<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended July 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________to__________
Commission File No. 0-23389
-------------------------
PAPER WAREHOUSE, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1612534
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7630 EXCELSIOR BOULEVARD
MINNEAPOLIS, MINNESOTA 55426
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (612) 936-1000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. YES [x] NO [ ]
On September 13, 1999, there were 4,627,936 shares of Common Stock, $.01 par
value, of Paper Warehouse, Inc. outstanding.
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<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
----
<S> <C> <C>
Item 1: Financial Statements
Consolidated Balance Sheets
as of July 30, 1999 and January 29, 1999 1
Consolidated Statements of Operations
for the Three and Six Months ended July 30, 1999
and July 31, 1998 2
Consolidated Statements of Cash Flows
for the Six Months ended July 30, 1999
and July 31, 1998 3
Notes to Consolidated Financial Statements 4-7
Item 2: Management's Discussion and Analysis of
Results of Operations and Financial Condition 8-15
Item 3: Quantitative and Qualitative Disclosures about Market Risk 16
PART II. OTHER INFORMATION
Item 4: Submission of Matters to a Vote of Security Holders 17
Item 6: Exhibits and Reports on Form 8-K 18
Signatures 19
</TABLE>
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
July 30, January 29,
1999 1999
---------------- -----------------
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................................ $ 1,369,997 $ 64,507
Merchandise inventories, net............................................. 19,655,900 16,302,070
Accounts receivable...................................................... 468,939 1,105,262
Prepaid expenses and other current assets................................ 2,017,539 613,584
---------------- -----------------
Total current assets............................................... 23,512,375 18,085,423
Property and equipment, net.............................................. 10,319,396 9,976,450
Other assets, net........................................................ 2,249,831 1,466,613
---------------- -----------------
Total assets..................................................... $36,081,602 $29,528,486
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Note payable - line of credit............................................ $ 5,945,801 $ 6,850,000
Current maturities of long-term debt..................................... 136,776 151,993
Current maturities of capital lease obligations.......................... 532,272 308,566
Accounts payable......................................................... 7,045,375 4,390,525
Accrued liabilities...................................................... 1,798,886 1,172,056
---------------- -----------------
Total current liabilities.......................................... 15,459,110 12,873,140
Convertible subordinated debentures......................................... 4,000,000 ---
Long-term debt, less current maturities..................................... 1,069,718 861,827
Capital lease obligations, less current maturities.......................... 1,289,556 635,204
Deferred rent credits....................................................... 1,289,424 1,068,331
---------------- -----------------
Total liabilities................................................ 23,107,808 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............................................ (905,927) 210,263
---------------- -----------------
Total stockholders' equity......................................... 12,973,794 14,089,984
---------------- -----------------
Total liabilities and stockholders' equity....................... $36,081,602 $29,528,486
================ =================
</TABLE>
See accompanying notes to consolidated financial statements.
1
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
---------------------------------- ----------------------------------
July 30, July 31, July 30, July 31,
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues:
Company-owned stores................................ $ 19,618,089 $14,748,314 $ 36,037,661 $26,940,573
Franchise related fees.............................. 303,455 324,789 576,312 627,974
--------------- --------------- --------------- ---------------
Total revenues................................. 19,921,544 15,073,103 36,613,973 27,568,547
Costs and expenses:
Costs of products sold and occupancy costs.......... 13,115,318 9,831,377 24,522,163 18,286,104
Store operating expenses............................ 4,051,571 2,880,677 8,725,461 6,067,640
General and administrative expenses................. 2,640,362 1,969,715 4,903,988 3,687,550
--------------- --------------- --------------- ---------------
Total costs and expenses....................... 19,807,251 14,681,769 38,151,612 28,041,294
Operating income (loss)........................ 114,293 391,334 (1,537,639) (472,747)
Interest expense, net............................... (231,675) (35,885) (447,715) (62,971)
Other income........................................ 285,970 10,200 302,583 21,195
--------------- --------------- --------------- ---------------
Income (loss) before income taxes and
cumulative effect of accounting change.......... 168,588 365,649 (1,682,771) (514,523)
Income tax (expense) benefit........................ (67,439) (146,260) 675,087 205,809
--------------- --------------- --------------- ---------------
Net income (loss) before cumulative effect of
accounting change............................... 101,149 219,389 (1,007,684) (308,714)
--------------- --------------- --------------- ---------------
Cumulative effect of accounting change, net (Note 2) --- --- (108,506) ---
--------------- --------------- --------------- ---------------
Net income (loss).............................. $ 101,149 $ 219,389 $ (1,116,190) $ (308,714)
=============== =============== =============== ===============
Basic weighted average shares outstanding...... 4,627,936 4,557,187 4,627,936 4,557,187
=============== =============== =============== ===============
Basic net income (loss) per share before
cumulative effect of accounting change.... $ .02 $ .05 $ (.22) $ (.07)
Cumulative effect of accounting change......... --- --- (.02) ---
--------------- --------------- --------------- ---------------
Basic net income (loss) per share.............. $ .02 $ .05 $ (.24) $ (.07)
=============== =============== =============== ===============
Diluted weighted average shares outstanding.... 5,315,963 4,557,187 4,627,936 4,557,187
=============== =============== =============== ===============
Diluted net income (loss) per share before
cumulative effect of accounting change.... $ .02 $ .05 $ (.22) $ (.07)
Cumulative effect of accounting change......... --- --- (.02) ---
--------------- --------------- --------------- ---------------
Diluted net income (loss) per share............ $ .02 $ .05 $ (.24) $ (.07)
=============== =============== =============== ===============
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended
------------------------------------
July 30, July 31,
1999 1998
--------------- ---------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss............................................................. $ (1,116,190) $ (308,714)
Adjustments to reconcile net loss to net cash used for operations:
Depreciation and amortization................................... 1,094,438 780,248
Gain on sale of property and equipment.......................... (1,414) (198)
Deferred taxes.................................................. (745,444) (205,809)
Other noncash items affecting earnings.......................... 200,114 ---
Changes in operating assets and liabilities, net of the effect of
the purchase of assets of a business:
Accounts receivable............................................. 636,323 110,016
Prepaid expenses and other current assets....................... (658,511) (578,599)
Merchandise inventories, net.................................... (3,353,830) (1,665,597)
Accounts payable................................................ 2,654,850 1,631,713
Accrued liabilities............................................. 631,994 210,676
Deferred rent credits........................................... 215,929 (114,693)
--------------- ---------------
Net cash used for operations.................................. (441,741) (140,957)
--------------- ---------------
INVESTING ACTIVITIES:
Purchase of assets of a business..................................... --- (626,447)
Proceeds from sale of property and equipment......................... 16,700 4,991
Net purchases of property and equipment.............................. (1,429,470) (1,817,163)
Other assets, net of effect of asset acquisition..................... --- (78,216)
--------------- ---------------
Net cash used for investing activities........................ (1,412,770) (2,516,835)
--------------- ---------------
FINANCING ACTIVITIES:
Proceeds from convertible subordinated debentures.................... 4,000,000 ---
Net (payments on) proceeds from notes payable....................... (904,199) 964,162
Proceeds from refinancing of mortgage................................ 1,100,000 ---
Principal payments on long-term debt................................. (907,326) (10,982)
Payment of debt issuance costs....................................... (1,006,532) ---
Net proceeds from (payments on) financing of property
and equipment..................................................... 878,058 (65,356)
--------------- ---------------
Net cash provided by financing activities..................... 3,160,001 887,824
--------------- ---------------
Net increase (decrease) in cash and cash equivalents.......... 1,305,490 (1,769,968)
Cash and cash equivalents, beginning of period....................... 64,507 2,059,737
--------------- ---------------
Cash and cash equivalents, end of period............................. $ 1,369,997 $ 289,769
=============== ===============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid during the period............................. $ 396,532 $ 71,173
Income taxes paid during the period......................... --- ---
=============== ===============
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
NOTES TO 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 July 30, 1999, the Company had a
total of 143 stores, consisting of 97 company-owned stores and 46 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 July 30, 1999 and July 31, 1998 and for the three
and six-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 and six months ended July 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
six months ended July 30, 1999.
(3) EARNINGS PER COMMON SHARE
Basic earnings per common share ("EPS") is computed based on the weighted
average shares of common stock outstanding during the applicable periods
while diluted EPS assumes conversions of potentially dilutive shares of
common stock outstanding during the applicable periods. Potential dilutive
shares of common stock for the Company include stock options which have
been granted to employees and outside directors, the Company's outstanding
convertible subordinated debentures and a warrant granted to the
underwriter as part of the convertible debenture offering.
4
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(3) EARNINGS PER COMMON SHARE (CONTINUED)
The components of basic and diluted EPS for the three and six-month periods
ended July 30, 1999 and July 31, 1998 are as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
---------------------------------- ----------------------------------
July 30, July 31, July 30, July 31,
Basic and diluted EPS: 1999 1998 1999 1998
-------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Basic EPS:
Net income (loss) before cumulative effect
of accounting change.......................... $ 101,149 $ 219,389 $ (1,007,684) $(308,714)
Cumulative effect of accounting change, net...... --- --- (108,506) ---
-------------- --------------- --------------- ---------------
Net income (loss)................................ $ 101,149 $ 219,389 $ (1,116,190) $ (308,714)
-------------- --------------- --------------- ---------------
Weighted average shares outstanding.............. 4,627,936 4,557,187 4,627,936 4,557,187
Basic EPS before cumulative effect of
accounting change............................. $ .02 $ .05 $ (.22) $ (.07)
Cumulative effect of accounting change, net...... --- --- (.02) ---
============== =============== =============== ===============
Basic EPS ....................................... $ .02 $ .05 $ (.24) $ (.07)
============== =============== =============== ===============
Diluted EPS:
Net income (loss) before cumulative effect
of accounting change.......................... $ 101,149 $ 219,389 $ (1,007,684) $ (308,714)
Impact of assumed conversions.................... 13,187 --- --- ---
-------------- --------------- --------------- ---------------
Net income (loss) before cumulative effect
of accounting change plus assumed conversions. 114,336 219,389 (1,007,684) (308,714)
Cumulative effect of accounting change, net...... --- --- (108,506) ---
-------------- --------------- --------------- ---------------
Net income (loss)................................ $ 114,336 $ 219,389 $ (1,116,190) $ (308,714)
-------------- --------------- --------------- ---------------
Weighted average shares outstanding.............. 4,627,936 4,557,187 4,627,936 4,557,187
Assumed conversions of:
Stock options................................. 2,313 --- --- ---
Convertible subordinated debentures........... 685,714 --- --- ---
-------------- --------------- --------------- ---------------
Adjusted weighted average shares outstanding..... 5,315,963 4,557,187 4,627,936 4,557,187
============== =============== =============== ===============
Diluted EPS before cumulative effect of
accounting change............................. $ .02 $ .05 $ (.22) $ (.07)
Cumulative effect of accounting change, net...... --- --- (.02) ---
-------------- --------------- --------------- ---------------
Diluted EPS ..................................... $ .02 $ .05 $ (.24) $ (.07)
============== =============== =============== ===============
</TABLE>
5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(4) 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. At July 30, 1999, the
Company had borrowings outstanding of approximately $5.9 million under this
revolving line of credit facility. 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. The Company was in compliance with such covenants at July 30,
1999. The Company's agreement requires the use of all cash receipts to pay
down its indebtedness and includes various covenants, which if violated,
could accelerate the maturity of the debt. Accordingly, borrowings
outstanding under the revolving credit facility are classified as a current
liability in the Company's consolidated balance sheet.
During second 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. The Company
received net proceeds of approximately $3.2 million from the issuance that
have been 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.
(5) COMMON STOCK AND STOCK OPTION TRANSACTIONS
At the Company's annual meeting of shareholders which took place on June
11, 1999, the shareholders approved an amendment to the Company's 1997
Stock Option and Compensation Plan to increase the number of shares
available for issuance to 1,025,000, to add non-employee directors,
consultants and independent contractors to the class of persons eligible to
receive awards under the Plan and to amend the provisions regarding the
Board's ability to amend the Plan without shareholder approval.
During the first six months of 1999, the Company granted options to
selected management of the Company to purchase 17,100 shares of the
Company's Common Stock at a range of $1.75 to $2.75 per share. The options
vest over three years and expire 10 years from the date of grant.
(6) SUBSEQUENT EVENT - INCORPORATION OF WHOLLY-OWNED SUBSIDIARY
Subsequent to the quarter end, the Company incorporated PartySmart.com,
Inc., as a wholly-owned subsidiary. PartySmart.com, Inc. will have a
storefront on the Web, selling selected party supplies and paper goods over
the Internet, and is expected to be operational during the third quarter of
1999. The Company has incurred costs of approximately $450,000 during the
second quarter and first six months of 1999 related to its Internet
venture. In recording these expenses, the Company has followed the guidance
as prescribed by SOP 98-1, "Accounting for the Costs of Computer Software
Developed for Internal Use," as well the guidance prescribed by SOP 98-5.
Accordingly, approximately $212,000 of
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(6) SUBSEQUENT EVENT - INCORPORATION OF WHOLLY-OWNED SUBSIDIARY (Continued)
capitalizable costs are reflected in Property and Equipment in the
Company's consolidated balance sheet at July 30, 1999 and the remaining
$238,000 is reflected in general and administrative expenses in the
Company's consolidated statement of operations for the three and six-month
periods ended July 30, 1999.
(7) RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the
current year presentation.
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
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
and a virtual retailer operating under the name PARTYSMART.COM. 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 143 stores, including 97 Company-owned stores and
46 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.
RESULTS OF OPERATIONS
NET INCOME (LOSS)
The Company reported net income of approximately $101,000 or $.02 per share,
for the second quarter ended July 30, 1999, compared to net income of
approximately $219,000, or $.05 per share for the second quarter ended July
31, 1998. The Company reported a net loss of $1.1 million, or ($.24) per
share year-to-date, compared to a net loss of $309,000, or ($.07) per share
for the prior-year comparable period. The principal reasons for the
year-to-date loss in the first half of fiscal 1999 were the seasonality of
revenues in addition to the large number of stores opened in the past nine
months which have expenses without a fully established revenue base. The net
loss for the first half of 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. Additionally, approximately $238,000 of the loss ($.03 per
share) reflects startup costs associated with the Company's Internet
business.
REVENUES
Total revenues consist of Company-owned stores sales and franchise revenues.
Company-owned stores enter the comparable store sales base at the beginning
of their 13th month of operations. During the first quarter of 1999, the
Company changed its comparable store sales definition to be more in line
with industry standards. Prior to the change, a store would not have been
included in the comparable store sales base until 12 months had passed, if
its retail square footage had increased more than 50%, or if it had been
relocated.
Franchise revenues consist of royalties received on sales, generally 4% of
the store's sales and initial franchise fees. We recognize initial franchise
fees when a franchisee signs a lease for the store, which is at the time we
have substantially performed all of our services.
COMPANY-OWNED STORES SALES
During the second quarter ended July 30, 1999, the Company opened two new
Company-owned stores, and closed two Company-owned stores, keeping the total
at 97 as of July 30, 1999, compared to 78 at the end of the second fiscal
quarter of 1998. During the first six months of 1999, the Company opened
three new Company-owned stores, and closed three Company-owned stores. For
the second quarter, comparable store sales increased 7.9% over the
prior-year comparable period. This growth rate favorably compares with a
comparable store sales
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
REVENUES (CONTINUED)
COMPANY-OWNED STORES SALES (CONTINUED)
increase of 0.4% for the second fiscal quarter of 1998. For the first six
months of 1999, comparable store sales increased 6.3%.
FRANCHISE RELATED FEES
Franchise related fees for the second quarter ended July 30, 1999 of
approximately $303,000 decreased 6.6% from franchise related fees of
approximately $325,000 for the second quarter ended July 31, 1998. For the
first six months of 1999, franchise related fees of approximately $576,000
decreased 8.2% from franchise related fees of approximately $628,000 for the
prior-year comparable period. 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 second fiscal quarter of 1999, one franchise
store was opened, bringing the total to 46 franchise stores at the end of
second fiscal quarter 1999 compared with 51 franchise stores at the end of
second quarter 1998. During the first six months of 1999, one franchise
store was opened and one franchise store was closed.
COSTS OF PRODUCTS SOLD AND OCCUPANCY COSTS
Cost of products sold and occupancy costs includes the direct cost of
merchandise, plus handling and distribution, and certain occupancy costs.
Cost of products sold and occupancy costs totaled $13.1 million or 66.9% of
Company-owned stores sales for the second quarter ended July 30, 1999, as
compared to $9.8 million or 66.7% of Company-owned stores sales for the
second quarter ended July 31, 1998. Cost of products sold and occupancy
costs totaled $24.5 million or 68.0% of Company-owned stores sales for the
first six months of 1999, compared with $18.3 million or 67.9% of
Company-owned stores sales for the first half of fiscal 1998. The increase
in this expense category primarily reflects higher occupancy costs,
resulting from the increased store base, partially offset by higher product
margins.
STORE OPERATING EXPENSES
Store operating expenses include all costs incurred at the store level, such
as advertising, credit card processing fees and store payroll. Store
operating expenses for the second quarter ended July 30, 1999 were $4.1
million or 20.7% of Company-owned stores sales, as compared to $2.9 million
or 19.5% of Company-owned stores sales for the comparable period in the
prior year. On a year-to-date basis, store operating expenses were $8.7
million or 24.2% of Company-owned stores sales, as compared to $6.1 million
or 22.5% of Company-owned stores sales for the first half of fiscal 1998.
The increase over prior year reflects the Company's new store growth,
including corresponding store labor expense increases, in addition to
continued increases in hourly compensation due to tight labor markets.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include corporate administrative expense
for Company-owned stores, expenses relating to franchising, primarily
payroll, legal, travel and advertising and non-capitalizable costs
associated with PartySmart.com.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
GENERAL AND ADMINISTRATIVE EXPENSES (CONTINUED)
For the second quarter ended July 30, 1999, general and administrative
expenses were $2.6 million or 13.3% of total revenues compared to $2.0
million or 13.1% of total revenues for the comparable period in the prior
year. For the first half of fiscal 1999, general and administrative expenses
were $4.9 million, or 13.4% of total revenues as compared to $3.7 million
for the prior-year comparable period, which was also 13.4% of total
revenues.
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. The year-over-year increase also
reflects approximately $238,000 of start-up costs incurred during the second
quarter of fiscal 1999 associated with our Internet strategy. Over the next
twelve-months, the Company expects general and administrative expenses to
increase resulting from the startup and operational costs of PartySmart.com.
In the aggregate, these expenses are also expected to increase as a
percentage of total revenues, reflecting the increased costs from the new
strategy against an immature revenue base.
INTEREST EXPENSE, NET
Interest expense, net of interest income, of approximately $232,000 or 1.2%
of total revenues for the second quarter ended July 30, 1999, increased
$196,000, over net interest expense for the second quarter ended July 31,
1998. On a year-to-date basis, net interest expense of approximately
$448,000 or 1.2% of total revenues for the first half of 1999 compared to
net interest expense of $63,000 or 0.2% of total revenues for the prior-year
comparable period. The increase over prior year reflects the Company's
borrowings under its revolving credit facility during the first six months
of 1999 necessary to fund working capital requirements in addition to the
amortization of the deferred financing costs related to its financing
activities occurring during the first half of 1999. In comparison, the
Company did not borrow under its revolving credit facility during the first
five months of fiscal 1998. The Company expects interest expense to increase
throughout the remainder of the year, primarily related to a higher level of
borrowings necessary to support the increased store base during the upcoming
peak season in addition to the issuance during the second quarter of 1999 of
$4 million of convertible subordinated debentures, bearing interest at 9%.
OTHER INCOME
During the second quarter of 1999, the Company received approximately
$250,000 from one of its landlords as consideration for terminating the
lease on one of its stores. This fee is reflected in other income in the
Company's consolidated statements of operations for the three and six months
ended July 30, 1999.
INCOME TAX (EXPENSE) BENEFIT
The Company's estimated annual effective income tax rate is 40% for 1999,
unchanged from the second quarter 1998 estimated annual rate.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
ANALYSIS OF FINANCIAL CONDITION
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:
- - borrowings under our revolving line of credit
- - proceeds from financings such as our initial public offering and our
public sale of our convertible subordinated debentures
- - payment terms from vendors
- - cash from operations
Our liquidity as measured by our working capital, was $8.1 million at July
30, 1999 compared to $5.2 million at January 29, 1999 and $7.5 million at
July 31, 1998. The Company's current ratio was 1.5 to 1.0 at July 30, 1999
compared to 1.4 to 1.0 at January 29, 1999 and 2.0 to 1.0 at July 31, 1998.
The decrease in the current ratio from the prior year primarily reflects the
increase in liabilities resulting from the issuance of $4.0 million of
subordinated debentures.
Merchandise inventories have increased approximately $3.4 million from the
end of fiscal 1998, reflecting necessary purchases for upcoming seasonal
events. This inventory growth was partially funded by a $2.7 million
increase in accounts payable.
Net cash used for operations totaled approximately $442,000 for the first
six months ended July 30, 1999 compared to net cash used for operations of
approximately $141,000 for the same period in 1998. The increase in net cash
used for operations primarily reflects the increase in merchandise
inventories and accounts payable related to new store growth.
Net cash used for investing activities was approximately $1.4 million for
the first six months ended July 30, 1999 and $2.5 million for the first six
months ended July 31, 1998. These expenditures during the first half of 1999
were related to opening and remodeling existing Company-owned stores,
upgrading our information systems and building the necessary infrastructure
to support our Internet strategy.
During the first six months of fiscal 1999, we made capital expenditures of
approximately $1.4 million, compared with approximately $1.8 million of
capital expenditures for the prior year-comparable period. Capital
expenditures in the first half of fiscal 1999 included approximately
$354,000 of costs 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
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
of Company-owned stores may vary from plan 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 finance
our new store fixtures and equipment with long-term capital leases, assuming
availability and reasonable terms.
We have opened three Company-owned stores to date, and anticipate opening up
to seven more 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 remaining planned Company-owned stores to be opened in fiscal
1999, as of July 30, 1999, we had signed leases for three new locations. Two
additional leases were signed subsequent to the quarter end. Most of these
leases are for ten-year terms, with five-year renewal options.
Net cash provided by financing activities was approximately $3.2 million for
the first six months of 1999 compared to net cash provided by financing
activities of $888,000 for the first half of 1998. The year-over-year
increase reflects the net proceeds received during the first six months of
1999 from the public offering of $4 million of convertible subordinated
debentures, the refinancing of our mortgage and the financing of property
and equipment.
We expect to fund our operations, capital expenditures and the growth in our
Company-owned stores, as well as our Internet business, from the following
sources:
- - available borrowing capacity under our revolving credit facility
- - cash generated from operations
- - the financing of property and equipment under long-term leases
- - proceeds received in July 1999 from our offering of $4 million of
convertible subordinated debentures
IMPACT OF YEAR 2000
The Year 2000 problem arose because many existing computer programs use only
the last two digits to refer to a year. Therefore, these computer programs
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 extent of the potential 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, or 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.
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
IMPACT OF YEAR 2000 (CONTINUED)
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 maintained at our
headquarters. We continue to solicit, and receive, 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 the end of the third quarter of fiscal 1999. In addition, while
we value our established relationships with our key suppliers, we are in the
process of identifying secondary vendors in the event that certain 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. The Corporate office and the cross-dock facility have completed
their upgrades and are Year 2000 compliant, while twenty-five store
locations are scheduled to receive alarm upgrades within the next two months
in order to make their systems compliant. We do not anticipate that expenses
for these replacements 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 the end of the third quarter of fiscal 1999.
We have completed upgrading our cash registers in order to achieve Year 2000
compliance. We have completed upgrading or replacing all applicable personal
computers and expect the remaining file server to be upgraded during third
quarter. 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
affect 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.
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
IMPACT OF YEAR 2000 (CONTINUED)
To date, we have received responses from 12 of our top 13 vendors to their
state of readiness, and each of these vendors confirmed that they are either
currently Year 2000 compliant or will be by December 31, 1999. 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. In the aggregate, we expect the total
incurred and anticipated costs associated with achieving Year 2000 readiness
to be less than $200,000.
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 have begun, and expect to further develop a formal
contingency plan related to the Year 2000 problem upon additional
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.
FINANCING
On April 8, 1999, we refinanced our 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 our office headquarters.
On June 7, 1999, we obtained a $15 million three-year revolving line of
credit facility for general working capital purposes, that replaced our
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 our assets. At July 30, 1999, we had borrowings outstanding of
approximately $5.9 million under this revolving line of credit facility. 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 were in compliance with such covenants at July
30, 1999.
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
FINANCING (CONTINUED)
During second quarter 1999, we 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. We received net
proceeds of approximately $3.2 million from the issuance which have been
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.
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.
FORWARD-LOOKING INFORMATION
This report 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, assumptions, estimates and
projections about our industry and us. When used in this report, the words
"expects," "believes," "anticipates," "estimates," "intends," and similar
expressions are intended to identify forward-looking statements.
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
report should be read as being applicable to all related forward-looking
statements wherever they appear in this report. We assume no obligation to
update these forward-looking statements publicly for any reason. Actual
results could differ materially form those anticipated in these
forward-looking statements, even if new information becomes available or
other events occur in the future.
15
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In addition to other sources of liquidity, we have utilized a combination
of fixed rate and floating rate debt to fund our operations, capital
expenditures and the growth in our Company-owned stores and our Internet
business. As a result of our floating rate debt, we are exposed to market
risk from changes in interest rates. We do not consider this exposure to be
material to our financial position, results of operations or cash flows. We
do not utilize any derivative financial instruments or engage in any other
hedging activities.
16
<PAGE>
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
a. The Company held its annual meeting of shareholders on June 11,
1999. Pursuant to Regulation 14 of the Securities Act of 1934,
proxies for such meeting were solicited. The following matters
were voted on at the meeting:
<TABLE>
<CAPTION>
Votes For Votes Withheld
--------- --------------
<S> <C> <C>
b. (1) To elect the following
individuals to serve as members
of the Company's Board of Directors
until the Annual Meeting of
Shareholders in the year 2000:
Yale T. Dolginow 4,386,077 24,440
Brent D. Schlosser 4,383,077 27,440
Diane C. Dolginow 4,378,877 31,640
Arthur H. Cobb 4,385,777 24,740
Marvin W. Goldstein 4,382,277 28,240
Martin A. Mayer 4,385,277 25,240
Jeffrey S. Halpern 4,385,577 24,940
</TABLE>
<TABLE>
<CAPTION>
Votes Votes Votes Broker
For Against Abstained Non-vote
--- ------- --------- --------
<S> <C> <C> <C> <C>
c. (2) To approve the amendment
of the Company's 1997 Stock
Option and Compensation
Plan to: 2,851,448 460,045 4,400 1,094,624
(A) increase the number of shares
available for issuance to
1,025,000,
(B) add non-employee directors,
consultants and independent
contractors to the class of
persons eligible to receive
awards under the Plan,
(C) amend the provisions regarding
the Board's ability to amend
the Plan without Shareholder
approval.
(3) To approve the 1998 Paper
Warehouse, Inc. Employee Stock
Purchase Plan 3,246,598 63,195 6,100 1,094,624
</TABLE>
17
<PAGE>
PART II. OTHER INFORMATION
(CONTINUED)
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. EXHIBITS:
Exhibit 12 - Computation re: Ratio of Earnings to Fixed Charges
Exhibit 27 - Financial Data Schedule
b. REPORTS ON FORM 8-K:
The Registrant did not file any reports on Form 8-K during the
quarter ended July 30, 1999.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PAPER WAREHOUSE, INC.
Date: September 13, 1999
By: /s/ Yale T. Dolginow
--------------------------------------
Name: Yale T. Dolginow
Title: President and Chief Executive
Officer
By: /s/ Cheryl W. Newell
--------------------------------------
Name: Cheryl W. Newell
Title: Chief Financial Officer
(Principal Financial Officer)
By: /s/ Diana G. Purcel
--------------------------------------
Name: Diana G. Purcel
Title: Controller
(Principal Accounting Officer)
19
<PAGE>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
12 Computation re: Ratio of Filed herewith
Earnings to Fixed Charges electronically
27 Financial Data Schedule Filed herewith
electronically
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARY
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
FOR THE SIX MONTHS ENDED JULY 30, 1999 AND JULY 31, 1998 EXHIBIT 12
AND FOR THE FIVE YEARS ENDED JANUARY 29, 1999
<TABLE>
<CAPTION>
($'S IN THOUSANDS) SIX MONTHS ENDED FISCAL YEAR ENDED
----------------------------- ---------------------------------
JULY 30, JULY 31, JANUARY 29, JANUARY 30,
RATIO OF EARNINGS TO FIXED CHARGES: 1999 1998 1999 1998
--------------- ------------- --------------- --------------
<S> <C> <C> <C> <C>
Earnings:
Consolidated net earnings $ (1,116) $ (309) $ (521) $ (207)
Extraordinary charge, net -- -- -- (110)
Cumulative effect of accounting change, net (108) -- -- --
Income taxes(1) 675 206 323 (22)
--------------- ------------- --------------- --------------
Total earnings before extraordinary charge
and cumulative effect of accounting change (1,683) (515) (844) (75)
Fixed Charges:
Interest expense 448 90 279 860
Interest portion of rental expense 1,593 1,024 2,378 1,779
--------------- ------------- --------------- --------------
Total fixed charges 2,041 1,114 2,657 2,639
Earnings available for fixed charges $ 358 $ 599 $ 1,813 $ 2,564
--------------- ------------- --------------- --------------
--------------- ------------- --------------- --------------
Ratio of earnings before extraordinary charge and cumulative
effect of accounting change to fixed charges (2) -- -- -- --
--------------- ------------- --------------- --------------
--------------- ------------- --------------- --------------
<CAPTION>
FISCAL YEAR ENDED
------------------------------------------------
JANUARY 31, FEBRUARY 2, JANUARY 27,
1997 1996 1995
-------------- --------------- --------------
<S> <C> <C> <C>
Earnings:
Consolidated net earnings $ 808 $ 797 $ 794
Extraordinary charge, net -- -- --
Cumulative effect of accounting -- -- --
change, net
Income taxes(1) (500) (494) (492)
-------------- --------------- --------------
Total earnings before extraordinary charge
and cumulative effect of accounting change 1,308 1,291 1,286
Fixed Charges:
Interest expense 834 547 227
Interest portion of rental expense 1,436 1,046 673
-------------- --------------- --------------
Total fixed charges 2,270 1,593 900
Earnings available for fixed charges $ 3,578 $ 2,884 $ 2,186
-------------- --------------- --------------
-------------- --------------- --------------
Ratio of earnings before extraordinary charge and cumulative
effect of accounting change to fixed charges(2) 1.58 1.81 2.43
-------------- --------------- --------------
-------------- --------------- --------------
</TABLE>
(1) Prior to November 1997, the Company was taxed as an S-Corporation. This
amount reflects the pro forma provision for taxes as if the Company were
taxed as a C-Corporation
(2) For the six months ended July 30, 1999 and July 31, 1998, earnings were not
adequate to cover fixed charges by approximately $1.7 million and $515,000,
respectively. For the fiscal years ended January 29, 1999 and January 30,
1998, earnings were not adequate to cover fixed charges by approximately
$844,000 and $75,000, respectively.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JAN-28-2000
<PERIOD-START> JAN-30-1999
<PERIOD-END> JUL-30-1999
<CASH> 1,370
<SECURITIES> 0
<RECEIVABLES> 469
<ALLOWANCES> 0
<INVENTORY> 19,656
<CURRENT-ASSETS> 23,512
<PP&E> 16,484
<DEPRECIATION> 6,165
<TOTAL-ASSETS> 36,082
<CURRENT-LIABILITIES> 15,459
<BONDS> 6,359
0
0
<COMMON> 46
<OTHER-SE> 12,928
<TOTAL-LIABILITY-AND-EQUITY> 36,082
<SALES> 36,614
<TOTAL-REVENUES> 36,614
<CGS> 33,248
<TOTAL-COSTS> 33,248
<OTHER-EXPENSES> 4,904
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 448
<INCOME-PRETAX> (1,683)
<INCOME-TAX> 675
<INCOME-CONTINUING> (1,008)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (108)
<NET-INCOME> (1,116)
<EPS-BASIC> (.24)
<EPS-DILUTED> (.24)
</TABLE>
