<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORTS PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended July 31, 1999
Commission File Number: 21859
FACTORY CARD OUTLET CORP.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 36-3652087
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
2727 Diehl Road,
Naperville, IL 60563-2371
- --------------------------------------------------------------------------------
(Address of principal executive offices, zip code)
Registrant's telephone number, including area code: (630) 579-2000
Indicate by check mark whether this registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
The number of shares of the Registrant's Common Stock outstanding as of
September 3, 1999 was 7,503,098.
<PAGE>
Factory Card Outlet Corp.
(Debtor in possession effective March 23, 1999)
Form 10-Q
For the Quarter Ended July 31, 1999
Index
<TABLE>
<CAPTION>
Page
<S> <C> <C>
Part I Financial Information
Item 1 Financial Statements (unaudited):
Consolidated Balance Sheets as of July 31, 1999 and January 30, 1999 3
Consolidated Statements of Operations for the three fiscal months and six fiscal
months ended July 31, 1999 and August 1, 1998 4
Consolidated Statements of Cash Flows for the six fiscal months
ended July 31, 1999 and August 1, 1998 5
Notes to Consolidated Financial Statements 6-8
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations 9-14
Item 3 Quantitative and Qualitative Disclosures About Market Risk 15
Part II Other Information 15
Signatures 16
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION, ITEM 1, FINANCIAL STATEMENTS
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
Consolidated Balance Sheets
(Dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
July 31, January 30,
1999 1999
--------------------- --------------------
<S> <C> <C>
ASSETS (Unaudited)
Current assets
Cash $ 1,360 $ 3,597
Merchandise inventories 51,826 61,658
Refundable income taxes 460 747
Prepaid expenses and other 1,106 980
--------------------- --------------------
Total current assets 54,752 66,982
Fixed assets, net 33,387 39,585
Other assets 903 1,004
--------------------- --------------------
Total assets $ 89,042 $ 107,571
===================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities not subject to compromise
Current liabilities:
Accounts payable $ 5,889 $ 33,089
Current maturities of long-term obligations - 2,161
Accrued expenses 8,853 8,755
--------------------- --------------------
Total current liabilities 14,742 44,005
--------------------- --------------------
Noncurrent liabilities:
Revolving credit note payable 13,903 20,653
Long-term obligations - 1,670
Term loan, net of discount - 9,669
Deferred rent liabilities 6,773 7,396
--------------------- --------------------
Total noncurrent liabilities 20,676 39,388
--------------------- --------------------
Liabilities subject to compromise 47,275 -
--------------------- --------------------
Stockholders' equity:
Common stock - $.01 par value at July 31, 1999 and January 30, 1999.
Voting class - authorized 15,000,000 shares; 7,503,098 shares issued and
outstanding at July 31, 1999 and January 30, 1999, respectively.
Non-voting class - authorized 205,000 shares, no shares issued or 75 75
outstanding.
Additional paid-in capital 52,040 52,021
Retained earnings (deficit) (45,766) (27,918)
--------------------- --------------------
Total stockholders' equity 6,349 24,178
--------------------- --------------------
Total liabilities and stockholders' equity $ 89,042 $ 107,571
===================== ====================
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
Consolidated Statements of Operations
(Dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
Three fiscal months ended Six fiscal months ended
------------------------------------------ -----------------------------------------
July 31, August 1, July 31, August 1,
1999 1998 1999 1998
------------------------------------------ -----------------------------------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net sales $ 52,234 $ 54,749 $ 104,767 $ 104,611
Cost of sales 26,421 27,994 54,541 52,381
------------------- ------------------- ------------------- -------------------
Gross profit 25,813 26,755 50,226 52,230
Selling, general and administrative expenses 24,982 27,168 50,750 50,915
Interest expense 582 913 1,476 1,694
------------------- ------------------- ------------------- -------------------
(Loss) income before reorganization items,
income taxes and extraordinary item 249 (1,326) (2,000) (379)
Reorganization items, net 2,009 - 14,556 -
------------------- ------------------- ------------------- -------------------
Loss before income taxes and
extraordinary item (1,760) (1,326) (16,556) (379)
Income taxes (benefit) - (530) - (151)
------------------- ------------------- ------------------- -------------------
Loss before extraordinary item (1,760) (796) (16,556) (228)
Extraordinary item-loss on early retirement
of debt - - 1,292 -
------------------- ------------------- ------------------- -------------------
Net loss $ (1,760) $ (796) $ (17,848) $ (228)
=================== =================== =================== ===================
Loss per share -
Basic/diluted $ (0.23) $ (0.11) $ (2.38) $ (0.03)
=================== =================== =================== ===================
Weighted average shares outstanding -
Basic/diluted 7,503,098 7,385,196 7,503,098 7,369,791
=================== =================== =================== ===================
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Six fiscal months ended
------------------------------------------
July 31, August 1,
1999 1998
-----------------------------------------
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (17,848) $ (228)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Depreciation and amortization of fixed assets 3,839 3,492
Amortization of deferred financing costs and debt discount 401 132
Reorganization items, net 13,590 -
Extraordinary loss on early retirement of debt 1,292 -
Other 30 866
Changes in assets and liabilities:
(Increase) decrease in assets:
Refundable income taxes 292 (131)
Merchandise inventories 5,889 (16,296)
Prepaid expenses and other assets (1,165) (1,234)
Increase (decrease) in liabilities:
Accounts payable (27,200) 11,337
Accrued expenses (3,485) (313)
Deferred rent liabilities 271 1,277
Liabilities subject to compromise 40,198 -
-------------- -------------
Net cash provided by (used in) operating activities 16,104 (1,098)
---------------- -------------
Net cash used in investing activities - purchase of fixed assets, net (957) (6,030)
---------------- --------------
Cash flows from financing activities:
Borrowings under revolving credit notes and term loan 125,977 57,158
Repayment of borrowings under revolving credit notes and term loan (143,253) (49,083)
Payment of long-term obligations (108) (894)
Proceeds from exercise of employee stock options - 138
--------------- -------------
Net cash (used in) provided by financing activities (17,384) 7,319
--------------- --------------
Net (decrease) increase in cash (2,237) 191
Cash at beginning of period 3,597 30
---------------- --------------
Cash at end of period $ 1,360 $ 221
================= ================
Supplemental cash flow information:
Interest paid $ 1,519 $ 2,345
Income taxes paid (refunded) (292) 93
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
FACTORY CARD OUTLET CORP.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
(Unaudited)
(1) Organization and Basis of Presentation
The consolidated unaudited financial statements include the accounts
of Factory Card Outlet Corp. and its wholly owned subsidiary, Factory Card
Outlet of America Ltd. (collectively the "Company"). The Company is a chain
of company-owned superstores offering an extensive selection of greeting
cards, giftwrap, balloons, party supplies and other special occasion
merchandise at everyday value prices. These financial statements have been
prepared by management without audit and should be read in conjunction with
the consolidated financial statements and notes for the fiscal year ended
January 30, 1999 included in the Company's Annual Report on Form 10-K. The
operating results for the interim periods are not necessarily indicative of
the results for the year. All intercompany balances and transactions have
been eliminated in consolidation. In the opinion of management, the
accompanying consolidated financial statements reflect all normal recurring
and certain nonrecurring adjustments necessary for a fair presentation of
the interim financial statements. In addition, certain prior year amounts
have been reclassified to conform to the current year presentation.
The Company filed voluntary petitions for relief under chapter 11 of
title 11 of the United States Bankruptcy Code (the "Bankruptcy Code") on
March 23, 1999 (the "petition date") under case numbers 99-685(JJF) and 99-
686(JJF) (the "Chapter 11 Cases"). The Company is currently operating its
business as debtors in possession under the jurisdiction of the United
States Bankruptcy Court for the District of Delaware (the "Bankruptcy
Court").
The accompanying consolidated financial statements have been prepared
assuming the Company will continue as a going concern and in accordance
with the American Institute of Certified Public Accountants Statement of
Position 90-7, Financial Reporting by Entities in Reorganization under the
Bankruptcy Code. The commencement of the Chapter 11 Cases and the net
losses resulting in a net deficit raise doubt about the Company's ability
to continue as a going concern. As discussed in Note 5, the Company has
recorded certain reorganization items during the six fiscal months ended
July 31, 1999. Additional adjustments, some of which could be material, may
be necessary as a consequence of a plan of reorganization. The continuation
of the Company's business as a going concern is contingent upon, among
other things, the ability to (1) formulate a plan of reorganization that
will be confirmed by the Bankruptcy Court, (2) achieve satisfactory levels
of future profitable operations, (3) maintain adequate financing, and (4)
generate sufficient cash from operations to meet future obligations.
The Bankruptcy Code provides that the Company has an exclusive period
during which only it may propose, file and solicit acceptances of a plan of
reorganization. The exclusive period for the Company to propose a plan of
reorganization currently expires on January 18, 2000. The Company has the
right to request that the Bankruptcy Court grant an extension of the
exclusive period. If the Company fails to file a plan of reorganization
during the exclusive period or, after such plan has been filed, if the
Company fails to obtain acceptance of such plan from the requisite impaired
classes of creditors and equity security holders during the exclusive
period and the exclusive period is not extended, any party in interest,
including a creditor, an equity security holder, a committee of creditors
or equity security holders, or an indenture trustee, may file their own
plan of reorganization for the Company. The Company is in the process of
developing a plan of reorganization for filing with the Bankruptcy Court.
However, there can be no assurances given when a plan will be filed or
that the plan that is ultimately filed will be accepted by creditors or
confirmed by the Bankruptcy Court.
6
<PAGE>
(2) Debtor in Possession Facility
Subsequent to the commencement of the Chapter 11 Cases, the Company
entered into a Revolving Credit and Guaranty Agreement (the "Loan
Agreement") dated March 23, 1999 which provides up to $50,000 (including
$10,000 for letters of credit) to fund working capital needs and for
general corporate purposes. Borrowing under the facility is limited by
inventory levels and has an interest rate of .75% over prime or, at the
Company's option, 3.75% over the London Interbank Offered Rate. The Loan
Agreement expires on the earlier of March 23, 2001 or the date the
Bankruptcy Court confirms a plan of reorganization. Borrowings under the
Loan Agreement are secured by substantially all of the Company's assets.
Certain restrictive covenants apply, including maintenance of certain
inventory levels, achievement of specified operating results and
limitations on the incurrence of additional liens and indebtedness, capital
expenditures, asset sales and payment of dividends.
Proceeds from the Loan Agreement were used in March 1999 to repay all
borrowings under the Company's previous revolving credit agreement and term
loan. As a result, the Company recognized an extraordinary loss of $1,292
associated with the early retirement of the Company's previous revolving
credit agreement and term loan.
(3) Management 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.
Significant estimates made as of and for the six fiscal month periods ended
July 31, 1999 and August 1, 1998 include reserves for store closings and
other reorganization items, provision for shrinkage, capitalized overhead
costs related to inventory and the carrying values of inventories. Actual
results could differ from those estimates.
(4) Liabilities Subject to Compromise
Liabilities subject to compromise refer to liabilities incurred prior
to the commencement of the Chapter 11 Cases. These liabilities consist
primarily of amounts outstanding for accounts payable, amounts accrued for
rejected leases, other accrued expenses and obligations under capital
leases. These amounts represent management's best estimate of known or
potential claims to be resolved in connection with the Chapter 11 Cases.
Such claims remain subject to future adjustments based on negotiations,
actions of the Bankruptcy Court, further developments with respect to
disputed claims or other events. The terms for the satisfaction of these
claims will be established in connection with the Chapter 11 Cases.
The Company has received approval from the Bankruptcy Court to pay or
otherwise honor certain of its prepetition obligations, including
prepetition wages, employee benefits and reimbursement of employee business
expenses, costs to transport merchandise, sales and use taxes and
insurance.
7
<PAGE>
(5) Reorganization Items
In April 1999, the Company obtained approval from the Bankruptcy Court
to close and conduct closing sales at 27 stores that are in markets the
Company does not intend to continue to operate in or are underperforming or
unprofitable. During the six fiscal months ended July 31, 1999, the Company
recorded a provision for reorganization costs relating to these store
closings of approximately $10,428. This provision included the write-down
of fixed assets, estimated lease rejection claims and the loss on the
disposition of merchandise inventory.
In addition to the provision for the store closing, reorganization
costs for professional fees and other costs related to the Company's
reorganization were $4,128 in the six fiscal months ended July 31, 1999.
(6) Income Taxes (Benefit)
In assessing the realization of deferred tax assets, management
considers the likelihood that those assets will be realized through future
taxable income. Because the realization of the deferred tax assets may be
limited by events involving the Chapter 11 Cases or other events related to
the ownership of the Company, the Company has recorded a valuation
allowance to fully reserve for the value of the net deferred tax assets at
July 31, 1999 and January 30, 1999.
(7) Earnings Per Share
In accordance with Statement of Financial Accounting Standards
("SFAS") No. 128, earnings per share - basic is computed by dividing net
income by the weighted average number of common shares outstanding during
the period. Earnings per share - diluted includes the effect of stock
options and warrants.
For the three and six fiscal months ended August 1, 1998, 86,203 and
73,387 options to purchase common stock outstanding during the periods,
respectively, were not included in the computation of earnings per share -
diluted because the option price was greater than the average market price
of the common shares. For the three and six fiscal months ended July 31,
1999, no options to purchase common stock were included in the computation
of earnings per share - diluted because the effect would be antidilutive.
8
<PAGE>
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Dollar amounts in thousands)
Certain statements in the following discussion and analysis constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known
and unknown risks, uncertainties and other factors which may cause the actual
results, performance, or achievements of the Company, or industry results, to be
materially different from any future results, performance, or achievements
expressed or implied by such forward-looking statements. On March 23, 1999, the
Company filed a petition for reorganization under chapter 11 of title 11 of the
United States Code and is operating as a debtor in possession. All forward-
looking statements relating to aspects of any plan of reorganization submitted
in connection with its chapter 11 proceedings are dependent upon, among other
things, further improvements in the Company's store-level operating performance,
the formation of an acceptable reorganization plan and the bankruptcy court
approval of the reorganization plan.
In general, the results, performance or achievements of the Company and its
stores are dependent upon a number of factors including, without limitation, the
following: effects resulting from the commencement and completion of the chapter
11 proceedings; ability to meet sales plans; weather and economic conditions;
dependence on key personnel; competition; ability to anticipate merchandise
trends and consumer demand; ability to maintain relationships with suppliers;
successful implementation of information systems; successful handling of
merchandise logistics; inventory shrinkage; ability to meet future capital
needs; governmental regulations; ability to complete corrective action necessary
to address Year 2000 issues; and other factors both referenced and not
referenced in this Form 10-Q. When used in this Report on Form 10-Q, the words
"estimate," "project," "anticipate," "expect," " intend," "believe," and similar
expressions are intended to identify forward-looking statements.
On September 3, 1999, the Company announced that it received notification
that the NASD's staff has delisted the Company's common stock from the NASDAQ
National Market effective September 1, 1999. NASD said the determination was
based on the uncertainties concerning the Company's pending Chapter 11 Cases on
the Company's shareholders. The Company is considering requesting the NASDAQ
Listing and Hearing Review Council to review the delisting decision.
The Company is a chain of company-owned superstores offering an extensive
selection of greeting cards, giftwrap, balloons, party supplies and other
special occasion merchandise at everyday value prices. As of September 3, 1999,
the Company operated 182 stores in 21 states. The Company currently does not
plan to open any additional stores in 1999.
9
<PAGE>
Results of Operations
The following table sets forth, for the periods indicated, selected
statement of operations data expressed as a percentage of net sales:
<TABLE>
<CAPTION>
Three fiscal months ended Six fiscal months ended
------------------------------ ------------------------------
July 31, August 1, July 31, August 1,
1999 1998 1999 1998
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 50.6 51.1 52.1 50.1
-------- --------- -------- ---------
Gross profit 49.4 48.9 47.9 49.9
Selling, general and administrative expenses 47.8 49.6 48.4 48.7
Interest expense 1.1 1.7 1.4 1.6
-------- --------- -------- ---------
(Loss) income before reorganization items,
income taxes and extraordinary item 0.5 (2.4) (1.9) (0.4)
Reorganization items, net 3.9 - 13.9 -
-------- --------- -------- ---------
Loss before income taxes and
Extraordinary item (3.4) (2.4) (15.8) (0.4)
Income tax (benefit) - (1.0) - (0.2)
-------- --------- -------- ---------
Loss before extraordinary item (3.4) (1.4) (15.8) (0.2)
Extraordinary item-loss on early retirement of debt - - 1.2 -
-------- --------- -------- ---------
Net loss (3.4)% (1.4)% (17.0)% (0.2)%
======== ========= ======== =========
Number of stores open at end of period 182 199 182 199
</TABLE>
Three Fiscal Months Ended July 31, 1999 and August 1, 1998
Net Sales. Net sales decreased $2,515, or 4.6%, to $52,234 for the three
fiscal month period ended July 31, 1999 from $54,749 for the three fiscal month
period ended August 1, 1998. The decrease resulted from a net sales decrease of
$4,704 as a result of stores closed during the quarter and a comparable store
sales decrease of $749, or 1.5%, offset by a net sales increase of $2,938 from
stores not included in the comparable store base. Comparable store sales were
impacted by the reduced flow of merchandise resulting from issues associated
with the Company's liquidity and the Chapter 11 Cases. The Company includes
stores opened 13 or 14 months after their opening date in the calculation of
comparable store sales.
Gross Profit. Cost of sales includes distribution costs. Gross profit
decreased $942, or 3.5%, to $25,813 for the three fiscal month period ended July
31, 1999 from $26,755 for the three fiscal month period ended August 1, 1998.
As a percentage of net sales, gross profit was 49.4% for the three fiscal month
period ended July 31, 1999 compared to 48.9% in the same period in the prior
year. Gross profit as a percentage of net sales increased primarily as a result
of lower distribution costs during the three fiscal months ended July 31, 1999.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses include store payroll, store occupancy, advertising,
depreciation, other store operating and corporate administrative expenses.
Store occupancy expenses are included in selling, general and administrative
expenses for all information presented. Selling, general and administrative
expenses decreased $2,186, or 8.0%, to $24,982 for the three fiscal month period
ended July 31, 1999 from $27,168 for the three fiscal month period ended August
1, 1998. Approximately $1,280 of this decrease resulted from operating 17 fewer
superstores during the quarter ended July 31, 1999 than the quarter ended August
1, 1998. During the three fiscal months ended August 1, 1998, the Company
recorded a pre-tax special charge of $655 relating to certain severance and new
store design costs which amounts have been included in selling, general and
10
<PAGE>
administrative expenses. As a percentage of net sales, selling, general and
administrative expenses decreased to 47.8% in the three fiscal month period
ended July 31, 1999 from 49.6% in the three fiscal month period ended August 1,
1998.
Interest Expense. Interest expense was $582 in the three fiscal month
period ended July 31, 1999 compared to $913 in the three fiscal month period
ended August 1, 1998. This decrease resulted primarily from lower borrowing
levels offset partially by a higher effective interest rate.
Reorganization Items, net. The Company recognized $2,009 of reorganization
items, net consisting of professional fees and other costs related to the
reorganization of the Company offset by a $710 reduction in the estimated store
closing costs in the three fiscal month period ended July 31, 1999.
Income Taxes. The Company's effective income tax rate was 40% during the
three fiscal month period ended August 1, 1998. Management believes that it is
more likely than not that deferred tax assets created by net operating losses
during the three fiscal month period ended July 31, 1999 will not be realized
through future taxable income. Therefore, the Company has increased its
valuation allowance, which was established during the fiscal year ended January
30, 1999, to fully reserve the potential tax benefits resulting from these net
operating losses. As a result, the effective tax rate for the three fiscal
month period ended July 31, 1999 was zero.
Six Fiscal Months Ended July 31, 1999 and August 1, 1998
Net Sales. Net sales increased $156, or 0.1%, to $104,767 for the six
fiscal month period ended July 31, 1999 from $104,611 for the six fiscal month
period ended August 1, 1998. The increase resulted from a net sales increase of
$6,822 from stores not included in the comparable store base offset by a net
sales decrease of $4,704 from stores closed during the second quarter and a
comparable store sales decrease of $1,962, or 2.0%. Comparable store sales were
impacted by the reduced flow of merchandise resulting from issues associated
with the Company's liquidity and the Chapter 11 Cases. The Company includes
stores opened 13 or 14 months after their opening date in the calculation of
comparable store sales.
Gross Profit. Cost of sales includes distribution costs. Gross profit
decreased $2,004, or 3.8%, to $50,226 for the six fiscal month period ended July
31, 1999 from $52,230 for the six fiscal month period ended August 1, 1998. As
a percentage of net sales, gross profit was 47.9% for the six fiscal month
period ended July 31, 1999 compared to 49.9% in the same period in the prior
year. Gross profit as a percentage of net sales decreased primarily as a result
of higher vendor promotional program monies recorded in the six fiscal months
ended August 1, 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses include store payroll, store occupancy, advertising,
depreciation, other store operating and corporate administrative expenses.
Store occupancy expenses are included in selling, general and administrative
expenses for all information presented. Selling, general and administrative
expenses decreased $165, or 0.3%, to $50,750 for the six fiscal month period
ended July 31, 1999 from $50,915 for the six fiscal month period ended August 1,
1998. During the six fiscal months ended August 1, 1998, the Company recorded a
pre-tax special charge of $655 relating to certain severance and new store
design costs which amounts have been included in selling, general and
administrative expenses. As a percentage of net sales, selling, general and
administrative expenses decreased to 48.4% in the six fiscal month period ended
July 31, 1999 from 48.7% in the six fiscal month period ended August 1, 1998.
Interest Expense. Interest expense was $1,476 in the six fiscal month
period ended July 31, 1999 compared to $1,694 in the six fiscal month period
ended August 1, 1998. This decrease resulted primarily from lower borrowing
levels offset partially by a higher effective interest rate.
11
<PAGE>
Reorganization Items, net. The Company has recognized $14,556 of
reorganization items, net consisting of a provision for the write down of fixed
assets, estimated lease rejection claims and the loss on the disposition of
merchandise inventory related to 27 store closings, professional fees, and other
costs related to the reorganization of the Company for the six fiscal month
period ended July 31, 1999.
Income Taxes. The Company's effective income tax rate was 40% during the
six fiscal month period ended August 1, 1998. Management believes that it is
more likely than not that deferred tax assets created by losses during the six
fiscal month period ended July 31, 1999 will not be realized through future
taxable income. Therefore, the Company has increased its valuation allowance,
which was established during the fiscal year ended January 30, 1999, to fully
reserve the potential tax benefits resulting from these losses. As a result, the
effective tax rate for the six fiscal month period ended July 31, 1999 was zero.
Year 2000 Readiness Disclosure
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the computer
programs that have date-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a temporary
inability to process transactions or engage in similar normal business
activities. The Company has initiated a Year 2000 program designed to identify
and correct any concerns which may be identified.
The Year 2000 program was developed with the help of independent
consultants and consists of teams identifying and evaluating Year 2000 issues
and remediating systems that are not Year 2000 compliant. The Company's program
to identify and evaluate Year 2000 readiness includes inventorying and testing
systems that are commonly thought of as information technology (IT), such as
computer networks, as well as systems that are not commonly thought of as IT
systems, such as timeclocks and the telephone system. IT systems with non-
compliant code are being modified or replaced with systems that are Year 2000
compliant. Similar actions are being taken with respect to non-IT systems. The
teams are also investigating the Year 2000 readiness of suppliers and other
third parties, which includes surveying their Year 2000 remediation programs,
and developing contingency plans where necessary.
Key IT and non-IT systems have been inventoried and assessed for compliance
and detailed plans have been developed for required system modifications or
replacements, including remediation and testing activities. As of June 30,
1999, remediation has been completed and all IT and non-IT systems have been
tested and certified as Year 2000 ready and have been moved into production
status.
Incremental costs directly related to Year 2000 issues which includes
equipment and software replacements, reprogramming, systems testing, and outside
consulting services, are estimated to be in the range of $1,000 to $1,100, of
which approximately $1,000 has been spent through July 31, 1999. This estimate
assumes that the Company will not incur significant Year 2000 related costs on
behalf of its suppliers or other third parties.
Due to some uncertainty inherent in the Year 2000 issue, including
uncertainty regarding the readiness of suppliers, the Company cannot yet
complete a comprehensive analysis of the most likely worst case Year 2000
scenario. However as of July 31, 1999, the Company has completed its Year 2000
readiness review of critical suppliers and has developed a contingency plan
outline. This plan includes, but is not limited to, developing emergency backup
and recovery procedures, manual processes, alternative systems and work around
procedures, identifying alternative suppliers and developing alternative plans
to engage in business activities with suppliers should they not be Year 2000
compliant. Contingency plans will be reviewed continually up through the date
change to Year 2000.
12
<PAGE>
Liquidity and Capital Resources
On March 23, 1999, the Company filed the Chapter 11 Cases to address
certain operational and liquidity disruptions. The Company's liquidity position
for the remainder of fiscal 1999 will be impacted primarily by the success of
initiatives undertaken to improve store level cash flows and the effects of the
Chapter 11 Cases. The Company's uses of capital for the remainder of fiscal 1999
are expected to include working capital for operating expenses and satisfaction
of current liabilities, expenditures related to maintaining and refurbishing
existing stores, interest payments on outstanding borrowings and costs
associated with the Chapter 11 Cases. The Company's long-term liquidity and the
adequacy of the Company's capital resources cannot be determined until a plan of
reorganization has been developed and confirmed in connection with the Chapter
11 Cases.
As a debtor in possession under the Bankruptcy Code, actions to collect
prepetition indebtedness are stayed and certain contractual obligations may not
be enforced against the Company. With the approval of the Bankruptcy Court,
certain of these obligations may be paid prior to the confirmation of the
reorganization plan. To date, the Company has received approval to pay
customary prepetition obligations associated with the daily operation of its
business, including employee wages and other obligations. As permitted under
the Bankruptcy Code, the Company has received Bankruptcy Court approval to
reject 13 real estate leases for stores that were never opened and to close and
conduct closing sales at 27 stores. These closing sales were completed in July
1999. The Company has not completed its review of all of its prepetition
contracts and leases for assumption or rejection. The ultimate amount of, and
settlement terms for, such liabilities are subject to an approved plan of
reorganization and, accordingly, the timing and form of settlement are not
presently determinable.
The Company is a party to a Revolving Credit and Guaranty Agreement (the
"Loan Agreement") dated as of March 23, 1999 which was entered into subsequent
to the commencement of the Chapter 11 Cases and will terminate upon the earlier
of the confirmation of a plan of reorganization in the Chapter 11 Cases or March
23, 2001. The Loan Agreement provides the Company with a revolving line of
credit for loans and letters of credit in an aggregate amount not to exceed
$50,000 outstanding at any one time, including a sublimit of $10,000 for the
issuance of letters of credit. The Company intends to use amounts borrowed
under the Loan Agreement for its ongoing working capital needs and for other
general corporate purposes.
The Loan Agreement contains certain restrictive covenants which, among
other things, require the Company to maintain certain inventory levels and
achieve specified operating results. The restrictive covenants also limit the
Company's capital expenditures, asset sales and dividends and the ability of the
Company to grant liens and incur additional indebtedness.
As of July 31, 1999, the Company had $13,903 of borrowings outstanding
under the Loan Agreement and had utilized approximately $7,580 under the Loan
Agreement to issue letters of credit. The Company believes that its cash flow
from operations, borrowings under the Loan Agreement, adequate trade terms and
the continued support of its vendors will provide it with sufficient liquidity
to conduct its operations while the Chapter 11 Cases are pending. The Company
will be exploring opportunities to obtain long-term financing to support the
Company's business plan after it emerges from Chapter 11; however, there can be
no assurance that the Company will be able to obtain such financing with
satisfactory terms, if at all.
13
<PAGE>
At July 31, 1999 and August 1, 1998, the Company's working capital was
$40,010 and $55,594, respectively. Net cash provided by operations for the six
fiscal month period ended July 31, 1999 was $16,104 compared to $1,098 of net
cash used for the six fiscal month period ended August 1, 1998. During the six
fiscal month period ended July 31, 1999, $5,889 of cash from operations was
provided by a reduction in the inventory levels compared to the six fiscal month
period ended August 1, 1998 in which $16,296 of cash from operations was used to
increase inventory levels to support new and existing stores.
Net cash used in investing activities during the six fiscal month periods
ended July 31, 1999 and August 1, 1998 was $957 and $6,030, respectively.
During the six fiscal month period ended August 1, 1998, net cash used in
investing activities was primarily for capital expenditures for new superstores
and equipment for the new distribution center.
Net cash used in financing activities during the six fiscal month period
ended July 31, 1999 was $17,384 compared to $7,319 of net cash provided by
financing activities during the six fiscal months ended August 1, 1998. At
August 1, 1998, the outstanding balance under the Company's previous borrowing
arrangements was $37,280. During March 1999 the Company used $24,732 of
borrowings under the Loan Agreement to pay the outstanding balances under the
Company's previous revolving credit agreement and term loan.
The Company does not intend to pay cash dividends in the foreseeable future
and under its current Loan Agreement is restricted from paying dividends on its
capital stock.
14
<PAGE>
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Company is subject to market risks from changes in interest rates. The
interest rate on the Company's revolving credit facilities, which represent a
significant portion of the Company's outstanding debt, is variable based on the
prime rate or, at the Company's option, the London Interbank Offered Rate.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
The Company commenced the Chapter 11 Cases on March 23, 1999. Additional
information relating to the Chapter 11 Cases is set forth in Part 1, Item 1 of
the Company's Annual Report on Form 10-K under the caption "Proceedings under
Chapter 11 of the Bankruptcy Code": and in Note 1 of the Notes to Consolidated
Financial Statements contained herein. Such information is incorporated herein
by reference. If it is determined that the liabilities subject to compromise in
the Chapter 11 Cases exceed the fair value of the net assets, unsecured claims
may be satisfied at less than 100% of their face value and the equity interests
of the Company's stockholders would be substantially (if not completely)
diluted. It is not possible at this time to predict the actual recovery, if any,
to which creditors and stockholders may be entitled.
Several claims and cases have been filed by creditors of the Company
relating to unpaid amounts due to such creditors. Payment of these amounts are
now stayed in the Chapter 11 Cases. The Company is also from time to time
involved in routine litigation incidental to the conduct of its business. As of
the date of this Quarterly Report on Form 10-Q, the Company is aware of no
material existing or threatened litigation to which it is or may be a party.
Item 2. Changes in Securities.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits and reports of Form 8-K
None.
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FACTORY CARD OUTLET CORP.
Dated: September 14, 1999 By: /s/ Stewart M. Kasen
----------------------------------
Stewart M. Kasen
Chairman of the Board,
President and Chief Executive Officer
Dated: September 14, 1999 By: /s/ Frederick G. Kraegel
----------------------------------
Frederick G. Kraegel
Senior Vice President and
Chief Financial Officer
(principal financial officer)
Dated: September 14, 1999 By: /s/ Diana B. Kanas
-----------------------------------
Diana B. Kanas
Vice President and Controller
(principal accounting officer)
16
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<LEGEND> This schedule contains summary financial information extracted from
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</LEGEND>
<MULTIPLIER> 1,000
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<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-29-2000
<PERIOD-START> MAY-02-1999
<PERIOD-END> JUL-31-1999
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<PP&E> 33,387
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