<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 October 29, 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 December 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 SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION PAGE
----
Item 1: Financial Statements
Consolidated Balance Sheets
as of October 29, 1999 and January 29, 1999 1
Consolidated Statements of Operations
for the Three and Nine Months ended October 29,
1999 and October 30, 1998 2
Consolidated Statements of Cash Flows
for the Nine Months ended October 29, 1999
and October 30, 1998 3
Notes to Consolidated Financial Statements 4-6
Item 2: Management's Discussion and Analysis of
Results of Operations and Financial Condition 7-14
Item 3: Quantitative and Qualitative Disclosures about
Market Risk 15
PART II. OTHER INFORMATION
Item 6: Exhibits and Reports on Form 8-K 16
Signatures 17
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
October 29, January 29,
1999 1999
---------------- ---------------
<S> <C> <C>
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents................................................ $ 1,058,334 $ 64,507
Merchandise inventories, net............................................. 21,219,240 16,302,070
Accounts receivable...................................................... 1,494,104 1,105,262
Prepaid expenses and other current assets................................ 1,694,270 613,584
---------------- -----------------
Total current assets............................................... 25,465,948 18,085,423
Property and equipment, net.............................................. 11,173,062 9,976,450
Other assets, net........................................................ 2,238,217 1,466,613
---------------- -----------------
Total assets..................................................... $38,877,227 $29,528,486
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Note payable - line of credit............................................ $ 5,585,148 $ 6,850,000
Current maturities of long-term debt..................................... 129,269 151,993
Current maturities of capital lease obligations.......................... 614,767 308,566
Accounts payable......................................................... 10,240,182 4,390,525
Accrued liabilities...................................................... 1,916,482 1,172,056
---------------- -----------------
Total current liabilities.......................................... 18,485,848 12,873,140
Convertible subordinated debentures......................................... 4,000,000 ---
Long-term debt, less current maturities..................................... 1,062,896 861,827
Capital lease obligations, less current maturities.......................... 1,416,478 635,204
Deferred rent credits....................................................... 1,356,084 1,068,331
---------------- -----------------
Total liabilities................................................ 26,321,306 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............................................ (1,323,800) 210,263
---------------- -----------------
Total stockholders' equity......................................... 12,555,921 14,089,984
---------------- -----------------
Total liabilities and stockholders' equity....................... $38,877,227 $29,528,486
================ =================
</TABLE>
See accompanying notes to consolidated financial statements.
1
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
---------------------------------- -------------------------------
October 29, October 30, October 29, October 30,
1999 1998 1999 1998
--------------- --------------- --------------- --------------
<S> <C> <C> <C> <C>
Revenues:
Company-owned stores sales................................ $ 21,447,241 $ 16,649,889 $ 57,484,902 $ 43,590,462
Franchise related fees.................................... 335,401 351,192 911,713 979,166
--------------- --------------- --------------- --------------
Total revenues....................................... 21,782,642 17,001,081 58,396,615 44,569,628
Costs and expenses:
Costs of products sold and occupancy costs................ 14,662,924 11,201,413 39,185,087 29,487,517
Store operating expenses.................................. 5,036,182 3,949,119 13,761,643 10,016,759
General and administrative expenses....................... 2,485,840 2,058,417 7,389,828 5,745,967
--------------- --------------- --------------- --------------
Total costs and expenses............................. 22,184,946 17,208,949 60,336,558 45,250,243
Operating loss....................................... (402,304) (207,868) (1,939,943) (680,615)
Interest expense, net..................................... (351,042) (65,946) (798,757) (128,917)
Other income.............................................. 56,884 11,528 359,467 32,723
--------------- --------------- --------------- --------------
Loss before income taxes and
cumulative effect of accounting change................ (696,462) (262,286) (2,379,233) (776,809)
Income tax benefit........................................ 278,589 104,915 953,676 310,724
--------------- --------------- --------------- --------------
Net loss before cumulative effect of
accounting change..................................... (417,873) (157,371) (1,425,557) (466,085)
--------------- --------------- --------------- --------------
Cumulative effect of accounting change, net (Note 2)...... --- --- (108,506) ---
--------------- --------------- --------------- --------------
Net loss............................................. $ (417,873) $ (157,371) $(1,534,063) $ (466,085)
=============== =============== =============== ==============
Net Loss Per Common Share:
Basic and diluted net loss per common share
before cumulative effect of accounting change..... $ (.09) $ (.03) $ (.31) $ (.10)
Cumulative effect of accounting change............... --- --- (.02) ---
--------------- --------------- --------------- --------------
Basic and diluted net loss per common share.......... $ (.09) $ (.03) $ (.33) $ (.10)
=============== =============== =============== ==============
Basic weighted average number of common shares
outstanding.......................................... 4,627,936 4,557,187 4,627,936 4,557,187
=============== =============== =============== ==============
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
------------------------------------
October 29, October 30,
1999 1998
--------------- ---------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss................................................................. $(1,534,063) $ (466,085)
Adjustments to reconcile net loss to net cash provided by operations:
Depreciation and amortization....................................... 1,684,550 1,219,581
Gain on sale of property and equipment.............................. (1,414) (277)
Deferred taxes...................................................... (1,024,033) (310,724)
Other noncash items affecting earnings.............................. 250,895 ---
Changes in operating assets and liabilities, net of the effect of the
purchase of assets of a business:
Accounts receivable................................................. (388,842) (117,586)
Prepaid expenses and other current assets........................... (56,653) (165,499)
Merchandise inventories, net........................................ (4,917,170) (4,717,184)
Accounts payable.................................................... 5,849,657 5,285,334
Accrued liabilities................................................. 748,087 761,102
Deferred rent credits.................................................... 284,092 68,396
--------------- ---------------
Net cash provided by operations................................... 895,106 1,557,058
--------------- ---------------
INVESTING ACTIVITIES:
Purchase of assets of a business......................................... --- (879,533)
Proceeds from sale of property and equipment............................. 16,700 5,504
Net purchases of property and equipment.................................. (2,861,653) (3,406,865)
Other assets, net of effect of asset acquisition......................... (38,189) (102,959)
--------------- ---------------
Net cash used for investing activities............................ (2,883,142) (4,383,853)
--------------- ---------------
FINANCING ACTIVITIES:
Proceeds from convertible subordinated debentures........................ 4,000,000 ---
Net (payments on) proceeds from notes payable........................... (1,264,852) 1,800,000
Proceeds from refinancing of mortgage.................................... 1,100,000 ---
Principal payments on long-term debt..................................... (921,655) (189,483)
Payment of debt issuance costs........................................... (1,019,105) ---
Proceeds from financing of property and equipment........................ 1,452,182 ---
Payments on financing of property and equipment.......................... (364,707) (115,552)
Distribution of Subchapter S Corporation accumulated earnings............ --- (133,482)
--------------- ---------------
Net cash provided by financing activities......................... 2,981,863 1,361,483
--------------- ---------------
Net increase (decrease) in cash and cash equivalents.............. 993,827 (1,465,312)
Cash and cash equivalents, beginning of period........................... 64,507 2,059,737
--------------- ---------------
Cash and cash equivalents, end of period................................. $1,058,334 $ 594,425
=============== ===============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid during the period................................. $ 636,007 $ 152,439
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", "Party Universe" and "PartySmart.com." At
October 29, 1999, the Company had a total of 147 stores, consisting of
101 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. and sells
selected party supplies and paper goods over the Internet through its
wholly-owned subsidiary, PartySmart.com, 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., Paper
Warehouse Franchising, Inc. and PartySmart.com, Inc. as of October 29,
1999 and January 29, 1999 and for the three and nine-month periods
ended October 29, 1999 and October 30, 1998. 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 nine months ended October 29, 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 nine months ended October
29, 1999.
(3) NET LOSS 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, when dilutive. 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. For the three and nine
month periods ended October 29, 1999, options to purchase 518,550
shares of common stock in addition to $4,000,000 of convertible
subordinated debentures were outstanding but were not included in the
computation of diluted EPS as their inclusion would have been
antidilutive. Had the inclusion of these
4
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(3) NET LOSS PER COMMON SHARE (CONTINUED)
items not been antidilutive, the Company would have assumed conversions
of convertible subordinated debentures of approximately 1.3 million and
stock options of approximately 1,000 for the third quarter ended
October 29, 1999, and would have assumed conversions of convertible
subordinated debentures of approximately 889,000 and stock options of
1,000 for the nine months ended October 29, 1999.
(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 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 October 29 1999, the Company had borrowings outstanding of
approximately $5.6 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.
Effective October 29, 1999, the bank agreed to amend one of the
financial covenants in the revolving credit facility. The Company was
in compliance with all of its financial covenants at October 29, 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 $4.0 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 nine months of 1999, the Company granted options to
selected management of the Company to purchase 106,350 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.
5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(6) INCORPORATION OF WHOLLY-OWNED SUBSIDIARY
During third quarter, the Company incorporated PartySmart.com, Inc. as
a wholly-owned subsidiary. PartySmart.com, Inc. has a storefront on the
Web, and sells selected party supplies and paper goods over the
Internet. PartySmart.com was launched in mid-September. The Company has
incurred start-up and operational costs of approximately $1.7 million
during the first nine months of 1999 related to its Internet venture.
In recording certain of 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 $968,000 of
capitalizable costs is reflected in net Property and Equipment in the
Company's Consolidated Balance Sheet at October 29, 1999. The remaining
expenses are reflected in their respective line items within costs and
expenses in the Company's Consolidated Statements of Operations for the
three and nine-month period ended October 29, 1999.
(7) RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the
current year presentation.
6
<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. Over the past 12 years, we
have grown from a total of 3 Company-owned stores located in the Minneapolis/St.
Paul metropolitan area to a total of 147 stores, including 101 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 LOSS
The Company reported a net loss of approximately $418,000, or ($.09) per share,
for the third quarter ended October 29, 1999, compared to a net loss of
approximately $157,000, or ($.03) per share for the third quarter ended October
30, 1998. The Company reported a net loss of $1.5 million, or ($.33) per share
year-to-date, compared to a net loss of $466,000, or ($.10) per share for the
prior-year comparable period. The principal reasons for the loss for the first
nine months of fiscal 1999 were the seasonality of revenues in addition to the
large number of stores opened in the past twelve months which have expenses
without a fully established revenue base. The net loss for the first nine months
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 $425,000
of the net loss ($.09 per share) reflects operational and startup costs
associated with the Company's Internet business. For the nine-month period ended
October 29, 1999, sales from our Internet business were insignificant.
REVENUES
Total revenues consist of Company-owned stores sales, franchise revenues and
revenues from our Internet business. 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 a fiscal year
had passed. The comparable stores sales definition also did not include stores
whose 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 third quarter ended October 29, 1999, the Company opened four new
Company-owned stores, bringing the total to 101 as of October 29, 1999, compared
to 88 at the end of the third fiscal quarter of 1998. During the first nine
months of 1999, the Company opened seven new Company-owned stores, and closed
three Company-owned stores. For the third quarter and first nine months of 1999,
comparable store sales increased 7.3% and 6.7%, respectively, over the
prior-year comparable periods.
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
REVENUES (CONTINUED)
FRANCHISE RELATED FEES
Franchise related fees for the third quarter ended October 29, 1999 of
approximately $335,000 decreased 4.5% from franchise related fees of
approximately $351,000 for the third quarter ended October 30, 1998. For the
first nine months of 1999, franchise related fees of approximately $912,000
decreased 6.9% from franchise related fees of approximately $979,000 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. The
number of franchise stores at the end of the third quarter ended October 29,
1999 was 46 compared with 49 franchise stores at the end of third quarter 1998.
During the first nine months of 1999, one franchise store was opened and one
franchise store was closed.
COSTS OF PRODUCTS SOLD AND OCCUPANCY COSTS
Costs of products sold and occupancy costs includes the direct cost of
merchandise, plus handling and distribution, and certain occupancy costs. Costs
of products sold and occupancy costs totaled $14.7 million or 68.4% of
Company-owned stores sales for the third quarter ended October 29, 1999, as
compared to $11.2 million or 67.3% of Company-owned stores sales for the third
quarter ended October 30, 1998. Costs of products sold and occupancy costs
totaled $39.2 million or 68.2% of Company-owned stores sales for the first nine
months of 1999, compared with $29.5 million or 67.6% of Company-owned stores
sales for the first nine months of fiscal 1998. The increase in this expense
category reflects higher occupancy costs, resulting from the increased store
base, partially offset by higher product margin dollars.
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 third quarter ended October 29, 1999 were $5.0 million or 23.5%
of Company-owned stores sales, as compared to $3.9 million or 23.7% of
Company-owned stores sales for the comparable period in the prior year. On a
year-to-date basis, store operating expenses were $13.8 million or 23.9% of
Company-owned stores sales, as compared to $10.0 million or 23.0% of
Company-owned stores sales for the first nine months 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 compensation due to tight labor markets.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include corporate administrative expenses
for Company-owned stores, expenses relating to franchising, primarily payroll,
legal, travel and advertising and non-capitalizable costs associated with
PartySmart.com. For the third quarter ended October 29, 1999, general and
administrative expenses were $2.5 million or 11.4% of total revenues compared to
$2.1 million or 12.1% of total revenues for
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
GENERAL AND ADMINISTRATIVE EXPENSES (CONTINUED)
the comparable period in the prior year. For the first nine months of fiscal
1999, general and administrative expenses were $7.4 million, or 12.7% of total
revenues as compared to $5.7 million for the prior-year comparable period, which
were 12.9% 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 $709,000 of operational and start-up costs associated with our
Internet strategy. Over the next twelve-months, the Company expects general and
administrative expenses to continue to increase resulting from the startup and
operational costs of PartySmart.com. In the aggregate, these general and
administrative expenses are also expected to increase as a percentage of total
revenues, reflecting the increased costs against an immature revenue base for
the new strategy.
INTEREST EXPENSE, NET
Interest expense, net of interest income, of approximately $351,000 or 1.6% of
total revenues for the third quarter ended October 29, 1999, increased $285,000,
over net interest expense for the third quarter ended October 30, 1998. On a
year-to-date basis, net interest expense of approximately $799,000 or 1.4% of
total revenues compared to net interest expense of $129,000 or 0.3% of total
revenues for the prior-year comparable period. The increase over prior year
reflects the Company's borrowings under its revolving credit facility and
convertible subordinated debentures during the first nine months of 1999
necessary to fund working capital requirements. Additionally, interest increased
due 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 and into the first half of fiscal year 2000. The expected
increase primarily relates to a higher level of borrowings necessary to support
a larger store base, a recent increase in the federal funds rate, and the
issuance during the second quarter of 1999 of $4.0 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 nine months ended October 29, 1999.
INCOME TAX BENEFIT
The Company's estimated annual effective income tax rate is 40% for 1999,
unchanged from the third quarter 1998 estimated annual rate.
9
<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 our Internet business, in addition to 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 $7.0 million at October
29, 1999 compared to $5.2 million at January 29, 1999 and $6.1 million at
October 30, 1998. The Company's current ratio was 1.4 to 1.0 at October 29, 1999
equal to the Company's current ratio at January 29, 1999. These results compare
to a current ratio of 1.5 to 1.0 at October 30, 1998.
Merchandise inventories have increased approximately $4.9 million from the end
of fiscal 1998, reflecting necessary purchases for a larger store base for
seasonal events. This inventory growth was more than fully funded by enhanced
payable leveraging as reflected by a $5.8 million increase in accounts payable.
Net cash provided by operations totaled approximately $895,000 for the nine
month period ended October 29, 1999 compared to net cash provided by operations
of approximately $1.6 million for the same period in 1998.
Net cash used for investing activities was approximately $2.9 million for the
nine months ended October 29, 1999 compared to $4.4 million for the nine
months ended October 30, 1998. During the first three quarters of fiscal
1999, we made net capital expenditures of approximately $2.9 million,
compared with approximately $3.4 million of net capital expenditures for the
prior year-comparable period. The expenditures made during fiscal 1999 were
primarily related to opening new Company-owned and remodeling existing
Company-owned stores, upgrading our information systems and building the
necessary infrastructure to support our Internet strategy. Capital
expenditures for the nine month period ended October 29, 1999 included
approximately $780,000 of costs related to new stores and approximately
$995,000 related to our Internet business. 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.
Capital expenditures for the remaining quarter of fiscal 1999 are expected to
be immaterial.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
It is our intention to finance new store fixtures and equipment with long-term
capital leases, assuming availability and reasonable terms.
We have opened seven and closed three Company-owned stores as of October 29,
1999, and have opened another Company-owned store subsequent to the quarter end.
We have no intentions to open any more Company-owned stores during the remainder
of fiscal 1999, and at present, we have no agreement in place 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.
During fiscal 2000, we plan to open up to ten new or remodeled company-owned
stores. As of October 29, 1999, we had four signed leases for new and remodeled
locations for fiscal year 2000.
Net cash provided by financing activities was approximately $3.0 million for the
first nine months of 1999 compared to net cash provided by financing activities
of $1.4 million for the comparable period in the prior year. The year-over-year
increase reflects the net proceeds received during fiscal 1999 from the public
offering of $4.0 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 $4.0 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.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
IMPACT OF YEAR 2000 (CONTINUED)
STATE OF READINESS. We have been actively engaged in evaluating the status of
our internal Information Technology ("IT") and non-IT systems for compliance
with Year 2000 issues. We hired an outside consultant who assisted us with
this process and documented our efforts and results regarding Year 2000
compliance in a Year 2000 depository, which is maintained at our
headquarters. We continue to receive verification from most of our 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, was completed earlier in the year.
The second phase, evaluating third-party systems, was completed during the
third quarter of fiscal 1999. In addition, while we value our established
relationships with our key suppliers, we continue to evaluate third party
vendor alternatives should any significant interruption occur in product
availability. 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 have reviewed our
non-IT systems, and have taken the necessary steps to modify, upgrade or replace
non-IT systems to be Year 2000 compliant. The Corporate office, the cross-dock
facility and all store locations have completed their upgrades and are Year 2000
compliant. We do not anticipate the need for further modifications or
replacements. If additional modifications or replacements were required,
however, we do not believe that these modifications or replacements would 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 completed testing of all hardware and software systems in November of
1999.
We have completed upgrading our cash registers and have completed upgrading or
replacing all applicable personal computers and file servers in order to achieve
Year 2000 compliance. 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 have substantially completed our assessment
as to 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. To
date, we have received responses from 12 of our top 13 vendors as 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 continue to solicit
confirmation of compliance from the remaining vendor. Our risk, however, with
regard to this vendor not being Year 2000 compliant, is mitigated by the fact
that we place orders with this vendor solely for Halloween seasonal purchases,
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
IMPACT OF YEAR 2000 (CONTINUED)
and therefore would not be placing orders with this vendor until mid fiscal
2000. 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 expect to complete a formal contingency plan, as related
to the Year 2000 problem, by mid-December.
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
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 October 29, 1999, we had borrowings outstanding of
approximately $5.6 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. Effective October 29, 1999, the bank agreed to
amend one of the financial covenants in the revolving credit facility. We
were in compliance with all of our financial covenants at October 29, 1999.
13
<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 $4.0 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.
14
<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.
15
<PAGE>
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. EXHIBITS:
Exhibit 10 - Amendment to Loan and Security Agreement
Exhibit 12 - Computation re: Ratio of Earnings to Fixed
Charges
Exhibit 27 - Financial Data Schedule
b. REPORTS ON FORM 8-K:
Form 8-K dated October 18, 1999 and Form 8-K/A dated October
22, 1999 reporting a change in Registrant's Certifying
Accountant and a change in Transfer Agent.
16
<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: December 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)
17
<PAGE>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION LOCATION
----------- ----------- --------
10 Amendment dated as of Filed herewith
December 10, 1999 to Loan electronically
and Security Agreement dated
as of June 7, 1999 By and
Between BankBoston Retail
Finance Inc. and Paper
Warehouse, Inc. and Paper
Warehouse Franchising, Inc.
12 Computation re: Ratio of Filed herewith
Earnings to Fixed Charges electronically
27 Financial Data Schedule Filed herewith
electronically
<PAGE>
EXHIBIT 10
AMENDMENT
DATED AS OF DECEMBER 10, 1999
TO
LOAN AND SECURITY AGREEMENT
DATED AS OF JUNE 7, 1999
BY AND BETWEEN
BANKBOSTON RETAIL FINANCE INC.
AND
PAPER WAREHOUSE, INC. AND PAPER WAREHOUSE FRANCHISING, INC.
WHEREAS, Paper Warehouse, Inc. and Paper Warehouse Franchising, Inc.
(together, the "Borrower") and BankBoston Retail Finance, Inc. (the "Lender")
are parties to that certain Loan and Security Agreement dated June 7, 1999 (the
"Loan Agreement"); and
WHEREAS, the Lender has agreed with the Borrower to amend the Fixed
Charge Coverage Ratio requirement as set forth in the Loan Agreement, subject to
certain terms and conditions as set forth below.
NOW, THEREFORE, in consideration of the foregoing and for other good
and valuable consideration, the receipt and legal sufficiency of which are
hereby acknowledged, the Lender and the Borrower agree as follows:
1. Effective October 29, 1999 the minimum Fixed Charge Coverage
Ratio requirement as set forth in Section 5.12.2 of the Loan
Agreement (by reference to Exhibit 5-12(b) of the Loan
Agreement) as applicable for the nine month period ending
October 29, 1999 shall be changed from 0.45:1 to 0.34:1.
2. The Borrower agrees to execute and deliver to the Lender such
additional documents contemplated by, or as may be necessary
to more fully implement, this Amendment to the Loan Agreement.
3. The Borrower represents (i) that all of the representations
and warranties made by the Borrower in the Loan Agreement are
true and correct on the date hereof as if made on and as of
this date, and (ii) that no Event of Default described in
Article 10 of the Loan Agreement shall exist and be
continuing.
4. The Borrower (i) reaffirms and ratifies its respective
Liabilities to the Lender under the Loan Agreement as amended
hereby and under all documents executed in connection
therewith (the "Loan Documents"), (ii) certifies that there
are no defenses, offsets or counterclaims as of the date
hereof to the Obligations, (iii) confirm and ratify its
continuing mortgage, pledge, assignment and grant of security
interests in the Collateral to and in favor of the Lender as
set forth in the Loan Documents, and (iv) agrees that the Loan
Agreement as amended hereby and all other Loan
<PAGE>
Documents shall remain in full force and effect, enforceable
against the Borrower in accordance with their respective
terms.
5. This Amendment to the Loan Agreement may be executed in
separate counterparts by the parties hereto, each of which
when so executed and delivered shall be an original, but all
of which shall constitute one and the same agreement. The
rights and obligations of the parties hereunder shall be
construed in accordance with and be governed by the laws of
the Commonwealth of Massachusetts.
IN WITNESS WHEREOF, each of the parties hereto has caused this
Amendment to the Loan Agreement to be duly executed by its duly
authorized officer as an instrument under seal in the Commonwealth of
Massachusetts.
BANKBOSTON RETAIL FINANCE INC.
By: /s/ James J. Ward
Name: James J. Ward
Title: Director
PAPER WAREHOUSE, INC.
By: /s/ Cheryl W. Newell
Name: Cheryl W Newell
Title: Vice President and CFO
PAPER WAREHOUSE FRANCHISING, INC.
By: /s/ Cheryl W. Newell
Name: Cheryl W Newell
Title: Vice President and CFO
<PAGE>
EXHIBIT 12
PAPER WAREHOUSE, INC. AND SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
FOR THE NINE MONTHS ENDED OCTOBER 29, 1999 AND OCTOBER 30, 1998
AND FOR THE FIVE YEARS ENDED JANUARY 29, 1999
<TABLE>
<CAPTION>
($'s in thousands) NINE MONTHS ENDED
------------------------
OCTOBER 29, OCTOBER 30,
RATIO OF EARNINGS TO FIXED CHARGES: 1999 1998
----------- -----------
<S> <C> <C>
Earnings:
Consolidated net (loss) earnings $(1,534) $ (466)
Extraordinary charge, net - -
Cumulative effect of accounting change, net (108) -
Income taxes (1) 953 311
------- -------
Total (loss) earnings before extraordinary charge
and cumulative effect of accounting change (2,379) (777)
Fixed Charges:
Interest expense 799 153
Interest portion of rental expense 2,438 1,627
------- -------
Total fixed charges 3,237 1,780
Earnings available for fixed charges $ 858 $ 1,003
======= =======
Ratio of earnings before extraordinary charge and cumulative
effect of accounting change to fixed charges (2) --- ---
======= =======
<CAPTION>
FISCAL YEAR ENDED
------------------------------------------------------------
JANUARY 29, JANUARY 30, JANUARY 31, FEBRUARY 2, JANUARY 27,
RATIO OF EARNINGS TO FIXED CHARGES: 1999 1998 1997 1996 1995
----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Earnings:
Consolidated net (loss) earnings $ (521) $ (207) $ 808 $ 797 $ 794
Extraordinary charge, net - (110) - - -
Cumulative effect of accounting change, net - - - - -
Income taxes (1) 323 (22) (500) (494) (492)
------- ------- ------- ------- -------
Total (loss) earnings before extraordinary charge
and cumulative effect of accounting change (844) (75) 1,308 1,291 1,286
Fixed Charges:
Interest expense 279 860 834 547 227
Interest portion of rental expense 2,378 1,779 1,436 1,046 673
------- ------- ------- ------- -------
Total fixed charges 2,657 2,639 2,270 1,593 900
Earnings available for fixed charges $ 1,813 $ 2,564 $ 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 nine months ended October 29, 1999 and October 30, 1998,
earnings were not adequate to cover fixed charges by approximately $2.4
million and $777,000, 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> 9-MOS
<FISCAL-YEAR-END> JAN-28-2000
<PERIOD-START> JAN-30-1999
<PERIOD-END> OCT-29-1999
<CASH> 1,058
<SECURITIES> 0
<RECEIVABLES> 1,494
<ALLOWANCES> 0
<INVENTORY> 21,219
<CURRENT-ASSETS> 25,466
<PP&E> 17,917
<DEPRECIATION> 6,744
<TOTAL-ASSETS> 38,877
<CURRENT-LIABILITIES> 18,486
<BONDS> 7,223
0
0
<COMMON> 46
<OTHER-SE> 12,510
<TOTAL-LIABILITY-AND-EQUITY> 38,877
<SALES> 58,397
<TOTAL-REVENUES> 58,397
<CGS> 52,947
<TOTAL-COSTS> 52,947
<OTHER-EXPENSES> 7,390
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 799
<INCOME-PRETAX> (2,379)
<INCOME-TAX> 954
<INCOME-CONTINUING> (1,425)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (109)
<NET-INCOME> (1,534)
<EPS-BASIC> (.33)
<EPS-DILUTED> (.33)
</TABLE>
