<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended July 28, 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 August 31, 2000, there were 4,644,940 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>
PART I. FINANCIAL INFORMATION PAGE
----
<S> <C> <C>
Item 1: Financial Statements
Consolidated Balance Sheets
as of July 28, 2000 and January 28, 2000 1
Consolidated Statements of Operations
for the Three and Six Months ended July 28, 2000
and July 30, 1999 2
Consolidated Statements of Cash Flows
for the Six Months ended July 28, 2000
and July 30, 1999 3
Notes to Consolidated Financial Statements 4-8
Item 2: Management's Discussion and Analysis of
Results of Operations and Financial Condition 9-17
Item 3: Quantitative and Qualitative Disclosures about Market Risk 18
PART II. OTHER INFORMATION
Item 2: Changes in Securities 19
Item 4: Submission of Matters to a Vote of Security Holders 19
Item 6: Exhibits and Reports on Form 8-K 20
Signatures 21
</TABLE>
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
July 28, January 28,
2000 2000
---------------- -----------------
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................................ $ 458,187 $ 469,768
Merchandise inventories.................................................. 20,330,432 20,206,851
Accounts receivable...................................................... 1,116,028 830,153
Prepaid expenses and other current assets................................ 1,096,771 1,003,398
---------------- -----------------
Total current assets............................................... 23,001,418 22,510,170
Property and equipment, net.............................................. 9,395,503 10,006,870
Deferred tax asset....................................................... 3,177,052 3,177,052
Other assets, net........................................................ 1,595,890 1,694,552
---------------- -----------------
Total assets..................................................... $37,169,863 $ 37,388,644
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable - line of credit........................................... $ 8,827,372 $ 6,303,648
Current maturities of long-term debt..................................... 632,798 715,517
Accounts payable......................................................... 6,603,639 8,226,993
Accrued liabilities...................................................... 1,854,442 1,751,634
Current portion - reserve for store closings............................. 531,536 811,709
---------------- -----------------
Total current liabilities.......................................... 18,449,787 17,809,501
Convertible subordinated debt............................................... 4,000,000 4,000,000
Other long-term debt, less current maturities............................... 2,202,893 2,447,852
Reserve for store closings, less current portion............................ 1,572,002 2,188,291
Deferred rent credits....................................................... 1,394,877 1,301,563
---------------- -----------------
Total liabilities................................................ 27,619,559 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;
4,639,475 and 4,627,936 shares issued and outstanding................. 46,395 46,279
Additional paid-in capital................................................ 13,848,345 13,833,442
Accumulated deficit....................................................... (4,344,436) (4,238,284)
---------------- -----------------
Total stockholders' equity......................................... 9,550,304 9,641,437
---------------- -----------------
Total liabilities and stockholders' equity....................... $37,169,863 $ 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 Six Months Ended
---------------------------------- ---------------------------------
July 28, July 30, July 28, July 30,
2000 1999 2000 1999
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues:
Retail sales........................................... $ 23,220,665 $ 19,618,089 $ 42,643,751 $ 36,037,661
Franchise related fees................................. 371,781 303,455 686,457 576,312
--------------- --------------- --------------- ---------------
Total revenues.................................... 23,592,446 19,921,544 43,330,208 36,613,973
Costs and expenses:
Costs of products sold and occupancy costs............. 14,954,528 13,115,318 28,391,768 24,522,163
Store operating expenses............................... 5,058,707 4,051,571 10,057,992 8,725,461
General and administrative expenses.................... 2,443,922 2,640,362 5,022,334 4,905,402
Repositioning credits.................................. (530,000) --- (530,000) ---
--------------- --------------- --------------- ---------------
Total costs and expenses.......................... 21,927,157 19,807,251 42,942,094 38,153,026
--------------- --------------- --------------- ---------------
Operating income (loss)........................... 1,665,289 114,293 388,114 (1,539,053)
Interest expense....................................... (426,207) (231,675) (827,304) (447,715)
Other income, net...................................... 227,960 285,970 276,520 303,997
--------------- --------------- --------------- ---------------
Income (loss) before income taxes and
cumulative effect of accounting change............. 1,467,042 168,588 (162,670) (1,682,771)
Income tax (expense) benefit........................... (588,143) (67,439) 56,518 675,087
--------------- --------------- --------------- ---------------
Net income (loss) before cumulative effect of
accounting change.................................. 878,899 101,149 (106,152) (1,007,684)
Cumulative effect of accounting change, net............ --- --- --- (108,506)
--------------- --------------- --------------- ---------------
Net income (loss)................................. $ 878,899 $ 101,149 $ (106,152) $ (1,116,190)
=============== =============== =============== ===============
Net Income (Loss) Per Common Share:
Basic net income (loss) per common share before
cumulative effect of accounting change....... $ .19 $ .02 $ (.02) $ (.22)
Cumulative effect of accounting change............ --- --- --- (.02)
--------------- --------------- --------------- ---------------
Basic net income (loss) per common share.......... $ .19 $ .02 $ (.02) $ (.24)
=============== =============== =============== ===============
Diluted net income (loss) per common share before
cumulative effect of accounting change....... $ .16 $ .02 $ (.02) $ (.22)
Cumulative effect of accounting change............ --- --- --- (.02)
--------------- --------------- --------------- ---------------
Diluted net income (loss) per common share........ $ .16 $ .02 $ (.02) $ (.24)
=============== =============== =============== ===============
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
PAPER WAREHOUSE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended
------------------------------------
July 28, July 30,
2000 1999
--------------- ---------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss............................................................. $ (106,152) $(1,116,190)
Adjustments to reconcile net loss to net cash used for operations:
Depreciation and amortization................................... 1,186,813 1,094,438
Repositioning credits........................................... (530,000) ---
Gain on sale of property and equipment.......................... (10,200) (1,414)
Deferred taxes.................................................. (65,068) (745,444)
Deferred rent credits........................................... 117,205 215,929
Other noncash items affecting earnings.......................... 112,514 200,114
Changes in operating assets and liabilities:
Merchandise inventories....................................... (123,581) (3,353,830)
Accounts receivable........................................... (285,875) 636,323
Prepaid expenses and other current assets..................... (28,305) (658,511)
Accounts payable.............................................. (1,623,354) 1,730,782
Accrued liabilities........................................... 78,917 631,994
Store closing reserves........................................ (366,462) ---
--------------- ---------------
Net cash used for operations................................ (1,643,548) (1,365,809)
INVESTING ACTIVITIES:
Purchases of property and equipment.................................. (637,968) (1,429,470)
Proceeds from sale of property and equipment......................... 92,450 16,700
--------------- ---------------
Net cash used for investing activities...................... (545,518) (1,412,770)
FINANCING ACTIVITIES:
Proceeds from convertible subordinated debentures.................... --- 4,000,000
Net proceeds from (payments on) notes payable - line of credit....... 2,523,724 (904,199)
Proceeds from refinancing of mortgage................................ --- 1,100,000
Net payments on other long-term debt................................. (13,285) (907,326)
Payment of debt issuance costs....................................... (33,580) (1,006,532)
Proceeds from financing of property and equipment.................... --- 1,105,039
Payments on financing of property and equipment...................... (314,393) (226,981)
Proceeds received from employee purchases of stock................... 15,019 ---
--------------- ---------------
Net cash provided by financing activities................... 2,177,485 3,160,001
--------------- ---------------
Net (decrease) increase in cash and cash equivalents........ (11,581) 381,422
Cash and cash equivalents, beginning of period....................... 469,768 988,575
--------------- ---------------
Cash and cash equivalents, end of period............................. $ 458,187 $ 1,369,997
=============== ===============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid during the period............................. $ 672,239 $ 396,532
Income taxes paid during the period......................... 8,108 ---
=============== ===============
</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 99 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 July 28,
2000 and January 28, 2000 and for the three and six month periods ended
July 28, 2000 and July 30, 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 generally
accepted accounting principles 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 six months ended July 28, 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 July 28, 2000
that were not included in the computation of diluted EPS for the six
month period ended July 28, 2000, as their inclusion would have been
antidilutive. In addition, options to purchase 787,325 and 429,300
shares of common stock were outstanding as of July 28, 2000 and July
30, 1999, respectively, but were excluded from the computation of
common share equivalents for the six month periods ended July 28, 2000
and July 30, 1999 because they were antidilutive. Had we not incurred
losses in these year-to-date periods, the inclusion of these items
would not have been antidilutive. Accordingly, for the six months ended
July 28, 2000, we would have assumed conversions of convertible
subordinated debentures into approximately 1.3 million common shares
and conversions of stock options into approximately 73,000 common
shares. For the first six months of fiscal 1999, we would have assumed
conversions of convertible subordinated debentures into approximately
127,000 common shares and conversions of stock options into
approximately 20,500 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 six-month
periods ended July 28, 2000 and July 30, 1999 are as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
----------------------------- ------------------------------
July 28, July 30, July 28, July 30,
Basic and diluted EPS: 2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Basic EPS:
Net income (loss) before cumulative effect
of accounting change .......................... $ 878,899 $ 101,149 $ (106,152) $(1,007,684)
Cumulative effect of accounting change, net ....... --- --- --- (108,506)
------------- ------------- ------------- -------------
Net income (loss) ................................. $ 878,899 $ 101,149 $ (106,152) $(1,116,190)
------------- ------------- ------------- -------------
Weighted average shares outstanding ............... 4,639,475 4,627,936 4,639,338 4,627,936
Basic EPS before cumulative effect of
accounting change ............................. $ .19 $ .02 $ (.02) $ (.22)
Cumulative effect of accounting change, net ....... --- --- --- (.02)
------------- ------------- ------------- -------------
Basic EPS ......................................... $ .19 $ .02 $ (.02) $ (.24)
============= ============= ============= =============
Diluted EPS:
Net income (loss) before cumulative effect
of accounting change .......................... $ 878,899 $ 101,149 $ (106,152) $(1,007,684)
Impact of assumed conversions ..................... 54,000 13,187 --- ---
------------- ------------- ------------- -------------
Net income (loss) before cumulative effect
of accounting change plus assumed conversions . 932,899 114,336 (106,152) (1,007,684)
Cumulative effect of accounting change, net ....... --- --- --- (108,506)
------------- ------------- ------------- -------------
Net income (loss) ................................. $ 932,899 $ 114,336 $ (106,152) $(1,116,190)
------------- ------------- ------------- -------------
Weighted average shares outstanding ............... 4,639,475 4,627,936 4,639,338 4,627,936
Assumed conversions of:
Stock options ................................... 37,982 42,301 --- ---
Convertible subordinated debentures ............. 1,333,333 253,968 --- ---
------------- ------------- ------------- -------------
Adjusted weighted average shares outstanding ...... 6,010,790 4,924,205 4,639,338 4,627,936
============= ============= ============= =============
Diluted EPS before cumulative effect of
accounting change ............................. $ .16 $ .02 $ (.02) $ (.22)
Cumulative effect of accounting change, net ....... --- --- --- (.02)
------------- ------------- ------------- -------------
Diluted EPS ....................................... $ .16 $ .02 $ (.02) $ (.24)
============= ============= ============= =============
</TABLE>
5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(3) FINANCING ARRANGEMENTS
We have outstanding as of July 28, 2000, convertible subordinated
debentures in an aggregate principal amount of $4.0 million, convertible
into approximately 1.3 million shares of our common stock. The debentures
bear interest at an annual rate of 9.0%, payable quarterly, and mature in
2005. 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 mailed a proxy
to our debenture holders requesting a waiver of this breach, and 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 ended July 28, 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 will increase to an annual rate of 10.5%, and will be
reflected in the December 15, 2000 interest payment to debenture holders. We
were in compliance with all of our financial covenants as required by the
indenture at July 28, 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. 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. The Standby Letter of Credit expires on December 6, 2000,
although it may expire as early as September 2000 assuming certain
conditions are met. 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. On
July 28, 2000 we had availability of approximately $10.3 million under this
line, of which approximately $8.8 million was outstanding. In consideration
for issuing the Standby Letter of Credit, during second quarter, 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 have agreed to indemnify
Mr. Dolginow for any liability he may incur 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 July 28, 2000.
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(4) COMMON STOCK AND STOCK OPTION TRANSACTIONS
During the first six months of fiscal 2000, we granted options to
selected management and to the board of directors to purchase 266,900 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. On July 31, 2000,
subsequent to the second quarter, employees purchased 5,465 shares of our
common stock pursuant to this plan.
(5) REPOSITIONING CREDITS - RESERVE FOR STORE CLOSINGS
The reserve for store closings reflects reductions related to ongoing
payments of rent, CAM and real estate taxes on the stores that were closed,
in addition to beneficial adjustments resulting from the subleasing of two
store locations that were previously closed.
During the second quarter ended July 28, 2000, we closed on an
agreement with a subtenant for the sublease of the previous Maple Grove,
Minnesota store location, which was relocated in March 2000. Per the
sublease agreement, beginning July 1, 2000, the sublessee agrees to pay,
over the term of the underlying lease, the fixed minimum monthly rental per
the underlying lease, plus charges including, but not limited to, common
area maintenance, real estate taxes, insurance costs and utility charges.
Accordingly, effective as of the date of closing, we reversed the remainder
of the store closing reserve that was established for this location during
the fourth quarter of fiscal 1999, for approximately $500,000.
Also during the second quarter of fiscal 2000, we closed on an
agreement with a subtenant for the sublease of the previous St. Joseph,
Missouri store location, which was relocated in April 1999. Beginning August
1, 2000, the sublessee agrees to pay, over the term of the underlying lease,
a portion of the fixed minimum monthly rental per the underlying lease plus
charges including, but not limited to, common area maintenance, real estate
taxes and insurance costs, provided such charges do not exceed a stated
amount per the sublease agreement. Accordingly, effective as of the date of
closing, we reversed the remainder of the store closing reserve that was
established for this during the fourth quarter of fiscal 1999, for
approximately $30,000.
(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 three and six months ended July 28, 2000.
7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(7) SUBSEQUENT EVENT - LISTING ON NASDAQ SMALLCAP MARKET
Subsequent to the second quarter ended July 28, 2000, the Nasdaq
Listing Qualifications Panel notified us that our stock was approved for
listing on the Nasdaq SmallCap Market effective August 4, 2000 under the
symbol PWHS. In late January 2000, Nasdaq notified us that we were not in
compliance with one of its maintenance standards, requiring at least $5.0
million of "public float" -- the total market value of common stock held by
shareholders who are not insiders, and gave us 90 calendar days to comply
with this standard. We were unable to meet this requirement and in April
applied for listing on the Nasdaq SmallCap Market.
(8) SUBSEQUENT EVENT - SHAREHOLDER RIGHTS OFFERING
On August 28, 2000, our Board of Directors approved a shareholder
rights offering in which we will distribute, to shareholders of record,
0.323 rights for each share of common stock held on the record date. Each
whole right will entitle its holder to purchase from us, one share of our
$.01 par value common stock at a subscription price of $1.25, for a total
subscription of up to 1,500,000 shares. We will not issue any fractional
rights and the rights will not be transferable. We are in the process of
preparing a registration statement on Form S-3 to file with the SEC
regarding this rights offering.
(9) 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 99 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 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 $879,000, or $.16 per share
on a diluted basis, for the second quarter ended July 28, 2000, compared to
net income of approximately $101,000, or $.02 per share on a diluted basis,
for the second quarter of fiscal 1999. We reported a net loss of $106,000,
or ($.02) per share year-to-date, compared to a net loss of approximately
$1.1 million, or ($.24) per share for the prior-year comparable period.
Included in the net loss for the first six 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 six
months of fiscal 2000, excluding the repositioning credits, was
approximately $1.3 million, a substantial improvement over EBITDA of
approximately ($141,000) 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 SIX MONTHS ENDED
------------------------------- -----------------------------
JULY 28, JULY 30, JULY 28, JULY 30,
2000 1999 2000 1999
------------- ------------- ------------ ------------
<S> <C> <C> <C> <C>
Costs of products sold and occupancy costs:
as % of total revenues...................... 63.4% 65.8% 65.5% 67.0%
as % of retail sales........................ 64.4% 66.9% 66.6% 68.0%
Store operating expenses:
as % of total revenues...................... 21.4% 20.3% 23.2% 23.8%
as % of retail sales........................ 21.8% 20.7% 23.6% 24.2%
General and administrative expenses:
as % of total revenues...................... 10.4% 13.3% 11.6% 13.4%
as % of retail sales........................ 10.5% 13.5% 11.8% 13.6%
Number of Company-owned stores................... 99 97 99 97
</TABLE>
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
REVENUES
RETAIL SALES. Retail sales of approximately $23.2 million for the
second quarter of fiscal 2000 increased $3.6 million, or 18%, over retail
sales of approximately $19.6 million for the comparable period in the prior
year. On a year-to-date basis, retail sales of approximately $42.6 million
increased $6.6 million, or 18%, over retail sales of approximately $36.0
million for the first six months of fiscal 1999. The increase in sales
primarily reflects the continued maturation of stores opened during fiscal
1998 and fiscal 1999, as approximately $4.7 million of this year-over-year
favorability was attributable to an increase in total comparable store
sales. To a lesser degree, the year-over-year increase reflects the slightly
larger store base. Sales from our Internet web site, which became
operational in the third quarter of fiscal 1999, were not significant, as
our site was under construction during the entire quarter. During the second
quarter ended July 28, 2000, we closed two Company-owned stores, bringing
the total to 99 at July 28, 2000, compared to 97 at July 30, 1999. Second
quarter 2000 comparable store sales increased 14.5% over the prior year
comparable period. For the six-month period, comparable store sales
increased 13.5% over the prior year comparable period. These growth rates
favorably compare to comparable store sales increases of 7.9% and 6.3% for
the second quarter and first six months of fiscal 1999.
FRANCHISE RELATED FEES. Franchise related fees for the second quarter
of fiscal 2000 of approximately $372,000 increased 23% over franchise
related fees of approximately $303,000 for the comparable period in the
prior year. For the six-month period ended July 28, 2000, franchise related
fees of approximately $686,000 increased 19% over franchise related fees of
approximately $576,000 for the prior year comparable period. The
year-over-year increase primarily reflects increased royalties from
increased franchise store sales. During the second fiscal quarter of 2000,
one franchise store closed, bringing the total of franchise stores to 47 at
July 28, 2000 compared with 46 franchise stores at the end of the second
fiscal quarter of fiscal 1999.
COSTS OF PRODUCTS SOLD AND OCCUPANCY COSTS
Cost of products sold and occupancy costs totaled approximately $15.0
million or 64.4% of retail sales for the second quarter ended July 28, 2000,
as compared to approximately $13.1 million or 66.9% of retail sales for the
second quarter ended July 30, 1999. Cost of products sold and occupancy
costs totaled approximately $28.4 million or 66.6% of retail sales for the
six month period ended July 28, 2000, as compared to approximately $24.5
million or 68.0% of retail sales for the comparable period in the prior
year. We realized an increase in our product margins for the second quarter
and first six months of fiscal 2000 compared to the prior year comparable
periods. This increase was primarily due to 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 second
quarter and first six months of fiscal 2000 versus the prior year comparable
periods. During fiscal 2000, we have realized increased sales across all of
our product categories year-over-year. However, we continue to experience
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 second quarter of fiscal 2000 were
approximately $5.1 million or 21.8% of retail sales, as compared to
approximately $4.1 million or 20.7% of retail sales for the comparable
period in the prior year. On a year-to-date basis, store operating expenses
were approximately $10.1 million or 23.6% of retail sales during fiscal
2000, compared to approximately $8.7 million or 24.2% of retail sales during
fiscal 1999. The decrease in the percentage for the year-to-date period
primarily reflects the continued maturation of our store base and our
ability to leverage year-over-year increases in store labor, advertising and
store operating expenses. The lower percentage also reflects increased
advertising rebates due to favorable sales volume for certain products. The
increase in the percentage for the second quarter of fiscal 2000 compared to
the second quarter of fiscal 1999, reflects the shift in the timing of an
advertising flyer from first quarter in fiscal 1999 to second quarter in
fiscal 2000. We continue to realize higher wage rate pressure due to the
tightness of labor markets.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses for the second quarter of fiscal
2000 were approximately $2.4 million, or 10.4% of revenues, compared to
general and administrative expenses of approximately $2.6 million, or 13.3%
of revenues for the second quarter of fiscal 1999. General and
administrative expenses were approximately $5.0 million, or 11.6% of
revenues for the first six months of fiscal 2000, compared to general and
administrative expenses of approximately $4.9 million, or 13.4% of revenues
for the comparable period in the prior year. The year-over year dollar
increase for the six-month period reflects approximately $489,000 of
operational costs associated with our Internet strategy, which became
operational in the third quarter of fiscal 1999. Over the remainder of
fiscal 2000, we expect general and administrative dollars to remain
relatively flat to the prior year and we expect to gain further leverage of
our general and administrative expense structure as our store base continues
to mature.
INTEREST EXPENSE
Interest expense, for the quarter ended July 28, 2000, of
approximately $426,000, or 1.8% of total revenues, increased $195,000, over
interest expense for the quarter ended July 30, 1999. On a year-to-date
basis, interest expense of approximately $827,000 for fiscal 2000, or 1.9%
of total revenues, increased approximately $380,000 over interest expense
for the first six months in the prior year. The increase over prior year
reflects borrowings from our revolving credit facility, necessary to fund
working capital requirements, in addition to interest payments related to
our convertible subordinated debentures, which were sold 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 continue to increase throughout 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.
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
INCOME TAX BENEFIT
Our estimated annual effective income tax rate for the second quarter
and first six months of fiscal 2000 is 40%, unchanged from the estimated
annual rate used in the prior year comparable periods.
ANALYSIS OF FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
Our primary 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 and our
public sale of convertible subordinated debt
- 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 $4.6 million at
July 28, 2000 and was $4.7 million at January 28, 2000. Our current ratio
was 1.25 to 1.00 at July 28, 2000 compared to 1.26 to 1.00 at January 28,
2000.
Merchandise inventories at July 28, 2000 were essentially flat to the
end of fiscal 1999, primarily reflecting the replenishment of everyday
product sales. Over the next several months we should begin to see an
increase in inventory levels due to 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 $1.6 million for
the six month period ended July 28, 2000 compared to net cash used for
operations of approximately $1.4 million 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. Our
ability to leverage our accounts payable has somewhat lessened, primarily
due to 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 vendor cash
discounts that are offered.
Net cash used for investing activities was approximately $546,000 for
the first six months of fiscal 2000, primarily reflecting capital
expenditures primarily related to opening, relocating and remodeling
Company-owned stores and upgrading our information systems. The net cash
used for investing activities for the first six months of fiscal 1999 was
approximately $1.4 million, consisting entirely of net capital expenditures.
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 an aggregate $972,000 on
capital expenditures. These capital expenditures will be for fixturing or
remodeling existing stores, and continuing investments in information
systems.
Net cash provided by financing activities was approximately $2.2
million for the first six months of 2000 compared to net cash provided by
financing activities of approximately $3.2 million for the first six months
of fiscal 1999. The year-over-year decrease reflects our prior year
subordinated debt offering, the refinancing of our mortgage and the
financing of our capital leases, partially offset by an increased usage of
our revolving line-of-credit in the current year.
SHAREHOLDER RIGHTS OFFERING
On August 28, 2000, our Board of Directors approved a shareholder
rights offering in which we will distribute, to shareholders of record,
0.323 rights for each share of common stock held on the record date. Each
whole right will entitle its holder to purchase from us, one share of our
$.01 par value common stock at a subscription price of $1.25, for a total
subscription of up to 1,500,000 shares. We will not issue any fractional
rights and the rights will not be transferable. We are in the process of
preparing a registration statement on Form S-3 to file with the SEC
regarding this rights offering.
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 about 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 recently increasing our borrowing
availability under our revolving credit facility, we have attempted to
generate or seek 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
- transactions such as our shareholder rights offering
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, Yale Dolginow or
our shareholders.
FINANCING
We have outstanding as of July 28, 2000, convertible subordinated
debentures in an aggregate principal amount of $4.0 million, convertible
into approximately 1.3 million shares of our common stock. The debentures
bear interest at an annual rate of 9.0%, payable quarterly, and mature in
2005. 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 mailed a proxy
to our debenture holders requesting a waiver of this breach, and 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 ended July 28, 2000, we obtained
a waiver for the breach of the covenant as of January 28, 2000 and obtained
the required approval for the amendments. Since we obtained the majority
vote, effective September 15, 2000, the interest rate on our subordinated
convertible debentures will increase to an annual rate of 10.5%, and will be
reflected in the December 15, 2000 interest payment to debenture holders. We
were in compliance with all of our financial covenants as required by the
indenture at July 28, 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. 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. The Standby Letter of Credit expires on December 6, 2000,
although it may expire as early as September 2000 assuming certain
conditions are met. 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. On
July 28, 2000 we had availability of approximately $10.3 million under this
line, of which approximately $8.8 million was outstanding. In consideration
for issuing the Standby Letter of Credit, during second quarter, 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 have agreed to indemnify
Mr. Dolginow for any liability he may incur 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 July 28, 2000.
NASDAQ SMALLCAP LISTING
Subsequent to the second quarter ended July 28, 2000, the Nasdaq
Listing Qualifications Panel notified us that our stock was approved for
listing on the Nasdaq SmallCap Market effective August 4, 2000 under the
symbol PWHS. In late January 2000, Nasdaq notified us that we were not in
compliance with one of its maintenance standards, requiring at least $5.0
million of "public float" -- the total market value of common stock held by
shareholders who are not insiders, and gave us 90 calendar days to comply
with this standard. We were unable to meet this requirement and in April
applied for listing on the Nasdaq SmallCap Market.
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.
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(CONTINUED)
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.
17
<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.
18
<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 July 28, 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 will increase 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
a. The Company held its annual meeting of shareholders on June 9, 2000.
Pursuant to Regulation 14 of the Securities Act of 1934, proxies for
such meeting were solicited. The following matters were voted on at
the meeting:
<TABLE>
<CAPTION>
Votes Votes Votes Broker
For Against Abstained Non-vote
--- ------- --------- --------
<S> <C> <C> <C> <C>
b. (1) To decrease the number of directors
on the Board of Directors to six: 3,891,162 6,985 5,100 ---
(2) To elect the following individuals to
serve as members of the Company's
Board of Directors until the Annual
Meeting of Shareholders in the year 2001:
<CAPTION>
Votes for Votes Withheld
--------- --------------
<S> <C> <C>
Yale T. Dolginow 3,718,507 184,740
Diane C. Dolginow 3,716,707 186,540
Arthur H. Cobb 3,718,507 184,740
Marvin W. Goldstein 3,718,507 184,740
Martin A. Mayer 3,718,507 184,740
Jeffrey S. Halpern 3,717,007 186,240
</TABLE>
19
<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
Exhibit 99.1 - Press Release Appointing Additional Director
b. REPORTS ON FORM 8-K:
The Registrant did not file any reports on Form 8-K during the
quarter ended July 28, 2000.
20
<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: August 31, 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)
21
<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
99.1 Press Release Appointing Filed herewith
Additional Director electronically
</TABLE>
