 * 2,000 18,080 *
</TABLE>
- ------------------------
* Less than one percent
(1) Based on 4,068,394 shares of Common Stock outstanding prior to this
offering.
(2) In computing the number of shares beneficially owned by an organization or
individual and the percentage ownership of that organization or individual
shares of Common Stock subject to options or warrants held by that
organization or individual which are currently exercisable, exercisable
within 60 days of November 19, 1996 or exercisable upon an underwritten
initial public offering (an "IPO") are deemed outstanding. However, such
shares are not deemed outstanding for the purposes of computing the
percentage ownership of each other organization or individual.
(3) Based on the additional 2,550,000 shares of Common Stock to be issued by the
Company in this offering.
(4) Garlen Investments Limited is beneficially owned by Mandataria Fiduciary
Limited, as trustee of a trust for the benefit of Muhammad Abdul Rahman
Al-Agil, Nasser Abdul Rahman Al-Agil, Abdullah Abdul Rahman Al-Agil,
Abdulkarim Abdul Rahman Al-Agil and Abdulsalam Abdul Rahman Al-Agil.
(5) Allstate Insurance Company is the beneficial owner of 873,356 shares of the
Common Stock which are held by the following owners of record: Allstate
Insurance Company--560,552, Allstate Life Insurance Company--225,498,
Continental Trust Company as Trustee for the Allstate Retirement
Plan--49,878 and Continental Trust Company as Trustee for the Agents Pension
Plan--37,428.
(6) Includes options to purchase 120,480 shares which are immediately
exercisable and an additional 80,320 shares which will be exercisable upon
an IPO.
(7) Includes options to purchase 64,256 shares which are immediately exercisable
and an additional 50,200 shares which will be exercisable upon an IPO. All
of the Common Stock and options to purchase Common Stock are held in the
Revocable Living Trust for J. Bayard Kelly, of which Mr. Kelly is the
beneficial owner.
(8) Consists of options to purchase 20,080 shares which are exercisable upon an
IPO. Does not include shares listed above owned by Bessemer Venture Partners
FCOA, which is a special purpose general partnership, whose managing partner
is Bessemer Venture Partners III L.P. Mr. Barach is a partner of the general
partner of, and has a pecuniary interest in, Bessemer Venture Partners III
L.P., and disclaims beneficial ownership except to the extent of his
partnership interest.
(9) Consists of options to purchase 20,080 shares which are exercisable upon an
IPO.
(10) Includes options to purchase 35,140 shares which are immediately
exercisable.
(11) Consists of options to purchase 4,016 shares which are immediately
exercisable and an additional 29,718 shares which will be exercisable upon
an IPO.
(12) Consists of options to purchase 12,048 shares which are immediately
exercisable.
(13) Consists of options to purchase 5,020 shares which are immediately
exercisable.
(14) Consists of options to purchase 2,008 shares which are immediately
exercisable and an additional 7,228 shares which will be exercisable upon an
IPO.
40
<PAGE>
(15) Includes options to purchase 298,087 shares which are immediately
exercisable and an additional 173,891 shares which will be exercisable upon
an IPO.
(16) Consists of warrants to purchase 119,371 shares.
(17) Consists of options to purchase 20,080 shares which will be exercisable
upon an IPO.
(18) As Custodian under NJUGMA for Andrea St. John Freeman; consists of options
to purchase 20,080 shares which are immediately exercisable.
41
<PAGE>
DESCRIPTION OF CAPITAL STOCK
GENERAL
As of the date of this Prospectus, the authorized capital stock of the
Company consists of (i) 1,600,000 shares of Common Stock, of which 232,500
shares are issued and outstanding, (ii) 205,000 shares of Non-Voting Common
Stock, none of which are issued and outstanding, and (iii) 84,750 shares of
Convertible Preferred Stock, of which 78,055 shares are issued and outstanding.
Upon the effectiveness of the Registration Statement, each share of Convertible
Preferred Stock will be converted into ten shares of Common Stock, or an
aggregate of 780,550 shares of Common Stock, and each share of Non-Voting Common
Stock will be converted into one share of Common Stock. Immediately prior to the
consummation of this offering, the capital stock of the Company will
automatically split on a one to 4.016 basis and there will be issued and
outstanding 4,068,394 shares of Common Stock. Upon conversion of the Convertible
Preferred Stock and Non-Voting Common Stock, all of the rights and designations
of the Convertible Preferred Stock and Non-Voting Common Stock, respectively,
will be automatically cancelled. Simultaneously therewith, the Company will file
a Restated Certificate of Incorporation with the Secretary of State of Delaware
providing for authorized capital stock of (i) 50,000,000 shares of Common Stock
and (ii) 10,000,000 shares of Preferred Stock. In addition, the Restated
Certificate of Incorporation will provide for the redesignation of the Common
Stock from no par value per share to $0.01 par value per share.
The following description provides a summary of the material rights and
limitations relating to ownership of the Company's capital stock. For a complete
legal description of the Company's capital stock, reference should be made to
the Restated Certificate of Incorporation and Amended and Restated By-Laws (the
"By-Laws"), copies of which are included as exhibits to the Registration
Statement of which this Prospectus is a part.
COMMON STOCK
Upon consummation of the offering of the shares of Common Stock offered
hereby, there will be 6,618,394 shares of Common Stock outstanding. An aggregate
of 1,064,641 shares of Common Stock are issuable upon exercise of outstanding
stock options and 191,601 shares of Common Stock are reserved for issuance under
the 1989 Stock Option Plan. All outstanding shares of Common Stock are, and the
shares to be issued in this offering will be, fully paid and non-assessable.
Each share of Common Stock is entitled to one vote on matters for which a vote
is required or allowed, and the Common Stock does not have cumulative voting
rights. Subject to preferences that may be applicable to any outstanding
Preferred Stock upon its designated issuance, the holders of Common Stock are
entitled to receive ratably such dividends, if any, as may be declared from time
to time by the Board of Directors out of funds legally available for that
purpose. See "Dividend Policy." In the event of a liquidation, dissolution or
winding up of the Company, holders of Common Stock are entitled to share ratably
in all assets remaining after payment of the Company's liabilities and the
liquidation preference of the Preferred Stock, if any, then outstanding. The
rights, preferences and privileges of holders of Common Stock are subject to,
and may be adversely affected by, the rights of holders of shares of any
Preferred Stock that the Company may designate and issue in the future. The
Common Stock has no preemptive or conversion rights or other subscription
rights. There are no redemptive or sinking fund provisions applicable to the
Common Stock.
PREFERRED STOCK
Upon consummation of this offering, under the Restated Certificate of
Incorporation, the Board of Directors will have the authority, without any
further vote or action by the stockholders, to provide for the issuance of up to
10,000,000 shares of Preferred Stock from time to time in one or more series
with such designations, powers, rights, preferences, qualifications, limitations
and restrictions as the Board of Directors may determine, including dividend
rates and priority redemption provisions, liquidation preferences, sinking fund
provisions, conversion rights, voting rights and the number of shares
constituting any series of Preferred Stock. Although it is not possible to state
the effect that any issuance of Preferred Stock might have on the rights of
holders of Common Stock, the issuance of Preferred Stock may have one or more of
the following effects: (i) restriction of Common Stock dividends if Preferred
Stock dividends have
42
<PAGE>
not been paid, (ii) dilution of the voting power and equity interest of holders
of Common Stock to the extent that any series of Preferred Stock has voting
rights or is convertible into Common Stock or (iii) prevention of current
holders of Common Stock from participating in the Company's assets upon
liquidation until any liquidation preferences granted to holders of Preferred
Stock are satisfied. In addition, the issuance of Preferred Stock may, under
certain circumstances, have the effect of discouraging a change in control of
the Company by, for example, granting voting rights to holders of Preferred
Stock that require approval by the separate vote of the holders of Preferred
Stock for any amendment to the Restated Certificate of Incorporation or for any
reorganization, consolidation, merger or other similar transaction involving the
Company. As a result, the issuance of such Preferred Stock may discourage bids
for the Common Stock at a premium over the market price therefor and could have
the effect of delaying, deferring or preventing a change of control of the
Company.
CERTAIN ANTI-TAKEOVER MATTERS
The Company is subject to the provisions of Section 203 of the DGCL
("Section 203"). Section 203 prohibits a publicly held Delaware corporation from
engaging in a "business combination" with any person (together with affiliates
and associates) acquiring 15% or more of the voting stock of the Company (an
"interested stockholder") for a period of three years following the date of such
acquisition, unless (i) the corporation has elected in its original certificate
of incorporation not to be governed by Section 203, (ii) the business
combination was approved by the Board of Directors of the corporation before the
other party to the business combination became an interested stockholder, (iii)
upon consummation of the transaction that made such person an interested
stockholder, the interested stockholder owned at least 85% of the voting stock
of the corporation outstanding at the commencement of the transaction (excluding
voting stock owned by directors who are also officers or held in employee
benefit plans in which the employees do not have a confidential right to tender
or vote stock held by the plan) or (iv) the business combination was approved by
the Board of Directors of the corporation and ratified by two-thirds of the
voting stock which is not owned by the interested stockholder. The three-year
prohibition also does not apply to certain business combinations proposed by an
interested stockholder following the announcement or notification of certain
extraordinary transactions involving the corporation and a person who was not an
interested stockholder during the previous three years or who became an
interested stockholder with the approval of the majority of the corporation's
directors. The term "business combination" is defined generally to include
mergers or consolidations between a Delaware corporation and an "interested
stockholder," transactions with an interested stockholder involving the assets
or stock of the corporation or its majority owned subsidiaries and transactions
that increase an "interested stockholder's" percentage ownership of stock.
Section 203 could prohibit or delay a merger, takeover or other change in
control of the Company and therefore could discourage attempts to acquire the
Company.
Under the Restated Certificate of Incorporation, special meetings of the
stockholders may only be called by resolution of the Board of Directors or by
the Chairman of the Board of Directors or President; provided, however, special
meetings of the stockholders shall also be called by the Chairman of the Board
of Directors, President or Secretary upon the written request (stating the
purpose or purposes of the meeting) of a majority of the members of the Board of
Directors or a majority of the stockholders.
The Restated Certificate of Incorporation also provides that no action
required to be taken or which may be taken at any annual or special meeting of
stockholders of the Company may be taken except at a duly called meeting of the
stockholders of the Company, or upon the unanimous written consent of the
stockholders entitled to vote at such meeting. Further, stockholders may only
propose actions to be taken by the Company and nominate members of the Board of
Directors upon 90 days' prior written notice to the Company.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is Registrar and
Transfer Company of Cranford, New Jersey.
43
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the offering, the Company will have 6,618,394 shares of
Common Stock outstanding. All shares of Common Stock being sold hereby will be
freely tradable without restriction or further registration under the Securities
Act, except for shares purchased by "affiliates" of the Company which will be
subject to the resale limitations under Rule 144 under the Securities Act ("Rule
144"). All remaining shares were issued and sold by the Company in private
transactions and are "restricted" stock within the meaning of Rule 144.
Consequently, such shares may not be resold unless they are registered under the
Securities Act or are sold pursuant to an applicable exemption from
registration, such as Rule 144 or Rule 144A under the Securities Act ("Rule
144A").
The Company, and each of its executive officers, directors and consultants
and certain stockholders of the Company and certain key employees who hold
options to purchase 803,200 shares of Common Stock, and holders of the
Subordinated Debentures who hold warrants to purchase 195,594 shares of Common
Stock, have agreed not to offer, sell, contract to sell, grant any option to
sell, or otherwise dispose of any shares of Common Stock (or any securities
convertible into or exchangeable for Common Stock or warrants or other rights to
purchase Common Stock) until the end of the Lock-Up Period without the prior
written consent of Alex. Brown & Sons Incorporated, except with respect to the
Company and the Selling Stockholders, for the sale of shares of Common Stock
offered hereby. Following the expiration of the Lock-Up Period, 3,828,234 shares
of Common Stock may be sold pursuant to a registration statement or an exemption
from registration, including Rule 144 under the Securities Act. See
"Underwriting."
In general, under Rule 144 as currently in effect, a stockholder (or
stockholders whose shares are aggregated) who has beneficially owned
"restricted" shares (as defined under Rule 144) for at least two years, and any
affiliate who owns shares that are not "restricted" shares, is entitled to sell,
within any three-month period, a number of shares that does not exceed the
greater of (i) one percent of the then outstanding shares of Common Stock or
(ii) the average weekly trading volume of the Common Stock reported through the
Nasdaq Stock Market during the four calendar weeks preceding the date on which
notice of the sale is filed with the Securities and Exchange Commission (the
"Commission"). Sales under Rule 144 are subject to certain manner of sale
provisions, notice requirements and the availability of current public
information about the Company. In addition, a stockholder who is not deemed an
affiliate of the Company at any time during the 90 days preceding a sale and who
has beneficially owned his shares for at least three years, is entitled to sell
such shares under Rule 144(k) without regard to volume limitations, manner of
sale provisions, notice requirements or the availability of current public
information concerning the Company. Rule 144A under the Securities Act permits
the immediate sale by the current holders of "restricted" shares of all or a
portion of their shares to certain qualified institutional buyers, as defined in
Rule 144A.
The Commission has proposed certain amendments to Rule 144 that would reduce
by one year the holding periods required for shares subject to Rule 144 to
become eligible for resale in the public market. This proposal, if adopted,
would accelerate by one year the dates on which shares of Common Stock will
become eligible for resale described above. No assurance can be given concerning
whether or when the proposal will be adopted by the Commission.
Any employee, officer or director of or consultant to the Company who was
granted options or purchased his or her shares upon exercise of such options
pursuant to a written compensatory plan or contract ("Rule 701 Shares") is
entitled to rely upon the resale provisions of Rule 701. Rule 701 permits
non-affiliates to sell their Rule 701 Shares without having to comply with the
public information, holding period, volume limitation or notice provisions of
Rule 144 and permits affiliates to sell their Rule 701 Shares without having to
comply with the holding period restrictions of Rule 144, in each case commencing
90 days after the date of this Prospectus.
The Company has granted options to purchase 1,064,641 shares of Common Stock
to certain sponsors, directors, officers, consultants and key employees pursuant
to the Company's 1989 Stock Option Plan.
After this offering, subject to the lock-up agreements described herein,
holders of 3,791,394 shares of Common Stock and the holders of the Subordinated
Debentures, who hold warrants to acquire 195,594
44
<PAGE>
shares of Common Stock, are entitled to certain rights with respect to the
registration of such shares under the Securities Act. Registration of such
shares under the Securities Act would result in such shares becoming freely
tradable without restriction under the Securities Act immediately upon the
effectiveness of such registration. See "Description of Capital
Stock--Registration Rights."
The Company intends to file a Registration Statement on Form S-8 under the
Securities Act to register the shares of Common Stock reserved for issuance
under the 1989 Stock Plan and the 1996 Stock Purchase Plan. Shares of Common
Stock issued under either plan after the effective date of such Registration
Statement generally will be available for sale in the open market by holders who
are not affiliates of the Company.
Holders of 3,791,394 shares of Common Stock (the "Registrable Securities")
are entitled to certain rights with respect to the registration of such shares
under Securities Act. In the event that the Company proposes to register any of
its securities under the Securities Act, other than pursuant to a Demand
Registration (as defined below) and the form used to register such securities
may be used for the registration of Registrable Securities, the holders of
Registrable Securities are entitled, subject to certain conditions and
limitations, to include such Registrable Securities in such registration.
Holders of 3,751,234 Registrable Securities have agreed to not exercise any
registration rights in connection with this offering and until the expiration of
the Lock-Up Period without the prior written consent of Alex. Brown & Sons
Incorporated. In addition, holders of a majority of each class (representing
each series of Convertible Preferred Stock which was converted into Common
Stock) of Registrable Securities (representing an aggregate of at least $7.5
million Registrable Securities) are entitled to request (on two occasions)
subject to certain conditions, that the Company register under the Securities
Act on a registration statement on Form S-1 (or any similar long form) all or a
portion of their Registrable Securities (a "Long Form Demand Registration"). The
holders of a majority of each class of Registrable Securities may also request
an unlimited number of registrations under the Securities Act on a registration
statement on Form S-2 or S-3 (or any similar short form) (a "Short Form Demand
Registration" and together with a Long Form Demand Registration, a "Demand
Registration").
Holders of the Subordinated Debentures also hold warrants to acquire 195,594
shares of Common Stock and are entitled to certain rights with respect to the
registration of such shares. In the event that the Company proposes to register
any of its securities under the Securities Act, other than pursuant to a Demand
Registration, and the form used to register such securities may be used for the
registration of the shares of Common Stock underlying such warrants, such
holders are entitled, subject to certain conditions and limitations, to include
such shares of Common Stock in such registration. The holders of the
Subordinated Debentures have agreed to not exercise any registration rights in
connection with this offering and until the expiration of the Lock-Up Period
without the prior written consent of Alex. Brown & Sons Incorporated.
Prior to this offering, there has been no public market for the Common Stock
and there can be no assurances with respect to the effect, if any, that public
sales of shares or the availability of shares will have on the market price
prevailing from time to time. Sales of substantial amounts of Common Stock in
the public market following this offering, or the perception that such sales may
occur, could adversely affect the market price. See "Risk Factors--Shares
Eligible for Future Sale."
45
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the underwriting agreement (the
"Underwriting Agreement"), the Underwriters named below (the "Underwriters"),
through their representatives, Alex. Brown & Sons Incorporated and Piper Jaffray
Inc. (the "Representatives"), have severally agreed to purchase from the Company
and the Selling Stockholders the following respective numbers of shares of
Common Stock at the initial public offering price less the underwriting
discounts and commissions set forth on the cover page of this Prospectus:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
- --------------------------------------------------------------------------------- ----------
<S> <C>
Alex. Brown & Sons Incorporated.................................................. 940,000
Piper Jaffray Inc................................................................ 622,000
A.G. Edwards & Sons, Inc......................................................... 70,000
Goldman, Sachs & Co.............................................................. 70,000
Morgan Stanley & Co. Incorporated................................................ 70,000
Robertson, Stephens & Company LLC................................................ 70,000
Smith Barney Inc................................................................. 70,000
Robert W. Baird & Co. Incorporated............................................... 55,000
The Chicago Corporation.......................................................... 55,000
Dain Bosworth Incorporated....................................................... 55,000
Equitable Securities Corporation................................................. 55,000
Gruntal & Co. Incorporated....................................................... 55,000
Janney Montgomery Scott Inc...................................................... 55,000
C.L. King & Associates, Inc...................................................... 55,000
McDonald & Company Securities, Inc............................................... 55,000
Scott & Stringfellow, Inc........................................................ 55,000
Stephens Inc..................................................................... 55,000
Tucker Anthony Incorporated...................................................... 55,000
Wessels, Arnold & Henderson, L.L.C............................................... 55,000
Wheat First Butcher Singer....................................................... 55,000
----------
Total........................................................................ 2,627,000
----------
----------
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will
purchase all shares of the Common Stock offered hereby if any of such shares are
purchased.
The Company has been advised by the Representatives of the Underwriters that
the Underwriters propose to offer the shares of Common Stock to the public at
the initial public offering price set forth on the cover page of this Prospectus
and to certain dealers at such price less a concession not in excess of $0.35
per share. The Underwriters may allow, and such dealers may reallow, a
concession not in excess of $0.10 per share to certain other dealers. After the
initial public offering, the offering price and other selling terms may be
changed by the Representatives of the Underwriters.
The Company and the Selling Stockholders have granted to the Underwriters an
option, exercisable not later than 30 days after the date of this Prospectus, to
purchase, pro rata, up to 394,050 additional shares of Common Stock at the
public offering price less the underwriting discounts and commissions set forth
on the cover page of this Prospectus. To the extent that the Underwriters
exercise such options, each of the Underwriters will have a firm commitment to
purchase approximately the same percentage thereof that the number of shares of
Common Stock to be purchased by it shown in the above table bears to 2,627,000,
and the Company and the Selling Stockholders will be obligated, pursuant to the
option, to sell such shares to the Underwriters. The Underwriters may exercise
such option only to cover over-allotments
46
<PAGE>
made in connection with the sale of Common Stock offered hereby. If purchased,
the Underwriters will offer such additional shares on the same terms as those on
which the 2,627,000 shares are being offered.
The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act.
The Company and each of its directors, executive officers and consultants
and holders of 3,828,234 shares of Common Stock and certain key employees who
hold options to purchase 803,200 shares of Common Stock and holders of warrants
to purchase 195,594 shares of Common Stock have agreed not to offer, sell,
contract to sell, grant any option to sell, or otherwise dispose of any of
shares of Common Stock (or any securities convertible into or exchangeable for
Common Stock or warrants or other rights to purchase Common Stock) for a period
of 180 days after the date of this Prospectus without the prior consent of the
Alex. Brown & Sons Incorporated. See "Shares Eligible for Future Sale."
The Representatives have advised the Company that the Underwriters do not
intend to confirm sales to any account over which they exercise discretionary
authority.
At the request of the Company, the Underwriters have reserved up to 258,000
shares of Common Stock for sale at the initial public offering price to certain
employees and other persons designated by the Company. The number of shares of
Common Stock available for sale to the general public will be reduced to the
extent such persons purchase such reserved shares. Any reserved shares not so
purchased will be offered by the Underwriters to the general public on the same
basis as the other shares offered hereby.
Prior to this offering, there has been no public market for the Common
Stock. Consequently, the initial public offering price for the Common Stock has
been determined by negotiation between the Company and the Representatives.
Among the factors considered in such negotiations were prevailing market
conditions, the results of operations of the Company in recent periods, the
market capitalizations and stages of development of other companies that the
Company and the Representatives believed to be comparable to the Company,
estimates of the business potential of the Company, the present state of the
Company's development and other factors deemed relevant.
LEGAL MATTERS
The validity of the issuance of the shares of Common Stock offered hereby
will be passed upon for the Company by Pitney, Hardin, Kipp & Szuch, Morristown,
New Jersey. Certain legal matters will be passed upon for the Underwriters by
Willkie Farr & Gallagher, New York, New York.
EXPERTS
The financial statements and schedule as of July 1, 1995 and June 29, 1996,
and for each of the years in the three-year period ended June 29, 1996, have
been included herein and in the Registration Statement of which this Prospectus
is a part in reliance upon the reports of KPMG Peat Marwick LLP, independent
certified public accountants, appearing elsewhere herein and in the Registration
Statement of which this Prospectus is a part, and upon the authority of said
firm as experts in accounting and auditing.
47
<PAGE>
ADDITIONAL INFORMATION
A Registration Statement on Form S-1 under the Securities Act relating to
the Common Stock offered hereby has been filed by the Company with the
Commission in Washington, D.C. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto, certain portions having been omitted from this Prospectus in
accordance with the rules and regulations of the Commission. Statements
contained in this Prospectus concerning the contents of any contract or any
other document referred to are not necessarily complete; reference is made in
each instance to the copy of such contract or document filed as an exhibit to
the Registration Statement, each such statement being qualified in all respects
by such reference. For further information with respect to the Company and the
Common Stock offered hereby, reference is made to such Registration Statement,
exhibits thereto and the financial statements, notes and schedules filed as a
part thereof. The Registration Statement may be inspected and copied at the
public reference facilities maintained by the Commission at 450 Fifth Street,
N.W., Washington, D.C. 20549, and at the Commission's regional offices located
in New York at Seven World Trade Center, New York, N.Y. 10007 and in Chicago at
Citicorp Center, Suite 1400, 500 West Madison Street, Chicago, Illinois 60661.
Copies of such materials, including the Registration Statement, can be obtained
from the Public Reference Section of the Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. The Commission also maintains a
World Wide Web site that contains reports, proxy and information statements, and
other information regarding registrants that file electronically with the
Commission. The site and this Registration Statement may be accessed at
http: //www.sec.gov. Copies of the Registration Statement may also be inspected
at the offices of Nasdaq Operations, 1735 K Street, N.W., Washington, D.C.
20006.
48
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----------
<S> <C>
ANNUAL
Independent Auditors' Report............................................................................. F-2
Consolidated Balance Sheets as of July 1, 1995 and June 29, 1996......................................... F-3
Consolidated Statements of Income for the fiscal years ended June 30, 1994, July 1, 1995 and June 29,
1996................................................................................................... F-4
Consolidated Statements of Stockholders' Equity for the fiscal years ended June 30, 1994, July 1, 1995
and June 29, 1996...................................................................................... F-5
Consolidated Statements of Cash Flows for the fiscal years ended June 30, 1994, July 1, 1995 and June 29,
1996................................................................................................... F-6
Notes to Consolidated Financial Statements............................................................... F-7
INTERIM
Consolidated Balance Sheets as of June 29, 1996 and September 28, 1996 (unaudited)....................... F-19
Consolidated Statements of Income for the 13-week periods ended September 30, 1995 and September 28, 1996
(unaudited) F-20
Consolidated Statements of Cash Flows for the 13-week periods ended September 30, 1995 and September 28,
1996 (unaudited)....................................................................................... F-21
Notes to Consolidated Financial Statements (unaudited)................................................... F-22
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Factory Card Outlet Corp.
We have audited the consolidated balance sheets of Factory Card Outlet Corp.
and subsidiary as of July 1, 1995 and June 29, 1996, and the related statements
of income, stockholders' equity and cash flows for each of the years in the
three-year period ended June 29, 1996. These consolidated financial statements
are the responsibility of the management of Factory Card Outlet Corp. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Factory Card
Outlet Corp. and subsidiary as of July 1, 1995 and June 29, 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended June 29, 1996 in conformity with generally accepted
accounting principles.
/s/ KPMG PEAT MARWICK LLP
Chicago, Illinois
September 30, 1996, except as to Note 12,
"Subsequent Events--Stock Split," which
is as of November 19, 1996
F-2
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JULY 1, JUNE 29,
1995 1996
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash............................................................................. $ 515,212 $ 202,344
Accounts receivable.............................................................. 29,152 248,888
Due from related parties......................................................... 92,844 187,711
Inventories...................................................................... 25,013,222 41,803,820
Prepaid expenses................................................................. 388,490 603,647
Deferred income taxes............................................................ 147,132 302,490
------------- -------------
Total current assets....................................................... 26,186,052 43,348,900
Fixed assets, net.................................................................. 10,178,726 14,923,891
Deferred financing costs........................................................... -- 244,405
Deferred income taxes.............................................................. 318,579 312,052
Other assets....................................................................... 117,758 250,594
------------- -------------
Total assets............................................................... $ 36,801,115 $ 59,079,842
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term obligations...................................... $ 534,036 $ 676,012
Accounts payable................................................................. 6,125,670 12,125,070
Due to related parties........................................................... 2,017,990 3,679,887
Income taxes payable............................................................. 41,699 282,771
Accrued expenses................................................................. 1,842,098 2,980,656
------------- -------------
Total current liabilities.................................................. 10,561,493 19,744,396
Revolving credit note payable...................................................... 5,800,000 13,127,155
Secured subordinated debentures, net of discount................................... -- 4,720,865
Long-term debt..................................................................... 751,661 664,223
Capital lease obligations.......................................................... 74,854 137,561
Deferred rent liabilities.......................................................... 2,973,018 3,561,851
------------- -------------
Total liabilities.......................................................... 20,161,026 41,956,051
------------- -------------
Stockholders' equity:
Preferred stock Series A and B convertible, $.01 par value. Authorized: Series
A--20,000 shares and Series B--34,750 shares. Issued and outstanding shares:
Series A--20,000 shares and Series B--32,416 shares............................ 14,456,506 14,456,506
Common stock, no par value, Voting class--1,600,000 shares authorized; 933,720
shares issued and outstanding; non-voting class--205,000 shares authorized, no
shares issued or outstanding................................................... 2,636,750 3,050,211
Accumulated deficit.............................................................. (453,167) (382,926)
------------- -------------
Total stockholders' equity................................................. 16,640,089 17,123,791
------------- -------------
Total liabilities and stockholders' equity................................. $ 36,801,115 $ 59,079,842
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED
-------------------------------------------
<S> <C> <C> <C>
JUNE 30, JULY 1, JUNE 29,
1994 1995 1996
------------- ------------- -------------
Net sales........................................................... $ 37,341,134 $ 63,174,091 $ 94,589,013
Cost of sales and occupancy....................................... 23,227,058 39,756,651 59,139,402
------------- ------------- -------------
Gross profit........................................................ 14,114,076 23,417,440 35,449,611
Selling, general and administrative expenses........................ 12,875,949 22,316,263 33,732,517
------------- ------------- -------------
Income from operations............................................ 1,238,127 1,101,177 1,717,094
Interest expense.................................................... 496,929 411,553 1,528,969
------------- ------------- -------------
Income before taxes............................................... 741,198 689,624 188,125
Income taxes........................................................ 292,093 322,100 117,884
------------- ------------- -------------
Net income........................................................ $ 449,105 $ 367,524 $ 70,241
------------- ------------- -------------
------------- ------------- -------------
Net income per common and common equivalent share................. $ 0.13 $ 0.08 $ 0.01
------------- ------------- -------------
------------- ------------- -------------
Weighted average common and common equivalent shares
outstanding..................................................... 3,396,644 4,838,570 5,049,869
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK TOTAL
------------------------ ----------------------- ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT DEFICIT EQUITY
--------- ------------- --------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1993................ 20,000 $ 2,823,163 803,200 $ 2,000,000 $ (1,015,711) $ 3,807,452
Net income.............................. -- -- -- -- 449,105 449,105
Series A convertible preferred stock
accreted redemption................... -- 254,085 -- -- (254,085) --
--------- ------------- --------- ------------ ------------- -------------
Balance at June 30, 1994................ 20,000 3,077,248 803,200 2,000,000 (820,691) 4,256,557
Net income.............................. -- -- -- -- 367,524 367,524
Issuance of Series B convertible
preferred stock....................... 32,416 11,379,258 -- -- -- 11,379,258
Common stock issued in lieu of
interest.............................. -- -- 66,264 236,750 -- 236,750
Acquisition of subsidiary minority
interest.............................. -- -- 64,256 400,000 -- 400,000
--------- ------------- --------- ------------ ------------- -------------
Balance at July 1, 1995................. 52,416 14,456,506 933,720 2,636,750 (453,167) 16,640,089
Net income.............................. -- -- -- -- 70,241 70,241
Additional paid in capital attributable
to common stock warrants.............. -- -- -- 413,461 -- 413,461
--------- ------------- --------- ------------ ------------- -------------
Balance at June 29, 1996................ 52,416 $ 14,456,506 933,720 $ 3,050,211 $ (382,926) $ 17,123,791
--------- ------------- --------- ------------ ------------- -------------
--------- ------------- --------- ------------ ------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED
-----------------------------------------
<S> <C> <C> <C>
JUNE 30, JULY 1, JUNE 29,
1994 1995 1996
------------ ------------ -------------
Cash flows from operating activities:
Net income......................................................... $ 449,105 $ 367,524 $ 70,241
Adjustments to reconcile net income to net cash used in operating
activities:
Depreciation and amortization of fixed assets.................... 808,164 1,446,370 2,544,310
Amortization of deferred financing costs and debt discount....... -- -- 221,948
Amortization of organization costs............................... 76,578 7,393 6,644
Accrual of stock on subordinated debentures and bridge loan...... 91,568 11,849 --
Deferred income taxes............................................ (131,752) (55,266) (148,831)
Loss (gain) on the disposal of equipment and vehicles............ 18,304 (2,210) 37,439
Change in assets and liabilities:
Decrease (increase) in assets:
Accounts receivable.......................................... 136,024 48,600 (314,603)
Inventories.................................................. (5,132,846) (9,131,663) (16,790,598)
Prepaid expenses............................................. (188,547) (78,267) (215,157)
Other assets................................................. (796) 21,390 (139,480)
Increase (decrease) in liabilities:
Accounts payable............................................. 1,414,275 1,823,227 7,661,297
Accrued expenses............................................. 539,786 790,944 1,138,558
Deferred rent liabilities.................................... 609,803 917,606 588,833
Income taxes payable......................................... 128,292 (287,109) 241,072
------------ ------------ -------------
Net cash used in operating activities................................ (1,182,042) (4,119,612) (5,098,327)
------------ ------------ -------------
Net cash used in investing activities--purchase of fixed assets...... (2,224,332) (6,864,952) (7,071,427)
------------ ------------ -------------
Cash flows from financing activities:
Borrowings under revolving credit note............................. 3,879,980 7,550,000 36,976,955
Repayment of borrowings under revolving credit note................ (1,500,000) (6,550,000) (29,649,800)
Proceeds (payment) of bridge loan.................................. 1,500,000 (1,500,000) --
Payments of long-term debt......................................... (276,230) (432,447) (538,242)
Proceeds from issuance of subordinated debentures.................. -- -- 4,667,973
Payment of subordinated debentures................................. (50,000) (450,000) --
Proceeds from issuance of Series B convertible preferred stock..... -- 11,379,258 --
Proceeds from term loan............................................ -- 1,100,000 400,000
------------ ------------ -------------
Net cash provided by financing activities............................ 3,553,750 11,096,811 11,856,886
------------ ------------ -------------
Net increase (decrease) in cash...................................... 147,376 112,247 (312,868)
Cash at beginning of year............................................ 255,589 402,965 515,212
------------ ------------ -------------
Cash at end of year.................................................. $ 402,965 $ 515,212 $ 202,344
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Factory Card
Outlet Corp. (the "Company") and its wholly owned subsidiary, Factory Card
Outlet of America, Ltd. ("FCO"). FCO is a chain of company-owned superstores
offering an extensive selection of party supplies, greeting cards, gift wrap,
and other special occasion merchandise at everyday value prices in 13 states,
primarily in the Midwest and mid-Atlantic regions of the United States.
All intercompany balances have been eliminated in consolidation.
FISCAL YEARS
In 1995, the Company adopted a policy in which its fiscal year ends on the
Saturday closest to June 30. The years ended July 1, 1995 and June 29, 1996,
referred to as fiscal 1995 and 1996, respectively, each reflect a 52-week
period. The year ended June 30, 1994 was a 365-day fiscal year.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period and related disclosures. Actual results
could differ from those estimates.
INVENTORIES
Inventories are stated at the lower of average cost or net realizable value.
All inventory is merchandise inventory. Cost has been determined by the retail
method of accounting for inventories. In determining the cost of inventory, the
Company includes costs incurred to purchase, store and distribute goods prior to
sale.
FIXED ASSETS
Fixed assets are stated at cost. Depreciation and amortization of fixed
assets is computed as follows:
<TABLE>
<CAPTION>
METHOD ESTIMATED USEFUL LIFE
-------------- ------------------------------------------------
<S> <C> <C>
Fixtures and equipment.......................... Straight-line 3 to 10 years
Leasehold improvements.......................... Straight-line Remaining initial term of the leases
</TABLE>
Amortization related to capital leases is included in depreciation and
amortization. Software costs are capitalized and amortized on a straight-line
basis over a three- or five-year period. Unamortized software costs included in
fixtures and equipment were $974,017 and $1,310,047 as of July 1, 1995 and June
29, 1996, respectively. Amortization of these software costs was $45,201 and
$337,187 for the fiscal years ended July 1, 1995 and June 29, 1996,
respectively.
ORGANIZATION COSTS
Organization costs were amortized using the straight-line method over a
five-year period. Accumulated amortization was $368,366 and $375,010 as of July
1, 1995 and June 29, 1996, respectively. At June 29, 1996, all organization
costs were fully amortized.
F-7
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company and its wholly owned subsidiary, FCO, file a consolidated
Federal income tax return. Deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between financial
reporting and tax bases of assets and liabilities and are measured using enacted
tax rates and laws that are expected to be in effect when the differences are
expected to reverse.
DEFERRED RENT LIABILITIES
Certain of the Company's operating leases provide for scheduled increases in
base rentals over their terms. For these leases, the Company recognizes the
total rental amounts due over the lease terms on a straight-line basis and,
accordingly, has established corresponding deferred rent liabilities for the
differences between the amounts recognized and the amounts paid. The Company
also receives certain lease incentives, primarily construction allowances. These
allowances have been deferred and are amortized on a straight-line basis over
the life of the lease as reductions of rent expense.
STORE PREOPENING EXPENSES
Store preopening costs, which include advertising, labor and supply costs,
are expensed within the fiscal year in which the related store is opened.
Prepaid expenses at July 1, 1995 and June 29, 1996, include $61,489 and $57,242,
respectively, of preopening costs for stores which have not yet been opened.
ADVERTISING EXPENSES
The Company expenses advertising costs when the advertising occurs.
Advertising production costs incurred before the advertising takes place are
recorded as prepaid assets. At July 1, 1995 and June 29, 1996, no amounts were
reported as prepaid. For the fiscal years ended June 30, 1994, July 1, 1995, and
June 29, 1996, advertising costs were $982,027, $1,464,354, and $2,471,996,
respectively.
EARNINGS PER SHARE
Earnings per share were computed by dividing net income by the weighted
average number of common shares and dilutive common equivalent shares
outstanding during the period. Dilutive common equivalent shares consist of
common shares issuable upon the conversion of the preferred stock and the
exercise of warrants and common stock options. Stock options issued during the
twelve-month period prior to the Company's initial public offering have been
included in the calculation as if they were outstanding for all periods
presented, even if antidilutive using the treasury stock method and the initial
public offering price.
F-8
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) FIXED ASSETS
<TABLE>
<CAPTION>
1995 1996
------------- -------------
<S> <C> <C>
Equipment and vehicles......................................... $ 10,452,017 $ 16,337,565
Leasehold improvements......................................... 3,389,984 4,578,763
------------- -------------
Total fixed assets............................................. 13,842,001 20,916,328
Less accumulated depreciation and amortization................. 3,663,275 5,992,437
------------- -------------
Fixed assets, net.............................................. $ 10,178,726 $ 14,923,891
------------- -------------
------------- -------------
</TABLE>
(3) DEBT
REVOLVING CREDIT AGREEMENT
The Company has a revolving credit agreement with its bank which permits the
Company to borrow up to a maximum $20,000,000. Advances under the agreement,
which expires December 31, 1996, are limited based on inventory levels as
defined in the agreement. Amounts outstanding under this and preceding
agreements totaled $13,127,155 and $5,800,000 at June 29, 1996 and July 1, 1995,
respectively. Interest is payable monthly at an annual rate equal to the bank's
prime rate on the first $15,000,000 of borrowings and the bank's prime rate plus
2 1/2% on the next $5,000,000. The bank's prime rate was 8.25% at June 29, 1996
and 9% at July 1, 1995. A fee of 1/4% per year is assessed on the unused portion
of the first $15,000,000 of the line. Borrowings under the revolving credit term
note are secured by all business assets of the Company. This agreement contains
restrictive covenants, the more significant of which require the maintenance of
minimum ratios of total liabilities to net worth and minimum levels of tangible
net worth and net working capital.
In September 1996, the Company entered into a new revolving credit agreement
with its bank which permits the Company to borrow up to a maximum $25,000,000.
Advances under the agreement, which expires October 1, 1998, are limited based
on inventory levels as defined in the agreement. Interest is payable monthly at
an annual rate equal to the bank's prime rate or, at the Company's option, 2.75%
over the London Interbank Offered Rate. A fee of 0.25% per year is assessed on
the unused portion of the line, except that if the unused portion exceeds
$20,000,000 the fee increases to 0.4%. Borrowings under the revolving credit
term note are secured by all business assets of the Company. This agreement
contains restrictive covenants, the more significant of which require the
maintenance of minimum ratios of total liabilities to net worth and minimum
levels of tangible net worth and net working capital.
SECURED SUBORDINATED DEBENTURES
On November 15, 1995, the Company entered into a $4,000,000 subordinated
debt agreement bearing interest at 12.5%. The debt is scheduled to mature on
November 15, 2000. For the first 18 months of the agreement, interest is payable
at a rate of 7.5% with the remaining 5% interest accruing until May 1, 1997,
when all unpaid interest is due and payable. At the time of issuance, the lender
received a warrant for the right to purchase 95,010 shares of the Company's
nonvoting common stock exercisable until November 30, 2000, at $0.0025 per
share. The number of shares available under the warrant increases over the term
of the debt. If the debt remains outstanding until maturity, the lender will
have the right to purchase a total of 215,659 shares.
F-9
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) DEBT (CONTINUED)
In June, 1996, the subordinated debt agreement was amended to increase the
borrowings by $1,000,000. The additional borrowings bear interest at 12.5%,
which is payable monthly. The lender also received a warrant to puchase 24,361
shares of the Company's nonvoting common stock exercisable until July 31, 2001,
at $.0025 per share. The additional borrowing is scheduled to mature June 27,
2001.
The fair market value of the warrants issued under the agreement was
$413,461 and was recorded as additional paid in capital on common stock and as a
discount on the face amount of the debt. The total amortization of the discount
and the related financing costs were $134,326 and $87,622, respectively, for the
fiscal year ended June 29, 1996.
LONG-TERM DEBT
Long-term debt consists principally of a term loan agreement and motor
vehicle and equipment loans.
<TABLE>
<CAPTION>
1995 1996
------------ ------------
<S> <C> <C>
Term loan......................................................... $ 1,100,000 $ 1,099,152
Various installment notes payable, due in monthly installments
through fiscal 2000, each including interest at rates ranging
from 2.9% to 11.36%, secured by motor vehicles.................. 148,273 118,276
------------ ------------
Total long-term debt.............................................. 1,248,273 1,217,428
Less current maturities of long-term debt......................... 496,612 553,205
------------ ------------
Long-term portion................................................. $ 751,661 $ 664,223
------------ ------------
------------ ------------
</TABLE>
On May 1, 1995 the Company entered into a term loan agreement with a bank
for $1,500,000. The term loan is secured by computer equipment and software.
Interest on the amount borrowed is calculated at a fixed rate of 8.08%. Payments
of principal and interest began July 31, 1995 and continue through June 30,
1998.
Maturities of long-term debt for each of the next five years are as follows:
<TABLE>
<CAPTION>
FISCAL YEAR AMOUNT
- -------------------------------------------------------------------------------- ------------
<S> <C>
1997............................................................................ $ 553,205
1998............................................................................ 649,288
1999............................................................................ 11,620
2000............................................................................ 3,315
2001............................................................................ --
------------
Total........................................................................... $ 1,217,428
------------
------------
</TABLE>
On April 20, 1994, the Company entered into a term loan agreement for
$1,500,000 with one of the Company's shareholders. This term loan matured and
was repaid on July 20, 1994. Interest on this loan accrued at a rate of 12% on
the outstanding and unpaid principal amount and was paid in common stock. In
addition, the Company paid a facility fee at maturity, as specified in the term
loan agreement.
F-10
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) DEBT (CONTINUED)
Subordinated debentures issued during fiscal year 1991, held by shareholders
and directors of the Company, matured on July 20, 1994. Interest on the
debentures accrued at the rate of 8.032 shares of common stock per quarter for
each $1,000 of debentures. Common stock totaling $236,750 was issued upon
maturity of the debentures in fiscal 1995.
(4) LEASE COMMITMENTS
The Company, through its FCO subsidiary, conducts substantially all of its
operations using leased premises. Store and office leases provide that real
estate taxes, insurance, maintenance, and operating expenses are obligations of
FCO and/or the Company. Certain store leases also provide for contingent rentals
based on sales in excess of specified minimums.
The cost of fixed assets held under capital leases and included in fixed
assets was $166,841 and $416,879 at July 1, 1995 and June 29, 1996,
respectively. Accumulated amortization related to such fixed assets was $34,513
and $77,628 at July 1, 1995 and June 29, 1996, respectively. Fixed assets held
under capital leases consists principally of office and warehouse equipment.
The following is a schedule of future minimum lease payments for capital and
operating leases with initial or remaining terms in excess of one year as of
June 29, 1996:
<TABLE>
<CAPTION>
CAPITAL OPERATING
FISCAL YEAR LEASES LEASES
- ------------------------------------------------------------------------------------- ---------- --------------
<S> <C> <C>
1997................................................................................. $ 145,129 $ 12,174,062
1998................................................................................. 89,372 12,918,620
1999................................................................................. 42,508 12,167,600
2000................................................................................. 21,080 11,739,569
Thereafter........................................................................... -- 52,973,872
---------- --------------
Total minimum lease payments......................................................... 298,089 101,973,723
Less amount representing interest.................................................... 37,721 --
---------- --------------
Present value of net minimum lease payments (including long-term obligations of
$137,561........................................................................... $ 260,368 $ --
---------- --------------
---------- --------------
</TABLE>
Rent expense charged to operations under operating leases was $3,930,191,
$5,904,484 and $10,213,885 in fiscal years 1994, 1995 and 1996, respectively.
F-11
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) INCOME TAXES
Income tax expense (benefit) consists of:
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
---------- ----------- ----------
<S> <C> <C> <C>
Year ended June 30, 1994:
U.S. Federal.............................................................. $ 331,526 $ (113,489) $ 218,037
State and local........................................................... 92,319 (18,263) 74,056
---------- ----------- ----------
$ 423,845 $ (131,752) $ 292,093
---------- ----------- ----------
---------- ----------- ----------
Year ended July 1, 1995:
U.S. Federal.............................................................. $ 321,114 $ (52,958) $ 268,156
State and local........................................................... 56,252 (2,308) 53,944
---------- ----------- ----------
$ 377,366 $ (55,266) $ 322,100
---------- ----------- ----------
---------- ----------- ----------
Year ended June 29, 1996:
U.S. Federal.............................................................. $ 257,675 $ (155,355) $ 102,320
State and local........................................................... 9,040 6,524 15,564
---------- ----------- ----------
$ 266,715 $ (148,831) $ 117,884
---------- ----------- ----------
---------- ----------- ----------
</TABLE>
Income tax expense differs from the amounts computed by applying the U.S.
Federal income tax rate of 34% to income before income taxes as a result of the
following:
<TABLE>
<CAPTION>
1994 1995 1996
----------------------- ----------------------- -----------------------
<S> <C> <C> <C> <C> <C> <C>
DOLLAR PERCENT DOLLAR PERCENT DOLLAR PERCENT
---------- ----------- ---------- ----------- ---------- -----------
Computed "expected" tax expense........................ $ 252,007 34.00% $ 234,472 34.00% $ 63,963 34.00%
Increase in income taxes resulting from:
State and local income taxes, net of Federal income
tax benefit........................................ 26,406 3.56 37,126 5.38 8,570 4.56
Non-deductible meals and entertainment............... 5,459 0.74 14,792 2.15 29,729 15.80
Non-deductible life insurance premiums............... -- -- 12,246 1.78 12,774 6.79
Non-deductible penalty............................... -- -- 11,751 1.70 -- --
Other, net........................................... 8,221 1.11 11,713 1.70 2,848 1.51
---------- ----- ---------- ----- ---------- -----
Income tax expense..................................... $ 292,093 39.41% $ 322,100 46.71% $ 117,884 62.66%
---------- ----- ---------- ----- ---------- -----
---------- ----- ---------- ----- ---------- -----
</TABLE>
F-12
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) INCOME TAXES (CONTINUED)
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
1994 1995 1996
---------- ---------- ------------
<S> <C> <C> <C>
Deferred tax assets:
Alternative minimum tax credit........................................... $ 115,854 $ 158,393 $ 382,682
Deferred rent liabilities................................................ 360,650 444,325 542,593
Accrued expenses......................................................... 147,552 149,634 209,652
Inventory shortage reserve............................................... -- -- 92,837
Debt discount and deferred financing costs............................... -- -- 60,211
---------- ---------- ------------
Total gross deferred tax assets............................................ 624,056 752,352 1,287,975
---------- ---------- ------------
Deferred tax liabilities:
Fixed assets............................................................. 156,563 284,140 673,433
Overhead capitalized in inventories...................................... 57,048 2,501 --
---------- ---------- ------------
Total gross deferred tax liabilities....................................... 213,611 286,641 673,433
---------- ---------- ------------
Net deferred tax asset..................................................... $ 410,445 $ 465,711 $ 614,542
---------- ---------- ------------
---------- ---------- ------------
</TABLE>
Management believes that, with respect to deferred tax assets, no valuation
allowance was necessary at July 1, 1995 and June 29, 1996. In assessing the
realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which temporary
differences become deductible. Management considers the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax planning
strategies in making this assessment. Based upon these criteria, management has
determined that it is more likely than not the Company will realize the benefits
of these deductible differences.
(6) STOCKHOLDERS' EQUITY
CONVERTIBLE PREFERRED STOCK--SERIES A AND B
Series A Convertible Preferred Stock, $.01 par value, was issued on July 10,
1989. Each share of this stock is convertible at the holders' discretion into
40.16 shares of common stock. Prior to the Series B Convertible Preferred Stock
offering outlined below, the Series A Convertible Preferred Stock was redeemable
at the holders' election at a price equal to the liquidation amount defined in
the stock purchase agreement plus 9% compounded annually from July 10, 1989,
reduced by any prior distribution amounts. Upon issuance of the Series B
Convertible Preferred Stock, accretion related to the Series A Convertible
Preferred Stock ceased and the redemption amount was fixed at $3,077,248.
Effective as of July 15, 1994, the Company entered into a stock purchase
agreement whereby it issued its Series B Convertible Preferred Stock, $.01 par
value per share. Each share of Series B Convertible Preferred Stock is
convertible at the holder's discretion into 40.16 shares of common stock. The
Company
F-13
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) STOCKHOLDERS' EQUITY (CONTINUED)
may require the conversion of all of the outstanding shares of Series B
Convertible Preferred Stock into shares of the Company's common stock in the
event of an underwritten public offering of shares of the Company's common stock
within the guidelines set forth in the stock purchase agreement.
At any time on or after June 15, 1999 and by majority vote, the Series B
Convertible Preferred stockholders have the option to elect to be redeemed as a
class. Upon such election, the Company will redeem all Series B Convertible
Preferred Stock in two equal installments, the first of which is payable 120
days following such election and the second payable one year thereafter. The
redemption provisions in place for the Series A Convertible Preferred Stock were
changed in conjunction with the issuance of the Series B Convertible Preferred
Stock so that the dates and terms are substantially identical to those of the
Series B Convertible Preferred Stock.
The Series A Convertible Preferred Stock and Series B Convertible Preferred
Stock (collectively, the "preferred stock") are structured as "participating"
preferred stock. That is, in the event of liquidation, dissolution, or winding
up of the Company, each holder of preferred stock will be entitled to be paid,
before any distribution or payment is made upon any junior securities, an amount
in cash equal to the aggregate liquidation value of all such holders' shares of
preferred stock, as determined in accordance with the terms of the Company's
Certificate of Incorporation, plus all accrued and unpaid dividends thereon.
The holders of preferred stock are entitled to vote with the holders of the
Company's common stock on each matter submitted to a vote of the Company's
stockholders, with each share of preferred stock having a number of votes equal
to the number of votes possessed by the number of shares of common stock into
which such share of preferred stock is convertible as of the record date for the
determination of stockholders entitled to vote on such matter.
ACQUISITION OF SUBSIDIARY'S MINORITY INTEREST
In September 1992, the Company entered into an agreement with The Card Mart
("Card Mart"), an entity in which a former director of the Company had a
partnership interest, to form FCOA-Baltimore. FCO managed the operations of
FCO-Baltimore, a chain of specialty stores in the Baltimore-Washington
metropolitan area offering a discount price format consistent with that of FCO's
other stores. Because FCOA-Baltimore was a controlled subsidiary, the
consolidated financial statements of the Company include the accounts of
FCOA-Baltimore.
In October 1994, FCOA-Baltimore was merged with and into FCO. In connection
with the merger, Card Mart, the holder of all of the FCOA-Baltimore preferred
stock, received 64,256 shares of the Company's common stock in exchange for its
interest in FCOA-Baltimore. The acquisition of this interest was accounted for
as a purchase. No goodwill was recognized for this transaction as the book value
of the net assets acquired approximated their fair market value.
PREFERRED STOCK
Preferred stock may be issued from time to time in one or more series at the
discretion of the Company's Board of Directors. Different series of preferred
stock shall not be construed to constitute different classes of shares for the
purposes of voting by classes unless expressly provided. All preferred stock
rights are granted at the discretion of the Board of Directors.
F-14
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) STOCKHOLDERS' EQUITY (CONTINUED)
COMMON STOCK
The voting, dividend, and liquidation rights of the holders of common stock
are subject to the rights of the holders of preferred stock of any series. The
holders of common stock are entitled to one vote for each share, except for the
holders of the non-voting class.
At June 29, 1996 shares of common stock were reserved for the following
purposes:
<TABLE>
<S> <C>
Conversion of Series A Convertible Preferred Stock............... 803,199
Conversion of Series B Convertible Preferred Stock............... 1,301,821
Exercise of outstanding stock options............................ 739,345
Granting of additional stock options............................. 212,446
Warrants convertible to nonvoting common stock................... 119,371
---------
3,176,182
---------
---------
</TABLE>
DIVIDEND RESTRICTIONS
The Company must obtain written consent from the holder of the revolving
credit note, the holders of the secured subordinated debentures and the consent
of a majority of the holders of the outstanding shares of Series A and Series B
Convertible Preferred Stock prior to declaring or paying dividends at any time.
(7) STOCK OPTION PLAN
A stock option plan was approved by the stockholders of the Company in July
1989 to provide additional incentives and opportunities through stock ownership
to employees, outside directors and consultants of the Company. Under the plan,
incentive stock options may be granted for the purchase of the Company's common
stock at an exercise price not less than 100% for the fair market value at the
time of grant as determined by the Board of Directors. The term of each option
is also determined by the Board of Directors, but shall not be more than ten
years from the date of grant. Options are exercisable in accordance with the
plan and generally vest at the rate of 20% to 25% per year from the date of
grant.
<TABLE>
<CAPTION>
1994 1995 1996
----------------------- ----------------------- -----------------------
<S> <C> <C> <C> <C> <C> <C>
NUMBER OPTION PRICE NUMBER OPTION PRICE NUMBER OPTION PRICE
OF SHARES PER SHARE OF SHARES PER SHARE OF SHARES PER SHARE
--------- ------------ --------- ------------ --------- ------------
Outstanding at beginning of year....... 261,040 $0.62-2.49 391,560 $0.62-6.23 707,217 $0.62-6.23
Options repurchased by Company......... -- -- (30,120) 6.23 -- --
Options forfeited...................... -- -- -- -- (40,160) 2.49-6.23
Granted................................ 130,520 6.23 345,777 2.49-6.23 72,288 2.49
--------- ------------ --------- ------------ --------- ------------
Outstanding at end of year............. 391,560 $0.62-6.23 707,217 $0.62-6.23 739,345 $0.62-6.23
--------- ------------ --------- ------------ --------- ------------
--------- ------------ --------- ------------ --------- ------------
Vested at end of year.................. 283,128 $0.62-6.23 303,208 $0.62-6.23 394,672 $0.62-6.23
Available for future grants at end of
year................................. 279,112 244,574 212,446
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-15
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) INCENTIVE SAVINGS PLAN
The Incentive Savings Plan (the Plan) is a defined contribution plan
sponsored by the Company for all eligible employees. Participants of the Plan
may elect to contribute between 2% and 13% of their pre-tax base salary, subject
to limitations imposed by the Internal Revenue Service.
The Company makes a discretionary matching contribution to the Plan at the
rate of 33% of the first 6% of the participant's contribution. For fiscal years
ended 1994, 1995 and 1996, the Company's discretionary matching contributions to
the Plan were $34,704, $53,661 and $86,043, respectively. The Plan also allows
for a discretionary base contribution to be made by the Company only if it has
current or accumulated net profits. No discretionary base contributions have
been made by the Company to date.
(9) RELATED-PARTY TRANSACTIONS
FCO made inventory purchases of $3,246,082 and $3,548,388 in fiscal 1995 and
1996, respectively, from a company which is beneficially owned by a stockholder
of the Company who is also a director of the Company. These purchases
represented approximately 8.6% and 6.2% of FCO's total inventory purchases in
fiscal 1995 and 1996, respectively. At July 1, 1995, FCO had no outstanding
amounts payable related to these purchases. At June 29, 1996, FCO owed $186,167
for these purchases.
During fiscal 1996, FCO entered into a 30-month supply agreement with Fine
Art Developments, p.l.c. (Fine Art), a publically owned United Kingdom company,
requiring FCO to purchase a minimum of 42% of its greeting card purchases from
Fine Art each year. During fiscal 1995 and 1996, FCO purchased $4,700,544 and
$4,927,014 of its greeting card purchases from Fine Art. At July 1, 1995 and
June 29, 1996, FCO owed $2,017,990 and $3,493,720 to Fine Art for these
purchases. In August 1996, Fine Art purchased 2,600 shares of convertible
preferred stock of the Company.
FCO also made wholesale sales of merchandise to Card Mart of approximately
$200,370 in fiscal 1994 and $282,246 in fiscal 1995. Included in the accounts
receivable balance at July 1, 1995 is approximately $41,325, relating to these
sales. FCOA-Baltimore engaged Card Mart to provide management and consulting
services, which subsequent to the merger of FCO and FCOA-Baltimore have been
discontinued. Management fees for fiscal years 1994, 1995 and 1996 were
$270,723, $168,929 and $30,000, respectively.
During fiscal 1996, the Company made a loan in the amount of $175,000 to its
President and Chief Executive Officer to assist with relocation expenses. The
loan bears interest at the prime rate of the Company's bank. The principal
balance of the loan was repaid in August 1996.
(10) SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
1994 1995 1996
---------- ---------- ------------
<S> <C> <C> <C>
Cash paid during the fiscal year for:
Interest................................................................. $ 403,799 $ 634,910 $ 1,173,344
Income taxes............................................................. 125,864 688,574 26,276
</TABLE>
Supplemental disclosure of non-cash financing activities:
Capital lease obligations incurred and notes payable on vehicle purchases
were $188,748, $191,938 and $255,487 in fiscal years 1994, 1995 and 1996,
respectively.
F-16
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(10) SUPPLEMENTAL CASH FLOW INFORMATION (CONTINUED)
The Company incurred charges of $91,568 in fiscal 1994 and $11,849 in fiscal
1995 in lieu of interest on the subordinated debentures and the bridge loan.
Accrued interest of $236,750 was repaid through the issuance of $236,750 of
common stock in fiscal 1995.
Additional paid in capital of $413,461 was recognized for the common stock
warrants issued during fiscal 1996.
The Company exchanged FCOA-Baltimore preferred stock of $400,000 to the
Company's common stock of $400,000 in fiscal 1995.
Accretion on Series A convertible preferred stock was $254,085 in fiscal
1994.
(11) FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments at July 1, 1995 and June 29, 1996
include trade accounts receivable, trade accounts payable, revolving credit term
note payable, subordinated debentures, capital lease obligation and long-term
debt. The carrying value of trade accounts receivable, trade accounts payable
and revolving credit term note payable approximates fair value because of the
short maturity of these instruments. The fair value of the Company's
subordinated debentures, capital lease obligations and long-term debt has been
determined based on discounted cash flows using current interest rates of
similar instruments and are not materially different from their financial
statement carrying values.
(12) SUBSEQUENT EVENTS
SECURED SUBORDINATED DEBT
On July 2, 1996, the Company issued $3,000,000 of secured subordinated debt
bearing annual interest at 12.5%. The debt is scheduled to mature on July 2,
2001. For the first six months of the agreement, interest will be payable at a
rate of 7.5% with the remaining 5% interest accruing until February 1, 1997,
when all unpaid interest is due and payable. At the time of issuance, the lender
received a warrant for the right to purchase 76,223 shares of non-voting common
stock exercisable until July 1, 2001 at $0.0025 per share. The number of shares
available under the warrant increases over the term of the debt. If the debt
remains outstanding until maturity, the lender will have the right to purchase a
total of 167,688 shares.
SERIES C CONVERTIBLE PREFERRED STOCK
On August 2, 1996, 25,639 shares of Series C Convertible Preferred Stock,
$0.01 par value, were issued in the amount of $9,730,000. The conversion,
redemption and other provisions of this series of preferred stock are identical
to that of the Series A and Series B Convertible Preferred Stock.
CONSTRUCTION OF NEW DISTRIBUTION AND OFFICE FACILITY
The Company is currently negotiating a lease for a new and larger
distribution center which is expected to begin operating in fiscal 1998. The new
center will be approximately 325,000 square feet and will provide for the
consolidation of the Company's administrative and distribution functions.
F-17
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) SUBSEQUENT EVENTS (CONTINUED)
STOCK SPLIT
Common stock and stock options reflect the one for 4.016 stock split of the
Company's common stock as approved by the Company's Board of Directors on
November 15, 1996.
F-18
<PAGE>
FACTORY CARD OUTLET CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 29, SEPTEMBER 28,
1996 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
ASSETS
Current assets:
Cash............................................................................. $ 202,344 $ 338,686
Accounts receivable.............................................................. 248,888 279,702
Due from related parties......................................................... 187,711 115,780
Inventories...................................................................... 41,803,820 50,610,129
Prepaid expenses................................................................. 603,647 768,426
Deferred income taxes............................................................ 302,490 1,303,153
------------- -------------
Total current assets........................................................... 43,348,900 53,415,876
Fixed assets, net.................................................................. 14,923,891 16,302,969
Deferred financing costs........................................................... 244,405 344,503
Deferred income taxes.............................................................. 312,052 312,052
Other assets....................................................................... 250,594 195,046
------------- -------------
Total assets................................................................... $ 59,079,842 $ 70,570,446
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term obligations...................................... $ 676,012 $ 702,018
Accounts payable................................................................. 12,125,070 15,079,530
Due to related parties........................................................... 3,679,887 4,102,733
Income taxes payable............................................................. 282,771 --
Accrued expenses................................................................. 2,980,656 3,512,357
------------- -------------
Total current liabilities...................................................... 19,744,396 23,396,638
Revolving credit note payable...................................................... 13,127,155 9,200,000
Subordinated debentures, net of discount........................................... 4,720,865 7,566,571
Long-term debt..................................................................... 664,223 527,797
Capital lease obligations.......................................................... 137,561 167,416
Deferred rent liabilities.......................................................... 3,561,851 3,678,895
------------- -------------
Total liabilities.............................................................. 41,956,051 44,537,317
------------- -------------
Stockholders' equity:
Preferred stock--Series A, B and C convertible, $.01 par value. Authorized:
Series A--20,000 shares, Series B--34,750 shares and Series C--30,000 shares.
Issued and outstanding: Series A--20,000 shares and Series B-- 32,416 shares at
June 29, 1996 and September 28, 1996, Series C--25,639 shares at September 28,
1996........................................................................... 14,456,506 24,228,943
Common stock, no par value. Voting class--1,600,000 shares authorized; 933,720
shares issued and outstanding; non-voting class-205,000 shares authorized; no
shares issued or outstanding................................................... 3,050,211 3,478,578
Accumulated deficit.............................................................. (382,926) (1,674,392)
------------- -------------
Total stockholders' equity..................................................... 17,123,791 26,033,129
------------- -------------
Total liabilities and stockholders' equity..................................... $ 59,079,842 $ 70,570,446
------------- -------------
------------- -------------
</TABLE>
statements.
F-19
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
13 WEEKS ENDED
----------------------------
<S> <C> <C>
SEPTEMBER 30, SEPTEMBER 28,
1995 1996
------------- -------------
<CAPTION>
(UNAUDITED)
<S> <C> <C>
Net sales.......................................................................... $ 16,816,662 $ 25,031,848
Cost of sales and occupancy........................................................ 11,023,795 16,996,375
------------- -------------
Gross profit..................................................................... 5,792,867 8,035,473
Selling, general and administrative expenses....................................... 7,600,492 9,664,842
------------- -------------
Loss from operations............................................................. (1,807,625) (1,629,369)
Interest expense................................................................... 190,373 597,297
------------- -------------
Loss before taxes................................................................ (1,997,998) (2,226,666)
Income tax benefit................................................................. (759,835) (935,200)
------------- -------------
Net loss......................................................................... $ (1,238,163) $ (1,291,466)
------------- -------------
------------- -------------
Net loss per common and common equivalent share.................................. $ (0.25) $ (0.26)
------------- -------------
------------- -------------
Weighted average common and common equivalent shares
outstanding.................................................................... 5,049,869 5,049,869
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-20
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
13 WEEKS ENDED
----------------------------
SEPTEMBER 30, SEPTEMBER 28,
1995 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
Cash flows from operating activities:
Net loss......................................................................... $(1,238,163) $(1,291,466)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization of fixed assets.................................. 548,124 752,590
Amortization of deferred financing costs and debt discount..................... -- 181,890
Amortization of organization costs............................................. 1,650 --
Deferred income taxes.......................................................... (759,835) (935,200)
Loss (gain) on the disposal of equipment and vehicles.......................... -- 1,382
Compensation expense related to stock options.................................. -- 164,355
Change in assets and liabilities:
Decrease (increase) in assets:
Accounts receivable........................................................ (141,675) 156,897
Inventories................................................................ (5,503,373) (8,806,309)
Prepaid expenses........................................................... (250,270) (164,779)
Other assets............................................................... (51,930) (27,558)
Increase (decrease) in liabilities:
Accounts payable........................................................... 5,143,136 4,362,626
Accrued expenses........................................................... 699,762 531,700
Deferred rent liabilities.................................................. 10,712 117,044
Income taxes payable....................................................... (117,100) (348,233)
------------- -------------
Net cash used in operating activities.............................................. (1,658,962) (5,305,061)
------------- -------------
Net cash used in investing activities--purchase of fixed assets.................... (1,891,772) (2,046,642)
------------- -------------
Cash flows from financing activities:
Borrowings under revolving credit note........................................... 3,350,000 15,336,737
Repayment of borrowings under revolving credit note.............................. (450,000) (19,263,892)
Proceeds from term loan.......................................................... 400,000 --
Payments of long-term debt....................................................... (126,911) (112,719)
Proceeds from issuance of subordinated debentures................................ -- 2,910,836
Proceeds from issuance of Series C convertible preferred stock................... -- 8,617,083
------------- -------------
Net cash provided by financing activities.......................................... 3,173,089 7,488,045
------------- -------------
Net increase (decrease) in cash.................................................... (377,645) 136,342
Cash at beginning of the period.................................................... 515,212 202,344
------------- -------------
Cash at end of the period.......................................................... $ 137,567 $ 338,686
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-21
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The consolidated financial statements included herein have been prepared by
management without audit and should be read in conjunction with the consolidated
financial statements and notes thereto for the fiscal year 1996 included in this
document. Due to the seasonality of the Company's business, the results for the
interim periods are not necessarily indicative of the results for the year.
Certain information and note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted, although management believes that the disclosures are
adequate to fairly present the information. The accompanying consolidated
financial statements reflect, in the opinion of management, all such adjustments
necessary for a fair presentation of the interim financial statements. In the
opinion of management, all such adjustments are of a normal recurring nature,
except for the accrual of approximately $164,000 in the three month period ended
September 28, 1996 representing compensation expense, some of which is
nonrecurring, relating to certain individuals, including certain directors and
employees of the Company.
(2) USE OF ESTIMATES
The preparation of these consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reported period and related disclosures.
Significant estimates made as of and for the thirteen weeks ended September 28,
1996 include provisions for shrinkage and promotional markdowns of merchandise
inventories. Actual results could differ from those estimates.
(3) DEBT
SECURED SUBORDINATED DEBT
On July 2, 1996, the Company issued $3,000,000 of secured subordinated debt
bearing annual interest at 12.5%. The debt is scheduled to mature on July 2,
2001. For the first six months of the agreement, interest will be payable at a
rate of 7.5% with the remaining 5% interest accruing until February 1, 1997 when
all unpaid interest is due and payable. At the time of issuance, the lender
received a warrant for the right to purchase 76,223 shares of non-voting common
stock exercisable until July 1, 2001, at $0.0025 per share. The number of shares
available under the warrant increases over the term of the debt. If the debt
remains outstanding until maturity, the lender will have the right to purchase a
total of 167,688 shares.
REVOLVING CREDIT AGREEMENT
In September 1996, the Company entered into a new revolving credit agreement
with its bank which permits the Company to borrow up to a maximum of
$25,000,000. Advances under the new agreement, which expires October 1, 1998,
are limited based on inventory levels as defined in the agreement. Interest is
payable monthly at an annual rate equal to the bank's prime rate or, at the
Company's option, 2.75% over the London Interbank Offered Rate. A fee of 0.25%
per year is assessed on the unused portion of the line, except if the unused
portion exceeds $20,000,000 the fee increases to 0.40%. Borrowings under the
revolving credit term note are secured by all business assets of the Company.
This agreement contains restrictive covenants, the more significant of which
require the maintenance of minimum ratios of total liabilities to net worth and
minimum levels of tangible net worth and net working capital.
F-22
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
LEASE COMMITMENTS
The Company entered into two capital lease agreements for computer equipment
and related software in October 1996. The cost of the equipment under these
leases totalled $2,113,000. Payments under these leases will be made over the
next four years.
In October 1996, the Company completed the negotiation of a ten-year lease
for a new distribution and administrative center commencing in October 1997.
Future minimum lease payments under this lease will total $19,727,400.
(4) STOCKHOLDERS' EQUITY
SERIES C PREFERRED STOCK
On August 2, 1996, 25,639 shares of Series C Convertible Preferred Stock,
$0.01 par value, were issued in the amount of $9,730,000. Each share of this
preferred stock is convertible at the holder's discretion into 40.16 shares of
voting common stock of the Company. The redemption and other provisions of this
series of preferred stock are identical to that of Series A and B Convertible
Preferred Stock.
STOCK OPTIONS
In July 1996, the Company granted options to purchase 351,400 shares of
common stock to certain individuals, including employees and directors, at an
option price of $2.49 per share. Options to purchase 190,760 shares which were
granted to employees vest over four years, and all other options were fully
vested in September 1996. Based on the estimated fair value of the Company's
common stock at the time of grant of these options of $3.30 per share, the
Company recognized compensation expense in the quarter ended September 28, 1996
of approximately $164,000. Of this amount, approximately $146,000 related to
options which were fully vested in September 1996. The estimated fair value of
the Company's common stock used in accounting for these options was based on
information from various sources which included a valuation prepared by Avalon
Group Ltd. (Avalon). The chairman and president of Avalon each own 100 shares of
the Company's Series B preferred stock (or 0.3% of issued and outstanding Series
B preferred stock) and each has options to purchase 4,016 shares of the
Company's common stock (or 0.8% of weighted average common shares).
(5) SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
SEPTEMBER 30, SEPTEMBER 28,
1995 1996
------------- -------------
<S> <C> <C>
Cash paid during the thirteen week period for:
Interest.......................................................................... $ 134,547 $ 397,277
Income taxes...................................................................... 112,600 371,750
</TABLE>
Supplemental disclosure of non-cash financing activities:
Capital lease obligations incurred and notes payable on vehicle purchases
were $86,408 in the 13-week period ended September 28, 1996. There were no
obligations incurred or notes payable in the 13-week period ended September
30, 1995.
In August, 1996, the Company exchanged Series C Preferred Stock for
consideration of trade accounts payable of $1,101,100.
Additional paid-in capital of $264,012 was recognized for the common stock
warrants issued in July, 1996.
F-23
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH THE OFFERING MADE HEREBY TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, THE SELLING STOCKHOLDERS
OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF ANY OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY
PERSON OR BY ANYONE IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH
OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE
HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 6
Use of Proceeds........................................................... 11
Dividend Policy........................................................... 11
Capitalization............................................................ 12
Dilution.................................................................. 13
Selected Consolidated Financial and Operating Data........................ 14
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 15
Business.................................................................. 23
Management................................................................ 31
Certain Transactions...................................................... 38
Principal and Selling Stockholders........................................ 39
Description of Capital Stock.............................................. 42
Shares Eligible for Future Sale........................................... 44
Underwriting.............................................................. 46
Legal Matters............................................................. 47
Experts................................................................... 47
Additional Information.................................................... 48
Index to Financial Statements............................................. F-1
</TABLE>
------------------------
UNTIL JANUARY 7, 1997, ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON
STOCK OFFERED HEREBY, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE
REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF
DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO
THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
2,627,000 SHARES
[LOGO]
COMMON STOCK
------------
PROSPECTUS
------------
ALEX. BROWN & SONS
INCORPORATED
PIPER JAFFRAY INC.
December 12, 1996
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
