<PAGE>
FILED PURSUANT TO RULE 424(b)(4)
REGISTRATION NO. 333-36911
1,778,000 SHARES
[Paper Warehouse, Inc. LOGO]
COMMON STOCK
All of the 1,778,000 shares of Common Stock offered hereby are being sold by
Paper Warehouse, Inc. Prior to this offering, there has been no public market
for the Common Stock. See "Underwriting" for a discussion of the factors
considered in determining the initial public offering price. Approximately $2.0
million and $300,000 of the net proceeds of the offering will be used to repay
indebtedness to Yale T. Dolginow and Brent D. Schlosser, respectively. Messrs.
Dolginow and Schlosser are executive officers, directors and principal
shareholders of the Company. See "Use of Proceeds." The Common Stock has been
approved for quotation on the Nasdaq National Market under the symbol "PWHS."
------------------------
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING 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>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS(1) COMPANY(2)
<S> <C> <C> <C>
Per Share................................ $7.50 $0.525 $6.975
Total(3)................................. $13,335,000 $933,450 $12,401,550
</TABLE>
(1) The Company and a shareholder of the Company (the "Selling Shareholder")
have agreed to indemnify the Underwriters against certain liabilities,
including liabilities under the Securities Act of 1933, as amended. See
"Underwriting."
(2) Before deducting offering expenses payable by the Company estimated at
$550,000.
(3) The Company and the Selling Shareholder have granted the Underwriters an
option, exercisable within 30 days of the date of this Prospectus, to
purchase up to an aggregate of 266,700 additional shares of Common Stock,
solely to cover over-allotments, if any. If such option is exercised in
full, the total Price to Public, Underwriting Discounts and Commissions,
Proceeds to Company and Proceeds to Selling Shareholder will be $15,335,250,
$1,073,468, $13,913,033 and $348,750, respectively. The Company will not
receive any of the proceeds from the sale of shares by the Selling
Shareholder. See "Principal and Selling Shareholders" and "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 are
subject to the right of the Underwriters to withdraw such offer and to reject
any order in whole or in part. It is expected that delivery of the shares of
Common Stock will be made on or about November 28, 1997.
[Dain Bosworth Incorporated LOGO]
THE DATE OF THIS PROSPECTUS IS NOVEMBER 24, 1997
<PAGE>
PAPER OVER 120 STORES NATIONWIDE!
WAREHOUSE
DISCOUNT PARTY & PAPER
[Following is a map of the United States indicating the location of
Company-owned and franchise stores; lines drawn on the map call out the location
of 11 stores in the Denver metropolitan area, 26 stores in the Minneapolis/St.
Paul metropolitan area, 7 stores in the Oklahoma City metropolitan area and 16
stores in the Kansas City metropolitan area]
<TABLE>
<S> <C> <C> <C>
COMPANY STORES FRANCHISE KANSAS (2) NEBRASKA (2)
COLORADO (11) STORES Lawrence Lincoln
Denver Metro Area (11) ARIZONA (5) Topeka NEVADA (1)
IOWA (3) Tucson (4) KENTUCKY (1) Sparks
Des Moines (2) Chandler Lexington NORTH DAKOTA (4)
Ankeny COLORADO (5) LOUISIANA (4) Fargo
KANSAS (9) Westminster Hammond Grand Forks
Kansas City Metro Area Wheat Ridge Mandeville Minot
MISSOURI (9) Longmont Baton Rouge Bismarck
Kansas City Metro Area Boulder Lafayette SOUTH DAKOTA (4)
Columbia Greeley MARYLAND (2) Rapid City
St. Joseph FLORIDA (1) Germantown Sioux Falls
MINNESOTA (29) Panama City Rockville Aberdeen
Minneapolis/St. Paul Metro Area GEORGIA (2) MINNESOTA (1) Watertown
(26) Roswell Duluth TENNESSEE (2)
St. Cloud Savannah MISSISSIPPI (1) Memphis
Rochester ILLINOIS (3) Hattiesburg Madison
Mankato Wheaton MISSOURI (1) TEXAS (2)
OKLAHOMA (10) Decatur Springfield Carrollton
Oklahoma City Metro Area (7) Champaign MONTANA (2) Dallas
Tulsa (3) IOWA (4) Billings WYOMING (2)
WISCONSIN (2) Iowa City Bozeman Casper
Onalaska Sioux City Cheyenne
Eau Claire Fort Dodge
Cedar Falls
</TABLE>
[Following are four pictures of typical store interiors]
[The inside front cover of the Prospectus is a gatefold design. The two
pages contained in the gatefold contain eight photos depicting products sold in
Company stores. Five of the photos (captioned "special occasion") depict
individuals celebrating special occasions (children's birthday, adult birthday,
weddings, theme parties and graduations). The other three photos (captioned
"seasonal and holiday") depict products sold by the Company used to celebrate
Valentine's Day, Halloween and Christmas. Below these pictures is a photo of a
typical Paper Warehouse storefront, a symbol representing the Company's low-
price pledge, a photo of gift wrapped boxes, the Paper Warehouse logo and the
Party Universe logo.]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN SUCH
SECURITIES, AND THE IMPOSITION OF A PENALTY BID, IN CONNECTION WITH THE
OFFERING. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN
THIS PROSPECTUS. ALL REFERENCES IN THIS PROSPECTUS TO "PAPER WAREHOUSE" OR THE
"COMPANY" REFER TO PAPER WAREHOUSE, INC. AND ITS WHOLLY-OWNED SUBSIDIARY. EXCEPT
AS OTHERWISE SPECIFIED, ALL INFORMATION IN THIS PROSPECTUS (I) REFLECTS A
37.57-FOR-1 STOCK SPLIT EFFECTED IN SEPTEMBER 1997, AND (II) ASSUMES NO EXERCISE
OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION. SEE "UNDERWRITING." REFERENCES TO
FISCAL YEARS IN THIS PROSPECTUS REFER TO THE FISCAL YEAR ENDING ON THE FRIDAY
NEAREST JANUARY 31 OF THE FOLLOWING CALENDAR YEAR (E.G., FISCAL 1996 ENDED ON
JANUARY 31, 1997).
THE COMPANY
Paper Warehouse is a growing chain of stores specializing in party supplies
and paper goods operating under the names PAPER WAREHOUSE and PARTY UNIVERSE.
The Company's four principal markets are Minneapolis/St. Paul, Kansas City,
Denver and Oklahoma City. Paper Warehouse stores offer an extensive assortment
of special occasion, seasonal and everyday paper products, including party
supplies, gift wrap, greeting cards and catering supplies, at everyday low
prices. The Company's 124 stores (73 Company-owned and 51 franchise stores) are
conveniently located in major retail trade areas to provide customers with easy
access to its stores. For the first six months of fiscal 1997, the Company's
revenues increased 27.3% to $24.7 million from $19.4 million for the comparable
period of fiscal 1996.
The Company offers a broad selection of party supplies and paper goods for a
wide variety of celebratory occasions and everyday uses, including birthdays,
weddings, baby showers, graduations and other family and religious celebrations,
as well as seasonal events such as Valentine's Day, Easter, Fourth of July,
Halloween, Thanksgiving, Christmas, Hanukkah and New Year's. Through the
Company's 8,500 square foot store prototype, the Company offers a comprehensive
selection of over 19,000 SKUs, which provides customers the convenience of
one-stop shopping for all party supplies and paper goods. The Company's
merchandise is organized by party themes, and the prominent signage and wide
aisles allow customers to easily access and coordinate the merchandise required
for all party occasions. The Company also believes that its extensive selection,
combined with high in-stock positions, often stimulates customers to purchase
additional products.
The Company believes that total United States retail sales of party and
special occasion merchandise (including greeting cards, party supplies, gift
wrap and related items) will grow to approximately $8.9 billion in 1997. Larger
format stores have become the fastest growing retail format within the party
goods industry by offering consumers a broader selection of merchandise at lower
prices compared to traditional party goods retailers. Paper Warehouse emphasizes
both convenient locations and an extensive selection of merchandise at everyday
low prices.
Paper Warehouse's goal is to be one of the leading suppliers of party
supplies and paper goods in existing markets and to establish a dominant
position in new markets. Paper Warehouse opened nine Company-owned stores in
fiscal 1997 and plans to open approximately 25 Company-owned stores in fiscal
1998. Approximately two-thirds of such new stores are expected to open in two
new geographic markets, one in the Midwest the other in the Western United
States. The Company has taken preliminary steps towards establishing itself in
these markets. One of the Company's primary competitors currently has several
stores in one of these markets. Additionally, management established three
franchise stores in fiscal 1997 and expects to establish between 15 and 20
franchise stores in fiscal 1998.
In order to increase its market share in existing markets, achieve a
dominant position in new markets and maximize operating efficiencies, the
Company employs the following growth strategy: (i) open multiple Company-owned
stores close to one another ("clustering") in new and existing metropolitan
markets, (ii) selectively open Company-owned stores in secondary markets that
can support one or two stores and that are contiguous with metropolitan markets
where the Company has existing stores, (iii) establish franchise stores in other
markets, and (iv) continuously refresh, remodel and expand existing stores.
3
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered.............. 1,778,000 shares
Common Stock to be outstanding
after the offering.............. 4,349,412 shares (1)
Use of proceeds................... To repay debt outstanding under the Company's revolving
credit facility, to repay Shareholder Notes, to repay
the Subordinated Notes and for new store expansion and
working capital and other general corporate purposes.
See "Use of Proceeds."
Nasdaq National Market symbol..... PWHS
</TABLE>
- ------------------------
(1) Assumes options and warrants to purchase 368,594 shares are exercised
immediately prior to this offering. Does not include an aggregate of 639,641
shares reserved for issuance under the Company's 1997 Stock Option and
Compensation Plan and Directors Stock Option Plan, of which 202,965 shares
will be subject to options to be granted upon consummation of this offering
at an exercise price equal to the initial public offering price. See
"Management--Employee and Directors Stock Option Plans."
------------------------
The first Paper Warehouse store opened in Minneapolis, Minnesota in 1983.
The current management team purchased this business in 1986 and incorporated the
Company in Minnesota in 1987. The Company's principal executive offices are
located at 7630 Excelsior Boulevard, St. Louis Park, Minnesota 55426 and its
telephone number is (612) 936-1000.
PAPER WAREHOUSE-Registered Trademark- and PARTY
UNIVERSE-Registered Trademark- are trademarks of the Company.
------------------------
THIS PROSPECTUS CONTAINS "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF
THE FEDERAL SECURITIES LAWS, WHICH INVOLVE RISKS AND UNCERTAINTIES AND WHICH CAN
BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "MAY," "WILL,"
"EXPECT," "ANTICIPATE," "ESTIMATE" OR "CONTINUE" OR THE NEGATIVE THEREOF OR
OTHER VARIATIONS THEREON OR COMPARABLE TERMINOLOGY. ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE PROJECTED IN SUCH FORWARD-LOOKING STATEMENTS DUE TO A
NUMBER OF FACTORS, INCLUDING THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE
IN THIS PROSPECTUS.
4
<PAGE>
SUMMARY OF FINANCIAL AND OPERATING DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEAR FIRST SIX MONTHS
----------------------------------------------------- --------------------
1992 1993 1994 1995 1996 1996 1997
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF EARNINGS DATA:
Revenues........................... $ 15,135 $ 18,218 $ 24,084 $ 33,478 $ 43,002 $ 19,444 $ 24,748
Operating income................... 600 1,096 1,494 1,781 2,080 598 957
Net income......................... 306 980 1,281 1,286 1,303 211 473
Pro forma net income(1)............ 313 608 794 797 808 131 293
Pro forma net income per
share(1)......................... 0.14 0.24 0.32 0.32 0.32 0.05 0.12
OPERATING DATA:
Number of stores open at end of
period:
Company-owned stores............. 37 40 42 55 64 60 68
Franchise stores................. 15 21 29 53 50 52 50
Remodeled stores................. 5 9 8 8 1 1 3
Comparable store sales
increase(2)...................... 8.6% 8.8% 16.6% 13.6%(3) 7.8%(3) 12.4% 9.5%
</TABLE>
<TABLE>
<CAPTION>
AUGUST 1, 1997
-------------------------
PRO FORMA
ACTUAL AS ADJUSTED(4)
--------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Working capital...................................................................... $ 5,561 $ 9,171
Total assets......................................................................... 19,086 20,560
Total debt(5)........................................................................ 11,132 921
Total stockholders' equity........................................................... 2,140 13,826
</TABLE>
- ------------------------
(1) Since February 1, 1993, the Company has been an S corporation and during
this period was not generally subject to corporate income taxes. The
statement of earnings data during this period reflects a pro forma provision
for income taxes as if the Company were subject to corporate income taxes
for such periods. This pro forma provision for income taxes is computed
using a combined federal and state tax rate of 38%. See "S Corporation
Distributions" and Note 10 of Notes to Financial Statements.
(2) Company-owned stores enter the comparable store sales base at the beginning
of their 13th month of operations. Stores in which retail square footage is
increased more than 50%, or stores which are relocated, are no longer
included in the comparable store sales base until 12 months have passed.
(3) For purposes of computing the increase in comparable store sales, this
computation assumes fiscal 1995 was a 52 week year.
(4) Adjusted to give effect to (i) an estimated $166,000 S corporation
distribution to existing shareholders upon consummation of this offering,
(ii) the exercise of options and warrants to purchase an aggregate of
368,594 shares immediately prior to this offering, and (iii) the sale of the
Common Stock offered by the Company hereby and (iv) the application of the
estimated net proceeds therefrom. See "S Corporation Distributions," "Use of
Proceeds" and Note 10 of Notes to Financial Statements.
(5) Total debt consists of total current and long-term debt. See
"Capitalization."
5
<PAGE>
RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION SET FORTH IN THIS PROSPECTUS, THE
FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING THE COMPANY
AND ITS BUSINESS BEFORE PURCHASING ANY OF THE SHARES OF COMMON STOCK OFFERED
HEREBY.
RISKS ASSOCIATED WITH GROWTH
The Company's ability to increase its sales and net earnings will depend in
part on its ability to open stores in new and existing markets and to operate
such stores on a profitable basis. Paper Warehouse, which currently operates 73
Company-owned stores, opened 11 Company-owned stores during fiscal 1996 and nine
Company-owned stores during fiscal 1997. In fiscal 1998, Paper Warehouse expects
to open approximately 25 Company-owned stores. Approximately two-thirds of such
stores are planned to be opened in two new geographic markets, one in the
Midwest the other in the Western United States. Although the Company has taken
preliminary steps towards establishing itself in these markets, the Company has
not legally committed itself in either market. If satisfactory sites are not
available in such markets or there is a change in the competitive environment,
alternative markets may be selected. One of the Company's primary competitors
currently has several stores in one of these markets. This planned expansion
represents a significant increase in the number of stores previously opened and
operated by the Company.
RISK OF OPENING NEW STORES
The Company's planned expansion in both new and existing markets is subject
to many risks, including, but not limited to, failure to identify suitable
markets, the unavailability of suitable sites on acceptable lease terms and the
failure to obtain qualified management and other store personnel. Operating
stores 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. Such challenges include adapting to local tastes
and customs as well as competing against local established and familiar
businesses, that may have innovative or other unique techniques for marketing
party supplies and paper goods. The Company's expansion plans may also place
significant demands on the Company's management, financial controls, operations
and information systems and may cause the Company to incur higher costs relating
to marketing and operations. The Company's expansion plans will also require an
increase in Company personnel, particularly store managers and sales associates
to operate the Company's new stores. There can be no assurance that the Company
will be able to continue to attract, develop, train and retain the personnel
necessary to pursue and maintain its growth and business strategies.
The Company's continued growth will depend on its ability to increase sales
in its existing stores. The opening of additional Company-owned stores in
existing markets could reduce sales from existing stores located in or near
those markets. Although the Company believes it has planned carefully for the
implementation of its expansion program, there can be no assurance that such
plans can be executed as presently envisioned or that the implementation of
those plans will not have an adverse effect on the Company's business, financial
condition and results of operations. See "Business--Expansion Strategy."
POTENTIAL NEED FOR ADDITIONAL FINANCING
The Company currently intends to finance new stores with cash generated from
operations, together with the net proceeds of this offering, payment terms from
vendors and available borrowings. The Company believes that funds from these
sources will be sufficient to finance the Company's growth plan to open
approximately 25 stores in fiscal 1998. To the extent that the funds generated
from the sources described above are insufficient to finance the Company's
growth plans, the Company would need to raise additional funds through debt or
equity financing. No assurance can be given that additional financing will be
available or that, if available, it will be available on terms favorable to the
Company. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources" and "Business--Expansion
Strategy."
6
<PAGE>
RISK OF POTENTIAL ACQUISITIONS
As part of its growth strategies, the Company periodically considers
strategic acquisitions of other retail stores or chains in the party supply
industry. As of the date of this Prospectus, the Company has no existing
agreements or commitments to affect any material acquisitions. 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
to the Company, including unanticipated business uncertainties, including
diversion of management attention, legal liabilities and significant costs and
expenses to the Company to complete the acquisition, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
RISK OF SEASONAL AND QUARTERLY REVENUE AND OPERATING FLUCTUATIONS
The Company's results of operations have historically fluctuated from
quarter to quarter for such reasons as seasonal variations in revenues and
operating expenses, the amount and timing of revenues contributed by new
Company-owned and franchise stores, the costs associated with the opening of new
stores and expenses incurred to support the Company's expansion strategy. As a
result of these seasonal variations, a significant portion of the Company's
operating income is generated in the second and fourth fiscal quarters.
Historically, the Company has engaged in more promotional activity during the
third quarter than the second quarter which results in reduced operating income
for the third quarter as compared to the second quarter. Any factors negatively
affecting the Company during the second and fourth fiscal quarters could have a
material adverse effect on the Company's financial condition and results of
operations for the entire fiscal year. Further, as a result of the seasonality
of the Company's revenue, the Company expects to incur a loss in the first
quarter of each year for the foreseeable future. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Quarterly Results
and Seasonality."
DEPENDENCE UPON KEY PERSONNEL
The Company's success depends in large part upon the abilities and continued
service of Yale T. Dolginow, its President and Chief Executive Officer, and
Brent D. Schlosser, its Executive Vice President in charge of merchandising.
While the Company has employment agreements with Messrs. Dolginow and Schlosser,
there can be no assurance that the Company will be able to retain the services
of such individuals. Loss of the services of Mr. Dolginow or Mr. Schlosser could
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Management--Employment Agreements."
RISKS ASSOCIATED WITH FRANCHISEES
During fiscal 1998 the Company plans to establish between 15 and 20 new
franchise stores. The continued growth and success of the Company is dependent
in part upon its ability to attract, contract with and retain qualified
franchisees and the ability of those franchisees to operate their stores
successfully and promote and develop the Paper Warehouse store concept. Although
the Company has established criteria to evaluate prospective franchisees and the
Company's franchise agreements include certain operating standards, each
franchisee operates its store independently and the Company is limited in its
ability to influence day-to-day store operations. There can be no assurance that
franchisees will be able to operate Paper Warehouse stores successfully in their
franchise areas in a manner consistent with the Company's concepts and
standards. Accordingly, the Company's franchisees could operate their stores in
a manner that damages the Company's reputation and, by reducing the gross
revenues of such stores, reduce the franchise revenue received by the Company.
See "Business--Franchising."
7
<PAGE>
FAILURE TO ANTICIPATE AND/OR RESPOND TO MERCHANDISING TRENDS
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. The Company makes merchandising decisions well in advance of the
seasons when such merchandise will be sold. Accordingly, any delay or failure by
the Company in identifying and responding to emerging trends could adversely
effect consumer acceptance of the merchandise in the Company's stores, which
would have a material adverse effect on the Company's business, financial
condition and results of operations. Certain licensed products sold by the
Company are in great demand for short time periods making it difficult to
project inventory needs for such products. Significant deviations from projected
demand for its products, in particular licensed products, could have a material
adverse effect on the Company's business, financial condition and results of
operations, either from lost sales due to insufficient inventory, higher
carrying costs associated with slower turning inventory or reduced or eliminated
margins due to the need to mark down excess inventory. See "Business--
Merchandising."
HIGHLY COMPETITIVE MARKET
The party supplies and paper goods retailing business is highly competitive.
Paper Warehouse stores compete with a variety of smaller and larger retailers,
including specialty party supply retailers (including other superstores), card
shops and designated departments in mass merchandisers, discount retailers, toy
stores, drug stores, supermarkets and department stores. Many of the Company's
competitors have substantially greater financial and personnel resources than
the Company. The Company may also encounter additional competition from new
entrants in the future in the Company's existing or planned new markets.
Increased competition by existing or future competitors may have a material
adverse effect on the Company. See "Business--Competition."
IMPLEMENTATION OF NEW INFORMATION SYSTEMS
In order to support the Company's continued expansion and enhance its
competitive position in the industry, the Company has entered into an agreement
to purchase a retail software package from JDA Software Company. Implementation
began during the third quarter of 1997 and is estimated to be completed sometime
during the third quarter of 1998. There can be no assurance that the JDA
Software will be implemented by the third quarter of 1998 or at all. The failure
to complete, or delays or problems in completing the implementation of the JDA
retail software package could have an adverse effect on the Company's business.
DEPENDENCE ON SUPPLIERS
The Company purchases its merchandise from approximately 150 suppliers. In
fiscal 1996, the Company's largest supplier represented approximately 13% of the
Company's purchases and the seven largest suppliers accounted for approximately
50% of the Company's purchases. The Company's future success is partially
dependent upon its ability to maintain good relationships with its principal
suppliers. Many of the Company's principal suppliers currently provide the
Company with certain incentives, such as volume purchasing allowances and trade
discounts. A reduction or discontinuance of these incentives could have a
material adverse effect on the Company. The Company does not have long-term
contracts with any of its suppliers, and any supplier could discontinue selling
to the Company at any time. While the Company believes its supplier
relationships are good, the failure by the Company to maintain good
relationships with its principal suppliers could have a material adverse effect
on the Company's business, financial condition or results of operations. See
"Business--Product Sourcing and Inventory Management."
EFFECT OF CHANGES IN CONSUMER PREFERENCES AND ECONOMIC CONDITIONS
The party goods business would be adversely affected if consumer demand for
single-use, disposable party goods were to diminish. For example, if cost
increases in raw materials such as paper or plastic were
8
<PAGE>
to cause the Company's prices to increase significantly, consumers might decide
to forgo the convenience associated with single-use, disposable products and use
standard dinnerware and flatware. Similarly, changes in consumer preferences
away from disposable products and in favor of reusable products for
environmental or other reasons could reduce the demand for the Company's
products. In addition, future adverse changes in economic conditions affecting
disposable consumer income, such as employment levels, the rate of inflation,
interest rates and taxation, could have an adverse effect on the party good
business. Because its operations are located principally in four metropolitan
areas, the Company is also subject to certain regional risks, such as the
economy, weather conditions, natural disasters and governmental regulations. If
any region in which the Company operates stores were to suffer an economic
downturn or other adverse regional events were to occur, there could be an
adverse impact on the Company's sales and profitability and its ability to
implement its planned expansion programs.
GOVERNMENT REGULATION
The Company, as a franchisor, is subject to regulation by the Federal Trade
Commission and also must comply with state laws regulating the offer and sale of
franchises and limiting the Company's ability to terminate or refuse to renew
franchises. The failure to obtain or maintain approvals to sell franchises could
adversely affect the Company. The Company and its franchisees are subject to
laws governing their relationships with employees, including minimum wage
requirements, overtime, working and safety conditions and citizenship
requirements. Because a significant number of the Company's employees are paid
at rates related to the federal minimum wage, increases in the minimum wage
would increase the Company's labor costs. See "Business--Government Regulation."
CONTROL BY MANAGEMENT; POSSIBLE ANTI-TAKEOVER EFFECT
Upon completion of this offering, Yale T. Dolginow, President and Chief
Executive Officer, and Brent D. Schlosser, Executive Vice President, will own or
have the right to vote and control the disposition of 50.6% of the Company's
outstanding Common Stock. Accordingly, these persons, acting together, will have
the ability to elect the Company's directors and determine the outcome of other
corporate actions requiring shareholder approval, regardless of the vote of the
other shareholders. Such control by existing shareholders could have the effect
of delaying, deferring or preventing a change in control of the Company. See
"Principal and Selling Shareholders."
DILUTION; DIVIDEND POLICY
Purchasers of Common Stock in this offering will incur immediate and
substantial dilution in the net tangible book value per share of their shares.
At the present time, the Company intends to use any earnings which may be
generated to finance further growth of the Company's business and does not
intend to pay dividends in the foreseeable future. See "Dilution" and "Dividend
Policy."
NO PRIOR MARKET FOR THE COMMON STOCK; POSSIBLE VOLATILITY OF STOCK PRICE
Prior to this offering, there has been no public market for the Common
Stock. Although the Common Stock has been approved for quotation on the Nasdaq
National Market, there can be no assurance that a market for the Common Stock
will develop or, if developed, will be sustained after this offering. The
initial public offering price of the Common Stock has been determined by
negotiations between the Company and the Representative. The market price for
the Common Stock may be volatile and fluctuate depending on various factors,
including the general economy, stock market conditions, analyst recommendations,
news announcements concerning the Company or the party supplies and paper goods
industry, variations in the Company's quarterly and annual operating results and
other factors. The stock market in general, and the market for shares of small
capitalization stocks in particular, have experienced significant price and
volume fluctuations that often have been unrelated to the operating performance
of particular companies. These market fluctuations may adversely effect the
market price of the Common Stock, and the negotiated initial public offering
price may not be indicative of future market prices of the Common
9
<PAGE>
Stock. There can be no assurance that the prices at which the Common Stock will
sell in the public market after this offering will not be lower than the Price
to Public. See "Underwriting."
POSSIBLE ISSUANCES OF PREFERRED STOCK; ANTI-TAKEOVER EFFECT OF MINNESOTA LAW
Pursuant to the Company's Amended and Restated Articles of Incorporation,
the Board of Directors has authority to fix the rights, preferences, privileges
and restrictions, including voting rights, of any shares of the Company's
preferred stock and to issue such stock without any further vote or action by
the shareholders. The rights of the holders of Common Stock will be subject to,
and may be adversely affected by, the rights and preferences of the holders of
any shares of preferred stock that the Board of Directors may create and issue
in the future. The issuance of any such preferred stock could have the effect of
delaying, deferring or preventing a change in control of the Company. In
addition, certain provisions of Minnesota law applicable to the Company could
have the effect of discouraging certain attempts to acquire the Company, which
could deprive the Company's shareholders of opportunities to sell their shares
of Common Stock at prices higher than prevailing market prices and may also have
a depressive effect on the market price of the Company's Common Stock. See
"Description of Capital Stock."
SHARES ELIGIBLE FOR FUTURE SALE
The Company and each of its directors and executive officers and all of its
existing shareholders have agreed with the Underwriters not to sell, offer to
sell, solicit an offer to buy, contract to sell, grant any option to purchase,
or otherwise transfer or dispose of any shares of Common Stock, or any
securities convertible into or exercisable or exchangeable for Common Stock, for
a period of 180 days after the effective date of this offering without the prior
written consent of the Representative. Following this offering, 4,349,412 shares
of Common Stock will be outstanding. Of such shares, the 1,778,000 shares of
Common Stock offered hereby will be freely tradable by persons who are not
affiliates of the Company and 2,571,412 shares of Common Stock will be subject
to 180-day lock-up agreements with the Underwriters. Upon expiration of the
180-day period, all of these shares will be eligible for public sale under Rule
144, subject in certain cases to volume and manner of sale limitations.
Approximately 90 days after completion of this offering, the Company intends to
file a Registration Statement on Form S-8 covering shares issuable under the
Company's 1997 Employee Stock Option and Compensation Plan and the Directors
Stock Option Plan, thus permitting the resale of such shares by non-affiliates
in the public market without restrictions under the Securities Act. Sales of a
substantial number of shares 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 "Shares Eligible for Future
Sale."
S CORPORATION STATUS; DISTRIBUTIONS
Since 1993, the Company has been treated as an S corporation under the
Internal Revenue Code of 1986 as amended (the "Code"). As a result, the
Company's shareholders prior to the consummation of this offering (Messrs.
Dolginow and Schlosser) (the "Current Shareholders") have been directly subject
to tax on the income of the Company for federal, state and certain local income
tax purposes. As an S corporation, the Company has made distributions of
accumulated net income to the Current Shareholders. In connection with this
offering, the Company will be converted to a C corporation and similar
distributions will not be made to the purchasers of Common Stock in this
offering. The Company believes that it has met the S corporation requirements
and, as of the date of this Prospectus, the Internal Revenue Service (the "IRS")
and other applicable state taxing authorities have not challenged the Company's
S corporation status. If, for any reason, the Company were subsequently
determined by the IRS or other applicable state taxing authorities not to have
met S corporation requirements, the Company could be liable to pay corporate
taxes on its income at the effective corporate tax rate for all or a part of the
period from February 1, 1993 through the consummation of this offering, plus
interest and possibly penalties. See "S Corporation Distributions" and "Certain
Transactions."
10
<PAGE>
S CORPORATION DISTRIBUTIONS
The Company has elected to be treated for federal and certain state income
tax purposes as an S corporation under the Code since February 1, 1993. As a
result, earnings of the Company since that time have been taxed for federal and
certain state income tax purposes directly to its Current Shareholders rather
than to the Company. In connection with this offering, the Company will be
converted from an S corporation to a C corporation under the Code. In past
years, the Company has paid annual distributions to its Current Shareholders to
provide them with funds to pay income taxes on such earnings and as a return on
their investment. The Company declared aggregate distributions to its Current
Shareholders of approximately $186,000, $963,000 and $808,000 during fiscal
1993, fiscal 1994 and fiscal 1995, respectively (87% of which was received by
Mr. Dolginow and 13% of which was received by Mr. Schlosser).
In January 1997, the Board of Directors of the Company declared a cash
dividend payable to the Current Shareholders of the Company (the "Fiscal Year
1996 Dividend"). The Fiscal Year 1996 Dividend was equal to the Company's
estimate of its accumulated taxable income from the time of its S corporation
election through the first eleven months of fiscal 1996 to the extent such
taxable income had not previously been distributed. This dividend aggregated
approximately $2.1 million and, following payment of approximately $1.9 million
to Mr. Dolginow and $278,000 to Mr. Schlosser, was loaned back to the Company
pursuant to term promissory notes accruing interest at 5.63% per annum (the
"First Shareholder Notes") that mature on January 13, 1998. In September 1997,
the Board of Directors of the Company declared a cash dividend payable to the
Current Shareholders of the Company (the "First Dividend"). The First Dividend
was equal to the Company's estimate of its accumulated taxable income from the
date of the Fiscal Year 1996 Dividend through the first six months of fiscal
1997 to the extent such taxable income had not previously been distributed. The
First Dividend aggregated approximately $166,000 and, following payment of
approximately $144,000 to Mr. Dolginow and $22,000 to Mr. Schlosser, was loaned
back to the Company pursuant to term promissory notes accruing interest at 5.63%
per annum that mature on October 2, 1998 (the "Second Shareholder Notes" and,
together with the First Shareholder Notes, the "Shareholder Notes"). The
Shareholder Notes will be repaid from the proceeds of this offering. The Board
of Directors of the Company also will declare a cash dividend payable to the
Current Shareholders, concurrent with the consummation of this offering (the
"Second Dividend" and, together with the First Dividend, the "Dividends") equal
to the balance, if any, of accumulated taxable income from the date of the First
Dividend through the date of the conversion of the Company to a C corporation in
connection with this offering. Because the Company does not currently anticipate
that it will have a material amount of accumulated taxable income during the
period from the date of the First Dividend through the date of the conversion of
the Company to a C corporation, the Company does not believe the Second Dividend
will be a material amount. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Overview." If a Second Dividend
is declared, a portion of the net proceeds of this offering would be used to pay
the dividend. See "Use of Proceeds." Purchasers of the Common Stock in this
offering will not receive any of these distributions.
The Company and the Current Shareholders are parties to an S Corporation Tax
Allocation and Indemnification Agreement (the "Tax Agreement") relating to their
respective income tax liabilities. The Tax Agreement indemnifies the
shareholders for any adjustments causing an increase in the shareholders'
federal and state income tax liability (including interest and penalties)
related to the Company's tax years prior to the consummation of this offering,
unless such adjustments result in or are related to a corresponding decrease in
the shareholders' federal and state income tax liability with respect to another
S corporation taxable year. Subject to certain limitations, the Tax Agreement
also provides that the Company will be indemnified by the shareholders with
respect to federal and state income taxes (plus interest and penalties) shifted
from an S corporation taxable year to a Company taxable year subsequent to the
consummation of this offering. Since the shareholders have not given any
security for their indemnification obligation, the Company's ability to collect
such payments is dependent upon the financial condition of the shareholders at
the time any such indemnification obligation arises. The Company is not aware of
any tax adjustments which may arise under the Tax Agreement. The Tax Agreement
further provides that to the extent that the accumulated taxable income of the
Company prior to its conversion to a C corporation is less than the Dividends,
the Current Shareholders will make a payment equal to such difference to the
Company, and if such accumulated taxable income is greater than the aggregate
amount of the Dividends, the Company will make an additional distribution equal
to such difference to such shareholders, in either case, with interest thereon.
Any payment made by the Company to the Current Shareholders pursuant to the Tax
Agreement may be considered by the Internal Revenue Service or the state taxing
authorities to be nondeductible by the Company for income tax purposes. See Note
10 of Notes to Financial Statements.
11
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from this offering after deducting
underwriting discounts and commissions and estimated offering expenses will be
approximately $11.9 million ($13.4 million if the Underwriters' over-allotment
option is exercised in full). The Company will not receive any of the proceeds
from the sale of shares by the Selling Shareholder.
The principal purpose of this offering is to reduce existing indebtedness to
provide additional capital to support the Company's continued expansion and
growth. The Company intends to use the proceeds of this offering as follows: (i)
approximately $5.8 million to repay the Company's current outstanding balance on
its revolving credit facility with Richfield Bank & Trust Co., which accrues
interest at the bank's base rate plus 0.5% (9.0% as of August 1, 1997) and
terminates on May 31, 1999, (ii) approximately $2.3 million to repay the
Shareholder Notes, which accrue interest at 5.63% per annum, and (iii)
approximately $2.3 million to repay the Subordinated Notes, which accrue
interest at 10% per annum and mature November 30, 2004. In addition, in the
event that the Company declares the Second Dividend, a portion of the net
proceeds will be used to pay the Second Dividend. Because the Company does not
currently anticipate that it will have a material amount of accumulated taxable
income during the period from the date of the First Dividend through the date of
the conversion of the Company to a C corporation, the Company does not believe
that the Second Dividend will be material. Messrs. Dolginow and Schlosser,
directors, executive officers and principal shareholders of the Company, are the
payees of the Shareholder Notes. The First Shareholder Notes mature on January
13, 1998 and the Second Shareholder Notes mature on October 2, 1998. See "S
Corporation Distributions." Mr. Dolginow has guaranteed a portion of the
Company's revolving credit facility with Richfield Bank & Trust Co. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" and "Certain Transactions."
The balance of the net proceeds of this offering will primarily be used for
new store expansion as well as for working capital and other general corporate
purposes. Pending the use of the net proceeds of this offering, the Company will
invest the funds in short-term, interest-bearing, investment-grade securities.
DIVIDEND POLICY
Other than the dividends described in "S Corporation Distributions," the
Company has not declared any cash dividends during the past two fiscal years or
the six months ended August 1, 1997. Following the consummation of this
offering, the Company's Board of Directors intends to retain the future earnings
of the Company, if any, to support the Company's operations and to finance its
growth and development. The Company does not intend to pay cash dividends on the
Common Stock in the foreseeable future. Any future determination as to the
payment of dividends will be at the discretion of the Board of Directors and
will depend on the Company's financial condition, results of operations, capital
requirements and such other factors as the Board of Directors may deem relevant.
In addition, the Company's current revolving credit facility prohibits the
payment of cash dividends by the Company except for distributions in connection
with the termination of its S corporation status.
12
<PAGE>
CAPITALIZATION
The following table sets forth the short-term debt and capitalization of the
Company (i) at August 1, 1997, (ii) pro forma to give effect to (x) the exercise
of options and warrants to purchase an aggregate of 368,594 shares immediately
prior to this offering, (y) the payment of the First Dividend, and (z) the
issuance of the Second Shareholder Notes, and (iii) pro forma as adjusted to
reflect the receipt and application of the net proceeds from the issuance and
sale by the Company of 1,778,000 shares of Common Stock offered hereby. This
table should be read in conjunction with the Financial Statements and Notes
thereto appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AUGUST 1, 1997
-----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Notes payable...................................................................... $ 2,136 $ 2,136 $ 0
Current maturities of long-term debt............................................... 22 22 22
--------- ----------- -----------
$ 2,158 $ 2,158 $ 22
--------- ----------- -----------
--------- ----------- -----------
Long-term debt, less current maturities............................................ $ 8,974 $ 9,140 $ 899
Stockholders' equity
Serial preferred stock; 10,000,000 shares authorized; none outstanding........... 0 0 0
Common stock, $0.01 par value, 40,000,000 shares authorized; 2,202,818 shares
issued and outstanding, actual; 2,571,412 shares issued and outstanding, pro
forma; 4,349,412 shares issued and outstanding, pro forma as adjusted(1)....... 22 26 43
Additional paid-in capital....................................................... 572 568 12,403
Retained earnings................................................................ 1,546 1,546 1,546
S Corporation distribution....................................................... -- (166) (166)
--------- ----------- -----------
Total stockholders' equity..................................................... 2,140 1,974 13,826
--------- ----------- -----------
Total capitalization......................................................... $ 11,114 $ 11,114 $ 14,725
--------- ----------- -----------
--------- ----------- -----------
</TABLE>
- ------------------------
(1) Does not include an aggregate of 639,641 shares reserved for issuance under
the Company's 1997 Stock Option and Compensation Plan and the Directors
Stock Option Plan, of which 202,965 shares will be subject to options to be
granted upon consummation of this offering at an exercise price equal to the
initial public offering price. See "Management--Employee and Directors Stock
Option Plans."
13
<PAGE>
DILUTION
The pro forma net tangible book value of the Company's Common Stock as of
August 1, 1997 was approximately $2.0 million, or $0.77 per share, after giving
pro forma effect to the exercise of options and warrants to purchase an
aggregate of 368,594 shares immediately prior to this offering and to the
payment of the First Dividend. Pro forma net tangible book value per share
represents the Company's total tangible assets less total liabilities divided by
the number of shares of Common Stock outstanding.
After giving effect to the sale by the Company of the 1,778,000 shares of
Common Stock offered hereby (after deduction of underwriting discounts and
commissions and estimated offering expenses), and application of the estimated
net proceeds therefrom, and without taking into account any other changes in
such net tangible book value after August 1, 1997 other than the exercise of
options and warrants to purchase an aggregate of 368,594 shares immediately
prior to this offering and the payment of the First Dividend, the pro forma net
tangible book value of the Company at August 1, 1997 would have been
approximately $13.8 million, or $3.18 per share. This represents an immediate
increase in net tangible book value of $2.41 per share to existing shareholders
and an immediate dilution of $4.32 per share to investors in this offering.
"Dilution" is determined by subtracting net tangible book value per share after
this offering from the initial public offering price, as illustrated by the
following table:
<TABLE>
<S> <C> <C>
Initial public offering price per share............................ $ 7.50
Pro forma net tangible book value per share at August 1, 1997.... $ 0.77
Increase per share attributable to investors in this offering.... 2.41
---------
Pro forma net tangible book value per share after this offering
(1).............................................................. 3.18
---------
Dilution per share to new investors................................ $ 4.32
---------
---------
</TABLE>
- ------------------------
(1) The above computation assumes no exercise of outstanding stock options. The
Company has reserved an aggregate of 639,641 shares of Common Stock for
issuance under the Company's 1997 Stock Option and Compensation Plan and the
Directors Stock Option Plan, of which 202,965 shares will be subject to
options to be granted upon consummation of this offering at an exercise
price equal to the initial public offering price. See "Management--Employee
and Directors Stock Option Plans."
In December 1992, Yale T. Dolginow purchased 660,857 shares of Common Stock
from a shareholder of the Company for a purchase price of $0.42 per share.
14
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
The selected combined/consolidated financial and operating data presented
below under the captions "Statement of Earnings Data," "Selected Operating
Data," and "Balance Sheet Data" for, and as of the end of, each of the years in
the five-year period ended January 31, 1997, and for the six-month periods ended
August 1, 1997 and August 2, 1996, are derived from the combined/consolidated
financial statements of the Company. The combined/consolidated balance sheets as
of January 31, 1997 and February 2, 1996, and the related statements of earnings
and retained earnings, and cash flows for each of the years in the three-year
period ended January 31, 1997 have been audited by KPMG Peat Marwick LLP,
independent certified public accountants; these financial statements and the
report thereon are included elsewhere in this Prospectus. The unaudited selected
data presented below is derived from the combined/consolidated unaudited balance
sheets as of January 29, 1993 and January 31, 1992, and as of August 1, 1997,
and August 2, 1996, and related unaudited statements of earnings and retained
earnings and cash flows for each of the periods then ended. The unaudited
combined/consolidated balance sheets as of August 1, 1997 and August 2, 1996,
and the related unaudited financial statements are included elsewhere in this
Prospectus. With respect to such unaudited financial statements, management
believes all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included.
<TABLE>
<CAPTION>
FISCAL YEAR FIRST SIX MONTHS
----------------------------------------------------- --------------------
1992 1993 1994 1995 1996 1996 1997
--------- --------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF EARNINGS DATA:
Revenue
Company-owned stores...................... $ 14,942 $ 17,847 $ 23,640 $ 32,414 $ 41,892 $ 18,970 $ 24,206
Franchise related fees.................... 193 371 443 1,064 1,110 474 542
--------- --------- --------- --------- --------- --------- ---------
Total revenues.......................... 15,135 18,218 24,084 33,478 43,002 19,444 24,748
Costs and expenses:
Costs of products sold and occupancy
costs................................... 10,170 11,718 15,474 21,879 27,947 12,946 16,267
Store operating expenses.................. 2,970 3,594 4,635 6,367 8,732 3,829 4,896
General and administrative expenses....... 1,395 1,810 2,480 3,451 4,293 2,071 2,628
--------- --------- --------- --------- --------- --------- ---------
Operating income........................ 600 1,096 1,494 1,781 2,080 598 957
Interest expense............................ 94 111 208 490 772 385 479
--------- --------- --------- --------- --------- --------- ---------
Income before income taxes(1)........... 505 985 1,286 1,291 1,308 213 478
Provision for income taxes(1)............... 198 5 5 5 5 2 5
--------- --------- --------- --------- --------- --------- ---------
Net income.................................. $ 306 $ 980 $ 1,281 $ 1,286 $ 1,303 $ 211 $ 473
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Pro forma provision for income taxes(1)..... (7) 372 487 489 495 80 180
Pro forma net income(1)..................... 313 608 794 797 808 131 293
Pro forma net income per share(1)........... 0.14 0.24 0.32 0.32 0.32 0.05 0.12
Supplemental pro forma net income per
share(2).................................. 0.32 0.14
SELECTED OPERATING DATA:
Number of stores open at end of period:
Company-owned stores...................... 37 40 42 55 64 60 68
Franchise stores.......................... 15 21 29 53 50 52 50
Remodeled stores.......................... 5 9 8 8 1 1 3
Comparable store sales(3)................... 8.6% 8.8% 16.6% 13.6%(4) 7.8%(4) 12.4% 9.5%
BALANCE SHEET DATA (AT END OF PERIOD):
Working capital............................. $ 492 $ 979 $ 2,301 $ 925 $ 1,701 $ 793 $ 5,561
Total assets................................ 4,080 5,517 8,211 14,934 16,270 16,150 19,086
Total debt.................................. 1,404 1,853 3,619 8,021 11,240 8,720 11,132
Total shareholders' equity.................. 1,535 2,328 2,646 3,124 1,793 3,334 2,140
</TABLE>
- ------------------------------
(1) Since February 1, 1993, the Company has been an S corporation and during
this period was not generally subject to corporate income taxes. The
statement of operations data during this period reflects a pro forma
provision (benefit) for income taxes as if the Company were subject to
corporate income taxes for such periods. This pro forma provision (benefit)
for income taxes is computed using a combined federal and state tax rate of
38%. See "S Corporation Distributions" and Note 10 of Notes to Financial
Statements.
(2) The above computation gives effect to the sale of those shares necessary to
repay: (1) debt outstanding under the Company's revolving credit facility,
(2) the Shareholder Notes (including the effect of the September
distribution) and (3) the Subordinated Notes.
(3) Company-owned stores enter the comparable store sales base at the beginning
of their 13th month of operations. Stores in which retail square footage is
increased more than 50% or stores which are relocated, are no longer
included in the comparable store sales base until 12 months have passed.
(4) For purposes of computing the increase in comparable store sales, this
computation assumes fiscal 1995 was a 52 week year.
15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion of the Company's results of operations and its
liquidity and capital resources should be read in conjunction with "Selected
Financial and Operating Data" and the Financial Statements of the Company and
related Notes thereto appearing elsewhere in this Prospectus.
OVERVIEW
Paper Warehouse is a growing chain of stores specializing in party supplies
and paper goods operating under the names PAPER WAREHOUSE and PARTY UNIVERSE.
The current management team purchased the business in 1986 and incorporated the
Company in Minnesota in 1987. At the time of the acquisition, the Company
consisted of three stores located in Minneapolis/St. Paul metropolitan area. In
1987, the Company began granting franchises. Over the past 10 years, the Company
has grown to an aggregate of 124 stores, including 73 Company-owned stores and
51 franchise stores throughout 23 states. In growing the number of Company-owned
stores, management has employed a strategy of clustering stores in the Company's
principal markets to provide its customers with convenient store locations,
expand its total market share and achieve favorable economies of scale.
During the early 1990s, the Company began increasing the size of its stores
to accommodate a significantly wider breadth and depth of party supplies
available to the industry. The current prototype store, introduced in 1994, is
8,500 square feet and offers over 19,000 SKUs. Management believes this
prototype is the optimal store format for its planned expansion.
From fiscal 1994 through fiscal 1996, Paper Warehouse has opened 24 new
Company-owned stores and has remodeled 17 existing Company-owned stores. As a
result of this expansion and the installation of its POS system, occupancy,
advertising and depreciation expenses have increased as a percentage of
Company-owned store revenue. To finance this expansion and investment in
technology, the Company has increased bank borrowings and issued Subordinated
Notes, in addition to using cash generated from operations. The increased
borrowings resulted in higher interest expense as a percentage of total revenue
during this period. In addition, store labor expense as a percentage of
Company-owned store revenue has increased during this period, the result of
increased minimum wage. As a result of the increases in expenses outlined above,
pro forma net income as a percentage of total revenues has declined from 3.3% to
1.9% over the period.
Prior to this offering, the Company elected to be treated for federal and
state income tax purposes as an S corporation under the Code and comparable
state tax laws. As a result, earnings of the Company have been taxed for federal
and state income tax purposes directly to the shareholders of the Company,
rather than to the Company. In connection with this offering, the Company will
convert from an S corporation to a C corporation under the Code. The statement
of operations data for all periods discussed below includes a provision for
federal and state income taxes as if the Company were subject to federal and
state corporate income taxes for all such periods. This pro forma provision is
computed using a combined federal and state tax income tax rate of 38%. See "S
Corporation Distributions" and Note 10 of Notes to Financial Statements.
Total revenue consists of Company-owned store sales and franchise revenues.
Franchise revenues are generated from royalties received on sales, generally 4%
of the store's sales, and initial franchise fees, which are recognized at the
time a store opens. Company-owned stores enter the comparable store sales base
at the beginning of their 13th month of operations. Stores in which retail
square footage is increased more than 50%, or stores which are relocated, are no
longer included in the comparable store sales base until 12 months have passed.
Cost of goods sold include the direct cost of merchandise, plus handling and
distribution, coupon costs, and certain occupancy costs. Store operating
expenses include all costs incurred at the store level, such as advertising,
credit card processing fees, and store payroll. General and
16
<PAGE>
administrative expenses include corporate administrative expense for the
Company-owned stores and expenses relating to franchising, primarily payroll,
legal, travel, and advertising.
RECENT DEVELOPMENTS
Based on preliminary results for the third quarter ended October 31, 1997,
the Company believes that sales of Company-owned stores will increase
approximately 21% from the comparable period of the prior fiscal year.
Comparable store sales increases were approximately 10% over the prior period.
The balance of the increase in sales is attributable to new and remodeled
Company-owned stores. Pro forma net income for the third quarter is expected to
be approximately break-even compared to approximately $26,000 for the comparable
period of fiscal 1996. The Company believes that the decrease in pro forma net
income from the comparable period in 1996 is primarily the result of additional
advertising expense and additional operating expenses associated with hiring new
senior management personnel and upgrading systems infrastructure to support its
growth plans. Also, the Company incurred additional borrowings during the
quarter and pre-opening expenses related to three stores that opened in the
first week of the fourth quarter.
As a result of the early retirement of the Subordinated Notes in connection
with the offering, the Company will incur a one-time charge to earnings, in the
fourth quarter, of approximately $180,000 for the unamortized portion of the
Company's expenses related to issuance of the Subordinated Notes.
RESULTS OF OPERATIONS
SIX MONTHS ENDED AUGUST 1, 1997 COMPARED TO SIX MONTHS ENDED AUGUST 2, 1996
REVENUE. The number of Company-owned stores increased to 68 stores at the
end of the six months ended August 1, 1997, from 60 stores at the end of the six
months ended August 2, 1996. Company-owned store sales increased 27.6% to $24.2
million for the first six months of fiscal 1997 from $19.0 million for the
comparable period of fiscal 1996. Of this increase, approximately $4.4 million
is attributable to comparable store sales and approximately $800,000 is
attributable to new and remodeled Company-owned stores. Comparable store sales
increased 9.5% for the six months ended August 1, 1997, compared to the prior
period.
The number of franchise stores decreased to 50 franchise stores at the end
of the six months ended August 1, 1997, from 52 franchise stores at the six
months ended August 2, 1996. Franchise revenue increased 14.4% to $542,000 for
the first six months of fiscal 1997 from $474,000 for the comparable period of
fiscal 1996. Initial franchise fees decreased $19,700 due to a reduction in
franchise store openings in the first six months of fiscal 1997. The decrease in
initial franchise fees was offset by increased royalty payments resulting from
higher sales in the franchise stores.
COST OF GOODS SOLD. Cost of goods sold for the first six months of fiscal
1997 was $16.3 million, or 67.2% of Company-owned store revenue, as compared to
$12.9 million, or 68.2%, of Company-owned store revenue, for the comparable
period of fiscal 1996. The decrease as a percentage of Company-owned store
revenues was primarily attributable to a decrease in the cost of merchandise
arising from greater volume discounts and more favorable pricing from vendors.
STORE OPERATING EXPENSES. Store expenses for the first six months of fiscal
1997 were $4.9 million, or 20.2% of Company-owned store revenue, as compared to
$3.8 million, or 20.2% of Company-owned store revenue, for the comparable period
of fiscal 1996.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
for the first six months of fiscal 1997 were $2.6 million as compared to $2.1
million. The increase was primarily due to an increased number of stores.
17
<PAGE>
INTEREST EXPENSE. Interest expense increased $94,000 to $479,000, or 1.9%
of total revenue for the first six months of fiscal 1997 from $385,000, or 2.0%
of total revenue for the comparable period of fiscal 1996. This is the result of
increased bank borrowing necessary to fund the Company's growth. Interest rates
have been stable.
PRO FORMA NET INCOME. As a result of the factors discussed above, pro forma
net income increased 123.7%, to $293,000, or 1.2% of total revenue for the first
six months of fiscal 1997 from $131,000, or 0.7% of total revenue for the
comparable period of fiscal 1996. Pro forma net income includes a provision for
federal and state income taxes.
FISCAL YEAR 1996 (52 WEEKS) COMPARED TO FISCAL YEAR 1995 (53 WEEKS)
REVENUE. The number of Company-owned stores increased to 64 at the end of
fiscal 1996 from 55 Company-owned stores at the end of fiscal 1995.
Company-owned store revenue increased 29.2% to $41.9 million for fiscal 1996
from $32.4 million for fiscal 1995. Of this increase, approximately $2.0 million
was attributable to comparable store sales increases and approximately $7.5
million is attributable to new and remodeled Company-owned stores. For purposes
of computing the increase in comparable store sales, this calculation assumes
fiscal 1995 was a 52 week year. Comparable store sales increased 7.8% for the
fiscal year ended 1996 compared to the prior period.
The number of franchise stores decreased to 50 franchise stores at the end
of fiscal 1996 from 53 franchise stores at the end of fiscal 1995. During fiscal
1996, one of the Company's franchisees, a catalog showroom chain operating
franchise stores as designated departments within 12 of its stores, ceased
business. As a result of this action, these franchise stores, which contributed
$61,000 in franchise revenues to the Company in fiscal 1996, ceased operating.
Franchise revenue increased 4.3%, to $1.1 million for fiscal 1996 from $1.1
million for fiscal 1995. Initial franchise fees decreased $320,000 due to a
reduction in franchise store openings in the fiscal 1996. The decrease in
initial franchise fees was offset by increased royalty payments resulting from
increased sales in the franchise stores.
COST OF GOODS SOLD. Cost of goods sold for fiscal 1996 was $27.9 million,
or 66.7% of Company-owned store revenue, as compared to $21.9 million, or 67.5%,
of Company-owned store revenue for fiscal 1995. The decrease as a percentage of
Company-owned store revenue was primarily attributable to greater volume
discounts and more favorable pricing from vendors.
STORE OPERATING EXPENSES. Store operating expenses for 1996 were $8.7
million, or 20.8% of Company-owned store revenue, as compared to $6.4 million,
or 19.6% of Company-owned store revenue in fiscal 1995. The increase as a
percentage of Company-owned store revenue was primarily attributable to
increases in store labor, advertising, utilities, and depreciation. Store labor
increased due to the increase in minimum wage, and increased management staff at
larger stores.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $4.2 million compared to $3.5 million in fiscal 1995. The increase in
general and administrative expenses was primarily due an increase number of
stores.
INTEREST EXPENSE. Interest expense increased $282,000 to $772,000, or 1.8%
of total revenue in fiscal 1996 from $490,000, or 1.5% of total revenue, in
fiscal 1995. The increase is due to greater bank borrowing, used to finance the
Company's growth.
PRO FORMA NET INCOME. As a result of the factors discussed above, pro forma
net income increased 1.4%, to $808,000, or 1.9% of total revenue in fiscal 1996
from $797,000, or 2.4% of total revenue in fiscal 1995. Pro forma net income
includes a provision for federal and state income taxes.
18
<PAGE>
FISCAL YEAR 1995 (53 WEEKS) COMPARED TO FISCAL YEAR 1994 (52 WEEKS)
REVENUE. The number of Company-owned stores increased to 55 at the end of
fiscal 1995, from 42 Company-owned stores at the end of fiscal 1994.
Company-owned store revenue increased 37.1%, to $32.4 million for fiscal 1995
from $23.6 million for fiscal 1994. Of this increase, $2.6 million was
attributable to comparable store sales, $6.2 million was attributable to new and
remodeled Company-owned stores. Comparable store sales increased 13.6% for the
fiscal year ended 1996 compared to the prior period.
The number of franchise stores increased to 53 at the end of fiscal 1995,
from 29 franchise stores at the end of fiscal 1994. Franchise revenue increased
140.3%, to $1.1 million for fiscal 1995 from $443,000 for fiscal 1994. Initial
franchise fees increased $380,000, primarily from establishing 27 new franchise
stores, including a 12-store franchisee. Royalty payments increased $242,000.
COST OF GOODS SOLD. Cost of goods sold for fiscal 1995 was $21.9 million,
or 67.5% of Company-owned store revenue, as compared to $15.5 million, or 65.5%,
of Company-owned store revenue, for fiscal 1994. The increase as percentage of
Company-owed store revenue was primarily attributable to an increase in
occupancy costs from the new Company-owned stores without a commensurate
increase in revenue.
STORE OPERATING EXPENSES. Store operating expenses for fiscal 1995 were
$6.4 million, or 19.6% of Company-owned store revenue, as compared to $4.6
million, or 19.6% of Company-owned store revenue for fiscal 1994.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
for fiscal 1995 were $3.5 million as compared to $2.5 million. This increase in
general and administrative expenses was primarily due to an increase in the
number of stores.
INTEREST EXPENSE. Interest expense increased 135.2%, to $490,000, or 1.5%
of total revenue for fiscal 1995 from $208,000, or 0.9% of total revenue for
fiscal 1994. This increase resulted primarily from increased borrowing under the
Company's bank facility.
PRO FORMA NET INCOME. As a result of the factors discussed above, pro forma
net income increased 0.4%, to $797,000, or 2.4% of total revenue for fiscal 1995
from $794,000, or 3.3% of total revenue for fiscal 1994. Pro forma net income
includes a provision for federal and state income taxes.
19
<PAGE>
QUARTERLY RESULTS AND SEASONALITY
The following table sets forth the Company's unaudited consolidated
quarterly results of operations for each of the quarters in fiscal 1995, fiscal
1996, and the first two quarters of fiscal 1997, in thousands. This quarterly
information is unaudited, but has been prepared on the same basis as the annual
financial information and, in the opinion of management, reflects all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation indicative of the results for the representative fiscal year.
The results of operations for any quarter are not necessarily indicative of the
results of any future period.
<TABLE>
<CAPTION>
FISCAL 1995
---------------------------------------------------------------
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------- --------------- --------------- --------------
<S> <C> <C> <C> <C>
Total revenue...................................... $ 5,766 $ 8,276 $ 8,471 $ 10,965
% of full year................................... 17.2% 24.7% 25.3% 32.8%
Operating income (loss)............................ $ (292) $ 821 $ 361 $ 891
% of full year................................... (16.4%) 46.1% 20.3% 50.0%
</TABLE>
<TABLE>
<CAPTION>
FISCAL 1996
-------------------------------------------------------------
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------- --------------- ------------- --------------
<S> <C> <C> <C> <C>
Total revenue...................................... $ 8,739 $ 10,705 $ 11,278 $ 12,280
% of full year................................... 20.3% 24.9% 26.2% 28.6%
Operating income (loss)............................ $ (119) $ 717 $ 240 $ 1,242
% of full year................................... (5.7%) 34.5% 11.5% 59.7%
</TABLE>
<TABLE>
<CAPTION>
FISCAL 1997
------------------------------
FIRST QUARTER SECOND QUARTER
------------- ---------------
<S> <C> <C> <C> <C>
Total revenue...................................... $ 11,129 $ 13,619
Operating income (loss)............................ $ (216) $ 1,173
</TABLE>
The Company's results of operations have historically fluctuated from
quarter to quarter for such reasons as seasonal variations in revenues and
operating expenses, the amount and timing of revenues contributed by new
Company-owned and franchise stores, the costs associated with the opening of new
stores, and expenses incurred to support the Company's expansion strategy. As a
result of these seasonal variations, a significant portion of the Company's
operating income is generated in the second and fourth fiscal quarters.
Historically, the Company has engaged in more promotional activity during the
third quarter than the second quarter, which results in reduced operating income
for the third quarter as compared to the second quarter. Any factors negatively
affecting the Company during the second and fourth fiscal quarters could have a
material adverse effect on the Company's financial condition and results of
operations for the entire fiscal year. Further, as a result of the seasonality
of the Company's revenue, the Company expects to incur a loss in the first
quarter of each year for the foreseeable future.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary capital requirements are for ongoing operations,
principally inventory, and capital improvements to support the opening of new
Company-owned stores and the remodeling of existing Company-owned stores.
Historically, the Company's primary sources of liquidity have been met by cash
from operations, payment terms from vendors, and borrowing under its revolving
lines of credit and the Subordinated Notes.
At August 1, 1997 and August 2, 1996, the Company's working capital was $5.6
million and $793,000 respectively. Cash provided (used) by operating activities
for the first six months of fiscal 1997 and fiscal 1996 was $995,000 and
($219,000), respectively. For these two periods, $2.4 million and $1.4 million,
respectively, was used to increase inventory levels to support new and existing
Company-owned stores. At the end of fiscal 1996 and fiscal 1995, the Company's
working capital was $1.7 million, and $925,000, respectively. For fiscal 1996
and fiscal 1995, cash provided by operating activities was $85,000, and
$394,000, respectively. In each of these periods, $1.9 million and $3.1 million
was used to increase inventory levels to support new and existing Company-owned
stores.
20
<PAGE>
At August 1, 1997 and August 2, 1996, the Company's accounts payable were
$4.4 million and $2.9 million, respectively. The increase in accounts payable
was primarily attributable to increased merchandise inventory. Historically, the
amount of the Company's obsolete inventory has been immaterial.
Net cash used in investing activities for the first six months of fiscal
1997 and the comparable period of fiscal 1996 was $759,000 and $762,000,
respectively. Net cash used in investing activities for fiscal 1996 and fiscal
1995, was $1.2 million and $3.5 million, respectively. These expenditures were
primarily to open new and remodel existing Company-owned stores and upgrade the
Company's information systems.
For fiscal 1997, the Company expects to spend approximately $1.8 million on
capital expenditures which includes approximately $1.2 million on new stores and
approximately $600,000 on further information systems upgrades. As a result of
these information system upgrades, the Company does not currently anticipate
that it will incur material liabilities with respect to year 2000 costs. The
Company currently plans to open approximately 25 stores in fiscal 1998. Total
capital expenditures in 1998 are estimated to be $4.2 million. These capital
expenditures will be for new store openings, fixturing and remodeling existing
stores, and information systems. The Company intends to continue to finance all
of its new stores with long-term operating leases, assuming availability and
reasonable terms.
Net cash provided from (used in) financing activities during the first six
months of fiscal 1997 and the comparable period of fiscal 1996 was ($233,000)
and $700,000, respectively. As of August 1, 1997, and August 2, 1996, the
outstanding balance under the Company's then-existing line of credit was $5.8
million and $5.5 million, respectively. Net cash provided from financing
activities for fiscal 1996 and fiscal 1995, was $585,000 and $3.6 million,
respectively.
In January 1997, the Company entered into a new $7.5 million revolving
credit facility. The credit facility accrues interest at the bank's base rate
plus 0.5% and expires on May 31, 1999. The credit facility is secured by
substantially all the assets of the Company. The Company is required to maintain
certain customary covenants. The credit facility also prohibits the Company from
paying dividends except for distributions in connection with the termination of
its S corporation status. The initial borrowing of this facility were used to
retire in full the outstanding balance under the Company's previous credit
facility. The Subordinated Notes were issued as part of the Company's 1994
private placement, are secured by a lien on substantially all of the Company's
assets and are subordinated to the credit facility. The Subordinated Notes
accrue interest quarterly at the rate of 10% per annum. See Notes 3 and 4 of
Notes to Financial Statements.
The Company believes that cash generated by operating activities, the net
proceeds from this offering and availability under its credit facility will be
sufficient to finance its current and anticipated operations and planned capital
expenditures at least through fiscal 1998. To the extent that the funds
generated from these sources are insufficient to finance the Company's
activities in the short or long term, the Company would need to raise additional
funds through public or private financing. No assurance can be given that
additional financing will be available or that, if available, it will be
available on terms favorable to the Company.
INFLATION
The Company believes that inflation has not had a material impact upon its
historical operating results, and does not expect it to have such an impact in
the future. There can be no assurance that the Company's business will not be
affected by inflation in the future.
RECENTLY ISSUED ACCOUNTING STANDARDS
The Financial Accounting Standards Board has issued two financial accounting
standards ("FAS") which became effective January 1, 1996. The standards are FAS
121, "Accounting for the Impairment of Long-Live Assets and for Long-Lived
Assets to Be Disposed Of," and FAS 123, "Accounting for Stock-Based
Compensation." The Company does not expect FAS 121 to impact its financial
position or results of operations. In addition, the Company does not expect to
adopt the non-mandatory provisions of FAS 123. Accordingly, this standard will
not impact the Company's financial position or results of operations.
21
<PAGE>
BUSINESS
GENERAL
Paper Warehouse is a growing chain of stores specializing in party supplies
and paper goods operating under the names PAPER WAREHOUSE and PARTY UNIVERSE.
The Company's four principal markets are Minneapolis/St. Paul, Kansas City,
Denver and Oklahoma City. Paper Warehouse stores offer an extensive assortment
of special occasion, seasonal and everyday paper products, including party
supplies, gift wrap, greeting cards and catering supplies, at everyday low
prices. The Company's 124 stores (73 Company-owned and 51 franchised stores) are
conveniently located in major retail trade areas to provide customers with easy
access to its stores. For the first six months of fiscal 1997, the Company's
revenues increased 27.3% to $24.7 million from $19.4 million for the comparable
period of fiscal 1996.
The Company offers a broad selection of party supplies and paper goods for a
wide variety of celebratory occasions and everyday uses, including birthdays,
weddings, baby showers, graduations and other family and religious celebrations,
as well as seasonal events such as Valentine's Day, Easter, Fourth of July,
Halloween, Thanksgiving, Christmas, Hanukkah and New Year's. Through the
Company's 8,500 square foot superstore prototype, the Company offers a
comprehensive selection of over 19,000 SKUs, which provides customers the
convenience of one-stop shopping for all party supplies and paper goods. The
Company's merchandise is organized by party themes, and the prominent signage
and wide aisles allow customers to easily access and coordinate the merchandise
required for all party occasions. The Company also believes that its extensive
selection, combined with high in-stock positions, often stimulates customers to
purchase additional products.
Paper Warehouse's goal is to be one of the leading suppliers of party
supplies and paper goods in existing markets and to establish a dominant
position in new markets. Paper Warehouse opened nine Company-owned stores in
fiscal 1997 and plans to open approximately 25 Company-owned stores in fiscal
1998. Approximately two-thirds of such stores are expected to open in two new
geographic markets, one in the Midwest the other in the Western United States.
The Company has taken preliminary steps towards establishing itself in these
markets. One of the Company's primary competitors currently has several stores
in one of these markets. Additionally, management established three franchise
stores in fiscal 1997 and expects to establish between 15 and 20 franchise
stores in fiscal 1998.
INDUSTRY OVERVIEW
Consumers purchase party supplies and paper goods frequently throughout the
year in order to create, enhance and celebrate a wide range of celebratory
occasions and everyday use. The Company believes that total United States retail
sales of party and special occasion merchandise (including greeting cards, party
supplies, gift wrap and related items) will grow to approximately $8.9 billion
in 1997. The Company believes that the industry will continue to grow as a
result of a number of factors, including increasing depth and breadth of
available party merchandise, increasing consumer awareness and acceptance of the
ease and convenience of disposable party goods and the trend toward at-home
entertaining.
Management believes that convenience, selection and price are the principal
factors used by consumers in determining where to purchase party supplies and
paper goods. Historically, consumers have purchased these products from small,
independent party goods stores and card shops offering a broad selection in
certain merchandise categories at higher prices and from designated departments
in mass merchandisers, discount retailers, toy stores, drug stores and
supermarkets offering a limited selection at lower prices. Although traditional
party goods retailers differ in the breadth of merchandise selection and price,
they have tended to be convenient for consumers.
Larger format stores have become the fastest growing retail format within
the party goods industry by offering consumers a broader selection of
merchandise at lower prices compared to traditional party goods retailers. Paper
Warehouse, through its strategy of clustering multiple large format stores in
metropolitan
22
<PAGE>
markets, emphasizes both convenient locations and an extensive selection of
merchandise at everyday low prices.
BUSINESS STRATEGY
The Company's goal is to be the leading supplier of party supplies and paper
goods in each of its existing and prospective markets. The key elements of the
Company's strategy are as follows:
CONVENIENT LOCATIONS. Based upon the results of its customer surveys and
focus groups, the Company believes that convenience is one of the most important
criteria to a customer in deciding where to shop for party goods. As a result,
the Company clusters stores in metropolitan markets, making travel to a Paper
Warehouse store convenient for its customers. For example, the Company has 26
stores in the Minneapolis/St. Paul metropolitan area, 16 stores in the Kansas
City metropolitan area, 16 stores in the Denver metropolitan area (including
five franchise stores) and seven stores in the Oklahoma City metropolitan area.
The Company locates its stores in or near visible high traffic strip mall
centers in close proximity to prominent mass merchandise, discount or grocery
store anchors to promote customer convenience.
EXTENSIVE MERCHANDISE SELECTION. Paper Warehouse offers an extensive
selection of merchandise to provide its customers with a one-stop shopping
solution for party supplies and paper goods. The Company's broad and diverse
selection of merchandise includes party supplies, gift wrapping products,
greeting cards and household and catering food service supplies. The Company
believes that its extensive selection of party supplies and paper goods combined
with high in-stock positions often stimulates customers to purchase additional
products.
EVERYDAY LOW PRICES. The Company provides customers with everyday low
prices on all merchandise at discounts ranging from 10% to 50% off the
manufacturer's suggested retail price. In addition, the Company guarantees that
it will meet or beat any advertised price on the products it offers. The Company
reinforces its everyday low price strategy with signs prominently displayed
throughout its stores and through its extensive promotional advertising.
CUSTOMER FRIENDLY STORE ENVIRONMENT. The Company creates a customer
friendly store environment through its easy to shop store format and commitment
to customer service, which includes employee training, innovative party planning
assistance and a "no hassle" return policy. Paper Warehouse stores are bright
and festively decorated to correspond to the current season. Prominent signage
and wide aisles are organized by party themes, enabling customers to easily move
about the stores and coordinate party supplies for any occasion. The Company has
developed party planning aids and has trained store personnel to assist
customers in purchasing the proper party supplies for a particular event. The
Company believes that this customer friendly environment provides customers with
a pleasant shopping experience and encourages browsing, impulse purchases and
repeat visits.
COMPREHENSIVE ADVERTISING. The Company maintains aggressive advertising and
marketing programs designed to educate consumers about its convenient store
locations, promote the breadth and value of its product offering, increase its
name recognition and increase sales during seasonal and special events. The
Company's strategy of clustering stores in metropolitan markets enables it to
cost effectively employ a variety of media, including newspaper, radio,
television and direct mail mini-catalogs.
EXPANSION STRATEGY
In order to increase its market share in existing markets, achieve a
dominant position in new markets and maximize operating efficiencies, the
Company employs the following expansion strategy: (i) open multiple
Company-owned stores close to one another in new and existing metropolitan
markets, (ii) selectively open Company-owned stores in secondary markets that
can support one or two stores and that are contiguous with metropolitan markets
served by Company-owned stores, (iii) establish franchise stores in other
markets, and (iv) continuously refresh, remodel and expand existing stores.
23
<PAGE>
CLUSTER COMPANY-OWNED STORES IN METROPOLITAN MARKETS. To provide its
customers with convenient store locations, expand its total market share and
achieve favorable economies of scale, the Company's strategy is to continue
clustering stores in larger metropolitan markets, primarily in the Midwest and
western United States. During fiscal 1997, the Company opened four new stores in
the Minneapolis/St. Paul area, where it currently operates 26 stores, one new
store in the Kansas City area, where it now operates 18 stores, two new stores
in the Denver area, where it now operates 11 stores and franchises five stores,
one new store in the Oklahoma area, where it now operates 10 stores. The Company
is currently planning to enter two new metropolitan markets in fiscal 1998.
EXPAND COMPANY-OWNED STORES IN CONTIGUOUS MARKETS. The Company seeks to
open stores in secondary markets contiguous to metropolitan markets where the
Company has existing stores. These secondary markets provide an opportunity for
the Company to increase sales and to realize operational efficiencies resulting
from their close proximity to its larger metropolitan markets. The Company only
establishes stores in secondary markets that can be managed by the district
manager of the contiguous metropolitan market.
EXPAND FRANCHISE STORES IN OTHER MARKETS. The Company establishes franchise
stores in markets that are not contiguous to metropolitan areas with
Company-owned stores. In addition, the Company grants development rights in
metropolitan markets where the Company does not plan to open Company-owned
stores. The Company believes that these markets typically are not served
adequately by the party goods industry. In addition to generating franchise
revenues, franchise stores benefit the Company through increased name
recognition and increased buying power from its suppliers.
REFRESH, REMODEL AND EXPAND EXISTING STORES. The Company continuously
reviews opportunities to remodel or expand its existing stores. Since 1992, the
Company has expanded and/or remodeled 34 stores. The Company believes that it
must continue to refresh its existing store base to keep up with current retail
trends and to keep its stores fresh and appealing to its customers. In addition,
the Company takes advantage of expansion opportunities for its smaller stores
when opportunities are available and when the store's operating results warrant
the expansion.
Paper Warehouse plans to open approximately 25 Company-owned stores in
fiscal 1998. The Company plans to open between 15 and 20 new franchise stores in
fiscal 1998. The Company has entered into agreements with two franchisees for
two new stores and has granted development rights to a developer that may open
multiple new stores. The Company is in the process of negotiating the terms and
conditions of these franchise arrangements and there can no assurance that these
negotiations will be successfully concluded.
In addition to new store openings, the Company's growth strategy also
includes increasing comparable store sales through its advertising and marketing
programs and merchandising presentations. The Company also periodically
considers strategic acquisitions of other retail chains in the party supply
industry. As of the date of this Prospectus, the Company has no existing
agreements or commitments to affect any material acquisitions.
PAPER WAREHOUSE STORES
FORMAT. The Company developed its current store prototype based on
management's industry and other extensive retail experience and customer
research. Paper Warehouse operates stores that range in size from 3,000 square
feet to 8,500 square feet of retail space. Management introduced its current
8,500 square foot prototype store in 1994 and believes it is the optimal store
format for its future growth. Of the 73 Company-owned stores approximately 80%
are 6,000 square feet or larger.
Paper Warehouse stores are designed to create a customer friendly
environment. The Company uses vibrant colors, theme-oriented merchandise
displays and unique products to create a fun and festive shopping experience.
The focal point of the Company's stores is the seasonal display located at the
front of
24
<PAGE>
each store which creates a "store-within-a-store" appearance. These displays
maximize the season's selling impact and are updated continuously to promote a
fresh image within the store. Customers are able to easily move about the
different departments and find specific product categories due to prominent,
easy to read signage, bright lighting and wide aisles. To assist customers in
coordinating party supplies for any occasion, the Company locates related
departments, such as gift wrap and greeting cards, adjacent to one another and
displays related merchandise such as party hats, plates, cups and napkins
together within a department. Management believes that the Paper Warehouse store
layout assists customers in finding and coordinating their party supply needs,
as well as encourages browsing, impulse purchases and repeat visits.
CUSTOMER SERVICE. Paper Warehouse seeks to provide a high level of customer
service to enhance its customer friendly store environment. Store managers and
sales associates are trained to assist customers with party planning and event
coordination. In addition, the Company provides party planning guides and
checklists for graduation, Halloween, Hanukkah, Christmas and New Year's. The
Company's "no hassle" return policy makes it easy for customers to return or
exchange products, which the Company believes encourages customers to purchase
additional quantities. Certain products which require additional sales
assistance, such as balloons and custom printing, are located near check-out
counters where sales associates can readily assist customers. Management
continually monitors its level of customer service by regular store visits and
by employing anonymous "mystery shoppers." Mystery shoppers visit all Company-
owned stores at least once per quarter to rate personnel on various aspects of
customer service, including responsiveness, quality of product displays and
store cleanliness. A portion of store managers' compensation is based on the
results of these mystery shopper surveys.
OPERATIONS AND TRAINING. Each Company-owned store is typically operated by
a general manager, one assistant manager and a varying number of full-time and
part-time sales associates, depending on the store size, sales volume and
selling season. General managers are responsible for all aspects of the store's
day-to-day operations, including employee hiring and training, work scheduling,
expense control and customer service. These managers report to a district or
operations manager, each of whom is responsible for approximately 10 to 18
stores. Within each geographic market, the Company uses floating managers to
assist in smaller stores that cannot support both a manager and an assistant
manager. In addition, floating managers support store managers during busy
holiday seasons and substitute for store managers during vacations and other
absences. The floating managers also work with newly hired store managers to
ensure a smooth transition for sales personnel and customers.
Prior to the opening of a new Company-owned store, store managers are
usually intensely trained for two weeks, depending on prior experience and
receive additional on-going training. During the new store set-up, a manager
receives additional training from the Company's district management team. After
the store opening, corporate headquarters personnel spend considerable time
overseeing the operations. Each district has a dedicated trainer who visits the
stores to work with the Store Managers, reinforcing prior training and providing
on-going training. Periodic training sessions are scheduled for store managers
in the central or district offices on various topics, including human resources,
merchandising, loss prevention and employee supervision. Additional training
topics are covered at monthly managers' meetings and through monthly mailings
and the Company's monthly newsletter.
Paper Warehouse stores are typically open from 9:00 a.m. to 9:00 p.m. Monday
through Friday, from 9:00 a.m. to 6:00 p.m. on Saturday and from 11:30 a.m. to
5:00 p.m. on Sunday.
SITE SELECTION AND LOCATION
SITE SELECTION. In order to efficiently cluster stores in metropolitan
markets, the Company has developed a site selection process that examines
various criteria, including population density, demographics, traffic counts,
storefront visibility and presence, local competition, lease rates and parking
availability. The Company locates its stores in or near visible high traffic
strip mall centers in close proximity to prominent mass merchandise, discount or
grocery store anchors. The Company's strategy of
25
<PAGE>
clustering stores in metropolitan markets promotes customer convenience and
creates favorable economies of scale for marketing, advertising and operations.
LOCATIONS. As of November 5, 1997 Paper Warehouse had 73 Company-owned
stores in the following locations:
<TABLE>
<CAPTION>
LOCATION NUMBER OF STORES
- ---------------------------------------------------------------------------- ---------------------
<S> <C>
Minnesota
Minneapolis/St. Paul Metropolitan Area.................................... 26
Mankato................................................................... 1
Rochester................................................................. 1
St. Cloud................................................................. 1
Kansas/Missouri
Kansas City Metropolitan Area............................................. 16
Columbia.................................................................. 1
St. Joseph................................................................ 1
Colorado
Denver Metropolitan Area.................................................. 11
Oklahoma
Oklahoma City Metropolitan Area........................................... 7
Tulsa..................................................................... 3
Iowa
Des Moines................................................................ 3
Wisconsin
Onalaska.................................................................. 1
Eau Claire................................................................ 1
</TABLE>
MERCHANDISING
The Company offers a broad selection of party supplies and paper goods for a
wide variety of celebratory occasions and everyday uses, including birthdays,
weddings, baby showers, graduations and other family and religious celebrations,
as well as seasonal events such as Valentine's Day, Easter, Fourth of July,
Halloween, Thanksgiving, Christmas, Hanukkah and New Year's. Through the
Company's 8,500 square foot store prototype, the Company offers a comprehensive
selection of over 19,000 SKUs, which provides customers the convenience of
one-stop shopping for all party supplies and paper goods. The Company's
merchandise is organized by party themes, and the prominent signage and wide
aisles allow customers to easily access and coordinate the merchandise required
for all party occasions. The Company also believes that its extensive selection,
combined with high in-stock positions, often stimulates customers to purchase
additional products.
The Company's merchandise offering consists of the following:
PARTY SUPPLIES. The Company offers an extensive selection of complementary
and coordinating party supplies in both unique and traditional patterns, colors
and designs. The Company's party supplies include invitations, plates, napkins,
party favors, streamers, banners, candles, balloons, party snacks and seasonal
novelties such as Halloween costumes and Christmas decor. The Company's 8,500
square foot store prototype offers over 140 ensembles of party goods for many
occasions, which include party hats, plates, napkins and cups. A significant
portion of the Company's party goods ensembles involves the use of movie and
television figures, animated characters and celebrity likenesses licensed to the
manufacturer of such ensembles.
26
<PAGE>
GIFT WRAPPING PRODUCTS. The Company offers a wide assortment of gift
wrapping products in various patterns and colors, including gift wrap, gift
bags, gift boxes, tissue paper, ribbons, bows, shred and gift tags. In addition
to holiday selections, the Company offers distinctive gift packaging products
for special occasions such as birthdays, graduations, weddings, baby showers and
other family and religious celebrations.
GREETING CARDS. The Company features a wide variety of special occasion,
seasonal and everyday greeting cards. The Company's 8,500 square foot prototype
store offers over 3,300 titles. The Company carries traditional, humorous and
contemporary brand name greeting cards at significantly lower prices than
national greeting card chain stores.
HOUSEHOLD AND CATERING FOOD SERVICE SUPPLIES. The Company offers paper
supplies such as toilet paper, paper towels, dispenser towels, plates, cups,
serving trays and bowls and table coverings. In addition to offering such
products to the Company's regular party goods customers, the Company is a paper
product supplier for many commercial users of paper products, including catering
companies and non-profit organizations.
The Company provides customers with everyday low pricing on all products, at
discounts ranging from 10% to 50% off the manufacturer's suggested retail price.
In addition, the Company guarantees that it will meet or beat any advertised
price on the products it offers. The Company reinforces its everyday low price
strategy with signs prominently displayed throughout its stores and extensive
promotional advertising.
PRODUCT SOURCING AND INVENTORY MANAGEMENT
The Company purchases its merchandise from approximately 150 suppliers. In
fiscal 1996, the Company's largest supplier, Amscan Holdings, Inc., accounted
for approximately 13% of the Company's purchases and the seven largest suppliers
represented approximately 50% of the Company's purchases. The Company does not
have long-term purchase commitments or exclusive contracts with any of its
suppliers. Management believes that alternative sources of product are available
at comparable terms and conditions. The Company considers numerous factors in
supplier selection, including price, payment terms, product offerings and
product quality.
The Company negotiates pricing with suppliers on behalf of all Company-owned
and franchise stores and believes that its buying power enables it to receive
favorable pricing terms and to more readily obtain high demand merchandise.
Although franchise stores are responsible for purchasing their own inventory,
franchisees are able to make purchases on the Company's negotiated pricing
terms. As the Company adds new stores, the Company believes it will increase the
volume of its inventory purchases and benefit further from increased discounts
and trade allowances and more favorable payment terms from its suppliers.
More than 95% of the Company's merchandise is shipped directly from the
supplier to the Company's stores. Drop shipment of merchandise provides the
Company with flexibility in pursuing new markets without the geographical
constraints and costs associated with a central distribution system. Deliveries
are processed and inventory items are inspected, sorted and priced in a
segregated receiving area in the back of the store (approximately 10% of total
gross square feet per store) before being placed on the selling floor. The
Company believes that it realizes substantial savings by not maintaining a
central distribution system.
In addition, the Company uses cross-dock distribution for suppliers that
will not ship directly to each store, such as overseas suppliers, and to
facilitate opportunistic volume purchases by the Company. The Company maintains
space for cross-dock distribution in each of the Company's principal
metropolitan markets, including Minneapolis/St. Paul, Denver, Oklahoma and
Kansas City, for separation and redistribution to the other Paper Warehouse
stores within that market. The Company's primary cross dock facility in
Minneapolis is designed for the separation and distribution of merchandise
system wide.
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<PAGE>
ADVERTISING AND MARKETING
The Company maintains aggressive advertising and marketing programs. The
Company's strategy of clustering stores in metropolitan markets enables it to
cost effectively employ a variety of media. The Company advertises primarily
through newspaper and direct mail inserts, television and radio. Paper Warehouse
also promotes products through the use of direct mail mini-catalogs, as well as
through in-store coupon books and party planning aids.
The Company's advertising efforts are designed to educate consumers about
its convenient store locations, promote the breadth and value of its product
offering and increase its name recognition. The Company's advertising consists
primarily of full color newspaper and direct mail inserts designed around major
holidays and the spring and summer seasons. For fiscal 1996, the Company
distributed 11 newspaper and direct mail inserts and plans on distributing 16
inserts for fiscal 1997. Inserts are supplemented by television advertising for
Halloween, Christmas and New Year's and by radio advertising for graduation,
Easter and the spring season. In addition, Paper Warehouse typically advertises
the opening of new stores in newspaper and direct mail inserts and on radio.
Management has initiated a targeted direct mail program to increase sales
for special events. The Company currently mails mini-catalogs of wedding and
graduation party goods to brides-to-be and families of high school graduates.
Management has recently expanded this direct mail program to other special
occasions such as a child's first birthday. The Company also plans to produce a
mini-catalog for organizations purchasing basic party and paper goods for
commercial or institutional use. The Company's institutional customers include a
variety of small businesses, food product companies, schools, synagogues,
churches, civic groups and other organizations.
For fiscal 1996, the Company spent approximately 80% of its marketing budget
on full color newspaper and direct mail inserts, approximately 15% for
television and radio advertising and the remainder of the budget was used for
direct mail mini-catalogs and in-store sales promotions.
INFORMATION SYSTEMS
The Company's information systems are an important factor in supporting its
continued expansion and enhancing its competitive position in the industry. The
Company completed the installation of Point of Sale ("POS") terminals in all its
Company owned stores in third quarter 1996. The POS terminals allow price lookup
and inventory tracking by SKU. By polling transaction data nightly from each
store's POS terminals, the system provides daily sales information and inventory
levels at the store, department, class and SKU level, allowing the corporate
office to monitor daily sales, gross profit, pricing and inventory by SKU across
its entire store base. Also, the Company's automatic merchandise replenishment
system uses this information to allocate goods to individual stores based on
specific SKU requirements.
The Company entered into an agreement with JDA Software Company in September
1997 to replace its current corporate office software. Implementation began
during the third quarter of 1997 and is estimated to be completed during the
third quarter of 1998. The JDA retail software package will operate on an IBM
AS/400 platform, requiring the Company to purchase new hardware. Switching
hardware platforms will provide the Company the benefit of parallel operations
during the conversion process. In addition, the Company plans to make extensive
use of JDA's Minneapolis consulting office in both the implementation and data
conversion process.
The JDA system supports the complete range of retail cycle functions in the
areas of finance, merchandising and distribution, providing management with more
sophisticated tools to utilize the information collected by its POS terminals.
In addition, the Company plans to develop enhancements such as data warehousing
and electronic data interchange to improve the Company's ability to
systematically manage its inventory. The Company's current information system is
already performing most of these functions, however, management believes JDA
will improve the efficiency of these tasks.
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<PAGE>
FRANCHISING
The Company has offered franchises of its Paper Warehouse store concept
since October 1987. As of November 5, 1997, the Company had 51 franchise stores.
The Company's 51 franchise stores are located in the following states:
<TABLE>
<CAPTION>
NUMBER OF
LOCATION STORES
- ------------------------------------------------------------------------------------ ---------------
<S> <C>
Arizona............................................................................. 5
Colorado............................................................................ 5
Florida............................................................................. 1
Georgia............................................................................. 2
Illinois............................................................................ 3
Iowa................................................................................ 4
Kansas.............................................................................. 2
Kentucky............................................................................ 1
Louisiana........................................................................... 4
Maryland............................................................................ 2
Minnesota........................................................................... 1
Mississippi......................................................................... 1
Missouri............................................................................ 1
Montana............................................................................. 2
Nebraska............................................................................ 2
Nevada.............................................................................. 1
North Dakota........................................................................ 4
South Dakota........................................................................ 4
Tennessee........................................................................... 2
Texas............................................................................... 2
Wyoming............................................................................. 2
</TABLE>
The Company establishes franchise stores in markets that are not contiguous
to metropolitan areas with Company-owned stores. In addition, the Company grants
development rights in metropolitan markets where the Company does not plan to
open Company-owned stores. The Company believes that these markets typically are
not served adequately by the party goods industry. In addition to generating
franchise revenues, franchise stores benefit the Company through increased name
recognition and increased buying power from its suppliers.
The Company assists franchisees in all aspects of opening and operating a
Paper Warehouse store. During the pre-opening phase, Company support includes
site evaluation and assistance with lease negotiations, store build-out
assistance, fixture, equipment, supplies and inventory procurement, opening
advertisement materials and operational training. The Company provides its
franchisees with ongoing services such as business planning, operations and
promotional activities. In addition, the Company performs the merchandising
process for its franchisees. The Company makes periodic inspections of its
franchise stores to ensure that the franchisee is complying with the Company's
various requirements and quality standards. The Company generally has not
granted franchisees the right to prevent the Company or other franchisees from
establishing stores within a particular territory. However, the Company has
entered, and may in the future enter, into multiple store development agreements
with franchisees granting to them certain exclusive rights to develop stores in
specified markets, so long as the franchisee meets a stated development schedule
and complies with other provisions of the development agreement and the
franchise agreement.
Paper Warehouse franchise revenues are comprised of initial franchise fees
and continuing royalty payments. The Company's current initial franchise fee
ranges from $19,000 to $25,000 for new franchisees,
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<PAGE>
depending on the type of store. The Company occasionally negotiates a special
rate for developers opening multiple stores. If a franchisee enters into a
second or third franchise agreement it may receive a discount on the initial fee
associated with the second or third store. Franchisees are also required to pay
the Company a continuing royalty equal to a percentage of their weekly gross
sales. Historically, this percentage has varied from 3% to 5%. Currently, new
franchises pay the Company a continuing royalty of 4% of gross sales.
The franchisee's initial investment depends primarily upon store size. This
investment includes the initial franchise fee, real estate and leasehold
improvements, fixtures and equipment, signs, point-of-sale systems, deposits and
business licenses, initial inventory, opening promotional expenses and working
capital. The Company may also require franchisees to pay a weekly advertising
fee not to exceed 1% of gross sales, although to date it has not required such
fee. Each franchisee is granted a license from the Company for the right to use
certain intellectual property rights, including the mark PAPER WAREHOUSE or
PARTY UNIVERSE and related designs. The Company's franchise agreements provide
for a ten-year term and often contain conditional renewal options.
COMPETITION
The party and paper supply retailing business is highly competitive. In
order to compete successfully against other party good retailers, the Company
believes it must maintain convenient locations, broad merchandise selections,
competitive pricing and strong customer service. Paper Warehouse stores compete
with a variety of smaller and larger retailers, including specialty party supply
retailers such as Party City and Factory Card Outlet, card shops such as
Hallmark and designated departments in mass merchandisers, discount retailers,
toy stores, drug stores, supermarkets and department stores such as Target and
Wal-Mart. Many of these competitors have substantially greater financial
resources than the Company.
TRADEMARKS AND SERVICE MARKS
The marks PAPER WAREHOUSE and PARTY UNIVERSE are federally registered
trademarks owned by the Company. The Company is aware of the common law usage of
the name PAPER WAREHOUSE by several companies in various parts of the United
States, which may prevent the Company from using that name in certain regional
markets. In markets where PAPER WAREHOUSE cannot be used by the Company, it
intends to use the name PARTY UNIVERSE, for Company-owned and franchise stores.
Because of the Company's regional approach to advertising and store clustering,
the Company believes that the use of a single trademark within each market is
more important to its growth and business strategy than the use of one mark
nationally.
GOVERNMENT REGULATION
As a franchisor, the Company must comply with rules and regulations adopted
by the Federal Trade Commission and with state laws that regulate the offer and
sale of franchises. The Company also must comply with a number of state laws
that regulate certain substantive aspects of the franchisor-franchisee
relationship. These laws regulate the franchise relationship, for example, by
requiring the franchisor to deal with its franchisees in good faith, by
prohibiting interference with the right of free association among franchisees
and by regulating illegal discrimination among franchises with regard to
charges, royalties or fees. To date, those laws have not precluded the Company
from seeking franchisees in any given area and have not had a material adverse
effect on the Company's operations.
All Paper Warehouse 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
30
<PAGE>
comply with the Fair Labor Standard Act and various state laws governing matters
such as minimum wage, overtime and other working conditions. The Company also
must comply with the provisions of the Americans with Disabilities Act of 1990,
which generally requires that employers provide reasonable accommodation for
employees with disabilities and that stores be accessible to customers with
disabilities.
EMPLOYEES
As of August 1, 1997, the Company employed approximately 200 full-time and
approximately 500 part-time employees. The Company considers its relationships
with its employees to be good. None of the Company's employees is covered by a
collective bargaining agreement.
PROPERTIES
Paper Warehouse currently leases the locations for its 73 Company-owned
stores. The Company purchased an approximate 25,000 square foot building for its
headquarters and cross-dock distribution facility in St. Louis Park, Minnesota
in 1995. As of August 1, 1997, the secured debt on such property was $920,908,
of which $509,354 was owed to Richfield Bank & Trust Co. and $411,554 was owed
to the U.S. Small Business Administration. Richfield Bank & Trust Co. holds a
first mortgage on such property and the U.S. Small Business Administration holds
a second mortgage. The Company anticipates that its new Company-owned stores
will typically have ten-year leases with at least one five-year renewal option.
LEGAL PROCEEDINGS
The Company is not a party to any material litigation and is not aware of
any threatened litigation that would have a material adverse effect on its
business.
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<PAGE>
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND CERTAIN KEY PERSONNEL
The following sets forth certain information with respect to the directors,
executive officers and certain key personnel of the Company as of October 1,
1997:
<TABLE>
<CAPTION>
DIRECTORS AND EXECUTIVE OFFICERS AGE POSITION
- ----------------------------------- --- ---------------------------------------------------------------------
<S> <C> <C>
Yale T. Dolginow................... 54 President, Chief Executive Officer and Chairman of the Board
Brent D. Schlosser................. 44 Executive Vice President and Director
Cheryl W. Newell................... 44 Vice President and Chief Financial Officer
Diane C. Dolginow.................. 53 Secretary and Director
Arthur H. Cobb..................... 46 Director
Marvin W. Goldstein................ 54 Director
Martin A. Mayer.................... 55 Director
Jeffrey S. Halpern................. 54 Director
<CAPTION>
CERTAIN KEY PERSONNEL AGE POSITION
- ----------------------------------- --- ---------------------------------------------------------------------
<S> <C> <C>
Carol A. Carroll................... 46 Vice President of Stores
Willard V. Lewis................... 61 Vice President of Store Development
Steven P. Durst.................... 29 Vice President of Information Systems
Michael A. Anderson................ 37 Controller/Treasurer
Francis E. O'Neil.................. 62 Director of Franchising
Kristen Lenn....................... 30 Director of Human Resources
</TABLE>
DIRECTORS AND EXECUTIVE OFFICERS
Yale T. Dolginow has been President, Chief Executive Officer and a director
of the Company since 1986. From 1982 to 1986, he served as President and Chief
Executive Officer of Carlson Catalog Showrooms, Inc., which was a chain of 59
catalog showrooms located throughout the Midwest. From 1981 to 1982, Mr.
Dolginow served as Assistant to the President of Dayton Hudson Corporation. From
1978 to 1980, Mr. Dolginow served as President of Modern Merchandising, Inc., a
70 store retail chain operating in several markets, and as Executive Vice
President from 1977 to 1978. From 1968 until 1976, Mr. Dolginow was the Chief
Executive Officer and President of Dolgin's, Inc., a chain of catalog showroom
stores which operated in the Kansas City and St. Louis metropolitan markets. Mr.
Dolginow and Diane C. Dolginow are husband and wife.
Brent D. Schlosser has been Executive Vice President and a director of the
Company since 1986. From 1982 to 1986, he served in various capacities,
including Vice President Marketing/Buying and Executive Vice President
Marketing/Merchandising, at Carlson Catalog Showrooms, Inc. From 1977 to 1982,
he served as Director of Marketing for Modern Merchandising, Inc. From 1975 to
1977, Mr. Schlosser was advertising director for Dolgin's, Inc.
Cheryl W. Newell has been Vice President and Chief Financial Officer of the
Company since August 1997. From 1991 to August 1997, Ms. Newell was a Vice
President with the Corporate Banking Group at U.S. Bancorp, a bank holding
company, responsible for management of desktop technology, disaster recovery,
training and development. From 1986 to 1991 Ms. Newell was a Vice President with
Citicorp, a bank holding company. From 1976 to 1986, Ms. Newell was a Vice
President at Norwest Bank.
32
<PAGE>
Diane C. Dolginow has been a director of the Company since 1986 and
Secretary since August 1997. Ms. Dolginow and Mr. Dolginow are husband and wife.
Ms. Dolginow was a director of Dolgin's Inc. from 1968 to 1976, and since 1994
has been a director on the National Advisory Board of School of Education at
University of Kansas.
Arthur H. Cobb has been a director of the Company since 1992. He is a
consultant and certified public accountant. Since June 1987, he has been engaged
in providing financial consulting services and is President of Cobb &
Associates, Ltd. Prior thereto, Mr. Cobb was a partner with Peat Marwick
Mitchell & Co.
Marvin W. Goldstein has been a director of the Company since December 1996.
Mr. Goldstein is currently a financial consultant. From April 1997 through
August 1997, Mr. Goldstein was Executive Vice President and Chief Operating
Officer of Regis Corp., a national chain of hair salons. From 1995 through
December 1996, Mr. Goldstein was Chairman of the Board, Chief Executive Officer
and President of Pet Food Warehouse, Inc., a specialty retailer. From 1992 to
September 1994, he was President and Chief Operating Officer of the Department
Store Division of Dayton Hudson Corporation. From 1981 through 1987 he served as
Senior Vice President of Merchandising and Senior Vice President of Stores for
R.H. Macy, California. From 1976 to 1981 he served as Vice President General
Merchandise of Carter Hawley Hale, Inc. From 1966 to 1976, he served as
Divisional Merchandise Manager and Associate Buyer of the Department Store
Division of Dayton Hudson Corporation. Mr. Goldstein is a director of Buffets,
Inc.
Martin A. Mayer has been a director of the Company since 1992. He has been
an adjunct professor of marketing at the University of San Diego since 1995 and
has been an independent financial consultant since 1992. Mr. Mayer was a partner
with Peat Marwick Mitchell & Co., a public accounting firm, from 1973 until
1992. Mr. Mayer is a certified public accountant.
Jeffrey S. Halpern has been a director of the Company since 1997. He has
been Chairman of the Board and Chief Executive Officer of Southwest Casino and
Hotel Corp. since 1993. Mr. Halpern was a partner in the law firm of Popham,
Haik, Schnobrich & Kaufman, Ltd. from 1989 until 1993, and a founding partner of
Halpern & Druck from 1980 to 1989.
CERTAIN KEY PERSONNEL
Carol A. Carroll has been Vice President of Stores of the Company since
1997. Prior to that time and since 1994, she was Director of Stores. From 1992
to 1994, she was Director of Stores of CBR, Inc., a privately-owned retailer,
specializing in airport retail. From 1976 to 1992 she served as a District
Manager, managing 17 stores in a five state area, for Best Products, Inc.
Willard V. Lewis has been Vice President of Store Development of the Company
since 1997. Prior to that time and since 1992 he was Director of Development.
From 1990 to 1992, Mr. Lewis served as Vice President of Network Facilities
Professionals, Inc., a Minnesota-based computer software firm. He was employed
by Dolgin's, Inc. from 1970 to 1985, served as Vice President and Treasurer from
1973 to 1977 and President and General Manager from 1977 to 1985.
Steven P. Durst has been Vice President of Information Systems since 1997.
Prior to that time and since 1995, he was Director of Information Systems. From
1990 to 1995, he was employed by Exxon Corporation where he performed various
engineering and business planning functions. Mr. Durst is the son-in-law of Mr.
and Ms. Dolginow.
Michael A. Anderson has served as Controller/Treasurer of the Company since
1997. Prior to that time and since 1991, he was Controller. From 1987 to 1991,
he was an accountant at Lurie, Eiger, Besikof & Company, a Minneapolis public
accounting firm. From 1982 to 1986, he was a staff accountant with Marvin O.
Anderson, LPA, a public accounting firm located in Minnesota.
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<PAGE>
Francis E. O'Neil has served as Director of Franchising since 1997. From
1995 to 1997, he was Director of Marketing at Graphics Xpress, a subsidiary of
Meyers Printing Co. From 1993 to 1995, he was a New Business Consultant at
Deluxe Corporation. From 1990 to 1993, he was Vice President of Marketing for
Insty-Prints, Inc. From 1985 to 1996 he provided consulting services to various
firms, including Paper Warehouse as President of Franchise Forum, Inc. Mr.
O'Neil has provided consulting services to the Company on a regular basis since
1992.
Kristen Lenn has served as Director of Human Resources since August 1997.
Prior to that time and since 1994, she was a Senior Consultant with McGladrey &
Pullen, LLP, a public accounting firm. She provided a wide range of Human
Resources Generalist services to clients. From 1989 to 1994, she was employed by
various organizations as a human resources generalist.
The Company's executive officers are appointed annually by the Company's
directors. Each of the Company's directors continues to serve until his or her
successor has been designated and qualified.
DIRECTOR COMPENSATION
The Company pays non-employee directors $500 for each meeting attended, plus
expenses. Upon the consummation of this offering, the Company will grant,
pursuant to the Directors Stock Option Plan, an option to acquire 10,000 shares
of Common Stock to each of its non-employee directors at an exercise price equal
to the initial public offering price (the "Directors' Stock Options"). These
options will have a term of ten years and vest in equal installments over three
years beginning one year from the date of grant. In the event of the (i) death
of the director; (ii) upon the removal of the director from the Board without
cause; (iii) in the event the director is not re-nominated or re-elected as a
director; (iv) in the event of a change in control of the Company, as defined in
any existing agreements between the Company and its senior officers; or (v) in
the event the director voluntarily resigns from the Board, all options granted
to such director will become immediately exercisable in full.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has an Audit Committee and Compensation Committee.
The Audit Committee, which is currently comprised of Messrs. Cobb, Goldstein and
Mayer, recommends to the Board of Directors the appointment of independent
auditors and oversees the accounting and auditing functions of the Company. The
Compensation Committee, which is currently comprised of Messrs. Mayer and
Goldstein, reviews and recommends compensation of officers and directors,
administers stock option plans and reviews major personnel matters.
EXECUTIVE COMPENSATION
The following table sets forth information with respect to all compensation
paid or earned for services rendered to the Company in the fiscal year ended
January 31, 1997 by the Chief Executive Officer and the only other executive
officer whose aggregate salary and bonus exceeded $100,000.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL
COMPENSATION ALL OTHER
------------- COMPENSATION
NAME AND PRINCIPAL POSITION FISCAL YEAR SALARY ($) ($)(1)
- ------------------------------------------------------------------------- ----------- ------------- ----------------
<S> <C> <C> <C>
Yale T. Dolginow ........................................................ 1996 285,000 27,005
President and Chief Executive Officer
Brent D. Schlosser ...................................................... 1996 145,000 1,282
Executive Vice President
</TABLE>
- ------------------------
(1) Other compensation amounts include $1,278 for Mr. Dolginow and $1,282 for
Mr. Schlosser as matching contributions under the Company's 401(k) Plan;
$25,727 as the value of benefits for Mr. Dolginow, determined as prescribed
by the Securities and Exchange Commission for such valuations, under a
"split dollar" life insurance arrangement.
34
<PAGE>
No options were granted to any executive officers or any other employee of
the Company in fiscal 1996.
EMPLOYMENT AGREEMENTS
In February 1997, the Company entered into two year employment agreements
with Yale T. Dolginow and Brent D. Schlosser pursuant to which they serve as
President and Chief Executive Officer and Executive Vice President of the
Company, respectively. Pursuant to their respective employment agreements,
Messrs. Dolginow and Schlosser receive an annual base salary of $285,000 and
$150,000, respectively, subject to increase by the Compensation Committee based
upon the Company's performance and other factors. Pursuant to such agreements,
Messrs. Dolginow and Schlosser may not during the agreement term or for one year
thereafter disclose confidential information about the Company and have agreed
not to compete with the Company for a two-year period after any termination of
employment, other than termination without "good cause" as defined in their
respective agreements. Messrs. Dolginow and Schlosser may each terminate their
employment with the Company upon 30 days' written notice to the Board of
Directors. Their respective agreements also terminate automatically upon the
death of the executive or upon written notice by the Board of Directors of the
Company, upon the disability of the executive provided such disability continues
for a period of more than 90 days. If either is terminated by the Company
without "good cause" as defined in their respective agreements, the terminated
employee is entitled to receive his respective base salary for 12 months. For
purposes of their respective agreements, "good cause" means (i) commission of a
felony; (ii) theft or embezzlement of Company property or commission of similar
acts involving moral turpitude; or (iii) the failure to substantially perform
their respective material duties under the agreements which willful failure is
not cured within thirty days after receipt of written notice from the Board of
Directors specifying the nonperformance.
EMPLOYEE AND DIRECTORS STOCK OPTION PLANS
The Company has adopted a 1997 Stock Option and Compensation Plan (the
"Employee Stock Plan") and a Director Stock Option Plan (the "Director Stock
Plan" together with the Employee Stock Plan, the "Stock Plans"). Officers and
key employees may be granted stock options, stock appreciation rights, stock
awards, performance shares and cash awards under the Employee Stock Plan. The
Company has reserved an aggregate 639,641 shares of Common Stock for issuance
under the Stock Plans.
The Employee Stock Plan is administered by the Compensation Committee (the
"Compensation Committee") of the Board of Directors of the Company whose members
must qualify as "non-employee directors" (as such term is defined under Rule
16b-3 of the Securities Exchange Act of 1934, as amended). The Compensation
Committee will be authorized to determine, among other things, the employees to
whom, and the times at which, options and other benefits are to be granted, the
number of shares subject to each option, the applicable vesting schedule and the
exercise price. The Compensation Committee will also determine the treatment to
be afforded to a participant in the Employee Stock Plan in the event of
termination of employment for any reason, including death, disability or
retirement. Under the Employee Stock Plan the maximum term of a stock option is
ten years for incentive options and ten years plus one day for non-statutory
options and no option may be exercised during the first twelve months of its
term. Upon the occurrence of a "change in control," unless otherwise determined
by the Board of Directors and a majority of the "continuing directors"
("continuing directors" are directors who were in office prior to the occurrence
of or public announcement of a "change in control," directors in office for a
period of more than two years and directors nominated and approved by the
"continuing directors"), (i) the restrictions on all shares of restricted stock
awards lapse immediately, (ii) all outstanding options and stock appreciation
rights will become exercisable immediately, and (iii) all performance shares
shall be deemed to be met and payment made immediately. For purposes of the
Employee Stock Plan, a "change in control" occurs when (i) any person or group
becomes the beneficial owner of 30% or more of any equity security of the
Company entitled to vote for the election of directors; (ii) a majority of the
members of the Board of
35
<PAGE>
Directors of the Company is replaced within the period of less than two years by
directors not nominated and approved by the Board of Directors; or (iii) the
shareholders of the Company approve an agreement to merge or consolidate with or
into another corporation or an agreement to sell or otherwise dispose of all or
substantially all of the Company's assets (including a plan of liquidation). The
Company has granted, pursuant to the Employee Stock Plan, concurrent with the
consummation of this offering, options to purchase an aggregate of 162,965
shares at an exercise price equal to the initial public offering price of this
offering. Such options vest over a five-year period beginning on the first
anniversary of the date of grant and will terminate in ten years.
The Director Stock Plan is administered by the Board of Directors. Pursuant
to the terms of the Directors Stock Plan, upon election to the Board of
Directors of the Company, each non-employee director will be automatically
granted a non-statutory option to purchase 10,000 shares of the Common Stock of
the Company at an exercise price equal to the fair market value of the Company's
Common Stock on the date of grant. Such options vest in one-third increments
beginning on the first anniversary of the date of grant. Pursuant to the
Director Stock Plan, the Company has granted concurrent with the consummation of
this offering options to purchase an aggregate of 40,000 shares of Common Stock
to the nonemployee directors of the Company at an exercise price equal to the
initial public offering price of this offering. These options will have a term
of ten years and vest in equal installments over three years beginning one year
from the date of grant. In the event of the (i) death of the director; (ii) upon
the removal of the director from the Board without cause; (iii) in the event the
director is not re-nominated or re-elected as a director; (iv) in the event of a
change in control of the Company, as defined in any existing agreements between
the Company and its senior officers; or (v) in the event the director
voluntarily resigns from the Board, all options granted to such director will
become immediately exercisable in full.
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<PAGE>
CERTAIN TRANSACTIONS
For information concerning the Dividends paid to Mr. Dolginow and Mr.
Schlosser, the Shareholder Notes issued to Messrs. Dolginow and Schlosser for
working capital purposes following certain S corporation distributions, and the
Tax Agreement between the Company and Messrs. Dolginow and Schlosser, see "S
Corporation Distributions."
Prickly Pear Paper, Inc. ("Prickly Pear") operates four franchise stores in
Tucson, Arizona. Susan Hazan, Mr. Dolginow's sister, is a 95% shareholder and is
the President and Chief Executive Officer of Prickly Pear and Mr. Dolginow is
the Vice President of Prickly Pear. Prickly Pear paid franchise, continuing and
other fees to the Company in fiscal 1994, 1995 and 1996 in the aggregate amount
of approximately $41,000, $56,000 and $84,000, respectively. On January 8, 1996,
the Company loaned Prickly Pear $80,000, interest free. Such loan was repaid in
fiscal 1995.
In March 1996, Sunflower Party and Paper, Inc. ("Sunflower") purchased a
Paper Warehouse store located in Lawrence, Kansas from the Company for an
aggregate amount of $144,000 plus the assumption of certain liabilities of the
Company relating to that store, and began operating this store as a franchise
store. Sunflower is wholly owned by Larry and Patty Schlosser, the brother and
sister-in-law of Mr. Schlosser. During fiscal 1996, Sunflower paid the Company
an aggregate of approximately $39,000 in franchise and other fees. On March 1,
1996, Sunflower also entered into a Sublease Agreement with the Company pursuant
to which Sunflower agreed to sublease the property in Lawrence, Kansas from the
Company pursuant to terms of the original lease between the Company and the
owner of the property. The sublease expires on February 28, 1998. Total payments
to the Company under the terms of the Sublease were approximately $51,000 in
fiscal 1996. The Company remains liable for the full performance of the original
lease.
Prior to February 1, 1997, Paper Warehouse Franchising, Inc. ("PWF") was
beneficially owned 87% by Yale T. Dolginow and 13% by Brent D. Schlosser.
Pursuant to an arrangement between the Company and PWF, the Company provided PWF
with office facilities, equipment and other administrative support and
management services in exchange for the payment by PWF to the Company of at
least 90% of PWF's pre-tax profits. The Company received $154,000, $560,000 and
$0 from PWF for fiscal 1994, fiscal 1995 and fiscal 1996, respectively pursuant
to this arrangement. On February 1, 1997, Messrs. Dolginow and Schlosser
contributed the stock of PWF beneficially owned by them to the Company and PWF
became a wholly-owned subsidiary of the Company.
In January 1997, the Company entered into a $7.5 million revolving credit
facility with Richfield Bank & Trust Co. Mr. Dolginow has personally guaranteed
$1.5 million of the Company's obligations with respect to such facility. This
Guaranty will be released concurrent with the consummation of this offering. In
June 1995, Richfield Bank & Trust Co. also loaned the Company $945,000 to
finance, in part, the acquisition of the Company's corporate headquarters. Mr.
Dolginow has also personally guaranteed a loan to the Company from the U.S.
Small Business Administration in the orginal principal amount of $433,000, the
proceeds of which were also used to finance, in part, the acquisition of the
Company's corporate headquarters. See "Business--Properties." Prior to January
1997, the Company had borrowed pursuant to a $6.5 million revolving credit
facility with Richfield Bank & Trust Co. Mr. Dolginow is a director of Richfield
Bank and Trust Co.
In connection with Yale T. Dolginow's purchase of the Company from LSG
Corporation ("LSG"), the Company granted LSG an option to acquire 220,285 shares
of Common Stock upon the occurrence of certain events. Concurrently with the
consummation of this offering, LSG has agreed to exercise such option. See
"Description of Capital Stock--LSG Option."
The Company believes that all prior transactions between the Company, its
officers, directors or other affiliates of the Company have been on terms no
less favorable than could have been obtained from unaffiliated third parties.
Any future transactions and loans with officers, directors or 5% beneficial
shareholders of the Company's Common Stock will be on terms no less favorable to
the Company than could be obtained from unaffiliated third parties and will be
approved by a majority of the independent outside members of the Company's Board
of Directors who do not have an interest in the transactions.
37
<PAGE>
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth as of November 24, 1997, and as adjusted to
reflect the sale of the shares of Common Stock offered hereby, certain
information with respect to the beneficial ownership of the shares of the
Company's Common Stock by (i) each person known by the Company to be the
beneficial owner of more than 5% of the outstanding Common Stock, (ii) each
director, (iii) each executive officer named in the "Summary Compensation Table"
above, (iv) the Selling Shareholder, and (v) all executive officers and
directors as a group. Unless otherwise indicated, each of the following persons
has sole voting and investment power with respect to the shares of Common Stock
set forth opposite their respective names. Unless otherwise indicated, the
address of each of the directors and executive officers is 7630 Excelsior
Boulevard, Minneapolis, Minnesota 55426.
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENTAGE OWNERSHIP
BENEFICIALLY ------------------------------------
NAME OF BENEFICIAL OWNER OWNED BEFORE OFFERING AFTER OFFERING(1)
- ------------------------------------------------------------ ----------------- --------------- -------------------
<S> <C> <C> <C>
Yale T. Dolginow............................................ 1,916,443 87.0% 44.1%
Brent D. Schlosser.......................................... 286,375 13.0% 6.6%
Diane C. Dolginow........................................... --(2) -- --
Arthur H. Cobb.............................................. -- -- --
Marvin Goldstein............................................ -- -- --
Martin A. Mayer............................................. 27,728(3) 1.2% *
Jeffrey S. Halpern.......................................... -- -- --
LSG Corporation............................................. 220,285(4) 9.1% 4.5%
All directors and executive officers as a group
(eight persons)........................................... 2,202,818 100.0% 50.6%
</TABLE>
- ------------------------
* Less than 1%
(1) Assumes the exercise of options and warrants to purchase an aggregate of
368,594 shares immediately prior to this offering.
(2) Does not include shares beneficially owned by Yale T. Dolginow, Ms.
Dolginow's husband.
(3) Represents 27,728 shares issuable upon exercise of a stock option granted by
Mr. Dolginow which is exercisable within 60 days of this Prospectus.
(4) The address of such shareholder is 11479 Valley View Road, Eden Prairie, MN
55344. The shareholders of LSG Corporation are Stanford Weiner, Lawrence
Weiner and Gary Stone. Upon consummation of this offering, LSG Corporation
has agreed to exercise its option. In addition, LSG has granted the
Underwriters an option, exercisable within 30 days of the date of this
Prospectus, to purchase up to 50,000 shares of Common Stock solely to cover
over-allotments, if any. See " Underwriting." If the Underwriters'
over-allotment option is exercised in full, the number of shares
beneficially owned by the Selling Shareholder after this offering and the
percent ownership after this offering will be 147,219 and 3.2%,
respectively.
38
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company presently consists of 50,000,000
shares, 40,000,000 of which are Common Stock, par value $0.01 per share, and,
10,000,000 shares of Preferred Stock, par value $0.01 per share, issuable in
series (the "Serial Preferred Stock").
COMMON STOCK
As of September 30, 1997, there were 2,202,818 shares of Common Stock
outstanding held by two owners of record. All outstanding shares of Common Stock
are, and the shares offered hereby will be, fully paid and nonassessable. The
holders of Common Stock are entitled to one vote for each share held of record
on all matters voted upon by the shareholders and may not cumulate votes for the
election of directors. Thus, the owners of a majority of the shares of Common
Stock outstanding have the power to elect all of the directors. Subject to the
rights of any future class or series of Serial Preferred Stock that may be
authorized and issued in the future by the Board of Directors, each share of
outstanding Common Stock is entitled to participate equally in any distribution
of net assets made to the shareholders in liquidation, dissolution or winding up
of the Company and is entitled to participate equally in dividends as and when
declared by the Board of Directors. There are no redemption, sinking fund,
conversion or preemptive rights with respect to the shares of Common Stock. All
shares of Common Stock have equal rights and preferences.
SERIAL PREFERRED STOCK
Under governing Minnesota law and the Company's Amended and Restated
Articles of Incorporation (the "Articles"), no action by the Company's
shareholders is necessary, and only action of the Board of Directors is required
to authorize the issuance of any shares of Serial Preferred Stock. The Board of
Directors is empowered to establish, and to designate the name of, each class or
series of the shares of Serial Preferred Stock and to set the terms of such
shares (including terms with respect to redemption, sinking fund, dividend,
liquidation, preemptive, conversion and voting rights and preferences), any or
all of which may be greater than the rights of the holders of Common Stock.
Accordingly, the Board of Directors, without shareholder approval, may issue
shares of Serial Preferred Stock with terms (including terms with respect to
redemption, sinking fund, dividend, liquidation, preemptive, conversion and
voting rights and preferences) that could adversely affect the voting power and
other rights of holders of the Common Stock. At present, the Board of Directors
has not authorized or issued any shares of Serial Preferred Stock and has no
present plan to establish any such additional class or series.
The Serial Preferred Stock may have the effect of discouraging an attempt,
through acquisition of a substantial number of shares of Common Stock, to
acquire control of the Company with a view to effecting a merger, sale or
exchange of assets or a similar transaction. For example, the Board of Directors
could issue such shares as a dividend to holder of Common Stock or place such
shares privately with purchasers who may side with the Board of Directors in
opposing a takeover bid. The anti-takeover effects of the Serial Preferred Stock
may deny shareholders the receipt of a premium on their Common Stock and may
also have a depressive effect on the market price of the Common Stock.
LSG OPTION
The first Paper Warehouse store opened in Minneapolis, Minnesota in 1983.
The sole shareholder of the Company at that time was LSG Corporation ("LSG"). In
1986 Yale T. Dolginow acquired 70% of the outstanding Common Stock of the
Company. In December 1992, Mr. Dolginow purchased all of the shares of Common
Stock of the Company owned by LSG and the Company granted LSG, for nominal
consideration, an option to acquire 220,285 shares of Common Stock upon the
occurrence of a merger or the initial public offering of the Company's
securities (the "Event Option"). The Event Option terminates November 30, 1997.
The Company also granted LSG a conditional option, effective January 1, 1998, to
purchase 220,285 shares of Common Stock in the event the Event Option is not
exercised (the "1998 Option"). Upon exercise of the 1998 Option and receipt of
shares, LSG has the right to put (the "Put Option") the shares to the Company at
a price equal to the aggregate book value per share of the shares calculated as
of the end of the immediately preceding fiscal year of the Company. The 1998
Option and the
39
<PAGE>
Put Option terminate on December 31, 1998, and the 1998 Option terminates upon
the exercise by LSG of the Event Option.
The exercise price of each of the Event Option and the 1998 Option is
$150,000 plus an amount equal to 10% of all capital and equity contributions
made to the Company between December 1, 1992 and the date of exercise. As a
result of the exercise of the Warrants (as herein defined) immediately prior to
this offering, the aggregate exercise price of the LSG Option will be $172,999.
Shares of Common Stock issuable upon exercise of the Event Option do not have
registration rights. Concurrently with the consummation of the offering, LSG has
agreed to exercise the LSG Option on a cashless basis, whereby the exercise
price will be paid by reducing the number of shares issued upon exercise of the
LSG Option in an amount equal to the aggregate exercise price divided by the
initial price to the public in the offering. LSG will be issued 197,219 shares
upon the "cashless exercise" of the LSG Option. LSG has granted the Underwriter
an option to purchase an additional 50,000 shares to cover over-allotments. See
"Underwriting." The shares issued upon exercise of the LSG Option will be
restricted securities as defined in Rule 144 under the Securities Act and may
only be publicly resold pursuant to a registration statement or pursuant to an
exemption from the registration statement requirements, including Rule 144 under
the Securities Act after expiration of the then applicable holding period.
WARRANTS
In connection with the Company's 1994 private placement of the Subordinated
Notes the Company issued to the 37 purchasers of the Subordinated Notes warrants
("Warrants") to purchase an aggregate of 183,720 shares of Common Stock at an
exercise price of $1.25 per share. The Warrants provide that if the Company
issues shares of Common Stock to LSG pursuant to the LSG Option, the number of
shares of Common Stock purchasable in the aggregate upon exercise of the
Warrants will be increased to 202,040 shares of Common Stock at an exercise
price of $1.14. A warrant holder may require the Company to redeem the holder's
Warrants at any time beginning November 30, 1998, and the Company may redeem the
Warrants at any time beginning November 30, 1999, in either case at a defined
redemption price.
Pursuant to a registration rights agreement with the Company dated December
7, 1994, holders of Warrants have certain rights with respect to the
registration of shares issuable upon exercise of the Warrants under the
Securities Act. Under the terms of the agreement, if the Company proposes to
register any of its securities under the Securities Act for its own account or
for the account of others, the holders are entitled to include such shares
therein, subject to any limitation by the underwriters in the offering on the
number of shares included in such registration. The Company is required to use
its best efforts to effect all such registrations, subject to certain conditions
and limitations. Each of the Warrant holders has been given notice of this
offering and of such registration rights and none of such holders has exercised
such registration rights in connection with this offering. Concurrent with the
consummation of the offering, holders of all of the Warrants have agreed to
convert their Warrants into an aggregate of 171,375 shares of Common Stock and
have agreed not to sell the Common Stock issuable upon exercise of such Warrants
until at least 180 days after the effective date of this offering.
STATE LAW PROVISIONS WITH POTENTIAL ANTI-TAKEOVER EFFECT
Certain provisions of Minnesota law described below could have an
anti-takeover effect. These provisions are intended to provide management
flexibility and to enhance the likelihood of continuity and stability in the
composition of the Company's Board of Directors and in the policies formulated
by the Board and to discourage an unsolicited takeover of the Company, if the
Board determines that such a takeover is not in the best interests of the
Company and its shareholders. However, these provisions could have the effect of
discouraging certain attempts to acquire the Company which could deprive the
Company's shareholders of opportunities to sell their shares of Common Stock at
prices higher than prevailing market prices.
Section 302A.671 of the Minnesota Business Corporation Act (the "MBCA")
applies, with certain exceptions, to any acquisition of voting stock of the
Company (from a person other than the Company, and other than in connection with
certain mergers and exchanges to which the Company is a party) resulting in
40
<PAGE>
the beneficial ownership of 20% or more of the voting stock then outstanding.
Section 302A.671 requires approval of any such acquisition by a majority vote of
the shareholders of the Company prior to its consummation. In general, shares
acquired in the absence of such approval are denied voting rights and are
redeemable at their then-fair market value by the Company within 30 days after
the acquiring person has failed to give a timely information statement to the
Company or the date the shareholders voted not to grant voting rights to the
acquiring person's shares.
Section 302A.673 of the MBCA generally prohibits any business combination by
the Company, or any subsidiary of the Company, with any shareholder that
purchases 10% or more of the Company's voting shares (an "interested
shareholder") within four years following such interested shareholder's share
acquisition date, unless the business combination is approved by a committee of
all of the disinterested members of the Board of Directors of the Company before
the interested shareholder's share acquisition date.
The Company's Amended & Restated Bylaws (the "Bylaws") provide that Section
302A.673 of the MBCA, is not applicable to any business combination (as defined
in the MBCA) of the Company with, with respect to, proposed by or on behalf of,
or pursuant to, any written or oral agreement, arrangement, relationship,
understanding, or otherwise with Yale T. Dolginow and/or Brent D. Schlosser or
any of their respective affiliates or associates (as defined in the MBCA).
CERTAIN LIMITED LIABILITY AND INDEMNIFICATION PROVISIONS
The Company's Articles limit the liability of its directors to the fullest
extent permitted by law. Specifically, directors of the Company will not be
personally liable for monetary damages for breach of the fiduciary duty as
directors, except for liability for (i) any breach of the director's duty of
loyalty to the Company or its shareholders, (ii) acts or omissions not in good
faith or which involve intentional misconduct or a knowing violation of law,
(iii) corporate distributions which are in contravention of restrictions in the
MBCA, the Company's Articles or Bylaws, or any agreement to which the Company is
a party, (iv) violations of Minnesota securities laws, (v) any transaction from
which the director derives an improper personal benefit, or (vi) any act or
omission occurring prior to the effective date of the provision in the Company's
Articles eliminating or limiting liability. This provision will generally not
limit liability under state or federal securities law.
Section 302A.521 of the MBCA provides that a Minnesota business corporation
must indemnify any director, officer, employee or agent of the corporation made
or threatened to be made a party to a proceeding, by reason of the former or
present official capacity (as defined) of the person, against judgments,
penalties, fines, settlements and reasonable expenses incurred by the person in
connection with the proceeding if certain statutory standards are met.
"Proceeding" means a threatened, pending or completed civil, criminal,
administrative, arbitration or investigative proceeding, including one by or in
the right of the corporation. Section 302A.521 contains detailed terms regarding
such right of indemnification and reference is made thereto for a complete
statement of such indemnification rights.
Article 6 of the Company's Bylaws provides that each director, officer and
employee of the Company shall be indemnified by the Company in accordance with,
and to the fullest extent permissible by, applicable law.
Insofar as indemnification for liabilities arising under the Security Act
may be permitted to directors, officers or persons controlling the Company
pursuant to the foregoing provisions, the Company has been informed that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act, and is therefore
unenforceable.
TRANSFER AGENT AND REGISTRAR
Firstar Trust Company is the transfer agent and registrar of the Common
Stock.
41
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters named below, for which Dain Bosworth Incorporated is acting as
representative (the "Representative"), have severally agreed to purchase from
the Company the shares of Common Stock offered hereby. Each Underwriter will
purchase the number of shares of Common Stock at the price to public less the
underwriting discounts and commissions set forth on the cover page of this
Prospectus, in the amounts set forth below opposite their respective names.
<TABLE>
<CAPTION>
UNDERWRITERS NUMBER OF SHARES
- --------------------------------------------------------------------------- -----------------
<S> <C>
Dain Bosworth Incorporated................................................. 1,098,000
Robert W. Baird & Co. Incorporated......................................... 40,000
George K. Baum & Company................................................... 40,000
J.C. Bradford & Co......................................................... 40,000
EVEREN Securities, Inc..................................................... 40,000
Fahnestock & Co. Inc....................................................... 40,000
Janney Montgomery Scott Inc................................................ 40,000
Jefferies & Company, Inc................................................... 40,000
John G. Kinnard and Company Incorporated................................... 40,000
Ladenburg Thalmann & Co. Inc............................................... 40,000
McDonald & Company Securities, Inc......................................... 40,000
Morgan Keegan & Company, Inc............................................... 40,000
Piper Jaffray Inc.......................................................... 40,000
Principal Financial Securities, Inc........................................ 40,000
Rauscher Pierce Refsnes, Inc............................................... 40,000
Raymond James & Associates, Inc............................................ 40,000
Sutro & Co. Incorporated................................................... 40,000
Tucker Anthony Incorporated................................................ 40,000
-----------------
Total.................................................................... 1,778,000
-----------------
-----------------
</TABLE>
The Underwriting Agreement provides that the Underwriters' obligations are
subject to conditions precedent and that the Underwriters are committed to
purchase all shares of Common Stock offered hereby (other than those covered by
the over-allotment option described below) if the Underwriters purchase any
shares. The Representative has advised the Company that the several Underwriters
may offer the shares of Common Stock directly to the public at the price to
public set forth on the cover page of this Prospectus and to certain dealers at
the price to public less a concession not exceeding $0.29 per share. The
Underwriters may allow, and such dealers may reallow, a concession not exceeding
$0.10 per share to other dealers. After the shares of Common Stock are released
for sale to the public, the Representative may change the initial price to
public and other selling terms.
The Company and the Selling Shareholder have granted to the Underwriters an
option, exercisable for 30 days after the date of this Prospectus, to purchase
up to an aggregate of 216,700 and 50,000 additional shares of Common Stock,
respectively, at the same price per share as the initial shares to be purchased
by the Underwriters. The Underwriters may purchase these shares solely to cover
over-allotments, if any, in connection with the sale of Common Stock offered
hereby. If the Underwriters exercise the over-allotment option, the Underwriters
will be obligated, subject to certain conditions, to purchase additional shares
in approximately the same proportion as those in the above table.
The Underwriting Agreement provides that the Company, the Selling
Shareholder and the Underwriters will indemnify each other against certain
liabilities, including liabilities under the Securities Act, in connection with
this offering.
42
<PAGE>
The Company and all of its directors, executive officers and shareholders
have agreed not to sell, offer to sell, solicit an offer to buy, contract to
sell, grant an option to purchase, or otherwise transfer or dispose of any
shares of Common Stock, or any securities convertible into or exercisable or
exchangeable for Common Stock, for a period of 180 days after the date of this
Prospectus without the prior written consent of the Representative.
The Representative has informed the Company that the Underwriters do not
intend to confirm sales to any account over which they exercise discretionary
authority.
In order to facilitate the offering of the Common Stock, the Underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
price of the Common Stock. Specifically, the Underwriters may over-allot the
Common Stock in connection with the offering, creating a short position in the
Common Stock for their own account. In addition, to cover over-allotments or to
stabilize the price of the Common Stock, the Underwriters may bid for, and
purchase, shares of the Common Stock in the open market. The Underwriters may
also reclaim selling concessions allowed to an underwriter or a dealer for
distributing the Common Stock in the offering, if the Underwriters repurchase
previously distributed Common Stock in transactions to cover their short
positions, in stabilization transactions or otherwise. Finally, the Underwriters
may bid for, and purchase, shares of the Common Stock in market making
transactions and impose penalty bids. These activities may stabilize or maintain
the market price of the Common Stock above market levels that may otherwise
prevail. The Underwriters are not required to engage in these activities, and
may end any of these activities at any time.
Prior to this offering, there has been no public market for the Common
Stock. The initial public offering price for the Common Stock has been
determined by negotiation between the Company and the Representative. In
determining the initial price to public, the Company and the Representative
considered, among other things, the history of and prospects for the industry in
which the Company operates, past and present operations and earnings of the
Company and the trend of such earnings, the qualifications of the Company's
management, the general condition of the securities markets at the time of this
offering and the market prices for other publicly traded companies. There can be
no assurance, however, that the prices at which the Common Stock will sell in
the public market after this offering will not be lower than the Price to
Public.
43
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no market for the Common Stock of the
Company. Sales of a substantial number of shares of Common Stock in the public
market following this offering, or the perception that such sales could occur,
could have a material adverse effect on the prevailing market price of the
Common Stock and could adversely affect the ability of the Company to raise
equity capital in the future.
Upon completion of this offering, 4,349,412 shares of Common Stock will be
outstanding (4,566,112 shares if the Underwriters' over-allotment option is
exercised in full), of which the 1,778,000 shares offered hereby (2,044,700
shares if the Underwriters' over-allotment option is exercised in full) will be
freely tradeable on the public market without restriction or further
registration under the Securities Act, by persons who are not deemed to be
affiliates of the Company as that term is defined in the Securities Act. The
remaining 2,571,412 shares of Common Stock were issued and sold by the Company
in private transactions, and are "restricted stock" within the meaning of Rule
144, and public sale thereof is restricted except to the extent they are
registered under the Securities Act or sold in accordance with an exemption from
such registration such as Rule 144. The Company and the holders of these
remaining shares have entered into lock-up agreements with the Underwriters
under which they have agreed not to sell, offer to sell, solicit an offer to
buy, contract to sell, grant any option to purchase, or otherwise transfer or
dispose of any shares of Common Stock, or any securities convertible into or
exercisable or exchangeable for Common Stock, for a period of 180 days after the
date of this Prospectus without the prior written consent of the Representative.
Upon expiration of the 180-day period, all of these remaining shares will be
eligible for immediate public sale under Rule 144(k).
In general, Rule 144 as currently in effect provides that if at least one
year has elapsed since shares of Common Stock that constitute restricted stock
were last acquired from the Company or an affiliate of the Company, the holder
is generally entitled to sell, within any three-month period, a number of shares
that does not exceed the greater of 1% of the shares of Common Stock then
outstanding or the reported average weekly trading volume of the Common Stock
during the four calendar weeks immediately preceding the date on which notice of
the sale is sent to the Commission. Sales under Rule 144 are subject to certain
manner of sale restrictions, notice requirements and availability of current
public information concerning the Company. Under Rule 144(k), a person who is
not an affiliate of the Company during the three months preceding the sale,
generally may sell shares without regard to the volume limitations, manner of
sale provision, notice requirements or the availability of public information
concerning the Company, provided that at least two years have elapsed since the
shares were last acquired from the Company or an affiliate.
The Company intends to file a registration statement under the Securities
Act to register an aggregate of 639,641 shares of Common Stock reserved for
issuance under the Stock Plans, thus permitting the resale of such shares by
non-affiliates in the public market without restriction under the Securities
Act, subject, however, to vesting requirements with the Company and the lock-up
agreements described above.
44
<PAGE>
LEGAL MATTERS
The validity of the shares of Common Stock being sold in this offering will
be passed upon for the Company by Maslon Edelman Borman & Brand, LLP,
Minneapolis, Minnesota. Oppenheimer Wolff & Donnelly, Minneapolis, Minnesota is
acting as counsel for the Underwriters in connection with certain legal matters
relating to the shares of Common Stock offered hereby.
INDEPENDENT PUBLIC ACCOUNTANTS
The combined/consolidated financial statements of Paper Warehouse, Inc. as
of January 31, 1997 and February 2, 1996, and for each of the years in the
three-year period ended January 31, 1997 have been included herein and in the
Registration Statement in reliance upon the report of KPMG Peat Marwick LLP,
independent certified public accountants, appearing elsewhere herein, and upon
the authority of said firm as experts in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission,
Washington, D.C. 20549, a Registration Statement under the Securities Act with
respect to the shares of Common Stock offered hereby. This Prospectus does not
contain all of the information set forth in the Registration Statement and the
exhibits and schedules thereto, certain parts of which are omitted as permitted
by the rules and regulations of the Commission. For further information with
respect to the Company and the Common Stock offered hereby, reference is made to
the Registration Statement and the exhibits and schedules filed therewith.
Although all material terms and provisions of any material contract or other
document filed are referred to in this Prospectus and described herein, such
descriptions are not necessarily complete, and in each instance reference is
made to the copy of such contract or other document filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference. The Registration Statement and the exhibits and schedules
thereto may be inspected, without charge, 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 at 500 West Madison Street, Suite 1400,
Chicago, IL 60661, and 7 World Trade Center, Suite 1500, New York, New York
10048. Copies of all or any part of the Registration Statement can also be
obtained from the Public Reference Section of the Commission at 450 Fifth
Street, N.W., Washington, D.C. 20549, at prescribed rates. The Commission also
maintains a Web site (http://www.sec.gov) that contains reports, proxy and
information statements, and other information that has been or will be filed by
the Company.
The Company intends to furnish its shareholders with annual reports
containing audited financial statements and quarterly reports for the first
three quarters of each fiscal year containing unaudited interim financial
information.
45
<PAGE>
PAPER WAREHOUSE, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Independent Auditors' Report............................................................................... F-2
Combined/Consolidated Balance Sheets as of February 2, 1996, January 31, 1997, August 2, 1996 (unaudited)
and August 1, 1997 (unaudited)........................................................................... F-3
Combined/Consolidated Statements of Earnings and Retained Earnings for the fiscal years ended January 27,
1995, February 2, 1996, and January 31, 1997, and the six-month periods ended August 2, 1996 (unaudited)
and August 1, 1997 (unaudited)........................................................................... F-4
Combined/Consolidated Statements of Cash Flows for the fiscal years ended January 27, 1995, February 2,
1996, and January 31, 1997, and the six-month periods ended August 2, 1996 (unaudited) and August 1, 1997
(unaudited).............................................................................................. F-5
Notes to Combined/Consolidated Financial Statements........................................................ F-6
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Paper Warehouse, Inc.:
We have audited the accompanying combined/consolidated balance sheets of
Paper Warehouse, Inc. and subsidiary (the Company) as of February 2, 1996 and
January 31, 1997, and the related combined/ consolidated statements of earnings
and retained earnings, and cash flows for each of the years in the three-year
period ended January 31, 1997. These combined/consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these combined/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 combined/consolidated financial statements referred to
above present fairly, in all material respects, the financial position of Paper
Warehouse, Inc. and subsidiary as of February 2, 1996 and January 31, 1997, and
the results of their operations and their cash flows for each of the years in
the three-year period ended January 31, 1997, in conformity with generally
accepted accounting principles.
/s/ KPMG Peat Marwick LLP
Minneapolis, Minnesota
February 28, 1997, except
as to the fourth and fifth paragraphs
of note 10(a) which are as
of September 26, 1997
F-2
<PAGE>
PAPER WAREHOUSE, INC.
COMBINED/CONSOLIDATED BALANCE SHEETS
FEBRUARY 2, 1996, JANUARY 31, 1997,
AUGUST 2, 1996 AND AUGUST 1, 1997
<TABLE>
<CAPTION>
PRO FORMA
AUGUST 1,
FEBRUARY 2, JANUARY 31, AUGUST 2, AUGUST 1, 1997 (NOTE
1996 1997 1996 1997 10(B))
------------- ------------- ------------- ------------- -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
ASSETS
Current assets:
Cash............................................ $ 885,440 $ 357,167 $ 604,142 $ 359,516 $ 359,516
Inventories, net................................ 7,716,758 9,568,680 9,144,189 11,949,521 11,949,521
Accounts receivable............................. 479,164 261,424 163,859 183,908 183,908
Prepaid expenses and other current assets....... 132,312 119,053 210,429 414,202 414,202
------------- ------------- ------------- ------------- -------------
Total current assets........................ 9,213,674 10,306,324 10,122,619 12,907,147 12,907,147
Property and equipment, net..................... 5,193,485 5,461,219 5,514,005 5,681,746 5,681,746
Other assets, net............................... 527,032 502,639 513,055 496,615 496,615
------------- ------------- ------------- ------------- -------------
$ 14,934,191 $ 16,270,182 $ 16,149,679 $ 19,085,508 $ 19,085,508
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable................................... $ 4,763,939 $ 5,870,000 $ 5,473,939 $ 0 $ 0
Notes payable--related party.................... 0 0 0 2,136,193 2,136,193
Current maturities of long-term debt............ 23,040 22,015 22,668 22,015 22,015
Accounts payable................................ 2,610,505 2,122,285 2,875,901 4,357,481 4,357,481
Accrued liabilities:
Payroll and related expenses.................. 218,302 268,046 287,852 312,816 312,816
Accrued interest.............................. 87,788 17,407 107,726 69,593 69,593
Other......................................... 585,508 305,433 561,891 448,426 448,426
Pro forma dividends declared subsequent to
period end (note 10(b))....................... 0 0 0 0 166,000
------------- ------------- ------------- ------------- -------------
Total current liabilities................... 8,289,082 8,605,186 9,329,977 7,346,524 7,512,524
Notes payable (note 10(b)) 0 0 0 5,775,000 5,775,000
Notes payable--related party...................... 0 2,136,193 0 0 0
Long-term debt, less current maturities........... 3,233,656 3,211,575 3,223,702 3,198,893 3,198,893
Deferred rent credits and other................... 287,878 524,694 261,849 624,846 624,846
------------- ------------- ------------- ------------- -------------
Total liabilities........................... 11,810,616 14,477,648 12,815,528 16,945,263 17,111,263
Stockholders' equity (note 10(a)):
Serial preferred stock, 10,000,000 shares
authorized; none issued or outstanding........ 0 0 0 0 0
Common stock, $.01 par value.
Authorized 40,000,000 shares; issued and
outstanding 2,202,818 shares................ 22,028 22,028 22,028 22,028 22,028
Additional paid-in capital...................... 572,472 572,472 572,472 572,472 572,472
Retained earnings............................... 2,529,075 1,198,034 2,739,651 1,545,745 1,379,745
------------- ------------- ------------- ------------- -------------
Total stockholders' equity.................. 3,123,575 1,792,534 3,334,151 2,140,245 1,974,245
Commitments and contingencies (note 5)............
------------- ------------- ------------- ------------- -------------
$ 14,934,191 $ 16,270,182 $ 16,149,679 $ 19,085,508 $ 19,085,508
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
</TABLE>
See accompanying notes to combined/consolidated financial statements.
F-3
<PAGE>
PAPER WAREHOUSE, INC.
COMBINED/CONSOLIDATED STATEMENTS OF EARNINGS AND RETAINED EARNINGS
YEARS ENDED JANUARY 27, 1995, FEBRUARY 2, 1996, AND JANUARY 31, 1997,
AND THE SIX-MONTH PERIODS ENDED AUGUST 2, 1996 AND AUGUST 1, 1997
<TABLE>
<CAPTION>
JANUARY 27, FEBRUARY 2, JANUARY 31, AUGUST 2, AUGUST 1,
1995 1996 1997 1996 1997
-------------- ------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue:
Company-owned stores.............. $ 23,640,633 $ 32,414,215 $ 41,892,173 $ 18,969,660 $ 24,205,806
Franchise related fees............ 442,867 1,064,092 1,109,737 473,878 542,350
-------------- ------------- ------------- ------------- -------------
Total revenue................... 24,083,500 33,478,307 43,001,910 19,443,538 24,748,156
-------------- ------------- ------------- ------------- -------------
Costs and expenses:
Costs of products sold and
occupancy costs................. 15,474,410 21,879,566 27,946,561 12,946,154 16,267,318
Store operating expenses.......... 4,634,847 6,367,150 8,732,589 3,828,979 4,895,477
General and administrative
expenses........................ 2,479,972 3,450,737 4,242,960 2,070,616 2,628,166
-------------- ------------- ------------- ------------- -------------
Operating income................ 1,494,271 1,780,854 2,079,800 597,789 957,195
Interest expense.................. 208,301 489,891 771,549 384,713 479,021
-------------- ------------- ------------- ------------- -------------
Income before income
taxes......................... 1,285,970 1,290,963 1,308,251 213,076 478,174
Income taxes........................ 5,000 5,181 5,300 2,500 5,039
-------------- ------------- ------------- ------------- -------------
Net income...................... 1,280,970 1,285,782 1,302,951 210,576 473,135
Retained earnings:
Beginning of the period........... 1,733,850 2,051,783 2,529,075 2,529,075 1,198,034
Distributions of earnings......... (963,037) (808,490) (2,633,992) 0 (125,424)
-------------- ------------- ------------- ------------- -------------
End of the period................. $ 2,051,783 $ 2,529,075 $ 1,198,034 $ 2,739,651 $ 1,545,745
-------------- ------------- ------------- ------------- -------------
-------------- ------------- ------------- ------------- -------------
Weighted average common shares
outstanding..................... 2,202,818 2,202,818 2,202,818 2,202,818 2,202,818
Pro forma data (unaudited-note
10(b))
Historical net income............. $ 1,280,970 $ 1,285,782 $ 1,302,951 $ 210,576 $ 473,135
Pro forma provision for income
taxes........................... 486,769 488,597 495,121 80,019 179,791
-------------- ------------- ------------- ------------- -------------
Pro forma net income.............. $ 794,201 $ 797,185 $ 807,830 $ 130,557 $ 293,344
-------------- ------------- ------------- ------------- -------------
Pro forma net income per common
share........................... $ 0.32 $ 0.32 $ 0.32 $ 0.05 $ 0.12
-------------- ------------- ------------- ------------- -------------
-------------- ------------- ------------- ------------- -------------
</TABLE>
See accompanying notes to combined/consolidated financial statements.
F-4
<PAGE>
PAPER WAREHOUSE, INC.
COMBINED/CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JANUARY 27, 1995, FEBRUARY 2, 1996, AND JANUARY 31, 1997,
AND THE SIX-MONTH PERIODS ENDED AUGUST 2, 1996 AND AUGUST 1, 1997
<TABLE>
<CAPTION>
JANUARY 27, FEBRUARY 2, JANUARY 31, AUGUST 2, AUGUST 1,
1995 1996 1997 1996 1997
------------- ------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income...................................... $ 1,280,970 $ 1,285,782 $ 1,302,951 $ 210,576 $ 473,135
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation and amortization................. 432,748 695,356 959,901 455,346 546,818
Gain on sale of property and equipment........ (170) (1,775) (4,375) 0 (1,892)
Changes in operating assets and liabilities;
net of the effect of the purchase of the
assets of a business:
Accounts receivable......................... (82,116) (300,022) 217,740 315,306 77,516
Prepaid expenses and other current assets... 43,312 (68,308) 13,259 (78,117) (295,149)
Merchandise inventories..................... (1,443,016) (3,061,944) (1,851,922) (1,427,431) (2,380,841)
Accounts payable............................ 271,985 1,462,471 (488,220) 265,396 2,235,196
Accrued liabilities......................... 337,771 382,694 (63,896) 39,841 340,100
------------- ------------- ------------- ------------- -------------
Net cash provided (used) by operating
activities.............................. 841,484 394,254 85,438 (219,083) 994,883
------------- ------------- ------------- ------------- -------------
Cash flows from investing activities:
Proceeds from sale of property and equipment.... 3,683 1,775 136,960 0 7,807
Purchases of property and equipment............. (1,122,206) (3,454,752) (1,317,283) (751,625) (745,466)
Purchases of trademarks......................... (2,969) (2,947) 0 0 0
Other assets, net of effect of asset
acquisition................................... (92,983) (51,329) (18,544) (10,263) (21,770)
------------- ------------- ------------- ------------- -------------
Net cash used in investing activities..... (1,214,475) (3,507,253) (1,198,867) (761,888) (759,429)
------------- ------------- ------------- ------------- -------------
Cash flows from financing activities:
Net proceeds from related party loans........... 0 0 2,136,193 0 0
Net proceeds from (payments on) notes payable to
bank.......................................... (61,167) 3,448,939 1,106,061 710,000 (95,000)
Proceeds from issuance of long-term debt........ 3,557,158 958,000 0 0 0
Principal payments on long-term debt............ (1,729,326) (6,215) (23,106) (10,327) (12,681)
Payment of debt acquisition fees................ (251,546) (8,000) 0 0 0
Distribution of earnings........................ (963,037) (808,490) (2,633,992) 0 (125,424)
------------- ------------- ------------- ------------- -------------
Net cash provided (used) by financing
activities.............................. 552,082 3,584,234 585,156 699,673 (233,105)
------------- ------------- ------------- ------------- -------------
Net increase (decrease) in cash........... 179,091 471,235 (528,273) (281,298) 2,349
Cash:
Beginning of period............................. 235,114 414,205 885,440 885,440 357,167
------------- ------------- ------------- ------------- -------------
End of period................................... $ 414,205 $ 885,440 $ 357,167 $ 604,142 $ 359,516
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest...................................... $ 194,614 $ 474,819 $ 877,410 $ 364,775 $ 426,836
Income taxes.................................. 5,000 10,181 5,300 300 5,039
</TABLE>
See accompanying notes to combined/consolidated financial statements.
F-5
<PAGE>
PAPER WAREHOUSE, INC.
NOTES TO COMBINED/CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 27, 1995, FEBRUARY 2, 1996, AND JANUARY 31, 1997
UNAUDITED AS TO THE SIX-MONTH PERIODS ENDED
AUGUST 2, 1996 AND AUGUST 1, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Paper Warehouse, Inc. (the Company) is a paper and party goods retailer
operating 64 company-owned stores in the states of Minnesota, Missouri, Iowa,
Kansas, Oklahoma, Colorado, and Wisconsin. Paper Warehouse, Inc. also sells
Paper Warehouse franchises through its affiliated company, which became a
wholly-owned subsidiary as of February 1, 1997 (see note 10(a)). The Company's
acquisition of its affiliate was accounted for as a combination of companies
under common control. In exchange for the initial and continuing fees received,
the Company provides management assistance to and gives franchisees the right to
use the name "Paper Warehouse" or "Party Universe."
BASIS OF COMBINATION
The financial statements of the Company represent the combined financial
statements of the two affiliates as of and for the fiscal years ended January
27, 1995, February 2, 1996, and January 31, 1997 and the six-month period ended
August 2, 1996. The financial statements for the six-month period ended August
1, 1997 represent the consolidated financial statements of the two companies.
The Company's financial statements have been prepared on the same basis for all
periods presented, whether combined or consolidated. The results of all
intercompany transactions have been eliminated.
ACCOUNTING ESTIMATES
The preparation of combined 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 and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying value of the Company's financial assets and liabilities,
because of their short-term nature, is approximately fair value. The fair value
of the Company's borrowing, if recalculated based on current interest rates,
would not significantly differ from the recorded amounts.
S CORPORATION ELECTION
The Company has elected to be taxed as an S corporation under the Internal
Revenue Code. The Company has agreed to make distributions of earnings in
amounts sufficient to enable stockholders to pay their federal and state income
taxes resulting from pass-through of taxable income as a result of the S
corporation election.
FISCAL YEAR
The Company's fiscal year ends on the Friday closest to January 31. The
fiscal year ended February 2, 1996 included 53 weeks, and the fiscal year ended
January 31, 1997 included 52. Unless otherwise stated, references to years in
this report relate to fiscal years rather than to calendar years.
F-6
<PAGE>
PAPER WAREHOUSE, INC.
NOTES TO COMBINED/CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 27, 1995, FEBRUARY 2, 1996, AND JANUARY 31, 1997
UNAUDITED AS TO THE SIX-MONTH PERIODS ENDED
AUGUST 2, 1996 AND AUGUST 1, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MERCHANDISE INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined by
the first in, first out (FIFO) method.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is computed by the
straight-line method over the estimated useful lives of the assets as follows:
<TABLE>
<CAPTION>
ESTIMATED
METHOD USEFUL LIFE
-------------- -------------
<S> <C> <C>
Fixtures and equipment........................................ Straight-line 5 to 7 years
Building...................................................... Straight-line 40 years
Land improvements............................................. Straight-line 40 years
</TABLE>
Maintenance, repairs, and minor renewals are expensed as incurred. Upon
retirement or disposal of assets, the cost and accumulated depreciation are
eliminated from the respective accounts and the related gains or losses are
credited or charged to income.
DEBT ACQUISITION COSTS
Debt acquisition costs relate to costs associated with the issuance of notes
payable. These costs are being amortized over the related term of the debt using
the straight-line method.
INTANGIBLE ASSETS
The excess of cost over fair value of net assets resulting from the
acquisition of a store created goodwill that is being amortized over 15 years
using the straight-line method.
Costs of acquiring trademarks have been capitalized and are being amortized
on a straight-line basis over ten years.
OTHER ASSETS
Other assets consist primarily of security deposits and lease acquisition
fees. Lease acquisition fees are amortized over the related lease term using the
straight-line method.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND
FOR LONG-LIVED ASSETS TO BE DISPOSED OF, on January 1, 1996. This statement
requires that long-lived assets and certain identifiable intangibles be reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future net cash flows expected to be generated by the asset. If such
F-7
<PAGE>
PAPER WAREHOUSE, INC.
NOTES TO COMBINED/CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 27, 1995, FEBRUARY 2, 1996, AND JANUARY 31, 1997
UNAUDITED AS TO THE SIX-MONTH PERIODS ENDED
AUGUST 2, 1996 AND AUGUST 1, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell. Adoption of this statement
did not have a material impact on the Company's financial position or results of
operations.
DEFERRED RENT CREDITS
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 credits for the
differences between the amounts recognized and the amounts paid.
PRE-OPENING COSTS
Costs associated with the opening of new stores are expensed as incurred.
STOCK-BASED COMPENSATION
Compensation expense for stock option grants is recognized in accordance
with Accounting Principles Board (APB) Opinion 25, ACCOUNTING FOR STOCK ISSUED
TO EMPLOYEES. Had the Company incurred compensation expense in the disclosure
periods required by SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, pro
forma effects on net income would have been provided as if the fair value based
method, as defined in SFAS No. 123, had been applied.
ADVERTISING
The Company expenses the cost of advertising as incurred or the first time
the advertisement takes place.
PRO FORMA NET INCOME PER SHARE
Pro forma net income per common share is determined by dividing pro forma
net income by the weighted average number of common shares and common share
equivalents outstanding.
The Company will adopt SFAS No. 128, EARNINGS PER SHARE, in the fourth
quarter of the fiscal year ending January 30, 1998. The Company does not expect
the implementation of SFAS No. 128 to have a material impact on earnings per
share.
F-8
<PAGE>
PAPER WAREHOUSE, INC.
NOTES TO COMBINED/CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 27, 1995, FEBRUARY 2, 1996, AND JANUARY 31, 1997
UNAUDITED AS TO THE SIX-MONTH PERIODS ENDED
AUGUST 2, 1996 AND AUGUST 1, 1997
(2) PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
FEBRUARY 2, JANUARY 31, AUGUST 2, AUGUST 1,
1996 1997 1996 1997
------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Fixtures and equipment............ $ 5,992,179 $ 7,120,047 $ 6,716,608 $ 7,859,135
Buildings......................... 1,041,702 1,041,702 1,041,702 1,041,702
Land and improvements............. 319,733 319,733 319,733 319,733
Accumulated depreciation and
amortization.................... (2,160,129) (3,020,263) (2,564,038) (3,538,824)
------------- ------------- ------------- -------------
$ 5,193,485 $ 5,461,219 $ 5,514,005 $ 5,681,746
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</TABLE>
Depreciation and amortization expense on property and equipment was
$415,453, $652,802, and $913,918 for the years ended January 27, 1995, February
2, 1996, and January 31, 1997, respectively, and $455,346 and $546,818 for the
six-month periods ended August 2, 1996 and August 1, 1997, respectively.
(3) NOTES PAYABLE TO BANK
The Company has a revolving line of credit agreement with its bank that
permits borrowings up to $7,500,000. Borrowings under the agreement bear
interest at the bank's base rate plus .5% and are secured by all assets of the
Company. The agreement contains restrictive covenants which, among other things,
require the Company to maintain a minimum tangible net worth and minimum current
ratios.
The current agreement is subject to annual renewal by the Company and the
bank. Additionally, the Company's majority stockholder has personally guaranteed
$1,500,000 of these notes. There was $4,763,939 and $5,870,000 outstanding under
the agreement as of February 2, 1996 and January 31, 1997, respectively, and
$5,473,948 and $5,775,000 outstanding at August 2, 1996 and August 1, 1997,
respectively (see note 10(a)).
F-9
<PAGE>
PAPER WAREHOUSE, INC.
NOTES TO COMBINED/CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 27, 1995, FEBRUARY 2, 1996, AND JANUARY 31, 1997
UNAUDITED AS TO THE SIX-MONTH PERIODS ENDED
AUGUST 2, 1996 AND AUGUST 1, 1997
(4) LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
FEBRUARY 2, JANUARY 31, AUGUST 2, AUGUST 1,
1996 1997 1996 1997
------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Note payable in monthly installments of $3,551, including
interest at 6.914% through October 2015. The note is
secured by a second mortgage on the Company's office
headquarters, assignment of a life insurance policy,
and the personal guarantee of the Company's majority
stockholder............................................ $ 429,542 $ 418,834 $ 424,313 $ 411,554
Term note payable in monthly installments of $4,796,
including interest at 9.08% through December 2015. The
note is secured by a first mortgage on the Company's
office headquarters.................................... 524,310 514,756 519,511 509,354
Note payable in monthly installments of $322, including
interest at 8% through May 1996........................ 2,844 0 2,546 0
$2,300,000 subordinated note payable to private placement
holders with interest due quarterly at 10%. Principal
installments of $575,000 due annually commencing
November 30, 2001...................................... 2,300,000 2,300,000 2,300,000 2,300,000
------------ ------------ ------------ ------------
3,256,696 3,233,590 3,246,370 3,220,908
Less current maturities.................................. 23,040 22,015 22,668 22,015
------------ ------------ ------------ ------------
$ 3,233,656 $ 3,211,575 $ 3,223,702 $ 3,198,893
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Long-term subordinated related party notes payable due
March 5, 1998, with interest at 5.63%.................. 0 2,136,193 0 0
</TABLE>
On December 12, 1994, the Company completed a private placement of 46 units,
each unit consisting of a 10% subordinated note of the Company due in annual
installments commencing November 30, 2001 through November 30, 2004, and one
detachable common stock purchase warrant. Subject to certain adjustments, each
warrant entitles the holder thereof to purchase 3,994 shares of common stock,
$.01 par value, of the Company at a price of $1.25 per share anytime after
November 30, 1995 and before November 30, 2004. The entire proceeds of
$2,300,000 were recorded as long-term debt.
F-10
<PAGE>
PAPER WAREHOUSE, INC.
NOTES TO COMBINED/CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 27, 1995, FEBRUARY 2, 1996, AND JANUARY 31, 1997
UNAUDITED AS TO THE SIX-MONTH PERIODS ENDED
AUGUST 2, 1996 AND AUGUST 1, 1997
(4) LONG-TERM DEBT (CONTINUED)
Aggregate annual maturities of long-term debt subsequent to the fiscal year
ended January 31, 1997 are as follows:
<TABLE>
<S> <C>
1998............................................................ $ 22,015
1999............................................................ 2,160,041
2000............................................................ 25,928
2001............................................................ 602,776
2002............................................................ 605,326
2003 and thereafter............................................. 1,953,697
</TABLE>
(5) LEASES
The Company leases all of its retail stores and corporate offices under
noncancelable operating leases which have various expiration dates. In addition
to base rents, certain leases require the Company to pay its share of
maintenance and real estate taxes, and include provisions for contingent rentals
based upon sales. Certain of the leases contain renewal options under which the
Company may extend the terms three to five years.
Future minimum rental payments due under noncancelable operating leases at
January 31, 1997 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING IN JANUARY: AMOUNT
- ------------------------------------------------------------------------------- -------------
<S> <C>
1998........................................................................... $ 4,701,108
1999........................................................................... 4,589,634
2000........................................................................... 4,443,846
2001........................................................................... 3,929,569
2002........................................................................... 3,881,994
Thereafter..................................................................... 12,715,404
-------------
$ 34,261,555
-------------
-------------
</TABLE>
Rent expense for all operating leases for the years ended January 27, 1995,
February 2, 1996, and January 31, 1997, and the six-month periods ended August
2, 1996 and August 1, 1997 were as follows:
<TABLE>
<CAPTION>
JANUARY 27, FEBRUARY 2, JANUARY 31, AUGUST 2, AUGUST 1,
1995 1996 1997 1996 1997
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Minimum rentals........ $ 2,081,693 $ 3,138,814 $ 4,309,403 $ 2,068,516 $ 2,564,330
Contingent rentals..... 3,754 0 0 0 0
------------ ------------ ------------ ------------ ------------
$ 2,085,447 $ 3,138,814 $ 4,309,403 $ 2,068,516 $ 2,564,330
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
</TABLE>
F-11
<PAGE>
PAPER WAREHOUSE, INC.
NOTES TO COMBINED/CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 27, 1995, FEBRUARY 2, 1996, AND JANUARY 31, 1997
UNAUDITED AS TO THE SIX-MONTH PERIODS ENDED
AUGUST 2, 1996 AND AUGUST 1, 1997
(6) INCOME TAXES--S CORPORATION ELECTION
As indicated in note 1, the Company has elected to be taxed as an S
corporation under the Internal Revenue Code. The Company's earnings or losses
are allocated to its stockholders for inclusion in their individual tax returns.
The Company has provided $5,000, $5,181, and $5,300, for income tax expense
relating to the State of Minnesota minimum tax for the years ended January 27,
1995, February 2, 1996, and January 31, 1997, respectively, and $2,500 and
$5,039 for the six-month periods ended August 2, 1996 and August 1, 1997,
respectively.
(7) RELATED PARTY TRANSACTIONS
Four of the Company's franchise stores are substantially owned by two
related parties of the Company's majority stockholder. Continuing franchise fees
collected from these related parties were $37,605, $52,845, and $75,639, for the
fiscal years ended January 27, 1995, February 2, 1996, and January 31, 1997,
respectively, and $20,144 and $42,285 in the six-month periods ended August 2,
1996 and August 1, 1997, respectively. The Company had a receivable of $8,842,
$21,224, and $19,428, from this franchisee at January 27, 1995, February 2,
1996, and January 31, 1997, respectively, and a receivable of $20,141 and $6,681
as of August 2, 1996 and August 1, 1997, respectively.
During the year ended January 31, 1997, the Company sold a Paper Warehouse
store to a related party for $144,000. The transaction resulted in no gain or
loss to the Company. Continuing fees collected from this related party were
$17,851 for the year ended January 31, 1997. The Company had a receivable of
$368 from this franchisee as of January 31, 1997.
On January 13, 1997, the Company issued notes payable to the Company's two
primary shareholders for the aggregate amount of $2,136,193. These notes bear
interest at 5.63%, are fully subordinated to all other long-term obligations,
and are due March 5, 1998.
(8) STOCK OPTIONS
The Company entered into an option agreement (the Agreement) on December 1,
1992. The Agreement, which was amended in its entirety on October 6, 1994,
provides the following:
<TABLE>
<CAPTION>
INITIAL
EXERCISE NUMBER OF EXERCISE
DESCRIPTION DATE SHARES PRICE EXPIRATION DATE
- ------------------------------ ---------- --------- ------------- ------------------------------
<S> <C> <C> <C> <C>
Event option.................. (1) 220,285 (3) 11/30/97
1998 option................... 1/1/98 220,285 (3) 12/31/98 or exercise of the
event option
Put option.................... (2) (2) (3) 12/31/98
</TABLE>
- ------------------------
(1) The event option is exercisable upon a triggering event. The triggering
event is defined as either any merger between the Company and any unrelated
entity or the offering of capital stock of the Company pursuant to a public
offering registered under the Securities Act of 1933.
F-12
<PAGE>
PAPER WAREHOUSE, INC.
NOTES TO COMBINED/CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 27, 1995, FEBRUARY 2, 1996, AND JANUARY 31, 1997
UNAUDITED AS TO THE SIX-MONTH PERIODS ENDED
AUGUST 2, 1996 AND AUGUST 1, 1997
(8) STOCK OPTIONS (CONTINUED)
(2) Upon receipt of the 1998 option shares, the buyer has the right to put the
1998 option shares back to the Company at a price equal to the aggregate
book value per share of the 1998 option shares calculated at the end of the
immediately preceding fiscal year of the Company.
(3) Exercise price equals $150,000 plus an amount equal to 10% of all capital
and equity contributions made to the Company since December 1, 1992. To
date, there have been no capital or equity contributions made to the Company
since December 1, 1992.
(9) EMPLOYEE BENEFITS
The Company has a retirement savings plan, covering substantially all
employees who have completed one year of service and attained 21 years of age,
which includes a noncontributory profit sharing plan and 401(k) feature.
Employees become fully vested in the plan on a graduated scale over a six-year
period. Contributions to the profit sharing plan are made at the discretion of
the plan committee. The 401(k) feature allows for employee's elective salary
deferrals up to 15% of their compensation, but not in excess of certain
limitations.
Discretionary contributions to the profit sharing plan were $25,000, $0, and
$0 for the fiscal years ended January 27, 1995, February 2, 1996, and January
31, 1997, respectively, and $0 and $0 for the six-month periods ended August 2,
1996 and August 1, 1997, respectively.
On March 1, 1996, the Company established a Voluntary Employee Benefit Plan
and Employee Benefit Trust for the sole and exclusive benefit of its employees.
The Company matches 25% of the first four percent of employee contributions to
the plan. Company contributions were $17,831 for the year ended January 31,
1997, and $3,939 and $13,271 for the six-month periods ended August 2, 1996 and
August 1, 1997, respectively.
(10) SUBSEQUENT EVENTS
10(A)
Effective as of February 1, 1997, Paper Warehouse Franchising, Inc. became a
wholly-owned subsidiary of Paper Warehouse, Inc. through a stock transfer of all
the outstanding shares of Paper Warehouse Franchising, Inc. to Paper Warehouse,
Inc.
On February 6, 1997, the Board of Directors of the Company increased the
number of common shares authorized for issuance from 200,000 to 40,000,000 and
authorized 10,000,000 shares of serial preferred stock.
On February 25, 1997, the Company purchased the assets of a franchisee for
$72,650.
On September 26, 1997, the Board of Directors of the Company declared a
37.57217275 to 1 common stock split increasing the number of common shares
issued and outstanding from 58,629 to 2,202,818. All references to share and per
share amounts in the accompanying combined/consolidated financial statements
reflect this stock split.
F-13
<PAGE>
PAPER WAREHOUSE, INC.
NOTES TO COMBINED/CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 27, 1995, FEBRUARY 2, 1996, AND JANUARY 31, 1997
UNAUDITED AS TO THE SIX-MONTH PERIODS ENDED
AUGUST 2, 1996 AND AUGUST 1, 1997
(10) SUBSEQUENT EVENTS (CONTINUED)
Effective September 26, 1997, the Company's revolving line of credit
agreement with the bank was amended to extend the renewal date to May 31, 1999,
and to eliminate the personal guarantee of the Company's majority stockholder of
$1,500,000 of the note.
10(B) PROFORMA PROVISION FOR INCOME TAXES--UNAUDITED
The Company anticipates filing a Form S-1 Registration Statement in October
1997. Upon completion of such offering, the Company will terminate its S
Corporation federal tax status and change to a C Corporation and, accordingly,
will be subject to federal and certain state income taxes. Prior to such
termination, the Company will distribute to its current stockholders all
accumulated S Corporation earnings as of the termination date. Accordingly, the
pro forma effect of this transaction has been disclosed in the accompanying pro
forma balance sheet. The existing balance of retained earnings does not need to
be transferred to additional paid in capital as required by the Securities and
Exchange Commission's Staff Accounting Bulletin 4.B since all accumulated S
Corporation earnings will be distributed in connection with the initial public
offering. In September 1997, the Board of Directors of the Company declared a
cash dividend payable to the current stockholders of the Company equal to the
Company's estimate of its accumulated taxable income from the date of the last
dividend paid, in January 1997, through the first six months of the fiscal year
ending January 1998 to the extent such taxable income had not previously been
distributed. This dividend aggregated approximately $166,000 and, following
payment, was loaned back to the Company by the shareholders pursuant to term
notes accruing interest at 5.63% annually. The Board of Directors also
anticipates declaring a cash dividend payable to the current shareholders,
concurrent with the consummation of the offering, equal to the balance of any
accumulated taxable income from the date of the September 1997 dividend through
the date of the conversion of the Company to a C Corporation in connection with
the offering.
Pro forma net income and pro forma net income per share for the fiscal years
ended January 27, 1995, February 6, 1996, and January 31, 1997, and for the
six-month periods ended August 2, 1996 and August 1, 1997, have been determined
assuming that the Company had been taxed as a C Corporation for federal and
certain state income tax purposes for such periods.
Unaudited pro forma income taxes represent the estimated income taxes that
would have been reported had the Company been a taxable entity for both federal
and state income tax purposes for the fiscal years ended January 27, 1995,
February 2, 1996, and January 31, 1997. The components of the unaudited pro
forma income tax provision are summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED
-------------------------------------
JANUARY 27, FEBRUARY 2, JANUARY 31,
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
Federal..................................................... $ 409,911 $ 411,450 $ 416,944
State....................................................... 76,858 77,147 78,177
----------- ----------- -----------
Unaudited pro forma provision for income taxes.............. $ 486,769 $ 488,597 $ 495,121
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
F-14
<PAGE>
PAPER WAREHOUSE, INC.
NOTES TO COMBINED/CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 27, 1995, FEBRUARY 2, 1996, AND JANUARY 31, 1997
UNAUDITED AS TO THE SIX-MONTH PERIODS ENDED
AUGUST 2, 1996 AND AUGUST 1, 1997
(10) SUBSEQUENT EVENTS (CONTINUED)
A reconciliation of taxes based on the federal statutory rate of 34% and the
unaudited pro forma provision for income taxes for the fiscal years ended
January 27, 1995, February 2, 1996, and January 31, 1997 is summarized as
follows:
<TABLE>
<CAPTION>
YEAR ENDED
-------------------------------------------------
JANUARY 27, FEBRUARY 2, JANUARY 31,
1995 1996 1997
--------------- --------------- ---------------
<S> <C> <C> <C>
Income taxes at the federal statutory rate.................. 34% 34% 34%
State income taxes, net of federal benefit.................. 4 4 4
-- -- --
Unaudited pro forma provision for income taxes.............. 38% 38% 38%
-- -- --
-- -- --
</TABLE>
F-15
<PAGE>
[Inside back cover][The inside back cover contains 7 photographs of the
Company's merchandise, store display and advertising.]
<PAGE>
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- --------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION 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 SHAREHOLDER OR THE
UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION
IS NOT QUALIFIED TO DO SO OR TO ANYONE TO WHOM 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 THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THE
INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE OF THIS
PROSPECTUS.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary............................. 3
Risk Factors................................... 6
S Corporation Distributions.................... 11
Use of Proceeds................................ 12
Dividend Policy................................ 12
Capitalization................................. 13
Dilution....................................... 14
Selected Financial and Operating Data.......... 15
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 16
Business....................................... 22
Management..................................... 32
Certain Transactions........................... 37
Principal and Selling Shareholders............. 38
Description of Capital Stock................... 39
Underwriting................................... 42
Shares Eligible for Future Sale................ 44
Legal Matters.................................. 45
Independent Public Accountants................. 45
Additional Information......................... 45
Index to Financial Statements.................. F-1
</TABLE>
------------------------
UNTIL DECEMBER 19, 1997 (25 DAYS AFTER DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS
DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY REQUIREMENT
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.
1,778,000 SHARES
[Paper Warehouse, Inc. LOGO]
COMMON STOCK
-------------
PROSPECTUS
-------------
[Dain Bosworth Incorporated LOGO]
NOVEMBER 24, 1997
- --------------------------------------------------------------------------------
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