Paper Source, Inc – 158 Store Fine Paper/Gift Retailer Files Chapter 11 Less than a Year After Acquiring 30 Papyrus Stores Out of Bankruptcy; Investcorp-Owned Debtors Agree DIP Financing and Stalking Horse Role for Apollo’s MidCap Financial Trust

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March 1, 2021 – Paper Source, Inc and one affiliated debtor (“Paper Source” or the “Debtors”) filed for Chapter 11 protection with the U.S. Bankruptcy Court in the Eastern District of Virginia, lead case number 21-30660. The Debtors, a Chicago-based "premier lifestyle brand and gift retailer," are represented by Christopher A. Jones of Whiteford, Taylor & Preston, LLP. Further board-authorized engagements include (i) Willkie Farr & Gallagher LLP as general bankruptcy counsel, (ii) M-III Advisory Partners, LP as restructuring advisors, (iii) SSG Capital Advisors, LLC as investment banker, (iv) A&G Real Estate Partners as real estate advisor and (v) Epiq Corporate Restructuring as claims agent. 

At filing, the Debtors note between 1,000 and 5,000 creditors; estimated assets between $100.0mn and $500.0mn; and estimated liabilities between $100.0mn and $500.0mn ($103.2mn of funded debt). Documents filed with the Court list the Debtors’ three largest unsecured creditors as (i) Fedex Corporation ($2.2mn trade claim), (ii) 83 Spring Street Associates LLC ($872k rent claim) and (iii) Hartford Realty Co ($703k rent claim). 19 of the top 30 unsecured creditors (all claims in excess of 4146k) have rent claims.

In 2013, private equity group Investcorp International ("Investcorp," 80% common stock holding as at Petition date) purchased the Debtors from Brentwood Associates for an undisclosed price.

In March 2020, the Debtors acquired 30 stores from then competitor Papyrus as part of the latter's own bankruptcy. With that acquisition and as of the Petition date, the Debtors have approximately 158 stores.

In Petition date filings, the Debtors note that they have negotiated debtor-in-possession ("DIP") financing to be provided by Apollo Capital Management's MidCap Financial Trust ("MidCap") which is also to serve as stalking horse in a section 363 auction/sale process for substantially all of the Debtors' assets. As discussed further below, MidCap has agreed to credit bid amounts outstanding under a proposed $16.0mn new money, debtor-in-possession ("DIP") financing facility and $72.8mn of first lien prepetition debt.

Goals of the Chapter 11 Filings

The Kruczynski Declaration (defined below) provides: "The Debtors have commenced these Chapter 11 Cases to implement a comprehensive restructuring that will allow the Debtors to achieve certain objectives that are critical to their survival: (a) conduct a marketing process whereby the Debtors will seek to sell all or substantially all of their assets to MidCap Funding Investment XI LLC, an affiliate of MidCap Financial Trust— which is both the DIP Agent and Prepetition First Lien Agent—or another buyer; (b) evaluate and rationalize the Debtors’ real estate portfolio, including renegotiating lease terms to align the Debtors’ rent expenditures with prevailing market rates; and (c) continue operations without interruption, including minimizing any potential adverse effects to the Debtors’ businesses, customers, employees, trade partners and other key stakeholders."

Marketing Efforts and MidCap Stalking Horse Role

the Kruczynski Decalartion provides": "…the Debtors will conduct a postpetiton marketing process lasting approximately 50 days which will provide sufficient time for the Debtors and its advisors to obtain substantial lease concessions. This process will supplement the thorough and extensive pre-petition marketing process that the Debtors launched in December 2020 whereby by the Debtors contacted nearly 140 potential acquirers.

….the Debtors have entered into a “stalking horse” agreement (the “Stalking Horse Agreement”) with MidCap Funding Investments XI LLC (the 'Stalking Horse Purchaser'). The Stalking Horse Purchaser is an acquisition entity designated by (a) MidCap Financial Trust ('MidCap') in its capacity as administrative agent and collateral agent for the DIP Lenders (in such capacities, the “DIP Agent”) and (b) MidCap in its capacity as administrative agent and collateral agent for the Prepetition First Lien Lenders (in such capacities, the “Prepetition First Lien Agent”). Under the terms of the 'stalking horse' asset purchase agreement (the “Stalking Horse Agreement'), MidCap has agreed to credit bid an amount equal to (a) the full amount of obligations under the DIP Facility (the 'DIP Obligations') in the expected aggregate principal amount of $16.0 million and (b) up to the full amount of the obligations under the prepetition First Lien Facility (the 'Prepetition First Lien Obligations') in the aggregate principal amount of approximately $72.8 million as of the Petition Date (together, the 'Credit Bid')."

Prepetition Indebtedness

The Debtors' current capital structure is largely the result of certain refinancing transactions that took place in May 2019. Debtor Pine Holdings, Inc.’s only asset is the 100% equity interest it holds in Debtor Paper Source, Inc. As of the Petition date, the Debtors’ capital structure consists of outstanding funded-debt obligations in the aggregate principal amount of approximately $103,188,208.08. The following table summarizes the Debtors’ outstanding funded-debt obligations as of the Petition Date (collectively, the “Prepetition Credit Facilities”):

Stalking horse MidCap is the agent in respect of the first lien indebtedness noted in the first three rows of the chart above.

DIP Financing

The Debtors have arranged $16.0mn of new money, DIP delayed-draw term loans, of which $7.75mn will be available upon entry of an interim DIP order, with Midcap as DIP agent. 

Leases

The Debtors are party to 163 leases, comprised of 158 active retail locations, 3 non-active retail locations, the Company’s headquarters, and distribution center. These leases create fixed costs for the Debtors of approximately $36 million per year. Due to the loss of revenue from store closures in 2020 as a result of the COVID-19 pandemic, the Debtors sought rent waivers and deferrals for the majority of the leases. While the Company was able to successfully negotiate a number of rent deferrals and rent abatements with its landlords, each of those arrangements expired in December 2020. As a result of these deferrals and other unpaid rent obligations, the Debtors have outstanding rent obligations of approximately $15.8 million as of the Petition Date.

As to the Debtors' lease negotiations, the Kruczynski Declaration continues: "Responses within the landlord community varied. Many landlords made no concessions. Some landlords agreed to the Company’s request, while others negotiated bespoke rent relief arrangements. These negotiated rent concessions helped the Company navigate an increasingly tight liquidity profile for the remainder of 2020. However, each of these agreements expired prior to January 2021. Since then, the onslaught of landlords threatening to terminate lease agreements has increased to the point where the Company was left no other option but file these Chapter 11 Cases."

Events Leading to the Chapter 11 Filing

In a declaration in support of the Chapter 11 filing (the “Kruczynski Declaration”),Robert Kruczynski, the Debtors’ chief financial officer, detailed the events leading to the Debtors' Chapter 11 filing. In addition to detailing the "onslaught" of threatened lease terminations, the Kruczynsk Declaration provides: “Before the COVID-19 pandemic began—which required Paper Source to close 100% of its retail operations for over one month in the Spring of 2020—the Debtors’ business had been strong. On March 2, 2020, the Debtors acquired 27 leases out of the chapter 11 proceedings of Papyrus, historically one of the Company’s biggest competitors in the high-quality paper product space. The logic of the acquisition was simple: Paper Source acquired the best leases out of Papyrus’ portfolio and was uniquely positioned to leverage its existing supply chain, vendor network and distribution capabilities to add bottom line growth to the Company’s balance sheet. The sale represented a 22% expansion of the Debtors’ retail footprint at a time when many retailers were continuing to close their stores. Investcorp helped the Company finance the acquisition by purchasing $8,000,000 of Series A Convertible Preferred stock—a significant vote of confidence in the long term equity value of the Company. Unfortunately, the Company never realized the benefits of the Papyrus acquisition. Less than three weeks later, on March 16, 2020, the Company decided to shut down all of its retail locations in the face of the unprecedented global COVID-19 pandemic. At the time of this decision, approximately 83% of the Debtors’ sales were generated through in-store sales.”

Principal Shareholders

Funds affiliated with, or managed by, Investcorp constitute the majority owners of the Company through its equity holdings of debtor Pine Holdings, Inc. Debtor Pine Holdings, Inc. has three classes of equity—Series A Common, Series D Common, and Series A Convertible Preferred. MidCap Financial Trust and certain affiliated funds own both nonvoting preferred equity and nonvoting common equity in Pine Holdings, Inc. as a result of a capital infusion transaction that took place on October 16, 2020. A summary of the approximate ownership interests in Pine Holdings, Inc. is provided below:

About the Debtors

According to the Debtors: “Founded in 1983, Paper Source is a premier paper and gift store offering a curated selection of fine and artisanal papers, invitations, gifts, gift wrap, greeting cards and an exclusive collection of envelopes and cards. With the goal to "Do Something Creative Every Day," Paper Source is committed to offering inspiration and innovation to their customers as they celebrate all of life's moments, both big and small.  In support of this mission, Paper Source offers a creative aesthetic with a unique color palette and proprietary designs that are hand-illustrated by an in-house Art and Design team. As of early 2020 [ie before Papyrus purchase added 30 stores], Paper Source operates 135 stores nationwide, plus an ecommerce store and wholesale division."

Organizational Structure

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