Paper Warehouse Stores
Format. We operate stores that range in size from 3,000 square feet to 9,300 square feet of retail space. We introduced our 8,500-square foot prototype store in 1994, which was developed based on management’s extensive retail and other industry experience, in addition to customer research. Of our 86 Company-owned stores at January 31, 2003, approximately 90% were 6,000 square feet or larger.
Our stores are designed to create a customer-friendly environment. We use vibrant colors, theme-oriented merchandise displays and unique products to create a fun and festive shopping experience. The focal point of our stores is the seasonal display located at the front of each store, which creates a “store-within-a-store” appearance. This display maximizes the season’s selling opportunity and is continuously updated to promote a fresh image within the store. To assist customers in coordinating party supplies for their occasions, we locate related departments, such as gift-wrap and greeting cards adjacent to one another and display related merchandise such as party hats, plates, cups and napkins together within a department. Customers are able to easily move about the different departments to find specific product categories due to prominent, easy-to-read signage, bright lighting and wide aisles. We believe that our store layout assists customers in finding and coordinating their party supply needs, and also encourages browsing, impulse purchases and repeat visits.
Within our store base, we have several stores that we call “concept stores.” A concept store is basically our prototype store, but it has a different look and feel than our other stores. These stores have more colorful ceilings, lower shelves in the front of the store, carpeting and confetti-tiled floors and new vibrant, uncluttered signage. In addition, in our concept store, we endeavor to stow all extra merchandise out of sight. These features give the store a very open and organized feel, allow customers to more easily see merchandise throughout the store, and provide a more fun and festive shopping atmosphere. New Company-owned stores are configured as concept stores. In addition, we will convert non-concept stores to concept stores where the revenue potential justifies the investment involved. We believe that our concept stores help facilitate the creation of brand awareness, generate strong sales per square foot and are readily transferable to new markets.
During 2002, in order to attempt to achieve higher top-line sales and improve the productivity of our stores, we partnered with a key vendor of ours and began to test certain revisions to our prototype concept store in our Plymouth, MN store location. We re-merchandised the store with 2,500 additional items, improved the fixtures and changed the signage. During fiscal 2003, we will continue to evaluate the results of this test for possible rollout to other stores within our store base.
Party Smart ® Concept . We continue to distinguish our business from our competitors by positioning ourselves as the party expert. We believe that we have the opportunity to create a distinct identity for ourselves, one in which customers equate us with the word “party” in every possible way. We have implemented a program in our stores called Party Smart. We believe strongly in this concept and continue to invest financial and personnel resources towards the success of this program. We define Party Smart as being able to provide a customer with all the information and resources necessary to have a successful party, celebration or gathering. We reinforce this concept through shopping bag inserts, window and aisle signs, buttons for employees, in-store audio messages, radio broadcasting and the Internet. Through this program, we continue to strive towards:
• increasing the average purchase per customer visit; • increasing the frequency of store visits; and • developing customers’ preference for us over our competitors. The first phase of the Party Smart program consisted of the following:
• providing helpful and engaging in-store presentations to add value to the shopping experience; • communicating our expertise by giving customers party ideas, decorating tips, referrals and planning advice and integrating this with our in-depth product knowledge; and • creating a “party planning resource center” in each store that carries different types of brochures for different types of parties and seasonal events such as entertainment and catering ideas, games to play at children’s birthday parties and shopping checklists.
Phase II of Party Smart stressed our commitment to building and enhancing management skills. This phase included, among other things, in-depth discussions and workshops covering a variety of managerial topics, the implementation of a new performance evaluation tool and the introduction of certain methods, including background checks, to enhance the evaluation of potential employee candidates.
During fiscal 2002, we continued promoting and supporting the Party Smart philosophy by reinforcing the use of training materials, updating the sales associates workbooks and enhancing the performance evaluation tools to reflect the standards of Party Smart . We reinforced the Party Smart customer service philosophy and marketing concept with an incentive contest for sales associates. We define a Party Smart associate as one who knows how to increase sales and encourage the customer to return to the store, and these associates were rewarded for their success and customer service improvement over a three-month period during our critical holiday season.
In an effort to raise loss prevention awareness, we implemented a proactive reporting tool, via the Internet, that is used by employees to report violations, concerns, suggestions, etc., in an anonymous manner. The service is also used to provide reports of a positive nature. The reports are sent immediately to our secure Corporate Combat™ site for private review.
During fiscal 2003, our focus on individual store performance will continue. We will implement a job match tool in our recruitment and assessment process to ensure performance success in store management. The online management tool will measure human potential and predict job success for new managers.
In addition, in conjunction with continued Party Smart Training, team building will play a role in improving store performance as well. By leveraging proven and effective team characteristics, the stores will be better prepared to reach their goals.
Customer Service. We strive towards providing a high level of customer service to enhance our store environment. Store managers and sales associates are trained to assist customers with party planning and event coordination. In connection with our Party Smart program, all employees are trained on how to provide nontraditional customer service to our customers. We want our employees to be able to offer our customers party ideas, decorating tips and referrals, as well as help customers find and purchase products. In addition, we provide party planning guides and checklists. Our “no hassles” return policy makes it easy for customers to return or exchange products, which we believe, encourages customers to purchase additional product quantities. Certain products that require additional sales assistance, such as balloons, are located near checkout counters where sales associates can readily assist customers.
In an effort to better understand our customer, during fiscal 2002, we retained the services of a customer research firm to conduct a 12-month customer research project during fiscal 2003. The research results are reported to us on a monthly basis. This firm has extensive experience in phone-based research with a roster of multi-store national clients. Their theory is that customer loyalty drives sales growth and their past research indicates that retail units with high customer satisfaction results have higher than average comparable growth sales. We expect this research will better inform us as to what the customer likes most about our stores and, what areas of the shopping experience the customer feels we have room to improve.
We also monitor our level of customer service by regular store visits and by employing anonymous “mystery shoppers.” Mystery shoppers visit all Company-owned stores at least once per quarter, and evaluate personnel based on our Party Smart philosophy , including various aspects of customer service, such as responsiveness, quality of product displays and store cleanliness. These mystery shopper results are utilized during the evaluation process of our store managers.
Operations and Training. Each Company-owned store is typically operated by a store manager, one assistant manager and a varying number of full-time and part-time sales associates, depending on the store size, sales volume and selling season. Store managers are responsible for all aspects of a store’s day-to-day operations, including employee hiring and training, work scheduling, expense control and customer service. These managers report to a district or operations manager, each of who is responsible for several stores. Within each geographic market, we use floating managers to assist in smaller stores that cannot support both a store manager and an assistant manager. In addition, floating managers support store managers during busy holiday seasons, substitute for store managers during vacations and other absences, and work with newly hired store managers to ensure a smooth transition for sales personnel and customers.
Before opening a new Company-owned store, we train store managers intensely for two weeks on average, depending on their prior experience. During the new store set-up, our district management team provides additional training to our store managers. After the store opening, corporate headquarters personnel spend considerable time overseeing the operations. We schedule periodic training sessions for store managers in the central or district offices on various topics, including human resources, merchandising, loss prevention and employee supervision. We cover additional training topics at monthly managers’ meetings and through mailings, such as our weekly merchandising updates and our monthly Company newsletter.
Paper Warehouse stores are typically open:
Monday through Friday
9:00 a.m. to 9:00 p.m.
Saturday
9:00 a.m. to 6:00 p.m.
Sunday
10:00 a.m. to 5:00 p.m.
Site Selection and Locations
Site Selection. We locate our stores in or near visible high traffic strip mall centers in close proximity to prominent mass merchandisers, discount or grocery store anchors. Our strategy of clustering stores in metropolitan markets promotes customer convenience and creates favorable economies of scale for marketing and advertising, operations and merchandising. In order to select the optimal location for our stores, we use a site selection process that considers various criteria, including:
• population density, and various demographics, including age and income; • parking availability, storefront visibility and presence; • local competition, traffic counts and lease rates.
Locations. As of January 31, 2003, we had 86 Company-owned stores in the following states: Number of Stores
Arizona
4
Colorado
14
Iowa
5
Kansas
8
Minnesota
28
Missouri
10
Nebraska
2
Oklahoma
14
Wisconsin
1
Total Company-owned Stores
86
Merchandising
Overview. In our 8,500 square foot prototype store, we offer a selection of approximately 12,000 everyday items, in addition to seasonal items, for a total of over 19,000 individual items. This broad array of goods makes us the one stop party goods shop for our customers. The store is organized by party themes and product classifications including: party supplies, gift-wrap items, catering/food service supplies, and greeting cards. The merchandise organization and our broad selections encourage impulse purchasing by our customers.
Party Supplies. We offer an extensive selection of regular and seasonal merchandise in the following categories:
| • plates | • favors | • candy | • invitations | • snacks | • novelties | |||||
| • napkins | • balloons | • banners | • streamers | • candles |
Every day we offer more than 130 tableware patterns ranging in design from licensed characters to florals to themes to wedding.
Gift Wrap. We offer a wide assortment of everyday and seasonal gift-wrap products. Our wide variety of colors and patterns in gift-wrap, gift bags, gift boxes, tissue paper, ribbons, bows, and gift tags ensures that all of our customers gift-wrap needs will be satisfied. We offer a complete selection of wrap supplies for holidays and special occasions such as birthdays, graduations, weddings, anniversaries and baby showers.
Greeting Cards. We offer a full selection of special occasion, seasonal and everyday greeting cards under the Ambassador brand of Hallmark, which are sold at 50% off the list price everyday.
Catering Food Service. We offer a full selection of food service products such as, plates, cups, trays, bowls, utensils and table coverings. These goods are available to certain customers such as businesses, caterers, non-profits and schools in bulk, at special organizational discounts.
Competitive Pricing . We provide the customer with paper goods and party supplies at everyday competitive prices, augmented by extensive advertising.
Product Sourcing and Inventory Management
We purchased everyday and seasonal merchandise from approximately 160 suppliers during fiscal 2002. During fiscal 2002, our largest supplier accounted for approximately 24% of our purchases and our 4 largest suppliers represented approximately 60% of our purchases. We have a multi-year exclusive supply agreement with a supplier of greeting cards for our Company-owned and franchise stores. During fiscal 2002, in order to assist us with our liquidity needs, this supplier provided our senior lender with a letter of credit that supported an overline with our bank. As consideration for issuing the letter of credit, we renegotiated our supply agreement with this supplier during fiscal 2002, thereby increasing our purchase commitments and revising the agreement to include party supplies. We have a remaining contractual obligation for chain-wide purchases of $64.3 million of greeting cards, gift-wrap and party supplies. We estimate that these purchase commitments will be fulfilled over a 7-year period. With the exception of the agreement with the above-mentioned supplier, we do not have any long-term purchase commitments or exclusive contracts with any of our other suppliers. Aside from greeting cards and licensed products, we believe that alternative sources of product are available. These alternate products, however, may not be available at comparable prices, or we may have to source these products from smaller vendors that may not have the financial capacity to provide us with credit terms. In addition, having to re-source alternative vendors could prove disruptive to our business and could cause additional financial constraints. We consider numerous factors in supplier selection, including price, payment terms, product offerings and product quality. We negotiate pricing with suppliers on behalf of all Company-owned and franchise stores. We believe that this buying power enables us to receive favorable pricing terms and to more readily obtain high demand merchandise. Although franchise stores are responsible for purchasing their own inventory, franchisees are able to make purchases on our negotiated pricing terms. As we add new stores, we believe we will increase the volume of our inventory purchases and benefit further from increased discounts, trade allowances and more favorable payment terms from our suppliers.
Approximately 95% of our everyday merchandise is shipped directly from the supplier to our stores. Deliveries are processed and inventory items are inspected, sorted and priced in a segregated receiving area in the back of the store (approximately 10% of total gross square feet per store) before being placed on the selling floor. We believe that we realize substantial savings by not maintaining a large central distribution system.
Some of our suppliers, such as overseas suppliers, will not ship directly to our stores, but will instead ship products directly to one store in each of our major metropolitan markets. This store then separates and ships the products to our other stores within that market. This approach allows us to make opportunistic volume purchases and allows us to carry products not available from domestic suppliers. We utilize some of the stores in our markets for the separation and redistribution of products to other stores within that market. Up until the fourth quarter of fiscal 2002, we maintained a relatively small cross-dock facility in Minneapolis, Minnesota from which we separated and distributed seasonal merchandise system-wide, including to our franchise stores. In an effort to reduce costs, during the fourth quarter of fiscal 2002, management made the decision to close the Minnesota cross-dock facility and to actively try and sublet the location. Going forward, we will utilize a third-party for the distribution of product. We believe that we will realize cost savings in future years by using a third-party to distribute our product.
Advertising and Marketing
We run aggressive advertising and marketing programs. Our real estate strategy of clustering stores in metropolitan markets enables us to maximize our marketing dollars through cost efficient media purchasing. We advertise in newspaper inserts, direct mail, and radio. We augment this external media with internal elements such as aggressive in/on store signage, store specific direct mail pieces, coupon books and party planning guides.
Our advertising focuses on a price-per-item, and is designed to show value and create customer urgency during the ad period. Our advertising consists of 4 color inserts primarily designed for, and run, during major seasonal and holiday times. In fiscal 2002 we ran 16 major promotional events in all of our markets. During major sales periods and events, radio augments our print advertising. During fiscal 2002, we spent approximately 65% of our marketing budget on print media, 25% on broadcast media and the balance on yellow pages, in store events and signage.
We have targeted specific customer groups for direct marketing efforts. We recognize that there are many reasons for parties and special celebratory events, and we target our marketing efforts to those varied reasons. We have programs that target upcoming weddings, graduations, and children’s birthdays, as well as institutional/food service customers. Special discounts of 15% are available to certain institutional customers.
In fiscal 2003, we are enhancing our advertising and in-store marketing programs by:
• adding to our insert program with additional advertising in Sunday papers in selected markets; • emphasizing key categories, such as balloons and discounted greeting cards, that provide store differentiation for us in every ad; • featuring “value” ensembles, which retail under $1.00 in most ads; • implementing a new, customer-friendly signing package in every store; and • using “Great Prices” and “Celebration” as consistent marketing themes in our ads and in our stores.
Information Systems
We believe that a strong information systems infrastructure is essential to our current operations and is critical towards enhancing our competitive position in our industry. We have invested significantly in building this infrastructure. Our current system provides daily sales information and inventory levels at store, department, class, and product level. This information allows the corporate office to monitor daily sales, gross profit, repricing and inventory by product across the entire store base. Also, our automatic merchandise replenishment system uses this information to reorder goods for individual stores based on specific product requirements.
During fiscal 2002 we completed the implementation of time and attendance software, which provides better tracking, accuracy, and analysis of store labor hours. In fiscal 2002 we also completed a major upgrade to our merchandising system, which will allow the company to react more quickly to sales trends, by looking at detailed information at a weekly level, instead monthly. We have added an enhancement to our “POS Smart” system, which is our back-office computer system, to allow the stores to print receiving documents at their store, instead of mailing or faxing the documents. The implementation of our financial planning system is nearly complete. This system should facilitate better planning and forecasting by the company and faster communication of financial results to upper management. During fiscal 2003 we will finalize the implementation of the financial planning system, and we will turn on additional functionality in our “POS Smart” system to improve accuracy in receiving and transferring of merchandise.
Internet and e-commerce
In order to augment our store sales and strengthen our name recognition, we developed a website, PartySmart.com, to sell party supplies and paper goods over the Internet. We believe this site is an additional distribution channel for consumers who want to purchase party or theme products on-line, and it is an
information tool for consumers who want party planning advice or who want to identify the nearest Paper Warehouse or Party Universe location. On this site, we offer everyday party goods for parties and celebrations such as baby showers, birthdays, theme parties and anniversaries. In addition, the site is regularly updated with unique themes and product offerings that match the current season, such as Halloween and Christmas.
We believe that the Internet can be an important information tool and that our website has the potential to be a successful distribution channel for us. However, to date, revenues from our e-commerce site have been insignificant. We will continue to evaluate the website’s contributions to ensure that they are aligned with our overall goals and objectives. If we determine that our website is not meeting our objectives, at that time, we will determine alternative business solutions such as outsourcing the business with a strategic partner or possible sale of the site.
Franchising
We have offered franchises of our Paper Warehouse store concept since October 1987. As of January 31, 2003, we had 39 franchisees operating 50 franchise stores in the following locations: Number of Stores
Arizona
1
Canada
1
Colorado
4
Florida
1
Georgia
1
Illinois
1
Iowa
2
Kansas
2
Kentucky
1
Louisiana
4
Maryland
1
Massachusetts
1
Michigan
1
Minnesota
1
Mississippi
1
Missouri
2
Montana
3
Nebraska
3
Nevada
3
North Dakota
4
South Dakota
3
Texas
7
Wyoming
2
Total Franchise Stores
50
We typically establish franchise stores in markets outside of metropolitan areas with Company-owned stores, as we believe that these markets are not usually served adequately by the party supplies and paper goods industry. In addition to generating franchise revenues, franchise stores benefit us through increased name recognition and increased buying power with our suppliers.
We assist franchisees in opening and operating a Paper Warehouse store. During the pre-opening phase, our support includes:
• site evaluation and assistance with lease negotiations; • store build-out assistance; • fixtures, equipment, supplies and inventory procurement; • opening advertising materials; and • operations training.
We make available to our franchisees, services such as business planning, operations and promotional activities. In addition, we perform the merchandising process for our franchisees. We make periodic inspections of the franchise stores to ensure that the franchisee is complying with our various requirements and quality standards. We have considered, and may, in the future, enter into multiple store development agreements with franchisees granting them certain exclusive rights to develop stores in specified markets, so long as the franchisee meets a stated development schedule and complies with other provisions of the development agreement and the franchise agreement.
Our franchise revenues are comprised of initial franchise fees and continuing royalty payments. Our current initial franchise fee is typically $35,000 for new franchisees. We may offer a discounted franchise fee for developers opening multiple stores. If a franchisee enters into a second or third franchise agreement they will receive a discount on the initial fee associated with the second or third store. Franchisees are also required to pay us a continuing royalty equal to a percentage of their weekly gross sales. Historically, this percentage has varied from 3% to 5%. Currently, new franchises pay us a continuing royalty of 5% of their gross sales.
The franchisee’s initial investment depends primarily upon store size. This investment includes the initial franchise fee, real estate and leasehold improvements, fixtures and equipment, signs, point-of-sale systems, deposits and business licenses, initial inventory, opening promotional expenses and working capital. We reserve the right to require franchisees to pay a weekly advertising fee not to exceed 1% of gross sales, although to date we have not charged this fee. Each franchisee is granted a license from us for the right to use certain of our intellectual property rights, including the mark Paper Warehouse ® or Party Universe ® and related designs. Our franchise agreements are for a ten-year term and contain conditional renewal options.
Competition
The party supplies and paper goods retailing business is highly competitive. In order to compete successfully against other party supplies and paper goods competition, we believe we must maintain convenient locations, broad merchandise selections, competitive pricing and strong customer service. Our stores compete with a variety of smaller and larger retailers, including:
• specialty party supply retailers; • other party superstores such as Party City and Factory Card Outlet; • card shops; • designated departments in mass merchandisers, discount retailers, toy stores, drug stores, supermarkets and department stores; and • other Internet retailers.
We believe the following factors distinguish our business from other party superstores:
• we have grown our number of stores in a more controlled manner; • our clustering growth strategy creates a critical mass of stores in our principal markets, which allows us to promote customer convenience and create favorable economies of scale for marketing, advertising and operations; and • we have a strong dedicated senior management team and board of directors with significant retail experience.
Trademarks and Service Marks
We use the marks Paper Warehouse, Party Universe and Party Smart, all of which are federally registered. We are aware of the common law usage of the name Paper Warehouse by several companies in various parts of the United States, which may prevent us from using that name in certain regional markets. In new markets, or markets where we cannot use Paper Warehouse, we intend to use the name Party Universe . Because of our regional approach to advertising and store clustering, we believe that the use of a single trademark within each market is more important to our business strategy than the use of one mark nationally.
Seasonality and Seasonal Events
We generate a significant amount of sales from our seasonal events, and we are significantly dependent on our seasonal events. We have three primary seasonal events and several secondary seasonal events. Our primary events are the Graduation season, Halloween and Christmas/Hanukkah. Our secondary seasonal events consist of Valentine’s Day, St. Patrick’s Day, Easter, Mother’s Day, Father’s Day, Fourth of July and New Year’s. In combination, these seasonal events represented approximately 22% of our annual sales volume for fiscal 2002.
Government Regulation
As a franchisor, we comply with rules and regulations adopted by the Federal Trade Commission and with state laws that regulate the offer and sale of franchises. We also comply with a number of state laws that regulate certain substantive aspects of the franchisor-franchisee relationship. These laws regulate the franchise relationship, for example, by requiring the franchisor to deal with franchisees in good faith, by prohibiting interference with the right of free association among franchisees and by regulating illegal discrimination among franchises with regard to charges, royalties or fees. To date, those laws have not kept us from seeking franchisees in any given area and have not affected our operations.
All of our stores comply with regulations adopted by federal agencies and with licensing and other regulations enforced by state and local health, sanitation, safety, fire and other departments. More stringent and varied requirements of local governmental bodies with respect to zoning, land use and environmental factors and difficulties or failures in obtaining the required licenses or approvals can delay and sometimes prevent the opening of a new store. In addition, we comply with the Fair Labor Standard Act and various state laws governing matters such as minimum wage, overtime and other working conditions. We also comply with the provisions of the Americans with Disabilities Act of 1990, which generally requires that employers provide reasonable accommodation for employees with disabilities and that stores be accessible to customers with disabilities.
Employees
As of January 31, 2003, we employed 305 full-time and 634 part-time employees. We consider our relationships with our employees to be good. None of our employees are covered by a collective bargaining agreement.
(d) Financial Information About Geographic Areas.
Since inception, with the exception of continuing franchise fees earned on our Canadian franchise’s retail sales equal to approximately $7,000 for fiscal 2002, all of our revenues have been derived from within the United States. In addition, since inception, all of our assets have been located in the United States.
The Company has a web site at www.partysmart.com. The contents of the Company’s web site are not part of, nor are they incorporated by reference in this annual report. The Company does make available on its website its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, or amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are also available on the SEC website at and www.SEC.gov the Company also provides paper copies of those reports free of charge upon request.
Item 1A. CAUTIONARY STATEMENT REGARDING FUTURE RESULTS, FORWARD-LOOKING INFORMATION AND CERTAIN IMPORTANT FACTORS.
Paper Warehouse makes written and oral statements from time to time, including statements contained in this Annual Report on Form 10-K regarding its business and prospects, such as projections of future performance, statements of management’s plans and objectives, forecasts of market trends, and other matters that are forward-looking statements within the meaning of Sections 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. Statements containing the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimates,” “projects,” “believes,” “expects,” “anticipates,” “intends,” “target,” “goal,” “plans,” “objective,” “should” or similar expressions identify forward-looking statements, which may appear in documents, reports, filings with the Securities and Exchange Commission, news releases, written or oral presentations made by our officers or other representatives to analysts, shareholders, investors, news organizations and others, and discussions with our management and other Company representatives. For such statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
Our future results, including results related to forward-looking statements, involve a number of risks and uncertainties. No assurance can be given that the results reflected in any forward-looking statements will be achieved. Any forward-looking statements made by us or on our behalf speak only as of the date on which such statement is made. Our forward-looking statements are based upon assumptions that are sometimes based upon estimates, data, communications and other information from suppliers, government agencies and other sources that may be subject to revision. We do not undertake any obligation to update or keep current either (i) any forward-looking statement to reflect events or circumstances arising after the date of such statement, or (ii) the important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or which are reflected from time to time in any forward-looking statement which may be made by us or on our behalf.
In addition to other matters identified or described by us from time to time in filings with the SEC, there are several important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or results that are reflected from time to time in any forward-looking statement that may be made by us or on our behalf. Some of these important factors, but not necessarily all of the important factors, include the following:
We Have Experienced Losses and May Not be Profitable
We incurred a net loss of approximately $4.2 million for fiscal 2002. We incurred net losses of $9.8 million and $434,000 for fiscal 2001 and fisca
