<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 13, 1999
REGISTRATION NO. 333-79161
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
PRE-EFFECTIVE AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------------
PAPER WAREHOUSE, INC.
(Exact name of registrant as specified in its charter)
------------------------------
<TABLE>
<S> <C> <C>
MINNESOTA 5943 41-1612534
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Classification Code Number) Identification
incorporation or organization) No.)
</TABLE>
------------------------------
7630 EXCELSIOR BOULEVARD
MINNEAPOLIS, MINNESOTA 55426
(612) 936-1000
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
------------------------------
YALE T. DOLGINOW
PRESIDENT AND CHIEF EXECUTIVE OFFICER
7630 EXCELSIOR BOULEVARD
MINNEAPOLIS, MINNESOTA 55426
(612) 936-1000
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
COPIES TO:
BRUCE A. MACHMEIER, ESQ. DANIEL A. YARANO, ESQ.
Oppenheimer Wolff & Donnelly LLP Fredrikson & Byron, P.A.
Plaza VII, Suite 3400 Suite 1100
45 South Seventh Street 900 Second Avenue South
Minneapolis, Minnesota 55402 Minneapolis, Minnesota 55402
(612) 607-7000 (612) 347-7000
------------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
------------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended, check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration number of the earlier effective
registration statement for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. / /
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION, DATED JUNE 14, 1999
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES. THIS PROSPECTUS IS NOT SOLICITING AN OFFER TO BUY
THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE>
[LOGO]
$4,000,000
9% CONVERTIBLE SUBORDINATED DEBENTURES DUE SEPTEMBER 15, 2005
ISSUE PRICE: $1,000 PER DEBENTURE
------------------
We are a growing chain of retail stores specializing in party supplies and
paper goods operating under the names PAPER WAREHOUSE and PARTY UNIVERSE. We
currently have a total of 142 stores, including 97 Company-owned stores and 45
franchise stores, operating in 24 states. Our common stock trades on the Nasdaq
National Market under the trading symbol "PWHS." On June 8, 1999, the last
reported sale price of our common stock was $2.94 per share.
The Debentures will mature and their principal will be payable on September
15, 2005. They will bear interest at a rate of 9% per year, and we will make the
first interest payment on September 15, 1999. After that, we will pay interest
on the Debentures each year on the 15th of December, March, June and September.
The Debentures are convertible into shares of our common stock initially at the
price of $ per share. They are unsecured obligations and your right to payment
is subordinated in right of payment to all of our senior indebtedness. We have
the right to redeem the Debentures after July 15, 2002. You may require us to
repurchase the Debentures if we experience a change of control.
We plan to use the proceeds from this offering to develop an internet
website to sell party supplies and paper goods, to reduce our outstanding
indebtedness and for other general corporate purposes. The Debentures will not
be listed on any securities exchange or quoted on Nasdaq or any over-the-
counter market. Miller & Schroeder may make a market in the Debentures, but it
is not obligated to do so. We will issue a fully registered Debenture in each
purchaser's name.
<TABLE>
<CAPTION>
PER DEBENTURE TOTAL
<S> <C> <C>
Public offering price................................................................ $ 1,000 $ 4,000,000
Underwriting discounts and commissions............................................... $ 75 $ 300,000
Proceeds to Paper Warehouse.......................................................... $ 925 $ 3,700,000
</TABLE>
THIS INVESTMENT INVOLVES SIGNIFICANT RISKS. SEE "RISK FACTORS" BEGINNING ON
PAGE 7.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
MILLER & SCHROEDER FINANCIAL, INC.
THE DATE OF THIS PROSPECTUS IS JULY , 1999
<PAGE>
PROSPECTUS SUMMARY
IN THIS PROSPECTUS, "PAPER WAREHOUSE," "COMPANY," "WE," "OUR," AND "US"
REFER TO PAPER WAREHOUSE, INC. AND OUR SUBSIDIARY, BUT NOT TO MILLER &
SCHROEDER. "YOU" REFERS TO THE READER OF THIS PROSPECTUS. THIS SUMMARY
HIGHLIGHTS THE INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS. BECAUSE THIS
IS ONLY A SUMMARY, IT DOES NOT CONTAIN ALL OF THE INFORMATION THAT MAY BE
IMPORTANT TO YOU. FOR A MORE COMPLETE UNDERSTANDING OF THIS OFFERING, WE
ENCOURAGE YOU TO READ THIS ENTIRE PROSPECTUS AND THE DOCUMENTS WE REFER YOU TO.
YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION AND CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES TO THOSE
STATEMENTS APPEARING ELSEWHERE IN THIS PROSPECTUS. ALL REFERENCES TO FISCAL
YEARS IN THIS PROSPECTUS REFER TO THE FISCAL YEAR ENDING ON THE FRIDAY NEAREST
JANUARY 31 OF THE FOLLOWING CALENDAR YEAR. FOR EXAMPLE, FISCAL 1998 ENDED ON
JANUARY 29, 1999.
PAPER WAREHOUSE
Paper Warehouse is a growing chain of retail stores specializing in party
supplies and paper goods. As of April 30, 1999, we had 142 stores, including 97
Company-owned stores and 45 franchise stores. These stores are conveniently
located in major retail trade areas to provide customers with easy access to our
stores. We operate these stores under the names PAPER WAREHOUSE and PARTY
UNIVERSE. Our seven principal markets are:
<TABLE>
<S> <C> <C>
- - Minneapolis/St. Paul, MN - Kansas City, MO and KS - Denver, CO
- - Oklahoma City/Tulsa, OK - Seattle, WA - Tucson, AZ
- - Omaha, NE and Des Moines, IA
</TABLE>
Our stores offer an extensive selection of party supplies and paper goods,
at everyday low prices. We offer party supplies and paper goods for a wide
variety of celebratory occasions, everyday uses and seasonal events, including:
<TABLE>
<CAPTION>
CELEBRATORY OCCASIONS AND EVERYDAY
USES SEASONAL EVENTS
- ------------------------------------- ---------------------------------
<S> <C> <C>
- - birthdays - Valentine's - Halloween
- - weddings Day - Christmas
- - baby showers - Easter - Hanukkah
- - graduations - Fourth of July - New Year's
- - other family and religious - Thanksgiving
celebrations
</TABLE>
Through our 8,500 square foot prototype, we offer a comprehensive selection
of over 19,000 different products. This selection provides customers the
convenience of one-stop shopping for party supplies and paper goods. Our
merchandise is organized by party themes. The prominent signage and wide aisles
in our stores allow customers easy access to coordinate the merchandise required
for all party occasions. We believe that our extensive and readily available
merchandise selection often stimulates customers to purchase additional
products.
We believe that total United States retail sales of party supplies and paper
goods, including greeting cards, gift wrap, catering supplies and related items,
was approximately $9.4 billion in 1998. Larger sized stores, such as our 8,500
square foot prototype, have become the fastest growing retail format within the
party supplies and paper goods industry by offering consumers a broader
selection of merchandise at lower prices compared to traditional party goods
retailers.
3
<PAGE>
STRATEGY
Our goal is to be one of the leading suppliers of party supplies and paper
goods in our principal markets and to establish a leading position in new
markets. During fiscal 1998 we added 27 Company-owned stores and we established
9 new franchise stores. We plan to add up to ten new Company-owned stores in
fiscal 1999. We also expect to establish between 10 and 15 franchise stores in
fiscal 1999.
To achieve our goal, we are pursuing the following strategies:
- differentiate Paper Warehouse from its competitors through store layout
and design, merchandising, customer service and party planning services
- cluster multiple Company-owned stores in new or existing metropolitan
markets
- selectively add Company-owned stores in secondary markets that are close
to metropolitan markets where we have existing stores
- establish franchise stores in other markets
- periodically refresh, remodel and expand existing Company-owned stores
- expand our sales and name recognition by developing and implementing an
internet website to sell our party supplies and paper goods
BACKGROUND
The first Paper Warehouse store opened in Minneapolis, Minnesota in 1983.
Two members of our current management team purchased the Paper Warehouse
business in 1986. We incorporated Paper Warehouse in Minnesota in 1987. Our
principal executive offices are located at 7630 Excelsior Boulevard,
Minneapolis, Minnesota, 55426. Our telephone number is (612) 936-1000.
4
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Issuer............................ Paper Warehouse, Inc.
Debentures Offered................ $4,000,000 principal amount of 9% Convertible
Subordinated Debentures due September 15, 2005
Principal Due..................... We will not pay principal over the term of the
Debenture. We plan to pay the entire principal balance
of the outstanding Debentures on September 15, 2005
Price per Debenture............... $1,000
Interest.......................... Annual fixed rate--9%
Payment frequency:
- First payment: September 15, 1999
- Remaining payments on the 15th day of December,
March, June and September
Ranking........................... The Debentures are unsecured, and are subordinate in
right of payment to all of our senior indebtedness, as
more fully described in "Description of Debentures"
under the heading "Subordination."
Conversion Rights................. You may convert the Debentures into our common stock at
any time at a conversion price of $ . This means
that for each $1,000 Debenture you convert you will
receive shares of our common stock. The conversion
price may be adjusted for certain reasons described in
"Description of Debentures" under the heading
"Conversion."
Optional Redemption by Us......... After July 15, 2002, we may redeem the Debentures at
$1,000 per Debenture plus accrued interest, plus a
premium if we redeem them before July 15, 2004. See
"Description of Debentures" under the heading "Optional
Redemption by Us."
Mandatory Repurchase.............. If we experience a change of control, you can require us
to purchase all, or part, of your Debentures at $1,020
per Debenture plus accrued interest. See "Description of
Debentures" under the heading "Repurchase at Option of
Holder."
Use of Proceeds................... We will use a portion of the proceeds from this offering
to develop and implement an internet website for the
sale of party supplies and paper goods as described in
"Business" under the heading "Internet and E-commerce."
We will use the remaining proceeds to repay outstanding
debt and for other general corporate purposes.
Trustee........................... Norwest Bank Minnesota, N.A.
</TABLE>
5
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
FIRST
QUARTER
FISCAL YEAR ENDED ENDED
--------------------------------------------------------------- ---------
JANUARY 27, FEBRUARY 2, JANUARY 31, JANUARY 30, JANUARY 29, MAY 1,
1995 1996 1997 1998 1999 1998
----------- ----------- ----------- ----------- ----------- ---------
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.................................... $ 24,084 $ 33,478 $ 43,002 $ 52,949 $ 63,491 $ 12,495
Operating (loss) income..................... 1,494 1,781 2,080 983 (590) (853)
Net (loss) income(1)........................ 1,281 1,286 1,303 (191) (521) (528)
Diluted net loss per share.................. N/A N/A N/A N/A (.11) (.12)
Pro forma net (loss) income(2).............. 794 797 808 (207) N/A N/A
Pro forma diluted net (loss) income per
share(1).................................. .32 .32 .32 (.08) N/A N/A
BALANCE SHEET DATA (AT PERIOD END):
Working capital............................. 2,301 925 1,701 9,383 5,212 8,227
Total assets................................ 8,211 14,934 16,270 21,017 29,528 21,794
Total long-term debt, net of current
maturities................................ 2,300 3,234 3,212 911 862 912
Total debt, excluding capital lease
obligations............................... 3,619 8,021 11,240 1,217 7,864 1,151
Total stockholders' equity.................. $ 2,646 $ 3,124 $ 1,793 $ 14,594 $ 14,090 $ 14,066
OTHER DATA:
Ratio of earnings to fixed charges(3)....... 2.43 1.81 1.58
--- --- ---
EBITDA(4)................................... $ 1,941 $ 2,512 $ 3,077 $ 1,905 $ 1,167 $ (473)
Ratio of EBITDA to Interest Expense(5)...... 8.7 4.8 3.8 2.3 4.2
---
OPERATING DATA (AT PERIOD END):
Number of stores open:
Company-owned stores...................... 42 55 64 73 97 75
Franchise stores.......................... 29 53 50 51 46 52
Comparable store sales increase(6).......... 16.6% 13.6% 9.0% 9.7% 4.2% 3.6%
<CAPTION>
APRIL 30,
1999
-----------
<S> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.................................... $ 16,692
Operating (loss) income..................... (1,635)
Net (loss) income(1)........................ (1,217)
Diluted net loss per share.................. (.26)
Pro forma net (loss) income(2).............. N/A
Pro forma diluted net (loss) income per
share(1).................................. N/A
BALANCE SHEET DATA (AT PERIOD END):
Working capital............................. 5,182
Total assets................................ 33,379
Total long-term debt, net of current
maturities................................ 1,076
Total debt, excluding capital lease
obligations............................... 7,777
Total stockholders' equity.................. $ 12,873
OTHER DATA:
Ratio of earnings to fixed charges(3).......
---
EBITDA(4)................................... $ (1,100)
Ratio of EBITDA to Interest Expense(5)......
---
OPERATING DATA (AT PERIOD END):
Number of stores open:
Company-owned stores...................... 97
Franchise stores.......................... 45
Comparable store sales increase(6).......... 4.6%
</TABLE>
- ------------------------
(1) We have historically incurred a loss in our first fiscal quarter. See "Risk
Factors--We Have Recently Experienced Losses and May Not be Profitable" and
"--Our Annual Results Are Dependent on Second and Fourth Quarters," and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations" and "--Seasonality."
(2) From February 1993 to November 1997, we were an S-Corporation and not
generally subject to corporate income taxes. The Statement of Operations
Data during this period reflects a pro forma provision for income taxes as
if we were subject to corporate income taxes for that period. This pro forma
provision for income taxes is computed using a combined federal and state
tax rate of 38%.
(3) In computing the ratio of earnings to fixed charges, earnings have been
based on income from continuing operations before income taxes and fixed
charges. Fixed charges consist of interest expense and the estimated
interest portion of rents (at one-third of rent expense). Earnings were not
adequate to cover fixed charges by approximately $1.9 million for the first
quarter ended April 30, 1999, by $880,000 for the first quarter ended May 1,
1998, by $844,000 in fiscal 1998 and by $75,000 in fiscal 1997. Assuming
this issuance had occurred at the beginning of the last fiscal year,
earnings would not have been adequate to cover fixed charges by
approximately $1.3 million.
(4) EBITDA consists of earnings before interest, income taxes, depreciation and
amortization. EBITDA is presented as additional information because it is a
commonly used financial measure. We also believe it to be a useful indicator
of our ability to meet our debt service requirements. We do not, however,
intend it as an alternative measure of operating results or cash flow from
operations.
(5) EBITDA was not adequate to cover interest expense by $1.3 million for the
first quarter ended April 30, 1999 and by $512,000 for the first quarter
ended May 1, 1998, primarily due to the seasonality of our business.
(6) Company-owned stores enter the comparable stores sale base at the beginning
of their 13th month of operations. For purposes of computing the increase in
comparable store sales, this computation assumes fiscal 1995 was a 52-week
year.
6
<PAGE>
RISK FACTORS
YOU SHOULD CONSIDER CAREFULLY THE FOLLOWING RISKS BEFORE BUYING THE
DEBENTURES. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES WE
FACE. ADDITIONAL RISKS AND UNCERTAINTIES NOT KNOWN TO US OR THAT WE CURRENTLY
DEEM IMMATERIAL MAY ALSO ADVERSELY IMPAIR OUR BUSINESS OPERATIONS OR FINANCIAL
CONDITION. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL
CONDITION OR RESULTS OF OPERATIONS MAY BE NEGATIVELY EFFECTED. THIS COULD CAUSE
US TO DEFAULT ON THE DEBENTURES. IT COULD ALSO CAUSE THE VALUE OF THE DEBENTURES
AND OUR COMMON STOCK TO DECLINE. YOU COULD LOSE ALL OR A PART OF YOUR
INVESTMENT.
WE HAVE RECENTLY EXPERIENCED LOSSES AND MAY NOT BE PROFITABLE
We incurred a net loss of $1.2 million for first quarter 1999, a net loss of
$521,000 for fiscal 1998 and a pro forma net loss of $207,000 for fiscal 1997.
We attribute these losses principally to:
- increases in competition among party supplies and paper goods retailers in
our geographic markets
- increases in store labor expenses due to the rise in the average hourly
wage rates and the additional staff needed to support our growth
- increases in general and administrative expenses necessary to support
implementation of our growth strategy
- increases in amortization expenses of goodwill from our purchases of
franchise stores
- seasonality of revenues resulted in first quarter losses in 1999
- expenses associated with a canceled acquisition and repayment of debt in
1997
Based upon our current business plans, start-up costs associated with our
internet strategy, and amortization of financing costs associated with these
Debentures, it is likely that we will not be profitable for fiscal 1999. We
cannot assure you that we will generate sufficient revenues, or control
operating expenses, to achieve or sustain profitability in later years.
WE MAY NOT BE ABLE TO PROFITABLY GROW OUR BUSINESS
In order to profitably grow our business we need to increase sales in our
existing markets and open stores in new markets. Additional Company-owned stores
in existing markets could reduce sales from our stores located in or near those
markets. Also, stores added in new markets may not be profitable.
WE MAY NOT BE ABLE TO EFFECTIVELY EXECUTE OUR GROWTH STRATEGY
Our growth strategy requires effective planning and management. Once a new
geographic market is identified, we must obtain suitable store sites on
acceptable terms. Also, the competitive and merchandising challenges we face in
new geographic markets may be different from the challenges we face in our
existing geographic markets. We may have to adapt to regional tastes and customs
and compete against established and familiar local businesses with innovative or
unique techniques for marketing party supplies and paper goods. Entering new
markets may also place significant demands on our management, financial
controls, operations and information systems. This may cause us to incur higher
costs relating to marketing and operations. Expansion will require an increase
in our personnel, particularly store managers and sales associates, to operate
our new stores.
OUR CLUSTERING STRATEGY MAY NOT BE PROFITABLE
Our growth strategy focuses on clustering stores in metropolitan markets and
selectively placing stores in secondary markets that are close to the
metropolitan markets in which we already have stores. Our growth strategy
requires us to be able to identify new geographic markets where the demographics
7
<PAGE>
support our strategy to cluster Company-owned stores. Although we believe that
this is the right strategy for Paper Warehouse, this strategy may not be
profitable.
OUR PLANS TO REMODEL AND RELOCATE STORES MAY REDUCE PROFITABILITY
In fiscal 1999 we plan to remodel approximately 20 stores and relocate 4
existing stores. This plan is subject to several risks, including:
- the loss of sales during the remodeling or relocation period
- cost overruns of the remodeling or relocation
- failure to achieve increased sales after the remodeling or relocation
We remodel our stores periodically to maintain a fresh look for the
customer, standardize store layout and fixtures, and improve merchandise
presentation. Remodeling may be as simple as repainting or creating new signage
to as extensive as conducting a total makeover. We relocate a store when it is
too small and there is no room to expand at the existing location or when a
store is not performing in its present location and a better location is
available.
WE MAY NEED TO RAISE ADDITIONAL CAPITAL TO SUPPORT OUR GROWTH STRATEGY
We may need to raise additional capital in the future to fund our operations
and support our growth strategy. If we decide to raise additional funds through
debt financing, this financing may be senior in right of payment to the
Debentures. If you convert your Debenture into our common stock and we then
raise additional funds by issuing equity securities, your percentage ownership
of our outstanding common stock will be reduced. These new equity securities may
also have rights, preferences or privileges senior to those of our common stock.
Financial difficulties of our competitors may affect our ability to obtain
financing even though our business is performing. Any additional financing may
not be available, or may not be available on favorable terms. If adequate funds
are not available or are not available on acceptable terms, we may be unable to
make payments on the Debentures, develop or enhance our products and services,
implement our growth strategy, take advantage of future opportunities or respond
to competitive pressures.
OUR ANNUAL RESULTS ARE DEPENDENT ON SECOND AND FOURTH QUARTERS
We generate a significant portion of our operating income in our second and
fourth fiscal quarters because of the seasonality of our revenues and
promotional expenses. Any factor that negatively affects our revenues or
increases our operating expenses during the second and fourth fiscal quarters
could negatively affect our annual results of operations. As a result of the
seasonality of our revenues, we expect to incur a loss in the first quarter of
each year for the foreseeable future. Due to increased promotional activities
during our third quarter, we have historically experienced reduced operating
income for this quarter.
COMPETITION MAY REDUCE OUR REVENUES AND OPERATING INCOME
Increased competition by existing or new competitors may reduce our sales
and cause us to incur losses. As a result of competition from other specialty
party supplies and paper goods retailers, we have experienced reduced sales
growth in our existing stores and incurred additional marketing and promotional
expenses. Our stores compete with a variety of smaller and larger retailers,
including:
- specialty party supplies and paper goods retailers, including other
superstores
- card shops and designated departments in mass merchandisers
- discount retailers
- toy stores
- drug stores
8
<PAGE>
- supermarkets
- department stores
Many of our competitors have substantially greater financial and personnel
resources than we do. We may also encounter additional competition from new
entrants in the future in our existing markets.
OUR BUSINESS DEPENDS ON CONTINUED GOOD RELATIONS WITH OUR SUPPLIERS
Our failure to maintain good relationships with our principal suppliers or
the loss of our principal suppliers would hurt our business. In fiscal 1998, our
largest supplier accounted for approximately 14% of our purchases and our eight
largest suppliers represented approximately 51% of our purchases. Many of our
principal suppliers currently provide us with incentives such as volume
purchasing allowances and trade discounts. If our suppliers reduce or
discontinue these incentives, prices from our suppliers would increase and our
profitability would be reduced. We do not have long-term contracts with any of
our suppliers, and any supplier could discontinue selling to us at any time.
WE NEED TO ATTRACT AND RETAIN QUALITY EMPLOYEES
Our success depends on attracting and retaining a large and growing number
of quality employees. Many of our employees are in entry level or part-time
positions with historically high rates of turnover. Our ability to meet our
labor needs while controlling costs is subject to external factors such as
unemployment levels, minimum wage legislation and changing demographics.
WE CANNOT ASSURE CONTINUED TRADING ON THE NASDAQ NATIONAL MARKET
In April 1999, the Nasdaq Stock Market notified us that we were not then in
compliance with one of its maintenance standards requiring that we maintain at
least $5.0 million of "public float"--the total market value of our common stock
held by stockholders who are not insiders. The Nasdaq Stock Market also informed
us that we had 90 calendar days to regain compliance with this standard. On June
9, 1999, Nasdaq notified us that we are in compliance with the $5.0 million
public float requirement, and the matter was closed. We cannot assure you,
however, that we will be able to sustain a $5.0 million public float, and if we
cannot, we may move to the Nasdaq SmallCap Market.
WE MAY EXPERIENCE "YEAR 2000" PROBLEMS
A significant amount of our Year 2000 exposure is in the readiness of third
parties with which we do business, where Year 2000 issues are much less within
our ability to predict or control. A supplier's failure to be Year 2000
compliant may interrupt the flow of products to our stores. We may also
experience a loss in revenues, earnings and cash flow if one or more of our
utility providers are not Year 2000 compliant and our stores are not able to
open because they do not have power, heat or water. It is possible that our
currently installed computer systems, software or other business systems, or
those of our suppliers, will not accept input of data, store data, or manipulate
data for the years 2000 and beyond without error or manipulation. We expect to
develop a formal contingency plan for the Year 2000 problem upon further
identification and assessment of all of the risks.
OUR FAILURE TO EXECUTE OUR FRANCHISE PROGRAM MAY REDUCE OUR PROFITABILITY
Our continued growth and success depends in part upon our ability to
attract, contract with and retain qualified franchisees. It also depends upon
the ability of those franchisees to operate their stores successfully and
promote and develop the Paper Warehouse store concept. During fiscal 1999 we
plan to establish approximately 10 to 15 new franchise stores. Although we have
established criteria to evaluate prospective franchisees, and our franchise
agreements include certain operating standards, each franchisee operates its
store independently. Various laws limit our ability to influence the day-to-day
operations of our franchise stores. We cannot assure you that franchisees will
be able to operate Paper Warehouse stores successfully and in a manner
consistent with our concepts and
9
<PAGE>
standards. As a result, our franchisees may operate their stores in a manner
that reduces the gross revenues of these stores, and therefore reduces our
franchise revenues.
Paper Warehouse, as a franchisor, is subject to both regulation by the
Federal Trade Commission and state laws regulating the offer and sale of
franchises. State laws limit our ability to terminate or refuse to renew
franchises. Our franchisees are also subject to labor laws, including minimum
wage requirements, overtime, working and safety conditions and citizenship
requirements. Our failure to obtain or maintain approvals to sell franchises, or
a franchisee's violation of any labor law, could cause us to lose or reduce our
franchise revenues.
A CHANGE IN CONSUMER PREFERENCES COULD NEGATIVELY AFFECT OUR BUSINESS
If consumer demand for single-use, disposable party goods were to diminish,
the party supplies and paper goods industry and our revenues would be negatively
affected. For example, if cost increases in raw materials such as paper or
plastic were to cause our 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 our products.
REGIONAL RISKS MAY AFFECT OUR BUSINESS
Because our operations are located principally in seven metropolitan areas,
we are subject to certain regional risks, such as the economy, weather
conditions, natural disasters and governmental regulations. If any region in
which we operate stores were to suffer an economic downturn or other adverse
regional risks were to occur, our sales and profitability could decline and our
ability to implement our growth strategy would be hindered.
OUR INTERNET STRATEGY MAY NOT BE PROFITABLE
We intend to use a portion of the proceeds from this offering to develop an
internet website for the sale of party supplies and paper goods. Our website may
not generate any profits and we may not recapture the money invested in our
internet strategy.
OUR FORMER STATUS AS AN S-CORPORATION COULD EXPOSE US TO LIABILITY
From February 1993 to November 1997, we were treated as an S-Corporation
under the Internal Revenue Code of 1986. In connection with the completion of
our initial public offering, we converted to a C-Corporation. If the IRS or any
state taxing authority were to challenge our prior S-Corporation status, we
could be liable to pay corporate taxes on our income, at the effective corporate
tax rate, for all or a part of the period we were an S-Corporation, plus
interest and possibly penalties.
WE NEED TO ANTICIPATE AND RESPOND TO MERCHANDISING TRENDS
Our success depends in part on our ability to anticipate and respond in a
timely manner to changing merchandise trends and consumer demands. We make
merchandising decisions well in advance of the seasons during which we will sell
the merchandise. As a result, if we fail to identify and respond quickly to
emerging trends, consumer acceptance of the merchandise in our stores could
diminish and we may experience a reduction in revenues. We sell certain licensed
products that are in great demand for short time periods, making it difficult to
project our inventory needs for these products. Significantly greater or
less-than-projected product demand, particularly for our licensed products,
could lead to one or more of the following:
- lost sales due to insufficient inventory
- higher carrying costs associated with slower turning inventory
- reduced or eliminated margins due to mark downs on excess inventory
10
<PAGE>
OUR INDEBTEDNESS COULD NEGATIVELY AFFECT OUR FINANCIAL POSITION
After this offering, we expect to have approximately $10.5 million of
borrowings outstanding which includes amounts outstanding under our revolving
line of credit, capital leases, mortgage and the Debentures. We may incur
additional indebtedness in the future. Our level of indebtedness could:
- prevent us from making interest and principal payments on the Debentures
- prevent us from satisfying other debt obligations
- affect our ability to fund our operations
- impair our ability to obtain additional financing
- make us more vulnerable to industry downturns and competitive pressures
- cause a substantial portion of our cash flow from operations to be spent
on principal and interest payments
- prevent us from meeting certain financial tests contained in our debt
obligations, which could lead to a default on those obligations
THE SUBORDINATION PROVISIONS MAY NEGATIVELY AFFECT THE DEBENTURE HOLDERS
The Debentures will be unsecured and subordinated in right of payment to all
our present and future senior debt, as described in "Description of
Debentures--Subordination." As a result, if we file for bankruptcy or liquidate
our business our assets will be available for payment of the Debentures only
after all our senior debt has been paid in full. After payment of all senior
debt there may not be sufficient assets remaining to pay the principal and
accrued interest on the Debentures. The Indenture, as described in "Description
of Debentures," does not prohibit us from incurring additional senior debt. If
we incur additional senior debt, our ability to pay the Debentures could be
substantially impaired.
WE MAY BE UNABLE TO REPURCHASE THE DEBENTURES
At your option, we will be obligated to repurchase the Debentures if we
experience certain types of changes of control. See "Description of
Debentures--Repurchase at Option of Holder." We may not have sufficient funds to
pay the repurchase price if you require us to repurchase your Debentures. If we
are required to repurchase Debentures because of a change of control, the
subordination provisions in the Indenture may prevent us from making any payment
to you, including any payment of the repurchase price, unless we first obtain
the consent of the holders of our senior debt or repay our senior debt in full.
We will not set aside any funds to repurchase the Debentures. We will not
pay principal over the term of the Debentures. We plan to pay the entire
principal balance of outstanding Debentures on September 15, 2005.
THERE IS NO ACTIVE TRADING MARKET FOR THE DEBENTURES
We have no present intention to have the Debentures authorized for quotation
on the Nasdaq system or listed on any securities exchange. Although Miller &
Schroeder has told us that it presently plans to make a market in the
Debentures, it may stop making a market in the Debentures at any time for any
reason. As a result, an active trading market for the Debentures may not develop
or, if one does develop, it may not be maintained. If an active market for the
Debentures does not develop, or cannot be sustained, your ability to sell your
Debenture may be limited or you may not be able to get the best price for your
Debenture.
OUR FORWARD-LOOKING STATEMENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES
This prospectus contains certain statements of a forward-looking nature
relating to future events or our future performance. These forward-looking
statements are based on our current expectations,
11
<PAGE>
assumptions, estimates and projections about us and our industry. When used in
this prospectus, the words "expects," "believes," "anticipates," "estimates,"
"intends," and similar expressions are intended to identify forward-looking
statements. These statements include, but are not limited to, statements of our
plans, strategies and prospects under the captions "Prospectus Summary," "Risk
Factors," "Use of Proceeds," "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Business" and other statements contained
elsewhere in this prospectus.
These forward-looking statements are only predictions and are subject to
risks and uncertainties that could cause actual events or results to differ
materially from those projected. The cautionary statements made in this
prospectus should be read as being applicable to all related forward-looking
statements wherever they appear in this prospectus. We assume no obligation to
update these forward-looking statements publicly for any reason. Actual results
could differ materially from those anticipated in these forward-looking
statements, even if new information becomes available or other events occur in
the future.
USE OF PROCEEDS
The net proceeds to us from the sale of the Debentures are estimated to be
approximately $3.2 million, after deducting underwriting discounts and
commissions and estimated offering expenses payable by us. We intend to use
approximately $1.5 million of the net proceeds to develop our internet website
to sell party supplies and paper goods online. See "Business--Internet and
E-commerce." We intend to use the remaining proceeds to repay outstanding
indebtedness under our revolving credit facility and general corporate purposes.
This debt bears interest at a rate of LIBOR plus 2.5%, which rate was 7.45% on
June 8, 1999. This debt matures in 2002. We use the borrowings under our credit
facility for working capital purposes.
PRICE RANGE OF COMMON STOCK
Our shares of common stock have traded on the Nasdaq National Market under
the symbol "PWHS" since November 25, 1997. The Debentures will not be listed on
any securities exchange or quoted by Nasdaq. The following table summarizes the
high and low sale prices per share of our common stock for the periods
indicated, as reported on the Nasdaq National Market. These prices do not
include commission, mark-ups or mark-downs.
<TABLE>
<CAPTION>
HIGH LOW
-------- ---------
<S> <C> <C>
FISCAL YEAR 1997
Fourth Quarter (since November 25, 1997)...................... $ 8 5/8 $ 5 5/8
FISCAL YEAR 1998
First Quarter................................................. $ 7 1/4 $ 4 5/8
Second Quarter................................................ 5 1/4 3 7/8
Third Quarter................................................. 4 1/4 1 5/8
Fourth Quarter................................................ 4 3/16 1 29/32
FISCAL YEAR 1999
First Quarter................................................. $ 2 5/16 $ 1 5/8
</TABLE>
For a recent closing price of our common stock, see the cover page of this
prospectus. As of June 8, 1999 there were approximately 132 holders of record of
our common stock.
12
<PAGE>
DIVIDEND POLICY
Other than S-Corporation distributions paid to our stockholders with respect
to periods when we were taxed as an S-Corporation, we have never declared or
paid any cash or stock dividends with respect to our common stock since we have
been a C-Corporation. We do not contemplate payment of dividends in the
foreseeable future. We anticipate that any earnings in the near future will be
retained to develop and expand our business. Some of our credit agreements
require the consent of the lender before we can pay dividends. The Indenture
governing the Debentures, as described in "Description of Debentures," includes
restrictions on paying dividends or making distributions on our capital stock.
See "Description of Debentures--Restrictive Covenants."
CAPITALIZATION
The following table sets forth our short-term debt and capitalization:
- as it existed on April 30, 1999
- as adjusted to give effect to the issuance of the Debentures and the
application of the estimated net proceeds from this offering
- as adjusted to give effect to the conversion of the Debentures into our
common stock assuming a conversion price of $3.00 per share
- not adjusted for expenses associated with our internet strategy which may
increase short-term debt approximately $1.5 million
This table should be read together with the Consolidated Financial
Statements and Notes thereto appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
APRIL 30, 1999
--------------------------------------
ADJUSTED ADJUSTED
FOR FOR
ACTUAL OFFERING CONVERSION
---------- ----------- -------------
($ IN THOUSANDS)
<S> <C> <C> <C>
Short-term debt (including capital lease obligations)................... $ 7,227 $ 4,007 $ 4,007
---------- ----------- -------------
---------- ----------- -------------
Long-term debt (including capital lease obligations).................... 2,495 6,495 2,495
Stockholders' equity
Serial Preferred Stock, $.01 par value; 10,000,000 shares authorized;
none issued or outstanding.......................................... -- -- --
Common stock, $.01 par value; 40,000,000 shares authorized............ 46 46 59
Additional paid-in capital............................................ 13,834 13,834 17,821
Accumulated deficit................................................... (1,007) (1,007) (1,007)
---------- ----------- -------------
Total stockholders' equity.......................................... 12,873 12,873 16,873
---------- ----------- -------------
Total capitalization................................................ $ 15,368 $ 19,368 $ 19,368
---------- ----------- -------------
---------- ----------- -------------
Total shares issued and outstanding(1).................................. 4,627,936 4,627,936 5,961,269
</TABLE>
- ------------------------
(1) As of April 30, 1999, excludes stock options to purchase 426,300 shares of
our common stock granted to employees and directors at a weighted average
exercise price of $4.89 per share. Also excludes a warrant for 50,000 shares
of our common stock to be issued to Miller & Schroeder in connection with
this offering. See "Management--Stock Option Plans" and Note 9 of the
Consolidated Financial Statements for the Years Ended January 29, 1999 and
January 30, 1998-- Stock Options.
13
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
The following selected consolidated financial and operating data are derived
from our Consolidated Financial Statements. The selected consolidated financial
and operating data should be read together with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our Consolidated
Financial Statements and Notes thereto appearing elsewhere in this prospectus.
The consolidated statement of operations data, and the consolidated balance
sheet data, as of and for the five years ended January 29, 1999 are derived from
our consolidated financial statements, which have been audited by KPMG LLP,
independent auditors. The selected data presented below for the quarters ended
April 30, 1999 and May 1, 1998 and as of April 30, 1999 and May 1, 1998 are
derived from our unaudited consolidated financial statements included elsewhere
in this prospectus.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
---------------------------------------------------------------
JANUARY 27, FEBRUARY 2, JANUARY 31, JANUARY 30, JANUARY 29,
1995 1996 1997 1998 1999
----------- ----------- ----------- ----------- -----------
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Company-owned stores................................... $ 23,641 $ 32,414 $ 41,892 $ 51,788 $ 62,219
Franchise related fees................................. 443 1,064 1,110 1,161 1,272
----------- ----------- ----------- ----------- -----------
Total revenues....................................... 24,084 33,478 43,002 52,949 63,491
Costs and expenses:
Costs of products sold and occupancy costs............. 15,474 21,880 27,946 34,966 41,253
Store operating expenses............................... 4,635 6,367 8,733 11,484 15,185
General and administrative expenses.................... 2,481 3,450 4,243 5,516 7,643
----------- ----------- ----------- ----------- -----------
Total costs and expenses............................. 22,590 31,697 40,922 51,966 64,081
----------- ----------- ----------- ----------- -----------
Operating (loss) income(1)........................... 1,494 1,781 2,080 983 (590)
Interest expense, net.................................... 208 490 772 797 254
Expenses of canceled acquisition......................... 261
--- --- --- ---
-----------
----------- ----------- ----------- -----------
(Loss) income before income taxes, extraordinary charge
and cumulative effect of accounting change............. 1,286 1,291 1,308 (75) (844)
Income tax benefit (expense)............................. (5) (5) (5) (6) 323
----------- ----------- ----------- ----------- -----------
(Loss) income before extraordinary charge and cumulative
effect of accounting change............................ 1,281 1,286 1,303 (81) (521)
Extraordinary charge, net................................ (110)
--- --- --- ---
Cumulative effect of accounting change, net..............
---
--- --- --- ---
-----------
----------- ----------- ----------- -----------
Net (loss) income.................................... $ 1,281 $ 1,286 $ 1,303 $ (191) $ (521)
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Diluted net loss per share........................... N/A N/A N/A N/A $ (0.11)
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Pro forma provision for income taxes(2).................. (487) (489) (495) (16) N/A
Pro forma net (loss) income(2)........................... 794 797 808 (207) N/A
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Pro forma diluted net (loss) income per share(2)......... $ 0.32 $ 0.32 $ 0.32 $ (0.08) N/A
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
SELECTED OPERATING DATA (AT PERIOD END):
Number of stores open:
Company-owned stores................................... 42 55 64 73 97
Franchise stores....................................... 29 53 50 51 46
Comparable store sales increase(3)....................... 16.6% 13.6% 9.0% 9.7% 4.2%
BALANCE SHEET DATA (AT PERIOD END):
Working capital.......................................... $ 2,301 $ 925 $ 1,701 $ 9,383 $ 5,212
Total assets............................................. 8,211 14,934 16,270 21,017 29,528
Total long-term debt, net of current maturities.......... 2,300 3,234 3,212 911 862
Total debt, excluding capital lease obligations.......... 3,619 8,021 11,240 1,217 7,864
Total stockholders' equity............................... 2,646 3,124 1,793 14,594 14,090
OTHER DATA:
Ratio of earnings to fixed charges(4).................... 2.43 1.81 1.58
--- ---
EBITDA(5)................................................ $ 1,941 $ 2,512 $ 3,077 $ 1,905 $ 1,167
Ratio of EBITDA to interest expense(6)................... 8.7 4.8 3.8 2.3 4.2
<CAPTION>
FIRST QUARTER ENDED
--------------------
MAY 1, APRIL 30,
1998 1999
--------- ---------
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Company-owned stores................................... $ 12,192 $ 16,419
Franchise related fees................................. 303 273
--------- ---------
Total revenues....................................... 12,495 16,692
Costs and expenses:
Costs of products sold and occupancy costs............. 8,454 11,406
Store operating expenses............................... 3,187 4,674
General and administrative expenses.................... 1,707 2,247
--------- ---------
Total costs and expenses............................. 13,348 18,327
--------- ---------
Operating (loss) income(1)........................... (853) (1,635)
Interest expense, net.................................... 27 216
Expenses of canceled acquisition.........................
--- ---
--------- ---------
(Loss) income before income taxes, extraordinary charge
and cumulative effect of accounting change............. (880) (1,851)
Income tax benefit (expense)............................. 352 743
--------- ---------
(Loss) income before extraordinary charge and cumulative
effect of accounting change............................ (528) (1,108)
Extraordinary charge, net................................
--- ---
Cumulative effect of accounting change, net.............. (109)
---
---------
---------
Net (loss) income.................................... $ (528) $ (1,217)
--------- ---------
--------- ---------
Diluted net loss per share........................... $ (.12) $ (.26)
--------- ---------
--------- ---------
Pro forma provision for income taxes(2).................. N/A N/A
Pro forma net (loss) income(2)........................... N/A N/A
--------- ---------
--------- ---------
Pro forma diluted net (loss) income per share(2)......... N/A N/A
--------- ---------
--------- ---------
SELECTED OPERATING DATA (AT PERIOD END):
Number of stores open:
Company-owned stores................................... 75 97
Franchise stores....................................... 52 45
Comparable store sales increase(3)....................... 3.6% 4.6%
BALANCE SHEET DATA (AT PERIOD END):
Working capital.......................................... $ 8,227 $ 5,182
Total assets............................................. 21,794 33,379
Total long-term debt, net of current maturities.......... 912 1,076
Total debt, excluding capital lease obligations.......... 1,151 7,777
Total stockholders' equity............................... 14,066 12,873
OTHER DATA:
Ratio of earnings to fixed charges(4)....................
--- ---
EBITDA(5)................................................ $ (473) $ (1,100)
Ratio of EBITDA to interest expense(6)...................
--- ---
</TABLE>
14
<PAGE>
- --------------------------
(1) We have historically incurred a loss in our first fiscal quarter. See "Risk
Factors--We Have Recently Experienced Losses and May Not be Profitable" and
"--Our Annual Results Are Dependent on Second and Fourth Quarters," and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations" and "--Seasonality."
(2) From February 1993 to November 1997, we were an S-Corporation and not
generally subject to corporate income taxes. The Statement of Operations
Data during this period reflects a pro forma provision for income taxes as
if we were subject to corporate income taxes for such period. This pro forma
provision for income taxes is computed using a combined federal and state
tax rate of 38%.
(3) Company-owned stores enter the comparable stores sale base at the beginning
of their 13th month of operations. For purposes of computing the increase in
comparable store sales, this computation assumes fiscal 1995 was a 52-week
year.
(4) In computing the ratio of earnings to fixed charges, earnings have been
based on income from continuing operations before income taxes and fixed
charges. Fixed charges consist of interest expense and the estimated
interest portion of rents (at one-third of rent expense). Earnings were not
adequate to cover fixed charges by approximately $1.9 million for the first
quarter ended April 30, 1999, by $880,000 for the first quarter ended May
30, 1998, by $844,000 in fiscal 1998 and by $75,000 in fiscal 1997. Assuming
this issuance had occurred at the beginning of the last fiscal year,
earnings would not have been adequate to cover fixed charges by
approximately $1.3 million.
(5) EBITDA consists of earnings before interest, income taxes, depreciation and
amortization. EBITDA is presented as additional information because it is a
commonly used financial measure. We also believe it to be a useful indicator
of our ability to meet our debt service requirements. We do not, however,
intend it as an alternative measure of operating results or cash flow from
operations.
(6) EBITDA was not adequate to cover interest expense by $1.3 million for the
first quarter ended April 30, 1999 and by $512,000 for the first quarter
ended May 1, 1998, primarily due to the seasonality of our business.
15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We are a growing chain of retail stores specializing in party supplies and
paper goods operating under the names PAPER WAREHOUSE and PARTY UNIVERSE. Two
members of our current management team purchased the business in 1986 and
incorporated it in Minnesota in 1987. At the time of the acquisition, we
consisted of three stores located in the Minneapolis/St. Paul metropolitan area.
In 1987, we began granting franchises. Over the past 12 years, we have grown to
a total of 142 stores, including 97 Company-owned stores and 45 franchise stores
throughout 24 states. In growing the number of Company-owned stores, our
management has employed a strategy of clustering stores in our principal markets
to provide our customers with convenient store locations, expand our total
market share and achieve favorable economies of scale.
We completed our initial public offering in late 1997, selling 1,985,800
shares of our common stock and raising net proceeds of $13.1 million. The
proceeds from that offering were used to retire our revolving line of credit,
prepay subordinated debt and retire other existing indebtedness. The balance of
the proceeds was used to finance new store openings and fund further expansion.
Before November 1997, we elected to be treated for federal and state income
tax purposes as an S-Corporation under the Internal Revenue Code of 1986 and
comparable state tax laws. For the purpose of discussion and analysis, we have
presented a pro forma tax provision and pro forma net income. These pro forma
amounts represent what the income tax provision and the net income would have
been if we had been a C-Corporation and thus subject to federal income taxation
for the entire period. This pro forma provision is computed using a combined
federal and state income tax rate of 38%.
Total revenues consist of Company-owned store sales and franchise revenues.
Company-owned stores enter the comparable store sales base at the beginning of
their 13th month of operations. Franchise revenues are generated from royalties
we receive on sales, generally 4% of the store's sales, and initial franchise
fees, which we recognize at the time the franchisee signs a lease for a store.
Cost of products sold and occupancy costs includes the direct cost of
merchandise, plus handling and distribution, 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
administrative expenses include corporate administrative expense for
Company-owned stores and expenses relating to franchising, primarily payroll,
legal, travel and advertising.
16
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain costs and
expenses as a percentage of total revenues and Company-owned store sales:
<TABLE>
<CAPTION>
FIRST QUARTER ENDED
FISCAL YEAR ENDED
------------------------------------------- ------------------------
JANUARY 31, JANUARY 30, JANUARY 29, APRIL 30,
1997 1998 1999 MAY 1, 1998 1999
------------- ------------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Costs of products sold and occupancy costs:
as % of total revenues............................... 65.0% 66.0% 65.0% 67.7% 68.3%
as % of Company-owned stores sales................... 66.7% 67.5% 66.3% 69.3% 69.5%
Store operating expenses:
as % of total revenues............................... 20.3% 21.7% 23.9% 25.5% 28.0%
as % of Company-owned stores sales................... 20.8% 22.2% 24.4% 26.1% 28.5%
General and administrative expenses:
as % of total revenues............................... 9.9% 10.4% 12.0% 13.7% 13.5%
as % of Company-owned stores sales................... 10.1% 10.7% 12.3% 14.0% 13.7%
Number of Company-owned stores......................... 64 73 97 75 97
</TABLE>
FIRST QUARTER ENDED APRIL 30, 1999 COMPARED TO FIRST QUARTER ENDED MAY 1, 1998
REVENUES. Company-owned stores sales of $16.4 million for the first quarter
ended April 30, 1999, increased $4.2 million, or 34.7% over Company-owned stores
sales for the comparable period in the prior year. Of this increase,
approximately $3.7 million is the result of new store growth and approximately
$551,000 is attributable to comparable store sales. During the first quarter
ended April 30, 1999, the Company opened one new Company-owned store, and closed
one Company-owned store, keeping the total Company-owned stores at 97 as of
April 30, 1999, compared to 75 at the end of the first fiscal quarter of 1998.
First fiscal quarter 1999 comparable store sales increased 4.6% over the prior
year comparable period. This growth rate favorably compares with a comparable
store sales increase of 3.6% for the first fiscal quarter of 1998.
Franchise related fees for the first quarter ended April 30, 1999 of
approximately $273,000 decreased 10.0% from franchise related fees of
approximately $303,000 for the first quarter ended May 1, 1998. The
year-over-year decrease reflects the Company's purchases throughout fiscal 1998
of 10 franchise stores, reducing the Company's royalties received on product
sales from these former franchise stores. During the first fiscal quarter of
1999, the Company closed one franchise store, bringing the total to 45 franchise
stores at the end of first fiscal quarter 1999 compared with 52 franchise stores
at the end of first fiscal quarter 1998.
COST OF PRODUCTS SOLD AND OCCUPANCY COSTS. Cost of products sold and
occupancy costs totaled $11.4 million or 69.5% of Company-owned stores sales for
the first quarter ended April 30, 1999, as compared to $8.5 million or 69.3% of
Company-owned stores sales for the first quarter ended May 1, 1998. The increase
primarily reflects higher occupancy costs, resulting from the increased store
base, partially offset by higher product margins.
STORE OPERATING EXPENSES. Store operating expenses for the first quarter
ended April 30, 1999 were $4.7 million or 28.5% of Company-owned stores sales,
as compared to $3.2 million or 26.1% of Company-owned stores sales for the
comparable period in the prior year. This unfavorable variance reflects the
Company's new store growth, and corresponding store labor expense increases, in
addition to continued increases in hourly compensation due to tight labor
markets.
GENERAL AND ADMINISTRATIVE EXPENSES. For the first quarter ended April 30,
1999 general and administrative expenses were $2.2 million or 13.5% of total
revenues compared to $1.7 million or
17
<PAGE>
13.7% of total revenues for the comparable period in the prior year. The dollar
increase is primarily the result of higher payroll and benefit costs resulting
from the addition of several corporate positions, necessary to support the
Company's continued growth.
INTEREST EXPENSE. Interest expense, net of interest income, of
approximately $216,000 or 1.3% of total revenues for the first quarter ended
April 30, 1999, increased $189,000, over net interest expense for the first
quarter ended May 1, 1998. The increase reflects the Company's borrowings under
its revolving credit facility during the first three months of 1999 necessary to
fund working capital requirements. The Company did not borrow under its
revolving credit facility during the first three months of 1998. The Company
expects interest expense to increase throughout the remainder of the year,
primarily related to the anticipated issuance of the Debentures.
INCOME TAX BENEFIT. The Company's estimated annual effective income tax
rate is 40% for 1999, unchanged from the first quarter 1998 estimated annual
rate.
NET LOSS. As a result of the factors discussed above, the Company reported
a net loss of approximately $1.2 million, or $.26 per share, for the first
quarter ended April 30, 1999, compared to a net loss of approximately $528,000,
or $.12 per share for the first quarter ended May 1, 1998. The net loss for
first quarter 1999 included the net impact of a cumulative effect of accounting
change of approximately $109,000 ($.02 per share) from the adoption in the first
quarter of a newly issued accounting pronouncement. The principal reasons for
the loss in first quarter of fiscal 1999 were the seasonality of revenues and
the large number of stores opened in the past nine months which have expenses
without a fully established revenue base.
FISCAL YEAR ENDED JANUARY 29, 1999 (FISCAL 1998) COMPARED TO FISCAL YEAR ENDED
JANUARY 30, 1998 (FISCAL 1997)
REVENUES. Company-owned store revenues increased 20.1% to $62.2 million for
fiscal 1998 from $51.8 million for fiscal 1997, primarily due to an increase in
the number of Company-owned stores from 73 stores at the end of fiscal 1997 to
97 stores at the end of fiscal 1998. Approximately $1.1 million of the increase
in revenues was attributable to comparable store sales increases and
approximately $9.3 million was attributable to new and remodeled Company-owned
stores. Comparable store sales increased 4.2% for the fiscal year ended 1998
over the prior period. In fiscal 1998, we opened 17 Company-owned stores,
purchased 10 franchise stores and closed 3 stores. Stores whose leases expired
were either closed or relocated to larger spaces.
The number of franchise stores decreased from 51 stores at the end of fiscal
1997 to 46 stores at the end of fiscal 1998. We opened nine new franchise
stores, purchased ten franchise stores, closed two franchise stores and
terminated two franchise stores. Franchise revenues increased 9.5% from $1.2
million for fiscal 1997 to $1.3 million for fiscal 1998. Initial franchise fees
increased 84.5% or $60,000 due to an increase in the number of franchise store
openings in fiscal 1998. The increase in initial franchise fees was augmented by
increased royalty payments resulting from increased sales in the franchise
stores. Royalty payments averaged 4% of sales in the franchise stores.
COST OF PRODUCTS SOLD AND OCCUPANCY COSTS. Cost of products sold and
occupancy costs for fiscal 1998 were $41.3 million or 66.3% of Company-owned
store revenues, as compared to $35.0 million or 67.5% of Company-owned store
revenues for fiscal 1997. Cost of products sold and occupancy costs reflects the
direct cost of merchandise and store occupancy costs, including rent, common
area maintenance costs, and real estate taxes. The decrease as a percentage of
Company-owned store revenues was primarily related to one-time events that
decreased the cost of product.
STORE OPERATING EXPENSES. Store operating expenses for fiscal 1998 were
$15.2 million or 24.4% of Company-owned store revenues, as compared to $11.5
million or 22.2% of Company-owned store revenues in fiscal 1997. The increased
percentage was primarily attributable to increases in store labor,
18
<PAGE>
and secondarily attributable to increased store operating expenses. The largest
increase was in payroll and related benefits. The average hourly wage rates
continued to increase due to tight labor markets.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $7.6 million or 12.0% of total revenues in fiscal 1998 compared to $5.5
million or 10.4% of total revenues in fiscal 1997. The increase in general and
administrative expenses was primarily attributable to increases in necessary
infrastructure and additional staff to support the growing Company-owned store
base. Amortization expense of goodwill increased due to our purchases of
franchise stores.
INTEREST EXPENSE. Interest expense, net of interest income, decreased from
$798,000 (1.5% of total revenues in fiscal 1997) to $254,000 (.4% of total
revenues in fiscal 1998). We used the net proceeds of our initial public
offering to repay certain bank debt, subordinated debt, and stockholder notes,
and to fund new store growth. We did not borrow under our bank revolving line of
credit until late in the second quarter of fiscal 1998.
NET LOSS. As a result of the factors discussed above, we had a net loss of
$521,000 in fiscal 1998. This compares to a pro forma net loss of $207,000 in
fiscal 1997. The principal reasons for the loss in fiscal 1998 were increased
competition, increased store labor expenses and increased marketing and
promotional expenses.
FISCAL YEAR ENDED JANUARY 30, 1998 (FISCAL 1997) COMPARED TO FISCAL YEAR ENDED
JANUARY 31, 1997 (FISCAL 1996)
REVENUES. Company-owned store revenues increased 23.6% from $41.9 million
for fiscal 1996 to $51.8 million for fiscal 1997. This increase was partially
attributable to an increase in the number of Company-owned stores from 64 stores
at the end of fiscal 1996 to 73 stores at the end of fiscal 1997. Approximately
$3.0 million of the increase in revenues was attributable to comparable store
sales increases and approximately $6.9 million was attributable to new and
remodeled Company-owned stores. Comparable store sales increased 9.7% for the
fiscal year ended January 31, 1997 over the prior period.
The number of franchise stores increased from 50 franchise stores at the end
of fiscal 1996 to 51 at the end of fiscal 1997. Franchise revenues increased
4.6% from $1.1 million for fiscal 1996 to $1.2 million for fiscal 1997. Initial
franchise fees decreased 57.0% or $94,000 due to a reduction in the number of
franchise store openings in fiscal 1997. The decrease in initial franchise fees
was offset by increased royalty payments resulting from increased sales in the
franchise stores. Royalty payments averaged 4% of sales in the franchise stores.
COST OF PRODUCTS SOLD AND OCCUPANCY COSTS. Cost of products sold and
occupancy costs for fiscal 1997 were $35.0 million or 67.5% of Company-owned
store revenues, as compared to $27.9 million or 66.7% of Company-owned store
revenues for fiscal 1996. Cost of products sold and occupancy costs reflects the
direct cost of merchandise and store occupancy costs, including rent, common
area maintenance costs, and real estate taxes. The increase as a percentage of
Company-owned store revenues was primarily related to increases in occupancy
costs, particularly increases in real estate taxes and common area maintenance
charges.
STORE OPERATING EXPENSES. Store operating expenses for fiscal 1997 were
$11.5 million or 22.2% of Company-owned store revenues, as compared to $8.7
million or 20.8% of Company-owned store revenues in fiscal 1996. The increase as
a percentage of Company-owned store revenues was primarily attributable to
increases in store labor, advertising and credit card fees. The largest increase
was in payroll and related benefits, resulting from an increase in the federal
minimum wage in third quarter and a tight labor market, especially in the third
and fourth quarter, which caused hourly labor rates to increase. Advertising
increased during the important Halloween and Christmas selling seasons. A new
poster flyer concept was introduced for Halloween. Credit card fees also
increased as a result of a
19
<PAGE>
change in our strategy in late fiscal 1996 to begin accepting credit cards. The
roll out of credit card acceptance was completed in mid-1997.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $5.5 million or 10.4% of total revenues in fiscal 1997, as compared to $4.2
million or 9.9% in fiscal 1996. The increase in general and administrative
expenses was primarily attributable to necessary infrastructure and additional
staff to support the growing Company-owned store base. Additionally, in fiscal
1997, we added members to our senior management team.
INTEREST EXPENSE. Interest expense, net of interest income, increased
$26,000 from $772,000 or 1.8% of total revenues in fiscal 1996 to $798,000, or
l.5% of total revenues in fiscal 1997. We used the net proceeds of our initial
public offering to repay certain bank debt, subordinated notes, and stockholder
notes, changing our status from a "net borrower" to a "net investor" by fiscal
year end.
EXTRAORDINARY CHARGE AND EXPENSES OF CANCELED ACQUISITION. As a result of
the early retirement of the subordinated notes in connection with our initial
public offering, we incurred a one-time charge to earnings in the fourth quarter
of $183,000 for the unamortized portion of our expenses related to issuance of
the subordinated notes. Additionally, we took a fourth quarter charge of
$261,000 related to the expenses associated with our proposed acquisition of The
Paper Factory of Wisconsin, Inc. which we terminated on January 26, 1998.
PRO FORMA NET (LOSS) INCOME. As a result of the factors discussed above, we
realized a pro forma net loss of $207,000 in fiscal 1997 as compared to pro
forma net income of $808,000 for fiscal 1996. Pro forma net (loss) income
includes a benefit (provision) for federal and state income taxes. The principal
reasons for the loss in fiscal 1997 were the expenses associated with the
terminated acquisition and the noncash charge associated with the early payment
of the subordinated notes.
SEASONALITY
Our results of operations have historically fluctuated from quarter to
quarter because of variations in revenues and operating expenses. We generate a
significant portion of our operating income in our second and fourth fiscal
quarters because of seasonal events. Any factor that negatively affects our
revenues or increases our operating expenses during the second and fourth fiscal
quarters could negatively affect our annual results of operations. As a result
of the seasonality of our revenues, we expect to incur a loss in the first
quarter of each year for the foreseeable future. Due to increased promotional
activities during our third quarter, we have historically experienced reduced
operating income for this quarter.
Our results of operations also fluctuate from quarter to quarter as a result
of our expansion strategy for the following reasons:
- the timing of new store openings
- costs associated with the opening of new stores
- expenses incurred to support our expansion strategy
LIQUIDITY AND CAPITAL RESOURCES
Our primary capital requirements are for ongoing operations, principally
inventory and capital improvements to support the continued growth of new
Company-owned stores as well as the remodeling or relocation of existing
Company-owned stores. Our primary sources of liquidity have been:
- cash from operations
- payment terms from vendors
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<PAGE>
- borrowings under our revolving line of credit
- proceeds from financings such as our initial public offering
Our liquidity as measured by our working capital, was $5.2 million at April
30, 1999 and at January 29, 1999, and was $9.4 million at January 30, 1998. At
the end of fiscal 1997 it was $9.4 million. The Company's current ratio was 1.3
to 1.0 at April 30, 1999 compared to 1.4 to 1.0 at January 29, 1999 and 3.1 to
1.0 at January 30, 1998.
Net cash provided by operations totaled approximately $407,000 for the first
quarter ended April 30, 1999 compared to net cash used for operations of
approximately $189,000 for the same period in 1998. The increase in cash flows
from operations primarily reflects the increase in merchandise inventories and
accounts payable related to new store growth, in addition to enhanced accounts
payable leveraging. Cash (used for) provided by operations for each of the last
three fiscal years was approximately ($2.2 million) in fiscal 1998, $746,000 in
fiscal 1997, and $85,000 in fiscal 1996. The decrease in cash flows from
operations in fiscal 1998 compared to fiscal 1997 was primarily attributable to
an increase in merchandise inventories to support new and existing Company-owned
stores.
Merchandise inventories have increased approximately $2.7 million from the
end of fiscal 1998, reflecting necessary purchases in order to support the new
store base and for our upcoming seasonal events. This inventory growth was more
than fully funded by a $4.0 million increase in accounts payable at the end of
our first fiscal quarter. At the end of fiscal 1998 our accounts payable were
$4.4 million. At the end of fiscal 1997 they were $3.0 million. The increase in
accounts payable for fiscal 1998 over fiscal 1997 was primarily attributable to
increased merchandise inventory.
Net cash used for investing activities was approximately $558,000 for the
first quarter ended April 30, 1999 and $1.0 million for the first quarter ended
May 1, 1998. Net cash used for investing activities was approximately $6.7
million for fiscal 1998, $2.5 million for fiscal 1997 and $1.2 million for
fiscal 1996. These expenditures were primarily related to opening and remodeling
existing Company-owned stores and upgrading our information systems.
During the first three months of fiscal 1999, we made capital expenditures
of approximately $574,000, compared with approximately $816,000 of capital
expenditures for the prior year comparable period. Capital expenditures in the
first quarter of fiscal 1999 included approximately $121,000 of costs related to
new stores. During fiscal 1998, we had capital expenditures of approximately
$4.3 million, including approximately $3.2 million related to new stores. We
have invested and will continue to evaluate our needs for additional investment
in information technology and infrastructure capabilities in order to gain
operational efficiencies. We anticipate that we will spend an aggregate of
approximately $2.7 million on capital expenditures during fiscal 1999. If the
number of Company-owned stores we plan to open in fiscal 1999 increases or
decreases, this estimate may change accordingly. The number of Company-owned
stores may vary from planned primarily based upon the availability of suitable
locations on acceptable terms. These capital expenditures will be for new store
openings, fixturing, remodeling or relocating existing stores, and information
systems. We intend to continue to finance all of our new store fixtures and
equipment with long-term capital leases, assuming availability and reasonable
terms.
Net cash provided by financing activities was approximately $878,000 for the
first fiscal quarter of 1999 compared to net cash used for financing activities
of $90,000 for the first fiscal quarter of 1998. The year-over-year increase
reflects the net proceeds received during the first fiscal quarter of 1999 from
the refinancing of our mortgage and the financing of our capital leases. Net
cash provided by financing activities was $6.9 million for fiscal 1998, $3.5
million for fiscal 1997 and $585,000 for fiscal 1996. Cash provided by financing
activities in fiscal 1998 reflects our borrowing under our revolving line of
credit with our bank. Cash provided by financing activities in fiscal 1997 was
primarily from our initial public offering.
21
<PAGE>
In early June 1999, we obtained a $15 million three-year revolving line of
credit facility with BankBoston Retail Finance for general working capital
purposes, that replaced our previous $7.5 million credit facility. Borrowings
outstanding under the new line of credit bear interest, at a variable rate and
are secured by substantially all of our assets. The agreement with respect to
the credit facility contains covenants, which require us to satisfy certain
financial tests, and restrictions on our ability to pay dividends. We cannot
assure you that when our revolving line of credit expires we will be able to
renew it or replace it on comparable terms.
We anticipate opening up to ten Company-owned stores during fiscal 1999. In
addition, we may seek to acquire existing stores from franchisees. At present,
we have no agreement to acquire any franchise store. We expect that the average
new store cost for Company-owned stores will be approximately $186,000. These
expenditures include approximately $131,000 for fixtures and equipment,
including point-of-sale equipment, and $55,000 for store inventory, net of
accounts payable. Pre-opening expenses are expensed as incurred. We seek to
lease sites for our Company-owned stores rather than own real estate. Typically
we lease approximately 8,500 square feet for our Company-owned stores.
Out of our planned Company-owned stores to be opened in fiscal 1999, as of
April 30, 1999, we have signed leases for five new locations. Most of these
leases are for ten-year terms, with five-year renewal options.
On April 8, 1999, we refinanced our corporate office building. The new $1.1
million term note is payable in monthly installments of $8,612, including
interest at 7.125% per year, through May 2009. This note is secured by a first
mortgage on our corporate headquarters.
We expect to fund our operations, capital expenditures and the growth of our
business, from cash generated from operations, available borrowing capacity
under our revolving credit facility and proceeds from this offering.
INFLATION
We believe that inflation has not had a material impact upon our historical
operating results, and do not expect it to have such an impact in the future.
There can be no assurance that our business will not be affected by inflation in
the future.
IMPACT OF YEAR 2000
OVERVIEW. The Year 2000 problem arose because many existing computer
programs use only the last two digits to refer to a year. These computer
programs, therefore, do not properly recognize a year that begins with "20,"
instead of the current "19." If not corrected, many computer applications could
fail or create erroneous results. The impact of the Year 2000 problem is not yet
known, and if not timely corrected, could affect the global economy. It is
possible that our currently installed computer systems, software, other business
systems, or those systems of our suppliers, will not accept input of, store, or
manipulate output dates for the years 2000 and beyond without error or
manipulation.
STATE OF READINESS. We are actively engaged in the process of evaluating
the status of our internal Information Technology ("IT") and non-IT systems for
compliance with Year 2000 issues. We have hired an outside consultant to assist
us with this process and to document our efforts and results regarding Year 2000
compliance in a Year 2000 depository to be maintained at our headquarters. We
continue to solicit verification from our largest suppliers, as well as other
business partners, that they are Year 2000 compliant. The majority of our
exposure is in the readiness of third parties, where the situation is much less
within our ability to predict or control. The first phase, evaluating our
internal systems, is substantially complete. The second phase, evaluating third
party systems, was commenced in the second quarter of fiscal 1998, and we expect
to be substantially complete by mid-fiscal 1999. In addition, while we value our
established relationships with our key suppliers, we are in the process of
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<PAGE>
identifying secondary suppliers in the event that any of our business partners
are delayed in achieving Year 2000 compliance. We monitor our progress in
achieving Year 2000 compliance on a regular basis and regularly report our
progress to our management and board of directors.
NON-IT SYSTEMS. We believe that the failure of any internal non-IT systems
(E.G., alarms, telephone system, voicemail, access cards, locks, heating and
cooling systems, etc.) to be compliant for the Year 2000 would have little
effect on our business, operations, or financial condition as a whole. We
continue to review our non-IT systems, and will continue to take steps to
modify, upgrade or replace non-IT systems as necessary to be Year 2000
compliant. We do not anticipate that expenses for these replacement or
conversions will be material. We believe that any additional modifications or
replacements will not have a material impact on our business, operations or
financial condition.
MAJOR IT SYSTEMS. During 1998 and 1997, we upgraded or replaced our mission
critical data processing system, which controls our financial records, inventory
management and purchasing. We believe that these systems will function properly
with respect to dates in the Year 2000 and beyond. We have received
certification from many of our hardware and software suppliers of the upgraded
or replaced systems that the systems should function correctly in Year 2000 and
beyond. We are in the process of testing the certification received from our
hardware and software suppliers, which should be completed by third quarter
1999. We are in the process of upgrading our cash registers and personal
computers as necessary, in order to achieve Year 2000 compliance. All registers
that are not Year 2000 compliant will be upgraded by December 31, 1999. We
believe that any additional modifications or replacements will not have a
material impact on our business, operations or financial condition.
THIRD PARTY SYSTEMS. We have been in contact with our major suppliers and
service providers to understand their state of Year 2000 readiness. We have
asked our major suppliers and service providers to complete a survey on their
state of Year 2000 readiness, and we are assessing how this could hurt us. A
supplier's failure to be Year 2000 compliant may interrupt the flow of products
to our stores for sale. Depending on how long product supply to our stores is
interrupted, our business could suffer. Multiple sources of product supply
available to us, however, lessen this concern. We may also experience some
inconvenience if one or more of our utility providers are not Year 2000
compliant. Even if utility providers are not able to provide electricity, water,
heat, etc., to our stores following January 1, 2000, we will still attempt to
open all stores. If a utility failure would continue for more than several days,
the result could decrease our revenues, earnings and cash flow.
COSTS TO ADDRESS YEAR 2000 ISSUES. To date, our costs associated with Year
2000 readiness have been immaterial. We expect that any additional costs of
being Year 2000 compliant will also be immaterial.
RISKS TO THE COMPANY FOR YEAR 2000 ISSUES. Some risks associated with the
Year 2000 problem are beyond our ability to control, including the extent to
which our suppliers and service providers can address their Year 2000 problems.
We cannot estimate, therefore, the impact on us if third parties are not Year
2000 compliant. The failure by a supplier to adequately address the Year 2000
issue could hurt the supplier and disrupt our business. Our most likely worst
case Year 2000 scenario is if one or more of our stores does not have power,
heat or water. The stores affected could still open for business, however, using
a cash box to make sales and flashlights to provide light.
CONTINGENCY PLANS. We expect to develop a formal contingency plan related
to the Year 2000 problem upon further identification and assessment of all of
our risks.
The costs of our Year 2000 compliance programs and the timetable on which we
plan to complete these programs are based on our best estimates, and reflect
assumptions regarding the availability and cost of personnel trained in this
area, the compliance plans of third parties and similar uncertainties. However,
due to the complexity and pervasiveness of the Year 2000 issue, and in
particular the uncertainty regarding the compliance programs of third parties,
these estimates may not be achieved, and our actual results could be
significantly different from those anticipated.
23
<PAGE>
BUSINESS
Paper Warehouse is a growing chain of retail stores specializing in party
supplies and paper goods. As of April 30, 1999, we had 142 stores, including 97
Company-owned stores and 45 franchise stores. These stores are conveniently
located in major retail trade areas to provide customers with easy access to our
stores. We operate these stores under the names PAPER WAREHOUSE and PARTY
UNIVERSE. Our seven principal markets are:
<TABLE>
<S> <C> <C>
- - Minneapolis/St. Paul, MN - Kansas City, MO and KS - Denver, CO
- - Oklahoma City/Tulsa, OK - Seattle, WA - Tucson, AZ
- - Omaha, NE and Des Moines, IA
</TABLE>
Our stores offer an extensive selection of party supplies and paper goods,
at everyday low prices. We offer party supplies and paper goods for a wide
variety of celebratory occasions, everyday uses and seasonal events, including:
<TABLE>
<CAPTION>
CELEBRATORY OCCASIONS AND EVERYDAY
USES SEASONAL EVENTS
- ------------------------------------- ---------------------------------
<S> <C> <C>
- - birthdays - Valentine's - Halloween
- - weddings Day - Christmas
- - baby showers - Easter - Hanukkah
- - graduations - Fourth of July - New Year's
- - other family and religious - Thanksgiving
celebrations
</TABLE>
Through our 8,500 square foot prototype, we offer a comprehensive selection
of over 19,000 different products. This selection provides customers the
convenience of one-stop shopping for all party supplies and paper goods. Our
merchandise is organized by party themes. The prominent signage and wide aisles
in our stores allow customers easy access to coordinate the merchandise required
for all party occasions. We believe that our extensive and readily available
merchandise selection often stimulates customers to purchase additional
products.
PAPER WAREHOUSE STORES
FORMAT. We developed our current store prototype based on our management's
experience in the industry, other extensive retail experience and customer
research. We operate stores that range in size from 3,000 square feet to 8,500
square feet of retail space. Our management introduced our current 8,500 square
foot prototype store in 1994 and believes it is the optimal store format for our
future growth. Of the 97 Company-owned stores, approximately 87% are 6,000
square feet or larger.
Our stores are designed to create a customer-friendly environment. We use
vibrant colors, theme-oriented merchandise displays and unique products to
create a fun and festive shopping experience. The focal point of our stores is
the seasonal display located at the front of each store, which creates a
"store-within-a-store" appearance. This display maximizes the season's selling
impact and is updated continuously to promote a fresh image within the store. To
assist customers in coordinating party supplies for any occasion, we locate
related departments, such as gift-wrap and greeting cards, adjacent to one
another and display related merchandise such as party hats, plates, cups and
napkins together within a department. 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. We believe that our store
layout assists customers in finding and coordinating their party supply needs,
and also encourages browsing, impulse purchases and repeat visits.
In 1998 we introduced the "concept store." A concept store has a different
look and feel than our other stores. These stores have more colorful ceilings,
lower shelves in the front of the store, carpeting and confetti-tiled floors,
and new vibrant uncluttered signage. We store all extra merchandise out of
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<PAGE>
sight. These features give the store a very open and organized feel, allow
customers to see merchandise throughout the store, and provide a more fun and
festive shopping atmosphere. Of our 97 Company-owned stores, 19 are concept
stores. We anticipate that new Company-owned stores will be concept stores, and
we will selectively remodel existing stores to concept stores where the revenue
potential justifies the investment. We believe that our concept stores will
assist us in creating our brand awareness, will generate strong sales per square
foot and can be readily transferred to new markets.
PARTY SMART. We are seeking to distinguish our business from our
competitors by positioning Paper Warehouse as the party expert. We believe that
we have the opportunity to create a distinct identity for ourselves, one in
which customers equate us with the word "PARTY" in every possible way. To
achieve this recognition, we are beginning to implement a program in our stores
called PARTY SMART. We will introduce the PARTY SMART concept in our stores
through July 1999. PARTY SMART means being able to provide a customer with all
the information and resources necessary to throw a party. Our goals for this
program are to:
- increase average purchases per customer visit
- increase the frequency of store visits
- develop customers' preference for us over our competitors
In order to get customers to think of us as PARTY SMART we plan to:
- provide helpful and engaging in-store presentations to add value to the
shopping experience
- communicate our expertise by giving customers party ideas, decorating
tips, referrals and planning advice
- create a "party planning resource center" in each store carrying different
types of brochures for different types of parties and seasonal events such
as entertainment and catering ideas, games to play at children's birthday
parties and shopping checklists
- advertise our PARTY SMART concept through shopping bag inserts, window and
aisle signs, buttons for employees, in-store audio messages, radio
broadcasting and over the internet
CUSTOMER SERVICE. We seek to provide a high level of customer service to
enhance our customer-friendly store environment. Store managers and sales
associates are trained to assist customers with party planning and event
coordination. In connection with our PARTY SMART program, all employees are
being trained on how to provide nontraditional customer service to our shoppers.
We want our employees to be able to offer our shoppers party ideas, decorating
tips, and referrals in addition to helping shoppers find and purchase products.
In addition, we provide party planning guides and checklists. Our "no hassle"
return policy makes it easy for customers to return or exchange products, which
we believe encourages customers to purchase additional product quantities.
Certain products that require additional sales assistance, such as balloons and
custom printing, are located near checkout counters where sales associates can
readily assist customers. We continually monitor our 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 evaluate
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 store 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. Store 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, we use floating managers
25
<PAGE>
to assist in smaller stores that cannot support both a store 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.
Before opening a new Company-owned store, we usually train store managers
intensely for two weeks, depending on prior experience. During the new store
set-up, our district management team provides additional training to our store
managers. 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. We schedule periodic training sessions
for store managers in the central or district offices on various topics,
including human resources, merchandising, loss prevention and employee
supervision. We cover additional training topics at monthly managers' meetings
and through monthly mailings and our monthly newsletter.
Paper Warehouse stores are typically open:
<TABLE>
<S> <C>
9:00 a.m. to 9:00
Monday through Friday................................ p.m.
9:00 a.m. to 6:00
Saturday............................................. p.m.
11:30 a.m. to 5:00
Sunday............................................... p.m.
</TABLE>
SITE SELECTION AND LOCATIONS
SITE SELECTION. In order to select the optimal location for our stores, we
use a site selection process that considers various criteria, including:
- population density
- demographics, including age and income
- parking availability
- storefront visibility and presence
- local competition
- lease rates
- traffic counts
We locate our stores in or near visible high traffic strip mall centers in
close proximity to prominent mass merchandisers, and discount or grocery store
anchors. Our strategy of clustering stores in metropolitan markets promotes
customer convenience and creates favorable economies of scale for marketing,
advertising and operations.
26
<PAGE>
LOCATIONS. As of April 30, 1999, we had 97 Company-owned stores in the
following locations:
<TABLE>
<CAPTION>
LOCATIONS NUMBER OF STORES
- ---------------------------------------------------------------------------- ---------------------
<S> <C>
Arizona
Tucson Metropolitan Area.................................................. 4
Colorado
Denver Metropolitan Area.................................................. 13
Colorado Springs.......................................................... 1
Iowa
Des Moines Metropolitan Area.............................................. 4
Cedar Falls............................................................... 1
Fort Dodge................................................................ 1
Iowa City................................................................. 1
Sioux City................................................................ 1
Kansas/Missouri
Kansas City Metropolitan Area............................................. 15
Columbia.................................................................. 1
Salina.................................................................... 1
St. Joseph................................................................ 1
Minnesota
Minneapolis/St. Paul Metropolitan Area.................................... 26
Mankato................................................................... 1
Rochester................................................................. 1
St. Cloud................................................................. 1
Nebraska
Omaha Metropolitan Area................................................... 2
Oklahoma
Oklahoma City Metropolitan Area........................................... 8
Tulsa..................................................................... 4
Washington
Seattle Metropolitan Area................................................. 8
Wisconsin
Onalaska.................................................................. 1
Eau Claire................................................................ 1
--
Total Company-owned stores.................................................. 97
--
--
</TABLE>
MERCHANDISING
OVERVIEW. Through our 8,500 square foot store prototype, we offer a
comprehensive selection of over 19,000 different products, providing customers
the convenience of one-stop shopping for all party supplies and paper goods. Our
merchandise is organized by party themes. The prominent signage and wide aisles
in our stores allow customers easy access to coordinate the merchandise required
for all party occasions. We also believe that our extensive and readily
available merchandise selection often stimulates customers to purchase
additional products.
PARTY SUPPLIES. We offer an extensive selection of complementary and
coordinating party supplies in unique and traditional patterns, colors and
designs. Our party supplies include:
<TABLE>
<S> <C> <C> <C> <C> <C>
- - invitations - plates - napkins - party - streamers - giftware
- - banners - candles - balloons favors - candy - seasonal
- party novelties
snacks
</TABLE>
27
<PAGE>
Our 8,500 square foot store prototype offers over 150 ensembles of party
goods for many occasions, which include party hats, plates, napkins and cups. A
significant portion of our party goods ensembles involves the use of movie and
television figures, animated characters and celebrity likenesses licensed to the
manufacturer of these ensembles.
GIFT WRAPPING PRODUCTS. We offer 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, we offer distinctive gift packaging products for special occasions
such as birthdays, graduations, weddings, baby showers and other family and
religious celebrations.
GREETING CARDS. We feature a wide variety of special occasion, seasonal and
everyday greeting cards. Our 8,500 square foot store prototype offers over
10,000 titles. We carry traditional, humorous and contemporary brand name
greeting cards at significantly lower prices than national greeting card chain
stores.
HOUSEHOLD AND CATERING FOOD SERVICE SUPPLIES. We offer paper supplies such
as toilet paper, paper towels, dispenser towels, plates, cups, serving trays and
bowls and table coverings. In addition to offering these products to our regular
party goods customers, we are a paper product supplier for many commercial users
of paper products, including catering companies and non-profit organizations.
LOW PRICES. We provide customers with everyday low pricing on all products,
at discounts ranging from 10% to 50% off the manufacturer's suggested retail
price. In addition, we guarantee that we will meet or beat any advertised price
on the products we offer. We reinforce our everyday low price strategy with
signs prominently displayed throughout our stores and extensive promotional
advertising.
PRODUCT SOURCING AND INVENTORY MANAGEMENT
We purchase our merchandise from approximately 150 suppliers. In fiscal
1998, our largest supplier, Amscan Holdings, Inc., accounted for approximately
14% of our purchases and our eight largest suppliers represented approximately
51% of our purchases. We do not have long-term purchase commitments or exclusive
contracts with any of our suppliers. We believe that alternative sources of
product are available at comparable terms and conditions. We consider numerous
factors in supplier selection, including price, payment terms, product offerings
and product quality.
We negotiate pricing with suppliers on behalf of all Company-owned and
franchise stores. We believe that this buying power enables us 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 our negotiated pricing terms. As we
add new stores, we believe we will increase the volume of our inventory
purchases and benefit further from increased discounts and trade allowances and
more favorable payment terms from our suppliers.
More than 95% of our merchandise is shipped directly from the supplier to
our stores. Shipping merchandise directly to our stores provides us 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. We believe that we realize
substantial savings by not maintaining a central distribution system.
Some of our suppliers, such as overseas suppliers, will not ship directly to
our stores. These suppliers instead ship products directly to one store in each
of our major metropolitan markets, which then separates and ships the products
to our other stores within that market. This approach allows us to make
opportunistic volume purchases. We maintain space in at least one of our stores
in each of our principal markets, including Minneapolis/St. Paul, Denver, Kansas
City, Oklahoma City, Tucson, Omaha and Seattle, for the separation and
redistribution of products to our other stores within that market.
28
<PAGE>
We maintain a small warehouse in Minneapolis from which we separate and
distribute merchandise systemwide, including to our franchise stores.
ADVERTISING AND MARKETING
We maintain aggressive advertising and marketing programs. Our strategy of
clustering stores in metropolitan markets enables us to cost effectively employ
a variety of media. We advertise primarily through newspaper, direct mail
inserts and radio. We also promote products through the use of direct mail
mini-catalogs as well as through in-store coupon books and party planning aids.
Our advertising efforts are designed to educate consumers about our
convenient store locations, promote the breadth and value of our product
offering and stress the customer service levels of our sales associates. Our
advertising consists primarily of full color newspaper and direct mail inserts
designed around major holidays and the spring and summer seasons. In fiscal
1998, we distributed 17 newspaper and direct mail inserts. We supplement inserts
by radio advertising for New Year's, Easter, the spring season, graduation,
Halloween, and Christmas. In addition, we typically advertise the opening of new
stores in newspaper and direct mail inserts as well as on the radio.
We have initiated a targeted direct mail program to increase sales for
special events. We currently mail mini-catalogs of wedding and graduation party
goods to brides-to-be and families of high school graduates. We have recently
expanded this direct mail program to other special occasions such as a child's
first birthday, and to organizations purchasing basic party supplies and paper
goods for commercial or institutional use. Our institutional customers include a
variety of small businesses, caterers, food service companies, schools,
synagogues, churches, civic groups and other organizations.
In fiscal 1998, we spent approximately 75% of our marketing budget on full
color newspaper and direct mail inserts, approximately 20% for television and
radio advertising and the remainder on direct mail mini-catalogs and in-store
sales promotions. We plan to increase our marketing efforts in fiscal 1999 to
support our PARTY SMART concept and our e-commerce activities.
INFORMATION SYSTEMS
Our information systems are integral to continuing our expansion and
enhancing our competitive position in the industry. We completed the
installation of Point of Sale ("POS") terminals in all our Company-owned stores
in the third quarter of fiscal 1996. The POS terminals allow price lookup and
inventory tracking by product. By polling transaction data nightly from each
store's POS terminals, the system provides daily sales information and inventory
levels at store, department, class and product level. This information allows
the corporate office to monitor daily sales, gross profit, pricing and inventory
by product across our entire store base. Also, our automatic merchandise
replenishment system uses this information to allocate goods to individual
stores based on specific product requirements.
We completed the installation of JDA Retail Software Package in the first
quarter of fiscal 1998. The JDA Retail Software Package operates on an IBM
AS/400 platform, which required us to purchase new hardware. Switching hardware
platforms provided us with the benefit of parallel operations during the
conversion process. In addition, we have made 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 our management with
more sophisticated tools to utilize the information collected by our POS
terminals. Our previous information systems were already performing most of the
functions of the JDA Retail Software Package. Our management believes, however,
that JDA has improved the efficiency of these tasks. In addition, we plan to
develop enhancements such as
29
<PAGE>
data warehousing and electronic data interchange to improve our ability to
systematically manage our inventory.
INTERNET AND E-COMMERCE
The internet is a network linking computers throughout the U.S. and the
world. International Data Corporation ("IDC") estimates that more than 56
million people in the United States used the internet in 1998 and that more than
136 million people will use the internet by the year 2002. Women, our principal
customers, now make up half of all U.S. adult internet users, up from 18% of
users three years ago. This growing use of the internet represents a significant
opportunity for businesses to conduct commerce online. IDC projects that by the
year 2000, 46 million consumers in America will be buying online. While online
retail is still in its infancy, party supplies and paper goods online retailing
is even more underdeveloped. We believe that prior to 18 months ago no company
had a website offering party goods. Today, there appear to be only a few
substantial websites offering party goods.
We believe that the internet provides us an opportunity to grow our
business. We expect that it will allow us to attract new customers in our
existing markets and reach customers in geographic markets not currently served
by our stores. We also expect that it will enable us to better serve our current
customers. From the proceeds of this offering, we plan to design, implement and
support our online retail business. We believe that our conventional retail
infrastructure, established name recognition, management experience and supplier
relationships will support our entrance into the online market. Additional sales
of our products online will increase the volume of our inventory purchases,
allowing us to benefit further from increased discounts and trade allowances and
more favorable payment terms from suppliers. If we are able to take advantage of
additional benefits from suppliers, we expect to be able to offer lower prices.
We believe low prices will ultimately be one of the single most important
factors stimulating purchasing on the internet.
One part of our website strategy is to offer our PARTY SMART program on the
internet. Initially we plan to promote and sell a "party in a box" concept. This
means that a customer will be able to purchase a package of party goods
containing all the items necessary to throw a specific type of party (e.g., baby
showers, birthdays, theme parties and anniversaries).
We intend to develop a website that, when fully developed, will allow a
shopper to, among other things:
- preview our store to learn more about our history, products and services
- put together an entire party with one visit to our website
- obtain party advice, ideas and tips
- access a list of our local and national strategic partners (e.g.,
entertainers, caterers, rental supply firms, and operators of bowling
alleys, skating rinks and pools)
- pay for everything at one time at a check-out screen
- return to check on the status of orders that have already been placed
- receive e-mail from us about new items that would fit the selected party
theme, or items asked about but were unavailable when the order was placed
- contact customer service about the products and services available on our
website
- evaluate our performance and the performance of our website following the
party
- receive other information about us, such as franchising opportunities,
investor relations and career opportunities
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<PAGE>
We designed our current website, PAPERWAREHOUSE.COM, to offer business
opportunities to individuals interested in owning a Paper Warehouse franchise.
This website only contains a homepage and we plan to update the content of this
website and provide links to other websites with a portion of the proceeds from
this offering.
We intend to design, develop and implement our website with a strategic
technical partner. We intend to contract with an internet fulfillment service
provider to process and ship orders, acknowledge and track orders, handle
returns and canceled orders and provide other customer services.
Our current implementation plan to launch our new website involves three
stages:
- upgrading the content of PAPERWAREHOUSE.COM so that visitors will be able
to easily access our other company information which we expect to complete
by the end of Summer 1999
- developing and implementing the new website, including its e-commerce
capabilities, which we expect to complete in time for Halloween 1999
- providing maintenance and enhancements to improve our customer's shopping
experience
The costs to develop and implement our internet strategy, and the timetable
on which we plan to launch this strategy, are based on our best estimates. The
following factors, among others, may negatively impact the success of our
internet strategy:
- failure of our strategic partners to efficiently and timely perform
- changes in technology
- failure to attract customers to our website
- increased competition in party suppliers and paper goods online retailing
- changes in consumer preferences
- problems associated with Year 2000
If any of the above were to occur, our estimates may not be achieved, and
our actual results could be significantly different from those anticipated.
31
<PAGE>
FRANCHISING
We have offered franchises of our Paper Warehouse store concept since
October 1987. As of April 30, 1999, we had 32 franchisees operating 45 franchise
stores located in the following states:
<TABLE>
<CAPTION>
LOCATIONS NUMBER OF STORES
- ---------------------------------------------------------------------------- ---------------------
<S> <C>
Arizona..................................................................... 1
Colorado.................................................................... 5
Florida..................................................................... 1
Georgia..................................................................... 2
Illinois.................................................................... 2
Iowa........................................................................ 2
Kansas...................................................................... 2
Kentucky.................................................................... 1
Louisiana................................................................... 4
Maryland.................................................................... 1
Minnesota................................................................... 1
Mississippi................................................................. 1
Missouri.................................................................... 1
Montana..................................................................... 2
Nebraska.................................................................... 3
Nevada...................................................................... 1
North Dakota................................................................ 4
South Dakota................................................................ 5
Tennessee................................................................... 1
Texas....................................................................... 3
Wyoming..................................................................... 2
--
Total Franchise Stores...................................................... 45
--
--
</TABLE>
We establish franchise stores in markets outside of metropolitan areas with
Company-owned stores. We believe that these markets typically are not served
adequately by the party supplies and paper goods industry. In addition to
generating franchise revenues, franchise stores benefit us through increased
name recognition and increased buying power from our suppliers.
We assist franchisees in opening and operating a Paper Warehouse store.
During the pre-opening phase, our support includes:
- site evaluation and assistance with lease negotiations
- store build-out assistance
- fixture, equipment, supplies and inventory procurement
- opening advertising materials
- operations training
We make available to our franchisees services such as business planning,
operations and promotional activities. In addition, we perform the merchandising
process for our franchisees. We make periodic inspections of the franchise
stores to ensure that the franchisee is complying with our various requirements
and quality standards. We 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.
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<PAGE>
Our franchise revenues are comprised of initial franchise fees and
continuing royalty payments. Our current initial franchise fee ranges from
$19,000 to $25,000 for new franchisees, depending on the type of store. We may
offer a discount franchise fee for developers opening multiple stores. If a
franchisee enters into a second or third franchise agreement it will receive a
discount on the initial fee associated with the second or third store.
Franchisees are also required to pay us 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 us 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. We may also require franchisees to pay a weekly advertising fee not to
exceed 1% of gross sales, although to date we have not charged this fee. Each
franchisee is granted a license from us for the right to use certain
intellectual property rights, including the mark PAPER WAREHOUSE or PARTY
UNIVERSE and related designs. Our franchise agreements provide for a ten-year
term and contain conditional renewal options.
COMPETITION
The party supplies and paper goods retailing business is highly competitive.
In order to compete successfully against other party supplies and paper goods
retailers, we believe we must maintain convenient locations, broad merchandise
selections, competitive pricing and strong customer service. Our stores compete
with a variety of smaller and larger retailers, including:
- specialty party supply retailers
- other superstores such as Party City and Factory Card Outlet
- card shops such as Hallmark
- designated departments in mass merchandisers, discount retailers, toy
stores, drug stores, supermarkets and department stores
Many of our competitors have substantially greater financial and personnel
resources than we do. We may also encounter additional competition from new
entrants in the future in our existing or planned new markets. Increased
competition by existing or future competitors may reduce our sales and cause us
to incur a loss.
Two of our major competitors are currently having significant financial
difficulties. In March 1999, Factory Card Outlet filed for reorganization under
Chapter 11 of the bankruptcy code. Party City has not yet released its financial
results for 1998, has experienced significant management turnover since January
1, 1999 and has defaulted under its secured credit facility. We do not believe
that the problems facing Party City and Factory Card Outlet are indicative of a
weakness in the party goods industry or with our business. We believe that the
following factors distinguish our business from that of Factory Card Outlet and
Party City:
- we have grown our number of stores in a more controlled manner
- our clustering growth strategy creates a critical mass of stores in our
principal markets, which allows us to promote customer convenience and
create favorable economies of scale for marketing, advertising and
operations
- we have a strong senior management team with significant retail experience
We expect competition in the e-commerce market to increase from a growing
number of companies selling goods and services over the internet, including
companies focusing exclusively on party goods and services.
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<PAGE>
Increased competition from these and other sources could require us to
respond to competitive pressures by establishing pricing, marketing and other
programs or seeking out additional strategic alliances or acquisitions that may
be less favorable to us than we could otherwise establish or obtain. This could
negatively effect our business.
TRADEMARKS AND SERVICE MARKS
We use the marks PAPER WAREHOUSE, PARTY UNIVERSE and PARTY SMART. PAPER
WAREHOUSE and PARTY UNIVERSE are federally registered trademarks. We have
recently submitted an application to register the trademark PARTY SMART. We are
aware of the common law usage of the name PAPER WAREHOUSE by several companies
in various parts of the United States, which may prevent us from using that name
in certain regional markets. In markets where we cannot use PAPER WAREHOUSE, we
intend to use the name PARTY UNIVERSE. Because of our regional approach to
advertising and store clustering, we believe that the use of a single trademark
within each market is more important to our growth and business strategy than
the use of one mark nationally.
GOVERNMENT REGULATION
As a franchisor, we comply with rules and regulations adopted by the Federal
Trade Commission and with state laws that regulate the offer and sale of
franchises. We also 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 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 kept us from seeking franchisees in any given area and have not
effected our operations.
All of our stores 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, we comply with the Fair Labor Standard Act and various state
laws governing matters such as minimum wage, overtime and other working
conditions. We also 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 April 30, 1999, we employed approximately 325 full-time and
approximately 870 part-time employees. We consider our relationships with our
employees to be good. None of our employees are covered by a collective
bargaining agreement.
FACILITIES
We own a 23,000 square foot building in a suburb of Minneapolis, Minnesota,
in which our headquarters are located. We lease a 17,000 square foot building in
a suburb of Minneapolis, Minnesota for warehouse space. We lease all the
locations for our 97 Company-owned stores. We anticipate that our new
Company-owned stores will typically have ten-year leases with at least one
five-year renewal option.
LEGAL PROCEEDINGS
We are not a party to any material litigation. We are not aware of any
threatened litigation that would negatively impact our business.
34
<PAGE>
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND OTHER KEY PERSONNEL
The following table contains certain information about our directors and
executive officers:
<TABLE>
<CAPTION>
NAME AGE POSITION
- -------------------------------- --- ------------------------------------------------------
<S> <C> <C>
Yale T. Dolginow(2)............. 56 President, Chief Executive Officer and Chairman of the
Board
Brent D. Schlosser.............. 45 Executive Vice President and Director
Cheryl W. Newell................ 46 Vice President and Chief Financial Officer
Diane C. Dolginow............... 55 Secretary and Director
Steven P. Durst................. 31 Vice President of Merchandising
Arthur H. Cobb(1)............... 48 Director
Marvin W. Goldstein(1)(2)....... 55 Director
Martin A. Mayer(1)(2)........... 56 Director
Jeffrey S. Halpern.............. 56 Director
</TABLE>
The following table contains certain information about other key personnel:
<TABLE>
<CAPTION>
NAME AGE POSITION
- -------------------------------- --- ------------------------------------------------------
<S> <C> <C>
Diana G. Purcel................. 32 Controller
Michael A. Anderson............. 38 Vice President of Franchising
Steven R. Anderson.............. 52 Vice President and Chief Information Officer
Carol A. Carroll................ 48 Vice President of Stores
Willard V. Lewis................ 64 Vice President of Store Development
Kristen Lenn.................... 31 Director of Human Resources
</TABLE>
- ------------------------
(1) Member of Audit Committee
(2) Member of Compensation Committee
YALE T. DOLGINOW currently serves as President, Chief Executive Officer and
a director and was part of the original management team that purchased the Paper
Warehouse business in 1986. Mr. Dolginow has been in the retail business since
1968 and has served in various capacities with numerous retail and mail-order
companies, such as President and Chief Executive Officer of Carlson Catalog
Showrooms, Inc., Assistant to the President of Dayton Hudson Corporation,
President of Modern Merchandising, Inc. and Chief Executive Officer and
President of Dolgin's, Inc. Mr. Dolginow and Diane C. Dolginow are husband and
wife.
BRENT D. SCHLOSSER currently serves as Executive Vice President and a
director and was also part of the original management team that purchased the
Paper Warehouse business in 1986. From 1982 to 1986, Mr. Schlosser served in
various capacities, including Vice President Marketing/Buying and Executive Vice
President Marketing/Merchandising at Carlson Catalog Showrooms, Inc. From 1977
to 1982, Mr. Schlosser 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 currently serves as Vice President and Chief Financial
Officer and joined us in August 1997. From 1991 to August 1997, Ms. Newell was a
Vice President with the Corporate Banking
35
<PAGE>
Group at U.S. Bancorp, a bank holding company, responsible for management of
desktop technology, disaster recovery and 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 n/k/a Wells
Fargo Corporation.
DIANE C. DOLGINOW currently serves as our Secretary and a director and
joined us in 1986. 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 the
School of Education at University of Kansas. Ms. Dolginow and Mr. Dolginow are
husband and wife.
STEVEN P. DURST currently serves as Vice President of Merchandising and
joined us in 1995. Mr. Durst joined us as Director of Information Systems,
became Vice President of Information Systems in 1997 and assumed his current
position in 1998. From 1995 to 1997 Mr. Durst served as Director of Information
Systems for the Company. From 1990 to 1995 Mr. Durst was employed by Exxon
Corporation where he performed various engineering and business planning
functions. Mr. Durst is the son-in-law of Mr. and Mrs. Dolginow.
ARTHUR H. COBB has served as a director since 1992. He is a consultant and
certified public accountant. Since 1978, he has been engaged in providing
financial consulting services and is President of Cobb & Associates, Ltd. Mr.
Cobb was a partner with Peat Marwick Mitchell & Co., n/k/a KPMG Peat Marwick
LLP, a public accounting firm.
MARVIN W. GOLDSTEIN has served as a director since 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 August 1995 through April 1997, Mr.
Goldstein was Chairman of the Board, Chief Executive Officer and President of
Pet Food Warehouse, Inc., a specialty retailer. From February 1988 to September
1994, Mr. Goldstein served in various positions at the Department Store Division
of Dayton Hudson Corporation, including President and Chief Operating Officer,
Chairman and Chief Executive Officer. Mr. Goldstein is a director, and serves on
the compensation committee, of each of the following companies: Wilson's, The
Leather Experts, Inc., Buffet's, Inc., A.R.C.A., Inc., Greenspring, Inc. and
kidBoard, inc.
MARTIN A. MAYER has served as a director 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., n/k/a KPMG Peat Marwick LLP, a public accounting firm,
from 1973 until 1992. Mr. Mayer is a certified public accountant.
JEFFREY S. HALPERN has served as a director 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.
DIANA G. PURCEL currently serves as Controller and joined us in April 1999.
Before joining the Company and since March 1998, Ms. Purcel was Divisional
Controller for Corporate Planning and Reporting for Damark International, Inc.
From 1994 to 1998, Ms. Purcel was a Senior Analyst with Dayton Hudson
Corporation. Before joining Dayton Hudson Corporation and since 1988, Ms. Purcel
was an auditor with Arthur Andersen, LLP.
MICHAEL A. ANDERSON currently serves as Vice President of Franchising and
joined us in 1991. Mr. Anderson joined us as Controller and assumed his current
position in 1999. From 1987 to 1991, Mr. Anderson was an accountant at Luri,
Eiger, Besikof & Company, a Minneapolis public accounting firm. From 1982 to
1986, Mr. Anderson was a staff accountant with Marvin O. Anderson, LPA, a public
accounting firm located in Minnesota.
36
<PAGE>
STEVEN R. ANDERSON currently serves as Vice President and Chief Information
Officer of the Company and joined us in December 1998. From May 1997 until June
1998, Mr. Anderson was Senior Vice President and Chief Information Officer for
County Seat, a publicly-held specialty soft goods retailer. From 1986 to 1997,
Mr. Anderson held a number of information systems positions, including Senior
Vice President and Chief Information Officer at Best Buy Co., a publicly-held
specialty retailer.
CAROL A. CARROLL currently serves as Vice President of Stores and joined us
in 1994. Ms. Carroll joined us as Director of Stores and until she assumed her
current position in 1997. From 1992 to 1994, Ms. Carroll was Director of Stores
of CBR, Inc., a privately-owned retailer, specializing in airport retail. From
1976 to 1992, Ms. Carroll served as a District Manager, managing 17 stores in a
five-state area, for Best Products, Inc.
WILLARD V. LEWIS currently serves as Vice President of Store Development and
joined us in 1992. Mr. Lewis joined us as Director of Development and assumed
his current position in 1997. From 1990 to 1992, Mr. Lewis served as Vice
President of Network Facilities Professionals, Inc., a Minnesota-based computer
software firm. Mr. Lewis was employed by Dolgin's, Inc. from 1970 to 1985.
KRISTEN LENN currently serves as Director of Human Resources and joined us
in August 1997. From 1994 to 1997, Ms. Lenn was a Senior Consultant with
McGladrey & Pullen, LLP, a public accounting firm, and provided a wide range of
human resources generalist services to clients.
DIRECTOR COMPENSATION
DIRECTORS' FEES. We pay non-employee directors $1,000 for each meeting
attended, plus we reimburse all out-of-pocket expenses incurred on behalf of
Paper Warehouse.
DIRECTOR OPTIONS. Eligible directors participate in the Director Stock
Option Plan (the "Director Plan"). The Board administers the Director Plan.
Under the terms of the Director Plan, the Board automatically grants each newly
elected non-employee director a non-statutory option to purchase 10,000 shares
of our common stock at an exercise price equal to the fair market value of our
common stock on the date of grant. These options vest in one-third increments
beginning on the first anniversary of the date of grant and on each of the next
two anniversaries of this date. On November 24, 1997, the Board granted each of
the non-employee directors an option to acquire 10,000 shares of our common
stock at an exercise price of $7.50 per share. These options have a term of ten
years from November 24, 1997 and vest in one-third increments on each of
November 24, 1998, 1999 and 2000.
On June 4, 1998, the Board granted each of the non-employee directors a
non-statutory option outside of the Director Plan to acquire 5,000 shares of our
common stock at an exercise price of $4.25 per share, the closing sale price of
our common stock on the date of grant. On December 7, 1998, the Board granted
each of the non-employee directors another non-statutory option outside of the
Director Plan to acquire 6,250 shares of our common stock at an exercise price
of $2.75 per share, the closing sale price of our common stock on the date of
grant. All options granted to non-employee directors outside of the Director
Plan, have a term of ten years from the date of grant and vest in one-third
increments beginning on the first anniversary of the date of grant and on each
of the next two anniversaries of this date.
All options granted to these non-employee directors will become immediately
exercisable in full if any of the following events occur:
- the death of the director
- the removal of the director from the Board without cause
- the director is not re-nominated or re-elected as a director
37
<PAGE>
- a change in control of Paper Warehouse, as defined in any existing
agreements between us and our senior officers
- the director voluntarily resigns from the Board
CONSULTING FEES. In fiscal 1998, we paid Martin A. Mayer $1,800 plus
expenses for strategic planning services Mr. Mayer rendered to us in connection
with senior management strategic planning meetings. We also paid Marvin W.
Goldstein $12,000 in fiscal 1998 for consulting services Mr. Goldstein rendered
to us in connection with providing merchandising training and strategic
planning.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
AUDIT COMMITTEE. Our board of directors has an Audit Committee. The Audit
Committee is currently comprised of Messrs. Cobb, Goldstein and Mayer. The Audit
Committee:
- assists the Board with its accounting, auditing, operating and reporting
practices
- analyzes our annual financial statements
- selects and works with our independent auditors
- monitors the adequacy of our internal controls for compliance with
corporate policies and directives
COMPENSATION COMMITTEE. Our board of directors also has a Compensation
Committee. The Compensation Committee is currently comprised of Messrs.
Dolginow, Mayer and Goldstein. The Compensation Committee:
- reviews and recommends to the Board the compensation of our directors,
executive officers and key employees
- administers our 1997 Stock Option and Compensation Plan
38
<PAGE>
EXECUTIVE COMPENSATION
The following table provides summary information concerning cash and
non-cash compensation for each of the last three fiscal years paid to or earned
by our President and Chief Executive Officer and our three other most highly
compensated executive officers, each of whose total annual salary and bonus
exceeded $100,000 in the fiscal year ended January 29, 1999 (the "Named
Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
-------------
ANNUAL COMPENSATION SECURITIES
NAME AND ----------------------- UNDERLYING ALL OTHER
PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) OPTIONS (#) COMPENSATION ($)(1)
- ---------------------------------------------- --------- ---------- ----------- ------------- -------------------
<S> <C> <C> <C> <C> <C>
Yale T. Dolginow.............................. 1998 $ 285,000 $ -- -- $ 27,405
PRESIDENT AND 1997 285,000 -- -- 27,335
CHIEF EXECUTIVE OFFICER 1996 285,000 -- -- 27,005
Brent D. Schlosser............................ 1998 145,000 -- -- 1,394
EXECUTIVE VICE PRESIDENT 1997 145,000 -- -- 1,450
1996 145,000 -- -- 1,394
Cheryl W. Newell(2)........................... 1998 125,000 15,000 17,000 481
VICE PRESIDENT AND 1997 62,749 -- 17,000 --
CHIEF FINANCIAL OFFICER 1996 -- -- -- --
Steven P. Durst............................... 1998 93,462 10,000 11,200 787
VICE PRESIDENT OF 1997 70,000 5,000 11,200 700
MERCHANDISING 1996 55,000 -- -- 254
</TABLE>
- ------------------------
(1) Represents amounts of matching contributions we made to the Named Executive
Officers' respective 401(k) accounts, except for Mr. Dolginow which amounts
also include $25,727 in each of 1998, 1997 and 1996 as the value of benefits
for Mr. Dolginow, determined as prescribed by the SEC for this type of
valuation, under a "split dollar" life insurance arrangement.
(2) Ms. Newell has been Vice President and Chief Financial Officer of the
Company since August 1997.
39
<PAGE>
OPTION GRANTS
The following table summarizes option grants during the fiscal year ended
January 29, 1999 to the Named Executive Officers and the potential realizable
value of the options.
OPTION GRANTS IN FISCAL YEAR 1998
<TABLE>
<CAPTION>
% OF POTENTIAL REALIZABLE
TOTAL VALUE AT ASSUMED
NUMBER OF OPTIONS ANNUAL RATES OF STOCK
SECURITIES GRANTED TO EXERCISE PRICE APPRECIATION
UNDERLYING EMPLOYEES OR BASE FOR OPTION TERM(1)
OPTIONS IN FISCAL PRICE EXPIRATION ---------------------
NAME GRANTED (#) YEAR 1998 ($/SHARE) DATE 5% 10%
- ----------------------------------------------- ------------- --------------- ----------- ----------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Cheryl W. Newell............................... 17,000 9.3% $ 2.75 12/07/08 $ 29,401 $ 74,507
Steven P. Durst................................ 11,200 6.1% 2.75 12/07/08 19,370 49,087
</TABLE>
- ------------------------
(1) These amounts represent certain assumed rates of appreciation only. Actual
gains, if any, on stock option exercises depend upon our common stock's
future performance, overall market conditions and the executive's continued
involvement with us. The amounts represented in this table will not
necessarily be achieved.
All options set forth in the above table vest in one-third increments
beginning on the first anniversary of the date of grant and on each of the next
two anniversaries of this date with all options granted becoming fully vested
three years from the date of grant. See "Stock Option Plans--Employee Stock
Option Plan" for change in control provisions.
OPTION EXERCISES
The following table summarizes option exercises during the fiscal year ended
January 29, 1999 and the number and value of options held by the Named Executive
Officers as of January 29, 1999.
AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1998
AND 1998 FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF VALUE OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES VALUE JANUARY 29, 1999 (#) JANUARY 29, 1999 ($)(1)(2)
ACQUIRED ON REALIZED ---------------------------- ------------------------------
NAME EXERCISE (#) ($)(2) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------------- --------------- ----------- ------------- ------------- ------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Yale T. Dolginow..................... -- $ -- -- -- $ -- $ --
Brent D. Schlosser................... -- -- -- -- -- --
Cheryl W. Newell..................... 0 0 5,666 28,334 0 0
Steven P. Durst...................... 0 0 3,733 18,667 0 0
</TABLE>
- ------------------------
(1) Based on the January 29, 1999 closing price of the common stock of $2.125.
(2) The "Value Realized" and the "Value of Unexercised In-the-Money Options"
amounts are calculated based on the excess of the market value of our common
stock on the date of exercise or January 29, 1999 over the exercise price.
The exercise price of options may be paid in cash or in shares of our common
stock valued at fair market value on the day prior to the date of exercise.
EMPLOYMENT AGREEMENTS
In July 1997, Cheryl W. Newell entered into an employment agreement with us
to serve as Chief Financial Officer. Ms. Newell will receive an annual base
salary of $115,000, subject to increase by the Board based upon her performance,
appropriate industry guideline data and other factors. Ms. Newell
40
<PAGE>
may also receive an annual bonus based upon her performance. Upon the completion
of our initial public offering of common stock, Ms. Newell received an option to
purchase 17,000 shares of our common stock as provided in her employment
agreement. Under her agreement, Ms. Newell may not disclose confidential
information about us for the term of the agreement and for one year thereafter
and may not compete with us for a two-year period after termination of her
employment with us. Ms. Newell may terminate her employment with us upon 30
days' written notice to us at any time for any reason.
STOCK OPTION PLANS
EMPLOYEE STOCK OPTION PLAN. We have adopted a 1997 Stock Option and
Compensation Plan (the "Employee Stock Plan"). We may grant officers, key
employees, non-employee directors and independent contractors, stock options,
stock appreciation rights, stock awards, performance shares and cash awards
under the Employee Stock Plan. We have reserved an aggregate 1,025,000 shares of
our common stock for issuance under the Employee Stock Plan.
The Compensation Committee of our Board administers the Employee Stock Plan.
The Compensation Committee is authorized to determine, among other things, the
following:
- the participants 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
- 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 stock options and ten years plus one day for non-statutory
stock options. No option may be exercised during the first 12 months after the
date of grant. Upon the occurrence of a "change in control," unless otherwise
determined by our board of directors and a majority of the "continuing
directors" ("continuing directors" are directors who were in office before 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):
- the restrictions on all shares of restricted stock awards lapse
immediately
- all outstanding options and stock appreciation rights will become
exercisable immediately
- 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:
- any person or group becomes the beneficial owner of 30% or more of any of
our equity security entitled to vote for the election of directors
- a majority of the members of our board of directors is replaced within the
period of less than two years by directors not nominated and approved by
our board of directors
- our stockholders 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 our assets (including a plan of liquidation)
Pursuant to our Employee Stock Plan, we have granted options to purchase an
aggregate of 327,200 shares at an exercise price equal to the fair market value
on the date of grant. These options
41
<PAGE>
vest over a three-year period beginning on the first anniversary of the date of
grant and expire ten years from the date of grant.
DIRECTORS STOCK OPTION PLAN. We have adopted the Director Plan. The Board
administers the Director Plan. We have reserved an aggregate of 40,000 shares of
our common stock for issuance under the Director Plan. See "Director
Compensation--Director Options."
EMPLOYEE STOCK PURCHASE PLAN
On December 7, 1998, our Board approved an Employee Stock Purchase Plan,
subject to stockholder approval. The Employee Stock Purchase Plan reserves
150,000 shares of our common stock for issuance and purchase by our employees to
assist them in acquiring a stock ownership interest in us and to encourage them
to remain our employees. The Employee Stock Purchase Plan is intended to qualify
under Section 423 of the Internal Revenue Code and permits eligible employees to
purchase shares of our common stock at a discount through payroll deductions
during specified six-month offering periods. No employee may purchase more than
$25,000 worth of stock in any calendar year or 5,000 shares of our common stock
in any one offering period. Our Compensation Committee administers the Employee
Stock Purchase Plan. Generally, the purchase price of our common stock under the
Employee Stock Purchase Plan must not be less than 85% of the fair market value
of the common stock on the first or last day of the offering period, whichever
is lower. As of April 30, 1999, no shares have been purchased under the Employee
Stock Purchase Plan. Our stockholders approved the Employee Stock Purchase Plan
at our annual meeting on June 11, 1999. The first offering period under the
Employee Stock Purchase Plan will begin on August 1, 1999.
42
<PAGE>
CERTAIN TRANSACTIONS
We employ Steven P. Durst as Vice President of Merchandising, a position he
has held since June 1998. Before that time Mr. Durst served as our Vice
President of Information Systems and as our Director of Information Systems. Mr.
Durst joined us in 1995 and is the son-in-law of Yale T. Dolginow, our President
and Chief Executive Officer, and Diane C. Dolginow, our Secretary. During fiscal
1998, we paid Mr. Durst $103,462 in annual compensation.
Before our initial public offering, we were treated as an S-Corporation
under the Internal Revenue Code for federal and certain state income tax
purposes. As a result, our earnings were taxed directly to our then current
stockholders, Mr. Dolginow and Mr. Schlosser (the "S-Corporation Stockholders")
rather than to us. To provide the S-Corporation Stockholders with the funds to
pay income taxes on these earnings and as a return on their investment, we paid
annual distributions to them. In connection with our initial pubic offering, we
converted from an S-Corporation to a C-Corporation under the Code. In January
1997, the Board declared a cash dividend payable to the S-Corporation
Stockholders, which the board of directors intended to equal the balance of
accumulated taxable income from the date of the last dividend to the
S-Corporation Stockholders (January 13, 1997) through July 31, 1997. The precise
amount of the cash dividend was to be later determined by us and our auditors
upon the completion of our tax returns. Before our initial public offering, we
estimated the cash dividend to be equal to $166,000. Because the amount of the
cash dividend was not finalized at the closing of the initial public offering,
it was not actually paid at that time. In October 1998, we completed all of our
required tax returns for the period when we were an S-Corporation and determined
that the actual amount of the cash dividend should have been $133,000 and not
$166,000. On October 8, 1998, we paid the S-Corporation Stockholders a total of
$133,000 to satisfy our obligation to pay the S-Corporation Stockholders the
cash dividend, which payment was consistent with the tax agreement described
below.
Paper Warehouse and both Messrs. Dolginow and Schlosser are parties to an
S-Corporation Tax Allocation and Indemnification Agreement relating to their
respective income tax liabilities. The tax agreement provides that we will
indemnify Messrs. Dolginow and Schlosser for any adjustments causing an increase
in their federal and state income tax liability (including interest and
penalties) related to our tax years before our initial public offering. They are
not indemnified if the adjustments result in or are related to a corresponding
decrease in their federal and state income tax liability with respect to another
S-Corporation taxable year.
Subject to certain limitations, the tax agreement also provides that Messrs.
Dolginow and Schlosser will indemnify us with respect to federal and state
income taxes (plus interest and penalties) in connection with shifting from an
S-Corporation taxable year to a C-Corporation taxable year subsequent to our
initial public offering. Since neither Mr. Dolginow nor Mr. Schlosser have given
any security for their indemnification obligations, our ability to collect these
payments depends upon their financial condition at the time of any these
indemnification obligation arises. We are not aware of any tax adjustments that
may arise under the tax agreement.
The tax agreement further provides that to the extent that our accumulated
taxable income prior to our conversion to a C-Corporation is less than the cash
dividends, Messrs. Dolginow and Schlosser will make a payment equal to the
difference to us, and if the accumulated taxable income is greater than the
aggregate amount of the cash dividends, we will make an additional distribution
equal to the difference to them, in either case, with interest thereon. Any
payment we make to them pursuant to the tax agreement may be considered by the
Internal Revenue Service or the state taxing authorities to be nondeductible by
us for income tax purposes.
In December 1998, we entered into an Asset Purchase Agreement with Prickly
Pear Paper, Inc. and Susan Hazan. Prickly Pear operated four franchise stores in
Tucson, Arizona, and Ms. Hazan was president and a 95% stockholder of Prickly
Pear. Ms. Hazan is Mr. Dolginow's sister. Mr. Dolginow was Prickly Pear's Vice
President. We purchased all of the assets of the four franchise stores for
43
<PAGE>
approximately $1.2 million cash and 70,749 shares of our common stock for an
aggregate purchase price of $1,349,974. We allocated the purchase price based on
the fair market value of the net assets and recorded any excess as goodwill. We
now employ Ms. Hazan as a district manager. Before the acquisition, Prickly Pear
paid franchise, continuing and other fees to us in fiscal 1998 in the aggregate
amount of approximately $88,728.
In March 1996, we sold a Paper Warehouse store located in Lawrence, Kansas
to Sunflower Party and Paper, Inc. for an aggregate amount of $144,000 plus the
assumption of some of our liabilities relating to that store. Sunflower operates
this store as a franchise store and is wholly-owned by Larry and Patty
Schlosser, the brother and sister-in-law of Mr. Schlosser. During fiscal 1998,
Sunflower paid us an aggregate of approximately $24,810 in franchise and other
fees. On February 28, 1998, Sunflower renewed its sublease with us through
January 30, 2002. Total payments to us under the terms of the sublease were
approximately $66,227 during fiscal 1998.
Mr. Dolginow is a director of Richfield Bank & Trust Co. We had a $7,500,000
line of credit with Richfield Bank, which was paid-in-full on June 7, 1999. On
April 8, 1999 we refinanced the loan from Richfield Bank for our corporate
headquarters. As part of the refinancing, Mr. Dolginow was released from his
personal guarantee to the U.S. Small Business Administration in the original
principal amount of $433,000, the proceeds of which were also used to finance,
in part, the acquisition of the our corporate headquarters.
We believe that all prior transactions between us and our officers,
directors and other affiliates have been on terms no less favorable than could
have been obtained from unaffiliated third parties. Any future transactions and
loans with our officers, directors or 5% stockholders will be on terms no less
favorable to us than could be obtained from unaffiliated third parties and will
be approved by a majority of the independent outside members of our board of
directors who do not have an interest in the transactions.
44
<PAGE>
PRINCIPAL SHAREHOLDERS AND BENEFICIAL
OWNERSHIP OF MANAGEMENT
The following table sets forth information regarding the beneficial
ownership of our common stock as of June 1, 1999, unless otherwise noted by:
- each stockholder who we know beneficially owns more than 5% of our
outstanding common stock
- each director and nominee for election to our Board
- each executive officer named in the Summary Compensation Table above
- all of our executive officers and directors as a group
The address for all of our executive officers and directors is 7630
Excelsior Boulevard, Minneapolis, Minnesota 55426.
<TABLE>
<CAPTION>
SHARES OF COMMON STOCK
BENEFICIALLY OWNED(1)
-----------------------
PERCENT
OF
NAME AMOUNT CLASS(2)
- ----------------------------------- -------------- ------
<S> <C> <C>
Yale T. Dolginow................... 1,917,443(3) 41.4%
Brent D. Schlosser................. 286,375 6.2%
Diane C. Dolginow.................. (4)0 *
Arthur H. Cobb..................... 5,999(5) *
Marvin W. Goldstein................ 14,999(6) *
Martin A. Mayer.................... 48,322(7) 1.0%
Jeffrey S. Halpern................. 4,999(8) *
Cheryl W. Newell................... 8,666(9) *
Steven P. Durst.................... 3,733(10) *
Wellington Management Company LLP
75 State Street
Boston, Massachusetts 02109...... 444,900(11) 9.6%
All directors and executive
officers as a group (9
persons)......................... 2,290,536(12) 48.8%
</TABLE>
- ------------------------
* Less than 1% of the outstanding shares.
(1) Shares not outstanding but deemed beneficially owned by virtue of the right
of a person or member of a group to acquire them within 60 days are treated
as outstanding only when determining the amount and percent owned by the
person or group. Unless otherwise noted, all of the shares shown are held
by individuals or entities possessing sole voting and investment power with
respect to these shares of common stock.
(2) Based on 4,627,936 shares of our common stock outstanding as of June 1,
1999.
(3) Includes 301,000 shares held in trust for Mr. Dolginow's daughters.
(4) Does not include shares beneficially owned by Yale T. Dolginow, Ms.
Dolginow's husband.
(5) Includes options to purchase 4,999 shares of our common stock exercisable
within 60 days.
(6) Includes options to purchase 4,999 shares of our common stock exercisable
within 60 days.
(7) Includes options to purchase 43,322 shares of our common stock exercisable
within 60 days, of which 38,323 shares represent shares issuable upon
exercise of a stock option granted to Mr. Mayer by Mr. Dolginow.
45
<PAGE>
(8) Includes options to purchase 4,999 shares of our common stock exercisable
within 60 days.
(9) Includes options to purchase 5,666 shares of our common stock exercisable
within 60 days.
(10) Includes options to purchase 3,733 shares of our common stock exercisable
within 60 days.
(11) Based solely on a Schedule 13G dated December 31, 1998, reporting
beneficial ownership of 444,900 shares of our common stock held by
Wellington Management Company, LLP, as an investment adviser, which are
all held of record by clients of Wellington Management. Wellington
Management has shared voting power over 364,900 shares and shared
dispositive power over 444,900 shares.
(12) Includes options to purchase 67,718 shares of our common stock exercisable
within 60 days.
46
<PAGE>
DESCRIPTION OF DEBENTURES
We will issue the Debentures under an Indenture dated as of July 15, 1999
between us and Norwest Bank Minnesota, N.A., as trustee. Many of the terms and
conditions applicable to the Debentures will be contained in the Indenture. The
following summarizes some, but not all, of the provisions of the Debentures and
the Indenture. Prospective buyers of the Debentures should refer to the actual
terms of the Debentures and the Indenture for the definitive terms and
conditions. Copies of the proposed forms of Indenture and Debentures are filed
as exhibits to the Registration Statement of which this prospectus is a part. As
used in this Description of Debentures, the words "we," "us," or "our" do not
include any of our subsidiaries unless expressly stated. Capitalized terms used,
but not defined, in this Description of Debentures have the meanings given in
the Indenture.
GENERAL
The total principal amount of the Debentures will be limited to $4,000,000.
The Debentures represent our general unsecured obligations and are subordinate
in right of payment to our Senior Debt as described under "--Subordination." We
will issue the Debentures in fully registered form only, without coupons, in
denominations of $1,000 each and any integral multiple of $1,000. The Debentures
will mature on September 15, 2005 unless converted, redeemed or repurchased
before the maturity date. See "--Conversion," "--Optional Redemption by Us" and
"--Repurchase at Option of Holder."
The Debentures will accrue interest at an annual rate of 9%. We will pay the
first interest payment on September 15, 1999, and quarterly after that date on
the 15th day of December, March, June and September. We will also pay all
accrued interest upon maturity, conversion, redemption and repurchase of the
Debentures. Interest will be payable to the person in whose name the Debenture
is registered at the close of business on the Regular Record Date for the
interest installment, which is the 15th day of the calendar month preceding each
Interest Payment Date. If any payment date falls on a day that is not a business
day, we will make the payment on the next business day and we will not pay any
additional interest. We will generally make all interest payments on the
Debentures by check mailed to the holders entitled to the interest. Whenever
interest is paid, the payment will include interest accrued to, but excluding,
the interest payment date or the date of redemption, conversion, repurchase or
maturity. We will compute interest on the Debentures on the basis of a 360-day
year comprised of 12 30-day months.
The Indenture restricts our ability to enter into transactions, unless we
first satisfy certain conditions described in the Indenture. If the transaction
involves a "Change of Control," you will have the right to require us to
repurchase your Debentures, in the manner described in "--Repurchase at Option
of Holder." Dividends, stock splits and other distributions may result in an
adjustment to the conversion price of the Debentures.
The Debentures will have no sinking fund. A sinking fund is a custodial or
similar account into which regularly scheduled deposits are made for purposes of
funding the redemption or repurchase of the principal amount of the Debentures.
As long as we are a reporting company under the Exchange Act, we must
furnish to the Trustee and all Debenture holders all reports required to be
filed with the Commission under the Exchange Act.
The holder of any Debenture, may present such Debenture for registration,
transfer or exchange at an office of Norwest Bank Minnesota, as trustee, located
in the continental United States. The Trustee will maintain a registry for the
Debentures. We will not charge any fee for registration, transfer or exchange of
any Debentures. We may request reimbursement for taxes incurred by us in
connection with any registration, transfer or exchange of Debentures. We are not
required to register the transfer
47
<PAGE>
or exchange of any Debenture that has been previously surrendered for
repurchase, conversion or redemption.
CONVERSION
You may convert your Debenture, in whole or in part, into our common stock
at an initial conversion price equal to $ principal amount of Debentures
for each share of common stock. You may convert your Debenture at any time
before the close of business on July 15, 2005. If we call the Debentures for
redemption or you submit the Debentures for repurchase, your conversion rights
will expire at the close of business on the Redemption Date or the Repurchase
Date, as applicable.
You may exercise the right to convert your Debentures in denominations of
integral multiples of $1,000 by delivering your Debentures to the trustee's
designated office in the U.S. accompanied by a written notice that you elect to
convert your Debentures. If the date of conversion occurs after a Regular Record
Date, but before the next Interest Payment Date, and we have not called the
Debentures for redemption, we will pay you the interest due on the next Interest
Payment Date, regardless of the conversion, but only interest to the date of
conversion. If the principal amount you wish to convert is not evenly divisible
by the conversion price, instead of issuing a fractional share, we will pay you
a cash adjustment in an amount equal to the same fraction of the conversion
price per share of common stock.
If you present a Debenture for conversion, you will not be required to pay
any taxes or duties relating to the issuance of our common stock (except to the
extent relating to exchange or currency control matters or the status of the
person converting the Debentures), but you will be required to pay any tax or
duty resulting from the issuance of common stock in the name of any other
person.
The conversion price may be adjusted upon certain events including:
- our issuing common stock or other capital stock as a dividend or
distribution to the holders of our common stock
- our dividing or combining our outstanding shares of common stock into a
different number of shares
- our issuing common stock as a result of reclassification of our common
stock
- subject to certain exceptions, our fixing a record date for making a
rights offering to our stockholders
- our Board determining that a reduction is in our best interest, to the
extent permitted by law
In the event of any reclassification or other change in our common stock, or
our consolidation, merger, or combination with or into another entity or a sale
or conveyance to another person of our property and assets as an entirety or
substantially as an entirety, that results in the holders of our common stock
becoming entitled to receive stock, other securities, cash or other property or
assets on or in exchange for their shares of common stock, you will generally be
entitled to convert your Debentures into the type and amount of property or
assets, including cash, that you would have received had the Debentures been
converted immediately before the event. All references in this Description of
Debentures to "common stock" in the context of your right to convert, should be
construed to mean either our common stock or the other property into which the
Debenture is convertible.
You may, in certain circumstances, be deemed to have received a distribution
or dividend subject to U.S. income tax as a result of an adjustment (or the
nonoccurrence of an adjustment) to the conversion price of your Debentures. See
"--Certain United States Federal Income Tax Considerations."
48
<PAGE>
Unless the adjustment in the conversion price requires an increase or
decrease of at least $.01 per share, we will not be required to make any
adjustments in the conversion price. Any adjustment not made will be taken into
account in subsequent adjustments.
OPTIONAL REDEMPTION BY US
On or after July 15, 2002, we may elect to redeem the Debentures. If we
elect to redeem the Debentures, we must redeem all of them. We will not be
allowed to redeem the Debentures before July 15, 2002. We will provide the
holders of the Debentures at least 30 but not more than 60 days notice of our
intent to redeem the Debentures.
The Redemption Price for the Debentures (expressed as a percentage of the
principal amount of each Debenture thereof) will be as follows for Debentures
redeemed in the 12-month periods beginning on July 15 of each of the following
years:
<TABLE>
<CAPTION>
PERCENTAGE OF
YEARS EACH DEBENTURE
- ----------------------------------------------------------------------------- ---------------
<S> <C>
1999-2001.................................................................... No call
2002......................................................................... 108%
2003......................................................................... 104%
2004 and thereafter.......................................................... 100%
</TABLE>
We will also pay accrued interest through the Redemption Date. If an
Interest Payment Date occurs before the Redemption Date, the interest payable on
such Interest Payment Date will be paid to the holder of record as of the
relevant Record Date. Interest not so paid will be paid to the party to whom the
Redemption Price is paid.
We have no right to redeem the Debentures during any period when an Event of
Default, or an event which, with notice or lapse of time or both, would
constitute an Event of Default, has occurred and is continuing.
REPURCHASE AT OPTION OF HOLDER
If we experience a Change of Control before September 15, 2005, you will
have the right, at your option, to require us to repurchase all or part of your
Debentures on the 45th calendar day after the date that we mail a notice to you
of the occurrence of a Change of Control. We will pay the Repurchase Price in
cash and the Repurchase Price will be 102% of the principal amount of the
Debentures. We will also pay accrued interest up to the Repurchase Date. If an
Interest Payment Date is on or before the Repurchase Date, we will pay the
interest payable on such Interest Payment Date to the holder of record on the
relevant Record Date. Interest not so paid will be paid to the party to whom the
Repurchase Price is paid.
You may exercise your repurchase rights by delivering written notice
indicating, among other things, that you have elected to exercise your
repurchase rights to the Trustee on or before the close of business on the 30th
calendar day after the date of our repurchase notice. The notice is to be
accompanied by the Debentures, endorsed for transfer to us.
The Indenture defines "Change of Control" as follows:
- "Change of Control" of Paper Warehouse will be deemed to have occurred at
such time as any Person is or becomes the beneficial owner (as defined in
Rule 13d-3 under the Exchange Act) of shares of our capital stock
entitling such Person to exercise 50% or more of the total voting
49
<PAGE>
power of all shares of our capital stock entitled to vote in elections of
directors. A "Change of Control" will not be deemed to have occurred if
any of the following has occurred:
TRIANGLE the Person is Yale T. Dolginow, or an Affiliate of his, and
such Person does not become the beneficial owner of shares of
our capital stock entitling such Person to exercise 66% or
more of the total voting power of all shares of our capital
stock entitled to vote in elections of directors;
TRIANGLE the closing price of our common stock equals or exceeds 125%
of the effective conversion price on any five trading days
during the ten trading-day period immediately preceding the
date of the Change of Control; or
TRIANGLE all the consideration (excluding cash payments for fractional
shares) to be paid for our common stock in the transaction(s)
constituting a Change of Control consists of shares of common
stock traded on a national securities exchange or quoted on
the Nasdaq National Market System and as a result of such
transaction(s) the Debentures become convertible solely into
such common stock.
In the event that we are required to repurchase the Debentures, there can be
no assurances that we will have sufficient funds to pay the Repurchase Price. A
Change of Control may result in a default (directly or by way of a cross-default
provision) under one or more agreements governing our Senior Debt. In such a
circumstance, the subordination provisions contained in the Indenture may
prevent us from making any payment on the Debentures, including a payment of the
Repurchase Price, unless we first obtain the consent of the holders of defaulted
Senior Debt or repay the Senior Debt in full.
Your right to require us to repurchase Debentures as a result of a Change of
Control may have the effect of delaying, deferring or preventing a Change of
Control or other attempt to acquire control of us. Consequently, the right may
make more difficult a merger, consolidation or tender offer, or an assumption of
control by a holder of a large block of our shares and the removal of incumbent
management. The Change of Control repurchase feature is a result of negotiations
between us and Miller & Schroeder and is not the result of our knowledge of any
specific effort to accumulate shares of common stock or to obtain control of us
by means of a merger, tender offer, solicitation or otherwise, or part of a plan
by us to adopt a series of anti-takeover provisions. We have no present
intention to engage in a transaction involving a Change of Control, although it
is possible that we would decide to do so in the future.
Rule 13e-4 under the Exchange Act requires the distribution of certain
information to security holders in the event of certain issuer tender offers and
may apply in the event of a repurchase. We will comply with this rule to the
extent applicable.
SUBORDINATION
All payments under the Debentures are, to the extent provided in the
Indenture, subordinate and junior to the prior payment in full of all Senior
Debt. The subordination provisions apply to existing Senior Debt as well as
Senior Debt incurred after the date of this prospectus. The Debentures will be
senior in right of payment to any Subordinated Debt and to any debt (other than
the Debentures) held by an affiliate of ours, whether outstanding at the closing
of this offering or created thereafter.
Upon any distribution of our assets, dissolution, winding up, liquidation or
reorganization of us, the payments on the Debentures will be subordinated in
right of payment to the prior payment in full of all Senior Debt. Moreover, if
the Debentures are accelerated following an Event of Default, the holders of any
Senior Debt then outstanding will be entitled to payment in full before the
holders of the Debentures are entitled to receive any payment on the Debentures.
However, our obligations to make payments with respect to the Debentures will
not otherwise be affected. We are the sole obligor on the Debentures.
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In addition, the subordination provisions will prevent us from making any
payments on the Debentures if:
- we fail to pay any payment of principal, interest, premium, or other
obligation, if any, due on any Senior Debt beyond the applicable grace
period
- any other default occurs and is continuing under any Senior Debt that
permits holders of the Senior Debt to accelerate the maturity of any
Senior Debt
We may resume making payments on the Debentures once the default on the
Senior Debt is cured or waived or otherwise ceases to exist.
The Indenture defines "Senior Debt" as follows:
"Senior Debt' means the principal of, premium (if any) and interest on
(i) any and all Indebtedness of the Company (other than the Debentures,
Parity Debt and Subordinated Debt) incurred in connection with the
borrowing of money, all Indebtedness to the extent it is secured by real
estate and/or assets of the Company (including Capitalized Lease
Obligations), all Indebtedness evidenced by bonds, debentures, mortgages,
notes or other securities or other instruments, incurred, assumed or
guaranteed by the Company before, at or after the date of execution of
this Indenture, all Indebtedness evidenced by bankers' acceptances of
similar instruments, or by letters of credit, bank guarantees or
reimbursement obligations therefor, all Indebtedness under swap or
hedging transactions, and Indebtedness represented by previously issued
and outstanding debentures which have been called for redemption and (ii)
all renewals, extensions and refundings thereof; provided that any
Indebtedness shall not be Senior Debt if the instrument creating or
evidencing any such Indebtedness or pursuant to which such Indebtedness
is outstanding, provides that such Indebtedness, or such renewal,
extension or refunding thereof, is junior or is not superior in right of
payment to the Debentures."
The Indenture does not prevent us from incurring additional Senior Debt. As
of April 30, 1999, we had approximately $9.7 million of outstanding Indebtedness
which is expected to be Senior Debt.
The subordination provisions of the Indenture and the Debentures will not
prevent the occurrence of any default or Event of Default or limit the rights of
any holder of Debentures to pursue any other rights or remedies with respect to
the Debentures.
As a result of the subordination provisions, in the event of the
liquidation, bankruptcy, reorganization, insolvency, receivership or similar
proceedings, holders of the Debentures may receive less than other creditors (on
a ratable basis).
EVENTS OF DEFAULT AND REMEDIES
The following events are included as "Events of Default" in the Indenture:
- our failure to pay interest on the Debentures when due if the failure
continues for 30 days
- our failure to pay the principal of, or premium, if any, on any of the
Debentures when due
- our breach of any financial covenant and continuance of such breach for a
period of 30 days after the date of our report to the Trustee
- our failure to perform any other covenant or warranty in the Indenture if
the failure continues for 30 days after appropriate notice is given to the
Company, the Trustee and the Debenture holders, as applicable
- a default by us on any Indebtedness (other than the Debentures and the
mortgage on our corporate headquarters) that results in the acceleration
of Indebtedness in an amount in excess
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of $500,000 and the Indebtedness or the acceleration has not been
discharged for 60 days after notice is given in accordance with the
Indenture
- certain events involving bankruptcy, insolvency or reorganization of us
- a final judgment by a court against us for the payment of money in an
amount in excess of $500,000 (net of insurance proceeds) which judgment
remains unsatisfied for 30 days after the right to appeal such judgment
has expired or terminated
The Trustee will be generally required, within 60 days after its becoming
aware of a default, to provide the registered holders of the Debentures written
notice of the default. Except in the case of a payment default, the Trustee will
not be required to deliver a notice of default if it determines in good faith
that withholding the notice is in the best interest of the holders of the
Debentures.
If an Event of Default has occurred and is continuing, the Trustee, or the
holders of not less than 25% of the aggregate principal amount of the
Debentures, may declare all amounts outstanding on the Debentures to be
immediately due and payable. If an Event of Default occurs resulting from the
bankruptcy, insolvency or reorganization of us, all unpaid principal of and
accrued interest on the outstanding Debentures would become due and payable
immediately without any declaration or other act on the part of the Trustee or
holders of Debentures.
The Indenture will generally provide that the holders of a majority in
principal amount of the outstanding Debentures may direct the time, method and
place of conducting any proceeding for any remedy available to the Trustee or
exercising any trust or power conferred on the Trustee, subject to certain
limitations. Before proceeding to exercise any right or power under the
Indenture at the direction of the holders, the Trustee will be entitled to
receive from the holders reasonable security or indemnity against any costs,
expenses and liabilities that it might incur as a result. Following an Event of
Default for nonpayment, each holder to which the default pertains will have the
absolute right to institute suit to enforce payment of any Debentures held by
it.
Generally, the holders of at least a majority in aggregate principal amount
of the outstanding Debentures may on behalf of the holders of all Debentures
waive any default or Event of Default. The consent of all Debenture holders will
be required to waive any Events of Default relating to a failure to make payment
on any Debenture, convert any Debenture into common stock or to comply with any
of the provisions of the Indenture that would require the consent of affected
holders to modify.
Within 90 days of the end of each fiscal year, we will be required to send
the Trustee a statement of certain of our officers stating:
- that such officer has analyzed our activities during such year and
supervised the performance under this Indenture
- whether, to the best of such officer's knowledge based on such analysis,
we are in compliance with our obligations under this Indenture or if we
have defaulted on such obligations
We are also required, if certain of our officers obtain knowledge that we
are not in compliance with the terms of the Indenture or the Debentures, to
deliver to the Trustee a statement specifying the nature of the default and the
action we have taken, are taking or proposes to take to cure the default.
RESTRICTIVE COVENANTS
CONSOLIDATION, MERGER OR SALE OF ASSETS. The Indenture provides that we may
not consolidate or merge with or into another Person or convey, transfer or
lease all or substantially all of our properties and assets to another Person,
Paper Warehouse or any Subsidiary, unless,
- if we are not the surviving entity, such surviving entity must be a U.S.
business entity and expressly assume all of our obligations under the
Debentures and the Indenture
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- no Event of Default will exist or will occur immediately after giving
effect to the transaction
- certain other conditions are satisfied
LIMITATIONS ON TRANSACTIONS WITH AFFILIATES. Any Indebtedness between the
Company and any Affiliate will be subordinate and junior in right of payment to
the Debentures, unless such Indebtedness is borrowed from Yale Dolginow and
approved by a majority of our Board's Independent members prior to the date of
such Indebtedness. We cannot, and we cannot permit any Subsidiary, to engage in
any transaction of any kind or nature with any of our Affiliates, other than a
wholly-owned Subsidiary, unless
- a majority of our Board's Independent members determines that the
transaction terms are fair to us or our subsidiary, as the case may be
- the terms of the transaction are more beneficial to us or Subsidiary, as
the case may be, than a similar transaction with an unrelated person under
the same circumstances
- a person experienced in the nature of the transaction certifies the
transaction to the Board as fair to us or our Subsidiary, as the case may
be, and the terms are those that would be found in similar transactions
with unrelated persons under the same circumstances
RESTRICTIONS ON DIVIDENDS AND REDEMPTIONS. We can only make dividends or
distributions that are paid in our capital stock. Neither us nor our Subsidiary
may purchase, redeem or acquire for value any of our capital stock, unless we
meet certain conditions specified in the Indenture.
NET WORTH. We must at all times during the term of the Debentures keep and
maintain Consolidated Tangible Net Worth at an amount not less than $7,000,000
plus 50% of positive Consolidated Net Income earned after January 29, 1999.
MODIFICATIONS OF THE INDENTURE
The Indenture generally allows the Trustee and us, with the consent of the
holders of not less than a majority of the aggregate principal amount of the
outstanding Debentures, to modify the Indenture, any supplemental indenture or
the Debentures. The following modifications require the consent of each affected
Debenture holder:
- an extension of the maturity of any Debenture or any interest or premium
payment
- a reduction in the rate or an extension of the time or payment of interest
on any Debenture
- a reduction in the principal amount of any Debenture
- a reduction in any amount payable upon redemption or repurchase of any
Debenture
- any modification to our obligation to repurchase any Debenture upon the
happening of a Change of Control if adverse to any holder of Debentures
- any modification that impairs or adversely affects the right of any holder
to institute suit for the payment of any Debenture
- any change in currency in which any Debenture is payable
- any modification, to the right of the holders to convert the Debentures
into common stock if adverse to any holder of Debentures
- any modification of the subordination provisions that adversely affects
the holders of the Debentures
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SATISFACTION AND DISCHARGE
We may discharge our obligations under the Indenture while the Debentures
remain outstanding if:
- all Debentures are within one year of their scheduled maturity or the date
on which they are scheduled for redemption; and
- we have deposited with the Trustee an amount sufficient to pay all
outstanding Debentures on their scheduled maturity or the date scheduled
for redemption.
GOVERNING LAW
The Indenture and the Debentures will be governed by the laws of the State
of Minnesota.
CONCERNING THE TRUSTEE
Norwest Bank Minnesota, N.A. will serve as Trustee under the Indenture and
is also the Debenture Registrar.
The Trustee under the Indenture, has been appointed by us as the initial
paying agent, conversion agent, registrar and custodian with regard to the
Debentures. We may maintain deposit accounts and conduct other banking
transactions with the Trustee or its affiliates in the ordinary course of
business.
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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of certain U.S. federal income tax considerations
applicable to U.S. holders of Debentures relating to the purchase, ownership and
disposition of the Debentures and of common stock into which Debentures may be
converted, but is not a complete analysis of all potential tax considerations.
The summary assumes that the Debentures will be treated as "debt" and not
"equity" for federal income tax purposes. This summary is based on laws,
regulations, rulings and decisions now in effect, which may change in the
future. It relates only to those of you who will hold Debentures and common
stock into which Debentures may be converted as "capital assets" (within the
meaning of Section 1221 of the Internal Revenue Code) and does not address
particular tax considerations or individual circumstances. You may be subject to
special tax rules if you are:
- subject to the alternative minimum tax;
- a bank or other financial institution;
- a tax-exempt organization;
- an insurance company;
- a foreign person or entity;
- a broker or dealer in securities or currencies;
- holding Debentures as a position in a hedging transaction, "straddle" or
"conversion transaction"; or
- deemed to sell Debentures or common stock under the constructive sale
provisions of the Internal Revenue Code.
This summary discusses the tax considerations applicable to those of you who
are the initial purchasers of the Debentures and who purchase the Debentures at
their "issue price" as defined in Section 1273 of the Internal Revenue Code. It
does not discuss the tax considerations applicable to subsequent purchasers of
the Debentures. The summary does not, therefore, discuss application of (i) the
"market discount" rules of Internal Revenue Code Sections 1276 to 1278 or (ii)
the "bond premium" amortization rules of Internal Revenue Code Section 171.
Moreover, the "original issue discount" rules of Internal Revenue Code Sections
1271 to 1275 are not generally discussed herein since Debentures are not
anticipated to be issued at a discount from their face value.
We have not sought any ruling from the IRS or an opinion of counsel with
respect to the statements we make and the conclusions we reach in the following
summary, and we are not certain that the IRS will agree with our statements and
conclusions. The IRS may successfully adopt a contrary position. Our summary
does not consider the effect of the federal estate or gift tax laws, the
alternative minimum tax or the tax laws of any applicable foreign, state, local
or other jurisdiction.
Those of you considering the purchase of Debentures should consult your own
tax advisors with respect to the application of the U.S. federal income tax laws
to your particular situation as well as any tax consequences arising under the
Federal estate or gift tax rules, under the laws of any state, local or foreign
taxing jurisdiction or under any applicable tax treaty.
TAXATION OF INTEREST
Interest paid on the Debentures will be included in your income as ordinary
income at the time it is treated as received or accrued, in accordance with your
regular method of tax accounting. If there is a Change of Control, as defined in
the "Description of Debentures--Repurchase at Option of Holder," we may be
required to pay additional interest on the Debentures. Those payments will
result in the recognition of additional interest or original issue discount
income with respect to the Debentures. According to Treasury Regulations, the
possibility of an additional payment on a Debenture will not affect the amount
of interest or original issue discount income you recognize (or the timing of
your
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recognition) if the likelihood of the additional payment, as of the date the
Debentures are issued, is remote. We believe that the likelihood of a Change of
Control occurring is remote and do not intend to treat the possibility of one
occurring as affecting the yield to maturity of any Debenture. The IRS may not
agree with us.
SALE, EXCHANGE OR REDEMPTION OF THE DEBENTURES
When you sell or exchange a Debenture or a Debenture is redeemed, other than
in the case of a conversion (discussed below), you will generally recognize
capital gain or loss equal to the difference between:
- the amount of cash proceeds and the fair market value of any property
received on the sale, exchange or redemption (except to the extent the
amount is attributable to accrued interest income not previously included
in your taxable income, which will be taxable as ordinary income, or is
attributable to accrued interest that was previously included in income,
which amount may be received without generating further taxable income);
and
- your adjusted tax basis in the Debenture.
Your adjusted tax basis in a Debenture generally will equal the amount you
paid for the Debenture. Capital gain or loss will be long-term capital gain or
loss if your holding period for the Debenture is more than one year at the time
of sale, exchange or redemption.
CONVERSION OF THE DEBENTURES
You will generally not recognize any income, gain or loss upon conversion of
a Debenture into common stock except to the extent that the common stock is
considered attributable to accrued interest not previously included in your
taxable income (which is taxable as ordinary income) or with respect to cash
received in lieu of a fractional share of common stock. Your tax basis in the
common stock received on conversion of a Debenture will be the same as your
adjusted tax basis in the Debenture at the time of conversion (reduced by any
basis allocable to a fractional share interest), and the holding period of the
common stock received on conversion will generally include the holding period of
the converted Debenture. However, your tax basis in shares of common stock
considered attributable to any accrued interest generally will equal the amount
of the accrued interest included in income, and the holding period for such
common stock will begin on the date of conversion. An adjustment of the
conversion ratio of the Debentures, in some circumstances, could be treated as a
constructive distribution, as discussed under "Dividends" below.
Cash you receive in lieu of a fractional share of common stock upon
conversion will be treated as payment in exchange for the fractional share of
common stock. Accordingly, cash you receive in lieu of a fractional share of
common stock generally will result in capital gain or loss (measured by the
difference between the cash received for the fractional share and your adjusted
tax basis in the fractional share).
DIVIDENDS
Any dividends paid to you on the common stock after a conversion generally
will be included in your taxable income as ordinary income to the extent of our
current or accumulated earnings and profits. You may, in certain circumstances,
be deemed to have received constructive distributions if the conversion ratio of
the Debentures is adjusted. Adjustments to the conversion price made pursuant to
a bona fide reasonable adjustment formula which has the effect of preventing the
dilution of your interest as a holder of the debt instrument will generally not
be considered to result in a constructive distribution. Certain of the possible
adjustments provided in the Debentures (including, without limitation,
adjustments in respect to taxable dividends to our stockholders) will not
qualify as being made pursuant to a bona fide reasonable adjustment formula. If
these adjustments are made, you, as a
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Debenture holder, might be deemed to have received constructive distributions
taxable as dividends even though you have not received any cash or property as a
result of the adjustments. In certain circumstances, the failure of the
Debentures to provide for such an adjustment may result in taxable dividend
income to the holders of common stock.
SALE OF COMMON STOCK
Upon the sale or exchange of common stock, you will generally recognize
capital gain or loss equal to the difference between:
- the amount of cash and the fair market value of any property you receive
upon the sale or exchange; and
- your adjusted tax basis in the common stock.
Capital gain or loss will be long-term capital gain or loss if your holding
period in common stock is more than one year at the time of the sale or
exchange. Your basis and holding period in common stock received upon conversion
of a Debenture are determined as discussed above under "Conversion of the
Debentures."
INFORMATION REPORTING AND BACKUP WITHHOLDING TAX
In general, information reporting requirements will apply to payments of
principal, redemption premium, if any, interest on a Debenture, payments of
dividends on common stock, payments of the proceeds of the sale of a Debenture
and payments of the proceeds of the sale of common stock. A 31% backup
withholding tax may apply to some or all of these payments unless you:
- certify that you are a corporation, or come within certain other exempt
categories of recipients when required to demonstrate this fact; or
- provide a taxpayer identification number on IRS Form W-9 promptly when
requested, certify as to no loss of exemption from backup withholding, and
otherwise comply with applicable requirements of the backup withholding
rules.
Any amounts withheld under the backup withholding rules from your payment
will be allowed as a credit against your U.S. federal income tax and may entitle
you to a refund, provided that you furnish required information to the IRS.
THE PRECEDING DISCUSSION OF CERTAIN U.S. FEDERAL INCOME TAX CONSEQUENCES IS
FOR GENERAL INFORMATION ONLY AND IS NOT TAX ADVICE. ACCORDINGLY, YOU SHOULD
CONSULT YOUR OWN TAX ADVISOR AS TO THE PARTICULAR U.S. FEDERAL, STATE, AND LOCAL
TAX CONSEQUENCES OF PURCHASING, HOLDING AND DISPOSING OF OUR DEBENTURES AND
COMMON STOCK. YOU SHOULD ALSO CONSULT A TAX ADVISOR AS TO THE UNITED STATES
ESTATE AND GIFT TAX CONSEQUENCES AND THE FOREIGN TAX CONSEQUENCES OF PURCHASING,
HOLDING AND DISPOSING OF OUR DEBENTURES AND COMMON STOCK, AS WELL AS THE
CONSEQUENCES OF ANY PROPOSED CHANGE IN APPLICABLE LAWS.
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.
COMMON STOCK
As of April 30, 1999, there were 4,627,936 shares of common stock
outstanding. All outstanding shares of common stock are 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 stockholders. Stockholders
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
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future class or series of Serial Preferred Stock that the Board may authorize
and issue in the future, each share of outstanding common stock is entitled to
participate equally in any distribution of net assets made to the stockholders
in liquidation, dissolution or winding up of Paper Warehouse 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 our Amended and Restated Articles of
Incorporation, no action by our stockholders is necessary, and only action of
the board of directors is required to authorize the issuance of any shares or
series 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 these 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 stockholder 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 us with a view to effecting a merger, sale or exchange of
assets or a similar transaction. For example, the board of directors could issue
these shares as a dividend to holder of common stock or place these 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
stockholders the receipt of a premium on their common stock and may also have a
depressive effect on the market price of the common stock.
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 our 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
our stockholders. However, these provisions could have the effect of
discouraging certain attempts to acquire us which could deprive our stockholders
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 us, and other than in connection with certain
mergers and exchanges to which we are a party) resulting in the beneficial
ownership of 20% or more of the voting stock then outstanding. Section 302A.671
requires approval of any acquisition of this type by a majority vote of our
stockholders before the consummation of the acquisition. In general, shares
acquired in the absence of this approval are denied voting rights and we may
redeem the shares at their then fair market value within 30 days after the
acquiring person has failed to give a timely information statement to us or the
date the stockholders voted not to grant voting rights to the acquiring person's
shares.
Section 302A.673 of the MBCA generally prohibits any business combination by
us, or any of our subsidiaries, with any stockholder that purchases 10% or more
of our voting shares (an "interested shareholder") within four years following
the interested shareholder's share acquisition date, unless the
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business combination is approved by a committee of all of the disinterested
members of our board of directors before the interested shareholder's share
acquisition date.
Our Amended & Restated Bylaws provide that Section 302A.673 of the MBCA is
not applicable to any business combination (as defined in the MBCA) of Paper
Warehouse 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 or Brent D. Schlosser or any of their respective
affiliates or associates (as defined in the MBCA).
CERTAIN LIMITED LIABILITY AND INDEMNIFICATION PROVISIONS
Our Amended and Restated Articles of Incorporation limit the liability of
our directors to the fullest extent permitted by law. Specifically, our
directors will not be personally liable for monetary damages for breach of the
fiduciary duty as directors, except for liability for
- any breach of the director's duty of loyalty to us or our stockholders
- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law
- corporate distributions which are in contravention of restrictions in the
MBCA, our Articles or Bylaws, or any agreement to which we are a party
- violations of Minnesota securities laws
- any transaction from which the director derives an improper personal
benefit
- any act or omission occurring before the effective date of the provision
in our 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
this right of indemnification and reference is made thereto for a complete
statement of these indemnification rights.
Article 6 of our Bylaws provides that each of our directors, officers and
employees will be indemnified by us 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 us pursuant to
the foregoing provisions, we have been informed that in the opinion of the SEC
this 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.
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UNDERWRITING
Under the terms and subject to the conditions contained in the Underwriting
Agreement, Miller & Schroeder Financial, Inc. has agreed to purchase from us and
we have agreed to sell to Miller & Schroeder, Debentures, in the total principal
amount of $4,000,000. Miller & Schroeder will purchase the Debentures from us
for $3,700,000, net of its underwriting discount fee of $300,000. We have agreed
to pay Miller & Schroeder a nonaccountable expense allowance in the amount of
$120,000, 3.0% of the gross proceeds of this offering and a management fee in
the amount of $80,000, 2% of the gross proceeds of this offering.
Miller & Schroeder will be committed to take and pay for all of the
Debentures if any are purchased.
The Underwriting Agreement provides for reciprocal indemnification between
us, Miller & Schroeder and each of Miller & Schroeder's and our officers,
directors and controlling persons against civil liabilities in connection with
this offering, including certain liabilities under the Securities Act. Insofar
as indemnification for liabilities arising under the Securities Act may be
permitted pursuant to such indemnification provisions, we have been advised that
in the opinion of the SEC such indemnification is against public policy as
expressed in the Securities Act and is therefore unenforceable.
Miller & Schroeder proposes to offer the Debentures to the public at $1,000
per Debenture, and to certain selected dealers at such price less a concession
of $ per Debenture. Miller & Schroeder does not intend to confirm sales to
any account over which it has discretionary authority.
In connection with this offering, we have agreed to issue and sell to Miller
& Schroeder, for nominal consideration, a warrant (the "Underwriter's Warrant")
to purchase 50,000 shares of our common stock at $ per share. The
Underwriter's Warrant contains anti-dilution provisions providing for
appropriate adjustments on the occurrence of certain events. The Underwriter's
Warrant also provides certain demand and participatory rights to require
registration under the Securities Act of the shares underlying the Underwriter's
Warrant. The Underwriter's Warrant will be exercisable commencing one year from
the date of this prospectus and for a period of four years thereafter. The
Underwriter's Warrant will be restricted from sale, transfer, assignment or
hypothecation except to officers or successors of Miller & Schroeder. Any
profits realized by Miller & Schroeder upon the sale of the Underwriter's
Warrant or the securities issuable upon exercise thereof may be deemed to
constitute additional underwriting compensation.
In order to facilitate the offering of the Debentures, Miller & Schroeder
may engage in transactions that stabilize, maintain or otherwise affect the
price of the Debentures. In addition, to stabilize the price of the Debentures,
Miller & Schroeder may bid for, and purchase, Debentures in the open market.
Miller & Schroeder may also reclaim selling concessions allowed to a dealer for
distributing Debentures in the offering, if Miller & Schroeder repurchases
previously distributed Debentures in transactions to cover its short positions,
in stabilization transactions or otherwise. Finally, Miller & Schroeder may bid
for, and purchase, Debentures in market making transactions and impose penalty
bids. These activities may stabilize or maintain the market price of the
Debentures above the market level that may otherwise prevail. Miller & Schroeder
is not required to engage in these activities and may end any of these
activities at any time. Any such activities will be undertaken in accordance
with the rules and regulations under the Exchange Act, if at all.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. Neither Miller & Schroeder nor us
make any representation or prediction as to the direction or magnitude of any
effect that the transactions described above might have on the price of the
Debentures. In addition, neither Miller & Schroeder nor us make any
representations that Miller &
60
<PAGE>
Schroeder will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.
Before the offering, there has been no public market for the Debentures. We
do not intend to list the Debentures on any securities exchange or include them
for quotation on the Nasdaq system. Miller & Schroeder has advised us that it
intends initially to make a market in the Debentures, but it is not obligated to
do so and may discontinue market making at any time without notice.
The foregoing is a summary of the material provisions of the Underwriting
Agreement and the Underwriter's Warrant. Copies of such documents have been
filed as exhibits to the Registration Statement of which this prospectus is a
part.
The following table summarizes the compensation we will pay to Miller &
Schroeder:
<TABLE>
<CAPTION>
FORM OF COMPENSATION AMOUNT
- -------------------------------------------------------------- -------------
<S> <C>
Total underwriting discounts and commissions.................. $ 300,000
Non-accountable expense allowance............................. $ 120,000
Management fee................................................ $ 80,000
Warrant....................................................... 50,000 shares
</TABLE>
The following table itemizes all of the expenses we expect to incur in
connection with this offering (all expenses are estimates other than the SEC
registration and NASD fees which are actual) other than underwriting discounts,
fees and commissions which are set forth in the table above.
<TABLE>
<S> <C>
SEC registration fee.............................................. $ 1,668
NASD filing fee................................................... 1,100
Legal fees and expenses........................................... 80,000
Accounting fees and expenses...................................... 25,000
Blue Sky fees and expenses........................................ 5,000
Printing and engraving expenses................................... 50,000
Trustee and registrar fees and expenses........................... 10,000
Miscellaneous..................................................... 107,232
---------
Total........................................................... $ 280,000
---------
---------
</TABLE>
LEGAL MATTERS
The validity of the Debentures being sold in this offering will be passed
upon for us by Oppenheimer Wolff & Donnelly LLP, Minneapolis, Minnesota.
Fredrikson & Byron, P.A., Minneapolis, Minnesota, is acting as counsel for
Miller & Schroeder in connection with certain legal matters relating to the
Debentures offered hereby.
EXPERTS
The consolidated financial statements of Paper Warehouse, Inc. as of January
29, 1999 and January 30, 1998, and for each of the years in the three-year
period ended January 29, 1999 have been included herein and in the Registration
Statement in reliance upon the report of KPMG LLP, independent auditors,
appearing elsewhere in this prospectus, and upon the authority of said firm as
experts in accounting and auditing.
61
<PAGE>
ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission a Registration
Statement on Form S-1 under the Securities Act with respect to the Debentures
and common stock offered by this prospectus. 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
us and the Debentures and common stock offered in this prospectus, 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,
these descriptions are not necessarily complete, and in each instance reference
is made to the copy of the contract or other document filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
the reference.
We are subject to the periodic reporting and other informational
requirements of the Exchange Act pursuant to Section 15(d) thereof and, in
accordance therewith, file reports, proxy statements and other information with
the Commission. For further information with respect to us, reference is hereby
made to such reports and other information which, together with the Registration
Statement and the exhibits and schedules thereto, can 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 Room
of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, at
prescribed rates. You may obtain information on the operation of the SEC's
Public Reference Room by calling the SEC at 1-800-SEC-0330. The Commission also
maintains a website (http.//www.sec.gov) that contains reports, proxy and
information statements, and other information that has been or will be filed by
us.
Our World Wide Web site address is WWW.PAPERWAREHOUSE.COM. The information
included in our website is not made a part of this prospectus.
62
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Independent Auditors' Report............................................................................... F-2
Consolidated Balance Sheets as of January 29, 1999 and January 30, 1998.................................... F-3
Consolidated Statements of Operations for the Years Ended January 29, 1999, January 30, 1998 and January
31, 1997................................................................................................. F-4
Consolidated Statements of Stockholders' Equity for the Years Ended January 29, 1999, January 30, 1998 and
January 31, 1997......................................................................................... F-5
Consolidated Statements of Cash Flows for the Years Ended January 29, 1999, January 30, 1998 and January
31, 1997................................................................................................. F-6
Notes to Consolidated Financial Statements................................................................. F-7
Consolidated Balance Sheets as of April 30, 1999 (Unaudited) and January 29, 1999.......................... F-17
Consolidated Statements of Operations for the First Quarters Ended April 30, 1999 and May 1, 1998
(Unaudited).............................................................................................. F-18
Consolidated Statements of Cash Flows for the First Quarters Ended April 30, 1999 and May 1, 1998
(Unaudited).............................................................................................. F-19
Notes to Unaudited Consolidated Financial Statements....................................................... F-20
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Paper Warehouse, Inc. and Subsidiary:
We have audited the accompanying consolidated balance sheets of Paper
Warehouse, Inc. and Subsidiary (the Company) as of January 29, 1999 and January
30, 1998, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the years in the three-year period ended
January 29, 1999. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by the Company's management, as well as evaluating
the overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Paper
Warehouse, Inc. and Subsidiary as of January 29, 1999 and January 30, 1998, and
the results of their operations and their cash flows for each of the years in
the three-year period ended January 29, 1999, in conformity with generally
accepted accounting principles.
/s/ KPMG Peat Marwick LLP
March 19, 1999
Minneapolis, Minnesota
F-2
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
JANUARY 29, 1999 AND JANUARY 30, 1998
<TABLE>
<CAPTION>
JANUARY 29, JANUARY 30,
1999 1998
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 64,507 $ 2,059,737
Inventories, net................................................................. 16,302,070 11,161,549
Accounts receivable.............................................................. 1,105,262 451,937
Prepaid expenses and other current assets........................................ 613,584 153,968
------------- -------------
Total current assets........................................................... 18,085,423 13,827,191
Property and equipment, net...................................................... 9,976,450 6,798,228
Other assets, net................................................................ 1,466,613 391,918
------------- -------------
Total assets................................................................. $ 29,528,486 $ 21,017,337
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable--line of credit.................................................... $ 6,850,000 $ --
Current maturities of long-term debt............................................. 151,993 305,585
Current maturities of capital lease obligation................................... 308,566 179,671
Accounts payable................................................................. 4,390,525 2,989,016
Accrued liabilities:
Payroll and related expenses................................................... 563,112 369,486
Accrued expenses............................................................... 337,014 349,718
Accrued interest............................................................... 15,037 10,317
Other.......................................................................... 256,893 240,765
------------- -------------
Total current liabilities...................................................... 12,873,140 4,444,558
Capital lease obligation, less current maturities.................................. 635,204 355,927
Long-term debt, less current maturities............................................ 861,827 911,409
Deferred rent credits and other.................................................... 1,068,331 711,659
------------- -------------
Total liabilities.............................................................. 15,438,502 6,423,553
Stockholders' equity:
Serial preferred stock; 10,000,000 shares authorized; none issued or
outstanding.................................................................... -- --
Common stock, $.01 par value. 40,000,000 shares authorized; 4,627,936 and
4,557,187 shares issued and outstanding, respectively.......................... 46,279 45,572
Additional paid-in capital....................................................... 13,833,442 13,683,807
Retained earnings................................................................ 210,263 864,405
------------- -------------
Total stockholders' equity..................................................... 14,089,984 14,593,784
Total liabilities and stockholders' equity..................................... $ 29,528,486 $ 21,017,337
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JANUARY 29, 1999, JANUARY 30, 1998 AND JANUARY 31, 1997
<TABLE>
<CAPTION>
JANUARY 29, JANUARY 30, JANUARY 31,
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
Revenues:
Company-owned stores.............................................. $ 62,218,553 $ 51,787,842 $ 41,892,173
Franchise related fees............................................ 1,271,973 1,161,097 1,109,737
------------- ------------- -------------
Total revenues.................................................. 63,490,526 52,948,939 43,001,910
Costs and expenses:
Costs of products sold and occupancy costs........................ 41,252,342 34,966,018 27,946,561
Store operating expenses.......................................... 15,185,082 11,484,271 8,732,589
General and administrative expenses............................... 7,643,011 5,515,491 4,242,960
------------- ------------- -------------
Total costs and expenses........................................ 64,080,435 51,965,780 40,922,110
Operating (loss) income......................................... (589,909) 983,159 2,079,800
Interest expense, net............................................. 254,405 797,567 771,549
Expenses of canceled acquisition.................................. -- 260,852 --
------------- ------------- -------------
(Loss) income before income taxes and extraordinary charge........ (844,314) (75,260) 1,308,251
Income tax benefit (expense)...................................... 323,654 (5,941) (5,300)
------------- ------------- -------------
(Loss) income before extraordinary charge......................... (520,660) (81,201) 1,302,951
------------- ------------- -------------
Extraordinary charge for extinguishment of debt................... -- (182,611) --
Tax benefit of extraordinary charge............................... -- 72,846 --
------------- ------------- -------------
Extraordinary charge, net......................................... -- (109,765) --
------------- ------------- -------------
Net (loss) income............................................... $ (520,660) $ (190,966) $ 1,302,951
------------- ------------- -------------
------------- ------------- -------------
Basic and diluted earnings per share:
Weighted average shares outstanding............................... 4,572,979
Net loss per share................................................ $ (0.11)
-------------
Pro forma net (loss) income......................................... $ (206,610) $ 807,830
Pro forma basic earnings per share:
Weighted average shares outstanding............................... 2,630,811 2,202,818
(Loss) income before extraordinary charge per share............... $ (0.04) $ 0.37
Extraordinary charge per share.................................... (0.04) --
------------- -------------
Net (loss) income per share....................................... $ (0.08) $ 0.37
------------- -------------
------------- -------------
Pro forma diluted earnings per share:
Weighted average shares outstanding............................... 2,630,811 2,514,250
(Loss) income before extraordinary charge per share............... $ (0.04) $ 0.32
Extraordinary charge per share.................................... (0.04) --
------------- -------------
Net (loss) income per share....................................... $ (0.08) $ 0.32
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JANUARY 29, 1999, JANUARY 30, 1998 AND JANUARY 31, 1997
<TABLE>
<CAPTION>
NUMBER OF ADDITIONAL TOTAL
PREFERRED COMMON COMMON PAID-IN RETAINED STOCKHOLDERS'
STOCK SHARES STOCK CAPITAL EARNINGS EQUITY
----------- ---------- --------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, February 2, 1996.................. -- 2,202,818 $ 22,028 $ 572,472 $ 2,529,075 $ 3,123,575
Net income............................... -- -- -- -- 1,302,951 1,302,951
Distribution of earnings................. -- -- -- -- (2,633,992) (2,633,992)
----- ---------- --------- ------------- ------------ -------------
Balance, January 31, 1997.................. -- 2,202,818 22,028 572,472 1,198,034 1,792,534
Net loss................................. -- -- -- -- (190,966) (190,966)
Distribution of earnings................. -- -- -- -- (142,663) (142,663)
Exercise of event option................. -- 197,219 1,972 (1,972) -- --
Conversion of warrants................... -- 171,350 1,714 (1,714) -- --
Issuance of common stock pursuant to
public offering........................ -- 1,985,800 19,858 13,115,021 -- 13,134,879
----- ---------- --------- ------------- ------------ -------------
Balance, January 30, 1998.................. -- 4,557,187 45,572 13,683,807 864,405 14,593,784
Net loss................................. -- -- -- -- (520,660) (520,660)
Distribution of earnings................. -- -- -- -- (133,482) (133,482)
Issuance of common stock
(See Note 8)........................... -- 70,749 707 149,635 -- 150,342
----- ---------- --------- ------------- ------------ -------------
Balance, January 29, 1999.................. -- 4,627,936 $ 46,279 $ 13,833,442 $ 210,263 $ 14,089,984
----- ---------- --------- ------------- ------------ -------------
----- ---------- --------- ------------- ------------ -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JANUARY 29, 1999, JANUARY 30, 1998 AND JANUARY 31, 1997
<TABLE>
<CAPTION>
JANUARY 29, JANUARY 30, JANUARY 31,
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATIONS:
Net (loss) income.................................................... $ (520,660) $ (190,966) $ 1,302,951
Adjustments to reconcile net (loss) income to net cash (used for)
provided by operations:
Write-off of subordinated debt fees................................ -- 182,611 --
Depreciation and amortization...................................... 1,732,220 1,140,966 959,901
Gain on sale of property and equipment............................. (277) (1,892) (4,375)
Deferred taxes..................................................... (323,654) 902 --
Changes in operating assets and liabilities, net of the effect of the
purchase of the assets of a business:
Accounts receivable................................................ (653,325) (190,513) 217,740
Prepaid expenses and other current assets.......................... (459,616) (34,915) 13,259
Merchandise inventories, net....................................... (3,966,362) (1,592,869) (1,851,922)
Accounts payable................................................... 1,401,509 866,731 (488,220)
Accrued liabilities................................................ 558,442 566,365 (63,896)
------------- ------------- -------------
Net cash (used for) provided by operations....................... (2,231,723) 746,420 85,438
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of assets of a business..................................... (2,239,165) -- --
Proceeds from sale of property and equipment......................... 6,349 7,807 136,960
Purchases of property and equipment.................................. (4,334,787) (2,438,110) (1,317,283)
Other assets, net of effect of asset acquisition..................... (117,420) (118,390) (18,544)
------------- ------------- -------------
Net cash used for investing activities........................... (6,685,023) (2,548,693) (1,198,867)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from initial public offering, net........................... -- 13,134,879 --
(Payments on) net proceeds from related party loans.................. -- (2,136,193) 2,136,193
Net proceeds from note payable--other -- 55,353 --
Net proceeds from (payments on) notes payable to bank................ 6,850,000 (5,870,000) 1,106,061
Principal payments on long-term debt................................. (203,174) (2,072,131) (23,106)
Net proceeds from capital leases..................................... 408,172 535,598 --
Distribution of earnings............................................. (133,482) (142,663) (2,633,992)
------------- ------------- -------------
Net cash provided by financing activities........................ 6,921,516 3,504,843 585,156
------------- ------------- -------------
Net (decrease) increase in cash and cash equivalents............. (1,995,230) 1,702,570 (528,273)
Cash and cash equivalents, beginning of year......................... 2,059,737 357,167 885,440
Cash and cash equivalents, end of year............................... $ 64,507 $ 2,059,737 $ 357,167
------------- ------------- -------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest....................................................... $ 274,004 $ 846,538 $ 877,410
Income taxes................................................... -- 5,039 5,300
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 29, 1999 AND JANUARY 30, 1998
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) DESCRIPTION OF BUSINESS
Paper Warehouse, Inc. (the Company) is a paper and party goods retailer
operating 97 stores in the states of Arizona, Colorado, Iowa, Kansas, Minnesota,
Missouri, Nebraska, Oklahoma, Washington and Wisconsin. The Company also sells
Paper Warehouse franchises through a wholly-owned subsidiary. In exchange for
the initial and continuing franchise fees received, the Company provides
management assistance and gives franchisees the right to use the name "Paper
Warehouse" or "Party Universe."
(B) BASIS OF PRESENTATION
Effective February 1, 1997, the Company acquired Paper Warehouse
Franchising, Inc., a company under common control. The acquisition has been
accounted for on an "as if pooled" basis and, accordingly, the accompanying
financial statements include the financial condition and results of operations
of both companies for all periods presented. Intercompany transactions have been
eliminated in consolidation.
(C) ACCOUNTING ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities 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.
(D) FAIR VALUES OF FINANCIAL INSTRUMENTS
Due to their short-term nature, the carrying value of the Company's
financial assets and liabilities approximates their fair value. The fair value
of the Company's borrowings, if recalculated based on current interest rates,
would not significantly differ from the recorded amounts.
(E) S-CORPORATION ELECTION
Prior to its initial public offering in November 1997, the Company had
elected to be taxed as an S-Corporation under the Internal Revenue Code. The
Company had 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.
(F) FISCAL YEAR
The Company's fiscal year ends on the Friday closest to January 31st. The
fiscal years ended January 29, 1999, January 30, 1998, and January 31, 1997
included 52 weeks. Unless otherwise stated, references to years in this report
relate to fiscal years rather than to calendar years.
(G) MERCHANDISE INVENTORIES
Inventories, are stated at the lower of cost (as determined on a first-in,
first-out basis) or market. The Company reviews slow moving merchandise and
takes appropriate markdowns to move the inventory. Periodically the Company
reviews inventory valuations and takes appropriate write-downs, as it deems
necessary.
F-7
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 29, 1999 AND JANUARY 30, 1998
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(H) CASH EQUIVALENTS
Cash equivalents of $4,641 at January 29, 1999, consist of short-term
investment in money market accounts with funds available at any time. For
purposes of the Consolidated Statements of Cash Flows, the Company considers all
highly liquid instruments with maturities of three months or less to be cash
equivalents.
(I) PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is computed by the
method indicated over the estimated useful lives of the assets as follows:
<TABLE>
<CAPTION>
ESTIMATED
METHOD USEFUL LIVES
-------------- -------------
<S> <C> <C>
Computers..................................................... Straight-line 3 years
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.
(J) 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.
The costs of acquiring trademarks have been capitalized and are being
amortized on a straight-line basis over 10 years.
(K) 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.
(L) DEFERRED RENT CREDIT
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.
(M) PRE-OPENING COSTS
Costs associated with the opening of new stores are expensed as incurred.
F-8
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 29, 1999 AND JANUARY 30, 1998
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(N) 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 Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for Stock-based Compensation," been applied, the compensation
expense would have been different; see Note 9.
(O) ADVERTISING
The Company expenses the cost of advertising as incurred or the first time
the advertisement takes place.
(P) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In April 1998, the Accounting Standards Executive Committee (AcSEC) issued
Statement of Position (SOP) No. 98-5, "Reporting on the Costs of Start-Up
Activities." This SOP provides guidance on the financial reporting of start-up
costs and organization costs and requires that these costs be expensed as
incurred. This SOP is effective for fiscal years beginning after December 15,
1998. The Company has not yet determined the impact that adoption of this SOP
will have on the Company's financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This Statement
establishes accounting and reporting standards for derivative instruments and
for hedging activities. This Statement is effective for fiscal years beginning
after June 15, 1999. The Company believes that adoption of this Statement will
have no impact on the Company's financial position or results of operations.
(2) PROPERTY AND EQUIPMENT, NET
Property and equipment, net consists of the following:
<TABLE>
<CAPTION>
JANUARY 29, JANUARY 30,
1999 1998
------------- ------------
<S> <C> <C>
Fixtures and equipment........................................... $ 13,486,409 $ 8,860,634
Building......................................................... 1,273,088 1,041,702
Land and improvements............................................ 319,733 319,733
Accumulated depreciation and amortization........................ (5,102,780) (3,423,841)
------------- ------------
Total property and equipment, net................................ $ 9,976,450 $ 6,798,228
------------- ------------
------------- ------------
</TABLE>
Depreciation and amortization expense on property and equipment was
$1,678,532, $1,094,714 and $913,918 for the fiscal years ended January 29, 1999,
January 30, 1998 and January 31, 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 prime rate (7.75% at January 29, 1999) plus .5% and are
secured by substantially 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. At January 29, 1999,
the Company was in compliance with all of the covenants under its credit
facility.
F-9
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 29, 1999 AND JANUARY 30, 1998
(3) NOTES PAYABLE TO BANK (CONTINUED)
The current agreement is subject to renewal by May 31, 1999. There was
$6,850,000 borrowings outstanding under the agreement as of January 29, 1999.
There were no borrowings outstanding as of January 30, 1998.
(4) LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
JANUARY 29, JANUARY 30,
1999 1998
------------ ------------
<S> <C> <C>
Term 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..................................... $ 395,281 $ 407,497
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................................................................. 492,383 504,143
Notes payable in monthly installments of $2,711, including interest at 7.92% through
December 1999....................................................................... 26,156 55,354
$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 100,000 250,000
------------ ------------
Total long-term debt.................................................................. 1,013,820 1,216,994
Less current maturities............................................................... 151,993 305,585
------------ ------------
Long-term debt...................................................................... $ 861,827 $ 911,409
------------ ------------
------------ ------------
</TABLE>
On December 12, 1994, the Company completed a private placement of 46 units,
each unit consisting of a 10% subordinated note 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 the Company's common
stock, $.01 par value, 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. The warrants were converted into 171,350 shares of
common stock concurrent with the consummation of the public offering. The
Company repaid $150,000 and $2,050,000 of the debt during fiscal 1998 and in the
fourth quarter of fiscal 1997, respectively, and expects to pay the remaining
$100,000 in fiscal 1999. Total interest expense for the fiscal years ended
January 29, 1999, January 30, 1998 and January 31, 1997 was $278,824, $839,449
and $809,029, respectively.
F-10
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 29, 1999 AND JANUARY 30, 1998
(4) LONG-TERM DEBT (CONTINUED)
Aggregate annual maturities of long-term debt subsequent to the fiscal year
ended January 29, 1999 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING IN JANUARY:
- --------------------------------------------------------------------------------
<S> <C>
2000.......................................................................... $ 151,993
2001.......................................................................... 27,865
2002.......................................................................... 30,327
2003.......................................................................... 32,869
2004 and thereafter........................................................... 770,766
------------
Total maturities of long-term debt.............................................. $ 1,013,820
------------
------------
</TABLE>
(5) LEASES
The Company leases all of its retail stores under noncancelable operating
leases that 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 lease commitments due under noncancelable operating leases at
January 29, 1999 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING IN JANUARY:
- -------------------------------------------------------------------------------
<S> <C>
2000......................................................................... $ 8,771,636
2001......................................................................... 8,319,612
2002......................................................................... 8,191,964
2003......................................................................... 7,738,108
2004......................................................................... 7,319,693
Thereafter................................................................... 22,075,297
-------------
Total future minimum lease commitments......................................... $ 62,416,310
-------------
-------------
</TABLE>
Rent expense for all operating leases for the years ended January 29, 1999,
January 30, 1998, and January 31, 1997 was $7,135,092, $5,337,555 and $4,309,403
respectively.
During fiscal 1998, the Company entered into a capital lease agreement for
equipment and fixtures. During fiscal 1997, the Company entered into a capital
lease agreement for software. Future maturities under these agreements are as
follows:
<TABLE>
<CAPTION>
YEAR ENDING IN JANUARY:
- ----------------------------------------------------------------------------------
<S> <C>
2000............................................................................ $ 308,566
2001............................................................................ 268,921
2002............................................................................ 119,106
2003............................................................................ 130,407
2004............................................................................ 116,770
----------
Total future maturities of capital leases......................................... $ 943,770
----------
----------
</TABLE>
F-11
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 29, 1999 AND JANUARY 30, 1998
(6) INCOME TAXES
As indicated in Note 1, prior to November 25, 1997, the Company elected to
be taxed as an S-Corporation under the Internal Revenue Code. The Company's
earnings or losses for the S-Corporation period are allocated to its
stockholders for inclusion in their individual tax returns. As a result, no
provision for federal taxes was required at the corporate level for that period.
A provision was made for state taxes during the S-Corporation period as some
states impose a tax upon S-Corporations. The Company has provided federal and
state income taxes for all periods after November 28, 1997.
An income tax benefit of approximately $324,000 was recorded for the fiscal
year ended January 29, 1999. Income tax expense of $5,941 and $5,300 was
recorded for the fiscal years ended January 30, 1998 and January 31, 1997. These
amounts differed from the amounts computed by the U.S. federal income tax rate
of 34% to pretax income from continuing operations as a result of the following:
<TABLE>
<CAPTION>
FISCAL YEAR ENDING:
-------------------------------------
<S> <C> <C> <C>
JANUARY 29, JANUARY 30, JANUARY 31,
1999 1998 1997
----------- ----------- -----------
Computed "expected" tax (benefit) expense for twelve-month period.......... $ (287,067) $ (25,756) $ 416,944
Increase (reduction) in income taxes resulting from:
Adjustment to reflect S-Corporation election............................. -- (15,644) (416,944)
Adjustment to deferred tax assets and liabilities to reflect adoption of
SFAS 109............................................................... -- 43,251 --
State and local income taxes, net of federal income tax benefit............ (48,548) (1,313) 5,300
Other permanent differences................................................ 11,961 5,403 --
----------- ----------- -----------
Total income tax (benefit) expense......................................... $ (323,654) $ 5,941 $ 5,300
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDING:
-------------------------------------
<S> <C> <C> <C>
JANUARY 29, JANUARY 30, JANUARY 31,
1999 1998 1997
----------- ----------- -----------
Current:
Federal.................................................................. $ -- $ -- $ --
State.................................................................... -- 5,039 5,300
----------- ----------- -----------
-- 5,039 5,300
Deferred:
Federal.................................................................. (275,106) 767 --
State.................................................................... (48,548) 135 --
----------- ----------- -----------
(323,654) 902 --
Total income tax (benefit) expense......................................... $ (323,654) $ 5,941 $ 5,300
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
F-12
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 29, 1999 AND JANUARY 30, 1998
(6) INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at January 29,
1999 and January 30, 1998 are presented below.
<TABLE>
<CAPTION>
AS OF:
-------------------------
<S> <C> <C>
JANUARY 29, JANUARY 30,
1999 1998
------------ -----------
Deferred tax assets:
Accounts receivable principally due to allowance for doubtful accounts................. $ -- $ 4,800
Inventories, principally due to additional costs inventoried for tax purposes pursuant
to the Tax Reform Act of 1986........................................................ 156,500 103,040
Difference in timing of lease deductions............................................... 454,911 296,874
Net operating loss carryforward........................................................ 529,843 237,988
------------ -----------
Total gross deferred tax asset..................................................... 1,141,254 642,702
------------ -----------
Deferred tax liabilities:
Plant and equipment, principally due to differences in depreciation and capitalized
interest............................................................................. 623,922 467,702
Software, principally due to the differences in amortization........................... 121,733 103,056
------------ -----------
Total gross deferred liabilities................................................... 745,655 570,758
------------ -----------
Net deferred tax asset............................................................. $ 395,599 $ 71,944
------------ -----------
------------ -----------
</TABLE>
At January 29, 1999, the Company has a net operating loss carryforward for
federal income tax purposes of $1,324,607 which is available to offset future
federal taxable income, if any, through 2019.
(7) RELATED PARTY TRANSACTIONS
A related party of one of the Company's majority stockholders had previously
owned four of the Company's franchise stores. On November 9, 1998, the Company
purchased all the assets of these four franchise stores. The total purchase
price was $1,349,974, which was made up of both cash and stock. Goodwill in the
amount of $267,974 was recognized on this purchase. Continuing franchise fees
collected from this related party were $88,728 and $108,034, in 1998 and 1997,
respectively. The Company had no outstanding receivable as of January 29, 1999
and a $6,940 receivable from this franchisee at January 30, 1998.
A related party of one of the Company's majority stockholders substantially
owns one of the Company's franchise stores. Continuing fees collected from this
related party were $24,810 and $22,777 for the years ended January 29, 1999 and
January 30, 1998, respectively. The Company had a receivable of $708 and $317
from this franchisee as of January 29, 1999 and January 30, 1998, respectively.
(8) EQUITY TRANSACTIONS AND WEIGHTED AVERAGE SHARE DISCLOSURE
In December 1998, the Company issued 70,749 shares of common stock in
partial consideration for the purchase of Prickly Pear Paper, Inc.
F-13
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 29, 1999 AND JANUARY 30, 1998
(8) EQUITY TRANSACTIONS AND WEIGHTED AVERAGE SHARE DISCLOSURE (CONTINUED)
In February 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.
In September 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 consolidated financial statements reflect this
stock split.
In November and December 1997, the Company registered and sold a total of
1,985,800 shares of common stock at a price of $7.50 each in a public offering
pursuant to the Securities Act of 1933. Total proceeds to the Company were
$13,850,955. This amount, net of other related costs of the offering of
$716,028, has been reflected in common stock and additional paid-in capital in
these consolidated financial statements.
In December 1997, the Company requested the holders of it's 10% subordinated
notes issued in 1994 to surrender the notes. Each note had one detachable common
stock warrant good for 3,725 shares of common stock. Accordingly, 171,350 shares
of common stock were issued when the notes were prepaid.
A reconciliation of weighted average shares used in the earnings per share
calculation is as follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDING
-------------------------------------
<S> <C> <C> <C>
JANUARY 29, JANUARY 30, JANUARY 31,
1999 1998 1997
----------- ----------- -----------
Basic weighted average shares...................... 4,572,979 2,630,811 2,202,818
Potential common shares............................ -- -- 311,432
----------- ----------- -----------
Diluted weighted average shares.................... 4,572,979 2,630,811 2,514,250
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
(9) STOCK OPTIONS
In order to attract and retain employees and directors, while preserving
cash resources, the Company has, since going public, utilized stock option
awards. During fiscal 1997, the Company adopted a stock option plan (the Plan)
pursuant to which the Company may grant stock options to employees and the board
of directors. The Plan authorizes grants of options to purchase up to 639,641
shares of authorized but unissued common stock. Stock options are granted with
an exercise price equal to the stock's fair market value at the date of grant.
All stock options have ten-year terms and vest ratably over three years from the
date of grant.
At January 29, 1999, there were options issued and outstanding to purchase
412,200 shares of the Company's common stock issued to employees and directors.
In fiscal 1998, the Company granted stock option awards to certain of its
employees and directors for the purchase of an aggregated amount of 227,750
shares of the Company's common stock. These options are exercisable at prices
from $2.07 to $5.00 per share and expire in 2008. During fiscal 1997, 184,450
options were awarded to certain of its employees and directors. These options
are exercisable at $7.50 per share and expire in 2007.
The per share weighted-average fair value of these options using the Black
Scholes option-pricing model is $2.10 with the following weighted-average
assumptions: volatility 60%, expected dividend yield .0%, risk-free rate of
5.5%, and an expected life of 5 years.
F-14
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 29, 1999 AND JANUARY 30, 1998
(9) STOCK OPTIONS (CONTINUED)
Details of the status of stock options as of January 29, 1999 are reflected
in the table below.
<TABLE>
<CAPTION>
SHARES UNDER PRICE WEIGHTED-AVERAGE
OPTION RANGE EXERCISE PRICE
------------- ------------- -----------------
<S> <C> <C> <C>
Unexercised options outstanding January
31, 1997................................ -- -- --
Options granted......................... 184,450 $ 7.50 $ 7.50
Options exercised....................... -- -- --
Options forfeited....................... -- -- --
------------- ------------- -----
Unexercised options outstanding January
30, 1998................................ 184,450 $ 7.50 $ 7.50
Options granted......................... 227,750 $ 2.07-$5.00 $ 2.90
Options exercised....................... -- -- --
Options forfeited....................... -- -- --
------------- ------------- -----
Unexercised options outstanding January
29, 1999................................ 412,200 $ 2.75-$7.50 $ 4.96
------------- ------------- -----
------------- ------------- -----
</TABLE>
The following table summarizes information concerning options outstanding
and exercisable as of January 29, 1999:
<TABLE>
<CAPTION>
EXERCISABLE
OUTSTANDING OPTIONS OPTIONS
------------------- ------------------
<S> <C> <C>
Number of options............................... 412,200 61,483
Weighted average remaining contractual life, in
years......................................... 9.36 8.83
Weighted average exercise price................. $ 4.96 $ 7.50
</TABLE>
The Company applies ABP Opinion No. 25 in accounting for options granted
under its stock option plans and, accordingly, no compensation cost has been
recognized for its stock options granted to its employees or directors in the
consolidated financial statements. Had the Company determined compensation cost
based on the fair value at the grant date for its stock options under SFAS No.
123, the Company's net loss would have increased to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
FISCAL YEAR FISCAL YEAR
1998 1997
--------------- ---------------
<S> <C> <C>
Net loss--as reported in fiscal 1998 and as reported pro
forma assuming C-Corporation status in fiscal 1997.... $ (520,660) $ (206,610)
Net loss--pro forma..................................... $ (677,149) $ (500,291)
Net loss per share--as reported in fiscal 1998 and as
reported pro forma assuming C-Corporation status in
fiscal 1997........................................... $ (0.11) $ (0.08)
Net loss per share--pro forma........................... $ (0.15) $ (0.19)
</TABLE>
F-15
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JANUARY 29, 1999 AND JANUARY 30, 1998
(10) 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. There were no discretionary contributions to the profit sharing
plan in any of the fiscal years.
The Company has 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 4% of employee contributions to the plan. Company contributions were
$34,358 and $25,422 for the years ended January 29, 1999 and January 30, 1998,
respectively.
On December 7, 1998, the board approved an Employee Stock Purchase Plan to
be approved by the stockholders at the 1999 Annual Meeting. If approved by the
stockholders, the first enrollment period is not expected to begin until August
1, 1999.
(11) EXTRAORDINARY CHARGE
Upon completing the Company's initial public offering in November 1997, the
Company exercised its option to repay subordinated debt. The Company then took a
one-time charge of $182,611, which represented the unamortized portion of the
fees associated with the debt. This amount is shown as an extraordinary charge
in the accompanying Consolidated Statement of Operations for the fiscal year
ended January 30, 1998.
(12) SUBSEQUENT EVENT (UNAUDITED)
On April 8, 1999 the Company refinanced its corporate office building. The
$1.1 million term note is payable in monthly installments of $8,612, including
interest at 7.125%, through May 2009. The note is secured by a first mortgage on
the Company's office headquarters.
F-16
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JANUARY 29,
1999
APRIL 30, -------------
1999
-------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 791,133 $ 64,507
Merchandise inventories, net..................................................... 18,997,829 16,302,070
Accounts receivable.............................................................. 938,296 1,105,262
Prepaid expenses and other current assets........................................ 1,336,537 613,584
------------- -------------
Total current assets........................................................... 22,063,795 18,085,423
Property and equipment, net...................................................... 10,012,196 9,976,450
Other assets, net................................................................ 1,303,256 1,466,613
------------- -------------
Total assets................................................................. $ 33,379,247 $ 29,528,486
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable--line of credit.................................................... $ 6,558,908 $ 6,850,000
Current maturities of long-term debt............................................. 142,069 151,993
Current maturities of capital lease obligation................................... 526,249 308,566
Accounts payable................................................................. 8,399,767 4,390,525
Accrued liabilities.............................................................. 1,254,550 1,172,056
------------- -------------
Total current liabilities...................................................... 16,881,543 12,873,140
Capital lease obligation, less current maturities.................................. 1,418,852 635,204
Long-term debt, less current maturities............................................ 1,076,420 861,827
Deferred rent credits.............................................................. 1,129,787 1,068,331
------------- -------------
Total liabilities.............................................................. 20,506,602 15,438,502
Stockholders' equity:
Serial preferred stock, $.01 par value; 10,000,000 shares authorized; none issued
or outstanding................................................................. -- --
Common stock, $.01 par value; 40,000,000 shares authorized; 4,627,936 shares
issued and outstanding......................................................... 46,279 46,279
Additional paid-in capital....................................................... 13,833,442 13,833,442
Accumulated (deficit) earnings................................................... (1,007,076) 210,263
------------- -------------
Total stockholders' equity..................................................... 12,872,645 14,089,984
------------- -------------
Total liabilities and stockholders' equity................................... $ 33,379,247 $ 29,528,486
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-17
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FIRST QUARTER ENDED
----------------------------
APRIL 30, MAY 1,
1999 1998
------------- -------------
<S> <C> <C>
Revenues:
Company-owned stores............................................................. $ 16,419,572 $ 12,192,259
Franchise related fees........................................................... 272,857 303,185
------------- -------------
Total revenues................................................................. 16,692,429 12,495,444
Costs and expenses:
Costs of products sold and occupancy costs....................................... 11,406,845 8,454,727
Store operating expenses......................................................... 4,673,890 3,186,973
General and administrative expenses.............................................. 2,247,013 1,706,830
------------- -------------
Total costs and expenses....................................................... 18,327,748 13,348,530
Operating loss................................................................. (1,635,319) (853,086)
Interest expense, net............................................................ 216,040 27,086
------------- -------------
Loss before income taxes and cumulative effect of accounting change.............. (1,851,359) (880,172)
Income tax benefit............................................................... 742,526 352,069
------------- -------------
Net loss before cumulative effect of accounting change........................... (1,108,833) (528,103)
------------- -------------
Cumulative effect of accounting change, net (Note 2)............................. (108,506) --
------------- -------------
Net loss....................................................................... $ (1,217,339) $ (528,103)
------------- -------------
------------- -------------
Basic and diluted loss per share:
Weighted average shares outstanding............................................ 4,627,936 4,557,187
Basic and diluted loss per share before cumulative effect of accounting
change....................................................................... $ (.24) $ (.12)
Cumulative effect of accounting change......................................... (.02) --
------------- -------------
Basic and diluted loss per share............................................... $ (.26) $ (.12)
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-18
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FIRST QUARTER ENDED
----------------------
APRIL 30, MAY 1,
1999 1998
---------- ----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss........................................................... $(1,217,339) $ (528,103)
Adjustments to reconcile net loss to net cash provided by (used
for) operations:
Depreciation and amortization.................................. 535,235 367,753
Gain on sale of property and equipment......................... (1,414) (107)
Deferred taxes................................................. (812,883) (352,069)
Other noncash items affecting earnings......................... 189,123 --
Changes in operating assets and liabilities, net of the effect of
the purchase of assets of a business:
Accounts receivable............................................ 166,966 99,625
Prepaid expenses and other current assets...................... 89,930 (312,988)
Merchandise inventories, net................................... (2,695,759) (857,941)
Accounts payable............................................... 4,009,242 1,284,356
Accrued liabilities............................................ 82,494 114,217
Deferred rent credits.......................................... 61,456 (3,523)
---------- ----------
Net cash provided by (used for) operations................... 407,051 (188,780)
---------- ----------
INVESTING ACTIVITIES:
Purchase of assets of a business................................... -- (148,710)
Proceeds from sale of property and equipment....................... 16,010 3,967
Purchases of property and equipment................................ (574,102) (816,487)
Other assets, net of effect of asset acquisition................... -- (49,170)
---------- ----------
Net cash used for investing activities....................... (558,092) (1,010,400)
---------- ----------
FINANCING ACTIVITIES:
Net payments on notes payable to bank.............................. (291,092) --
Proceeds from refinancing of mortgage.............................. 1,100,000 --
Principal payments on long-term debt............................... (895,331) (65,666)
Payment of debt acquisition fees................................... (37,241)
---
Net proceeds from (payments on) capital leases..................... 1,001,331 (24,490)
---------- ----------
Net cash provided by (used for) financing activities......... 877,667 (90,156)
---------- ----------
Net increase (decrease) in cash and cash equivalents......... 726,626 (1,289,336)
Cash and cash equivalents, beginning of period..................... 64,507 2,059,737
---------- ----------
Cash and cash equivalents, end of period........................... $ 791,133 $ 770,401
---------- ----------
---------- ----------
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid during the period.............................. $ 210,949 $ 30,305
Income taxes paid during the period.......................... -- --
---------- ----------
---------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-19
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
Paper Warehouse, Inc. (the Company) is a growing chain of retail stores
specializing in party supplies and paper goods, operating under the names "Paper
Warehouse" and "Party Universe." At April 30, 1999, the Company had a total of
142 stores, consisting of 97 company-owned stores and 45 franchise stores,
operating in 24 states. The Company sells Paper Warehouse franchises through its
wholly-owned subsidiary, Paper Warehouse Franchising, Inc.
The unaudited consolidated financial statements included herein have been
prepared by the Company pursuant to the Rules and Regulations of the Securities
and Exchange Commission ("SEC"), and represent the consolidated financial
statements of Paper Warehouse, Inc. and Paper Warehouse Franchising, Inc. as of
April 30, 1999 and May 1, 1998 and for the three month periods then ended. The
information furnished in these financial statements includes normal recurring
adjustments and reflects all adjustments, which are, in the opinion of
management, necessary for a fair presentation of such financial statements.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations. These
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and notes thereto included in the Company's
1998 Annual Report to Shareholders and its Form 10-K filed with the SEC.
Due to the seasonality of the Company's business, revenues and operating
results for the three months ended April 30, 1999 are not necessarily indicative
of the results to be expected for the full year.
(2) ACCOUNTING CHANGE
The Company adopted Statement of Position (SOP) No. 98-5, "Reporting on the
Costs of Start-Up Activities" during first quarter 1999. This SOP requires that
costs of start-up activities and organization costs be expensed as incurred.
Prior to the adoption of SOP No. 98-5, the Company's policy was to capitalize
lease acquisition fees and amortize them over the related lease term using the
straight-line method. The net impact of the change of approximately $109,000 or
$.02 per share, is shown as a cumulative effect of accounting change in the
Consolidated Statement of Operations for the three months ended April 30, 1999.
(3) FINANCING ARRANGEMENTS
On April 8, 1999, the Company refinanced its corporate office building. The
$1.1 million term note is payable in monthly installments of $8,612, including
interest at 7.125%, through May 2009. The note is secured by a first mortgage on
the Company's office headquarters.
On June 7, 1999, the Company obtained a $15 million three-year revolving
line of credit facility for general working capital purposes, that replaced its
previous $7.5 million facility. Borrowings outstanding under the new line of
credit bear interest, at a variable rate and are secured by substantially all of
the assets of the Company. The agreement with respect to the credit facility
contains covenants, which require the Company to satisfy certain financial
tests, and restrictions on the Company's ability to pay dividends.
Subsequent to first quarter 1999, the Company filed a Registration Statement
with the SEC for the public sale of a new issue of an aggregate principal amount
of $4 million of Convertible Subordinated Debentures due 2005. Proceeds from the
issuance will be used to develop and implement an Internet website for the sale
of party supplies and paper goods, to repay indebtedness and for other general
corporate purposes.
F-20
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) COMMON STOCK AND STOCK OPTION TRANSACTIONS
During first quarter the Company granted options to selected management of
the Company to purchase 14,100 shares of the Company's Common Stock at a range
of $1.88 to $2.75 per share. The options vest over three years and expire 10
years from the date of grant.
(5) RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation.
F-21
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
WE HAVE NOT AUTHORIZED ANY DEALER, SALESPERSON OR ANY OTHER PERSON TO
PROVIDE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS
PROSPECTUS. YOU MUST NOT RELY ON ANY UNAUTHORIZED INFORMATION OR REPRESENTATION.
THIS PROSPECTUS IS NOT AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY
THESE DEBENTURES IN ANY JURISDICTION WHERE IT IS UNLAWFUL TO DO SO. THE
INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF THE DATE OF THIS
PROSPECTUS.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 7
Use of Proceeds........................................................... 12
Price Range of Common Stock............................................... 12
Dividend Policy........................................................... 13
Capitalization............................................................ 13
Selected Financial and Operating Data..................................... 14
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 16
Business.................................................................. 24
Management................................................................ 35
Certain Transactions...................................................... 43
Principal Shareholders and Beneficial Ownership of Management............. 45
Description of Debentures................................................. 47
Description of Capital Stock.............................................. 57
Underwriting.............................................................. 60
Legal Matters............................................................. 61
Experts................................................................... 61
Additional Information.................................................... 62
Index to Consolidated Financial Statements................................ F-1
</TABLE>
$4,000,000
[LOGO]
9% CONVERTIBLE SUBORDINATED
DEBENTURES
---------------------
PROSPECTUS
---------------------
MILLER & SCHROEDER
FINANCIAL, INC.
JULY , 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the expenses we expect to incur in connection
with this offering (subject to future contingencies) (all expenses are estimates
other than the SEC registration and NASD fees which are actual) other than
underwriting discounts, commissions and fees:
<TABLE>
<S> <C>
SEC registration fee.............................................. $ 1,668
NASD filing fee................................................... 1,100
Legal fees and expenses........................................... 80,000
Accounting fees and expenses...................................... 25,000
Blue Sky fees and expenses........................................ 5,000
Printing and engraving expenses................................... 50,000
Trustee and registrar fees and expenses........................... 10,000
Miscellaneous..................................................... 107,232
---------
Total........................................................... $ 280,000
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Our Articles limit the liability of our directors to the fullest extent
permitted by law. Specifically, our directors will not be personally liable for
monetary damages for breach of their fiduciary duty as directors, except for
liability for (i) any breach of the director's duty of loyalty to us or our
stockholders, (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, our
Articles or Bylaws, or any agreement to which we are 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 before the
effective date of the provision in our 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 also contains detailed terms
regarding this right of indemnification and reference is made thereto for a
complete statement of these indemnification rights.
Article 6 of our Bylaws provides that each of our directors, officers and
employees will be indemnified by US in accordance with, and to the fullest
extent permissible by, applicable law.
Article 10 of our Bylaws provides that Section 302A.673 of the MBCA, is not
applicable to any Business Combination (as defined in the MBCA) of Paper
Warehouse 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 or Brent D. Schlosser or any of their respective
affiliates or associates (as defined in the MBCA).
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers or persons controlling us pursuant to
the foregoing provisions, we have been informed that in the opinion of the
Securities and Exchange Commission this indemnification is against public policy
as expressed in the Securities Act, and is therefore unenforceable.
II-1
<PAGE>
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
On December 17 1998, we completed an acquisition of all of the assets of
four franchise stores owned by Prickly Pear Paper, Inc. To acquire the assets,
we paid Prickly Pear approximately $1.2 million in cash and 70,749 shares of our
common stock for a total purchase price of $1,349,974. We believe that the
issuance of these shares of common stock is exempt from registration under
Section 4(2) of the Securities Act.
In connection with the completion of our initial public offering, we issued
201,064 shares of our common stock to the selling stockholder in the offering
pursuant to the cashless exercise of an option. No commissions were paid in
connection with this transaction. We believe that the issuance of these shares
is exempt from registration pursuant to Section 3(a)(9) under the Securities
Act.
In connection with the completion of our initial public offering, we issued
a total of 171,350 shares of our common stock to holders of warrants upon the
cashless exercise of these warrants. We believe that the issuance of these
shares is exempt from registration pursuant to Section 3(a)(9) under the
Securities Act.
ITEM 16. EXHIBITS.
<TABLE>
<CAPTION>
ITEM NUMBER DESCRIPTION OF ITEM
- --------------- ----------------------------------------------------------------------------------------------------
<C> <S>
1.1 Form of Underwriting Agreement (including form of Underwriter's Warrant).(2)
3.1 Amended and Restated Articles of Incorporation.(1)
3.2 Amended and Restated By-laws.(1)
4.1 Form of 10% Subordinated Note due November 30, 2004, dated December 7, 1994.(1)
4.2 Form of Warrant Agreement.(1)
4.3 Form of Warrant Conversion Agreement, as extended.(1)
4.4 Form of Indenture dated July , 1999 between the Company and Norwest Bank Minnesota N.A. relating
to the 9% Convertible Subordinated Debentures due September 15, 2005.(1)
4.5 Form of 9% Convertible Subordinated Debenture due September 15, 2005.(3)
4.6 Form of Underwriter's Warrant.(2) Filed as Appendix A to Exhibit 1.1.
5.1 Opinion of Oppenheimer Wolff & Donnelly LLP.(1)
10.1 1997 Stock Option and Compensation Plan.(1)
10.2 Directors' Stock Option Plan.(1)
10.3 Corporation Tax Allocation and Indemnification Agreement entered into on September 26, 1997 between
the Company and Yale T. Dolginow and Brent D. Schlosser.(1)
10.4 Employment Agreement by and between the Company and Yale T. Dolginow dated February 7, 1997.(1)
10.5 Employment Agreement by and between the Company and Brent D. Schlosser dated February 7, 1997.(1)
10.6 Amendment Number 1 to the Employment Agreement by and between the Company and Brent D. Schlosser
dated September 26, 1997.(1)
10.7 Combination Mortgage and Security Agreement and Fixture Financing Statement dated June 9, 1995 by
and between the Company and Richfield Bank & Trust Co.(1)
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
ITEM NUMBER DESCRIPTION OF ITEM
- --------------- ----------------------------------------------------------------------------------------------------
<C> <S>
10.8 Secured Promissory Note of the Company in favor of Richfield Bank & Trust Co. in the amount of
$945,000 dated June 9, 1995.(1)
10.9 Authorization and Note Guaranty of the Company dated May 25, 1995.(1)
10.10 Employment Agreement by and between the Company and Cheryl W. Newell dated July 14, 1997.(1)
10.11 Loan Agreement between Paper Warehouse, Inc., Yale T. Dolginow and Richfield Bank & Trust Co., dated
January 29, 1997.(1)
10.12 Revolving Promissory Note to Richfield Bank & Trust Co. dated January 29, 1997.(1)
10.13 Security Agreement between the Company and Richfield Bank & Trust Co. dated January 29, 1997.(1)
10.14 Amendment to Loan Agreement entered into as of October 1, 1997 by and between the Company, Yale T.
Dolginow and Richfield Bank & Trust Co.(1)
10.15 Master Lease by and between Targa Financial, Inc. and the Company dated October 22, 1997.(1)
10.16 Loan Agreement SBA Note No. COCL837046 3001 MN, dated August 15, 1995.(1)
10.17 Consulting Agreement entered into December 1, 1992 by and between Paper Warehouse, Inc. and Stanford
Weiner, Lawrence Weiner and Gary Stone.(1)
10.18 1998 Employee Stock Purchase Plan.(1)
10.19 Asset Purchase Agreement dated December 17, 1998 among the Company, Susan Hazan and Prickly Pear
Paper, Inc.(1)
10.20 Second Amendment to Loan Agreement dated March 31, 1998 between the Company and Richfield Bank &
Trust Co.(1)
10.21 Third Amendment to Loan Agreement dated March 15, 1999 between the Company and Richfield Bank &
Trust Co.(1)
10.22 Mortgage Note dated April 8, 1999 between the Company and Fortis Insurance Company.(1)
10.23 Mortgage and Security Agreement between the Company and Fortis Insurance Company dated April 8,
1999.(1)
10.24 Loan and Security Agreement between BankBoston Retail Finance Inc. and the Company dated June 7,
1999.(1)
12 Computation of Ratio of Earnings to Fixed Charges.(1)
21 Subsidiaries of Company.(1)
23.1 Consent of KPMG LLP.(2)
23.2 Consent of Oppenheimer Wolff & Donnelly LLP.(4)
24.1 Power of Attorney.(1)
27 Financial Data Schedule.(1)
</TABLE>
- ------------------------
(1) Previously filed.
(2) Filed herewith electronically
(3) Included in Indenture under Exhibit 4.4.
(4) Included in Exhibit 5.1 previously filed.
II-3
<PAGE>
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes that:
(1) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised 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. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of our counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
(2) For purposes of determining any liability under the Securities Act, the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant under Rule 424(b)(1) or (4) or 497(h) under
the Securities Act shall be deemed to be part of this registration statement as
of the time it was declared effective.
(3) For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered therein,
and this offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Pre-Effective Amendment No. 2 to the
Registration Statement to be signed on our behalf by the undersigned, thereunto
duly authorized in the City of Minneapolis, State of Minnesota, on July 13,
1999.
<TABLE>
<S> <C> <C>
PAPER WAREHOUSE, INC.
By: /s/ YALE T. DOLGINOW
-----------------------------------------
Yale T. Dolginow
PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, this
Pre-Effective Amendment No. 2 to the Registration Statement has been signed
below on the 13th day of July, 1999 by the following persons in the capacities
indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE
- ------------------------------ ---------------------------------------------
<C> <S>
/s/ YALE T. DOLGINOW President, Chief Executive Officer
- ------------------------------ and Chairman of the Board
Yale T. Dolginow (Principal Executive Officer)
*
- ------------------------------ Executive Vice President and Director
Brent D. Schlosser
/s/ CHERYL W. NEWELL
- ------------------------------ Vice President and Chief Financial Officer
Cheryl W. Newell (Principal Financial Officer)
*
- ------------------------------ Secretary and Director
Diane C. Dolginow
*
- ------------------------------ Controller
Diana G. Purcel (Principal Accounting Officer)
*
- ------------------------------ Director
Arthur H. Cobb
*
- ------------------------------ Director
Marvin W. Goldstein
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE
- ------------------------------ ---------------------------------------------
<C> <S>
*
- ------------------------------ Director
Martin A. Mayer
*
- ------------------------------ Director
Jeffrey S. Halpern
</TABLE>
<TABLE>
<S> <C> <C>
By: /s/ YALE T. DOLGINOW
-------------------------
Yale T. Dolginow
ATTORNEY-IN-FACT
</TABLE>
II-6
<PAGE>
FORM OF UNDERWRITING AGREEMENT
July ___, 1999
Miller & Schroeder Financial, Inc.
Pillsbury Center South, Suite 300
220 South Sixth Street
Minneapolis, MN 55402
Ladies and Gentlemen:
Paper Warehouse, Inc., a Minnesota corporation (the "Company"), hereby
confirms its agreement, subject to the terms and conditions stated herein, to
issue and sell to you (the "Underwriter"), four million ($4,000,000) principal
amount of its 9% Convertible Subordinated Debentures due September 15, 2005
("Debentures"). The Debentures are to be issued under an Indenture, dated as of
July ___, 1999 (the "Indenture") between the Company and Norwest Bank Minnesota,
N.A. as trustee (the "Trustee"). The Debentures are convertible into shares of
the Company's Common Stock, $.01 par value (the "Common Stock"). The Debentures
are more fully described in the Registration Statement and Prospectus as
hereafter defined.
1. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company hereby
represents and warrants to, and agrees with, the Underwriter that:
(a) A registration statement on Form S-1 (Registration No. 333-79161) with
respect to the Debentures has been prepared by the Company in conformity
with the requirements of the Securities Act of 1933, as amended (the "1933
Act") and the rules and regulations (the "Rules and Regulations") of the
Securities and Exchange Commission (the "SEC") thereunder and has been
filed with the SEC under the 1933 Act. If the Company has elected to rely
on Rule 462(b) under the 1933 Act to increase the size of the offering
registered under the 1933 Act, the Company will prepare and file with the
SEC a registration statement with respect to such increase pursuant to Rule
462(b). The Company has filed such amendments to the registration
statement and such amended preliminary prospectuses as may have been
required to be filed to the date hereof. If the Company has elected not to
rely upon Rule 430A, the Company has prepared and will promptly file an
amendment to the registration statement and an amended prospectus (provided
the Underwriter has consented to such filing). If the Company has elected
to rely upon Rule 430A, it will prepare and timely file a prospectus
pursuant to Rule 424(b) that discloses the information previously omitted
from the prospectus in reliance upon Rule 430A. Copies of such
registration statement, including a registration statement filed pursuant
to Rule 462(b), each pre-effective amendment thereto, and each related
preliminary prospectus have been delivered by the Company to the
Underwriter. Such registration statement, as amended or supplemented,
including all prospectuses included as a part thereof, financial schedules,
exhibits, the information (if any) deemed to be part thereof pursuant to
Rules 430A and 434
<PAGE>
under the 1933 Act and any registration statement filed pursuant to
Rule 462 under the 1933 Act, is herein referred to as the "Registration
Statement." The term "Prospectus" as used herein shall mean the final
prospectus, as amended or supplemented, included as a part of the
Registration Statement on file with the SEC when it becomes effective;
provided, however, that if a prospectus is filed by the Company
pursuant to Rules 424(b) and 430A or a term sheet is filed by the
Company pursuant to Rule 434 under the 1933 Act, the term "Prospectus"
as used herein shall mean the prospectus so filed pursuant to Rules
424(b) and 430A and the term sheet so filed pursuant to Rule 434. The
term "Preliminary Prospectus" as used herein means any prospectus, as
amended or supplemented, used prior to the Effective Date (as defined
in Section 5(a) hereof) and included as a part of the Registration
Statement, including any prospectus filed with the SEC pursuant to Rule
424(a).
(b) Neither the SEC nor any state securities division has issued any order
preventing or suspending the use of any Preliminary Prospectus or issued a
stop order with respect to the offering of the Debentures, or requiring the
recirculation of a Preliminary Prospectus and no proceedings for that
purpose have been instituted or, to the Company's knowledge, threatened.
Each part of the Registration Statement, when such part became or becomes
effective, each Preliminary Prospectus, on the date of filing with the SEC,
and the Prospectus and any amendment or supplement thereto, on the date of
filing thereof with the SEC and on the Closing Date (as defined in Section
2 hereof), as the case may be, conformed or will conform in all material
respects with the requirements of the 1933 Act and the Rules and
Regulations and securities laws ("Blue Sky Laws") of the states where the
Debentures are to be sold (the "States:) and contained or will contain all
statements that are required to be stated therein in accordance with the
1933 Act, Rules and Regulations and Blue Sky Laws of the States. When the
Registration Statement became or becomes effective and when any post-
effective amendments thereto shall become effective, the Registration
Statement did not and will not contain any untrue statement of a material
fact or omit to state a material fact required to be stated therein or
necessary to make the statements therein, in light of the circumstances
under which they were made, not misleading. Neither any Preliminary
Prospectus, on the date of filing thereof with the SEC, nor the Prospectus
or any amendment or supplement thereto, on the date of filing thereof with
the SEC and on the Closing Date, contained or will contain any untrue
statement of a material fact or omit to state a material fact necessary in
order to make the statements therein, in light of the circumstances under
which they were made, not misleading; provided, however, that none of the
representations and warranties in this Subsection 1(b) shall apply to
statements in, or omissions from, the Registration Statement, Preliminary
Prospectus or the Prospectus, or any amendment thereof or supplement
thereto, which are based upon and conform to written information furnished
to the Company by the Underwriter, as identified in Section 12 herein,
specifically for use in the preparation of the Registration Statement,
Preliminary Prospectus or the Prospectus, or any amendment or supplement
thereto. There is no contract or other document of the Company of a
character required by the 1933 Act or the Rules and Regulations to be
described in the Registration Statement or Prospectus, or to be filed as an
exhibit to the Registration Statement, that has not been described or filed
as required. The descriptions of all such contracts and documents or
references thereto are correct and include the information required under
the
2
<PAGE>
1933 Act and the Rules and Regulations. The conditions for use of a
Registration Statement on Form S-1 for the distribution of the Debentures
have been satisfied with respect to the Company. All descriptions in the
Registration Statement or Prospectus of statutes, regulations, legal or
governmental proceedings, the Indenture, the Debentures, or other contracts
or other documents are accurate in all material respects and fairly present
the information shown.
(c) KPMG Peat Marwick LLP, who have examined the consolidated financial
statements reported on by them and filed with the SEC as part of the
Registration Statement and the Prospectus, are independent public
accountants as required by the 1933 Act. The consolidated financial
statements of the Company and its Subsidiaries, including the related
notes, included in the Registration Statement and in the Prospectus (the
"Financial Statements") fairly present, on the basis stated therein, the
financial position, results of operations, cash flows and changes in
shareholders' equity of the Company and Paper Warehouse Franchising, Inc.
on a consolidated basis at the dates and for the periods to which they
relate. The Financial Statements have been prepared in accordance with
generally accepted accounting principles ("GAAP") consistently applied,
subject, in the case of unaudited financial statements, if any, to normal
year-end adjustments, and except as otherwise stated therein, throughout
the periods involved and comply in all material respects with the
requirements of the 1933 Act. The summaries of the Financial Statements
and other financial, statistical and related notes set forth in the
Prospectus (i) fairly present the information purported to be shown thereby
as of the dates and for the periods indicated on a basis consistent with
the audited consolidated financial statements of the Company and (ii) are
in compliance in all material respects with the requirements of the 1933
Act and the Rules and Regulations. There are no other financial statements
or schedules required to be included in the Registration Statement or
Prospectus that are not included in the Registration Statement or
Prospectus.
(d) Each of the Company and its Subsidiary, Paper Warehouse Franchising,
Inc. (the "Subsidiary" or "PWF"), are and at the Closing Date will be, duly
organized and validly existing and in good standing under the laws of their
respective states of incorporation with full power and authority (corporate
and other) to own, lease and operate their respective properties and
conduct their respective businesses as currently carried on and
contemplated and described in the Registration Statement and Prospectus and
no proceeding has been instituted in any such jurisdiction revoking,
limiting, curtailing or seeking to revoke, limit or curtail such
qualification. Each of the Company and its Subsidiaries are duly qualified
to do business as a foreign corporation in good standing in each
jurisdiction in which the character and location of their respective assets
or their respective business (existing or as contemplated by the
Prospectus) requires such qualification and which the failure to so qualify
would have a material adverse effect upon its business condition (financial
or otherwise), of the Company or PWF. No proceeding has been instituted in
any such jurisdiction revoking, limiting, curtailing or seeking to revoke,
limit or curtail such qualification.
3
<PAGE>
(e) There has not been, and at the Closing Date shall not have been, any
change in the Company's Amended and Restated Articles of Incorporation and
Amended and Restated Bylaws from those in effect as of the date of this
Agreement and filed as exhibits or incorporated by reference to the
Registration Statement. The Company and PWF are not in violation of their
respective Articles of Incorporation, Bylaws or other governing
instruments. The Company and PWF are not in default (nor with the giving
of notice or the passage of time or both would be in default) in the
performance of any obligation, agreement or condition contained in any
material contract or in any bond, debenture, note, indentured loan
agreement or other evidence of indebtedness or any loan agreement, contract
or joint venture agreement of the Company or PWF or other instrument to
which each is subject or by which any of their respective property or
assets are subject where such default could have a material adverse effect
on the condition (financial or otherwise), business or properties of the
Company or PWF. The Company and its Subsidiaries are not in violation of
any law, order, rule, regulation, writ, injunction, or decree of any
government, governmental instrumentality or court, domestic or foreign,
which violation is material to the business of the Company or PWF.
(f) The Company and PWF possess all franchises, licenses, certificates,
permits, authorizations, approvals and orders of all state, federal and
other governmental regulatory officials and bodies necessary to own their
respective properties, conduct their respective business as described in
the Registration Statement and Prospectus, and perform this Agreement and
consummate the transactions contemplated hereby, and the failure to possess
such licenses, certificates, permits, authorizations, approvals and orders
would not, individually or in the aggregate, have a material adverse effect
on the condition (financial or otherwise), business, or properties of the
Company and PWF, taken as a whole, or have obtained waivers from any such
applicable requirements from the appropriate state, federal or other
regulatory authorities, which will be delivered to the Underwriter on the
Closing Date. The Company and each of its Subsidiaries are conducting
their business in compliance with all material laws, rules and regulations
of the jurisdictions in which each is conducting business. All such
licenses, permits, approvals, certificates, consents, orders and other
authorizations are in full force and effect, and the Company and its
Subsidiaries have not received notice of any proceeding or action relating
to the revocation or modification of any such license, permit, approval,
certificate, consent, order or other authorization which, individually or
in the aggregate, if the subject of an unfavorable decision, ruling or
finding, might adversely affect the conduct of the business or the
condition, financial or otherwise, or the earnings, affairs or business
prospects of the Company and the Subsidiaries taken as a whole.
(g) Subsequent to the respective dates as of which information is given in
the Registration Statement and Prospectus, except as is described in the
Registration Statement and Prospectus through the date of this Agreement:
(i) the Company and PWF have not incurred, and will not have incurred, any
material liabilities or obligations, direct or contingent, or entered into
any transactions, in each case, other than in the ordinary course of
business; (ii) the Company and PWF have not and will not have paid or
declared any dividends or other distributions on their capital stock;
(iii) except in the
4
<PAGE>
ordinary course of business consistent with past practice, there has
not been and will not have been any material change in the capital
stock or outstanding debt, including any capitalized lease obligation,
of the Company or its Subsidiaries, or any issuance of options,
warrants, convertible securities other than may be issued pursuant to
the Company's 1997 Compensation Stock Option Plan, as amended, the
Employee Stock Purchase Plan and the Directors' Stock Option Plan, or
other rights to purchase the capital stock of the Company or its
Subsidiaries or any material adverse change or a development involving
a prospective material adverse change in or affecting the condition
(financial or otherwise), business, key personnel, properties, assets,
results of operations, or net worth of the Company and its Subsidiaries
taken as a whole; and (iv) the Company or its Subsidiaries has not
sustained any material loss or damage to their respective properties or
interference with their respective business, whether or not insured.
(h) There are no actions, suits, investigations or proceedings pending
before any court or governmental agency, authority or body, to which the
Company or its Subsidiary is a party or of which the business or property
of the Company or its Subsidiary is the subject which might: (i) result in
any material adverse change in the condition (financial or otherwise),
business or prospects of the Company; (ii) materially and adversely affect
its properties or assets; (iii) prevent consummation of the transactions
contemplated by this Agreement and Indenture; or (iv) adversely affect its
ability to repay the Debentures; and, to the best of the Company's
knowledge, no such actions, suits or proceedings are threatened. The
Company is not aware of any facts which would form the basis for the
assertion of any claim or liability which are not disclosed in the
Registration Statement or the Prospectus or adequately reserved for in the
Financial Statements which are a part thereof, except for such claims or
liabilities which are not currently expected to have a material adverse
effect on the condition (financial or otherwise) or the earnings, affairs
or business prospects of the Company or its Subsidiary. All pending legal
or governmental proceedings to which the Company or its Subsidiary is a
party or to which any of their respective property is subject, which are
not described in the Registration Statement and the Prospectus, including
ordinary routine litigation incidental to the business, are, considered in
the aggregate, not material to the Company or its Subsidiaries.
(i) The Company has full power and authority to execute and deliver this
Agreement and to perform its obligations hereunder. This Agreement has
been duly and validly authorized, executed and delivered by the Company and
will constitute a valid, legal and binding agreement of the Company,
enforceable in accordance with its terms, if and when this Agreement shall
have become effective in accordance with Section 9 hereof, except as
enforcement of rights to indemnity in this Agreement may be limited by
federal or state securities laws and except as enforcement may be limited
under bankruptcy, insolvency, or other similar laws affecting enforcement
of creditors' rights generally. The performance of this Agreement and the
consummation of the transactions herein contemplated will not result in a
breach or violation of any of the terms and provisions of, or constitute a
default (or with the giving of notice or the passage of time or both would
so constitute a breach or default) or result in the creation or imposition
of any lien, charge
5
<PAGE>
or encumbrance upon any property or assets of the Company or any
Subsidiary pursuant to (i) any indenture, mortgage, deed of trust, loan
agreement, bond, debenture, note agreement or other evidence of
indebtedness; lease, contract or other agreement or instrument to which
the Company or any Subsidiary is a party or by which the property or
assets of the Company or any Subsidiary is bound, (ii) the Company's or
its Subsidiary's Articles of Incorporation or Bylaws or other
organizational documents or (iii) any statute or any order, rule or
regulation of any court, governmental agency or body having
jurisdiction over the Company or any Subsidiary. No consent, approval,
authorization, order, registration, filing, qualification, license, or
permit of or with any court or any public, governmental or regulatory
agency or body having jurisdiction over the Company or its Subsidiaries
or their properties or assets, is required for the execution, delivery
and performance of this Agreement or the consummation of the
transactions contemplated hereby, including the issuance, sale and
delivery of the Debentures, except as may be required under the 1933
Act, the Rules and Regulations, the Blue Sky Laws of the States, the
rules and regulations of Nasdaq and the rules and regulations of the
National Association of Securities Dealers, Inc. ("NASD") in connection
with the offer and sale of the Debentures by the Underwriter.
(j) The Company has full power and authority to execute and deliver the
Indenture and Underwriter's Warrant, as defined herein, and to perform its
obligations thereunder. The Indenture and the Underwriter's Warrant have
been duly and validly authorized and when executed and delivered by the
Company on the Closing Date, will each constitute valid, legal and binding
agreements of the Company enforceable in accordance with their terms,
except as rights of indemnification may be limited by federal or state
securities laws and except as enforcement may be limited under bankruptcy,
insolvency or other similar laws affecting enforcement of creditors' rights
generally. The Company's performance of Indenture and the Underwriter's
Warrant and the consummation of the transactions therein contemplated by
such agreements will not result in a breach or violation of any of the
terms and provisions of, or constitute a default (or with the giving of
notice or the passage of time or both would so constitute a breach or
default) or result in the creation or imposition of any lien, charge or
encumbrance upon any property or assets of the Company or its Subsidiary
pursuant to (i) any indenture, mortgage, deed of trust, loan agreement,
bond, debenture, note agreement or other evidence of indebtedness; lease,
contract or other agreement or instrument to which the Company or any
Subsidiary is a party or by which the property or assets of the Company or
any Subsidiary is bound, (ii) the Company's or any Subsidiary's Articles of
Incorporation or Bylaws or other organizational documents or (iii) any
statute or any order, rule or regulation of any court, governmental agency
or body having jurisdiction over the Company or any Subsidiary. No
consent, approval, authorization, order, registration, filing,
qualification, license, or permit of or with any court or any public,
governmental or regulatory agency or body having jurisdiction over the
Company or any Subsidiary or their properties or assets, is required for
the execution, delivery and performance of the Indenture and Underwriter's
Warrant or the consummation of the transactions contemplated thereby. The
Indenture and Underwriter's Warrant are in substantially the form filed as
an exhibit to the Registration Statement.
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(k) The Company has full power and authority to execute and deliver the
Debentures and to perform its obligations thereunder. The Debentures have
been duly and validly authorized and, when authenticated by the Trustee and
issued, delivered and sold in accordance with this Agreement and the
Indenture, will have been duly and validly executed, authenticated, issued
and delivered and will constitute valid and legally binding obligations of
the Company entitled to the benefits provided by the Indenture and
enforceable against the Company in accordance with their terms, except as
enforcement may be limited under bankruptcy, insolvency or other similar
laws affecting enforcement of creditors' rights generally.
(l) The Company has, as of the dates set forth in the Prospectus, the duly
authorized and outstanding capitalization set forth in the Prospectus.
There are no other classes of stock authorized or outstanding except as
described in the Prospectus, and the outstanding consolidated indebtedness
of the Company is as set forth, as of the dates set forth therein, in the
Prospectus and has been duly authorized by the Company. The outstanding
Common Stock of the Company is duly authorized and validly issued, fully
paid, and nonassessable. All statements relating to the Debentures
contained in the Registration Statement and Prospectus conform in all
material respects to the terms of the Debentures. The shares of Common
Stock issuable upon conversion of the Debentures ("Conversion Shares") and
shares of Common Stock issuable upon exercise of the Underwriter's Warrant
("UW Warrant Shares") have been duly authorized and when issued, delivered
and paid for pursuant to the terms of the Indenture and Underwriter's
Warrant, respectively, will be validly issued, fully paid, and
nonassessable and will conform to the description of the Company's Common
Stock contained in the Prospectus. A sufficient number of shares of the
Common Stock have been reserved for issuance upon conversion of the
Debentures and exercise of the Underwriter's Warrant. No preemptive rights
or similar rights of any security holders of the Company exist with respect
to the issuance and sale of the Debentures by the Company or conversion of
the Debentures or exercise of the Underwriter's Warrant. The Company has
no agreement with any security holder which gives such security holder the
right to require the Company to register under the 1933 Act any securities
of any nature owned or held by such person either in connection with the
transactions contemplated by this Agreement or after a demand for
registration by such holder. Upon payment for and delivery of the
Debentures pursuant to this Agreement, the Underwriter will acquire good
and marketable title to the Debentures free and clear of all liens,
encumbrances, or claims. The certificates evidencing the Debentures and
Common Stock comply as to form with all applicable provisions of federal
law and the laws of the State of Minnesota. Except as set forth in any
part of the Registration Statement, the Company and its Subsidiaries do not
have any outstanding options to purchase or any rights or warrants to
subscribe for, or any securities or obligations convertible into, or any
contract or commitments to issue or sell, any Common Stock or other
securities of the Company.
(m) The Company and its Subsidiaries have good and marketable title (in
fee simple as to real property) to all real and personal properties and
assets described in the
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Prospectus as being owned by them, free and clear of all security
interests, liens, charges, encumbrances, restrictions or defects except
such as are otherwise reflected in the financial statements included in
the Prospectus or described or referred to in the Prospectus or as such
do not materially affect the value of such property and do not
materially interfere with the use made of such property by the Company
or its Subsidiary. The Company and its Subsidiary hold valid and
enforceable leases for the properties (real and personal) described in
the Prospectus as leased by them with such exceptions as are not
material and do not interfere with the use made or proposed to be made
of such properties; the Company and its Subsidiary are not in default
(or with the giving of notice or the passage of time or both would be
in default) in respect to any of such leases, and to the best knowledge
of the Company, no claim of any sort has been asserted by anyone
adverse to the rights of the Company and its Subsidiaries as lessee
under any such lease or questioning its right to continued use and
possession of any of the leased properties under any such lease.
(n) Except as disclosed in the Prospectus, the Company and its Subsidiary
owns or possesses all patents, patent applications, trademarks, service
marks, tradenames, trademark registrations, service mark registrations,
copyrights, licenses, inventions, know-how, trade secrets and other similar
rights necessary for the conduct of their respective businesses as
currently carried on or intended to be carried on and as described in the
Prospectus. Except as disclosed in the Prospectus, no name which the
Company, its Subsidiary or any of its franchisees uses and no other aspect
of the business of the Company, its Subsidiary or any of its franchisees
involves or gives rise to any infringement of or conflict with, or licenses
or similar registrations, service mark registrations, copyrights, licenses,
inventions, trade secrets or other similar rights of others, and neither
the Company nor its Subsidiary has received any notice or claim of conflict
with the asserted rights of others with respect to any of the foregoing.
(o) The Company has filed all necessary federal, state, local and foreign
income, franchise and other tax returns required to be filed through the
date of this Agreement and has paid all taxes shown as due thereon other
than any which the Company or PWF is contesting in good faith. All tax
liabilities are adequately provided for on the books of the Company and
there is no tax proceeding or action pending or, to the best knowledge of
the Company, threatened against the Company.
(p) The Company has not distributed and will not distribute any prospectus
or any other offering material in connection with the offering and sale of
the Debentures other than the Preliminary Prospectus or the Prospectus or
other materials permitted by the 1933 Act and Rules and Regulations to be
distributed by the Company and consented to by the Underwriter.
(q) The Company owns no capital stock or other equity or ownership or
proprietary interest in any corporation, partnership, limited liability
company, association, trust or other entity and is not affiliated (as that
term is defined under the 1933 Act) with any other company or business
entity except as explicitly stated in the Prospectus. Except as
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<PAGE>
described in the Prospectus, the Company is not owned or controlled,
directly or indirectly, by any corporation, association or other entity.
(r) The Company maintains a system of internal accounting controls
sufficient to provide that:
(i) transactions are executed in accordance with management's
general or specific authorization;
(ii) transactions are recorded as necessary to permit
preparation of financial statements in conformity with generally
accepted accounting principles and to maintain accountability for
assets;
(iii) access to assets is permitted only in accordance with
management's general or specific authorization; and
(iv) the recorded accountability for assets is compared with
existing assets at reasonable intervals and appropriate action is
taken with respect to any differences.
(s) The Company maintains insurance, which is in full force and effect, of
the types and in amounts which are adequate for its business and as is
customary with insurance maintained by similar companies and businesses.
(t) No labor disturbance by the employees of the Company exists or, to the
best of the Company's knowledge, is imminent which could reasonably be
expected to have a material adverse effect on the conduct of the business,
operations, financial condition, or income of the Company.
(u) Neither the Company nor any Subsidiary is an "investment company" as
defined in the Investment Company Act of 1940, as amended and will not
become an "investment company" upon the sale of the Debentures.
(v) Neither the Company nor any employee or agent of the Company has made
any payment of funds of the Company or received or retained funds in
violation of any law, rule or regulation.
(w) Other than as contemplated by this Agreement, the Company has not
engaged any "finder" with respect to the transactions contemplated by this
Agreement and there is no outstanding claim for services in the nature of a
"finder's fee" with respect to such financing; and the Company agrees to
indemnify and hold the Underwriter harmless from and against any claims,
losses, judgments or expenses resulting from any finder's fees payable in
connection herewith.
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(x) There are no outstanding loans or advances or guarantees of
indebtedness by the Company to or for the benefit of any of the officers or
directors of the Company or any of the members of the families of any of
them except as are described in the Prospectus.
(y) The Company, after giving effect to the execution, delivery and
performance of this Agreement, the Indenture, and the Debentures and the
consummation of the transactions contemplated hereby and thereby will not
be:
(i) insolvent;
(ii) left with unreasonably small capital with which to engage
in its business; or
(iii) incurring debts beyond its ability to pay such debts as
they mature.
(z) The Company has not taken and will not take, directly or indirectly,
any action designed to cause or result in or which has constituted or which
constitute the stabilization or manipulation, as defined in the Securities
Exchange Act of 1934, as amended (the "1934 Act") or otherwise, of the
price of any outstanding securities of the Company to facilitate the sale
or resale of the Debentures.
(aa) The Company has timely filed all documents and amendments to
previously filed documents required to be filed by it pursuant to the 1934
Act and the Rules and Regulations. Each such document conformed in all
material respects with the requirements of the 1934 Act and contained all
information required to be stated therein in accordance with the 1934 Act.
No part of any such document contained any untrue statement of a material
fact or omitted to state a material fact required to be stated therein or
necessary to make the statements therein not misleading. True copies of
each of the documents incorporated by reference, if any, into each
Preliminary Prospectus and the Prospectus have been delivered by the
Company to the Underwriter. To the best of the Company's knowledge, the
executive officers and directors of the Company and stockholders who hold
more than 5% of the Company's outstanding Common Stock, have made, and are
current with, all filings, if any, that are required under the 1934 Act.
(bb) On the Closing Date, all transfer or other taxes, if any (other than
income taxes), which are required to be paid in connection with the sale or
transfer of the Debentures will have been fully paid or provided for by the
Company and all laws imposing such taxes will have been fully complied
with.
(cc) The Company has no defined benefit pension plan or other pension plan,
except for its 401(k) Plan which has been funded; which is intended to
comply with the provisions of the Employee Retirement Income Securities Act
of 1974, as amended, except as disclosed in the Registration Statement.
(dd) The Company has sold no securities in violation of Section 5(a) of the
1933 Act.
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(ee) Neither the Company, nor any affiliate thereof, does business with the
government of Cuba or with any person or affiliate located in Cuba.
(ff) All material transactions between the Company and its stockholders who
beneficially own more than 5% of any class of the Company's voting
securities have been accurately disclosed in the Prospectus, and the terms
of each such transaction are fair to the Company and on terms no less
favorable to the Company than the terms that could have been obtained from
unrelated parties.
(gg) No holders of the Company's securities who have demand or
participatory registration rights, have any right to include any of the
Company's securities in the Registration Statement nor is the Company
obligated to include any of its securities, other than the securities
described in this Agreement, in the Registration Statement.
(hh) The Company has not offered or sold any franchises or entered into any
franchise or similar agreements in violation of applicable federal, state
or local laws or regulations governing franchises or similar business
arrangements. All registrations or filings required to be made by the
Company in connection with the offer and sale of franchises or the
establishment or maintenance of franchise agreements or similar
arrangements have been made and remain in full force and effect. The
Company is not in breach of any franchise or similar agreement.
2. PURCHASE, SALE, DELIVERY AND PAYMENT.
(a) On the basis of the representations, warranties, and agreements herein
contained, but subject to the terms and conditions herein set forth, the
Company agrees to issue and sell to the Underwriter, and the Underwriter
agrees to purchase from the Company, the Debentures at a purchase price
equal to 92.5% of the per Debenture price offered to the public (as set
forth in the Prospectus at $1,000 per Debenture). The Underwriter will
purchase all of the Debentures if any are purchased.
(b) The Company will deliver the Debentures to the Underwriter at the
offices of Fredrikson & Byron, P.A. unless some other place is agreed upon,
at 10:00 A.M., Minneapolis time, against payment of the purchase price at
the same place, on the third full business day after the Effective Date, or
such earlier time as may be agreed upon between the Underwriter and the
Company, such time and place being herein referred to as the "Closing
Date."
(c) Certificates for the Debentures to be delivered will be registered in
such names and issued in such denominations as the Underwriter shall
request of the Company at least three full business days prior to the
Closing Date. The certificates will be made available to the Underwriter
in definitive form for the purpose of inspection and packaging at least 24
hours prior to the Closing Date.
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<PAGE>
(d) Payment for the Debentures shall be made by wire transfer to a
designated account of the Company, certified or official bank check or
checks in Clearing House funds, payable to the order of the Company.
(e) The Underwriter will make a public offering of the Debentures directly
to the public (which may include selected dealers who are members in good
standing with the NASD or foreign dealers not eligible for membership in
the NASD but who have agreed to abide by the interpretation of the NASD's
Board of Governors with respect to free-riding and withholding) as soon as
the Underwriter deems practicable after the Registration Statement becomes
effective at the initial public price set forth on the cover page of the
Prospectus, subject to the terms and conditions of this Agreement and in
accordance with the Prospectus. Such concessions from the public offering
price may be allowed selected dealers of the NASD as the Underwriter
determines, and the Underwriter will furnish the Company with such
information about the distribution arrangements as may be necessary for
inclusion in the Registration Statement. It is understood that the public
offering price and concessions may vary after the initial public offering
of the Debentures. The Underwriter shall offer and sell the Debentures
only in jurisdictions in which the offering of Debentures has been duly
registered or qualified, or is exempt from registration or qualification,
and shall take reasonable measures to effect compliance with applicable
state and local securities laws.
3. UNDERWRITER'S WARRANT. On the Closing Date, the Company shall sell to
you for $50 the Underwriter's Warrant, which shall first become exercisable one
year after the Effective Date and shall remain exercisable for a period of four
years thereafter. The Underwriter's Warrant shall be subject to certain
transfer restrictions and shall be in substantially the form filed as an exhibit
to the Registration Statement and attached as Appendix A hereto.
4. COVENANTS OF THE COMPANY. The Company hereby covenants and agrees
with the Underwriter as follows:
(a) If the Registration Statement has not become effective prior to the
date hereof, the Company will use its best efforts to cause the
Registration Statement and any subsequent amendments thereto to become
effective as promptly as possible. The Company will notify the Underwriter
promptly, after the Company shall receive notice thereof, of the time when
the Registration Statement, or any subsequent amendment thereto, has become
effective or any supplement to the Prospectus has been filed. Following
the execution and delivery of this Agreement, the Company will prepare, and
timely file or transmit for filing with the SEC in accordance with Rules
430A, 424(b) and 434, as applicable, copies of the Prospectus, or, if
necessary, a post-effective amendment to the Registration Statement
(including the Prospectus), in which event, the Company will take all
necessary action to have such post-effective amendment declared effective
as soon as possible. The Company will notify the Underwriter promptly upon
the Company's obtaining knowledge of the issuance by the SEC of any stop
order suspending the effectiveness of the Registration Statement or of the
initiation or threat of any proceedings for that purpose and will use its
best efforts to prevent the issuance of any stop order and, if a stop order
is issued, to obtain
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<PAGE>
as soon as possible the withdrawal or lifting thereof. The Company will
promptly prepare and file at its own expense with the SEC any
amendments of, or supplements to, the Registration Statement or the
Prospectus which may be necessary in connection with the distribution
of the Debentures by the Underwriter. During the period when a
Prospectus relating to the Debentures is required to be delivered under
the 1933 Act, the Company will promptly file any amendments of, or
supplements to, the Registration Statement or the Prospectus which may
be necessary to correct any untrue statement of a material fact or any
omission to state any material fact necessary to make the statements
therein, in light of the circumstances under which they were made, not
misleading. The Company will notify the Underwriter promptly of the
receipt of any comments from the SEC regarding the Registration
Statement or Prospectus or request by the SEC for any amendment thereof
or supplement thereto or for any additional information. The Company
will not file any amendment of, or supplement to, the Registration
Statement or Prospectus, whether prior to or after the Effective Date,
which shall not previously have been submitted to the Underwriter and
its counsel a reasonable time prior to the proposed filing or to which
the Underwriter shall have reasonably objected.
(b) The Company has used and will continue to use its best efforts to
register or qualify the Debentures for sale under the securities laws of
such jurisdictions as the Underwriter may designate and the Company will
file such consents to service of process or other documents necessary or
appropriate in order to effect such registration or qualification. In each
jurisdiction in which the Debentures shall have been registered or
qualified as above provided, the Company will continue such registrations
or qualifications in effect for so long as may be required for purposes of
the distribution of the Debentures, provided, however, that in no event
shall the Company be obligated to qualify to do business as a foreign
corporation in any jurisdiction in which it is not now so qualified or to
take any action which would subject it to the service of process in suits,
other than those arising out of the offering or sale of the Debentures in
any jurisdiction where it is not now so subject. In each jurisdiction
where any of the Debentures shall have been so qualified, the Company will
file such statements and reports as are or may be reasonably required by
the laws of such jurisdiction to continue such qualification in effect for
so long as the Debentures are outstanding. The Company will notify the
Underwriter immediately of, and confirm in writing, the suspension of
qualification of the Debentures or the threat of such action in any
jurisdiction. The Company will use its best efforts to qualify or register
its Common Stock and Debentures for sale in nonissuer transactions under
(or obtain or maintain exemptions from the application of) the securities
laws of such states designated by the Underwriter (and thereby permit
market-making transactions and secondary trading in its Common Stock and
Debentures in such states), and will comply with such securities laws and
will continue such qualifications, registrations and exemptions in effect
for so long as the Debentures are outstanding.
(c) The Company will furnish to the Underwriter, as soon as available,
copies of the Registration Statement (one of which will be signed and which
shall include all exhibits), the Preliminary Prospectus, the Prospectus and
any amendments or supplements to such documents, including any prospectus
prepared to permit compliance with Section 10(a)(3)
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of the 1933 Act, all in such quantities as the Underwriter may from
time to time reasonably request prior to the printing of each such
document. The Company specifically authorizes the Underwriter and all
dealers to whom any of the Debentures may be sold by the Underwriter to
use and distribute copies of such Preliminary Prospectuses and
Prospectuses in connection with the offer and sale of the Debentures as
and to the extent permitted by the federal and applicable state and
local securities laws.
(d) As soon as practicable (but in no event later than 90 days after the
close of the period covered thereby) the Company will make generally
available to its security holders, including Debenture holders, and furnish
to you, an earnings statement of the Company covering the period of 12
months beginning not later than the first day of the next fiscal quarter
following the Effective Date of the Registration Statement which will
satisfy the requirements of Section 11(a) or Rule 158 of the 1933 Act and
which need not be certified or audited by independent public accountants.
(e) For as long as the Company has more than 100 beneficial owners, but in
no event more than six years after the Effective Date, the Company will
furnish to the Underwriter, without need of request, concurrently with
furnishing such reports to its stockholders, the following reports: (i) as
soon as they are available, copies of all other reports (financial or
otherwise) mailed to security holders; and (ii) as soon as they are
available, copies of all reports and financial statements furnished to, or
filed with, the SEC, the NASD, any securities exchange or any state
securities commission by the Company. During such period, the foregoing
financial statements shall be on a consolidated basis to the extent that
the accounts of the Company and any Subsidiary or Subsidiaries are
consolidated and shall be accompanied by similar financial statements for
any significant subsidiary which is not so consolidated.
(f) Prior to or as of the Closing Date, the Company shall have performed
each condition to closing required to be performed by it pursuant to
Section 5 hereof, unless waived by the Underwriter in writing.
(g) Other than as permitted by the 1933 Act and the Rules and Regulations,
the Company will not distribute any Prospectus or other offering material
in connection with the Offering.
(h) The Company will cause all holders of its securities who have any
demand or participatory registration rights to waive any demand or
participatory registration rights which they may have in connection with
the offer and sale of the Debentures, in connection with any other offer or
sale of other securities of the Company, or as a result of "demand"
registration rights for a period of one year from the date of this
Agreement.
(i) The Company will apply the net proceeds from the sale of the
Debentures in the manner set forth under the caption "Use of Proceeds" in
the Prospectus.
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(j) The Company agrees that from the date of its execution of this
Agreement to the Closing Date, it will issue press releases, make public
statements and respond to inquiries of the press and securities analysts in
connection with this Offering only (i) in accordance with its obligations
under the 1934 Act after conferring with its counsel and (ii) after
conferring with its counsel and with the consent of the Underwriter.
(k) The Company will not claim the benefit of any usury laws against any
holders of the Debentures.
(l) The Company will provide the Underwriter with copies of reports,
certificates and supporting documentation furnished to the Trustee pursuant
to the Indenture or otherwise concurrently with furnishing such reports to
the Trustee.
(m) The Company will continue to appoint its current auditors or any
replacement firm of auditors reasonably acceptable to the Underwriter to
audit its financial statements.
(n) The Company agrees that the necessary legal work for drafting and
preparing the Indenture and for registration, qualification or perfection
of exemptions of the Debentures for sale under the Blue Sky Laws of such
States as the Underwriter may designate (the "Blue Sky States") shall be
performed by counsel for the Underwriter. All Blue Sky filing fees and up
to $5,000 of fees and expenses of Underwriter's counsel incurred in
connection with registering, qualifying or perfecting exemptions of the
Debentures for sale in the Blue Sky States shall be paid by the Company,
and up to $10,000 of the fees and expenses of Underwriter's counsel
incurred in connection with the preparation of the Indenture shall be paid
by the Company. Such Blue Sky and Indenture fees shall be paid regardless
of whether any closing shall occur and shall be in addition to the
Underwriter's fees, expenses and commission described in this Agreement.
(o) The Company will pay to the Underwriter a management fee in an amount
equal to 2.0% of the aggregate principal amount of the Debenture sold by
the Company.
(p) The Company will pay, in addition to the Blue Sky, Indenture and
management fees described in paragraphs (n) and (o) of this Section, all
costs and expenses related to the performance of its obligations under this
Agreement including, but not limited to: (i) all expenses incident to the
issuance and delivery of the Debenture, including taxes, if any; (ii) all
expenses incident to the preparation, filing and delivery of the
Registration Statement, each Preliminary Prospectus, the Prospectus, and
any amendments, supplements or submissions related thereto (including
exhibits); (iii) all expenses incident to the filing, delivery and
qualification of the Indenture and any amendments, supplements or
submissions related thereto (including up to $10,000 of fees and
disbursements of Underwriters' counsel, who has the responsibility for such
preparation); (iv) all NASD fees incurred by the Underwriter in connection
with the review of your compensation by the NASD; (v) the cost of preparing
and printing as many amendments to the Registration Statement as may be
necessary; (vi) the cost of all certificates representing the Debentures;
(vii) the fees and expenses of the Trustee and paying agent
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under the Indenture; (viii) the cost of printing and distributing all
documents related to the offering of the Debentures; (ix) the fees and
expenses of the Company's independent accounts, including the cost of
"cold comfort" review; (x) the fees and expenses of legal counsel for
the Company; (xi) the cost of furnishing and delivering to the
Underwriter and dealers participating in the distribution of the
Debentures copies of the Registration Statement (including Exhibits),
Preliminary Prospectuses, the Prospectuses and any amendments of, or
supplements to, any of the foregoing; and (xii) the nonaccountable
expense allowance of the Underwriter in an amount equal to 3.0% of the
aggregate principal amount of the Debentures sold by the Company, less
the $25,000 deposit paid by the Company to the Underwriter on May 13,
1999, provided, however, if this transaction is abandoned for any
reason, the Company will reimburse the Underwriter only for its actual
out-of-pocket accountable expenses in an amount not to exceed $50,000.
If upon such abandonment the Underwriter's actual accountable
out-of-pocket expenses do not exceed the $25,000 advance against the
Underwriter's nonaccountable expense allowance, the portion of the
advance not used will be reimbursed to the Company by the Underwriter.
(q) The Company will not take, and will use its best efforts to cause each
of its officers and directors not to take, directly or indirectly, any
action designed to or which might reasonably be expected to cause or result
in the manipulation of the price of any security of the Company to
facilitate the sale or resale of the Debentures.
(r) The Company will use its best efforts to maintain the listing of its
Common Stock on The Nasdaq National Market.
5. CONDITIONS OF THE UNDERWRITER OBLIGATIONS. The obligations of the
Underwriter to purchase and pay for the Debentures as provided herein shall be
subject to the accuracy of the representations and warranties of the Company, as
of the date hereof and the Closing Date, to the performance by the Company of
its obligations hereunder, and to the satisfaction of the following additional
conditions on or before the Closing Date:
(a) The Registration Statement shall have become effective not later than
5:00 P.M. Minneapolis time, on the first full business day following the
date of this Agreement, or such later date as shall be consented to in
writing by the Underwriter (the "Effective Date"). If the Company has
elected to rely upon Rule 430A, the information concerning the price of the
Debentures and price-related information previously omitted from the
effective Registration Statement pursuant to Rule 430A shall have been
transmitted to the SEC for filing pursuant to Rule 424(b) within the
prescribed time period, and prior to the Closing Date the Company shall
have provided evidence satisfactory to the Underwriter of such timely
filing (or a post-effective amendment providing such information shall have
been promptly filed and declared effective in accordance with the 1933 Act
and the Rules and Regulations). No stop order suspending the effectiveness
thereof shall have been issued and no proceeding for that purpose shall
have been initiated or, to the knowledge of the Company or the Underwriter,
threatened by the SEC or any state securities commission or similar
regulatory body. Any request of the SEC for additional information (to be
included
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in the Registration Statement or the Prospectus or otherwise)
shall have been complied with to the satisfaction of the Underwriter and
its legal counsel. The NASD, upon review of the terms of the Offering,
shall not have objected to the terms of the Underwriters' participation in
the Offering.
(b) The Underwriter shall not have been advised that the Registration
Statement or Prospectus, or any amendment thereof or supplement thereto,
contains any untrue statement of a material fact which omits to state a
material fact and which is required to be stated therein or is necessary to
make the statements contained therein, in light of the circumstances under
which they were made, not misleading.
(c) Subsequent to the date as of which information is given in the
Registration Statement and Prospectus, there shall not have occurred any
change, or any development involving a prospective change, which materially
and adversely affects the business or properties of the Company and which,
in the reasonable opinion of the Underwriter, materially and adversely
affects the market for the Debentures.
(d) The Underwriter and Underwriter's counsel shall have been furnished
with such documents and information as the Underwriter or they may have
requested.
(e) The Underwriter shall have received the opinion of Oppenheimer Wolff &
Donnelly LLP, counsel for the Company, dated as of the Closing Date and
satisfactory in form and substance to the Underwriter and its counsel, to
the effect that:
(i) The Company and its Subsidiaries have been duly organized
and are validly existing in good standing under the laws of their
respective states of organization with the requisite corporate
power and authority to own or lease properties and conduct their
respective businesses as described in the Prospectus. The
Company and its Subsidiaries are duly qualified to do business as
a foreign corporation in good standing in all jurisdictions where
the ownership or leasing of their properties or the conduct of
their respective businesses requires such qualification, except
where the failure to so qualify would not have a material adverse
effect on the Company and its Subsidiaries taken as a whole.
(ii) To the best of such counsel's knowledge, the Company does
not own any stock or other equity interest in any corporation,
partnership, joint venture, unincorporated association or other
entity other than PWF. The outstanding shares of capital stock
of each such subsidiary have been duly authorized and validly
issued, are fully paid and nonassessable and, to the best of such
counsel's knowledge, are owned directly or indirectly, by the
Company, free and clear of all liens, encumbrances and security
interests, other than security interests specifically disclosed
in the Prospectus. To the best knowledge of such counsel, no
options, warrants or other rights to purchase, agreements or other
obligations to issue or other rights to
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convert any obligations into any shares of capital stock or
ownership interests in each such subsidiary are outstanding.
(iii) The number of authorized and the number of issued and
outstanding shares of capital stock of the Company are as set
forth in the Prospectus, excluding the issuance of Capital Stock
upon the conversion of the Debentures, or the exercise of the
Underwriter's Warrant, and all such issued and outstanding
capital stock has been duly authorized and is validly issued,
fully paid, and nonassessable. The Company has all requisite
power and authority to issue and sell the Debentures in
accordance with and upon the terms and conditions set forth in
this Agreement, and all action required to be taken by the
Company for the due and proper authorization, issuance, sale and
delivery of the Debentures has been validly and sufficiently
taken. The Debentures to be issued and sold, upon issuance and
delivery of and payment for the Debentures hereunder will be duly
authorized, validly issued and fully paid. The Company's Amended
and Restated Articles of Incorporation, as amended and Amended
and Restated Bylaws contain no preemptive rights. To the best
knowledge of such counsel, no preemptive rights, contractual or
otherwise, of securities holders of the Company exist with
respect to the issuance or sale of the Debentures by the Company
pursuant to this Agreement or the issuance of the Conversion
Shares upon conversion of the Debentures to shares of the
Company's Common Stock and, to the best of such counsel's
knowledge, there are no rights to require registration of shares
of Common Stock or other securities of the Company which may be
exercised in connection with the filing of the Registration
Statement. The Debentures, Underwriter's Warrant and Common
Stock conform as to matters of law in all material respects to
the description of these securities made in the Prospectus, and
such description accurately sets forth the material legal
provisions thereof required to be set forth in the Prospectus.
(iv) The Common Stock to be issued upon conversion of the
Debentures has been duly authorized and when converted pursuant
to the terms of the Indenture will be validly issued, fully paid
and nonassessable. A sufficient number of shares of Common Stock
of the Company have been reserved for issuance upon conversion of
the Debentures.
(v) The certificates evidencing the Debentures and Common Stock
comply as to form with the applicable provisions of the laws of
the State of Minnesota.
(vi) The Underwriter's Warrant has been duly authorized,
executed and delivered by the Company and are the valid and
binding obligations of the Company, enforceable in accordance
with their terms, except as enforcement of rights to indemnity
and contribution in this Agreement
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may be limited by federal or state securities laws or principals
of public policy and subject to the qualification that the
enforceability of the Company's obligations hereunder and
thereunder may be limited by bankruptcy, fraudulent conveyance,
insolvency, reorganization, moratorium and other laws relating to
or affecting creditors' rights generally, and by general equitable
principals when applied by a court of law or equity. The Common
Stock when issued and paid for in accordance with the terms of the
Underwriter's Warrant will be validly issued, fully paid and
nonassessable. A sufficient number of shares of Common Stock has
been reserved for issuance upon exercise of the Underwriter's
Warrant.
(vii) The Registration Statement has become and is effective
under the 1933 Act, the Prospectus has been filed as required by
Rule 424(b), if necessary, and to the best knowledge of such
counsel, no stop orders suspending the effectiveness of the
Registration Statement have been issued and no proceedings for
that purpose have been instituted or are pending or contemplated
under the Act.
(viii) The Registration Statement, the Prospectus and each
amendment or supplement thereto comply as to form in all material
respects with the requirements of the 1933 Act and the Rules and
Regulations (except that such counsel need express no opinion as
to the financial statements and related schedules included
therein).
(ix) Such counsel does not know of any contracts, agreements,
documents or instruments required to be filed as exhibits to the
Registration Statement or described in the Registration Statement
or the Prospectus which are not so filed or described as
required; and insofar as any statements in the Registration
Statement or the Prospectus constitute summaries of any contract,
agreement, document or instrument to which the Company or any of
its subsidiaries is a party, such statements are accurate
summaries and fairly present the information called for with
respect to such matters.
(x) To the best knowledge of such counsel, there are no legal
or governmental proceedings pending, or threatened, before any
court or administrative body or regulatory agency, to which the
Company or its Subsidiaries is a party or to which any of the
properties of the Company or its Subsidiaries are subject, that
are required to be disclosed in the Registration Statement or
Prospectus that are not so described, nor to the knowledge of
such counsel legal or governmental proceedings pending or
threatened, that are required to be described in the Registration
Statement or Prospectus that are not so described.
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(xi) No consent, approval, authorization, order or other action
of any court or governmental agency or body is required for the
execution and delivery of this Agreement and issuance and sale of
the Debentures as contemplated herein, except for the order of
the SEC making the Registration Statement effective and similar
authorizations required under the Blue Sky laws (as to which such
counsel need express no opinion) of any jurisdiction in
connection with the purchase and distribution of the Debentures
by the Underwriter and such other approvals (specified in such
opinion) as have been obtained.
(xii) The Company has full legal right, power and authority to
enter into this Agreement. This Agreement has been duly
authorized, executed and delivered by, and is a valid and binding
agreement of the Company, enforceable in accordance with its
terms, except as enforcement of rights to indemnity and
contribution in this Agreement may be limited by federal or state
securities laws or principals of public policy and subject to the
qualification that the enforceability of the Company's
obligations hereunder and thereunder may be limited by
bankruptcy, fraudulent conveyance, insolvency, reorganization,
moratorium and other laws relating to or affecting creditors'
rights generally, and by general equitable principals when
applied by a court of law or equity.
(xiii) The Indenture has been duly and validly authorized,
executed and delivered by the Company, is exempt from
qualification under the Trust Indenture Act, is in the form filed
as an exhibit to the Registration Statement and constitutes a
valid and legally binding obligation of the Company enforceable
against the Company in accordance with its terms, except as
enforcement of rights to indemnity and contribution in this
Agreement may be limited by federal or state securities laws or
principals of public policy and subject to the qualification that
the enforceability of the Company's obligations hereunder and
thereunder may be limited by bankruptcy, fraudulent conveyance,
insolvency, reorganization, moratorium and other laws relating to
or affecting creditors' rights generally, and by general
equitable principals when applied by a court of law or equity.
(xiv) The execution or delivery of this Agreement, Indenture and
Underwriter's Warrant and the consummation of the transactions
described herein and therein will not result in a violation of or
default under, the Company's Amended and Restated Articles of
Incorporation, as amended, Amended and Restated Bylaws or other
governing documents, or violate any law, order, rule, regulation,
writ, franchise, injunction, or decree known to such counsel of
any government, governmental agency or court having jurisdiction
over the Company or its Subsidiaries or any of their properties,
and, to the best of such counsel's knowledge, the
20
<PAGE>
Company is not, nor with the giving of notice or lapse of time or
both would be, in violation of or default under, nor will the
execution and delivery of this Agreement, Indenture, and
Underwriter's Warrant and the consummation of the transactions
described therein result in a violation of or default under the
terms or provisions of any bond, debenture, note, or other
evidence of indebtedness or any contract, license, indenture,
mortgage, loan agreement, joint venture or partnership agreement,
lease, agreement or instrument to which the Company or its
Subsidiaries are a party or by which the Company or its
Subsidiaries or any of their properties are bound which are
described in the Prospectus or attached to the Registration
Statement as an Exhibit.
(xv) The Debentures conform to the description thereof contained
under the heading "Description of Debentures" in the Prospectus.
(xvi) The statements (i) in the Prospectus under the captions
"Business -- Government Regulation" (excluding any statements
relating to franchising), "Business - Facilities, -- Legal
Proceedings," "Management -- Employment Agreements, -- Stock
Option Plans, -- Director Compensation, -- Employee Stock
Purchase Plan," "Certain Transactions," "Description of
Debentures," "Certain United States Federal Income Tax
Considerations," and "Description of Capital Stock," and (ii) in
the Registration Statement in Item 14 insofar as such statements
constitute a summary of statutes, legal and governmental
proceedings, contracts and other documents, are accurate
summaries in all material respects and fairly present the
information called for with respect to such matters.
(xvii) The Company holds, and is operating in compliance with
all grants, authorizations, licenses, permits, easements,
consents, certificates and orders of any governmental or self-
regulatory body required for the conduct of its business, except
to the extent that any failure to comply with any such material
grants, authorizations, permits, easements, consents,
certificates and orders will not, individually or in the
aggregate, have a material adverse effect on the business,
condition (financial or otherwise), results of operations,
stockholders' equity or prospects of the Company and its
Subsidiaries, taken as a whole. All such grants, authorizations,
licenses, permits, easements, consents, certifications and orders
are valid and in full force and effect.
(xviii) Although such counsel cannot guarantee the accuracy,
completeness or fairness of the statements contained in the
Registration Statement or the Prospectus, based upon such
counsel's activities in the ordinary course of its engagement
with the Company, no facts have come to such counsel's attention
that cause such counsel to believe that, as of its
21
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Effective Date, the Registration Statement or any further
amendment thereto made by the Company prior to the Closing Date
(other than the financial statements and related schedules
therein, as to which such counsel need express no opinion),
contained an untrue statement of a material fact or omitted to
state a material fact required to be stated therein or necessary
to make the statements therein not misleading or that, as of its
date, the Prospectus or any further amendment or supplement
thereto made by the Company prior to the Closing Date (other than
the financial statements and related schedules therein, as to
which such counsel need express no opinion), contained an untrue
statement of a material fact or omitted to state a material fact
necessary to make the statements therein, in light of the
circumstances in which they were made, not misleading or that, as
of the Closing Date, either the Registration Statement or the
Prospectus or any further amendment or supplement thereto made by
the Company prior to the Closing Date (other than the financial
statements and related schedules therein, as to which such counsel
need express no opinion), contains an untrue statement of a
material fact or omits to state a material fact necessary to make
the statements therein, in light of the circumstances in which
they were made, not misleading; and such counsel does not know of
any amendment to the Registration Statement required to be filed.
(f) The Underwriter shall receive the opinion of Gray Plant Mooty Mooty &
Bennett, P.A., special franchise counsel for the Company, dated as of the
Closing Date and satisfactory in form and substance to the Underwriter and
its counsel, to the effect that:
(i) PWF's uniform franchise offering circulars filed by PWF on
or after April 30, 1998 (the "UFOCS") in California, Florida,
Illinois, Indiana, Maryland, Michigan, Minnesota, Nebraska, New
York, North Dakota, South Dakota, Utah, Virginia, Washington and
Wisconsin (PWF has previously filed the required notice in Texas
and Kentucky)(the "Filing States") and the uniform franchise
offering circulars prepared for use by PWF on or after April 30,
1998 (the "FTC Offering Circulars") in states other than the
Filing States, Hawaii and Rhode Island (the "Nonregistration
States"), inclusive of attached exhibits, complied as to form, as
of the effective date of such respective documents, with the
applicable material requirements of the Federal Trade Commission
("FTC") franchise and business opportunity laws and regulations
(the "FTC Rule") and the franchise disclosure laws of the Filing
States (except that we express no opinion as to the financial
statements and other financial information included in the
respective UFOCS and FTC Offering Circulars).
(ii) PWF has received or filed the necessary state
approvals/notices in the Filing States for PWF to offer and sell
franchises in these respective
22
<PAGE>
states in accordance with the applicable franchise laws and
regulations of such states and as described in PWF's UFOCS and FTC
Offering Circulars. PWF is not required to submit a franchise
registration application for approval in the Nonregistration
States prior to the offer and sale of a Paper Warehouse franchise
in such states. No other licenses, approvals, certificates or
permits are required under the federal or state franchise laws and
regulations for PWF to offer and sell franchises in the Filing
States or the Nonregistration States.
(iii) The descriptions of federal and state franchise regulations
set forth in the Prospectus under the captions "Risk Factors --
Our Failure to Execute Our Franchise Program May Reduce Our
Profitability" and "Business -- Government Regulation," when
taken together, fairly and accurately describe the status of the
material governmental franchise regulations pertaining to the
Company's franchising activities.
(iv) The description of PWF's franchise agreements set forth in
the Prospectus under the caption "Business -- Franchising"
accurately summarizes the material terms of PWF's franchise
agreements contained in PWF's UFOCS and FTC Offering Circulars.
(v) To such counsel's knowledge, there is no pending or
threatened governmental proceeding, for which the Company or PWF
have received written notice, concerning the violation by the
Company or PWF of any FTC Rule or any state franchise
registration or franchise disclosure law.
In the addition to the matters set forth above, such opinion shall also
include a statement to the effect that, although such counsel cannot guarantee
the accuracy, completeness or fairness of any of the statements contained in the
Registration Statement or Prospectus as they relate to the Company's franchise
operations, in connection with such counsel's representation of the Company in
the preparation of the disclosures in the Registration Statement relating to the
Company's franchise operations, nothing has come to the attention of such
counsel which causes them to believe that the disclosures regarding the
Company's franchise operations contained in the Registration Statement or
Prospectus (except as to the financial and statistical information, as to which
no opinion need be expressed) contain an untrue statement of a material fact or
omit to state a material fact required to be stated therein or necessary to make
the statements therein, in light of the circumstances in which they were made,
not misleading.
(g) In addition, as of the Closing Date, the Company shall have delivered
to the Underwriter an opinion, satisfactory to the Underwriter, of Merchant
Gould, P.A., special intellectual property counsel for the Company, dated
as of the Closing Date, and satisfactory in form and substance to the
Underwriter and its counsel, to the effect that:
(i) To the best of such counsel's knowledge, and except as
stated below, there are no legal, governmental or administrative
proceedings pending or threatened against the Company that relate
to the Company's
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<PAGE>
trademarks, service marks, trade name, trade dress or other
intellectual property.
(ii) To the best of such counsel's knowledge, the Company has
not received any notice of conflict with the asserted rights of
others in respect of any trademarks, services marks, trade names,
trademark registrations, service mark registrations, copyrights,
licenses, inventions, trade secrets, patents, patent
applications, know-how, or similar rights, nor of any threatened
actions with respect thereto, which, if determined adversely to
the Company, would individually or in the aggregate have a
material adverse effect on the general affairs, financial
position, net worth or results of operations of the Company.
(iii) To the best of such counsel's knowledge, the Company owns,
possesses, is licensed or has sufficient rights to its material
trademarks, trademark applications, trademark registrations,
service marks, service mark registrations, copyrights and
licenses as are described in the Prospectus and which are
necessary for the Company's present or planned future business as
described in the Prospectus.
(iv) The description of the Company's and its Subsidiary's
intellectual property rights set forth in the Prospectus under
the caption "Business -- Trademarks and Service Marks" fairly and
accurately describe the status of the Company's and its
Subsidiary's trademark and service mark rights.
In addition to the matters set forth above, such opinion shall also include
a statement to the effect that, although such counsel cannot guarantee the
accuracy, completeness or fairness of any of the statements contained in the
Registration Statement or Prospectus as they relate to the Company's
intellectual property matters, in connection with such counsel's representation
of the Company in the preparation of the disclosures in the Registration
Statement relating to the Company's intellectual property matters, nothing has
come to the attention of such counsel which causes them to believe that the
disclosures regarding the Company's intellectual property matters contained in
the Registration Statement or Prospectus (other than the financial statements
and statistical data, as to which such counsel need express no opinion) contains
an untrue statement of a material fact or omits to state a material fact
required to be stated therein or necessary to make the statements therein, in
light of the circumstances in which they were made, not misleading.
(h) At the time of execution of this Agreement and also at the Closing
Date, the Underwriter shall have received from KPMG Peat Marwick LLP a
letter or letters, dated the date of delivery thereof, in the form and
substance satisfactory to the Underwriter, stating that they are
independent public accountants with respect to the Company on a
consolidated basis within the meaning of the 1933 Act and that:
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<PAGE>
(i) In their opinion, the Financial Statements included in the
Registration Statement and Prospectus and reported on therein by
them comply as to form in all material respects with the
applicable accounting requirements of the 1933 Act and related
published rules and regulations;
(ii) On the basis of a limited review (but not an examination in
accordance with generally accepted auditing standards) consisting
of a reading of the unaudited financial statements included in
the Registration Statement and Prospectus (if any) and the latest
available interim financial statements of the Company subsequent
thereto; a reading of the minutes of the board of directors and
shareholders of the Company subsequent thereto; and inquiries of
officials of the Company and its Subsidiaries responsible for
financial and accounting matters and such other inquiries and
procedures as may be specified in such letter and agreed upon by
you, nothing has come to their attention that causes them to
believe that:
a) The unaudited financial statements included in the
Registration Statement and Prospectus, if any, do not
comply as to form in all material respects with the
applicable accounting requirements of the 1933 Act and with
the published Rules and Regulations or that such financial
statements are not fairly presented in conformity with
generally accepted accounting principles applied on a basis
consistent with that of the audited financial statements
included in the Registration Statement and Prospectus;
b) As of a specified date not more than five days prior to
the date of this Agreement in the case of the first letter
and not more than two business days prior to the date of
the Closing Date in the case of the second letter, there
have been any changes in the capital stock, increases in
debt, decreases in total accounts receivable, or total
inventories of the Company or any increase in liabilities
or decreases in assets or stockholders' equity of the
Company, in each case, as compared with amounts shown in
the most recent balance sheet included in the Prospectus;
and
c) For the period from the date of the most recent balance
sheet included therein to such specified date, there was
any decrease, as compared with the corresponding period of
the previous year, debt or total stockholder's equity, net
revenues or any decrease in income from operations or net
income or in basic or diluted per share amounts of net
income except, in each case, for such decreases which the
Prospectus discloses have occurred or may occur or which
are described in such letter.
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<PAGE>
(iii) In addition to the examination referred to in their report
included in the Prospectus and the limited procedures, inspection
of minute books, inquiries and other procedures referred to in
clause (ii) above, they have carried out certain specified
procedures requested by you, not constituting an audit in
accordance with generally accepted auditing standards with
respect to certain amounts, percentages and other financial
information which are derived from the accounting records and
other financial and statistical data of the Company and its
Subsidiaries which appear in the Prospectus including the
information set forth under the captions "Financial Highlights,"
"Capitalization," "Selected Consolidated Financial Data,"
"Management's Discussion and Analysis of Financial Condition and
Results of Operations," and which are specified by you and have
compared certain of such amounts, percentages and financial
information with the accounting records and other appropriate
data of the Company and its Subsidiaries and have found them to
be in agreement. In the event that the letters to be delivered
pursuant to this Subsection 6(i) shall set forth any changes,
increases or decreases, it shall be a further condition to the
Underwriter obligations that you, in your sole discretion, shall
have determined, after discussion with officers of the Company
responsible for financial and accounting matters, that such
changes, increases or decreases as set forth in such letters do
not reflect a material adverse change in the capital stock, debt,
net assets, net worth, assets, total accounts receivable, total
inventories or stockholders' equity of the Company on a
consolidated basis as compared with the amount shown in the most
recent consolidated balance sheet of the Company included in the
Prospectus or material adverse change in revenues or the total or
per share amounts of net income (loss).
(i) On the Closing Date, you shall have received a certificate, dated such
date, of the president and the chief financial officer of the Company to
the effect that:
(i) The representations and warranties of the Company in
Section 1 of this Agreement are true and correct as if made on
and as of such date and the Company has performed all obligations
and satisfied all conditions on its part to be performed or
satisfied at or prior to such date;
(ii) The SEC has not issued any order preventing or suspending
the use of any prospectus or issued a stop order suspending the
effectiveness of the Registration Statement and no proceedings
for that purpose have been instituted or are pending or to their
knowledge threatened under the 1933 Act;
(iii) The Registration Statement and the Prospectus and, if any,
each amendment and each supplement thereto contain all statements
and information required to be included therein and neither the
Registration
26
<PAGE>
Statement nor the Prospectus nor any amendment nor any supplement
thereto includes any untrue statement of a material fact or omits
to state any material fact required to be stated therein or
necessary to make the statements therein not misleading and since
the Effective Date, there has occurred no event required to be set
forth in an amendment to the Registration Statement or supplement
to the Prospectus which has not been so set forth.
(iv) Subsequent to the respective dates as of which information
is given in the Registration Statement and Prospectus and prior
to the date of such certificate, and except as set forth or
contemplated in the Registration Statement or the Prospectus:
(A) neither the Company nor its Subsidiary has incurred, except
in the ordinary course of business, any lease obligations or any
direct or contingent liabilities or commitments, (B) the Company
has not entered into any transaction other than in the ordinary
course of business, (C) neither the Company nor its Subsidiary
has paid or declared any dividends or other distributions on its
capital stock, (D) there has not been any change in the capital
stock or any material adverse change, (increase or decrease) in
the outstanding debt, total accounts receivable, total
inventories, net assets, net worth, or stockholders' equity of
the Company or its Subsidiary or any material adverse change in
or affecting the condition (financial or otherwise), business,
key personnel, properties, assets, results of operations (present
or prospective), or net worth of the Company and (E) no legal or
governmental proceeding affecting the Company or the transactions
contemplated hereby has been instituted or threatened; and
(v) Subsequent to the respective dates as of which information
is given in the Registration Statement and the Prospectus, the
conduct of the business and operations of the Company or its
Subsidiaries has not, except as otherwise stated therein, been
materially interfered with by strike, fire, flood, hurricane,
accident, or other calamity (whether or not insured) or by any
court, arbitrator or governmental action, order or decree and,
except as otherwise expressly stated therein, the properties of
the Company or its Subsidiaries have not sustained any material
loss or damage (whether or not insured) as a result of any such
occurrence.
(j) The Underwriter shall have received all necessary written consents
from the Company's and its Subsidiary' lenders and any other person whose
consent is required in connection with this Agreement and the transactions
contemplated thereby.
(k) The Debentures shall have been qualified for sale under the Blue Sky
Laws of the States and in such amounts as shall have been specified by the
Underwriter.
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(l) Subsequent to the execution and delivery of this Agreement, there
shall not have occurred:
(i) Any change or development involving a prospective change in
or affecting particularly the business or properties of the
Company which in the judgment of the Underwriter materially
impairs the investment quality of the Debentures;
(ii) Any suspension or limitation of trading in securities
generally on the New York Stock Exchange, the American Stock
Exchange, Nasdaq, or any setting of minimum prices for trading on
either such exchange or on Nasdaq or any suspension of trading of
any securities of the Company;
(iii) Any banking moratorium;
(iv) Any outbreak or escalation of major hostilities in which
the United States is involved, any declaration of war by Congress
or any other substantial national or international calamity or
emergency if, in the judgment of the Underwriter, the effect of
any such outbreak, escalation, declaration, calamity or emergency
makes it impractical or inadvisable to proceed with completion of
the sale of and payment for the Debentures;
(v) Any material adverse change in existing financial,
political or economic conditions in the United States or
elsewhere which change, in the opinion of the Underwriter, has
materially and adversely affected the market for the Debentures
or other securities of the Company or the prospects for the
Company, its business or its properties; or
(vi) Any substantial loss to the Company by strike, fire, flood,
accident or other calamity of such a character as to interfere
materially with the conduct of the business and operations of the
Company regardless of whether such loss shall have been insured.
(m) The Underwriter shall have received, dated as of the Closing Date,
from the Secretary of the Company a certificate of incumbency certifying
the names, titles and signatures of the officers authorized to execute this
Agreement according to the resolutions of the Board of Directors of the
Company authorizing and approving the execution, delivery and performance
of this Agreement, a copy of such resolutions to be attached to such
certificate, certifying such resolutions and certifying that the Company's
Amended and Restated Articles of Incorporation, as amended, and the
Company's Amended and Restated Bylaws have been validly adopted and have
not been amended or modified.
All such opinions, certificates, letters and documents shall be in
compliance with the provisions hereof only if they are satisfactory in form and
substance to the Underwriter and to its
28
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counsel. If any of the conditions specified in this section shall not have
been fulfilled when and as required by this Agreement, this Agreement and all
obligations of the Underwriter hereunder may be canceled at, or at any time
prior to the Closing Date by the Underwriter. Any such cancellation shall be
without liability of the Underwriter to the Company and shall be in writing
or by telegraph or telephone and confirmed in writing. The Underwriter may
waive in writing the nonperformance by the Company of any one or more of the
foregoing conditions or extend the time for performance of such conditions.
Each such waiver shall be applicable only to the item to which it relates and
the closing to which it relates and no waiver or series of waivers shall be
deemed to have waived any condition at any time other than the condition at
the time explicitly waived.
6. INDEMNIFICATION.
(a) The Company hereby agrees to indemnify and hold harmless the
Underwriter and each person, if any, who controls the Underwriter within
the meaning of Section 15 of the 1933 Act against any losses, claims,
damages or liabilities to which the Underwriter or each such controlling
person may become subject, under the 1933 Act, the 1934 Act, the Blue Sky
Laws, the common law or otherwise, insofar as such losses, claims, damages
or liabilities (or judicial or governmental actions or proceedings in
respect thereof) arise out of, or are based upon, (i) any untrue statement
or alleged untrue statement of a material fact contained in the
Registration Statement or any amendment thereof, or the omission or alleged
omission to state in the Registration Statement or any amendment thereof a
material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were
made, not misleading; (ii) any untrue statement or alleged untrue statement
of a material fact contained in any Preliminary Prospectus if used prior to
the Effective Date of the Registration Statement or in the Prospectus (as
amended or as supplemented, if the Company shall have filed with the SEC
any amendment thereof or supplement thereto), or the omission or alleged
omission to state therein a material fact required to be stated therein or
necessary in order to make the statements therein, in light of the
circumstances under which they were made, not misleading; or (iii) any
untrue statement or alleged untrue statement of a material fact contained
in any application or other statement executed by the Company or based upon
written information furnished by the Company filed in any jurisdiction in
order to qualify the Debentures under, or exempt the Debentures or the sale
thereof from qualification under, the Blue Sky Laws of such jurisdiction,
or the omission or alleged omission to state in such application or
statement a material fact required to be stated therein or necessary to
make the statements threin, in light of the circumstances under which they
were made, not misleading; and the Company will reimburse the Underwriter
and each such controlling person for any legal or other expenses reasonably
incurred by the Underwriter or controlling person (subject to the
limitation set forth in Section 6(c) hereof) in connection with
investigating or defending against any such loss, claim, damage, liability
or action; provided, however, that the Company will not be liable in any
such case to the extent that any such loss, claim, damage or liability
arises out of, or is based upon, an untrue statement, or alleged untrue
statement, omission or alleged omission, made in reliance upon and in
conformity with written information furnished to the Company by, or on
behalf of, the Underwriter specifically for
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<PAGE>
use in the preparation of the Registration Statement or any such post
effective amendment thereof, any such Preliminary Prospectus or the
Prospectus or any such amendment thereof or supplement thereto, or in any
application or other statement executed by the Company or the Underwriter
filed in any jurisdiction in order to qualify the Debentures under, or
exempt the Debentures or the sale thereof from qualification under, the
Blue Sky Laws of such jurisdiction; and further provided that the
foregoing indemnity insofar as it relates to any actual or alleged untrue
statement or omission made in or from any Preliminary Prospectus or the
Prospectus but eliminated or remedied in the Prospectus (including any
amendment or supplement) shall not inure to the benefit of the
Underwriter (or any person controlling the Underwriter) in respect of any
action or claim asserted by a person who purchased the Debenture from the
Underwriter unless such person was sent or given a copy of the Prospectus
with or prior to the written confirmation of the sale of the Debenture to
such person.
(b) The Underwriter agrees to indemnify and hold harmless the Company,
each of the Company's directors, each of the Company's officers who has
signed the Registration Statement and each person who controls the Company
within the meaning of Section 15 of the 1933 Act against any losses,
claims, damages or liabilities to which the Company or any such director,
officer, or controlling person may become subject, under the 1933 Act, the
1934 Act, the Blue Sky Laws, the common law, or otherwise, insofar as such
losses, claims, damages, or liabilities (or judicial or governmental
actions or proceedings in respect thereof) arise out of, or are based upon,
(i) any untrue statement or alleged untrue statement of a material fact
contained in the Registration Statement or any amendment thereof, or the
omission or alleged omission to state in the Registration Statement or any
amendment thereof, a material fact required to be stated therein or
necessary to make the statements therein not misleading; (ii) any untrue
statement or alleged untrue statement of a material fact contained in any
Preliminary Prospectus if used prior to the Effective Date of the
Registration Statement or in the Prospectus (as amended or as supplemented,
if the Company shall have filed with the SEC any amendment thereof or
supplement thereto), or the omission or alleged omission to state therein a
material fact required to be stated therein or necessary in order to make
the statements therein, in light of the circumstances under which they were
made, not misleading; or (iii) any untrue statement or alleged untrue
statement of a material fact contained in any application or other
statement executed by the Company or by the Underwriter and filed in any
jurisdiction in order to qualify the Debentures under, or exempt the
Debentures or the sale thereof from qualification under, the Blue Sky Laws
of such jurisdiction, or the omission or alleged omission to state in such
application or statement a material fact required to be stated therein or
necessary to make the statements therein, in light of the circumstances
under which they were made, not misleading; in each case to the extet, but
only the extent, that such untrue statement, alleged untrue statement,
omission or alleged omission, was made in reliance upon and in conformity
with written information furnished to the Company by, or on behalf of, the
Underwriter specifically for use in the preparation of the Registration
Statement or any such post effective amendment thereof, any such
Preliminary Prospectus or the Prospectus or any such amendment thereof or
supplement thereto, or in any application or other statement executed by
the Company or by the Underwriter and filed in any jurisdiction; and the
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Underwriter will reimburse any legal or other expenses reasonably incurred
by the Company or any such director, officer or controlling person in
connection with investigating or defending against any such loss, claim,
damage, liability or action. This indemnity agreement is in addition to
any liability which the Underwriter may otherwise have.
(c) Promptly after receipt by an indemnified party under this Section 6 of
notice of the commencement of any action, such indemnified party will, if a
claim in respect thereof is to be made against any indemnifying party under
this Section 6, notify in writing the indemnifying party of the
commencement thereof. The omission so to notify the indemnifying party
will not relieve it from any liability under this Section 6 as to the
particular item for which indemnification is then being sought, unless such
omission so to notify prejudices the indemnifying party's ability to defend
such action. In case any such action is brought against any indemnified
party and the indemnified party notifies an indemnifying party of the
commencement thereof, the indemnifying party will be entitled to
participate therein and, to the extent that it may wish, jointly with any
other indemnifying party similarly notified, to assume the defense thereof,
with counsel who shall be reasonably satisfactory to such indemnified
party; and after notice from the indemnifying party to such indemnified
party of its election so to assume the defense thereof, the indemnifying
party will not be liable to such indemnified party under this Section 6 for
any legal or other expenses subsequently incurred by such indemnified party
in connection with the defense thereof other than reasonable costs of
investigation; provided, however, that if, in the reasonable judgment of
the indemnified party, it is advisable for such parties and controlling
persons to be represented by separate counsel, any indemnified party shall
have the right to employ separate counsel to represent it and all other
parties and their controlling persons who may be subject to liability
arising out of any claim in respect of which indemnity may be sought by the
Underwriter against the Company or by the Company against the Underwriter
hereunder, in which event the fees and expenses of such separate counsel
shall be borne by the indemnifying party and paid as incurred. Any such
indemnifying party shall not be liable to any such indemnified party on
account of any settlement of any claim or action effected without the prior
written consent of such indemnifying party.
7. CONTRIBUTION.
(a) If the indemnification provided for in Section 6 is unavailable under
applicable law to, or insufficient to hold harmless, any indemnified party
in respect of any losses, claims, damages or liabilities referred to
therein, then each indemnifying party, in lieu of indemnifying such
indemnified party, shall contribute to the amount paid or payable by such
indemnified party as a result of such losses, claims, damages or
liabilities (i) in such proportion as is appropriate to reflect the
relative benefits received by the Company and the Underwriter from the
offering of the Debentures or (ii) if the allocation provided by clause (i)
above is not permitted by applicable law, in such proportion as is
appropriate to reflect not only the relative benefits referred to in clause
(i) above but also the relative fault of the Company and the Underwriter in
connection with the statements or omissions which
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<PAGE>
resulted in such losses, claims, damages or liabilities, as well as any
other relevant equitable considerations. The Company and the
Underwriter agree that contribution determined by pro rata allocation
(even if the Underwriter was considered a single person) would not be
equitable. The respective relative benefits received by the Company on
the one hand, and the Underwriter, on the other hand, shall be deemed
to be in the same proportion (A) in the case of the Company, as the
total price paid to the Company for the Debentures by the Underwriter
(net of underwriting discount received but before deducting expenses)
bears to the aggregate public offering price of the Debentures and (B)
in the case of the Underwriter, as the aggregate underwriting discount
and commissions received by them bears to the aggregate public offering
price of the Debentures, in each case as reflected in the Prospectus.
The relative fault of the Company and the Underwriter shall be
determined by reference to, among other things, whether the untrue or
alleged untrue statement of a material fact or the omission or alleged
omission to state a material fct relates to information supplied by the
Company or by the Underwriter and the parties' relative intent,
knowledge, access to information and opportunity to correct or prevent
such statement or omission. The amount paid or payable by a party as a
result of the losses, claims, damages and liabilities referred to above
shall be deemed to include any legal or other fees or expenses
reasonably incurred by such party in connection with investigating or
defending any action or claim. Notwithstanding the provisions of this
Section 7, the Underwriter shall not be required to contribute any
amount in excess of the amount by which the total price at which the
Debentures underwritten by it and offered to the public exceeds the
amount of any damages which the Underwriter has otherwise been required
to pay by reason of any untrue or alleged untrue statement or omission
or alleged omission in the Registration Statement, any Preliminary
Prospectus, the Prospectus or any amendment or supplement thereto. The
Underwriter's obligation to contribute pursuant to this section are
several and not joint. No person guilty of fraudulent
misrepresentation (within the meaning of Section 11(f) of the 1933 Act)
shall be entitled to contribution from any person who was not guilty of
such fraudulent misrepresentation. For purposes of this Section 7,
each person who controls an Underwriter within the meaning of the 1933
Act or the 1934 Act shall have the same rights to contribution as such
Underwriter, each person who controls the Company within the meaning of
the 1933 Act or the 1934 Act shall have the same rights to contribution
as the Company and each officer of the Company who shall have signed
the Registration Statement and each director of the Company shall have
the same rights to contribution as the Company.
(b) Promptly after receipt by a party to this Agreement of notice of the
commencement of any action, suit or proceeding, such person will, if a
claim for contribution in respect thereof is to be made against another
party (the "Contributing Party"), notify the Contributing Party of the
commencement thereof, but the omission so to notify the Contributing Party
will not relieve the Contributing Party from any liability which it may
have to any party other than under this Section 7, unless such omission so
to notify prejudices the indemnifying party's ability to defend such
action. Any notice given pursuant to Section 6 hereof shall be deemed to
be like notice hereunder. In case any such action, suit or proceeding is
brought against any party, and such person notifies a Contributing Party of
the commencement thereof, the Contributing Party will be entitled to
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<PAGE>
participate therein with the notifying party and any other Contributing
Party similarly notified.
8. SURVIVAL OF INDEMNITIES, CONTRIBUTION AGREEMENTS, WARRANTIES AND
REPRESENTATIONS. The respective indemnity and contribution agreements of the
Company and the Underwriter contained in Sections 6 and 7, respectively, the
representations and warranties of the Company set forth in Section 1 hereof and
the covenants of the Company set forth in Section 4 hereof shall remain
operative and in full force and effect, regardless of any investigation made by,
or on behalf of, the Underwriter, the Company, any of its officers and
directors, or any controlling person referred to in Sections 6 and 7, and shall
survive the delivery of and payment for the Debentures. The aforesaid indemnity
and contribution agreements shall also survive any termination or cancellation
of this Agreement. Any successor of any party or of any such controlling
person, or any legal representative of such controlling person, as the case may
be, shall be entitled to the benefit of the respective indemnity and
contribution agreements.
9. EFFECTIVE DATE OF THIS AGREEMENT AND TERMINATION.
(a) This Agreement shall become effective at 8:00 a.m., Minnesota time, on
the first full day following the Effective Date, after which the
Underwriter shall commence selling the Debentures to the public, or such
earlier time as the Underwriter shall release the Debentures for sale to
the public. The Underwriter shall notify the Company immediately after the
Underwriter has taken any action which causes this Agreement to become
effective. Until this Agreement is effective, it may be terminated by the
Company or by the Underwriter by giving notice as hereinafter provided,
except that the provisions of Sections 4(q) and (r) and Sections 6, 7, 9,
12 and 13 shall at all times be effective. For purposes of this Agreement,
the release of the Debentures for sale to the public shall be deemed to
have been made when the Underwriter releases, by facsimile or otherwise,
firm offers of the Debentures to securities dealers or release for
publication a newspaper advertisement relating to the Debentures, whichever
occurs first.
(b) Until the Closing Date, this Agreement may be terminated by the
Underwriter, at its option, by giving notice to the Company, if (i) the
Company shall have sustained a loss by fire, flood, accident or other
calamity which is material with respect to the business of the Company; the
Company shall have become a party to material litigation, not disclosed in
the Registration Statement or the Prospectus; or the business or financial
condition of the Company shall have become the subject of any material
litigation, not disclosed in the Registration Statement or the Prospectus;
or there shall have been, since the respective dates as of which
information is given in the Registration Statement or the Prospectus, any
material adverse change in the general affairs, business, key personnel,
capitalization, financial position or consolidated net worth of the
Company, whether or not arising in the ordinary course of business, which
loss or change, in the reasonable judgment of the Underwriter, shall render
it inadvisable to proceed with the delivery of the Debentures, whether or
not such loss shall have been insured; (ii) trading in securities generally
on the New York Stock Exchange, American Stock Exchange, Nasdaq National
Market, Nasdaq SmallCap Market or the over-the-counter market shall have
been suspended or minimum
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<PAGE>
prices shall have been established on such exchange by the SEC or by
such exchanges or markets; (iii) a general banking moratorium shall
have been declared by federal, New York or Minnesota authorities; (iv)
there shall have been such a material adverse change in general
economic, monetary, political or financial conditions, or the effect of
international conditions on the financial markets in the United States
shall be such that, in the judgment of the Underwriter, makes it
inadvisable to proceed with the delivery of the Debentures; (v) the
enactment, publication, decree or other promulgation of any federal or
state statute, regulation, rule or order of either of any court or
other governmental authority whih, in the judgment of the Underwriter,
materially and adversely affects or will materially and adversely
affect the business or operations of the Company; (vi) there shall be a
material outbreak of hostilities or material escalation and
deterioration in the political and military situation between the
United States and any foreign power, or a formal declaration of war by
the United States of America shall have occurred; (vii) the Company
shall have failed to comply with any of the provisions of this
Agreement on its part to be performed on or prior to such date or if
any of the conditions, agreements, representations or warranties of the
Company shall not have been fulfilled within the respective times
provided for in this Agreement; (viii) the Company is no longer
registered under the 1934 Act; or (ix) the Company's Common Stock is no
longer listed on The Nasdaq National Market or Nasdaq SmallCap Market.
Any such termination shall be without liability of any party to any
other party, except as provided in Sections 6, 7, 9, 12 and 13 hereof;
provided, however, that the Company shall remain obligated to pay costs
and expenses to the extent provided in Sections 4(q) and (r) of Section
4 of this Agreement.
(c) If the Underwriter elects to prevent this Agreement from becoming
effective or to terminate this Agreement as provided in this Section 9, it
shall notify the Company promptly by telegram or telephone, confirmed by
letter sent to the address specified in Section 10 hereof. If the Company
shall elect to prevent this Agreement from becoming effective, it shall
notify the Underwriter promptly by telegram or telephone, confirmed by
letter sent to the address specified in Section 10 hereof.
10. NOTICES. All communications hereunder shall be in writing and, if
sent to the Underwriter, shall be mailed by certified or registered mail or hand
delivered or sent by facsimile transmission and confirmed in writing to Miller &
Schroeder Financial, Inc., Pillsbury Center, Minneapolis, Minnesota 55440 with a
copy to Daniel A. Yarano, Esq., Fredrikson & Byron, P.A., 900 Second Avenue
South, Minneapolis, MN 55402 and if sent to the Company, shall be mailed by
certified or registered mail or hand delivered or sent by facsimile
transmission, and confirmed in writing to the Company at Paper Warehouse, Inc.,
7630 Excelsior Boulevard, St. Louis Park, MN 55426, Attention: Chief Financial
Officer, with a copy to Bruce Machmeier, Oppenheimer Wolff & Donnelly LLP, Plaza
VII, 45 South Seventh Street, Suite 3400, Minneapolis, MN 55402.
11. SUCCESSORS. This Agreement shall inure to the benefit of and be
binding upon the Underwriter, the Company, and their successors, assigns and
legal representatives, and nothing in this Agreement is intended or shall be
construed to give any other person any legal or equitable right, remedy or claim
under or in respect of this Agreement or any provision herein contained,
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<PAGE>
this Agreement and all conditions and provisions hereof being intended to be
and being for the sole and exclusive benefit of such persons and for the
benefit of no other person, except that the representations and warranties of
the Company contained in this Agreement shall also be for the benefit of any
person or persons who control the Underwriter within the meaning of Section
15 of the 1933 Act. No purchaser of Debentures will be deemed a successor
because of such purchase.
12. INFORMATION FURNISHED BY UNDERWRITER. The statements under the
caption "Underwriting" in any Preliminary Prospectus and in the Prospectus
constitute the only written information furnished by, or on behalf of, the
Underwriter specifically for use with reference to the Underwriter referred to
in Section 1(b) and Section 6 hereof. The Underwriter hereby represents and
warrants to, and agrees with, the Company that in connection with the
Underwriter's distribution of the Debentures to the public: (i) other than to
employees and agents of the Underwriter and of dealers participating in the
distribution of the Debentures, the Underwriter has not distributed and will not
distribute any prospectus or any other offering material in connection with the
offering and sale of the Debentures other than the Preliminary Prospectus or the
Prospectus or other materials permitted by the 1933 Act and Rules and
Regulations to be distributed by the Underwriter and consented to by the Company
or its counsel; (ii) neither the Underwriter nor any officer or other person
employed by the Underwriter will provide any information or make any
representations to purchasers of the Debentures, other than such information and
representations as are either contained in the Preliminary Prospectus or the
Prospectus or are not inconsistent with the information set forth in the
Preliminary Prospectus or the Prospectus; and (iii) the Underwriter will
endeavor to comply with Rule 2310, Conduct Rules, of the National Association of
Securities Dealers, Inc. Manual and similar applicable state and federal
securities laws regarding the suitability of the Debentures for its customers.
13. GOVERNING LAW. This Agreement shall be governed by, and construed in
accordance with the substantive laws of the State of Minnesota without regard to
its choice of laws provisions.
14. COUNTERPARTS. This Agreement may be signed in any number of
counterparts and all such counterparts taken together shall constitute the
single Agreement of the parties.
If the foregoing is in accordance with your understanding of our agreement,
kindly sign and return to us the enclosed duplicate of this Agreement, whereupon
it will become a binding agreement between the Company and the Underwriter in
accordance with its terms.
Very truly yours,
PAPER WAREHOUSE, INC.
By___________________________________
Its__________________________________
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ACCEPTANCE
The foregoing Underwriting Agreement is
hereby confirmed and accepted by us as of
the date first written above.
MILLER & SCHROEDER FINANCIAL, INC.
By____________________________
Its___________________________
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APPENDIX A
UNDERWRITER'S WARRANT
To Purchase 50,000 Shares of Common Stock
of
Paper Warehouse, Inc.
THIS CERTIFIES THAT, for good and valuable consideration, Miller &
Schroeder Financial, Inc. (the "Underwriter"), or its registered assigns, is
entitled to subscribe for and purchase from Paper Warehouse, Inc., a Minnesota
corporation (the "Company"), at any time after July __, 2000, up to and
including July __, 2004, Fifty Thousand (50,000) fully paid and nonassessable
shares of the Common Stock of the Company at the price of $___ [120% of market
price immediately prior to effective date] per share (the "Warrant Exercise
Price"), subject to the antidilution provisions of this Warrant. Reference is
made to this Warrant in the Underwriting Agreement dated July __, 1999, by and
between the Company and the Underwriter. The shares which may be acquired upon
exercise of this Warrant are referred to herein as the "Warrant Shares." As
used herein, the term "Holder" means the Underwriter, any party who acquires all
or a part of this Warrant as a registered transferee of the Underwriter, or any
record holder or holders of the Warrant Shares issued upon exercise, whether in
whole or in part, of the Warrant; the term "Common Stock" means and includes the
Company's presently authorized common stock, $.01 par value, and shall also
include any capital stock of any class of the Company hereafter authorized which
shall not be limited to a fixed sum or percentage in respect of the rights of
the holders thereof to participate in dividends or in the distribution of assets
upon the voluntary or involuntary liquidation, dissolution, or winding up of the
Company, provided, however, that the Warrant Shares shall include shares
designated as Common Stock on the date this Warrant was originally issued; and
the term "Convertible Securities" means any stock or other securities
convertible into, or exchangeable for, Common Stock.
This Warrant is subject to the following provisions, terms and conditions:
1. EXERCISE; TRANSFERABILITY.
(a) The rights represented by this Warrant may be exercised by the Holder
hereof, in whole or in part (but not as to a fractional share of Common Stock),
by written notice of exercise (in the form attached hereto) delivered to the
Company at the principal office of the Company prior to the expiration of this
Warrant and accompanied or preceded by the surrender of this Warrant along with
a check in payment of the Warrant Exercise Price for such shares or without
payment of cash pursuant to Section 10 hereof.
(b) Until exercisable, this Warrant may not be sold, assigned,
hypothecated, or otherwise transferred, other than by will or pursuant to the
operation of law, except to a person who is an officer or partner of the
Underwriter. Further, this Warrant may not be sold, transferred, assigned,
hypothecated or divided into two or more Warrants of smaller denominations, nor
may
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any Warrant Shares issued pursuant to exercise of this Warrant be
transferred, except as provided in Section 7 hereof.
2. EXCHANGE AND REPLACEMENT. Subject to Sections l and 7 hereof, this
Warrant is exchangeable upon the surrender hereof by the Holder to the
Company at its office for new Warrants of like tenor and date representing in
the aggregate the right to purchase the number of Warrant Shares purchasable
hereunder, each of such new Warrants to represent the right to purchase such
number of Warrant Shares (not to exceed the aggregate total number
purchasable hereunder) as shall be designated by the Holder at the time of
such surrender. Upon receipt by the Company of evidence reasonably
satisfactory to it of the loss, theft, destruction, or mutilation of this
Warrant, and, in case of loss, theft or destruction, of indemnity or security
reasonably satisfactory to it, and upon surrender and cancellation of this
Warrant, if mutilated, the Company will make and deliver a new Warrant of
like tenor, in lieu of this Warrant; provided, however, that if the
Underwriter shall be such Holder, an agreement of indemnity by such Holder
shall be sufficient for all purposes of this Section 2. This Warrant shall be
promptly canceled by the Company upon the surrender hereof in connection with
any exchange or replacement. The Company shall pay all expenses, taxes
(other than stock transfer taxes), and other charges payable in connection
with the preparation, execution, and delivery of Warrant pursuant to this
Section 2.
3. ISSUANCE OF THE WARRANT SHARES.
(a) The Company agrees that the shares of Common Stock purchased hereby
shall be and are deemed to be issued to the Holder as of the close of business
on the date on which this Warrant shall have been surrendered and the payment
made for such Warrant Shares as aforesaid. Subject to the provisions of the
next section, certificates for the Warrant Shares so purchased shall be
delivered to the Holder within a reasonable time, not exceeding fifteen (15)
days after the rights represented by this Warrant shall have been so exercised,
and, unless this Warrant has expired, a new Warrant representing the right to
purchase the number of Warrant Shares, if any, with respect to which this
Warrant shall not then have been exercised shall also be delivered to the Holder
within such time.
(b) Notwithstanding the foregoing, however, the Company shall not be
required to deliver any certificate for Warrant Shares upon exercise of this
Warrant except in accordance with exemptions from the applicable securities
registration requirements or registrations under applicable securities laws.
Nothing herein, however, shall obligate the Company to effect registrations
under federal or state securities laws, except as provided in Section 9. If
registrations are not in effect and if exemptions are not available when the
Holder seeks to exercise the Warrant, the Warrant exercise period will be
extended, if need be, to prevent the Warrant from expiring, until such time as
either registrations become effective or exemptions are available, and the
Warrant shall then remain exercisable for a period of at least 30 calendar days
from the date the Company delivers to the Holder written notice of the
availability of such registrations or exemptions. The Holder agrees to execute
such documents and make such representations, warranties, and agreements as may
be required solely to comply with the
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exemptions relied upon by the Company, or the registrations made, for the
issuance of the Warrant Shares.
4. COVENANTS OF THE COMPANY. The Company covenants and agrees that all
Warrant Shares will, upon issuance, be duly authorized and issued, fully paid,
nonassessable, and free from all taxes, liens, and charges with respect to the
issue thereof. The Company further covenants and agrees that during the period
within which the rights represented by this Warrant may be exercised, the
Company will at all times have authorized and reserved for the purpose of issue
or transfer upon exercise of the subscription rights evidenced by this Warrant a
sufficient number of shares of Common Stock to provide for the exercise of the
rights represented by this Warrant.
5. ANTIDILUTION ADJUSTMENTS. The provisions of this Warrant are subject
to adjustment as provided in this Section 5.
(a) The Warrant Exercise Price shall be adjusted from time to time such
that in case the Company shall hereafter:
(i) pay any dividends on any class of stock of the Company
payable in Common Stock or Convertible Securities;
(ii) subdivide its then outstanding shares of Common Stock into
a greater number of shares; or
(iii) combine outstanding shares of Common Stock, by
reclassification or otherwise;
then, in any such event, the Warrant Exercise Price in effect immediately prior
to such event shall (until adjusted again pursuant hereto) be adjusted
immediately after such event to a price (calculated to the nearest full cent)
determined by dividing (a) the number of shares of Common Stock outstanding
immediately prior to such event, multiplied by the then existing Warrant
Exercise Price, by (b) the total number of shares of Common Stock outstanding
immediately after such event (including the maximum number of shares of Common
Stock issuable in respect of any securities convertible into Common Stock), and
the resulting quotient shall be the adjusted Warrant Exercise Price per share.
An adjustment made pursuant to this Subsection shall become effective
immediately after the record date in the case of a dividend or distribution and
shall become effective immediately after the effective date in the case of a
subdivision, combination or reclassification. If, as a result of an adjustment
made pursuant to this Subsection, the Holder of any Warrant thereafter
surrendered for exercise shall become entitled to receive shares of two or more
classes of capital stock or shares of Common Stock and other capital stock of
the Company, the Board of Directors of the Company (whose determination shall be
conclusive) shall determine the allocation of the adjusted Warrant Exercise
Price between or among shares of such classes of capital stock or shares of
Common Stock and other capital stock. All calculations under this Subsection
shall be made to the nearest cent or to the nearest 1/100 of a share, as the
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case may be. In the event that at any time as a result of an adjustment made
pursuant to this Subsection, the Holder of any Warrant thereafter surrendered
for exercise shall become entitled to receive any shares of the Company other
than shares of Common Stock, thereafter the Warrant Exercise Price of such other
shares so receivable upon exercise of any Warrant shall be subject to adjustment
from time to time in a manner andon terms as nearly equivalent as practicable to
the provisions with respect to Common Stock contained in this Section.
(b) Upon each adjustment of the Warrant Exercise Price pursuant to Section
5(a) above, the Holder of each Warrant shall thereafter (until another such
adjustment) be entitled to purchase at the adjusted Warrant Exercise Price the
number of shares, calculated to the nearest full share, obtained by multiplying
the number of shares specified in such Warrant (as adjusted as a result of all
adjustments in the Warrant Exercise Price in effect prior to such adjustment) by
the Warrant Exercise Price in effect prior to such adjustment and dividing the
product so obtained by the adjusted Warrant Exercise Price.
(c) In case of any consolidation or merger to which the Company is a party
other than a merger or consolidation in which the Company is the continuing
corporation, or in case of any sale or conveyance to another corporation of the
property of the Company as an entirety or substantially as an entirety, or in
the case of any statutory exchange of securities with another corporation
(including any exchange effected in connection with a merger of a third
corporation into the Company), there shall be no adjustment under Subsection (a)
of this Section above but the Holder of each Warrant then outstanding shall have
the right thereafter to convert such Warrant into the kind and amount of shares
of stock and other securities and property which he would have owned or have
been entitled to receive immediately after such consolidation, merger, statutory
exchange, sale, or conveyance had such Warrant been converted immediately prior
to the effective date of such consolidation, merger, statutory exchange, sale,
or conveyance and in any such case, if necessary, appropriate adjustment shall
be made in the application of the provisions set forth in this Section with
respect to the rights and interests thereafter of any Holders of the Warrant, to
the end that the provisions set forth in this Section shall thereafter
correspondingly be made applicable, as nearly as may reasonably be, in relation
to any shares of stock and other securities and property thereafter deliverable
on the exercise of the Warrant. The provisions of this Subsection shall
similarly apply to successive consolidations, mergers, statutory exchanges,
sales or conveyances.
(d) Upon any adjustment of the Warrant Exercise Price, then and in each
such case, the Company shall give written notice thereof, by first-class mail,
postage prepaid, addressed to the Holder as shown on the books of the Company,
which notice shall state the Warrant Exercise Price resulting from such
adjustment and the increase or decrease, if any, in the number of shares of
Common Stock purchasable at such price upon the exercise of this Warrant,
setting forth in reasonable detail the method of calculation and the facts upon
which such calculation is based.
6. NO VOTING RIGHTS. This Warrant shall not entitle the Holder to any
voting rights or other rights as a shareholder of the Company.
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7. NOTICE OF TRANSFER OF WARRANT OR RESALE OF THE WARRANT SHARES.
(a) Subject to the sale, assignment, hypothecation, or other transfer
restrictions set forth in Section 1 hereof, the Holder, by acceptance hereof,
agrees to give written notice to the Company before transferring this Warrant
or transferring any Warrant Shares of such Holder's intention to do so,
describing briefly the manner of any proposed transfer. Promptly upon
receiving such written notice, the Company shall present copies thereof to
the Company's counsel and to counsel to the original purchaser of this
Warrant. If in the opinion of each such counsel the proposed transfer may be
effected without registration or qualification (under any federal or state
securities laws), the Company, as promptly as practicable, shall notify the
Holder of such opinion, whereupon the Holder shall be entitled to transfer
this Warrant or to dispose of Warrant Shares received upon the previous
exercise of this Warrant, all in accordance with the terms of the notice
delivered by the Holder to the Company; provided that an appropriate legend
may be endorsed on this Warrant or the certificates for such Warrant Shares
respecting restrictions upon transfer thereof necessary or advisable in the
opinion of counsel and satisfactory to the Company to prevent further
transfers which would be in violation of Section 5 of the Securities Act of
1933, as amended (the "1933 Act") and applicable state securities laws; and
provided further that the prospective transferee or purchaser shall execute
such documents and make such representations, warranties, and agreements as
may be required solely to comply with the exemptions relied upon by the
Company for the transfer or disposition of the Warrant or Warrant Shares.
(b) If in the opinion of either of the counsel referred to in this Section
7, the proposed transfer or disposition of this Warrant or such Warrant Shares
described in the written notice given pursuant to this Section 7 may not be
effected without registration or qualification of this Warrant or such Warrant
Shares the Company shall promptly give written notice thereof to the Holder, and
the Holder will limit its activities in respect to such as, in the opinion of
both such counsel, are permitted by law.
8. FRACTIONAL SHARES. Fractional shares shall not be issued upon the
exercise of this Warrant, but in any case where the Holder would, except for the
provisions of this Section, be entitled under the terms hereof to receive a
fractional share, the Company shall, upon the exercise of this Warrant for the
largest number of whole shares then called for, pay a sum in cash equal to the
same fraction of the Fair Market Value (as defined in Section 10(d)) per share
of Common Stock as of the close of business on the date the Holder exercises the
Warrant.
9. REGISTRATION RIGHTS.
(a) If the Company at any time after July __, 2000 and prior to the end of
the two-year period following complete exercise of this Warrant, but no more
than seven (7) years from the date of this Warrant, proposes to register under
the 1933 Act (except by a Form S-4 or Form S-8 Registration Statement or any
successor forms thereto) or qualify for a public distribution under Section 3(b)
of the 1933 Act, any of its securities, it will give written notice to all
Holders of this Warrant, any Warrants issued pursuant to Section 2 and/or
Section 3(a) hereof, and any Warrant
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Shares not therefore registered under the 1933 Act and sold of its intention
to do so and, on the written request of any such Holder given within twenty
(20) days after receipt of any such notice (which request shall specify the
interest in this Warrant or the Warrant Shares intended to be sold or
disposed of by such Holder and describe the nature of any proposed sale or
other disposition thereof), the Company will use its best efforts to cause
all such Warrant Shares, the Holders of which shall have requested the
registration or qualification thereof, to be included in such registration
statement proposed to be filed by the Company; provided, however, that if a
greater number of Warrant Shares is offered for participation in the proposed
offering than in the reasonable opinion of the managing underwriter of the
proposed offering can be accommodated without adversely affecting the
proposed offering, then the amount of Warrant Shares proposed to be offered
by such Holders for registration, as well as the number of securities of any
other selling shareholders participating in the registration, shall be
proportionately reduced to a number deemed satisfactory by the managing
underwriter and provided further, that nothing herein shall prevent the
Company from, at any time, abandoning or delaying any registration.
(b) Further, on a one-time basis only, during the four-year period
commencing one year after the date of this Warrant, upon request by the Holder
or Holders of an aggregate of at least a majority in interest of this Warrant,
of any Warrants issued pursuant to Section 2 and/or Section 3(a) hereof, and of
any Warrant Shares not theretofore registered under the 1933 Act and sold, the
Company will promptly take all necessary steps to register or qualify, under the
1933 Act and the securities laws of such states as the Holders may reasonably
request, such number of Warrant Shares issued and to be issued upon conversion
of the Warrants requested by such Holders in their request to the Company;
PROVIDED, HOWEVER, that the Company shall not be obligated to effect any such
registration or qualification pursuant to this Section 9(b) (and upon the
happening of the occurrences referred to in subparagraph (i) below may withdraw
or abandon any such registration):
(i) if the Company shall furnish to such holders a certificate signed by
the Chairman of the Board of Directors of the Company stating that in the
good faith judgment of the Board of Directors of the Company, (x) the
offering would interfere in any material respect with any financing,
acquisition, corporate reorganization or other material transaction under
consideration by the Company or (y) there is some other material
development relating to the condition (financial or other) of the Company
that has not been disclosed to the general public and as to which it is in
the Company's best interests to not disclose such development; PROVIDED,
HOWEVER, that, in any such event, the Company shall only have the right to
defer the filing of the registration statement for a period of not more
than ninety (90) days after the Company furnishes the holders with such
certificate.
(ii) from and after the date on which the Company has filed a registration
statement with the SEC relating to an underwritten offering that has
resulted in the holders being given the opportunity to include Warrant
Shares in such registration statement pursuant to the provisions of Section
9(a) hereof, through and until such period of time as reasonably
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required by the managing underwriter for such other underwritten offering
but in no event longer than six months after the effective date of such
registration statement; or
(iii) in any particular jurisdiction in which the Company would be required
to qualify to do business or to execute a general consent to service of
process in effecting such registration, qualification or compliance.
The Company shall keep effective and maintain any registration, qualification,
notification, or approval specified in this Subsection (b) for such period as
may be reasonably necessary for such Holder or Holders of such Warrant Shares to
dispose thereof and from time to time shall amend or supplement the prospectus
used in connection therewith to the extent necessary in order to comply with
applicable law; PROVIDED, HOWEVER, if the registration specified in this
Subsection (b) is pursuant to a Form S-1 Registration Statement or successor
form thereto, the Company is only required to maintain such registration during
the 90-day period immediately following the effective date of such registration.
(c) With respect to each inclusion of securities in a registration
statement pursuant to this Section 9, the Company shall bear the following fees,
costs, and expenses: all registration, filing and NASD fees, printing expenses,
fees and disbursements of counsel and accountants for the Company, fees and
disbursements of counsel for the underwriter or underwriters of such securities
(if the Company is required to bear such fees and disbursements), all internal
expenses, the premiums and other costs of policies of insurance against
liability arising out of the public offering, and legal fees and disbursements
and other expenses of complying with state securities laws of any jurisdictions
in which the securities to be offered are to be registered or qualified. Fees
and disbursements of special counsel and accountants for the selling Holders,
underwriting discounts and commissions, and transfer taxes for selling Holders
and any other expenses relating to the sale of securities by the selling Holders
not expressly included above shall be borne by the selling Holders.
(d) The Company hereby indemnifies each of the Holders of this Warrant and
of any Warrant Shares, and the officers and directors, if any, who control such
Holders, within the meaning of Section 15 of the 1933 Act, against all losses,
claims, damages, and liabilities caused by (1) any untrue statement or alleged
untrue statement of a material fact contained in any Registration Statement or
Prospectus (and as amended or supplemented if the Company shall have furnished
any amendments thereof or supplements thereto), or any Preliminary Prospectus or
any state securities law filings; and (2) any omission or alleged omission to
state therein a material fact required to be stated therein or necessary to make
the statements therein not misleading except insofar as such losses, claims,
damages, or liabilities are caused by any untrue statement or omission contained
in information furnished in writing to the Company by such Holder expressly for
use therein; and each such Holder by its acceptance hereof severally agrees that
it will indemnify and hold harmless the Company, each of its officers who signs
such Registration Statement, and each person, if any, who controls the Company,
within the meaning of Section 15 of the 1933 Act, with respect to losses,
claims, damages, or liabilities which are
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caused by any untrue statement or omission contained in information furnished
in writing to the Company by such Holder expressly for use therein.
10. ADDITIONAL RIGHT TO CONVERT WARRANT.
(a) The holder of this Warrant shall have the right to require the Company
to convert this Warrant (the "Conversion Right") at any time after it is
exercisable, but prior to its expiration into shares of Company Common Stock as
provided for in this Section 10. Upon exercise of the Conversion Right, the
Company shall deliver to the Holder (without payment by the Holder of any
Warrant Exercise Price) that number of shares of Company Common Stock equal to
the quotient obtained by dividing (x) the value of the Warrant at the time the
Conversion Right is exercised (determined by subtracting the aggregate Warrant
Exercise Price for the Warrant Shares in effect immediately prior to the
exercise of the Conversion Right from the aggregate Fair Market Value for the
Warrant Shares immediately prior to the exercise of the Conversion Right) by (y)
the Fair Market Value of one share of Company Common Stock immediately prior to
the exercise of the Conversion Right.
(b) The Conversion Right may be exercised by the Holder, at any time or
from time to time, prior to its expiration, on any business day by delivering a
written notice in the form attached hereto (the "Conversion Notice") to the
Company at the offices of the Company exercising the Conversion Right and
specifying (i) the total number of shares of Common Stock the Holder will
purchase pursuant to such Conversion Right and (ii) a place and date not less
than one or more than 20 business days from the date of the Conversion Notice
for the closing of such purchase.
(c) At any closing under Section 10(b) hereof, (i) the Holder will
surrender the Warrant and (ii) the Company will deliver to the Holder a
certificate or certificates for the number of shares of Company Common stock
issuable upon such conversion, together with cash, in lieu of any fraction of a
share, and (iii) the Company will deliver to the Holder a new warrant
representing the number of shares, if any, with respect to which the Warrant
shall not have been exercised.
(d) Fair Market Value of a share of Common Stock as of a particular date
(the "Determination Date") shall mean:
(i) If the Company's Common Stock is traded on an exchange or
is quoted on the National Association of Securities Dealers, Inc. Automated
Quotation ("NASDAQ") National Market System, then the average closing or
last sale prices, respectively, reported for the ten (10) business days
immediately preceding the Determination Date, and
(ii) If the Company's Common Stock is not traded on an exchange
or on the NASDAQ National Market System but is traded on the over-the-
counter market, then
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the average closing bid and asked prices reported for the ten (10)
business days immediately preceding the Determination Date.
IN WITNESS WHEREOF, Paper Warehouse, Inc. has caused this Warrant to be
signed by its duly authorized officer and this Warrant to be dated July ___,
1999.
PAPER WAREHOUSE, INC.
By:__________________________________
Its:_______________________________
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To: Paper Warehouse, Inc.
NOTICE OF EXERCISE OF WARRANT -
To Be Executed by the Registered Holder in Order to Exercise the Warrant
The undersigned hereby irrevocably elects to exercise the attached Warrant to
purchase for cash, _________________ of the shares issuable upon the exercise of
such Warrant, and requests that certificates for such shares (together with a
new Warrant to purchase the number of shares, if any, with respect to which this
Warrant is not exercised) shall be issued in the name of
______________________________
(Print Name)
Please insert social security
or other tax identification
number of registered holder of
certificate (______________) Address:
______________________________
______________________________
Date: _______________ ______________________________
Signature*
*The signature on the Notice of Exercise of Warrant must correspond exactly to
the name as written upon the face of the Warrant in every particular without
alteration or enlargement or any change whatsoever. When signing on behalf of a
corporation, partnership, trust or other entity, PLEASE indicate your
position(s) and title(s) with such entity.
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ASSIGNMENT FORM
To be signed only upon authorized transfer of Warrants.
FOR VALUE RECEIVED, the undersigned hereby sells, assigns, and transfers
unto _____________________________, the assignee, whose address is
______________________ and whose tax identification or social security number is
__________________ the right represented by the foregoing Warrant to purchase
_______ shares of the Common Stock of Paper Warehouse, Inc. to which the within
Warrant relates and appoints _____________, attorney, to transfer said right on
the books of Paper Warehouse, Inc. with full power of substitution in the
premises.
Name of Warrant Holder/Assignor
Dated:________________ _____________________________
(Signature)*
Address of Warrant Holder/Assignor:
Tax Identification No. or Social ______________________________
Security No. of Warrant Holder/Assignor
______________________________
______________________________
*Note: The above signature should correspond exactly with the name on the first
page of the Warrant or with the name of the assignee appearing on a duly
executed assignment form.
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CASHLESS EXERCISE FORM
(To be executed upon exercise of Warrant
pursuant to Section 10)
The undersigned hereby irrevocably elects a cashless exercise of the right
of purchase represented by the within Warrant Certificate for, and to purchase
thereunder, ______________ shares of Common Stock, as provided for in Section 10
therein.
Please issue a certificate or certificates for such Common Stock in the
name of, and pay any cash for any fractional share to:
Name___________________________________
(Please print Name)
Address________________________________
_______________________________________
Tax Identification No. or Social
Security No._______________________
Signature______________________________
NOTE: The above signature should correspond exactly with the name on the
first page of this Warrant Certificate or with the name of the assignee
appearing on a duly executed assignment form.
And if said number of shares shall not be all the shares purchasable under
the within Warrant Certificate, a new Warrant Certificate is to be issued in the
name of said undersigned for the balance remaining of the shares purchasable
thereunder rounded up to the next higher number of shares.
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EXHIBIT 23.1
INDEPENDENT AUDITOR'S CONSENT
To Board of Directors
Paper Warehouse, Inc. and Subsidiary:
We consent to the use of our report included herein and to the references to our
firm under the headings "Experts" and "Selected Financial and Operating Data" in
the prospectus.
/s/ KPMG LLP
Minneapolis, Minnesota
July 13, 1999
