<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 27, 2000
/ / 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 or 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: (952) 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 8, 2000, there were 5,639,652 shares of Common Stock, $.01 par
value, of Paper Warehouse, Inc. outstanding.
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<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets
as of October 27, 2000 and January 28, 2000 1
Consolidated Statements of Operations
for the Three and Nine Months ended October 27, 2000
and October 29, 1999 2
Consolidated Statements of Cash Flows
for the Nine Months ended October 27, 2000
and October 29, 1999 3
Notes to Consolidated Financial Statements 4-8
Item 2: Management's Discussion and Analysis of
Results of Operations and Financial Condition 9-16
Item 3: Quantitative and Qualitative Disclosures about Market Risk 17
PART II. OTHER INFORMATION
Item 2: Changes in Securities 18
Item 6: Exhibits and Reports on Form 8-K 19
Signatures 20
</TABLE>
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
October 27, January 28,
2000 2000
---------------- -----------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................ $ 819,757 $ 469,768
Merchandise inventories.................................................. 20,776,635 20,206,851
Accounts receivable...................................................... 1,372,654 830,153
Prepaid expenses and other current assets................................ 874,499 1,003,398
---------------- -----------------
Total current assets............................................... 23,843,545 22,510,170
Property and equipment, net.............................................. 9,071,280 10,006,870
Deferred tax asset....................................................... 3,177,052 3,177,052
Other assets, net........................................................ 1,530,972 1,694,552
---------------- -----------------
Total assets..................................................... $37,622,849 $ 37,388,644
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable - line of credit........................................... $ 8,835,259 $ 6,303,648
Current maturities of long-term debt..................................... 590,062 715,517
Accounts payable......................................................... 7,207,802 8,226,993
Accrued liabilities...................................................... 2,184,951 1,751,634
Current portion - reserve for store closings............................. 488,045 811,709
---------------- -----------------
Total current liabilities.......................................... 19,306,119 17,809,501
Convertible subordinated debt............................................... 4,000,000 4,000,000
Other long-term debt, less current maturities............................... 2,075,942 2,447,852
Reserve for store closings, less current portion............................ 1,251,016 2,188,291
Deferred rent credits....................................................... 1,430,812 1,301,563
---------------- -----------------
Total liabilities................................................ 28,063,889 27,747,207
---------------- -----------------
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;
4,644,940 and 4,627,936 shares issued and outstanding................. 46,449 46,279
Additional paid-in capital................................................ 13,854,678 13,833,442
Accumulated deficit....................................................... (4,342,167) (4,238,284)
---------------- -----------------
Total stockholders' equity......................................... 9,558,960 9,641,437
---------------- -----------------
Total liabilities and stockholders' equity....................... $37,622,849 $ 37,388,644
================ =================
</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 27, October 29, October 27, October 29,
2000 1999 2000 1999
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues:
Retail sales........................................... $ 22,367,181 $ 21,447,241 $ 65,010,932 $ 57,484,902
Franchise related fees................................. 421,099 335,401 1,107,556 911,713
--------------- --------------- --------------- ---------------
Total revenues.................................... 22,788,280 21,782,642 66,118,488 58,396,615
Costs and expenses:
Costs of products sold and occupancy costs............. 14,749,759 14,662,924 43,141,527 39,185,087
Store operating expenses............................... 5,508,677 5,036,182 15,566,669 13,761,643
General and administrative expenses.................... 2,251,598 2,485,840 7,273,932 7,371,151
Repositioning credits.................................. (160,000) --- (690,000) ---
--------------- --------------- --------------- ---------------
Total costs and expenses.......................... 22,350,034 22,184,946 65,292,128 60,317,881
--------------- --------------- --------------- ---------------
Operating income (loss)........................... 438,246 (402,304) 826,360 (1,921,266)
Interest expense....................................... (461,783) (351,042) (1,289,087) (798,757)
Other income, net...................................... 29,527 56,884 306,047 340,790
--------------- --------------- --------------- ---------------
Income (loss) before income taxes and
cumulative effect of accounting change............. 5,990 (696,462) (156,680) (2,379,233)
Income tax (expense) benefit........................... (3,721) 278,589 52,797 953,676
--------------- --------------- --------------- ---------------
Net income (loss) before cumulative effect of
accounting change.................................. 2,269 (417,873) (103,883) (1,425,557)
Cumulative effect of accounting change, net............ --- --- --- (108,506)
--------------- --------------- --------------- ---------------
Net income (loss)................................. $ 2,269 $ (417,873) $ (103,883) $(1,534,063)
=============== =============== =============== ===============
Net Income (Loss) Per Common Share:
Basic and diluted net income (loss) per common
share before cumulative effect of accounting
change....................................... $ 0.00 $ (0.09) $ (0.02) $ (0.31)
Cumulative effect of accounting change............ --- --- --- (0.02)
--------------- --------------- --------------- ---------------
Basic and diluted net income (loss) per common
share........................................ $ 0.00 $ (0.09) $ (0.02) $ (0.33)
=============== =============== =============== ===============
</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 27, October 29,
2000 1999
--------------- ---------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss............................................................. $ (103,883) $(1,534,063)
Adjustments to reconcile net loss to net cash used for operations:
Depreciation and amortization................................... 1,763,623 1,684,550
Repositioning credits........................................... (690,000) ---
Gain on sale of property and equipment.......................... (10,700) (1,414)
Deferred taxes.................................................. (62,672) (1,024,033)
Deferred rent credits........................................... 157,457 284,092
Other noncash items affecting earnings.......................... 176,327 250,895
Changes in operating assets and liabilities:
Merchandise inventories....................................... (569,784) (4,917,170)
Accounts receivable........................................... (542,501) (388,842)
Prepaid expenses and other current assets..................... 191,571 (56,653)
Accounts payable.............................................. (1,019,191) 4,925,589
Accrued liabilities........................................... 405,109 748,087
Store closing reserves........................................ (570,939) ---
--------------- ---------------
Net cash used for operations................................ (875,583) (28,962)
INVESTING ACTIVITIES:
Purchases of property and equipment.................................. (882,850) (2,861,653)
Proceeds from sale of property and equipment......................... 92,950 16,700
Other assets, net.................................................... (6,600) (38,189)
--------------- ---------------
Net cash used for investing activities...................... (796,500) (2,883,142)
FINANCING ACTIVITIES:
Proceeds from convertible subordinated debentures.................... --- 4,000,000
Net proceeds from (payments on) notes payable - line of credit....... 2,531,611 (1,264,852)
Proceeds from refinancing of mortgage................................ --- 1,100,000
Net payments on other long-term debt................................. (20,107) (921,655)
Payment of debt issuance costs....................................... (33,580) (1,019,105)
Proceeds from financing of property and equipment.................... --- 1,452,182
Payments on financing of property and equipment...................... (477,258) (364,707)
Proceeds received from employee purchases of stock................... 21,406 ---
--------------- ---------------
Net cash provided by financing activities................... 2,022,072 2,981,863
--------------- ---------------
Net increase in cash and cash equivalents................... 349,989 69,759
Cash and cash equivalents, beginning of period....................... 469,768 988,575
--------------- ---------------
Cash and cash equivalents, end of period............................. $ 819,757 $1,058,334
=============== ===============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid during the period............................. $1,061,556 $ 636,007
Income taxes paid during the period......................... 9,433 ---
=============== ===============
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) BASIS OF PRESENTATION
We, ("Paper Warehouse, Inc." or the "Company"), are a growing
chain of retail stores, specializing in party supplies and paper goods.
We operate 98 stores in ten states throughout the central and western
regions of the United States under the names "Paper Warehouse" and
"Party Universe" and operate a web site under the name
"PartySmart.com." Additionally, we sell Paper Warehouse franchises
through our wholly owned subsidiary, Paper Warehouse Franchising, Inc.
We prepared these consolidated financial statements in
accordance with Securities and Exchange Commission ("SEC") Rules and
Regulations. These unaudited financial statements represent the
consolidated financial statements of Paper Warehouse, Inc., Paper
Warehouse Franchising, Inc. and PartySmart.com, Inc. as of October 27,
2000 and January 28, 2000 and for the three and nine month periods
ended October 27, 2000 and October 29, 1999. The information furnished
in these financial statements includes normal recurring adjustments and
reflects all adjustments, which are, in our opinion, necessary for a
fair presentation. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States have been
condensed or omitted. These consolidated financial statements should be
read in conjunction with the audited consolidated financial statements
and notes thereto included in our Annual Report to Shareholders and our
Form 10-K filed with the SEC.
Due to the seasonality of our business, revenues and operating
results for the three and nine months ended October 27, 2000 are not
necessarily indicative of the results to be expected for the full year.
(2) EARNINGS (LOSS) PER COMMON SHARE
Basic earnings per common share ("EPS") is computed as net
income (loss) divided by the weighted average number of common shares
outstanding during the periods.
Diluted EPS is computed as net income (loss) divided by the
weighted average number of common shares outstanding during the period;
increased to include assumed conversions of potentially dilutive shares
outstanding into common shares, when dilutive. Our potentially dilutive
shares of common stock include stock options which have been granted to
employees and outside directors, our outstanding convertible
subordinated debentures and a warrant granted to the underwriter as
part of our convertible debenture offering. We had $4.0 million of
convertible subordinated debentures outstanding as of October 27, 2000
that were not included in the computation of diluted EPS for the three
and nine month periods ended October 27, 2000, as their inclusion would
have been antidilutive. In addition, options to purchase 784,200 shares
were outstanding as of October 27, 2000 but were excluded from the
computation of common share equivalents for the nine month period ended
October 27, 2000 because they were antidilutive. Options to purchase
518,550 shares of common stock were outstanding as of October 29, 1999,
but were excluded from the computation of common share equivalents for
the three and nine month periods ended October 29, 1999 because they
were antidilutive. Had the inclusion of these items not been
antidilutive, we would have assumed conversions of convertible
subordinated debentures into approximately 1.3 million common shares
for the three and nine months ended October 27, 2000, and we would have
assumed conversions of stock options into approximately 59,000 common
shares for the nine month period ended October 27, 2000. For the third
quarter of fiscal 1999, we would have assumed conversions of
convertible subordinated debentures into approximately 1.3 million
common shares and conversions of stock options into approximately
15,100 common shares. For the first nine months of fiscal 1999, we
would have assumed conversions of convertible subordinated debentures
into approximately 529,100 common shares and conversions of stock
options into approximately 21,600 common shares.
4
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(2) EARNINGS (LOSS) PER COMMON SHARE (CONTINUED)
The components of basic and diluted EPS for the three and
nine-month periods ended October 27, 2000 and October 29, 1999 are as
follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
---------------------------------- ----------------------------------
October 27, October 29, October 27, October 29,
Basic and diluted EPS: 2000 1999 2000 1999
-------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Basic EPS:
Net income (loss) before cumulative effect
of accounting change........................... $ 2,269 $ (417,873) $(103,883) $(1,425,557)
Cumulative effect of accounting change, net........ --- --- --- (108,506)
-------------- --------------- --------------- ---------------
Net income (loss).................................. $ 2,269 $ (417,873) $(103,883) $(1,534,063)
============== =============== =============== ===============
Weighted average shares outstanding................ 4,644,810 4,627,936 4,641,162 4,627,936
Basic EPS before cumulative effect of
accounting change.............................. $ 0.00 $ (0.09) $ (0.02) $ (0.31)
Cumulative effect of accounting change, net........ --- --- --- (0.02)
-------------- --------------- --------------- ---------------
Basic EPS ......................................... $ 0.00 $ (0.09) $ (0.02) $ (0.33)
============== =============== =============== ===============
Diluted EPS:
Net income (loss) before cumulative effect
of accounting change........................... $ 2,269 $(417,873) $(103,883) $(1,425,557)
Cumulative effect of accounting change, net........ --- --- --- (108,506)
-------------- --------------- --------------- ---------------
Net income (loss).................................. $ 2,269 $(417,873) $(103,883) $(1,534,063)
============== =============== =============== ===============
Weighted average shares outstanding................ 4,644,810 4,627,936 4,641,162 4,627,936
Assumed conversions of stock options............... 97,817 --- --- ---
-------------- --------------- --------------- ---------------
Adjusted weighted average shares outstanding....... 4,742,627 4,627,936 4,641,162 4,627,936
============== =============== =============== ===============
Diluted EPS before cumulative effect of
accounting change.............................. $ 0.00 $ (0.09) $ (0.02) $ (0.31)
Cumulative effect of accounting change, net........ --- --- --- (0.02)
-------------- --------------- --------------- ---------------
Diluted EPS ....................................... $ 0.00 $ (0.09) $ (0.02) $ (0.33)
============== =============== =============== ===============
</TABLE>
5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(3) FINANCING ARRANGEMENTS
We have outstanding as of October 27, 2000, convertible
subordinated debentures in an aggregate principal amount of $4.0
million, which mature in 2005. These debentures are convertible into
approximately 1.3 million shares of our common stock. Up until
September 15, 2000, the debentures bore interest at an annual rate of
9.0% that was payable quarterly. The indenture under which these
debentures were issued contains covenants that require us to satisfy
certain financial tests and imposes restrictions on our ability to pay
dividends. As of our fiscal 1999 year end, we were in breach of a
covenant requiring a minimum consolidated tangible net worth, however,
we were current on all required payments under the indenture. During
the second quarter of fiscal 2000, we requested a waiver of this breach
from our debenture holders, and requested amendments, to replace the
definition of consolidated tangible net worth in the indenture with a
definition of consolidated net worth, and to increase the interest rate
on the debentures. In order for us to obtain the waiver and approval of
the amendments, an affirmative vote from greater than 50% of the dollar
value of the bonds outstanding was required. We offered debenture
holders a 150 basis point increase in the interest rate to an annual
rate of 10.5%, effective as of September 15, 2000, contingent upon
obtaining a majority affirmative vote. Additionally, we offered each
debenture holder a consent fee of $10 per bond, payable only upon
obtaining his or her affirmative vote. During the second quarter of
fiscal 2000, we obtained a waiver for the breach of the covenant as of
January 28, 2000 and obtained required approval for the amendments.
Since we obtained the majority vote, effective September 15, 2000, the
interest rate on our subordinated convertible debentures increased to
an annual rate of 10.5%, and will be reflected in the December 15, 2000
quarterly interest payment to debenture holders. We were in compliance
with all of our financial covenants as required by the indenture at
October 27, 2000.
We have a $15.0 million multi-year revolving line of credit
facility with a bank for general working capital purposes that expires
in June 2002. Borrowings outstanding under this line of credit bear
interest at a variable rate and are secured by substantially all of our
assets. The credit agreement contains covenants, which require us to
satisfy certain financial tests and impose restrictions on our ability
to pay dividends. Advances under this credit line are limited to a
fixed percentage of certain assets, primarily inventory. As a result of
the limitations on the fixed percentage and on inventory levels, we
often maximize the availability under our line during intra-month peaks
and at certain times during the year. In March 2000, Yale T. Dolginow,
Chairman and Chief Executive Officer, through Wells Fargo, N.A. issued
a $1.2 million Standby Letter of Credit in favor of Fleet Retail
Finance, Inc. as beneficiary. This Standby Letter of Credit caused
Fleet Retail Finance, Inc., the lender for our revolving line of
credit, to provide us with up to a $1.2 million overadvance on our
revolving line of credit. During the third quarter of fiscal 2000, we
notified Fleet of our intent to release Yale T. Dolginow from the
Standby Letter of Credit as of October 1, 2000. On October 1, 2000 we
met the requirements for early expiration and the Standby Letter of
Credit was cancelled.
In consideration for issuing the Standby Letter of Credit, we
granted an option to Yale T. Dolginow to purchase 50,000 shares of our
common stock at an exercise price of $.97 per share, equal to 110% of
the market price of our underlying stock as of the date of grant. We
agreed to indemnify Mr. Dolginow for any liability incurred in
connection with the Standby Letter of Credit.
We were in compliance with all of our financial covenants as
required by the credit facility at October 27, 2000.
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(4) COMMON STOCK AND STOCK OPTION TRANSACTIONS
During the first nine months of fiscal 2000, we granted options
to selected management and to the board of directors to purchase
282,900 shares of our common stock at an exercise price range of $0.88
to $1.50 per share. The options vest over three years and expire 10
years from the date of grant.
On March 6, 2000, the Compensation Committee of the Board of
Directors approved the repricing to $2.00 per common share of 424,300
options, all of which were originally granted in excess of $2.00 per
common share. The repricing of these options creates in substance a
modification. Accordingly, these options will be treated as variable
awards, and we will reflect changes in their value in the general and
administrative expense line until the options are exercised or expire.
Pursuant to our Employee Stock Purchase Plan, on January 31,
2000, employees purchased 11,539 shares of our common stock, and on
July 31, 2000, employees purchased 5,465 shares of our common stock.
(5) REPOSITIONING CREDITS - RESERVE FOR STORE CLOSINGS
The reserve for store closings reflects reductions related to
ongoing payments of rent, common area maintenance and real estate taxes
on the stores that were closed, in addition to beneficial adjustments
resulting from the subleasing of three store locations that were
previously closed.
During the third quarter ended October 27, 2000, we closed on an
agreement with a subtenant for the sublease of the previous St. Cloud,
Minnesota store location, which was relocated in July 1999. Beginning
with the January 2001 payment, the sublessee agrees to pay, over the
term of the underlying lease, a portion of the fixed minimum monthly
rental per the underlying lease. In addition, the sublessee agrees to
pay charges including, but not limited to, common area maintenance,
real estate taxes and insurance costs. Accordingly, effective as of the
date of closing, we reversed $160,000 of the store closing reserve that
was established for this location during the fourth quarter of fiscal
1999.
During the second quarter of fiscal 2000, we closed on
agreements to sublease the Maple Grove, Minnesota and St. Joseph,
Missouri store locations, both of which had been previously relocated.
Accordingly, the reversal of $530,000 of the store closing reserves that
were established for these locations during the fourth quarter of fiscal
1999, is reflected in our consolidated statement of operations for the
nine months ended October 27, 2000.
(6) OTHER INCOME
During the second quarter of fiscal 2000, we received $200,000
as consideration for terminating the lease on our warehouse facility.
This fee is reflected in other income in our consolidated statements of
operations for the nine months ended October 27, 2000.
7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(7) SHAREHOLDER RIGHTS OFFERING
During the third quarter, we distributed, to shareholders of
record on September 15, 2000, 0.323 rights for each share of common
stock held on September 15, 2000. Each whole right entitled its holder
to purchase one share of our $.01 par value common stock at a
subscription price of $1.25. No fractional rights were issued and the
rights were not transferable. As a result of this offering, which
closed on October 30, 2000, we sold approximately 995,000 shares of
$.01 par value common stock and raised approximately $1.2 million,
which will be used for general working capital and corporate purposes.
(8) RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to
the current year presentation.
8
<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. We operate 98 stores in ten states throughout the central
and western regions of the United States under the names PAPER WAREHOUSE and
PARTY UNIVERSE, and operate a web site under the name PARTYSMART.COM. We also
sell Paper Warehouse franchises through our wholly owned subsidiary, Paper
Warehouse Franchising, Inc. We purchased the business, consisting of three
stores located in the Minneapolis/St. Paul metropolitan area, in 1986, and
incorporated it in Minnesota in 1987. In growing the number of Company-owned
stores, we employ a strategy of clustering stores in our principal markets to:
- provide our customers with convenient store locations
- expand our total market share
- achieve favorable economies of scale
REVENUES
Total revenues consist of retail sales from our Company-owned stores
and E-commerce web site, and franchise related fees. Franchise related fees
include royalties we receive on sales, generally 4% of the store's sales, and
initial franchise fees, recognized at the time the franchisee signs a lease
for a store, at which time we have substantially performed all of our
services. Company-owned stores enter the comparable store sales base at the
beginning of their 13th month of operations.
COSTS AND EXPENSES
Costs of products sold and occupancy costs include the direct cost of
merchandise, plus handling and distribution, and certain occupancy costs.
Store operating expenses include all costs incurred at the store
level, including store payroll and related benefits, advertising and credit
card processing fees.
General and administrative expenses include corporate administrative
expenses for Company-owned stores, expenses relating to franchising, such as
payroll, legal, travel and advertising, and non-capitalizable costs
associated with PartySmart.com, our Internet web site.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
RESULTS OF OPERATIONS
NET INCOME (LOSS) AND NET INCOME (LOSS) PER COMMON SHARE
We reported net income of approximately $2,300, or $.00 per share on a
diluted basis, for the third quarter ended October 27, 2000, compared to a
net loss of approximately $418,000, or ($.09) per share on a diluted basis,
for the third quarter of fiscal 1999. We reported a net loss of approximately
$104,000, or ($.02) per share year-to-date, compared to a net loss of
approximately $1.5 million, or ($.33) per share for the prior-year comparable
period. Included in the net loss for the first nine months of 1999 was the
net impact of a cumulative effect of accounting change of approximately
$109,000 ($.02 per share) from the adoption of an accounting pronouncement.
Earnings before interest, taxes, depreciation and amortization (EBITDA) for
the first nine months of fiscal 2000, excluding the repositioning credits,
was approximately $2.2 million, a substantial improvement over EBITDA of
approximately $104,000 for the comparable period in the prior year.
The following table sets forth for the periods indicated, certain
costs and expenses as a percentage of total revenues and retail sales:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------------- --------------------------------
OCTOBER 27, OCTOBER 29, OCTOBER 27, OCTOBER 29,
2000 1999 2000 1999
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Costs of products sold and occupancy costs:
as % of total revenues...................... 64.7% 67.3% 65.2% 67.1%
as % of retail sales........................ 65.9% 68.4% 66.4% 68.2%
Store operating expenses:
as % of total revenues...................... 24.2% 23.1% 23.5% 23.6%
as % of retail sales........................ 24.6% 23.5% 23.9% 23.9%
General and administrative expenses:
as % of total revenues...................... 9.9% 11.4% 11.0% 12.6%
as % of retail sales........................ 10.1% 11.6% 11.2% 12.8%
Number of Company-owned stores................... 98 101 98 101
</TABLE>
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
REVENUES
RETAIL SALES. Retail sales of approximately $22.4 million for the
third quarter of fiscal 2000 increased $920,000 or 4%, over retail sales of
approximately $21.4 million for the comparable period in the prior year. On a
year-to-date basis, retail sales of approximately $65.0 million increased
$7.5 million, or 13%, over retail sales of approximately $57.5 million for
the first nine months of fiscal 1999. The increase in sales primarily
reflects the continued maturation of stores opened during fiscal 1998 and
fiscal 1999, as approximately $5.2 million of the year-over-year favorability
for the nine month period was attributable to an increase in total comparable
store sales. Sales from our Internet web site, which became operational in
the third quarter of fiscal 1999, have not been significant during fiscal
2000, as our site was under construction during the first half of the year
and was relaunched in the third quarter. During the third quarter ended
October 27, 2000, we closed one Company-owned store, bringing the total to 98
at October 27, 2000, compared to 101 at October 29, 1999. Third quarter 2000
comparable store sales increased 2.8% over the prior year comparable period,
while, comparable store sales for the nine-month period increased 9.5% over
the prior year comparable period. These growth rates compare to comparable
store sales increases of 7.3% and 6.7% for the third quarter and first nine
months of fiscal 1999. We realized softer sales, as expected, during the
third quarter of fiscal 2000 due in part to a mid-week Halloween event this
year versus a weekend event in the prior year. In addition, as a result of a
shift in the retail accounting calendar in fiscal 2000, the last four days of
the Halloween season fell into our fourth quarter.
FRANCHISE RELATED FEES. Franchise related fees for the third quarter
of fiscal 2000 of approximately $421,000 increased 26% over franchise related
fees of approximately $335,000 for the comparable period in the prior year.
For the nine-month period ended October 27, 2000, franchise related fees of
approximately $1.1 million increased 21% over franchise related fees of
approximately $912,000 for the prior year comparable period. The
year-over-year increase primarily reflects increased royalties from increased
franchise store sales and higher initial franchise fees. During the third
fiscal quarter of 2000, one franchise store opened, bringing the total of
franchise stores to 48 at October 27, 2000 compared with 46 franchise stores
at the end of the third fiscal quarter of fiscal 1999.
COSTS OF PRODUCTS SOLD AND OCCUPANCY COSTS
Cost of products sold and occupancy costs totaled approximately $14.7
million or 65.9% of retail sales for the third quarter ended October 27,
2000, as compared to approximately $14.7 million or 68.4% of retail sales for
the third quarter ended October 29, 1999. Cost of products sold and occupancy
costs totaled approximately $43.1 million or 66.4% of retail sales for the
nine month period ended October 27, 2000, as compared to approximately $39.2
million or 68.2% of retail sales for the comparable period in the prior year.
We realized an increase in our product margins for both the third quarter and
first nine months of fiscal 2000 as compared to the same periods in the prior
year. The higher margin for the third quarter of fiscal 2000 reflects
selected price increases that were implemented earlier in the year. For the
year-to-date period, in addition to the price increases, the margin
favorability reflects a strong graduation season for the current year, in
which higher graduation sales were augmented by increased sales for solid
color merchandise, which typically carry higher margins. Increased purchasing
allowances as negotiated with our vendors additionally contributed to the
gross margin favorability for the third quarter and first nine months of
fiscal 2000 versus the prior year comparable periods. We continue to realize
increased sales across the majority of our product categories year-over-year.
However, we also are experiencing margin pressure in the juvenile birthday
category due to increased sales of licensed product, which typically has a
lower margin.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
STORE OPERATING EXPENSES
Store operating expenses for the third quarter of fiscal 2000 were
approximately $5.5 million or 24.6% of retail sales, as compared to
approximately $5.0 million or 23.5% of retail sales for the comparable period
in the prior year. On a year-to-date basis, store operating expenses were
approximately $15.6 million or 23.9% of retail sales during fiscal 2000,
compared to $13.8 million or 23.9% of retail sales during fiscal 1999. The
increase in the percentage for the third quarter of fiscal 2000 compared to
the third quarter of fiscal 1999 primarily reflects an increase in store
management salaries, as we continue to experience significant wage pressure
due to the tightness of labor markets, and increased staffing levels. The
increased percentage also reflects higher credit card fees resulting from an
increased usage of credit and debit cards in all markets and higher net
advertising expense.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses for the third quarter of fiscal
2000 were approximately $2.3 million, or 9.9% of revenues, compared to
general and administrative expenses of $2.5 million or 11.4% of revenues for
the third quarter of fiscal 1999. General and administrative expenses were
approximately $7.3 million, or 11.0% of revenues for the first nine months of
fiscal 2000, compared to general and administrative expenses of approximately
$7.4 million, or 12.6% of revenues for the comparable period in the prior
year. The year-over year favorability reflects a concerted attempt to reduce
overall general and administrative expenses during fiscal 2000. Over the
remainder of fiscal 2000, we expect general and administrative dollars to
remain relatively flat to the prior year as we maintain leverage of our
general and administrative expense structure.
INTEREST EXPENSE
Interest expense, for the quarter ended October 27, 2000, of
approximately $462,000, or 2.0% of total revenues, increased $111,000, over
interest expense for the quarter ended October 29, 1999. On a year-to-date
basis, interest expense of approximately $1.3 million for fiscal 2000, or
1.9% of total revenues, increased approximately $490,000 over interest
expense for the first nine months in the prior year. The increase over prior
year reflects an increased level of borrowing from our revolving credit
facility, necessary to fund working capital requirements, in addition to
interest payments related to our convertible subordinated debentures, which
were issued during the second quarter of fiscal 1999. Interest expense also
increased due to the amortization of the deferred financing costs related to
our financing activities during fiscal 1999 and increases in the prime rate.
We expect interest expense to increase slightly throughout the remainder of
fiscal 2000, primarily due to an increase in the effective annual rate on our
$4.0 million of convertible subordinated debentures from 9.0% to 10.5%,
effective September 15, 2000 and higher levels of borrowings on our revolving
line of credit.
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
INCOME TAX (PROVISION) BENEFIT
Our estimated annual effective income tax rate for the third quarter
and first nine months of fiscal 2000 is 40%, unchanged from the estimated
annual rate used in the prior year comparable periods. The tax (expense)
benefit as reported in our consolidated statement of operations for the three
and nine months ended October 27, 2000 reflects the provision of 40%, net of
payments made for state taxes.
ANALYSIS OF FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
Our principal capital requirements are for ongoing operations,
consisting primarily of investments in our inventory, in addition to capital
requirements necessary to support the continued growth of our information
systems infrastructure and our store base. Our primary sources of liquidity
have been:
- borrowings under our revolving line of credit
- proceeds from financings such as our initial public offering, our
public sale of convertible subordinated debt and our recent
shareholder rights offering
- payment terms from vendors
- lease financings
- cash from operations
Our liquidity needs vary throughout the year as a result of the
seasonal nature of our business. Our cash availability also fluctuates as a
result of:
- the level of our inventory, which primarily determines our
line-of-credit borrowing capacity
- quarterly fluctuations in revenues and operating income
- timing of seasonal purchases
- timing of new store openings, remodels and/or relocations
- intra-month cash needs for payment of rent, payroll and other
operational payables
Our liquidity as measured by our working capital, was $4.5 million at
October 27, 2000 and was $4.7 million at January 28, 2000. Our current ratio
was 1.24 to 1.00 at October 27, 2000 compared to 1.26 to 1.00 at January 28,
2000.
Merchandise inventory levels at October 27, 2000 increased 2.8% over
merchandise inventories at the end of fiscal 1999, primarily reflecting
increased levels necessary to support the upcoming seasonal events.
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Net cash used for operations totaled approximately $876,000 for the
nine month period ended October 27, 2000 compared to net cash used for
operations of approximately $29,000 for the same period in fiscal 1999. The
cash use primarily reflects a reduction in accounts payable from a high level
at year end to a more normalized level for this time of year and includes a
third quarter generation of cash of approximately $768,000. Our ability to
leverage our accounts payable has lessened during fiscal 2000, and we
continue to feel pressure from the vendor community, resulting from the
financial difficulties of other party goods stores in the industry. In
addition, we continue to strive, when possible, to take advantage of cash
discounts and other favorable terms that are offered by our vendors.
Net cash used for investing activities was approximately $796,000 for
the first nine months of fiscal 2000, primarily reflecting capital
expenditures related to upgrading our information systems and remodeling
Company-owned stores. The net cash used for investing activities for the
first nine months of fiscal 1999 was approximately $2.9 million.
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. For the remainder of
fiscal 2000, we anticipate that we will spend a minimal amount on capital
expenditures.
Net cash provided by financing activities was approximately $2.0
million for the first nine months of 2000 compared to net cash provided by
financing activities of approximately $3.0 million for the first nine months
of fiscal 1999. The year-over-year decrease reflects our prior year
subordinated debt offering, refinancing of our mortgage and financing of our
capital leases, partially offset by an increased usage of our revolving
line-of-credit in the current year.
MERCHANDISING ALLIANCE WITH HALLMARK CARDS, INC.
During the third quarter of fiscal 2000, we announced the formation
of a strategic partnership with Hallmark Cards, Inc and signed a multi-year
agreement that will allow Hallmark to be the exclusive supplier for greeting
cards for our corporate and franchise stores. Accordingly, in the fourth
quarter of fiscal 2000, we will begin selling Hallmark's Ambassador brand
greetings cards and giftwrap.
SHAREHOLDER RIGHTS OFFERING
During the third quarter, we distributed, to shareholders of record on
September 15, 2000, 0.323 rights for each share of common stock held on
September 15, 2000. Each whole right entitled its holder to purchase one
share of our $.01 par value common stock at a subscription price of $1.25. No
fractional rights were issued and the rights were not transferable. As a
result of this offering, which closed on October 30, 2000, we sold
approximately 995,000 shares of $.01 par value common stock and raised
approximately $1.2 million, which will be used for general working capital
and corporate purposes.
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Based on our current expectations concerning our business, we expect
the liquidity sources described above, together with funds generated by
operations, to be adequate to meet our cash needs over the next twelve
months, and we believe that we will be able to sufficiently obtain funds for
our long-term needs. In addition to our recent shareholder rights offering,
we have also generated additional working capital through:
- reducing corporate and store-wide expenses
- scaling back PARTYSMART.COM, our Internet website venture
- increasing prices
- seeking alternative sources for the financing of fixtures and
equipment
In our fiscal 1999 Form 10K, we previously disclosed that we were
evaluating a transaction consisting of the sale of our corporate office
building to Yale Dolginow, our Chairman and CEO, with subsequent lease back
to the Company, for which we had a signed letter of intent. Based on the
appraisal of the building and the increases in interest rates since we
refinanced our mortgage in early fiscal 1999, we determined that this
transaction was not in the best interest of the Company or our shareholders.
FINANCING
We have outstanding as of October 27, 2000, convertible subordinated
debentures in an aggregate principal amount of $4.0 million, which mature in
2005. These debentures are convertible into approximately 1.3 million shares
of our common stock. Up until September 15, 2000, the debentures bore
interest at an annual rate of 9.0% that was payable quarterly. The indenture
under which these debentures were issued contains covenants that require us
to satisfy certain financial tests and imposes restrictions on our ability to
pay dividends. As of our fiscal 1999 year end, we were in breach of a
covenant requiring a minimum consolidated tangible net worth, however, we
were current on all required payments under the indenture. During the second
quarter of fiscal 2000, we requested a waiver of this breach from our
debenture holders, and requested amendments, to replace the definition of
consolidated tangible net worth in the indenture with a definition of
consolidated net worth, and to increase the interest rate on the debentures.
In order for us to obtain the waiver and approval of the amendments, an
affirmative vote from greater than 50% of the dollar value of the bonds
outstanding was required. We offered debenture holders a 150 basis point
increase in the interest rate to an annual rate of 10.5%, effective as of
September 15, 2000, contingent upon obtaining a majority affirmative vote.
Additionally, we offered each debenture holder a consent fee of $10 per bond,
payable only upon obtaining his or her affirmative vote. During the second
quarter of fiscal 2000, we obtained a waiver for the breach of the covenant
as of January 28, 2000 and obtained required approval for the amendments.
Since we obtained the majority vote, effective September 15, 2000, the
interest rate on our subordinated convertible debentures increased to an
annual rate of 10.5%, and will be reflected in the December 15, 2000
quarterly interest payment to debenture holders. We were in compliance with
all of our financial covenants as required by the indenture at October 27,
2000.
15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
FINANCING (CONTINUED)
We have a $15.0 million multi-year revolving line of credit facility
with a bank for general working capital purposes that expires in June 2002.
Borrowings outstanding under this line of credit bear interest at a variable
rate and are secured by substantially all of our assets. The credit agreement
contains covenants, which require us to satisfy certain financial tests and
impose restrictions on our ability to pay dividends. Advances under this
credit line are limited to a fixed percentage of certain assets, primarily
inventory. As a result of the limitations on the fixed percentage and on
inventory levels, we often maximize the availability under our line during
intra-month peaks and at certain times during the year. In March 2000, Yale
T. Dolginow, Chairman and Chief Executive Officer, through Wells Fargo, N.A.
issued a $1.2 million Standby Letter of Credit in favor of Fleet Retail
Finance, Inc. as beneficiary. This Standby Letter of Credit caused Fleet
Retail Finance, Inc., the lender for our revolving line of credit, to provide
us with up to a $1.2 million overadvance on our revolving line of credit.
During the third quarter of fiscal 2000, we notified Fleet of our intent to
release Yale T. Dolginow from the Standby Letter of Credit as of October 1,
2000. On October 1, 2000 we met the requirements for early expiration and the
Standby Letter of Credit was cancelled.
In consideration for issuing the Standby Letter of Credit, we granted
an option to Yale T. Dolginow to purchase 50,000 shares of our common stock
at an exercise price of $.97 per share, equal to 110% of the market price of
our underlying stock as of the date of grant. We agreed to indemnify Mr.
Dolginow for any liability incurred in connection with the Standby Letter of
Credit.
We were in compliance with all of our financial covenants as required
by the credit facility at October 27, 2000.
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. We could be negatively impacted by substantial
cost increases for raw materials such as paper, petroleum and cardboard, as
significant cost increases in these areas could have a material impact on our
costs of products in future periods. In addition, continued increases in fuel
costs could have a negative impact on utility costs for our company-owned
stores.
FORWARD-LOOKING INFORMATION
Certain statements contained in this report include "forward-looking
statements" within the meaning of the Private Securities Litigation Reform
Act of 1995. All forward-looking statements in this document are based on
information currently available to us as of the date of this report, and we
assume no obligation to update any forward-looking statements.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results to differ materially from any
future results, performance or achievements expressed or implied by such
forward-looking statements. Such factors may include, among others, those
factors listed in our 1999 Form 10-K and our other filings with the
Securities and Exchange Commission.
16
<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. There have been recent increases
in the prime rate. 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.
17
<PAGE>
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
On July 20, 1999, we completed a public offering of $4.0 million
convertible subordinated debentures due September 15, 2005, bearing interest
at an annual rate of 9.0%, payable quarterly. The indenture under which these
debentures were issued contains covenants that require us to satisfy certain
financial tests. As of our fiscal 1999 year end, we were in breach of a
covenant requiring a minimum consolidated tangible net worth. However, we
were current on all required payments under the indenture. During the second
quarter ended July 28, 2000, we obtained from a majority of the debenture
holders a waiver for the breach of the covenant as of January 28, 2000. We
were in compliance with all of our financial covenants as required by the
indenture at October 27, 2000. A majority of the debenture holders also
approved amendments to the indenture to replace the definition of
consolidated tangible net worth and to increase the interest rate on the
debentures. In order to obtain the consent of a majority of the debenture
holders, we offered the debenture holders a 150 basis point increase in the
interest rate to an annual rate of 10.5%, beginning with the December 15,
2000 payment, contingent upon obtaining a majority affirmative vote. Since we
obtained the majority vote, the interest rate on our subordinated convertible
debentures increased to an annual rate of 10.5% effective September 15, 2000,
and will be reflected in the December 15, 2000 interest payment to debenture
holders.
18
<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 October 27, 2000.
19
<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 8, 2000
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)
20
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION LOCATION
----------- ----------- --------
<S> <C> <C>
12 Computation re: Ratio of Filed herewith
Earnings to Fixed Charges electronically
27 Financial Data Schedule Filed herewith
electronically
</TABLE>
