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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended January 31, 2003

Commission File No. 0-23389



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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

Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.03 par value

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 (the
Act) of 1934 during the preceding 12 months (or for such shorter period that
the Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [ X ]  
No   [   ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12-b-2 of the Act). Yes [  
]   No  [ X ]

The aggregate market value of the Common Stock held by non-affiliates of the
Registrant on August 2, 2002 (the last business day of the Registrants most
recently completed second quarter), based upon the last sale price of the
Common Stock as reported on the Over-the-Counter Bulletin Board on August 2,
2002, was $267,780. For purposes of this computation, affiliates of the
Registrant are deemed only to be the Registrants executive officers, directors
and greater than 10% shareholders. As of April 25, 2003, 1,886,192 shares of
the Registrants Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

None.



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TABLE OF CONTENTS



|                                                  |                                                                                                                   |  |  |  |  |  |  | 
|------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                           
|                                                  | ITEM 1. BUSINESS                                                                                                 
|                                                  | Item 1A. CAUTIONARY STATEMENT REGARDING FUTURE RESULTS, FORWARD-LOOKING INFORMATION AND CERTAIN IMPORTANT FACTORS
|                                                  | ITEM 2. PROPERTIES                                                                                               
|                                                  | ITEM 3. LEGAL PROCEEDINGS                                                                                        
|                                                  | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                      
|PART II                                          
|                                                  | ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                                    
|                                                  | ITEM 6. SELECTED FINANCIAL DATA                                                                                  
|                                                  | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                    
|                                                  | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                              
|                                                  | ITEM 8. FINANCIAL STATEMENTS                                                                                     
|                                                  | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                     
|PART III                                         
|                                                  | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                      
|                                                  | ITEM 11. EXECUTIVE COMPENSATION                                                                                  
|                                                  | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS          
|                                                  | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                          
|                                                  | ITEM 14. CONTROLS AND PROCEDURES                                                                                 
|PART IV                                          
|                                                  | ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K                                         
|SIGNATURES                                       
|EX-10.20 Amendment to Loan & Security Agreement  
|EX-12 Computation of Ratio of Earnings to Charges
|EX-23.1 Consent of Grant Thornton LLP            
|EX-99.1 Certification of Chief Executive Officer 
|EX-99.1 Certification of Chief Financial Officer 



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PAPER WAREHOUSE, INC.
Form 10-K

For the fiscal year ended January 31, 2003

TABLE OF CONTENTS

|         |          |  |                                                                                                          |  |     
|-------- | -------- |  | -------------------------------------------------------------------------------------------------------- |  | ----
|         |          |  | Description                                                                                              |  | Page
|         |          |  |                                                                                                          |  |     
|PART I   |          |  |                                                                                                          | 
|         | Item 1.  |  | Business                                                                                                 |  | 1   
|         | Item 1A. |  | Cautionary Statement Regarding Future Results, Forward-Looking
Information and Certain Important Factors |  | 11  
|         | Item 2.  |  | Properties                                                                                               |  | 14  
|         | Item 3.  |  | Legal Proceedings                                                                                        |  | 14  
|         | Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                      |  | 14  
|PART II  |          |  |                                                                                                          | 
|         | Item 5.  |  | Market for Registrants Common Equity and Related Stockholder Matters                                    |  | 15  
|         | Item 6.  |  | Selected Financial Data                                                                                  |  | 16  
|         | Item 7.  |  | Managements Discussion and Analysis of Financial Condition and
Results of Operations                    |  | 17  
|         | Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                                               |  | 30  
|         | Item 8.  |  | Financial Statements                                                                                     |  | 30  
|         | Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure                     |  | 30  
|PART III |          |  |                                                                                                          | 
|         | Item 10. |  | Directors and Executive Officers of the Registrant                                                       |  | 31  
|         | Item 11. |  | Executive Compensation                                                                                   |  | 34  
|         | Item 12. |  | Security Ownership of Certain Beneficial Owners and Management                                           |  | 40  
|         | Item 13. |  | Certain Relationships and Related Transactions                                                           |  | 42  
|         | Item 14. |  | Controls and Procedures                                                                                  |  | 42  
|PART IV  |          |  |                                                                                                          | 
|         | Item 15. |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                                          |  | 43  

(i)



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PART I

ITEM 1.     BUSINESS.

(a) General Development of Business

Paper Warehouse is a chain of retail stores specializing in party supplies
and paper goods. As of January 31, 2003, we had 136 stores, including 86
Company-owned stores and 50 franchise stores. These stores are conveniently
located in major retail trade areas to provide customers with easy access. We
operate these stores under the names Paper Warehouseand Party Universe. We
also operate a website, www.PartySmart.com. Our website is not intended to be,
and is not, a part of this Annual Report on Form 10-K. As of January 31, 2003,
our stores were located in the following principal markets:

|                            |  |                            |  |             
|--------------------------- |  | -------------------------- |  | ------------
|  Denver, CO               |  |   Oklahoma City/Tulsa, OK |  |   Omaha, NE
|                           
|  Minneapolis/St. Paul, MN |  |   Tucson, AZ              |  |             
|                           
|  Des Moines, IA           |  |   Kansas City, MO and KS  |  |             

We offer an extensive selection of party supplies and paper goods, at
everyday competitive prices, for a wide variety of celebratory occasions,
everyday uses and seasonal events, including:

|                                           |  |                    |                
|------------------------------------------ |  | ------------------ | ---------------
|Celebratory occasions and everyday uses    |  | Seasonal events   
|                                          
|  birthdays                               |  |   Valentines Day |   Halloween   
|                                          
|  weddings                                |  |   Easter          |   Thanksgiving
|                                          
|  baby showers                            |  |   Mothers Day    |   Christmas   
|                                          
|  graduations                             |  |   Fathers Day    |   Hanukkah    
|                                          
|  other family and religious
celebrations |  |   Fourth of July  |   New Years  

In our 8,500 square foot store prototype we offer a selection of over
19,000 everyday and seasonal, individual items. This broad array of goods makes
us the one-stop party goods shop for our customers. Our store prototype is
organized by party themes and product classifications including: party
supplies, gift-wrap items, catering/food service, and greeting cards. The
merchandise organization and display, along with our broad selections encourage
impulse purchasing by our customers.

The first Paper Warehouse store opened in Minneapolis, Minnesota in 1983.
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 this Annual Report on Form 10-K, Paper Warehouse,
Company, we, our and us refer to Paper Warehouse, Inc. and our
subsidiaries, Paper Warehouse Franchising, Inc. and PartySmart.com, Inc. Our
principal executive offices are located at 7630 Excelsior Boulevard,
Minneapolis, Minnesota 55426. Our telephone number is (952) 936-1000.

(b) Financial Information about Segments

Since our inception, our revenues, operating (losses) income and assets
have been attributable to the single industry segment of party supplies and
paper goods. Our revenues, operating (losses) income and assets for each of
the last three fiscal years is set forth elsewhere in the Form 10-K under Item
8, Financial Statements.





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(c) Narrative Description of Business

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 Smartas 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:
2Table of Contents
    
    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 Smartprogram 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 Smartstressed 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 Smartcustomer service
philosophy and marketing concept with an incentive contest for sales
associates. We define a Party Smartassociate 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 SmartTraining, 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 Smartprogram, 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.3Table of ContentsIn 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 Smartphilosophy,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.                     

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| |  |  | 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.

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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.

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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

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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.

8



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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.                                                                                                         

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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 Universeand Party Smart,all of
which are federally registered. We are aware of the common law usage of the
name Paper Warehouseby 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.

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(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 fiscal
2000, respectively. Our 2001 net loss reflects our decision to record a full
valuation allowance against our deferred tax asset, equal to approximately $6.1
million, as prescribed by authoritative accounting guidance. In fiscal 2002,
we increased our deferred tax asset and the

11



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corresponding valuation allowance by approximately $1.6 million and
accordingly did not record a benefit for our losses. We cannot assure you that
we will generate sufficient revenues or margins, or control operating expenses,
to achieve or sustain profitability in future years, or to reverse the
valuation allowance against our deferred tax asset.

Our Need to Raise Additional
Capital to Fund Our Operations Is Immediate

Based on
our current cash position, our recent inability to generate cash from
operations, and our need to purchase in advance inventory for our
upcoming seasonal events, our need to raise cash to satisfy our
working capital needs is immediate. We are actively pursuing
opportunities to satisfy our cash needs through debt and equity
financing. To date, however, we have not been successful in obtaining
the funds needed and we may be unable to obtain
funding to meet our immediate needs on terms acceptable to us or at
all. If we are successful in raising additional equity financing, the
terms of such financing will likely be dilutive to our existing
shareholders. Failure to improve our cash position in a timely manner
may prevent us from purchasing sufficient inventory for our upcoming
seasonal events and may hinder our ability to pay our debts as they
come due. In such case, we may seek, or be forced to seek protection
under the bankruptcy laws.

Our Indebtedness Could Negatively Affect Our Financial Position or Our
Continued Operations

As of January 31, 2003, we had approximately $11.0 million of borrowings
outstanding, which include amounts outstanding under our revolving line of
credit, our subordinated debentures, our mortgage, capital leases and other
miscellaneous debt. In addition, we have approximately $10.0 million of trade
payables, of which approximately $4.6 million is due on June 30, 2003. We are
more leveraged than some of our competitors, which might put us at a
competitive disadvantage. The substantial level of our indebtedness could:



| |  |  | impair our ability to obtain additional financing for
operations, inventory, capital expenditures or general corporate
purposes;      
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | cause a substantial portion of our cash flow from operations to
be spent on principal and interest payments;                          
|
| |  |  | affect our ability to fund our operations, including obtaining appropriate inventory levels;                                          
|
| |  |  | make us more vulnerable to economic or industry downturns and competitive pressures;                                                  
|
| |  |  | prevent us from making interest and principal payments on our
debt obligations as they come due;                                      
|
| |  |  | hinder our ability to adjust to changing market conditions; and                                                                       
|
| |  |  | prevent us from meeting certain financial tests contained in
our debt obligations, which could lead to a default on those
obligations.

In the event that we cannot pay our debts as they come due, including the
accounts payable that is due on June 30, 2003, we could either be forced into
bankruptcy or we could be forced to seek the protection of the bankruptcy laws.

Our Annual Results Are Significantly Dependent on the Results of Our Seasonal
Events

We rely significantly upon our ability to generate sales from our primary
and secondary seasonal events. Any factor that negatively affects our revenues
or increases our operating expenses during our seasonal events could negatively
affect our annual results of operations. For instance, we could spend a large
amount to advertise these events and not generate sufficient sales. In
addition, we commit to purchase inventory to support these events far in
advance of the selling season. If we are not timely in these purchases or are
unable to purchase the appropriate quantity, we could lose sales. Our seasonal
sales are heavily

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augmented by sales in our solid color and institutional/food
service product categories. A low sales performance for any of our seasonal categories could result in a high
level of carryover product, or product that is packed away, for that season.
Because we rely in part on proceeds from our seasonal events to purchase our
inventory of everyday products, a high level of carryover could reduce the
amount of money that we would have available to spend on our everyday product
categories and, therefore, could negatively impact the sales results for our
everyday product categories. Our fiscal quarters do not end on calendar
quarters, and as a result of yearly changes to the retail calendar as well as
various shifts in the calendar due to the timing of our seasonal events, our
quarterly results may not be comparable year-over-year.

Competition May Reduce Our Revenues and Operating Income

Increased competition by existing or future competitors may reduce our
sales. As a result of competition from other specialty party supplies and
paper goods retailers, as well as mass merchants, we have experienced reduced
sales growth in our existing stores and incurred additional marketing and
promotional expenses. Many of our competitors have substantially greater
financial resources than we do. Some of our competitors have been, or may be,
funded by certain members of the vendor community. We may also encounter
additional competition from new entrants in the future in our existing markets.

Our Business Depends on Continued Good Relations with Our Suppliers

During fiscal 2002, our largest supplier accounted for approximately 24%
of our purchases. Our 4 largest suppliers represented approximately 60% of our
purchases during fiscal 2002, and represent over 75% of the $4.6 million of
trade payables on which we were granted extended payment terms until June 30,
2003. Our failure to maintain good relationships with our principal suppliers
or the loss of our principal suppliers could hurt our business. Many of our
principal suppliers currently provide us with credit terms on purchases and
incentives such as volume purchasing allowances and trade discounts. If our
suppliers were to discontinue providing us with credit terms on everyday and
seasonal merchandise, a significant portion of our cash flow would have to be
utilized to purchase merchandise in advance, which could affect our ability to
fund our operations. If our suppliers were to reduce or discontinue these
volume purchasing allowances and trade discounts, prices from our suppliers
could increase, which could negatively impact our profitability. If we are
unable to pay, or further restructure, the $4.6 million of trade payables by
June 30, 2003, we could damage our relationships with our largest suppliers,
and would have difficulty in replacing them. Any supplier could discontinue
selling to us at any time.

A Failure in Executing Our Franchise Program May Negatively Impact our Revenue

Our growth and success depends in part upon our ability to attract,
contract with and retain qualified franchisees. It also depends upon the
ability of those franchisees to successfully operate their stores and promote
and develop the Paper Warehouse and Party Universe store concept. Although we
have established criteria to evaluate prospective franchisees, and our
franchise agreements include certain operating standards, each franchisee
operates his/her store independently. Various laws limit our ability to
influence the day-to-day operations of our franchise stores. We cannot assure
you that franchisees will be able to successfully operate Paper Warehouse
stores in a manner consistent with our concepts and standards. As a result,
our franchisees may operate their stores in a manner that reduces the gross
revenues of these stores, and therefore reduces our franchise revenues.

A Downturn in the Economy or a Change in Consumer Preferences Could Negatively
Affect Our Business

In general, our sales represent discretionary spending by consumers, which
is affected by many factors such as general business conditions, interest
rates, the availability of consumer credit, taxation, world events and consumer
confidence in future economic conditions. Consumer demand for single-use,
disposable party goods could decline during periods when disposable income is
lower or during periods of actual or

13



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perceived unfavorable economic conditions.
If cost increases in raw materials such as paper, plastic, cardboard or petroleum were to cause our prices to increase significantly,
consumers might decide to forgo the convenience associated with single-use,
disposable products and use standard dinnerware and flatware. Similarly,
changes in consumer preferences away from disposable products in favor of
reusable products for environmental or other reasons could reduce the demand
for our products. If this occurs, our revenues and profitability will decline.
In addition, because our operations are located principally in less than ten
metropolitan areas, we are subject to certain regional risks, such as the
economy, weather conditions, natural disasters and government regulations. If
any region in which we operate stores were to suffer an economic downturn or
other adverse regional risks were to occur, our sales could decline.

We Need to Anticipate and Respond to Merchandising Trends

Our success depends in part on our ability to anticipate and respond in a
timely manner to changing merchandise trends and consumer demands. We make
merchandising decisions well in advance of the seasons during which we will
sell the merchandise. As a result, if we fail to identify and respond quickly
to emerging trends, consumer acceptance of the merchandise in our stores could
diminish, and we may experience a reduction in revenues. We sell certain
licensed products that are in great demand for short time periods, making it
difficult to project our inventory needs for these products. Significantly
greater or less-than-projected product demand, could lead to one or more of the
following:



| |  |  | lost sales due to insufficient inventory;                                         
| | - |  | ----------------------------------------------------------------------------------
|
| |  |  | higher carrying costs associated with excess and/or slower turning inventory;     
|
| |  |  | higher levels of seasonal carryover merchandise; and                              
|
| |  |  | reduced or eliminated margins due to markdowns on excess or slow moving inventory.




ITEM 2.      PROPERTIES.

We own a 23,000 square foot building in a suburb of Minneapolis,
Minnesota, in which our headquarters is located. A term note with
approximately $1.0 million outstanding at January 31, 2003, is payable in
monthly installments of $8,612, including interest at 7.125%, through May 2009,
and is secured by a first mortgage on our office headquarters.

We lease a 23,600 square foot building in a suburb of Minneapolis,
Minnesota that we have used as warehouse space. During fiscal 2002, we decided
to close this facility and, beginning in fiscal 2003, we will be utilizing a
third-party for distribution of product to our stores, which is expected to
result in cost savings. We are actively trying to sublet this facility.

We lease all the locations for our Company-owned stores. We anticipate
that any new Company-owned stores will have ten-year leases with at least one
five-year renewal option.

We believe that the space provided by our corporate headquarters is
suitable and adequate to meet our operations for the foreseeable future.




ITEM 3.      LEGAL PROCEEDINGS.

We are not a party to any material litigation nor are we aware of any
threatened litigation that could have a material adverse effect on our
business.




ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

No matters were submitted to a vote of our security holders during the
fourth quarter of the fiscal year ended January 31, 2003.

14



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PART II




ITEM
5.      MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

(a)  Market Information

Since July 2, 2002 our common stock has traded on the Over-the-Counter
Bulletin Board under the symbol PWHS.OB. Prior to July 2, 2002, and since
August 4, 2001, our common stock traded on the NASDAQ SmallCap Market under the
symbol PWHS. Prior to August 4, 2001, and since November 25, 1997, our
common stock traded on the NASDAQ National Market under the symbol PWHS. The
following table summarizes the high and low closing sale prices per share of
our common stock for the periods indicated, as reported on the respective
markets. The prices for the first quarter of fiscal 2001 reflect the
retroactive application of our April 2001 one-for-three reverse stock split.
These prices do not include commissions, mark-ups or markdowns.

|                 |  |      |      |     |  |   |      | 
|---------------- |  | ---- | ---- | --- |  | - | ---- | 
|Fiscal Year 2002 |  | High |      | Low
|                 |  |      |      |    
|First Quarter    |  | $    | 1.73 |     |  | $ | 0.65 | 
|Second Quarter   |  |      | 1.55 |     |  |   | 0.30 | 
|Third Quarter    |  |      | 0.51 |     |  |   | 0.20 | 
|Fourth Quarter   |  |      | 0.30 |     |  |   | 0.13 | 

|                 |  |      |      |     |  |   |      | 
|---------------- |  | ---- | ---- | --- |  | - | ---- | 
|Fiscal Year 2001 |  | High |      | Low
|                 |  |      |      |    
|First Quarter    |  | $    | 1.94 |     |  | $ | 0.55 | 
|Second Quarter   |  |      | 2.00 |     |  |   | 1.25 | 
|Third Quarter    |  |      | 1.36 |     |  |   | 0.47 | 
|Fourth Quarter   |  |      | 0.91 |     |  |   | 0.56 | 

(b)  Holders

As of April 25, 2003, we had approximately 150 shareholders of record and
an estimated 700 beneficial shareholders.

(c)  Dividends

We have never declared or paid any cash or stock dividends with respect to
our common stock, as it is our policy, and the policy of our Board of
Directors, to retain any earnings to provide for our growth and development.
In addition, the declaration and payment of dividends is prohibited under our
revolving line of credit agreement as well as the trust indenture for our
subordinated debentures.

(d)  Recent Sale of Unregistered Securities

We did not engage in any unregistered sales of equity securities during
our fiscal year ended January 31, 2003.

15



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ITEM 6.     SELECTED FINANCIAL DATA.

The Selected Financial Data presented below should be read in conjunction
with the Consolidated Financial Statements and notes thereto included elsewhere
in this Form 10-K, and in conjunction with Managements Discussion and
Analysis of Financial Condition and Results of Operations included elsewhere
in this Form 10-K. The Selected Financial Data as of and for the fiscal years
ended January 31, 2003, February 1, 2002, February 2, 2001 and January 28, 2000
(fiscal years 2002, 2001, 2000 and 1999, respectively) have been derived from
our Consolidated Financial Statements as audited by Grant Thornton LLP,
independent certified public accountants. The Selected Financial Data as of
and for the year ended January 29, 1999 (fiscal year 1998) has been derived
from our Consolidated Financial Statements as audited by KPMG LLP, independent
certified public accountants.

Summary of Financial and Operating Data
(Dollars in thousands, except per share data)

|                                                 |                                                                                  |                                                    |        |             |      |      |        |        |      |      |     |        |     |   |        |        |     |   |     |        |     |  
|------------------------------------------------ | -------------------------------------------------------------------------------- | -------------------------------------------------- | ------ | ----------- | ---- | ---- | ------ | ------ | ---- | ---- | --- | ------ | --- | - | ------ | ------ | --- | - | --- | ------ | --- | -
|                                                 |                                                                                  |                                                    |        | Fiscal Year
|                                                 |                                                                                  |                                                    |        |            
|                                                 |                                                                                  |                                                    |        | 2002        |      | 2001 |        | 2000   |      | 1999 |     | 1998  
|                                                 |                                                                                  |                                                    |        |             |      |      |        |        |      |      |     |       
|Statement of Operations Data:                    |                                                                                  |                                                    |        |             |      |      |        |        |      |      |     |        |     |   |        |        |     |   |     |       
|                                                 | Revenues from continuing operations (1)                                          |                                                    | $      | 75,240      |      |      | $      | 75,917 |      |      | $   | 79,459 |     |   | $      | 74,974 |     |   | $   | 61,924 |    
|                                                 | Repositioning and store closing provision
(credits), net                         |                                                    |        | 263         |      |      |        | (121   | )    |      |     | (970   | )   |   |        | 3,962  |     |   |     |       |    
|                                                 | Operating (loss) income from continuing
operations (1)                           |                                                    |        | (3,990      | )    |      |        | (3,592 | )    |      |     | 1,545  |     |   |        | (5,854 | )   |   |     | 82     |    
|Net (loss) income from continuing operations (1) |                                                                                  |                                                    | (5,170 | )           |      |      | (7,902 | )      |      |      | 125 |        |     |   | (4,067 | )      |     |   | (59 | )     
|                                                 | Net gain (loss) from discontinued operations                                     |                                                    |        | 1,012       |      |      |        | (1,899 | )    |      |     | (559   | )   |   |        | (381   | )   |   |     | (461   | )  
|                                                 | Basic and diluted net (loss) income per share from
continuing operations (1) (2) |                                                    |        | (2.74       | )    |      |        | (4.19  | )    |      |     | 0.07   |     |   |        | (2.63  | )   |   |     | (0.04  | )  
|                                                 | Basic and diluted net income (loss) per share from
discontinued operations (2)   |                                                    |        | 0.54        |      |      |        | (1.01  | )    |      |     | (0.34  | )   |   |        | (0.25  | )   |   |     | (0.30  | )  
|Other Data:                                      |                                                                                  |                                                    |        |             |      |      |        |        |      |      |     |        |     |   |        |        |     |   |     |       
|                                                 | Number of stores open at year end:                                               |                                                    |        |             |      |      |        |        |      |      |     |        |     |   |        |        |     |   |     |        |    
|                                                 |                                                                                  | Company-owned stores  continuing operations       |        |             | 86   |      |        |        | 87   |      |     |        | 85  |   |        |        | 89  |   |     |        | 90  |  
|                                                 |                                                                                  | Company-owned stores  discontinued operations     |        |             |     |      |        |        | 13   |      |     |        | 13  |   |        |        | 13  |   |     |        | 7   |  
|                                                 |                                                                                  | Franchise stores                                   |        |             | 50   |      |        |        | 52   |      |     |        | 49  |   |        |        | 47  |   |     |        | 46  |  
|                                                 |                                                                                  | Comparable store sales (decrease)
increase (1) (3) |        |             | (1.6 | )%   |        |        | (3.3 | )%   |     |        | 5.3 | % |        |        | 9.3 | % |     |        | 2.9 | %
|Balance Sheet Data:                              |                                                                                  |                                                    |        |             |      |      |        |        |      |      |     |        |     |   |        |        |     |   |     |       
|                                                 | Merchandise inventories (1)                                                      |                                                    | $      | 12,826      |      |      | $      | 14,766 |      |      | $   | 15,673 |     |   | $      | 17,484 |     |   | $   | 15,149 |    
|                                                 | Total assets  continuing operations (1)                                         |                                                    |        | 21,280      |      |      |        | 24,529 |      |      |     | 30,711 |     |   |        | 33,218 |     |   |     | 28,357 |    
|                                                 | Net assets of discontinued operations                                            |                                                    |        |            |      |      |        | 2,546  |      |      |     | 2,987  |     |   |        | 3,453  |     |   |     | 1,773  |    
|                                                 | Long-term debt less current maturities (1) (4)                                   |                                                    |        | 4,996       |      |      |        | 5,329  |      |      |     | 5,681  |     |   |        | 6,062  |     |   |     | 1,336  |    
|                                                 | Total stockholders (deficit) equity                                             |                                                    |        | (3,565      | )    |      |        | 593    |      |      |     | 10,412 |     |   |        | 9,641  |     |   |     | 14,090 |    



---

|(1) |  | During fiscal 2002, we exited the Seattle market by completing the sale
of 13 of our stores located in Seattle. Items as noted have been restated
to reflect continuing operations.                                                     
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Reflects the retroactive application of our April 2001 one-for-three
reverse stock split.                                                                                                                                               
|   
|(3) |  | Company-owned stores enter the comparable store sales base at the
beginning of their 13th month of operation. For purposes of computing the
increase in comparable store sales, this computation assumes fiscal 2000
was a 52-week year.
|   
|(4) |  | Long-term debt consists of total debt, including capital lease
obligations, less current maturities.                                                                                                                                    

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ITEM 7.      MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Certain statements contained in this Annual Report on Form 10-K include
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. All forward-looking statements in this Annual
Report on Form 10-K are based on information currently available to us as of
the date of this Annual Report on Form 10-K, 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 Item 1A of this
Annual Report on Form 10-K and elsewhere in this Annual Report on Form 10-K,
and our other filings with the Securities and Exchange Commission. The
following discussion should be read in conjunction with Selected Financial
Data above (Item 6 of this Annual Report on Form 10-K) and our financial
statements and related notes appearing elsewhere in this Annual Report on Form
10-K.

Overview

We are a chain of retail stores specializing in party supplies and paper
goods. As of January 31, 2003, we operated 86 stores in nine states throughout
the central and western regions of the United States under the names Paper
Warehouseand Party Universe,and a website, www.PartySmart.com. Additionally,
we sell Paper Warehouse franchises through our wholly owned subsidiary, Paper
Warehouse Franchising, Inc. As of January 31, 2003, we had 50 franchise
stores. 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. We employ a strategy of clustering stores in our principal
markets to:



| |  |  | provide our customers with convenient store locations;
| | - |  | ------------------------------------------------------
|
| |  |  | expand our total market share; and                    
|
| |  |  | achieve favorable economies of scale.                 

Fiscal year

Our
fiscal year ends on the Friday closest to January 31st. Our fiscal
year is generally 52 weeks; however it periodically consists of 53 weeks. Our
fiscal year ended January 31, 2003 (fiscal 2002) and our fiscal year ended
February 1, 2002 (fiscal 2001) consisted of 52 weeks, and our fiscal year ended
February 2, 2001 (fiscal 2000) consisted of 53 weeks.

Basis of Presentation

The financial results presented and discussed herein reflect our results
and the results of our wholly owned subsidiaries. All intercompany balances
and transactions have been eliminated in consolidation.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

We prepare our consolidated financial statements in conformity with
generally accepted accounting principles in the United States of America (US
GAAP). This requires us to make estimates and judgments that affect reported
amounts and related disclosures. Actual results could differ from those
estimates. We consider the following policies to be the most critical in
understanding the judgments that are involved in the preparation of our
consolidated financial statements and the uncertainties that could impact our
financial condition, results of operations and cash flows.

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Inventory.Our largest asset is our merchandise inventory. Our
inventories are stated at the lower of cost (as determined on a first-in,
first-out basis) or market. We review slow moving merchandise and take
appropriate markdowns and write-downs, as necessary. On an annual basis, in
conjunction with a third party, we perform a physical count of our merchandise
inventories and record adjustments as applicable based on this physical count.

Store Opening and Closing Costs.Expenditures incurred in connection with
the opening of new stores or the remodeling of existing stores are expensed as
incurred. In the event that a store is planned to close before its lease has
expired, any remaining lease obligation, net of expected sublease recovery, is
provided for in the period we adopt the plan to close the store. In addition,
the remaining investment in fixed assets, net of the expected recovery value,
is also expensed. In determining the amount of any remaining net lease
obligation, we make various assumptions, including but not limited to the time
that it would take to sublet a location, the cost to sublet or terminate a
lease and future increases for common area maintenance and real estate taxes.

Critical Accounting Estimates

We have discussed the development and selection of the following critical
accounting estimates with the Audit Committee of our Board of Directors and the
Audit Committee has reviewed our disclosures relating to such estimates in this
Managements Discussion and Analysis.

Inventory Valuation.Our inventories are stated at the lower of cost (as
determined on a first-in, first-out basis) or market. Annually, we perform a
physical count of our merchandise inventories and record adjustments as
applicable based on this physical count. In order to approximate the amount of
inventory shortage, or shrink, identified at our year-end physical inventory,
throughout the year, we record an estimated shrink percentage that is applied
to net sales. This percentage is determined based on the most recent physical
inventory results as well as other factors, such as the time of year (i.e., the
percentage recorded in October is higher than at any other time due to
Halloween inventory, which carries a higher retail price-point), specifically
requested cycle-count results, and if a store or a district has had significant
theft issues. In general, paper products and party goods supplies have minimal
issues with damaged product or obsolescence. Vendors, however, often modify or
update patterns on an annual basis. If we are unable to sell through an
existing pattern before the changeover, we could end up with broken patterns
and accessories that could potentially be difficult to sell. Vendors will
often give us markdown dollars in advance to help mitigate the impact on margin
as a result of reducing the retail-selling price to sell through a pattern that
is, or will be, discontinued. We recognize these markdown dollars in gross
margin as the product is sold. We maintain a reserve on our books for
discontinued merchandise remaining at period end. The reserve for discontinued
inventory takes into consideration various factors such as the year in which
the product was discontinued and whether the retail value is less than cost.
At January 31, 2003, we had discontinued inventory of approximately $1.5
million and a reserve of approximately $125,000.

Store Opening and Closing Costs.In the event that a store is planned to
close before its lease has expired, any remaining lease obligation, net of
expected sublease recovery, is provided for in the period we adopt the plan to
close the store. In determining the amount of any remaining net lease
obligation, we make various assumptions, including but not limited to the time
that it would take to sublet a location, the cost to sublet or terminate a
lease and future increases for common area maintenance and real estate taxes.
In estimating the remaining lease obligation for a location, several factors
are considered including our history in subletting stores, the overall real
estate market, general economic conditions and whether we have any current, or
have had any recent leads on a location. The reserve for store closings at the
end of fiscal 2002 reflects a net provision of $263,000, equal to the estimated
remaining lease obligations on our cross-dock facility and on a store, both of
which we had adopted a plan during December 2002 to subsequently close. This
provision was partially offset by the reversal of excess amounts in the
reserve. In addition, the reserve

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for store closings also reflects reductions related to ongoing payments of
rent, common area maintenance, real estate taxes and other miscellaneous
expenses on stores that were previously closed.

Deferred Tax Asset Valuation Allowance.We currently have a full
valuation allowance against our deferred tax asset of approximately $7.7
million. The realization of these assets is contingent upon future taxable
earnings. Our deferred tax asset is reviewed for utilization using a more
likely than not approach as required by SFAS No. 109. As we have incurred
losses over the past several years, we have determined that a full valuation
allowance against our deferred tax asset is necessary to reduce the carrying
value of the Companys deferred tax assets to zero. We will continue to assess
the reasonableness of the valuation allowance against our deferred tax assets
and will consider reversing the valuation allowance when we begin to generate a
history of consistent earnings and project these earnings and utilization of
the deferred tax assets into the future.

Goodwill.We had $477,000 of goodwill as of January 31, 2003. Goodwill
is no longer amortized; however, it must be tested for impairment periodically,
or more frequently under certain circumstances, and written down when impaired.
We are subject to financial statement risk to the extent that goodwill becomes
impaired. In analyzing whether goodwill is impaired, we make certain
assumptions regarding the future cash flows of our stores and discount them in
determining fair value. Based on our analysis, we determined that our goodwill
was not impaired as of January 31, 2003.

Results of Operations

Revenues

Total revenues consist of retail sales from our Company-owned stores and
e-commerce website, and franchise related fees. Franchise related fees include
royalties we receive on sales, generally 4-5% of the stores sales, and initial
franchise fees, recognized at the time the franchisee signs a lease for a
store, and 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 thirteenth month of operation.

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, district store staff, expenses relating to
franchising, such as payroll, legal, travel and advertising, and
non-capitalizable costs associated with our Internet subsidiary.

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The following table sets forth for the periods indicated, certain costs
and expenses of continuing operations as a percentage of total revenues and
retail sales of continuing operations:

|                                                                |                        |  |                   |      |             |  |             |      |   |  |    |      |  
|--------------------------------------------------------------- | ---------------------- |  | ----------------- | ---- | ----------- |  | ----------- | ---- | - |  | -- | ---- | -
|                                                                |                        |  | Fiscal Year Ended
|                                                                |                        |  |                  
|                                                                |                        |  | January 31,       |      | February 1, |  | February 2,
|                                                                |                        |  | 2003              |      | 2002        |  | 2001       
|                                                                |                        |  |                   |      |             |  |            
|Costs of products sold and occupancy costs:                     |                        |  |                   |      |             |  |             |      |   |  |    |     
|                                                                | as % of total revenues |  |                   | 65.0 | %           |  |             | 65.9 | % |  |    | 63.8 | %
|                                                                | as % of retail sales   |  |                   | 66.4 | %           |  |             | 67.2 | % |  |    | 64.9 | %
|Store operating expenses:                                       |                        |  |                   |      |             |  |             |      |   |  |    |     
|                                                                | as % of total revenues |  |                   | 26.9 | %           |  |             | 25.4 | % |  |    | 23.5 | %
|                                                                | as % of retail sales   |  |                   | 27.5 | %           |  |             | 25.9 | % |  |    | 24.0 | %
|General and administrative expenses:                            |                        |  |                   |      |             |  |             |      |   |  |    |     
|                                                                | as % of total revenues |  |                   | 13.0 | %           |  |             | 13.6 | % |  |    | 12.0 | %
|                                                                | as % of retail sales   |  |                   | 13.3 | %           |  |             | 13.9 | % |  |    | 12.2 | %
|Number of Company-owned stores related to
continuing operations |                        |  | 86                |      |             |  | 87          |      |   |  | 85 |     

Fiscal Year Ended January 31, 2003 (Fiscal 2002  52 weeks) Compared to Fiscal
Year Ended February 1, 2002 (Fiscal 2001  52 weeks)

Revenues

Retail Sales.Retail sales from continuing operations of $73.7 million
for fiscal 2002 decreased approximately $701,000, or 0.94%, from retail sales
from continuing operations of $74.4 million for fiscal 2001. Full year
comparable store sales decreased 1.6%. This rate compares to a comparable
store sales decrease of 3.3% for fiscal 2001, calculated assuming fiscal 2000
was a 52-week year. Both fiscal 2002 and 2001 contained 52 weeks. Our 2002
sales fell short of expectations, as the retail industry and the overall
economy has continued to suffer and has struggled to rebound. Our sales
results were significantly impacted during fiscal 2002 as compared to fiscal
2001 as a result of our decision to reinstate the 50% discount on greeting
cards, which took place mid-fiscal 2002. In comparison, greeting cards were
sold at full retail cost during fiscal 2001. We made the decision to reinstate
the 50% discount after realizing a significant decline in overall transactions,
but particularly with greeting card unit sales, and after receiving numerous
negative comments from customers about the move to full retail price. As a
result of the pricing change, our sales results on greeting cards were $1.1
million below prior year levels. Sales from our Internet website, although
improved, were not significant during fiscal 2002. During the first quarter of
fiscal 2002, we exited the Seattle market when we completed the sale of 13
stores in Seattle. In addition, we closed one Company-owned store, bringing
the total to 86 as of January 31, 2003. At the end of fiscal 2001 in
comparison, we had a total of 100 Company-owned stores. Excluding the Seattle
stores that were sold in 2002, the total of Company-owned stores was 87 at the
end of fiscal 2001. As a result of our difficulty in obtaining product from
certain vendors due to our financial and liquidity position, our inventory
levels at January 31, 2003 were approximately $2.0 million below desired
levels. We anticipate that these reduced inventory levels will negatively
impact our sales results in fiscal 2003.

Franchise Related Fees.Fiscal 2002 franchise related fees of $1.5
million increased $24,000, or 1.6%, over fees for fiscal 2001. The
year-over-year increase reflects increased royalties from increased franchise
store sales. For both fiscal 2002 and 2001, royalty payments averaged 4% of
franchise store sales. During fiscal 2002, three franchise stores opened and
five franchise stores closed, bringing the total franchise stores to 50 as of
January 31, 2003, compared to 52 at the end of fiscal 2001.

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Costs and Expenses

Cost of Products Sold and Occupancy Costs.Cost of products sold and
occupancy costs for continuing operations totaled $48.9 million, or 66.4% of
retail sales, for fiscal 2002, as compared to $50.0 million, or 67.2% of retail
sales, for fiscal 2001. As a result of our aggressive markdown program in
fiscal 2001, we were able to remove a significant amount of slower moving and
discontinued items from our assortment, and we entered fiscal 2002 with a
higher blended margin on inventory available for sale than in the prior year.
Accordingly, our product margin percentage for fiscal 2002 increased over the
prior fiscal year. The increased margin also reflects a shift in sales from
seasonal product categories to everyday product categories, which typically
carry higher margins, successful pattern changeovers that took place earlier in
the year, and increased markdown dollars received from our vendors. These
increases were offset however, by lower margins on greeting cards, stemming
from the reintroduction of a 50% discount on greeting cards during the second
quarter of fiscal 2002. When we reintroduced the greeting card pricing, we
anticipated that the reintroduction of this discount program coupled with more
promotional product offerings would result in increased customer transactions
in our stores, in addition to increased greeting card unit sales. As a result
of these initiatives, however, we also expected to realize lower margins.
Since returning back to the 50% pricing in June 2002, we have seen a 53%
increase year-over-year in greeting card unit sales. Although our unit sales
for greeting cards continue to improve, they are still not at the levels we
experienced in fiscal 2000, before we made the original change to full retail
price. Occupancy costs from continuing operations for fiscal 2002 were higher
year-over-year, due to the annualization of rent on two stores that opened late
during the third quarter of fiscal 2001, and the expansion of an existing store
during fiscal 2002. Looking forward, we expect gross margins to remain
relatively flat to fiscal 2002.

Store Operating Expenses.Store operating expenses for continuing
operations for fiscal 2002 were $20.3 million, or 27.5% of retail sales, as
compared to $19.3 million, or 25.9% of retail sales, for fiscal 2001. The
increase year-over-year is due to higher net advertising costs. During fiscal
2002, we had two additional newspaper flyers, additional radio advertising, and
we moved from mailbox insertion to Sunday newspaper insertion, which costs
more. Additionally, the increase reflects moderate wage increases for store
personnel. Looking forward to fiscal 2003, we expect store operating expense
dollars to decrease as compared to fiscal 2002, primarily due to lower
depreciation expense as we continue to monitor and curtail capital
expenditures. We also continue to aggressively search for opportunities to
improve operational efficiencies and further reduce expenses.

General and Administrative Expenses.General and administrative expenses
were $9.8 million, or 13.0% of total revenues, for fiscal 2002, compared to
$10.3 million, or 13.6% of total revenues, for fiscal 2001. The year-over year
decrease reflects lower payroll and related benefits stemming from a one-time
discretionary payment made to employees during fiscal 2001, lower consulting
expenses, lower depreciation expense, as our website was fully depreciated
during fiscal 2002, and the cessation during fiscal 2002 of recording
amortization on our goodwill. These lower costs were partially offset by
increased legal and professional services costs associated with obtaining a
waiver for our default on our subordinated debentures. During the third
quarter of fiscal 2002, we announced an administrative expense reduction
initiative, which included a reduction in force that is expected to reduce
fiscal 2003 administrative costs by approximately $1.5 million from fiscal 2002
levels. We also continue to aggressively search for opportunities to further
reduce expenses.

Repositioning Credits/Provision.In the event we plan to close a store
before its lease has expired, we provide for any remaining lease obligation,
net of expected sublease recovery, in the period we adopt the plan to close the
store. During fiscal 2002, we recorded a net provision of $263,000 reflecting
the estimated remaining lease obligations on our cross-dock facility and on a
store, both of which we had adopted a plan during December 2002 to subsequently
close. This provision was partially offset by the reversal of excess

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amounts in the reserve. At January 31, 2003, we had a remaining store
closing reserve of approximately $674,000.

We review long-lived assets for impairment annually, and whenever events
or changes in circumstances indicate that the carrying amount may not be
recoverable. We recognize a loss for the difference if the fair value is less
than the carrying amount of the asset. No impairment loss was recognized in
either fiscal 2002 or fiscal 2001.

Interest Expense.For fiscal 2002, interest expense of $1.5 million, or
1.9% of total revenues, was 1.3% higher than interest expense of $1.4 million
for fiscal 2001. The slight increase over prior year reflects an accrual of
$100,000, which will be charged by our lender for a covenant waiver and loan
amendment, in addition to a higher average level of borrowings during fiscal
2002, offset by a lower variable rate of interest. We expect interest expense
for fiscal 2003 to be essentially flat to fiscal 2002 levels, reflecting a
slight increase in the prime rate, offset by a lower level of borrowings on our
revolving line of credit.

Net Loss.As a result of the factors discussed above, we realized a net
loss from continuing operations of $5.2 million, or $2.74 per diluted share, in
fiscal 2002. Our total loss for fiscal 2002, including a gain on the sale of
discontinued operations of $1.0 million, or $0.54 per diluted share, was $4.2
million, or $2.20 per diluted share. For fiscal 2001, we realized a net loss
from continuing operations of $7.9 million, or $4.19 per diluted share and a
total loss of $9.8 million, or $5.20 per diluted share.

Income Tax Benefit and Valuation Allowance.Our fiscal 2001 results
reflect our decision to record a full valuation allowance against our deferred
tax asset equal to approximately $6.1 million, as prescribed by authoritative
accounting guidance. Accordingly, during fiscal 2002, we recorded a valuation
allowance equal to the increase in our deferred tax asset of approximately $1.6
million, which resulted in a zero tax provision in our consolidated statement
of operations. Realization of the net operating loss carryforwards and other
deferred tax timing differences is contingent on future taxable earnings. The
recording of this allowance does not have any impact on, or correlation to, our
ability to operate as a continuing enterprise.

Our deferred tax asset was reviewed for expected utilization using a more
likely than not approach as required by Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes,by assessing the available
positive and negative evidence surrounding the recoverability of the deferred
tax asset. We continue to assess and evaluate strategies that will enable the
deferred tax asset, or portion thereof, to be utilized, and will reduce the
valuation allowance appropriately at such time when it is determined that the
more likely than not approach is satisfied.

Fiscal Year Ended February 1, 2002 (Fiscal 2001  52 weeks) Compared to Fiscal
Year Ended February 2, 2001 (Fiscal 2000  53 weeks)

Revenues

Retail Sales.Retail sales from continuing operations of $74.4 million
for fiscal 2001 decreased $3.6 million, or 4.6%, from retail sales from
continuing operations of $78.0 million for fiscal 2000. Fiscal 2001 contained
52 weeks compared to 53 weeks for fiscal 2000. Excluding
the 53rd week for
fiscal 2000, equal to approximately $1.1 million of sales, retail sales
declined 3.3% year-over-year. Our fiscal 2001 sales were negatively impacted
by the weakened economy, which was compounded by the September 11, 2001
tragedy, and resulting effect on consumer confidence. Although our seasonal
category sales consistently performed well during fiscal 2001, our everyday
product categories performed at below prior year levels. Sales from our
Internet website were not significant during fiscal 2001, although the
websites results reflected substantial improvement since its relaunch in the
third quarter of fiscal 2000. During fiscal 2001, we opened two Company-owned
stores, bringing the total stores related to continuing operations to 87 as of
February 1,

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2002, compared to 85 at the end of fiscal 2000. Comparable store sales
from continuing operations for fiscal 2001 decreased 3.3% from the prior year
comparable period, and were calculated assuming fiscal 2000 was a 52-week year.
This growth rate compared to a comparable store sales increase of 5.3% for
fiscal 2000.

Franchise Related Fees.Fiscal 2001 franchise related fees of $1.5
million increased $56,000, or 3.9%, over fees for fiscal 2000. The
year-over-year increase reflected increased royalties from increased franchise
store sales and higher initial franchise fees. For both fiscal 2001 and 2000,
royalty payments averaged 4% of franchise store sales. During fiscal 2001,
seven franchise stores opened and four franchise stores closed, bringing the
total franchise stores to 52 as of February 1, 2002, compared to 49 at the end
of fiscal 2000.

Costs and Expenses

Cost of Products Sold and Occupancy Costs.Cost of products sold and
occupancy costs from continuing operations totaled $50.0 million, or 67.2% of
retail sales, for fiscal 2001, as compared to $50.7 million, or 64.9% of retail
sales, for fiscal 2000. We realized a significant decrease in our product
margins during fiscal 2001 as compared to the prior year. The lower margin
reflected the implementation, during the second half of the year, of an
aggressive markdown program in which we elected to take faster and deeper
markdowns than we had previously done. This strategy enabled us to reduce
carryover and remove slower moving items from our merchandise assortment. This
strategy also allowed us to purchase fresher and trendier merchandise for
fiscal 2002. Occupancy costs were slightly higher year-over-year primarily due
to the opening of two new stores.

Store Operating Expenses.Store operating expenses from continuing
operations for fiscal 2001 were $19.3 million, or 25.9% of retail sales, as
compared to $18.7 million, or 24.0% of retail sales, for the comparable period
in the prior year. More than half the increase in the percentage
year-over-year was due to an increase in fixed labor costs. We continued to
realize higher wage rate pressure due to the tightness of certain labor
markets. Our labor needs, particularly for seasonal events, are projected
based on an expected sales volume, which didnt materialize in fiscal 2001. We
also realized higher net advertising costs year-over-year due to our investment
in two additional flyers in the second and third quarters of fiscal 2001 in an
effort to bring additional customers into our stores.

General and Administrative Expenses.General and administrative expenses
from continuing operations were $10.3 million, or 13.6% of total revenues, for
fiscal 2001, compared to $9.5 million, or 12.0% of total revenues, for fiscal
2000. Excluding the 53rd week of sales reflected in fiscal 2000s results of
approximately $1.1 million, fiscal 2000 general and administrative expenses as
a percentage of total revenue were 12.1%. The year-over year increase
reflected costs associated with the leasing and maintenance on our back-office
computer systems for our Company-owned stores, which were installed during
fiscal 2001. The increase also reflected higher payroll due to a one-time
discretionary payment to employees as well as higher health insurance costs, as
we absorbed a larger percentage of the health insurance coverage during fiscal
2001. In addition, during fiscal 2001 we incurred higher marketing costs for
our franchise operations to gain additional exposure in an effort to improve
franchise sales.

Repositioning Credits/Provision.In the event we plan to close a store
before its lease has expired, we provide for any remaining lease obligation,
net of expected sublease recovery, in the period we adopt the plan to close the
store. During fiscal 2001, we sublet one store location and reversed $230,000
of our repositioning reserve that was recorded during fiscal 1999. In
addition, during fiscal 2001, we recorded a provision of $108,000 equal to the
remaining lease obligations on a store that was subsequently relocated.

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We review long-lived assets for impairment annually, and whenever events
or changes in circumstances indicate that the carrying amount may not be
recoverable. We recognize a loss for the difference if the fair value is less
than the carrying amount of the asset. No impairment loss was recognized in
either fiscal 2001 or fiscal 2000.

Interest Expense.For fiscal 2001, interest expense of $1.4 million, or
1.9% of total revenues from continuing operations, decreased 14%, or $237,000
from interest expense of $1.7 million for fiscal 2000. The decrease from prior
year reflects a lower level of borrowings on our revolving credit facility
throughout the year, stemming from our ability to defer approximately $3.0
million in trade payments with some of our largest vendors, as well as
substantial reductions throughout the year in the prime rate. The interest
favorability was partially offset by the write-off of approximately $75,000 in
deferred financing costs associated with our previous line of credit.

Net Loss.As a result of the factors discussed above, we realized a net
loss from continuing operations of $7.9 million, or $4.19 per diluted share,
and a total net loss of $9.8 million, or $5.20 per diluted share, in fiscal
2001. For fiscal 2000, we realized net income from continuing operations of
$125,000, or $0.07 per diluted share, and a total net loss of $434,000, or
$0.27 per diluted share.

Income Tax Benefit and Valuation Allowance.Our fiscal 2001 results
reflect our decision to record a full valuation allowance against our deferred
tax asset equal to approximately $6.1 million, as prescribed by authoritative
accounting guidance. Realization of the net operating loss carryforwards and
other deferred tax timing differences is contingent on future taxable earnings.
The recording of this allowance did not have any impact on, or correlation to,
our ability to operate as a continuing enterprise.

Our deferred tax asset was reviewed for expected utilization using a more
likely than not approach as required by Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes,by assessing the available
positive and negative evidence surrounding the recoverability of the deferred
tax asset. We continue to assess and evaluate strategies that will enable the
deferred tax asset, or portion thereof, to be utilized, and will reduce the
valuation allowance appropriately at such time when it is determined that the
more likely than not approach is satisfied.

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. Any factor that negatively affects our revenues or increases our
operating expenses during these seasonal events could negatively affect our
annual results of operations. For instance, we could spend a large amount to
advertise these events and not generate sufficient sales. In addition, we
commit to purchase inventory to support these events far in advance of the
selling season. If we are not timely in these purchases or are unable to
purchase the appropriate quantity, we could lose sales. Our seasonal sales are
heavily augmented by sales in our solid color and institutional/food service
product categories. Therefore, a low sales performance for any of our seasonal
categories could impact the sales results for our everyday product categories.
Our fiscal quarters do not end on calendar quarters, and as a result of yearly
changes to the retail calendar as well as various shifts in the calendar due to
the timing of our seasonal events, our quarterly results may not be comparable
year-over-year.

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Typically during our first quarter, the combination of a minimal number of
smaller seasonal events with a fixed cost structure, results in a loss. We
expect to incur a loss in the first quarter of each year for the foreseeable
future.

Liquidity and Capital Resources

Our liquidity needs vary throughout the year as a result of the seasonal
nature of our business. In order to support our seasonal events, we have to
commit to purchase inventory far in advance of the selling season. Our cash
availability also fluctuates as a result of:



| |  |  | the level of our inventory, which primarily determines our line-of-credit borrowing capacity;
| | - |  | ---------------------------------------------------------------------------------------------
|
| |  |  | timing of purchases and our ability to negotiate credit terms on those purchases;            
|
| |  |  | our profitability;                                                                           
|
| |  |  | intra-month cash needs for payment of rent, payroll and other operational payables;          
|
| |  |  | our revolving line of credit covenants; and                                                  
|
| |  |  | timing of new store openings, remodels and/or relocations.                                   

Our primary cash requirements are for ongoing operations, consisting
primarily of investments in our inventory, costs associated with payroll, and
payments on our store leases consisting of rent, common area maintenance and
real estate taxes. Our primary sources of cash have been:



| |  |  | borrowings under our revolving line of credit;                                                                                                                                      
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | everyday payment terms from vendors;                                                                                                                                                
|
| |  |  | extended payment terms negotiated with certain of our vendors and landlords;                                                                                                        
|
| |  |  | proceeds from financings such as our shareholder rights
offering, our public sale of convertible subordinated debt, the
refinancing of our mortgage and our initial public offering;
|
| |  |  | lease financings.                                                                                                                                                                   

Over the
past several years, we have not generated sufficient cash from
operations to satisfy our operating needs. Beginning in the second
half of fiscal 2002, we undertook measures aimed at improving our
liquidity position. During the third quarter of fiscal 2002, we
implemented an operating expense reduction initiative, including a
reduction in force, projected to reduce fiscal 2003 expenses by
approximately $1.5 million from fiscal 2002 levels. We have
subsequently identified further expense reductions. In addition, in
order to assist with our short-term liquidity needs, we negotiated
with several of our largest vendors in the fourth quarter of fiscal
2002 to provide us with extended payment terms on approximately $4.6
million of accounts payable through June 2003.

Notwithstanding
these efforts, the Report of Independent Certified Public Accountants
accompanying our audited financial statements for the year ended
January 31, 2003 indicates that there is a substantial doubt
regarding our ability to continue our operations as a going concern
over the course of fiscal 2003 absent an infusion of cash. Based on
our current cash position, our recent inability to generate cash from
operations, and our need to purchase in advance inventory for our
upcoming seasonal events, our need to raise cash to satisfy our
working capital needs is immediate. We are actively pursuing
opportunities to satisfy our cash needs through debt and equity
financing. To date, however, we have not been successful in obtaining
the funds needed we may be unable to obtain funding to meet our
immediate needs on terms acceptable to us or at all. Failure to
obtain the required funds in a timely manner, or significantly
improve our cash position through other avenues, may prevent us from
purchasing sufficient inventory for our upcoming seasonal events and
may hinder our ability to pay our debts as they come due. In such
case, we may seek, or be forced to seek, protection under the
bankruptcy laws.



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In order to provide us with the liquidity we needed during the first
quarter of fiscal 2002, we entered into a short-term loan of $1.0 million with
an unrelated business partner, which was paid in full during fiscal 2002, as
agreed upon. Additionally during the first quarter of fiscal 2002 we sold our
13 stores in the Seattle market for approximately $4.5 million. We also
obtained additional liquidity due to an agreement with a key vendor that
resulted in additional borrowing capacity under our revolving credit agreement.
On September 5, 2002, Wells Fargo Retail Finance granted us an overline that
had provided us with approximately $1.4 million of excess availability on our
revolving line of credit. The overline expired on December 2, 2002. Amounts
outstanding under the overline bore interest at prime plus 150 basis points and
were fully secured by a standby letter of credit, issued by a major bank and
guaranteed by a key vendor. We have a multi-year contractual purchase
obligation with this vendor, and as consideration for issuing the letter of
credit, we negotiated additional purchase commitments with this vendor.

During the first quarter of fiscal 2001, in order to provide us with the
liquidity we needed to fund our operations into the second quarter, we
negotiated extended payment terms with several of our largest vendors. The
arrangements with our vendors resulted in the extended dating of approximately
$3.0 million of trade payments, which were repaid in full during fiscal 2001,
as agreed upon. In addition, we were able to extend approximately $500,000 of
rent payments into the second half of fiscal 2001 or beyond.

Our working capital related to continuing operations was a deficit of
approximately ($3.7) million at January 31, 2003 compared to ($2.8) million at
February 1, 2002. Our current ratio was 0.80 to 1.00 at January 31, 2003
compared to 0.85 to 1.00 at February 1, 2002. The year-over-year change in our
working capital and current ratio calculations was primarily due to a 13%
decline in inventory levels.

Net cash provided by (used for) continuing operations for each of the last
three fiscal years was approximately $858,000 in fiscal 2002, $782,000 in
fiscal 2001 and ($194,000) in fiscal 2000. Cash generation in fiscal 2002 and
2001 reflects a decline in inventory and an increase in accounts payable. The
reduction in inventory levels during fiscal 2002 reflects our difficulty in
obtaining product from certain vendors due to our financial difficulties and
liquidity position. As a result, our inventory levels at January 31, 2003 are
approximately $2.0 million below desired levels. The lower levels also reflect
a purposeful reduction in seasonal pack-away inventory, and delays in resetting
new patterns and implementing new programs. The increase in accounts payable
reflects extended terms by several of our largest vendors to June 30, 2003.
The reduction in inventory levels during fiscal 2001 reflects our decision
during fiscal 2001 to aggressively remove slower moving merchandise from our
assortment. The increase in accounts payable reflects the consolidation of
certain segments of our business to some of our larger vendors who offer more
extended terms than some of our smaller vendors. The cash use in fiscal 2000
reflects a reduction in merchandise inventory levels of $1.8 million and a
reduction in accounts payable of $1.9 million. We continue to strive, when
possible, to take advantage of cash discounts and other favorable terms that
are offered by our vendors.

Net cash provided by (used for) investing activities was approximately
$3.0 million for fiscal 2002, ($771,000) for fiscal 2001, and ($983,000) for
fiscal 2000. The generation of cash in fiscal 2002 reflects proceeds from the
sale of our Seattle stores and the cancellation of an insurance policy, net of
capital expenditures. The use of cash in fiscal 2001 and fiscal 2000 consisted
almost entirely of capital expenditures related to upgrading our information
systems and remodeling our Company-owned stores. We have invested and will
continue to evaluate our needs for additional investment in information
technology and infrastructure capabilities in order to gain operational
efficiencies. We anticipate that we will spend approximately $400,000 on
capital expenditures during fiscal 2003 for store relocations and remodels, and
continuing enhancements to information systems. We lease sites, of
approximately 8,500 square feet, for our

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Company-owned stores rather than own real estate. If the number of stores
we plan to open, relocate or remodel increases or decreases, this estimate may
change accordingly. Our plans may also vary based upon the availability of
suitable locations and the availability of acceptable terms. We may
additionally seek to acquire existing stores from franchisees. At present, we
have no agreement to acquire any franchise store.

Net cash (used for) provided by financing activities for continuing
operations was ($3.6 million) for fiscal 2002, and $1.2 million for both fiscal
2001 and fiscal 2000. The use of cash in fiscal 2002 primarily reflects
necessary payments on our revolving line-of-credit to stay within the
parameters of our credit facility as a result of low inventory levels. The
generation of cash in fiscal 2001 reflects the proceeds received from a $1.0
million note from an unrelated business partner in addition to increases in our
revolving line of credit, partially offset by required payments on our
long-term debt. The generation of cash in fiscal 2000 primarily reflects the
net proceeds received from our shareholder rights offering.

We have convertible subordinated debentures in an aggregate principal
amount of $4.0 million, which mature in 2005, and are convertible at $9.00 into
approximately 444,000 shares of our common stock. The indenture under which
these debentures were issued contains covenants that require us to satisfy
certain financial tests and impose restrictions on our ability to pay
dividends. The debentures bear interest at an annual rate of 10.5%, payable
quarterly.

As of the end of our 2001 fiscal year, and for much of our 2002 fiscal
year, we were in breach of a covenant under the indenture governing our
subordinated debentures, which required us to maintain a minimum consolidated
net worth of at least $7.0 million. This breach became an event of default
under the indenture, which caused a cross default under our revolving credit
agreement, and provided our secured lender with the right to prevent us from
paying future principal or interest payments to the holders of our subordinated
debentures until the event of default under the indenture was cured, waived or
ceased to exist and our secured lender had waived the default under the
revolving credit agreement. As a result, we were not allowed to timely make
two interest payments to our debenture holders. We asked our debenture holders
to waive the defaults existing under the indenture, as well as approve
amendments to the indenture to make certain changes in its financial covenants.
During the third quarter of fiscal 2002, we received the requisite consent
from the holders of our subordinated debentures to waive the defaults existing
under the indenture and approve the amendments to the indenture. We were also
able to receive a waiver from our senior lender for the cross default that
existed under our revolving credit agreement. As a result, we were
subsequently permitted to make, and we have made, all past due interest
payments on the debentures.

We have a $15.0 million multi-year revolving line of credit facility with
a bank for general working capital purposes that expires in September 2004.
Borrowings outstanding under this line of credit bear interest at a variable
rate and are secured by substantially all of our assets. 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. At January 31, 2003,
we had availability of $6.2 million, of which approximately $5.6 million was
outstanding. At February 1, 2002, we had availability of $10.0 million, of
which approximately $7.7 million was outstanding. Capacity under our revolving
line of credit is largely contingent on our inventory levels as well as an
advance rate on those inventory levels. The advance rate is determined based
on a third party valuation of our inventory that takes into consideration among
other factors, the quality of our inventory, in addition to the overall
economy, which determines the expected rate of sale and the estimated costs
should a liquidation of the inventory be required. A significant decline in
the valuation of our inventory as a result of any of the factors above could
have a significant impact on our borrowing capacity and on our ability to meet
short-term obligations.

During fiscal 2002, our senior lender granted us excess borrowing capacity
in the form of an overline. Between the period of September 5, 2002 and
December 2, 2002, this overline provided us with

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approximately $1.4 million of excess availability on our revolving line of
credit. Amounts outstanding under this overline bore interest at prime plus
150 basis points, and were fully secured by a standby letter of credit issued
by a major bank and guaranteed by a key vendor. We have a multi-year
contractual purchase obligation with this vendor, and as consideration for
issuing the letter of credit, we negotiated additional purchase commitments
with this vendor.

The
revolving credit agreement contains covenants, which require us to
maintain certain financial covenants and a certain level of
availability, imposes restrictions on our ability to pay dividends,
as well as other requirements. At January 31, 2003 and subsequent to
January 31, 2003, we were out of compliance with several covenants.
On May 1, 2003, we obtained a waiver for our non-compliance. This
waiver is conditional upon our providing a revised business plan on
or before May 31, 2003, our receiving a commitment and subsequent
funding for at least $5.0 million infusion of equity on or before
June 13, 2003 or such later date as approved by the lender in its
discretion, as well as other requirements. If we fail to meet any of
the waiver conditions, we will again be in default of the credit
agreement, and our lender will be entitled to demand full payment of
all outstanding amounts there under. A default under the
line-of-credit provision would not cause a cross default provision to
occur under any of our other debt.

We lease all of our retail stores under noncancelable operating leases
that have various expiration dates. Some of our operating leases provide for
scheduled increases in base rentals over their terms. For these leases, we
recognize the total rental amounts due over the lease terms on a straight-line
basis, and we establish corresponding deferred rent credits for the differences
between the amounts recognized and the amounts paid.

In addition to commitments we have related to our lease obligations, we
also have required payments to be made on our debt outstanding.

The following is a schedule summarizing our contractual obligations at
January 31, 2003:

|                                   |  |                        |            |        |  |           |           |           |  |         |            |  |  |   |           |       |  |   |           | 
|---------------------------------- |  | ---------------------- | ---------- | ------ |  | --------- | --------- | --------- |  | ------- | ---------- |  |  | - | --------- | ----- |  | - | --------- | 
|                                   |  | Payments due by period
|                                   |  |                       
|Contractual                        |  |                        |            |        |  | Less than |           |           |  |         |            |  |  |   |           | After
|Obligations:                       |  | Total                  |            | 1 year |  | 1-2 years |           | 3-4 years |  | 4 years
|                                   |  |                        |            |        |  |           |           |           |  |        
|Debt obligations (1) (2)           |  | $                      | 5,068,137  |        |  | $         | 105,889   |           |  | $       | 4,074,531  |  |  | $ | 85,910    |       |  | $ | 801,807   | 
|Capital lease obligations (2)      |  |                        | 333,381    |        |  |           | 298,221   |           |  |         | 35,160     |  |  |   |          |       |  |   |          | 
|Operating leases (3)               |  |                        | 42,523,273 |        |  |           | 9,559,276 |           |  |         | 15,179,421 |  |  |   | 9,733,834 |       |  |   | 8,050,742 | 
|                                   |  |                        |            |        |  |           |           |           |  |         |            |  |  |   |           |       |  |   |           | 
|Total contractual cash
obligations |  | $                      | 47,924,791 |        |  | $         | 9,963,386 |           |  | $       | 19,289,112 |  |  | $ | 9,819,744 |       |  | $ | 8,852,549 | 
|                                   |  |                        |            |        |  |           |           |           |  |         |            |  |  |   |           |       |  |   |           | 



(1)     
    Debt obligations reflect required principal payments on debt existing at
January 31, 2003, excluding $100,000 of subordinated notes payable on demand.
In addition, the debt obligations disclosure above does not reflect our $15.0
million revolving line-of-credit facility that had a balance outstanding of
approximately $5.6 million at January 31, 2003.

(2)     
    We define current maturities of long-term debt and capital lease
obligations as being due within a twelve-month period from January 31, 2003.

(3)     
    The amounts reflected for operating leases primarily represent
noncancelable lease payments on our retail store locations.

In addition to the contractual obligations above, we have a multi-year
exclusive 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

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overline with our bank. As consideration for issuing the letter
of credit, we renegotiated our supply agreement with this vendor 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.

In general, our highly-leveraged financial condition, as well as the
possible reactions of suppliers, franchisees, other creditors and employees to
publicity regarding our continuing losses, make it extremely difficult for us
to predict our actual liquidity needs. The assumptions underlying our
projections as to such needs, therefore, may not be realized as discussed
previously in the above liquidity and capital resources section.

Recently Issued Accounting Pronouncements and Passed Legislation

In June 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 146, Accounting for
Costs Associated with Exit or Disposal Activities.SFAS No. 146 addresses
accounting and processing for costs associated with exit or disposal
activities. SFAS No. 146 requires the recognition of a liability for a cost
associated with an exit or disposal activity when the liability is incurred
versus the date a company commits to an exit plan. In addition, SFAS No. 146
states the liability should be initially measured at fair value. The
requirements of SFAS No. 146 are effective for exit or disposal activities that
are initiated after December 31, 2002. We believe the adoption of SFAS No. 146
will not have a material effect on our consolidated financial position or
results of operations.

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others.FIN 45 addresses the disclosure
requirements of a guarantor in its interim and annual financial statements
about its obligations under certain guarantees that it has issued. FIN 45 also
requires a guarantor to recognize, at the inception of a guarantee, a liability
for the fair value of the obligation undertaken in issuing the guarantee. The
disclosure requirements of FIN 45 are effective for us for our year ended
January 31, 2003. The liability recognition requirements will be applicable
prospectively to all guarantees issued or modified after December 31, 2002.
This pronouncement is not anticipated to have a material effect on our
consolidated financial position or results of operations.

In December 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based
CompensationTransition and Disclosure. SFAS No. 148 amends the disclosure and
certain transition provisions of Statement 123, Accounting for Stock-Based
Compensation.Its disclosure provisions, which apply to all entities with
employee stock-based compensation, are effective for fiscal years ending after
December 15, 2002. New interim period disclosures are also required in
financial statements for interim periods beginning after December 15, 2002.
Other than the additional disclosure requirements, this pronouncement is not
anticipated to have a material effect on our consolidated financial position or
results of operations.

In January 2003, the FASB issued FIN No. 46 (FIN 46), Consolidation of
Variable Interest Entities.FIN 46 is an interpretation of Accounting Research
Bulletin No. 51, Consolidated Financial Statements,and addresses consolidation
of business enterprises of variable interest entities. FIN 46 applies
immediately to variable interest entities created or obtained after January 31,
2003 and it applies in the first fiscal year or interim period beginning after
June 15, 2003, to variable interest entities in which an enterprise holds a
variable interest that it acquired before February 1, 2003. This pronouncement
is not anticipated to have a material effect on our consolidated financial
position or results of operations.

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of
2002, which immediately impacts Securities and Exchange Commission registrants,
public accounting firms, lawyers and

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securities analysts. This legislation is
the most comprehensive since the passage of the Securities Act of 1933 and
Securities Exchange Act of 1934. It has far reaching effects on the standards
of integrity for corporate management, board of directors, and executive
management. Additional disclosures, certifications and procedures will be
required of the Company. We do not expect any material adverse effect on the
Company as a result of the passage of this legislation; however, the full scope
of the Sarbanes-Oxley Act has not yet been determined.

Inflation

We do not believe that inflation has had a material impact upon our
historical operating results, and we do not expect it to have a material impact
in the future. There can be no assurances, however, 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.




ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We have used 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
changes in the prime rate. We do not consider this exposure to be material to
our consolidated financial position, results of operations or cash flows. We
do not use any derivative financial instruments or engage in any other hedging
activities.




ITEM 8.        FINANCIAL STATEMENTS.

Our Consolidated Financial Statements and the reports of our independent
certified public accountants are included elsewhere in this Annual Report on
Form 10-K. The index to these financial statements is included in Item 15 (a)
(1) of this Annual Report.




ITEM
9.       CHANGES IN AND
DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND

FINANCIAL DISCLOSURE.


None.

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PART III




ITEM 10.     DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

Directors of the Registrant

The following table sets identifies the members of our Board of Directors
and sets forth certain information as of March 1, 2003, which has been
furnished to us by our directors.

|                            |  |     |    |       |  |                                                               |  |          |      | 
|--------------------------- |  | --- | -- | ----- |  | ------------------------------------------------------------- |  | -------- | ---- | 
|Information About Directors
|                           
|Name of Nominees            |  |     |    |       |  |                                                               |  | Director
|for Election                |  | Age |    | Title |  | Since                                                        
|                            |  |     |    |       |  |                                                              
|Yale T. Dolginow (1)        |  |     | 60 |       |  | Chairman of the
Board, President and
Chief Executive
Officer. |  |          | 1986 | 
|                            |  |     |    |       |  |                                                               |  |          |      | 
|Diane C. Dolginow           |  |     | 59 |       |  | Director and Secretary                                        |  |          | 1986 | 
|                            |  |     |    |       |  |                                                               |  |          |      | 
|Jeffrey S. Halpern (1)(2)   |  |     | 60 |       |  | Director                                                      |  |          | 1997 | 
|                            |  |     |    |       |  |                                                               |  |          |      | 
|Martin A. Mayer (1)(2)      |  |     | 60 |       |  | Director                                                      |  |          | 1992 | 
|                            |  |     |    |       |  |                                                               |  |          |      | 
|Richard W. Perkins (1)      |  |     | 72 |       |  | Director                                                      |  |          | 2000 | 



---

|(1) |  | Member of the Compensation Committee
|--- |  | ------------------------------------
|   
|(2) |  | Member of the Audit Committee       

Other Information About Directors

Yale T. Dolginowhas been President, Chief Executive Officer and Chairman
of the Board of Directors of the Company since 1986. From 1982 to 1986, Mr.
Dolginow served as President and Chief Executive Officer of Carlson Catalog
Showrooms, Inc., which was a chain of 59 catalog showrooms located throughout
the Midwest. From 1981 to 1982, Mr. Dolginow served as Assistant to the
President of Dayton Hudson Corporation, k/n/a Target Corporation. From 1978 to
1980, Mr. Dolginow served as President of Modern Merchandising, Inc. a 70-store
retail chain operating in several markets, and as Executive Vice President from
1977 to 1978. From 1968 to 1976, Mr. Dolginow was the Chief Executive Officer
and President of Dolgins, Inc. a chain of catalog showroom stores that
operated in the Kansas City and St. Louis metropolitan markets. Mr. Dolginow
is a member of the advisory board of University of Kansas School of Business,
and a director of Bet Shalom Congregation and the Minneapolis Heart Institute,
all three not-for-profit organizations. Mr. Dolginow and Diane C. Dolginow are
husband and wife.

Diane C. Dolginowhas been a director of the Company since 1986 and
Secretary since August 1997. Since 1994, Ms. Dolginow has been a director on
the National Advisory Board of the School of Education at the University of
Kansas, a not-for-profit organization. Ms. Dolginow and Mr. Dolginow are
husband and wife.

Jeffrey S. Halpernhas been a director of the Company since 1997. He has
been Chairman of the Board and Chief Executive Officer of Southwest Casino and
Hotel Corp. since 1993. Mr. Halpern was a partner in the law firm of Popham,
Haik, Schnobrich & Kaufman, Ltd. from 1989 to 1993, and a founding

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partner of
Halpern & Druck from 1980 to 1989. As an officer and director of Southwest
Casino and Hotel Corp., Mr. Halpern also holds the position of manager of Gold
Rush I, LLC, which filed a petition for reorganization under Chapter 11 of the
Bankruptcy Code before the U.S. Bankruptcy Court for the District of Minnesota
on August 31, 2001,
which plan was confirmed by the court on September 11, 2002. In
connection with the Chapter 11 proceeding, no petition has been filed by or
against Mr. Halpern in his individual capacity.

Martin A. Mayerhas been a director of the Company since 1992. He has
been President of Mayer and Associates since 2000. From 1992 to 2000, Mr.
Mayer was an independent financial consultant. Mr. Mayer was a partner with
Peat Marwick Mitchell & Co., k/n/a KPMG LLP, an international firm of certified
public accountants, from 1973 until 1992. Mr. Mayer is a certified public
accountant. Mr. Mayer is a director of American Select, a privately held
company.

Richard W. Perkinshas been a director of the Company since 2000. Mr.
Perkins is President of Perkins Capital Management, Inc., an investment
management company that he founded in 1984. From 1966 to 1984 he served as a
vice president of Piper Jaffray, k/n/a US Bancorp Piper Jaffray. Mr. Perkins
is a Chartered Financial Analyst and a fellow of the Financial Analysts
Federation. He is a director and on the compensation committee of
Bio-Vascular, Inc., CNS, Inc., iNTELEFILM Corporation, Lifecore Biomedical,
Inc., Nortech Systems, Inc., PW Eagle, Inc., Quantech, Ltd., Synovis Life
Technologies, Inc., Two Way TV (US), Inc., Vital Images, Inc., and XOX
Corporation, all public companies.

Executive Officers and Other Key Personnel

The following table contains certain information about our executive
officers and other key personnel as of March 1, 2003:

|                    |  |     |    |          |  |                                                                         
|------------------- |  | --- | -- | -------- |  | ------------------------------------------------------------------------
|Name                |  | Age |    | Position
|                    |  |     |    |         
|Yale T. Dolginow    |  |     | 60 |          |  | President, Chief Executive Officer and
Chairman of the Board            
|                    |  |     |    |          |  |                                                                         
|Diana G. Purcel     |  |     | 36 |          |  | Vice President and Chief Financial Officer                              
|                    |  |     |    |          |  |                                                                         
|Michael A. Anderson |  |     | 42 |          |  | Vice President of Franchising                                           
|                    |  |     |    |          |  |                                                                         
|Steven P. Durst     |  |     | 34 |          |  | Vice President of Strategic Planning,
Merchandise Planning and Budgeting
|                    |  |     |    |          |  |                                                                         
|Robert A. Henderson |  |     | 57 |          |  | Vice President and Chief Merchant                                       
|                    |  |     |    |          |  |                                                                         
|Kristen Lenn        |  |     | 35 |          |  | Vice President of Human Resources                                       
|                    |  |     |    |          |  |                                                                         
|Carol A. Nelson     |  |     | 52 |          |  | Vice President of Stores                                                
|                    |  |     |    |          |  |                                                                         
|James G. VanSoest   |  |     | 49 |          |  | Vice President of Information Systems                                   

Other Information About Executive Officers and Other Key Personnel

Yale T. Dolginow see Other Information About Directors  above.

Diana G. Purcel, CPAwas promoted to Vice President and Chief Financial
Officer during fiscal 2002, and has been with Paper Warehouse for 4 years.
Previously she served as our Controller and Chief Accounting Officer since 1999
and as one of our Vice Presidents since 2000. She is a certified public
accountant. From 1998 to 1999, Ms. Purcel was Divisional Controller for
Corporate Planning and Reporting for Damark International, Inc. (k/n/a Provell,
Inc). From 1994 to 1998, Ms. Purcel was a Senior Analyst with

32



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Dayton Hudson
Corporation (k/n/a Target Corporation). Prior to joining Dayton Hudson
Corporation and since 1988, Ms. Purcel was a senior auditor with Arthur
Andersen LLP.

Robert A. Hendersonhas served as Vice President and Chief Merchant since
April 2002. From 1983 to 1998, Mr. Henderson served as senior vice president,
general merchandising manager at Musicland
Corporation, a 1,600-store chain. Prior to that he served in
merchandising and marketing capacities at Modern Merchandising and Target
Corporation.

Steven P. Dursthas been with Paper Warehouse for 7 years. He has served
as Vice President of Strategic Planning, Merchandise Planning and Budgeting
since 2002. He served as Vice President of Merchandising since from 1998 to
2002, and continues to be involved in merchandising and planning. Mr. Durst
joined us in 1995 as Director of Information Systems, and became Vice President
of Information Systems in 1997. From 1990 to 1995, Mr. Durst was employed by
Exxon Corporation where he performed various engineering and business planning
functions. Mr. Durst is the son-in-law of Mr. and Mrs. Dolginow.

Michael A. Andersonhas served as our Vice President of Franchising since
1999 and has been with Paper Warehouse for 11 years. From 1991 to 1999 Mr.
Anderson served as our Controller. From 1987 to 1991, Mr. Anderson was an
accountant at Luri, Eiger, Besikof & Company, a Minneapolis public accounting
firm. From 1982 to 1986, Mr. Anderson was a staff accountant with Marvin O.
Anderson, LPA, a public accounting firm located in Minnesota.

Kristen Lennhas served as our Vice President of Human Resources for 5
years. From 1994 to 1997, Ms. Lenn was a Senior Consultant with McGladrey &
Pullen LLP (k/n/a RSM McGladrey, Inc.), a public accounting and consulting
firm, and provided a wide range of human resources services to clients. From
1989 to 1994, Ms. Lenn held a number of positions for mid-size companies
implementing human resources strategies.

Carol A. Nelsonhas served as our Vice President of Stores since 1997 and
has been with Paper Warehouse for 8 years. Ms. Nelson joined us as Director of
Stores from 1994 to 1997. From 1992 to 1994, Ms. Nelson was Director of Stores
of CBR, Inc., a privately owned retailer, specializing in airport retail. From
1976 to 1992, Ms. Nelson served as a District Manager, managing 17 stores in a
five-state area, for Best Products, Inc/Modern Merchandise.

James G. VanSoesthas served as our Vice President of Information Systems
since September of 2002, and has been with Paper Warehouse for 4 years. From
December 1998 through September of 2002, Mr. Van Soest served as the Director
of Technical Services for Paper Warehouse. From 1976 through 1998, Mr. Van
Soest held a number of positions in Information Systems, including Director of
Information Services, for County Seat Stores, a publicly held specialty soft
goods retailer.

Compliance with Section 16 (a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
our directors, executive officers and all persons who beneficially own more
than 10% of the outstanding shares of our Common Stock to file initial reports
of ownership and reports of changes in ownership of our Common Stock with the
SEC. Executive officers, directors and greater than 10% beneficial owners are
also required to furnish us copies of all Section 16(a) forms they file. To
our knowledge, based upon a review of the copies of such reports furnished to
us during the year ended January 31, 2003, and written representations by such
persons, none of the directors, officers and beneficial owners of greater than
10% of our Common Stock failed to file on a timely basis the forms required by
Section 16(a) of the Exchange Act.

33



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ITEM 11.     EXECUTIVE COMPENSATION.

Summary of Cash and Certain Other Compensation

The following table provides summary information concerning cash and
non-cash compensation for each of the last three fiscal years paid to or earned
by our President and Chief Executive Officer and our four other most highly
compensated executive officers who were serving as executive officers at the
end of the last completed fiscal year, and two additional individuals who
served as executive officers during the last completed fiscal year but departed
prior to fiscal yearend, each of whose total annual salary and bonus exceeded
$100,000 in the fiscal year ended January 31, 2003. The executive officers in
the following table are referred to in this Proxy Statement as our Named
Executive Officers.

|                            |  |      |      |            |  |                     |         |              |                     |   |        |  |  |            |           |     |  |   |        | 
|--------------------------- |  | ---- | ---- | ---------- |  | ------------------- | ------- | ------------ | ------------------- | - | ------ |  |  | ---------- | --------- | --- |  | - | ------ | 
|Summary Compensation Table 
|                           
|                            |  |      |      |            |  |                     |         |              |                     |   |        |  |  | Long-Term  |           |     |  |  
|                            |  |      |      |            |  | Annual Compensation |         | Compensation |                     |   |        | 
|                            |  |      |      |            |  |                     |         |              |                     |   |        | 
|                            |  |      |      |            |  |                     |         |              |                     |   |        |  |  | Securities |           |     |  |  
|Name and                    |  |      |      |            |  |                     |         |              |                     |   |        |  |  | Underlying | All Other
|Principal Position          |  | Year |      | Salary ($) |  | Bonus ($)           |         | Options (#)  | Compensation ($)(1)
|                            |  |      |      |            |  |                     |         |              |                    
|Yale T. Dolginow            |  |      | 2002 |            |  | $                   | 285,000 |              |                     |   |       |  |  |            |          |     |  | $ | 14,727 | 
|President and               |  |      | 2001 |            |  |                     | 285,000 |              |                     |   |       |  |  |            |          |     |  |   | 27,481 | 
|Chief Executive Officer     |  |      | 2000 |            |  |                     | 285,000 |              |                     |   |       |  |  |            | 16,667    | (2) |  |   | 27,481 | 
|Steven P. Durst             |  |      | 2002 |            |  | $                   | 130,000 |              |                     | $ | 4,000  |  |  |            |          |     |  | $ | 1,100  | 
|Vice President of Strategic |  |      | 2001 |            |  |                     | 117,500 |              |                     |   | 2,691  |  |  |            |          |     |  |   | 1,075  | 
|Planning, Merchandise       |  |      | 2000 |            |  |                     | 115,000 |              |                     |   |       |  |  |            | 8,334     |     |  |   | 1,062  | 
|Planning and Budgeting      |  |      |      |            |  |                     |         |              |                     |   |        |  |  |            |           |     |  |   |        | 
|Robert A. Henderson         |  |      | 2002 |            |  | $                   | 115,439 |              |                     |   |       |  |  |            | 20,000    | (3) |  | $ |       | 
|Vice President and Chief    |  |      |      |            |  |                     |         |              |                     |   |        |  |  |            |           |     |  |   |        | 
|Merchant (4)                |  |      |      |            |  |                     |         |              |                     |   |        |  |  |            |           |     |  |   |        | 
|Diana G. Purcel             |  |      | 2002 |            |  | $                   | 109,616 |              |                     | $ | 5,500  |  |  |            |          |     |  | $ | 1,096  | 
|Vice President and          |  |      | 2001 |            |  |                     | 98,846  |              |                     |   | 2,691  |  |  |            |          |     |  |   | 988    | 
|Chief Financial Officer     |  |      | 2000 |            |  |                     | 90,000  |              |                     |   | 4,500  |  |  |            | 8,334     |     |  |   | 415    | 
|Carol A. Nelson             |  |      | 2002 |            |  | $                   | 110,000 |              |                     | $ | 5,000  |  |  |            |          |     |  | $ | 762    | 
|Vice President of Stores    |  |      | 2001 |            |  |                     | 108,673 |              |                     |   | 2,691  |  |  |            |          |     |  |   | 664    | 
|                            |  |      | 2000 |            |  |                     | 99,608  |              |                     |   |       |  |  |            | 8,334     |     |  |   | 755    | 
|Cheryl W. Newell            |  |      | 2002 |            |  | $                   | 142,154 |              |                     | $ | 4,500  |  |  |            |          |     |  | $ | 948    | 
|Prior Vice President and    |  |      | 2001 |            |  |                     | 154,000 |              |                     |   | 2,691  |  |  |            |          |     |  |   | 1,540  | 
|Chief Financial Officer     |  |      | 2000 |            |  |                     | 140,000 |              |                     |   |       |  |  |            | 8,334     |     |  |   | 1,400  | 
|Steven R. Anderson          |  |      | 2002 |            |  | $                   | 130,307 |              |                     | $ | 4,500  |  |  |            |          |     |  | $ | 1,031  | 
|Prior Vice President and    |  |      | 2001 |            |  |                     | 154,000 |              |                     |   | 2,691  |  |  |            |          |     |  |   | 1,358  | 
|Chief Information Officer   |  |      | 2000 |            |  |                     | 135,000 |              |                     |   | 10,000 |  |  |            | 8,334     |     |  |   | 1,350  | 



---

|(1) |  | Represents amounts of matching contributions we made to the Named
Executive Officers respective 401(k) accounts, except for Mr. Dolginow.
His total also includes $12,863 for fiscal 2002 and $25,727 for fiscal
2001 and fiscal 2000 as the value of benefits for Mr. Dolginow, determined
as
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | prescribed by the Securities and Exchange Commission for such
valuations, under a split-dollar life insurance arrangement.
| |  | ----------------------------------------------------------------------------------------------------------------------------



|(2) |  | In consideration for Mr. Dolginow issuing a Standby Letter of Credit in
March 2000 in favor of Fleet Retail Finance, which provided our Company
with up to a $1.2 million overadvance on its line of credit, we granted
Mr. Dolginow an option to purchase 16,667 shares of our Common Stock at an
exercise price of $2.91 per share (which was equal to 110% of the market
price of our Common Stock on the date of grant).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(3) |  | Reflects options granted during fiscal 2002.                                                                                                                                                                                                                                                                                                                                                                                
|   
|(4) |  | Mr. Henderson was designated an executive officer as of May 28, 2002.                                                                                                                                                                                                                                                                                                                                                       

|                                  |  |                   |        |                    |  |              |       |            |  |                     |      |                |  |       |         |                   |  |                      |        |  |  |   |        | 
|--------------------------------- |  | ----------------- | ------ | ------------------ |  | ------------ | ----- | ---------- |  | ------------------- | ---- | -------------- |  | ----- | ------- | ----------------- |  | -------------------- | ------ |  |  | - | ------ | 
|Option Grants in Fiscal Year 2002
|                                 
|                                  |  |                   |        |                    |  |              |       |            |  |                     |      |                |  |       |         |                   |  | Potential Realizable
|                                  |  |                   |        |                    |  |              |       |            |  |                     |      |                |  |       |         | Value            
|                                  |  |                   |        |                    |  | % of         |       |            |  |                     |      |                |  |       |         | at Assumed Annual
|                                  |  |                   |        | Total              |  |              |       |            |  |                     |      |                |  | Rates
|                                  |  | Number of         |        | Options            |  |              |       |            |  |                     |      | of Stock Price
|                                  |  | Securities        |        | Granted to         |  | Exercise     |       |            |  |                     |      | Appreciation  
|                                  |  | UnderlyingOptions |        | Employeesin Fiscal |  | or
BasePrice |       | Expiration |  | for Option Term (2)
|Name                              |  | Granted (#)(1)    |        | Year 2002          |  | ($/Share)    |       | Date       |  | 5%                  |      | 10%           
|                                  |  |                   |        |                    |  |              |       |            |  |                     |      |               
|Yale T. Dolginow                  |  |                   |       |                    |  |              |      |            |  |                     | N/A  |                |  |       | N/A     |                   |  |                      |       |  |  |   |       | 
|Steven P. Durst                   |  |                   |       |                    |  |              |      |            |  |                     | N/A  |                |  |       | N/A     |                   |  |                      |       |  |  |   |       | 
|Robert A. Henderson               |  |                   | 20,000 |                    |  |              | 100.0 | %          |  | $                   | 1.00 |                |  |       | 5/28/12 |                   |  | $                    | 12,578 |  |  | $ | 31,875 | 
|Diana G. Purcel                   |  |                   |       |                    |  |              |      |            |  |                     | N/A  |                |  |       | N/A     |                   |  |                      |       |  |  |   |       | 
|Carol A. Nelson                   |  |                   |       |                    |  |              |      |            |  |                     | N/A  |                |  |       | N/A     |                   |  |                      |       |  |  |   |       | 



|(1) |  | All options set forth in the above table vest in one-third increments
beginning on the first anniversary of the date of grant and on each of the
next two anniversaries of such date with all options granted becoming
fully vested three years from the date of grant. See Change of Control
Arrangements below for change in control provisions relating to options
granted under our 1997 Option Plan.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | These amounts represent certain assumed rates of appreciation only.
Actual gains, if any, on stock option exercises are dependent upon the
future performance of the Companys Common Stock, overall market
conditions and the executives continued involvement with the Company.
The amounts represented in this table will not necessarily be achieved.                                                 

Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values

None of our Named Executive Officers exercised any stock options in fiscal
year 2002. The following table summarizes the number and value of options held
by our Named Executive Officers as of January 31, 2003.

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|                                   |  |                        |        |                               |  |             |        |               |  |   |   |  |  |   |   | 
|---------------------------------- |  | ---------------------- | ------ | ----------------------------- |  | ----------- | ------ | ------------- |  | - | - |  |  | - | - | 
|Fiscal 2002 Year-End Option Values
|                                  
|                                   |  | Number of              |        | Value of Unexercised         
|                                   |  | Unexercised Options at |        | In-the-Money Options         
|                                   |  | January 31, 2003(#)    |        | at January 31, 2003 ($)(1)(2)
|                                   |  |                        |        |                              
|Name                               |  | Exercisable            |        | Unexercisable                 |  | Exercisable |        | Unexercisable
|                                   |  |                        |        |                               |  |             |        |              
|Yale T. Dolginow                   |  |                        | 16,667 |                               |  |             |       |               |  | $ |  |  |  | $ |  | 
|Steven P. Durst                    |  |                        | 15,802 |                               |  |             |       |               |  |   |  |  |  |   |  | 
|Robert A. Henderson                |  |                        |       |                               |  |             | 20,000 |               |  |   |  |  |  |   |  | 
|Diana G. Purcel                    |  |                        | 10,001 |                               |  |             |       |               |  |   |  |  |  |   |  | 
|Carol A. Nelson                    |  |                        | 15,802 |                               |  |             |       |               |  |   |  |  |  |   |  | 



---

|(1) |  | All outstanding options on January 31, 2003 had an exercise price greater
than $0.13, the closing price of our Common Stock on that date.                                                                                                                                                                                               
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | The Value of Unexercised In-the-Money Options amounts are calculated
based on the excess of the market value of our Common Stock at January 31,
2003 over the exercise price. The exercise price of options may be paid
in cash or in shares of our Common Stock valued at fair market value on
the day prior to the date of exercise.

Compensation of Directors

Directors Fees. We pay non-employee directors $10,000 per year. All
out-of-pocket expenses incurred on behalf of the Company are also reimbursed.

Options. Each of our non-employee directors also participates in the
Director Stock Option Plan (the Director Plan). Our Board administers the
Director Plan. Pursuant to the terms of the Director Plan, upon election to
the Board, each non-employee director is automatically granted a non-statutory
option to purchase 3,334 shares of Common Stock at an exercise price equal to
the fair market value of the Companys Common Stock on the date of grant. Such
options vest in one-third increments beginning on the first anniversary of the
date of grant and on each of the next two anniversaries of such date. On March
6, 2000, options granted under the Director Plan were canceled. A new option
for 7,085 shares was granted to each Director under our 1997 Stock Option and
Compensation Plan, as amended and restated as of June 11, 1999, which is
referred to in the Proxy Statement as the 1997 Option Plan. The new option for
7,085 shares has identical terms to the options that were canceled, except for
a reduction in the exercise price. The reduced exercise price however, was
greater than the fair market value of the Companys stock on the date of grant.

On September 9, 1999, under our 1997 Option Plan, the Board granted each
of its non-employee directors a non-statutory stock option to acquire 6,667
shares of our Common Stock at an exercise price of $6.00 per share, the closing
sale price of the Companys Common Stock on the date of grant.

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On April 14, 2000, under our 1997 Option Plan, the Board granted each of
its non-employee directors a non-statutory stock option to acquire 3,334 shares
of our Common Stock at an exercise price of $2.64 per share, the closing sale
price of the Companys Common Stock on the date of grant.

Each of these options have a term of 10 years from the date of grant and
vest in one-third increments beginning on the first anniversary of the date of
grant and on each of the next two anniversaries of such date. For more
information regarding these options see Change in Control Arrangements below.

Consulting Services.In fiscal 2002, we paid Martin A. Mayer $18,750 plus
expenses for consulting services he rendered to us in connection with
consulting and senior management strategic planning meetings. This consulting
arrangement was cancelled during the third quarter of fiscal 2002.

Change in Control Arrangements

Under our 1997 Option Plan, if a change in control (as described below) of
Paper Warehouse occurs, then, unless otherwise determined by the Board of
Directors and a majority of our continuing directors:



| |  |  | the restrictions on all shares of restricted stock awards lapse immediately;                                       
| | - |  | -------------------------------------------------------------------------------------------------------------------
|
| |  |  | all outstanding options and stock appreciation rights will become exercisable immediately; and,                    
|
| |  |  | all performance shares shall be deemed to be met and payment made
immediately for purposes of the 1997 Option Plan.

Under the 1997 Option Plan, a change in control occurs when:



| |  |  | any person or group becomes the beneficial owner of 30% or more of
any of our equity securities entitled to vote for the election of
directors;                                                                         
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | a majority of the members of the Board is replaced within the
period of less than two years by directors not nominated and approved
by the Board; or                                                                    
|
| |  |  | our shareholders approve an agreement to merge or consolidate with
or into another corporation or an agreement to sell or otherwise
dispose of all or substantially all of our assets (including a plan of
liquidation).

Under the 1997 Option Plan continuing directors are directors



| |  |  | who were in office prior to the occurrence of a change in control
or any person publicly announcing an intention to acquire 20% or more
of any of our equity securities;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | who have been in office for a period of more than two years; and,                                                                                                         
|
| |  |  | who have been nominated and approved by the continuing directors.                                                                                                       

Compensation Committee Interlocks and Insider Participation

The following members or former members of our Board of Directors were
members of the Compensation Committee for fiscal 2002: Yale T. Dolginow,
Marvin W. Goldstein, Jeffrey S. Halpern, Martin A. Mayer and Richard W.
Perkins. Mr. Dolginow served in fiscal 2002 as our Chairman of the Board of
Directors, President and Chief Executive Officer. None of our executive
officers serve as a member of the

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board of directors or compensation committee
of any entity that has an executive officer serving as a member of our board of
directors or compensation committee.

Compensation Committee Report on Executive Compensation

The Compensation Committee of the Board has generally made decisions on
the compensation of our executives. In fiscal 2002, the Compensation Committee
consisted of Messrs. Dolginow, Goldstein, Halpern, Mayer, and Perkins. Messrs.
Halpern, Mayer and Perkins are non-employee directors. Mr. Goldstein, prior to
his resignation on March 5, 2003, also was a non-employee director of the
company. Decisions made by the Compensation Committee are reviewed by the full
Board. Pursuant to rules designed to enhance disclosure of our policies on
executive compensation, the Compensation Committee has prepared the report
below. It addresses our executive compensation policies for the fiscal year
ended January 31, 2003.

The Compensation Committees executive compensation policies are designed to:



| |  |  | align the long-term interests of management with those of our shareholders;         
| | - |  | ------------------------------------------------------------------------------------
|
| |  |  | attract, retain, and motivate a superior senior management team;                    
|
| |  |  | motivate our executives to achieve important annual and long-term performance goals;
|
| |  |  | reward above average corporate performance; and                                     
|
| |  |  | recognize individual initiative and achievements.                                   

Executive compensation is set at levels that the Compensation Committee
believes to be competitive with those offered by employers of comparable size,
growth and profitability in our industry.

There are three elements in our executive compensation program, all
determined by individual and corporate performance: base salary compensation,
bonus compensation and long-term incentive compensation. In addition,
executives receive benefits generally available to all our full-time employees.

In determining each component of compensation, the Compensation Committee
considers an executives total compensation package and reviews competitive
compensation data. Executive compensation is determined by considering the
overall scope of each position, its strategic importance to the Company, the
potential impact the individual may have on the Company, the skills and
experiences required by the individuals position, and the performance and
potential of the executive in the position.

Mr. Dolginows compensation was determined by the Compensation Committee
and approved by the Board. His compensation is based upon comparable company
information, his performance as Chairman and Chief Executive Officer, and the
financial performance of the Company. His compensation has not changed in six
years. Based on the above criteria, the executive compensation program for
fiscal 2002 did not provide for the payment of an annual bonus to Mr. Dolginow.
The executive officers base salary for fiscal year 2002 was kept at the same
level as fiscal year 2001 due to the Companys cost cutting efforts.

Long-term incentive compensation under the 1997 Option Plan is designed to
align executive compensation with the creation of shareholder value. The
Compensation Committee makes recommendations to the Board regarding the
granting of awards under the 1997 Option Plan to executives and key personnel,
including our Chief Executive Officer. Awards vest and options become
exercisable based upon criteria established by the Compensation Committee.
During fiscal 2002, the Compensation Committee granted a stock option award to
Mr. Henderson when he joined the Company.

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Section 162(m).Section 162(m) of the Internal Revenue Code of 1986, as
amended, limits to $1,000,000 the deductibility of certain compensation paid to
the Chief Executive Officer and each of the executive officers of a publicly
held corporation who are named in the Summary Compensation Table below. In
fiscal 2002, we did not pay compensation within the meaning of Section 162(m)
to such named executive officers in excess of $1,000,000, and we do not believe
we will do so in the foreseeable future. We do not have
a policy at this time regarding qualifying compensation paid to our
executive officers for deductibility under Section 162(m), but will formulate
such a policy if compensation levels ever approach $1,000,000.

| |                           
| | --------------------------
| | Submitted by:             
| | Yale T. Dolginow, Chairman
| | Jeffrey S. Halpern        
| | Martin A. Mayer           
| | Richard W. Perkins        

Stock Performance Graph

In accordance with the rules of the SEC, the following performance graph
compares for the period from November 25, 1997 (the date of our initial public
offering) to January 31, 2003, the yearly cumulative total shareholder return
on our Common Stock based on our trading on the Over-the-Counter Bulletin Board
since July 2, 2003, on the Nasdaq SmallCap Market from August 4, 2001 to July
2, 2003 and on the Nasdaq National Market from November 25, 1997 to August 4,
2001, with the yearly cumulative total return over the same period on the
Nasdaq Stock Market of all domestic issuers traded on the Nasdaq National
Market and SmallCap Market (the Nasdaq Market Index) and the total return of
the Nasdaq Retail Trade Index. The comparison assumes the investment of $100
on January 30, 1998, in each of the Companys Common Stock, the Nasdaq Market
Index and the Nasdaq Retail Trade Index, and that any dividends paid were
reinvested in the same security. Media General Financial Services prepared the
data points and the performance graph.

Stock Performance Graph

COMPARISON OF CUMULATIVE TOTAL RETURN AMONG
PAPER WAREHOUSE, INC., NASDAQ RETAIL TRADE INDEX
AND NASDAQ MARKET INDEX

|                          |  |         |        |         |  |         |        |        |  |        |        |         |  |   |        |  |  |   |        |  |  |   |        | 
|------------------------- |  | ------- | ------ | ------- |  | ------- | ------ | ------ |  | ------ | ------ | ------- |  | - | ------ |  |  | - | ------ |  |  | - | ------ | 
|Company/Index/Market      |  | 1/30/98 |        | 1/29/99 |  | 1/28/00 |        | 2/2/01 |  | 2/1/02 |        | 1/31/03
|                          |  |         |        |         |  |         |        |        |  |        |        |        
|Paper Warehouse, Inc.     |  | $       | 100.00 |         |  | $       | 34.69  |        |  | $      | 23.47  |         |  | $ | 12.24  |  |  | $ | 4.57   |  |  | $ | 0.71   | 
|NASDAQ Retail Trade Index |  |         | 100.00 |         |  |         | 143.60 |        |  |        | 147.15 |         |  |   | 153.49 |  |  |   | 170.61 |  |  |   | 135.73 | 
|NASDAQ Market Index       |  |         | 100.00 |         |  |         | 156.07 |        |  |        | 233.47 |         |  |   | 167.16 |  |  |   | 117.76 |  |  |   | 81.29  | 

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ITEM 12.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information regarding the beneficial
ownership of our Common Stock as of April 25, 2003, unless otherwise noted, by
(a) each shareholder who is known by us to beneficially own more than 5% of the
outstanding Common Stock; (b) each director and nominee for election to our
Board; (c) each executive officer named in the Summary Compensation Table
below; and (d) all executive officers and directors as a group. The address
for all executive officers and directors is 7630 Excelsior Boulevard,
Minneapolis, Minnesota 55426.

|                                                             |  |                        |           |                      |  |  |       |  |  |  |  | 
|------------------------------------------------------------ |  | ---------------------- | --------- | -------------------- |  |  | ----- |  |  |  |  | 
|                                                             |  | SHARES OF COMMON STOCK
|                                                             |  | Beneficially Owned (1)
|                                                             |  |                       
|Name                                                         |  | Amount                 |           | Percent of Class (2)
|                                                             |  |                        |           |                     
|Yale T. Dolginow                                             |  |                        | 998,872   | (3)                  |  |  | 52.5%
|Diane C. Dolginow                                            |  |                        | 0         | (4)                  |  |  | *    
|Jeffrey S. Halpern                                           |  |                        | 17,086    | (5)                  |  |  | *    
|Martin A. Mayer                                              |  |                        | 31,528    | (6)                  |  |  | 1.6% 
|Richard W. Perkins                                           |  |                        | 22,068    | (7)                  |  |  | 1.2% 
|Steven P. Durst                                              |  |                        | 15,802    | (8)                  |  |  | *    
|Robert A. Henderson                                          |  |                        |          |                      |  |  | *    
|Diana G. Purcel                                              |  |                        | 10,001    | (9)                  |  |  | *    
|Carol A. Nelson                                              |  |                        | 16,636    | (8)                  |  |  | *    
|Cheryl W. Newell                                             |  |                        | 1,000     |                      |  |  | *    
|Steven A. Anderson                                           |  |                        | 167       |                      |  |  | *    
|All directors and executive officers as a group
(11 persons) |  |                        | 1,113,160 | (10)                 |  |  | 55.8%



---

|*   |  | Less than 1% of the outstanding shares.                                                                                                                                                                                                                                                                                                                                                                                                     
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) |  | Shares not outstanding but deemed beneficially owned by virtue of the
right of a person or member of a group to acquire them within 60 days of
April 25, 2003, are treated as outstanding only when determining the
amount and percent owned by such person or group. Unless otherwise noted,
individuals or entities possessing sole voting power and investment power
with respect to shares of Common Stock hold all of the shares shown.

40



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##### Table of Contents



|(2)  |  | Calculated based on 1,886,192 shares of Common Stock outstanding as of
April 25, 2003, plus the amount this person may have the right to acquire
within 60 days.                                
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(3)  |  | Includes 132,741 shares owned individually by Mr. Dolginows three
daughters (44,247 shares each), and 16,667 shares of Common Stock
exercisable within 60 days.                                
|    
|(4)  |  | Ms. Dolginow does not own any shares directly and disclaims beneficial
ownership of all shares owned by her husband, Yale T. Dolginow.                                                          
|    
|(5)  |  | Includes options to purchase 17,086 shares of Common Stock exercisable
within 60 days.                                                                                                          
|    
|(6)  |  | Includes options to purchase 29,862 shares of Common Stock exercisable
within 60 days, of which 12,775 shares are issuable upon exercise of a
stock option granted to Mr. Mayer by Mr. Dolginow.
|    
|(7)  |  | Includes options to purchase 2,223 shares of Common Stock exercisable
within 60 days.                                                                                                           
|    
|(8)  |  | Includes options to purchase 15,802 shares of Common Stock exercisable
within 60 days.                                                                                                          
|    
|(9)  |  | Includes options to purchase 10,001 shares of Common Stock exercisable
within 60 days.                                                                                                          
|    
|(10) |  | Includes options to purchase 107,444 shares of Common Stock exercisable
within 60 days.                                                                                                         

Equity Compensation Plan Information

The Company maintains the 1997 Stock Option and Compensation Plan (the
Employee Plan) and the Directors Stock Option Plan (the Directors Plan),
which are approved to grant up to an aggregate of 666,667 and 38,214 shares of
common stock, respectively. The Employee Plan is designed to increase
shareholder value and to advance the interests of the Company by furnishing a
variety of economic incentives designed to attract, retain and motivate
employees (including officers, non-employee directors, consultants and
independent contractors). The Directors Plan is designed to encourage
increased share ownership by non-employee directors of the Company in order to
promote long-term shareholder value through continuing ownership of the
Companys common stock. The Companys shareholders have approved the Employee
Plan. The Directors Plan has not been submitted to the Companys shareholders
for approval.

41



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##### Table of Contents



The following table sets forth certain information as of January 31, 2003
with respect to the Employee Plan and the Directors Plan:

|                                                            |                                         |     |                  |         |                |                |                       |  |  |   |      |      |                     |  |                      |         | 
|----------------------------------------------------------- | --------------------------------------- | --- | ---------------- | ------- | -------------- | -------------- | --------------------- |  |  | - | ---- | ---- | ------------------- |  | -------------------- | ------- | 
|                                                            |                                         |     |                  |         |                |                |                       |  |  |   |      |      |                     |  | Number of Securities
|                                                            |                                         |     | Number of        |         |                |                |                       |  |  |   |      |      | Remaining Available
|                                                            |                                         |     | Securities to be |         | Weighted-      |                | for Future Issuances 
|                                                            |                                         |     | Issued Upon      |         | Average        |                | Under Equity         
|                                                            |                                         |     | Exercise of      |         | Exercise Price |                | Compensation Plans   
|                                                            |                                         |     | Outstanding      |         | of Outstanding |                | (Excluding Securities
|                                                            |                                         |     | Options          |         | Options        |                | Reflected            
|Plan Category                                               |                                         | (A) |                  | (B)     |                | in Column (A))
|                                                            |                                         |     |                  |         |                |               
|Equity Compensation Plans Approved By
Security Holders:     |                                         |     |                  |         |                |                |                       |  |  |   |      |      |                     |  |                      |        
|                                                            | 1997 Stock Option and Compensation
Plan |     |                  | 200,587 |                |                |                       |  |  |   | $    | 4.28 |                     |  |                      | 466,080 | 
|Equity Compensation Plans Not Approved
by Security Holders: |                                         |     |                  |         |                |                |                       |  |  |   |      |      |                     |  |                      |        
|                                                            | Directors Stock Option Plan            |     |                  | 3,334   |                |                |                       |  |  |   |      | 3.93 |                     |  |                      | 34,880  | 
|                                                            |                                         |     |                  |         |                |                |                       |  |  |   |      |      |                     |  |                      |        
|Total                                                       |                                         |     | 203,921          |         |                |                |                       |  |  | $ | 4.28 |      |                     |  | 500,960              |        




ITEM 13.     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

We have employed Steven P. Durst as our Vice President of Strategic
Planning, Merchandise Planning and Budgeting since September 25, 2002 and our
Vice President of Merchandising since June 1998. Prior to that time, and since
1997, Mr. Durst was our Vice President of Information Systems. From 1995 to
1997, Mr. Durst was our Director of Information Systems. Mr. Durst is the
son-in-law of Yale T. and Diane C. Dolginow, the President and Chief Executive
Officer and Secretary, respectively. During fiscal 2002, we paid Mr. Durst
$135,100 in annual compensation, including salary, bonus and other
compensation.

We believe that all prior transactions between us and our officers,
directors or other affiliates have been on terms no less favorable than could
have been obtained from unaffiliated third parties. Any future transactions
with our officers, directors or 5% beneficial shareholders will be on terms no
less favorable to us than could be obtained from unaffiliated third parties and
will be approved by a majority of the independent outside members of our Board
of Directors who have no interest in the transactions.




ITEM 14.     CONTROLS AND PROCEDURES.

The Companys management, including the Chief Executive Officer and Chief
Financial Officer, have conducted an evaluation of the effectiveness of the
design and operation of the Companys disclosure controls and procedures
pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 (the 1934
Act) within 90 days prior to the filing date of this annual report. Based on
that evaluation, the companys Chief Executive Officer and Chief Financial
Officer concluded that the Companys disclosure controls and procedures are
effective in ensuring that information required to be disclosed by the company
in the reports it files or submits under the 1934 Act is recorded, processed,
summarized, and reported within the time periods specified in the SECs rules
and forms. There have been no significant changes in internal controls, or in
other factors that could significantly affect internal controls, subsequent to
the date the Chief Executive Officer and Chief Financial Officer completed
their evaluation.

42



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##### Table of Contents






PART IV




ITEM 15.     EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(a)       Documents Filed as Part of this Report

(1)     Consolidated Financial Statements:

The following Consolidated Financial Statements are included in this
Annual Report on Form 10-K:

|                                                   |                                                           |  |             |     | 
|-------------------------------------------------- | --------------------------------------------------------- |  | ----------- | --- | 
|                                                   |                                                           |  | Page(s)    
|                                                   |                                                           |  |            
|Report of Independent Certified Public Accountants |                                                           |  | F-1         |    
|Financial Statements:                              |                                                           |  |             |    
|                                                   | Consolidated Balance Sheets                               |  |             | F-2 | 
|                                                   | Consolidated Statements of Operations                     |  |             | F-3 | 
|                                                   | Consolidated Statements of Stockholders (Deficit) Equity |  |             | F-4 | 
|                                                   | Consolidated Statements of Cash Flows                     |  |             | F-5 | 
|                                                   | Notes to Consolidated Financial Statements                |  | F-6 to F-19

(2)     Financial Statement Schedules:

Schedule II
- Valuation and Qualifying Accounts:

|                                   |  |            |           |           |  |            |         |          |  |         |         |  |  |     |         |            |  |   |           | 
|---------------------------------- |  | ---------- | --------- | --------- |  | ---------- | ------- | -------- |  | ------- | ------- |  |  | --- | ------- | ---------- |  | - | --------- | 
|                                   |  | Balance at |           |           |  |            |         |          |  |         |         |  |  |     |         | Balance at
|Reserve for Store                  |  | beginning  |           |           |  |            |         | Charges/ |  |         |         |  |  | end
|Closings                           |  | of year    |           | Provision |  | Write-offs |         | Credits  |  | of year
|                                   |  |            |           |           |  |            |         |          |  |        
|Fiscal
year ended
January 31, 2003 |  | $          | 695,000   |           |  | $          | 263,000 |          |  | $       | 284,000 |  |  | $   |        |            |  | $ | 674,000   | 
|Fiscal
year ended
February 1, 2002 |  | $          | 1,315,000 |           |  | $          | 108,000 |          |  | $       | 498,000 |  |  | $   | 230,000 |            |  | $ | 695,000   | 
|Fiscal
year ended
February 2, 2001 |  | $          | 3,000,000 |           |  | $          |        |          |  | $       | 715,000 |  |  | $   | 970,000 |            |  | $ | 1,315,000 | 

The reserve for store closings at the end of fiscal 2002 reflects a net
provision of $263,000, equal to the estimated remaining lease obligations on
our cross-dock facility and on a store, both of which we had adopted a plan
during December 2002 to subsequently close. This provision was partially
offset by the reversal of excess amounts in the reserve. In addition, the
reserve for store closings also reflects reductions related to ongoing payments
of rent, common area maintenance, real estate taxes and other miscellaneous
expenses on stores that were previously closed.

All other schedules have been omitted since they are not required, not
applicable or the information has been included in the financial statements or
the notes thereto.

43



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##### Table of Contents



(3)          Exhibits:

The exhibits to this Annual Report on Form 10-K are listed in the Exhibit
Index attached hereto.

A copy of any of the exhibits listed in the Exhibit Index or referred to
below will be furnished at a reasonable cost to any person who was a
shareholder of the Company on April 25, 2003, upon receipt from any such person
of a written request for any such exhibit. Such request should be sent to
Paper Warehouse, Inc., 7630 Excelsior Boulevard, Minneapolis, Minnesota 55426;
Attn: Shareholder Relations.

The following is a list of each management contract or compensatory plan
or arrangement required to be filed as an exhibit to this Annual Report on Form
10-K pursuant to Item 14(c):



| | 1. |  | Amended and Restated 1997 Stock Option and Compensation Plan
(incorporated by reference to our Quarterly Report on Form 10-Q for
the quarter ended August 3, 2001; File No. 000-23389).
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |  | Directors Stock Option Plan (incorporated by reference to our
Registration Statement on Form S-1; File No. 333-36911).                                                                
|
| | 3. |  | Amended and Restated 1998 Employee Stock Purchase Plan
(incorporated by reference to our Quarterly Report on Form 10-Q for
the quarter ended April 28, 2000; File No. 000-23389).      

(b)             Reports on Form 8-K.

We did not file any Current Reports on Form 8-K during the fourth quarter
of fiscal 2002.

44



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##### Table of Contents



Report of Independent Certified Public Accountants

The Board of Directors and Stockholders
Paper Warehouse, Inc.:

We have audited the accompanying consolidated balance sheets of Paper
Warehouse, Inc. and subsidiaries as of January 31, 2003 and February 1, 2002,
and the related consolidated statements of operations, stockholders (deficit)
equity, and cash flows for each of the three years in the period ended January
31, 2003. These consolidated financial statements are the responsibility of
the Companys management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Paper
Warehouse, Inc. and subsidiaries as of January 31, 2003 and February 1, 2002
and the results of their operations and their cash flows for each of the three
years in the period ended January 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has experienced recurring losses
from operations, has not generated sufficient cash flows from operations to
meet its operating and capital requirements, as well as other factors, all of
which raise substantial doubt about its ability to continue as a going concern.
Managements plans in regard to these matters are also described in Note 1.
The consolidated financial statements do not include any adjustments that might
result from the outcome of these uncertainties.

As discussed in Note 2 and 3 to the consolidated financial statements, the
company adopted Statement of Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assetson February 2, 2002.

We have also audited Schedule II of Paper Warehouse, Inc. and subsidiaries
for each of the three years in the period ended January 31, 2003. In our
opinion, this schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information therein.

| |                       
| | ----------------------
| | /s/ Grant Thornton LLP

Minneapolis, Minnesota
March 11, 2003 (except for Note 7, to which the date is
May 1, 2003)

F-1



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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
Consolidated Balance Sheets
January 31, 2003 and February 1, 2002

|                                                 |                                                                                                     |                                      |                                                      |             |             |            |             |             |            |            | 
|------------------------------------------------ | --------------------------------------------------------------------------------------------------- | ------------------------------------ | ---------------------------------------------------- | ----------- | ----------- | ---------- | ----------- | ----------- | ---------- | ---------- | 
|                                                 |                                                                                                     |                                      |                                                      |             | January 31, |            | February 1,
|                                                 |                                                                                                     |                                      |                                                      |             | 2003        |            | 2002       
|                                                 |                                                                                                     |                                      |                                                      |             |             |            |            
|ASSETS                                           |                                                                                                     |                                      |                                                      |             |             |            |             |            
|Current assets:                                  |                                                                                                     |                                      |                                                      |             |             |            |             |            
|                                                 | Cash and cash equivalents                                                                           |                                      | $                                                    | 144,318     |             |            | $           | 203,975     |           
|                                                 | Merchandise inventories                                                                             |                                      |                                                      | 12,826,346  |             |            |             | 14,765,866  |           
|                                                 | Accounts receivable                                                                                 |                                      |                                                      | 1,221,352   |             |            |             | 1,177,364   |           
|                                                 | Prepaid expenses and other current assets                                                           |                                      |                                                      | 490,807     |             |            |             | 521,686     |           
|                                                 |                                                                                                     |                                      |                                                      |             |             |            |             |            
|                                                 |                                                                                                     | Total current assets                 |                                                      |             | 14,682,823  |            |             |             | 16,668,891 |           
|Property and equipment, net                      |                                                                                                     |                                      | 5,315,204                                            |             |             |            | 6,207,849   |            
|Other assets, net                                |                                                                                                     |                                      | 1,281,964                                            |             |             |            | 1,652,147   |            
|Net assets of discontinued operations            |                                                                                                     |                                      |                                                     |             |             |            | 2,545,786   |            
|                                                 |                                                                                                     |                                      |                                                      |             |             |            |             |            
|                                                 |                                                                                                     |                                      | Total assets                                         |             | $           | 21,279,991 |             |             | $          | 27,074,673 | 
|                                                 |                                                                                                     |                                      |                                                      |             |             |            |             |            
|LIABILITIES AND STOCKHOLDERS (DEFICIT) EQUITY   |                                                                                                     |                                      |                                                      |             |             |            |             |            
|Current liabilities:                             |                                                                                                     |                                      |                                                      |             |             |            |             |            
|                                                 | Notes payable  line of credit                                                                      |                                      | $                                                    | 5,576,992   |             |            | $           | 7,731,966   |           
|                                                 | Notes payable  other                                                                               |                                      |                                                      |            |             |            |             | 1,000,000   |           
|                                                 | Current maturities of long-term debt                                                                |                                      |                                                      | 475,627     |             |            |             | 553,481     |           
|                                                 | Accounts payable                                                                                    |                                      |                                                      | 9,990,011   |             |            |             | 8,087,854   |           
|                                                 | Accrued liabilities                                                                                 |                                      |                                                      | 2,031,398   |             |            |             | 1,822,488   |           
|                                                 | Current portion  reserve for store closings                                                        |                                      |                                                      | 290,186     |             |            |             | 311,383     |           
|                                                 |                                                                                                     |                                      |                                                      |             |             |            |             |            
|                                                 |                                                                                                     | Total current liabilities            |                                                      |             | 18,364,214  |            |             |             | 19,507,172 |           
|Convertible subordinated debt                    |                                                                                                     |                                      | 4,000,000                                            |             |             |            | 4,000,000   |            
|Other long-term debt, less current maturities    |                                                                                                     |                                      | 995,665                                              |             |             |            | 1,328,979   |            
|Reserve for store closings, less current portion |                                                                                                     |                                      | 383,851                                              |             |             |            | 383,908     |            
|Deferred rent credits                            |                                                                                                     |                                      | 1,101,719                                            |             |             |            | 1,261,470   |            
|                                                 |                                                                                                     |                                      |                                                      |             |             |            |             |             |           
|                                                 |                                                                                                     |                                      | Total liabilities                                    |             |             | 24,845,449 |             |             |            | 26,481,529 | 
|                                                 |                                                                                                     |                                      |                                                      |             |             |            |             |            
|Commitments                                      |                                                                                                     |                                      |                                                     |             |             |            |            |            
|Stockholders (deficit) equity:                  |                                                                                                     |                                      |                                                      |             |             |            |             |            
|                                                 | Serial
preferred stock, $.03 par value; 3,333,333 shares authorized;
none issued or outstanding     |                                      |                                                      |            |             |            |             |            |           
|                                                 | Common
stock, $.03 par value; 13,333,333 shares authorized;
1,886,192 shares issued and outstanding |                                      |                                                      | 56,585      |             |            |             | 56,585      |           
|                                                 | Additional paid-in capital                                                                          |                                      |                                                      | 15,010,338  |             |            |             | 15,010,548  |           
|                                                 | Accumulated deficit                                                                                 |                                      |                                                      | (18,632,381 | )           |            |             | (14,473,989 | )         
|                                                 |                                                                                                     |                                      |                                                      |             |             |            |             |             |           
|                                                 |                                                                                                     | Total stockholders (deficit) equity |                                                      |             | (3,565,458  | )          |             |             | 593,144    |           
|                                                 |                                                                                                     |                                      |                                                      |             |             |            |             |            
|                                                 |                                                                                                     |                                      | Total liabilities and stockholders (deficit) equity |             | $           | 21,279,991 |             |             | $          | 27,074,673 | 
|                                                 |                                                                                                     |                                      |                                                      |             |             |            |             |            

See accompanying notes to Consolidated Financial Statements.

F-2



---



##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
Consolidated Statements of Operations
Years ended January 31, 2003, February 1, 2002 and February 2, 2001

|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |            |   |            |   | 
|------------------------------------------------------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------ | -------------------------------------------------- | ---------- | - | ----------- | ---------- | ----------- | - | ----------- | ---------- | ---------- | - | ---------- | - | 
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   | January 31, |            | February 1, |   | February 2,
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   | 2003        |            | 2002        |   | 2001       
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |            
|Revenues:                                                    |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |           
|                                                             | Retail sales                                                                                                                                                     |                                      | $                                                  | 73,703,440 |   |             | $          | 74,404,683  |   |             | $          | 78,002,576 |  
|                                                             | Franchise related fees                                                                                                                                           |                                      |                                                    | 1,536,618  |   |             |            | 1,512,665   |   |             |            | 1,456,376  |  
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |           
|                                                             |                                                                                                                                                                  |                                      | Total revenues                                     |            |   | 75,240,058  |            |             |   | 75,917,348  |            |            |   | 79,458,952 |  
|Costs and expenses:                                          |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |           
|                                                             | Costs of products sold and occupancy costs                                                                                                                       |                                      |                                                    | 48,930,124 |   |             |            | 50,005,332  |   |             |            | 50,659,206 |  
|                                                             | Store operating expenses                                                                                                                                         |                                      |                                                    | 20,254,383 |   |             |            | 19,293,949  |   |             |            | 18,704,706 |  
|                                                             | General and administrative expenses                                                                                                                              |                                      |                                                    | 9,782,225  |   |             |            | 10,331,672  |   |             |            | 9,520,353  |  
|                                                             | Repositioning and store closing provision (credits), net                                                                                                         |                                      |                                                    | 263,053    |   |             |            | (121,450    | ) |             |            | (970,000   | )
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |            |  
|                                                             |                                                                                                                                                                  |                                      | Total costs and expenses                           |            |   | 79,229,785  |            |             |   | 79,509,503  |            |            |   | 77,914,265 |  
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |           
|                                                             |                                                                                                                                                                  |                                      | Operating (loss) income from continuing
operations |            |   | (3,989,727  | )          |             |   | (3,592,155  | )          |            |   | 1,544,687  |  
|Interest expense                                             |                                                                                                                                                                  |                                      | (1,452,014                                         | )          |   |             | (1,432,884 | )           |   |             | (1,669,744 | )         
|Other income, net                                            |                                                                                                                                                                  |                                      | 271,278                                            |            |   |             | 132,326    |             |   |             | 335,229    |           
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |            |  
|(Loss) income from continuing operations before income taxes |                                                                                                                                                                  |                                      | (5,170,463                                         | )          |   |             | (4,892,713 | )           |   |             | 210,172    |           
|Income tax provision (Note 11)                               |                                                                                                                                                                  |                                      |                                                   |            |   |             | (3,010,079 | )           |   |             | (85,023    | )         
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |           
|                                                             |                                                                                                                                                                  |                                      | Net (loss) income from continuing operations       |            |   | (5,170,463  | )          |             |   | (7,902,792  | )          |            |   | 125,149    |  
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |            |  
|Discontinued operations: (Note 4)                            |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |           
|                                                             | Loss from discontinued operations of Seattle market
(net of income tax (provision) benefit of ($723,189) for fiscal
year 2001 and $380,023 for fiscal year 2000) |                                      |                                                    | (246,145   | ) |             |            | (1,898,691  | ) |             |            | (559,371   | )
|                                                             | Gain on sale of Seattle market net assets                                                                                                                        |                                      |                                                    | 1,258,216  |   |             |            |            |   |             |            |           |  
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |            |  
|                                                             |                                                                                                                                                                  |                                      | Net income (loss) from discontinued operations     |            |   | 1,012,071   |            |             |   | (1,898,691  | )          |            |   | (559,371   | )
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |            |  
|                                                             |                                                                                                                                                                  |                                      | Net loss                                           |            | $ | (4,158,392  | )          |             | $ | (9,801,483  | )          |            | $ | (434,222   | )
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |            |  
|Net loss per common share:                                   |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |           
|                                                             | Basic and diluted net loss per common share:                                                                                                                     |                                      |                                                    |            |   |             |            |             |   |             |            |            |  
|                                                             |                                                                                                                                                                  |                                      | Net (loss) income from continuing operations       |            | $ | (2.74       | )          |             | $ | (4.19       | )          |            | $ | 0.07       |  
|                                                             |                                                                                                                                                                  |                                      | Net income (loss) from discontinued operations     |            |   | 0.54        |            |             |   | (1.01       | )          |            |   | (0.34      | )
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |            |  
|                                                             |                                                                                                                                                                  |                                      | Net loss                                           |            | $ | (2.20       | )          |             | $ | (5.20       | )          |            | $ | (0.27      | )
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |            |  
|                                                             |                                                                                                                                                                  | Weighted average shares outstanding: |                                                    |            |   |             |            |             |   |             |            |            |   |           
|                                                             |                                                                                                                                                                  |                                      | Basic and diluted                                  |            |   | 1,886,192   |            |             |   | 1,884,470   |            |            |   | 1,627,311  |  
|                                                             |                                                                                                                                                                  |                                      |                                                    |            |   |             |            |             |   |             |            |            |  

See accompanying notes to Consolidated Financial Statements.

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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
Consolidated Statements of Stockholders (Deficit) Equity
Years Ended January 31, 2003, February 1, 2002 and February 2, 2001

|                          |                                                                                                        |  |           |   |           |  |           |         |         |   |             |       |           |   |            |           |               |   |             |            |   |   |            |            |  
|------------------------- | ------------------------------------------------------------------------------------------------------ |  | --------- | - | --------- |  | --------- | ------- | ------- | - | ----------- | ----- | --------- | - | ---------- | --------- | ------------- | - | ----------- | ---------- | - | - | ---------- | ---------- | -
|                          |                                                                                                        |  |           |   |           |  |           |         |         |   |             |       |           |   |            |           |               |   |             |            |   |   | Total     
|                          |                                                                                                        |  | Serial    |   | Number of |  |           |         |         |   | Additional  |       |           |   |            |           | Stockholders
|                          |                                                                                                        |  | Preferred |   | Common    |  | Common    |         | Paid-In |   | Accumulated |       | (Deficit)
|                          |                                                                                                        |  | Stock     |   | Shares    |  | Stock     |         | Capital |   | Deficit     |       | Equity   
|                          |                                                                                                        |  |           |   |           |  |           |         |         |   |             |       |          
|Balance, January 28, 2000 |                                                                                                        |  |          |   |           |  | 1,542,645 |         |         | $ | 46,279      |       |           | $ | 13,833,442 |           |               | $ | (4,238,284  | )          |   | $ | 9,641,437  |           
|                          | Net loss                                                                                               |  |           |  |           |  |           |        |         |   |             |      |           |   |            |          |               |   |             | (434,222   | ) |   |            | (434,222   | )
|                          | Issuance of common stock
pursuant to
shareholder rights
offering (net of
offering expenses of
$67,100) |  |           |  |           |  |           | 331,571 |         |   |             | 9,947 |           |   |            | 1,166,322 |               |   |             |           |   |   |            | 1,176,269  |  
|                          | Employee purchases of
stock                                                                            |  |           |  |           |  |           | 8,377   |         |   |             | 251   |           |   |            | 28,063    |               |   |             |           |   |   |            | 28,314     |  
|                          |                                                                                                        |  |           |   |           |  |           |         |         |   |             |       |           |   |            |           |               |   |             |            |   |   |            |           
|Balance, February 2, 2001 |                                                                                                        |  |          |   |           |  | 1,882,593 |         |         |   | 56,477      |       |           |   | 15,027,827 |           |               |   | (4,672,506  | )          |   |   | 10,411,798 |           
|                          | Net loss                                                                                               |  |           |  |           |  |           |        |         |   |             |      |           |   |            |          |               |   |             | (9,801,483 | ) |   |            | (9,801,483 | )
|                          | Employee purchases of stock                                                                            |  |           |  |           |  |           | 3,528   |         |   |             | 106   |           |   |            | 3,793     |               |   |             |           |   |   |            | 3,899      |  
|                          | Other                                                                                                  |  |           |  |           |  |           | 71      |         |   |             | 2     |           |   |            | (21,072   | )             |   |             |           |   |   |            | (21,070    | )
|                          |                                                                                                        |  |           |   |           |  |           |         |         |   |             |       |           |   |            |           |               |   |             |            |   |   |            |           
|Balance, February 1, 2002 |                                                                                                        |  |          |   |           |  | 1,886,192 |         |         |   | 56,585      |       |           |   | 15,010,548 |           |               |   | (14,473,989 | )          |   |   | 593,144    |           
|                          | Net loss                                                                                               |  |           |  |           |  |           |        |         |   |             |      |           |   |            |          |               |   |             | (4,158,392 | ) |   |            | (4,158,392 | )
|                          | Other                                                                                                  |  |           |  |           |  |           |        |         |   |             |      |           |   |            | (210      | )             |   |             |           |   |   |            | (210       | )
|                          |                                                                                                        |  |           |   |           |  |           |         |         |   |             |       |           |   |            |           |               |   |             |            |   |   |            |           
|Balance, January 31, 2003 |                                                                                                        |  |          |   |           |  | 1,886,192 |         |         | $ | 56,585      |       |           | $ | 15,010,338 |           |               | $ | (18,632,381 | )          |   | $ | (3,565,458 | )         
|                          |                                                                                                        |  |           |   |           |  |           |         |         |   |             |       |           |   |            |           |               |   |             |            |   |   |            |           

See accompanying notes to Consolidated Financial Statements.

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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
Consolidated Statements of Cash Flows
Years Ended January 31, 2003, February 1, 2002 and February 2, 2001

|                                                                                            |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |           |            |           |  
|------------------------------------------------------------------------------------------- | -------------------------------------------------------- | ----------------------------------------- | ----------------------------------------------------------------------------- | ---------- | ----------- | ---------- | ----------- | --------- | ----------- | ---------- | --------- | --------- | ---------- | --------- | -
|                                                                                            |                                                          |                                           |                                                                               |            | January 31, |            | February 1, |           | February 2,
|                                                                                            |                                                          | 2003                                      |                                                                               | 2002       |             | 2001      
|                                                                                            |                                                          |                                           |                                                                               |            |             |           
|OPERATING
ACTIVITIES:                                                                       |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |          
|Net loss                                                                                    |                                                          | $                                         | (4,158,392                                                                    | )          |             | $          | (9,801,483  | )         |             | $          | (434,222  | )        
|Adjustments to reconcile net loss to net cash provided by
(used for) continuing operations: |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |          
|                                                                                            | Net loss from discontinued operations                    |                                           |                                                                               | 246,145    |             |            |             | 1,898,691 |             |            |           | 559,371   |           
|                                                                                            | Gain on sale of discontinued operations                  |                                           |                                                                               | (1,258,216 | )           |            |             |          |             |            |           |          |           
|                                                                                            | Gain from cancellation of insurance policy               |                                           |                                                                               | (33,291    | )           |            |             |          |             |            |           |          |           
|                                                                                            | Depreciation and amortization                            |                                           |                                                                               | 1,943,892  |             |            |             | 2,131,146 |             |            |           | 2,117,451 |           
|                                                                                            | Repositioning and store closing provision (credits), net |                                           |                                                                               | 263,053    |             |            |             | (121,450  | )           |            |           | (970,000  | )         
|                                                                                            | Deferred taxes                                           |                                           |                                                                               |           |             |            |             | 3,733,268 |             |            |           | (295,000  | )         
|                                                                                            | Deferred rent credits                                    |                                           |                                                                               | (131,727   | )           |            |             | 225,618   |             |            |           | 109,043   |           
|Other noncash items affecting earnings                                                      |                                                          |                                           | 261,839                                                                       |            |             |            | 222,522     |           |             |            | 55,172    |          
|                                                                                            | Changes in operating assets and liabilities:             |                                           |                                                                               |            |             |            |             |           |             |            |           |           |           
|                                                                                            |                                                          | Merchandise inventories                   |                                                                               |            | 1,939,520   |            |             |           | 906,960     |            |           |           | 1,811,645  |          
|                                                                                            |                                                          | Accounts receivable                       |                                                                               |            | (43,988     | )          |             |           | (11,684     | )          |           |           | (337,713   | )        
|                                                                                            |                                                          | Prepaid expenses and other current assets |                                                                               |            | 30,879      |            |             |           | 91,471      |            |           |           | 131,001    |          
|                                                                                            |                                                          | Accounts payable                          |                                                                               |            | 1,902,157   |            |             |           | 1,763,113   |            |           |           | (1,902,252 | )        
|                                                                                            |                                                          | Accrued liabilities                       |                                                                               |            | 180,886     |            |             |           | 242,403     |            |           |           | (323,337   | )        
|                                                                                            |                                                          | Reserve for store closing                 |                                                                               |            | (284,307    | )          |             |           | (498,425    | )          |           |           | (714,834   | )        
|                                                                                            |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |          
|                                                                                            |                                                          |                                           | Net cash provided by (used for) continuing operations                         |            |             | 858,450    |             |           |             | 782,150    |           |           |            | (193,675  | )
|INVESTING ACTIVITIES:                                                                       |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |          
|Proceeds from sale of Seattle stores, net                                                   |                                                          |                                           | 3,925,222                                                                     |            |             |            |            |           |             |            |          |          
|Purchases of property and equipment, net                                                    |                                                          |                                           | (1,051,247                                                                    | )          |             |            | (770,385    | )         |             |            | (976,856  | )        
|Proceeds from cancellation of insurance policy                                              |                                                          |                                           | 197,812                                                                       |            |             |            |            |           |             |            |          |          
|Other, net                                                                                  |                                                          |                                           | (33,760                                                                       | )          |             |            | (635        | )         |             |            | (6,600    | )        
|                                                                                            |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |          
|                                                                                            |                                                          |                                           | Net cash provided by (used for) investing activities of
continuing operations |            |             | 3,038,027  |             |           |             | (771,020   | )         |           |            | (983,456  | )
|FINANCING ACTIVITIES:                                                                       |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |          
|Net (payments on) proceeds from notes payable  line of credit                              |                                                          |                                           | (2,154,974                                                                    | )          |             |            | 864,383     |           |             |            | 563,935   |          
|Proceeds from note payable  other                                                          |                                                          |                                           |                                                                              |            |             |            | 1,000,000   |           |             |            |          |          
|Net payments on other debt                                                                  |                                                          |                                           | (1,442,817                                                                    | )          |             |            | (381,704    | )         |             |            | (506,189  | )        
|Net proceeds from shareholder rights offering                                               |                                                          |                                           |                                                                              |            |             |            |            |           |             |            | 1,176,269 |          
|Payments of debt acquisition fees                                                           |                                                          |                                           |                                                                              |            |             |            | (240,970    | )         |             |            | (33,580   | )        
|Other                                                                                       |                                                          |                                           | (210                                                                          | )          |             |            | (19,132     | )         |             |            | 28,314    |          
|                                                                                            |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |          
|                                                                                            |                                                          |                                           | Net cash (used for) provided by financing activities of
continuing operations |            |             | (3,598,001 | )           |           |             | 1,222,577  |           |           |            | 1,228,749 |  
|                                                                                            |                                                          |                                           | Net cash used for discontinued operations                                     |            |             | (358,133   | )           |           |             | (1,457,610 | )         |           |            | (93,508   | )
|                                                                                            |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |          
|                                                                                            |                                                          |                                           | Net decrease in cash and cash equivalents                                     |            |             | (59,657    | )           |           |             | (223,903   | )         |           |            | (41,890   | )
|Cash and cash equivalents, beginning of year                                                |                                                          |                                           | 203,975                                                                       |            |             |            | 427,878     |           |             |            | 469,768   |          
|                                                                                            |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |          
|Cash and cash equivalents, end of year                                                      |                                                          | $                                         | 144,318                                                                       |            |             | $          | 203,975     |           |             | $          | 427,878   |          
|                                                                                            |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |          
|SUPPLEMENTAL CASH FLOW INFORMATION:                                                         |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |          
|                                                                                            |                                                          |                                           | Interest paid during the year                                                 |            | $           | 994,292    |             |           | $           | 1,095,146  |           |           | $          | 1,459,294 |  
|                                                                                            |                                                          |                                           | Income taxes paid during the year                                             |            |             | 5,125      |             |           |             | 5,125      |           |           |            | 10,758    |  
|                                                                                            |                                                          |                                           |                                                                               |            |             |            |             |           |             |            |           |          

See accompanying notes to Consolidated Financial Statements.

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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(1)  Nature of Business and Liquidity

Description of Business

We (Paper Warehouse, Inc. or the Company) are a chain of retail
stores, specializing in party supplies and paper goods. As of January 31,
2003, we operated 86 Company-owned stores in nine states throughout the central
and western regions of the United States under the names Paper Warehouse and
Party Universe, and a web site under the name PartySmart.com. In addition,
we sell Paper Warehouse franchises through our wholly owned subsidiary, Paper
Warehouse Franchising, Inc. As of January 31, 2003, we had 50 franchises.

Liquidity

Our consolidated financial statements have been prepared on the basis of
accounting principles applicable to a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. We have incurred net losses of approximately $4.2 million, $9.8
million and $434,000 for fiscal years 2002, 2001 and 2000, respectively. At
January 31, 2003, we had a shareholders deficit of $3.6 million and had
deficit working capital of $3.7 million.

At
January 31, 2003 and subsequent to January 31, 2003, we were out of
compliance with several covenants on our line-of-credit facility. On
May 1, 2003, we obtained a waiver for our non-compliance.
This waiver
is conditional upon our providing a revised business plan on or
before May 31, 2003, our receiving a commitment and subsequent
funding for at least $5.0 million infusion of equity on or before
June 13, 2003 or such later date as approved by the lender in its
discretion, as well as other requirements. If we fail to meet any of
the waiver conditions, we will again be in default of the credit
agreement, and our lender will be entitled to demand full payment of
all outstanding amounts there under. A default under the
line-of-credit provision would not cause a cross default provision to
occur under any of our other debt.

Based on
our current cash position, our recent inability to generate cash from
operations, and our need to purchase in advance inventory for our
upcoming seasonal events, our need to raise cash to satisfy our
working capital needs is immediate. We are actively pursuing
opportunities to satisfy our cash needs through debt and equity
financing. To date, however, we have not been successful in obtaining
the funds needed and we may be unable to obtain funding to meet our
immediate needs on terms acceptable to us or at all. If we are unable
to obtain the required funds in a timely manner, or significantly
improve our cash position through expense reductions or scaled back
operations, we may be forced to consider seeking the protection of
the bankruptcy laws in order to continue the operation of our
business.

Our
ability to continue as a going concern is dependent on us ultimately
achieving profitability and/or raising additional capital. However,
the factors noted in the above paragraphs raise substantial doubt
concerning our ability to continue as a going concern. The
consolidated financial statements do not include any adjustments
relating to the recoverability and classification of asset carrying
amounts, the amount and classification of liabilities that might
result should we be unable to continue as a going concern or the outcome
of these uncertainties.

(2)  Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. We have eliminated all
intercompany balances and transactions between the entities in consolidation.
All share and per share data have been restated to give effect to the
retroactive application of our one-for-three reverse stock split, that became
effective after the close of market on April 16, 2001 (See Note 12).

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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(2)  Summary of Significant Accounting Policies (continued)

Fiscal Year

Our
fiscal year ends on the Friday closest to January 31st. Our fiscal
year is generally 52 weeks; however it periodically consists of 53 weeks. Our
fiscal year ended January 31, 2003 (fiscal 2002) and our fiscal year ended
February 1, 2002 (fiscal 2001) consisted of 52 weeks, and our fiscal year ended
February 2, 2001 (fiscal 2000) consisted of 53 weeks. Unless otherwise stated,
references to years in this report relate to fiscal years rather than to
calendar years.

Accounting Estimates

The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities, and disclosure of contingent assets and liabilities,
at the date of the financial statements, and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.

Cash

Checks written, but not yet cleared totaling approximately $276,000 and
$2.1 million, are included in accounts payable as of January 31, 2003 and
February 1, 2002, respectively.

Merchandise Inventories

Inventories are stated at the lower of cost (as determined on a first-in,
first-out basis) or market. We review slow moving merchandise and take
appropriate markdowns and write-downs, as necessary.

Fair Values of Financial Instruments

Due to their short-term nature, the carrying value of our current
financial assets and liabilities approximates their fair value. The fair value
of our borrowings, if recalculated based on current interest rates, would not
significantly differ from the recorded amounts.

Long-Lived Assets

We review long-lived assets for impairment annually, and whenever events
or changes in circumstances indicate that the carrying amount may not be
recoverable. We recognize a loss for the difference if the fair value is less
than the carrying amount of the asset.

Property and Equipment

Property and equipment are recorded at cost. Depreciation is computed on
a straight-line basis over the estimated useful lives of 3 years for computers
and software costs, 5-7 years for fixtures and equipment and 40 years for
building and land improvements.

Other Assets

Other assets primarily consist of debt issuance costs, goodwill and
security deposits.

Debt issuance costs are amortized to interest expense over the term of the
related financing on a straight-line basis, which approximates the effective
interest method.

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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(2)  Summary of Significant Accounting Policies (continued)

Goodwill represents the excess of purchase price over net assets acquired.
At January 31, 2003, we had unamortized goodwill of approximately $477,000.
Through February 1, 2002, goodwill had been amortized over 15 years on a
straight-line basis. In accordance with the adoption of Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill and Intangible Assets,effective
February 2, 2002,(See Note 3) we reviewed our recorded goodwill and determined
it to have an indefinite life. Accordingly, we did not record any amortization
during fiscal 2002.

Deferred Rent Credits

Certain of our operating leases provide for scheduled increases in base
rentals over their terms. For these leases, we recognize the total rental
amounts due over the lease terms on a straight-line basis. We have established
corresponding deferred rent credits for the differences between the amounts
recognized and the amounts paid.

Store Opening and Closing Costs

Expenditures incurred in connection with the opening of new stores or the
remodeling of existing stores are expensed as incurred.

In the event that a store is planned to close before its lease has
expired, any remaining lease obligation, net of expected sublease recovery, is
provided for in the period we adopt the plan to close the store. In addition,
the remaining investment in fixed assets, net of the expected recovery value,
is also expensed.

Advertising Costs

Advertising costs for our stores are included in store operating expenses
and are expensed as incurred. These advertising costs for stores related to
continuing operations, net of advertising reimbursements, were approximately
$3.3 million for fiscal 2002, and $2.6 million for fiscal years 2001 and 2000.

Net Loss Per Common Share

Basic net loss per common share (EPS) equals net loss divided by the
weighted average number of common shares outstanding during the period.

Diluted EPS equals net 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, 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 at the
end of fiscal years 2002, 2001 and 2000 that were not included in the
computation of diluted EPS for these periods, as their inclusion would have
been antidilutive. In addition, options to purchase 203,921, 260,068 and
259,452 shares of common stock were outstanding at the end of fiscal years
2002, 2001 and 2000, respectively, but were excluded from the computation of
common share equivalents because they were antidilutive. Had we not incurred
losses in these periods, we would have assumed conversions of convertible
subordinated debentures into approximately 444,000 common shares for all three
fiscal years. We would not have assumed any conversions of stock options for
fiscal years 2002 or 2001. We would have assumed conversions of stock options
into approximately 19,000 common shares for fiscal year 2000.

F-8



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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(2) Summary of Significant Accounting Policies (continued)

Stock-Based Compensation

We have a stock option plan for employees and a separate stock option plan
for directors, as described more fully in Note 13. We use the intrinsic value
method to value our stock options issued to employees, and we account for those
plans under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. No
stock-based employee compensation cost is reflected in net loss, as all options
granted under those plans had an exercise price equal to the market value of
the underlying common stock on the date of grant. Had the fair value method
been applied, our compensation expense would have been different. The
following table illustrates the effect on net loss and net loss per share if we
had applied the fair value recognition provisions of SFAS No. 123, Accounting
for Stock-Based Compensation,to stock-based employee compensation for the
following fiscal years:

|                                                                                                                                          |  |             |            |             |  |             |            |   |  |   |          |  
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ----------- | ---------- | ----------- |  | ----------- | ---------- | - |  | - | -------- | -
|                                                                                                                                          |  | January 31, |            | February 1, |  | February 2,
|                                                                                                                                          |  | 2003        |            | 2002        |  | 2001       
|                                                                                                                                          |  |             |            |             |  |            
|Net loss  as reported                                                                                                                    |  | $           | (4,158,392 | )           |  | $           | (9,801,483 | ) |  | $ | (434,222 | )
|Less: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects |  |             | (17,340    | )           |  |             | (130,484   | ) |  |   | (239,000 | )
|                                                                                                                                          |  |             |            |             |  |             |            |   |  |   |          |  
|Net loss  pro forma                                                                                                                      |  | $           | (4,175,732 | )           |  | $           | (9,931,967 | ) |  | $ | (673,222 | )
|                                                                                                                                          |  |             |            |             |  |             |            |   |  |   |          |  
|Basic and diluted net loss per common share  as
reported                                                                                 |  | $           | (2.20      | )           |  | $           | (5.20      | ) |  | $ | (0.27    | )
|                                                                                                                                          |  |             |            |             |  |             |            |   |  |   |          |  
|Basic and diluted net loss per common share 
pro forma                                                                                   |  | $           | (2.21      | )           |  | $           | (5.27      | ) |  | $ | (0.41    | )
|                                                                                                                                          |  |             |            |             |  |             |            |   |  |   |          |  

(3)  Recently Adopted and Issued Accounting Pronouncements and Passed
Legislation

On February 2, 2002, we adopted SFAS No. 141, Business Combinations,SFAS
No. 142, Goodwill and Intangible Assets,and SFAS No. 144, Accounting for the
Impairment or Disposal of Long-lived Assets.As a result of the adoption of
SFAS No. 142, we ceased amortization of our goodwill on February 2, 2002. We
reviewed goodwill for impairment in accordance with SFAS No. 141 and SFAS No.
144, as assigned to reporting units as of February 2, 2002, the transitional
impairment testing date, and at the end of the fourth quarter, our annual
impairment testing date, and no impairment was identified. We have no other
intangible assets. We have goodwill of approximately $477,000. Amortization
expense related to goodwill prior to the adoption of SFAS No. 142 was $42,000
for each of the years ended February 1, 2002 and February 2, 2001. The
adoption of SFAS No. 141 and SFAS No. 142 did not have a material effect on our
consolidated financial statements or reporting of financial information. The
sale of the Seattle net assets were accounted for in accordance with SFAS No.
144 as discontinued operations.

In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 146, Accounting for Costs Associated with Exit or Disposal Activities.
SFAS No. 146 addresses accounting and processing for costs associated with exit
or disposal activities. SFAS No. 146 requires the recognition of a liability
for a cost associated with an exit or disposal activity when the liability is
incurred versus the date a company commits to an exit plan. In addition, SFAS
No. 146 states the liability should be initially measured at fair value. The
requirements of SFAS No. 146 are effective for exit or disposal activities that
are initiated after December 31, 2002. We believe the adoption of SFAS No. 146 will not have a material
effect on our consolidated financial position or results of operations.

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PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(3)  Recently Adopted and Issued Accounting Pronouncements and Passed
Legislation (continued)

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others.FIN 45 addresses the disclosure
requirements of a guarantor in its interim and annual financial statements
about its obligations under certain guarantees that it has issued. FIN 45 also
requires a guarantor to recognize, at the inception of a guarantee, a liability
for the fair value of the obligation undertaken in issuing the guarantee. The
disclosure requirements of FIN 45 are effective for us for our year ended
January 31, 2003. The liability recognition requirements will be applicable
prospectively to all guarantees issued or modified after December 31, 2002.
This pronouncement is not anticipated to have a material effect on our
consolidated financial position or results of operations.

In December 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based
CompensationTransition and Disclosure. SFAS No. 148 amends the disclosure and
certain transition provisions of SFAS No. 123, Accounting for Stock-Based
Compensation.Its disclosure provisions, which apply to all entities with
employee stock-based compensation, are effective for fiscal years ending after
December 15, 2002. New interim period disclosures are also required in
financial statements for interim periods beginning after December 15, 2002.
Other than the additional disclosure requirements, this pronouncement is not
anticipated to have a material effect on the Companys consolidated financial
position or results of operations.

In January 2003, the FASB issued FIN No. 46 (FIN 46), Consolidation of
Variable Interest Entities.FIN 46 is an interpretation of Accounting Research
Bulletin No. 51, Consolidated Financial Statements,and addresses consolidation
of business enterprises of variable interest entities. FIN 46 applies
immediately to variable interest entities created or obtained after January 31,
2003 and it applies in the first fiscal year or interim period beginning after
June 15, 2003, to variable interest entities in which an enterprise holds a
variable interest that it acquired before February 1, 2003. This pronouncement
is not anticipated to have a material effect on our consolidated financial
position or results of operations

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of
2002 (the Act), which immediately impacts Securities and Exchange Commission
registrants, public accounting firms, lawyers and securities analysts. This
legislation is the most comprehensive since the passage of the Securities Act
of 1933 and Securities Exchange Act of 1934. It has far reaching effects on
the standards of integrity for corporate management, board of directors, and
executive management. Additional disclosures, certifications and procedures
will be required of the Company. We do not expect any material adverse effect
on the Company as a result of the passage of this legislation; however, the
full scope of the Act has not yet been determined.

(4) Discontinued Operations

On April 23, 2002, we exited the Seattle market by completing the sale of
13 of our stores located in Seattle for approximately $4.5 million, consisting
of cash and assumption of debt. We sold substantially all of our assets used
in connection with the operation of those stores, consisting primarily of
inventory and equipment. In accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets,which we adopted on February 2,
2002, we have reflected the operating results of the 13 stores in the Seattle
market as discontinued operations in our consolidated statements of operations.
In addition, we have reflected the net assets of the 13 stores in the Seattle
market as net assets of discontinued operations in our consolidated balance
sheet at February 1, 2002. We recorded a gain of approximately $1.3 million in
connection with this sale. Retail sales related to these stores were
approximately $2.0 million, $10.9 million and $10.8 million for fiscal years
2002, 2001 and 2000, respectively.

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PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(5)     Repositioning Provision (Credits) and Store Closing Reserve

During December 2002, we adopted a plan to close our cross-dock facility
and a store and recorded a pre-tax charge of approximately $263,000, reflecting
the estimated remaining lease obligations on these facilities. In addition, we
reversed certain amounts that were previously reserved, that were determined to
be in excess of the amounts needed. At January 31, 2003, we had a remaining
store closing reserve of approximately $674,000.

During the fourth quarter of fiscal 1999, we adopted a plan to close four
under-performing stores, and recorded a pre-tax charge of approximately $1.7
million. This amount consisted primarily of reserves for lease obligations for
these four stores, net of expected sublease payments. Additionally, we
recorded an impairment charge of approximately $200,000 related to furniture
and fixtures and goodwill associated with these stores to be closed. These
four stores were subsequently closed during the first half of fiscal 2000. We
also reserved approximately $600,000 in fiscal 1999 for the remaining lease
obligations for one store that was subsequently relocated during the first
quarter of fiscal 2000. Additionally included in the fiscal 1999 repositioning
charge was a reserve for a change in the estimate of the remaining lease
obligations, net of expected sublease payments, for four stores that were
previously closed of approximately $700,000.

The reserve for store closings at the end of fiscal 2002 and 2001 also
reflects reductions related to ongoing payments of rent, common area
maintenance, real estate taxes and other miscellaneous expenses on stores that
were closed, in addition to adjustments resulting from the subsequent
subleasing of store locations. Prior to our original estimate of time to
sublease store locations, we closed on agreements to sublease three store
locations, and terminated the leases on two locations. Accordingly, we
recovered $230,000 of the store closing reserve during fiscal 2001 and we
recovered $970,000 of the store closing reserve during fiscal 2002.

(6)      Property and Equipment, net

Property and equipment for continuing operations, net, consisted of the
following at:

|                                          |                                   |   |             |           |             |   |             |           | 
|----------------------------------------- | --------------------------------- | - | ----------- | --------- | ----------- | - | ----------- | --------- | 
|                                          |                                   |   |            
|                                          |                                   |   | January 31, |           | February 1,
|                                          |                                   |   | 2003        |           | 2002       
|                                          |                                   |   |             |           |            
|Fixtures and equipment                    |                                   | $ | 15,217,801  |           |             | $ | 14,407,935  |          
|Building                                  |                                   |   | 1,273,088   |           |             |   | 1,273,088   |          
|Software costs                            |                                   |   | 984,897     |           |             |   | 741,597     |          
|Land and improvements                     |                                   |   | 319,733     |           |             |   | 319,733     |          
|Accumulated depreciation and amortization |                                   |   | (12,480,315 | )         |             |   | (10,534,504 | )        
|                                          |                                   |   |             |           |             |   |             |          
|                                          | Total property and equipment, net |   | $           | 5,315,204 |             |   | $           | 6,207,849 | 
|                                          |                                   |   |             |           |             |   |             |          

Depreciation and amortization expense on property and equipment related to
continuing operations was approximately $1.9 million for fiscal year 2002, and
$2.1 million for fiscal years 2001 and 2000.

(7)      Notes Payable  Line of Credit

We have a $15.0 million multi-year revolving line of credit facility with a
bank for general working capital purposes that expires in September 2004.
Borrowings outstanding under this line of credit bear interest at the rate of
prime plus 0.50% (4.75% at January 31, 2003). Interest on borrowings under
this line in fiscal year 2001 was at prime (4.75% at February 1, 2002.)
Borrowings are secured by substantially all of our assets. Advances under this
credit line are limited to a fixed percentage of certain assets, primarily
inventory. As a result of the borrowing limitation, primarily resulting from
the levels of inventory and a financial covenant at month end, we often
maximize the availability under this line during intra-month peaks and at
certain times during the year. At January 31, 2003, we had availability of
$6.2 million, of which

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PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(7)      Notes Payable  Line of Credit (continued)

approximately $5.6 million was outstanding. At February 1, 2002, we had
availability of $10.0 million, of which approximately $7.7 million was
outstanding.

The
revolving credit agreement contains covenants, which require us to
maintain certain financial covenants and a certain level of
availability, imposes restrictions on our ability to pay dividends,
as well as other requirements. At January 31, 2003 and subsequent to
January 31, 2003, we were out of compliance with several covenants. On
May 1, 2003, we obtained a waiver for our non-compliance. This waiver
is conditional upon our providing a revised business plan on or before
May 31, 2003, our receiving a commitment and subsequent funding for
at least $5.0 million infusion of equity on or before June 13, 2003
or such later date as approved by the lender in its discretion, as
well as other requirements. If we fail to meet any of the waiver
conditions, we will again be in default of the credit agreement, and
our lender will be entitled to demand full payment of all outstanding
amounts there under. A default under the line-of-credit provision
would not cause a cross default provision to occur under any of our
other debt.

(8)      Notes Payable  Other

As of February 1, 2002, we had a $1.0 million unsecured note payable to an
unrelated business partner, which was paid in full. In consideration for the
$1.0 million proceeds, we granted this business partner an option to purchase
3,750 shares of our common stock at an exercise price equal to the stocks fair
market value at the date of grant. This option has a ten-year term and vests
ratably over three years from the date of the grant.

(9)     Leases

Our assets under capital leases consist of agreements for equipment and
fixtures and an agreement for software. At January 31, 2003, assets under
capital leases were approximately $261,000, net of accumulated depreciation of
approximately $2.0 million. At February 1, 2002, assets under capital leases
were approximately $918,000, net of accumulated depreciation of approximately
$1.8 million.

We lease all of our retail stores under noncancelable operating leases
that have various expiration dates. In addition to base rents, some leases
require us to pay our share of common area maintenance and real estate taxes,
and include provisions for contingent rentals based upon sales. Some of the
leases contain renewal options under which we may extend the term three to five
years. Total rent expense from continuing operations, for all of our retail
stores in addition to our Minnesota cross-dock location, was approximately $8.6
million, $8.4 million and $8.2 million for fiscal years 2002, 2001 and 2000,
respectively.

Future minimum lease payments required under noncancelable lease
agreements existing at January 31, 2003 were:

|                                       |                                 |        |            |        |         |   |         |         | 
|-------------------------------------- | ------------------------------- | ------ | ---------- | ------ | ------- | - | ------- | ------- | 
|                                       |                                 |        | Operating  |        | Capital
|Fiscal Year:                           |                                 | Leases |            | Leases
|                                       |                                 |        |            |       
|2003                                   |                                 | $      | 9,559,276  |        |         | $ | 298,221 |        
|2004                                   |                                 |        | 8,276,558  |        |         |   | 35,162  |        
|2005                                   |                                 |        | 6,902,863  |        |         |   |        |        
|2006                                   |                                 |        | 5,261,274  |        |         |   |        |        
|2007                                   |                                 |        | 4,472,560  |        |         |   |        |        
|Thereafter                             |                                 |        | 8,050,742  |        |         |   |        |        
|                                       |                                 |        |            |        |         |   |         |        
|Total future minimum lease commitments |                                 | $      | 42,523,273 |        |         |   | 333,383 |        
|                                       |                                 |        |            |        |         |   |         |        
|Less: Interest at 9.4%-15.3%           |                                 |        |            |        |         |   | 30,228  |        
|                                       |                                 |        |            |        |         |   |         |        
|                                       | Total capital lease obligations |        |            |        |         |   | $       | 303,155 | 
|                                       |                                 |        |            |        |         |   |         |        

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PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(10) Long-Term Debt

Subordinated Convertible Debt

We have convertible subordinated debentures in an aggregate principal
amount of $4.0 million, which mature in 2005, and are convertible at $9.00 into
approximately 444,000 shares of our common stock. The indenture under which
these debentures were issued contains covenants that require us to satisfy
certain financial tests and impose restrictions on our ability to pay
dividends. The debentures bear interest at an annual rate of 10.5%, payable
quarterly.

Long-term debt consisted of the following at:

|                                                                                                                                                                       |                           |   |             |           |             |   |           |           | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------- | - | ----------- | --------- | ----------- | - | --------- | --------- | 
|                                                                                                                                                                       |                           |   | January 31, |           | February 1,
|                                                                                                                                                                       |                           |   | 2003        |           | 2002       
|                                                                                                                                                                       |                           |   |             |           |            
|Convertible subordinated debentures due 2005                                                                                                                           |                           | $ | 4,000,000   |           |             | $ | 4,000,000 |          
|Term note payable in monthly installments
of $8,612, including interest at 7.125%
through May 2009. The note is secured by a
first mortgage on our office headquarters |                           |   | 995,726     |           |             |   | 1,026,912 |          
|Note payable in monthly installments of
$5,827, including interest at 10.29%
through August 2003                                                                       |                           |   | 39,425      |           |             |   | 101,763   |          
|Subordinated notes payable to private
placement holders, called and payable upon
presentment                                                                           |                           |   | 100,000     |           |             |   | 100,000   |          
|Note payable in monthly installments of
$4,258, including interest at 8.67% through
September 2003                                                                     |                           |   | 32,986      |           |             |   |          |          
|                                                                                                                                                                       |                           |   |             |           |             |   |           |          
|                                                                                                                                                                       | Sub-total long-term debt  |   |             | 5,168,137 |             |   |           | 5,228,675 | 
|                                                                                                                                                                       | Capital lease obligations |   |             | 303,155   |             |   |           | 653,785   | 
|                                                                                                                                                                       | Less: current maturities  |   |             | 475,627   |             |   |           | 553,481   | 
|                                                                                                                                                                       |                           |   |             |           |             |   |           |          
|                                                                                                                                                                       | Long-term debt            |   | $           | 4,995,665 |             |   | $         | 5,328,979 | 
|                                                                                                                                                                       |                           |   |             |           |             |   |           |          

Required principal payments on long-term debt over the next five years,
excluding capital lease obligations and $100,000 of subordinated notes
payable on demand, are:

|             |                                   |   |           |           | 
|------------ | --------------------------------- | - | --------- | --------- | 
|Fiscal Year: |                                   |   |           |          
|             |                                   |   |           |          
|2003         |                                   | $ | 105,889   |          
|2004         |                                   |   | 35,942    |          
|2005         |                                   |   | 4,038,589 |          
|2006         |                                   |   | 41,430    |          
|2007         |                                   |   | 44,480    |          
|Thereafter   |                                   |   | 801,807   |          
|             |                                   |   |           |          
|             | Total required principal payments |   | $         | 5,068,137 | 
|             |                                   |   |           |          

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PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(11) Income Taxes

As prescribed by SFAS No. 109, Accounting for Income Taxes,we did not
record a tax benefit on our fiscal 2002 or our fiscal 2001 loss. The actual
income tax rate differed from the amounts computed by the U.S. federal income
tax rate of 34% to pretax net loss as a result of the following for the fiscal
years ending:

|                                                                                                         |                    |   |             |      |             |   |             |      |   |   |          |       |   
|-------------------------------------------------------------------------------------------------------- | ------------------ | - | ----------- | ---- | ----------- | - | ----------- | ---- | - | - | -------- | ----- | --
|                                                                                                         |                    |   | January 31, |      | February 1, |   | February 2,
|                                                                                                         |                    |   | 2003        |      | 2002        |   | 2001       
|                                                                                                         |                    |   |             |      |             |   |            
|Computed expected tax benefit on losses                                                                |                    | $ | (1,413,850  | )    |             | $ | (2,063,193  | )    |   | $ | (247,935 | )    
|Reduction in income taxes resulting from state
and local income taxes, net of federal income
tax benefit |                    |   | (181,225    | )    |             |   | (293,142    | )    |   |   | (25,850  | )    
|Change in valuation allowance                                                                            |                    |   | 1,582,500   |      |             |   | 6,088,500   |      |   |   |         |      
|Other permanent difference                                                                               |                    |   | 12,575      |      |             |   | 1,103       |      |   |   | (21,215  | )    
|                                                                                                         |                    |   |             |      |             |   |             |      |   |   |          |      
|Total income tax provision (benefit)                                                                     |                    | $ |            |      |             | $ | 3,733,268   |      |   | $ | (295,000 | )    
|                                                                                                         |                    |   |             |      |             |   |             |      |   |   |          |      
|                                                                                                         | Effective tax rate |   |             | 0.00 | %           |   |             | 61.5 | % |   |          | (40.5 | %)
|                                                                                                         |                    |   |             |      |             |   |             |      |   |   |          |      

The components of the income tax provision (benefit) were as follows for
the fiscal years ending:

|          |         |                                      |   |             |   |             |   |             |           |  |   |          |          |  
|--------- | ------- | ------------------------------------ | - | ----------- | - | ----------- | - | ----------- | --------- |  | - | -------- | -------- | -
|          |         |                                      |   |            
|          |         |                                      |   |            
|          |         |                                      |   | January 31, |   | February 1, |   | February 2,
|          |         |                                      |   | 2003        |   | 2002        |   | 2001       
|          |         |                                      |   |             |   |             |   |            
|Deferred: |         |                                      |   |             |   |             |   |             |           |  |   |         
|          | Federal |                                      | $ |            |   |             | $ | 3,270,987   |           |  | $ | (269,150 | )       
|          | State   |                                      |   |            |   |             |   | 462,281     |           |  |   | (25,850  | )       
|          |         |                                      |   |             |   |             |   |             |           |  |   |          |         
|          |         | Total income tax provision (benefit) |   | $           |  |             |   | $           | 3,733,268 |  |   | $        | (295,000 | )
|          |         |                                      |   |             |   |             |   |             |           |  |   |          |         

Deferred taxes, detailed below, recognize the impact of temporary
differences between the amounts of assets and liabilities recorded for
financial statement purposes and such amounts measured in accordance with tax
laws. Realization of the net operating loss carryforwards and other deferred
tax temporary differences are contingent on future taxable earnings. During
fiscal 2001, our deferred tax asset was reviewed for expected utilization using
a more likely than not approach as required by SFAS No. 109 by assessing the
available positive and negative evidence surrounding its recoverability.
Accordingly, we recorded a valuation allowance of approximately $6.1 million on
the deferred tax asset. During fiscal 2002, we recorded a valuation allowance
equal to approximately 1.6 million, for a total valuation allowance of $7.7
million.

We continue to assess and evaluate strategies that will enable the
deferred tax asset, or portion thereof, to be utilized, and will reduce the
valuation allowance appropriately at such time when it is determined that the
more likely than not approach is satisfied.

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PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(11) Income Taxes (continued)

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities were as
follows at:

|                                  |                                                                                              |                                   |                               |           |             |   |             |           |            |   | 
|--------------------------------- | -------------------------------------------------------------------------------------------- | --------------------------------- | ----------------------------- | --------- | ----------- | - | ----------- | --------- | ---------- | - | 
|                                  |                                                                                              |                                   |                               |           | January 31, |   | February 1,
|                                  |                                                                                              |                                   |                               |           | 2003        |   | 2002       
|                                  |                                                                                              |                                   |                               |           |             |   |            
|Deferred tax asset/(liability):   |                                                                                              |                                   |                               |           |             |   |             |          
|Short-term deferred income taxes: |                                                                                              |                                   |                               |           |             |   |             |          
|                                  | Inventories, principally due to additional costs inventoried for
tax purposes                |                                   | $                             | 132,102   |             |   | $           | 192,000   |           
|                                  |                                                                                              |                                   |                               |           |             |   |             |           |           
|Long-term deferred income taxes:  |                                                                                              |                                   |                               |           |             |   |             |          
|                                  | Net operating loss carryforwards                                                             |                                   |                               | 7,219,350 |             |   |             | 5,590,480 |           
|                                  | Reserve for store closings                                                                   |                                   |                               | 269,614   |             |   |             | 278,116   |           
|                                  | Difference in timing of lease deductions                                                     |                                   |                               | 537,664   |             |   |             | 763,141   |           
|                                  | Cumulative effect of accounting change                                                       |                                   |                               | 55,805    |             |   |             | 39,160    |           
|                                  | Plant and equipment, principally due to differences in depreciation
and capitalized interest |                                   |                               | (581,728  | )           |   |             | (761,078  | )         
|                                  | Software development expense                                                                 |                                   |                               |          |             |   |             | (42,622   | )         
|                                  | Other                                                                                        |                                   |                               | 38,193    |             |   |             | 29,303    |           
|                                  |                                                                                              |                                   |                               |           |             |   |             |           |           
|                                  |                                                                                              | Net long-term deferred tax assets |                               |           | 7,538,898   |   |             |           | 5,896,500  |  
|                                  |                                                                                              |                                   |                               |           |             |   |             |          
|                                  |                                                                                              | Total deferred tax assets         |                               |           | 7,671,000   |   |             |           | 6,088,500  |  
|                                  |                                                                                              |                                   |                               |           |             |   |             |          
|                                  |                                                                                              | Valuation allowance               |                               |           | (7,671,000  | ) |             |           | (6,088,500 | )
|                                  |                                                                                              |                                   |                               |           |             |   |             |           |           
|                                  |                                                                                              |                                   | Total net deferred tax assets |           | $           |  |             |           | $          |  | 
|                                  |                                                                                              |                                   |                               |           |             |   |             |          

At January 31, 2003, we had net operating loss carryforwards for federal
purposes of approximately $18.0 million, available to offset future taxable
income, if any, through fiscal 2022.

(12) Equity Transactions

On April 4, 2001, our Board of Directors approved a one-for-three reverse
stock split of our $.01 par value common and preferred stock for stockholders
of record on April 16, 2001. The reverse stock split reduced the number of
shares of common stock previously issued and outstanding at February 2, 2001
from 5,647,779 to 1,882,593, subsequently increased to 1,886,192 to eliminate
fractional interests. No fractional shares of common stock were issued in
connection with the reverse stock split. The par value of our common and
preferred stock correspondingly increased to $.03 per share. The reverse stock
split was effective as of the close of market on April 16, 2001. All share and
per share data is presented to give effect to the reverse stock split.

During fiscal 2000, we distributed to shareholders of record on September
15, 2000, 0.108 rights for each share of common stock held on September 15,
2000. Each whole right entitled its holder to purchase one-third share of our
$.03 par value common stock at a subscription price of $3.75. No fractional
rights were issued and the rights were not transferable. As a result of this
offering, we sold approximately 332,000 shares of $.03 par value common stock
and raised approximately $1.2 million of net proceeds, which was used for
general working capital and corporate purposes.

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PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(13) Stock Options

We have a stock option plan (the Plan) pursuant to which we grant stock
option awards in order to attract and retain eligible participants and to
preserve cash resources. Under this plan, 666,667 shares are authorized for
issuance and 200,587 were outstanding as of January 31, 2003. We also have a
separate director stock option plan (the Director Plan) which permits up to
38,214 shares to be issued, of which 3,334 were outstanding as of January 31,
2003. Under both plans, stock options are granted with an exercise price equal
to the stocks fair market value at the date of grant. All stock options have
ten-year terms and vest ratably over three years from the date of grant.

During fiscal 2000, the Compensation Committee of the Board of Directors
approved the repricing to $6.00 per common share of 141,433 options, all of
which were originally granted in excess of $6.00 per common share. The
repricing of these options creates in substance a modification. Accordingly,
these options are treated as variable awards, and we reflect changes in their
value in the general and administrative expense line until the options are
exercised or expire. All exercise prices as disclosed in the footnotes have
been restated to reflect the repricing of these options.

During fiscal 2001, our shareholders approved an amendment to the Plan to
increase the number of shares available for issuance from 341,667 to 666,667
and to add participants who own more than 10% of the companys common stock to
the class of participants eligible to receive incentive stock options.

Details of the status of stock options as of January 31, 2003 are
reflected in the tables below:

|                                     |                            |  |         |                   |   |             |      |           |  |          |         |         |   |           |      |      |  | 
|------------------------------------ | -------------------------- |  | ------- | ----------------- | - | ----------- | ---- | --------- |  | -------- | ------- | ------- | - | --------- | ---- | ---- |  | 
|                                     |                            |  |         | Options          
|                                     |                            |  |         |                  
|                                     |                            |  |         | Total Outstanding |   | Exercisable
|                                     |                            |  |         |                   |   |            
|                                     |                            |  |         |                   |   |             |      | Weighted- |  |          |         |         |   | Weighted-
|                                     |                            |  |         |                   |   |             |      | Average   |  |          |         |         |   | Average  
|                                     |                            |  |         | Number of         |   | Exercise    |      | Number of |  | Exercise
|                                     |                            |  |         | Shares            |   | Price       |      | Shares    |  | Price   
|                                     |                            |  |         |                   |   |             |      |           |  |         
|Options outstanding January 28, 2000 |                            |  | 173,516 |                   |   | $           | 5.99 |           |  |          | 173,516 |         |   | $         | 5.99 |     
|                                     | Options granted            |  |         | 94,312            |   |             |      | 2.75      |  |          |         | 62,875  |   |           |      | 2.75 | 
|                                     | Options forfeited/canceled |  |         | (8,376            | ) |             |      | 5.62      |  |          |         | (8,376  | ) |           |      | 5.88 | 
|                                     |                            |  |         |                   |   |             |      |           |  |          |         |         |   |           |      |      | 
|Options outstanding February 2, 2001 |                            |  | 259,452 |                   |   |             | 4.82 |           |  |          | 228,015 |         |   |           | 5.10 |     
|                                     | Options granted            |  |         | 4,384             |   |             |      | 0.99      |  |          |         | 1,461   |   |           |      | 0.99 | 
|                                     | Options forfeited/canceled |  |         | (3,768            | ) |             |      | 6.00      |  |          |         | (3,768  | ) |           |      | 6.00 | 
|                                     |                            |  |         |                   |   |             |      |           |  |          |         |         |   |           |      |      | 
|Options outstanding February 1, 2002 |                            |  | 260,068 |                   |   |             | 4.74 |           |  |          | 225,708 |         |   |           | 5.06 |     
|                                     | Options granted            |  |         | 20,000            |   |             |      | 1.00      |  |          |         |        |   |           |      |     | 
|                                     | Options forfeited/canceled |  |         | (76,147           | ) |             |      | 5.00      |  |          |         | (68,646 | ) |           |      | 5.26 | 
|                                     |                            |  |         |                   |   |             |      |           |  |          |         |         |   |           |      |      | 
|Options outstanding January 31, 2003 |                            |  | 203,921 |                   |   | $           | 4.28 |           |  |          | 157,062 |         |   | $         | 4.97 |     
|                                     |                            |  |         |                   |   |             |      |           |  |          |         |         |   |           |      |      | 

Options exercisable at February 1, 2002 and February 2, 2001 were 190,134
and 124,119, respectively.

F-16



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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(13)  Stock Options (continued)

|            |  |                   |         |               |  |           |     |           |  |               |      |          |  |         |         |           |  |  |     |  |  |   |      | 
|----------- |  | ----------------- | ------- | ------------- |  | --------- | --- | --------- |  | ------------- | ---- | -------- |  | ------- | ------- | --------- |  |  | --- |  |  | - | ---- | 
|            |  | Options          
|            |  |                  
|            |  | Total Outstanding |         | Exercisable  
|            |  |                   |         |              
|            |  |                   |         |               |  | Weighted- |     |           |  |               |      |          |  |         |         | Weighted- |  |  |     | 
|            |  |                   |         |               |  | average   |     | Weighted- |  |               |      |          |  | average |         | Weighted-
|Range of    |  | Number            |         | remaining     |  | average   |     | Number    |  | remaining     |      | average 
|exercise    |  | of                |         | contractual   |  | exercise  |     | of        |  | contractual   |      | exercise
|price       |  | shares            |         | life in years |  | price     |     | shares    |  | life in years |      | price   
|            |  |                   |         |               |  |           |     |           |  |               |      |         
|$0.71-$1.00 |  |                   | 23,750  |               |  |           | 9.2 |           |  | $             | 0.95 |          |  |         | 1,250   |           |  |  | 9.0 |  |  | $ | 0.71 | 
|$2.63-$3.93 |  |                   | 71,809  |               |  |           | 7.2 |           |  |               | 2.76 |          |  |         | 47,661  |           |  |  | 7.2 |  |  |   | 2.76 | 
|$4.31-$6.00 |  |                   | 108,362 |               |  |           | 5.5 |           |  |               | 6.00 |          |  |         | 108,151 |           |  |  | 5.5 |  |  |   | 6.00 | 
|            |  |                   |         |               |  |           |     |           |  |               |      |          |  |         |         |           |  |  |     |  |  |   |      | 
|            |  |                   | 203,921 |               |  |           | 6.6 |           |  |               | 4.28 |          |  |         | 157,062 |           |  |  | 6.1 |  |  |   | 4.97 | 
|            |  |                   |         |               |  |           |     |           |  |               |      |          |  |         |         |           |  |  |     |  |  |   |      | 

The per share weighted-average fair value of options granted each year
using the Black-Scholes option-pricing model was $0.10 at January 31, 2003,
$0.44 at February 1, 2002 and $1.14 at February 2, 2001, using the following
weighted-average assumptions for fiscal years:

|                         |  |      |     |      |  |      |     |   |  |  |     |  
|------------------------ |  | ---- | --- | ---- |  | ---- | --- | - |  |  | --- | -
|                         |  | 2002 |     | 2001 |  | 2000
|                         |  |      |     |      |  |     
|Volatility               |  |      | 90  | %    |  |      | 60  | % |  |  | 60  | %
|Expected divided yield   |  |      | 0.0 | %    |  |      | 0.0 | % |  |  | 0.0 | %
|Risk free rate           |  |      | 5.0 | %    |  |      | 5.0 | % |  |  | 5.0 | %
|Expected life (in years) |  |      | 7.0 |      |  |      | 5.0 |   |  |  | 5.0 |  

(14) Employee Benefits

We have a retirement savings plan that includes a 401(k) feature. The
plan covers substantially all employees who are 21 years of age and have worked
over 1,000 hours in one year. Employees become fully vested in the plan on a
graduated scale over a six-year period. The 401(k) feature allows for
employees to elect salary deferrals for up to 15% of their compensation, but
not in excess of certain limitations. We match 25% of the employees
contribution up to 4% of any employees compensation. Our contributions were
approximately $52,000 for fiscal years 2002 and 2001, and $54,000 for fiscal
year 2000. We reserve the right to make a discretionary contribution each plan
year, however we did not make any discretionary contributions in fiscal years
2002, 2001 or 2000.

Due to a low level of participation, during fiscal 2001, we suspended our
Employee Stock Purchase Plan, which was introduced in fiscal 1999. The plan
allowed eligible employees to purchase our stock at below-market prices through
elected payroll deductions equal to between 2% and 15% of their compensation.
The plan also allowed participants to purchase shares of our stock on each
offering date at the lower of 85% of the fair market value of one share of
common stock on the offering date or on the termination date of the offering
period. Pursuant to this plan, during fiscal 2001 and fiscal 2000, employees
purchased approximately 3,500 and 8,400 shares of our common stock,
respectively.

F-17



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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(15)  Commitments

We have a multi-year supply agreement with a vendor, to be the exclusive
supplier of greeting cards for our Company-owned and franchise stores. During
fiscal 2002, in order to assist us with our liquidity needs, this vendor
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 vendor 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. Total
chain-wide purchases under this agreement were approximately $8.9 million for
fiscal 2002. Total chain-wide purchases under the prior agreement, which
excluded party supplies were approximately $7.6 million and $3.2 million for
fiscal 2001 and fiscal 2000, respectively.

(16) Major Suppliers

We have two suppliers that individually represented greater than 10% of
total purchases for fiscal 2002 and that were determined to be significant to
our operations. The following table reflects purchases from these two
suppliers as a percentage of total purchases for fiscal years 2002, 2001 and
2000:

|                     |  |             |      |      |  |      |      |   |  |  |      |  
|-------------------- |  | ----------- | ---- | ---- |  | ---- | ---- | - |  |  | ---- | -
|                     |  | Fiscal Year
|                     |  |            
|                     |  | 2002        |      | 2001 |  | 2000
|                     |  |             |      |      |  |     
|Supplier A           |  |             | 23.5 | %    |  |      | 21.1 | % |  |  | 16.8 | %
|Supplier B           |  |             | 10.0 | %    |  |      | 10.1 | % |  |  | 3.0  | %
|All other suppliers* |  |             | 66.5 | %    |  |      | 68.8 | % |  |  | 80.2 | %

Combined accounts payable balances with supplier A and B above were $4.7
million at January 31, 2003, including amounts extended to June 30, 2003.
Accounts payable balances with these suppliers were $2.2 million at February 1,
2002.

*Purchases were either less than 10% of fiscal 2002 purchases or supplier was
determined not to be significant to our operations.

F-18



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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements

(17) Supplementary Financial Information (Unaudited)

The following represents unaudited selected quarterly financial
information for fiscal years 2002 and 2001 for continuing operations:

($s in 000s, except per share data)

|                              |  |               |        |                |  |               |        |                |  |      |        |      |  |      |        |      |  |   |        |   |  |   |        |   |  |   |        |   |  |   |        |  
|----------------------------- |  | ------------- | ------ | -------------- |  | ------------- | ------ | -------------- |  | ---- | ------ | ---- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | - |  | - | ------ | - |  | - | ------ | -
|                              |  | First Quarter |        | Second Quarter |  | Third Quarter |        | Fourth Quarter
|                              |  |               |        |                |  |               |        |               
|                              |  | 2002          |        | 2001           |  | 2002          |        | 2001           |  | 2002 |        | 2001 |  | 2002 |        | 2001
|                              |  |               |        |                |  |               |        |                |  |      |        |      |  |      |        |     
|Retail Sales                  |  | $             | 17,384 |                |  | $             | 17,457 |                |  | $    | 19,555 |      |  | $    | 19,010 |      |  | $ | 19,365 |   |  | $ | 19,814 |   |  | $ | 17,399 |   |  | $ | 18,123 |  
|Gross Profit (1)              |  |               | 6,270  |                |  |               | 6,097  |                |  |      | 6,877  |      |  |      | 6,645  |      |  |   | 6,687  |   |  |   | 6,629  |   |  |   | 4,940  |   |  |   | 5,027  |  
|Net loss (2)                  |  |               | (648   | )              |  |               | (347   | )              |  |      | (486   | )    |  |      | (213   | )    |  |   | (852   | ) |  |   | (561   | ) |  |   | (3,184 | ) |  |   | (6,782 | )
|Basic and Diluted
EPS (2) (3) |  | $             | (0.34  | )              |  | $             | (0.19  | )              |  | $    | (0.26  | )    |  | $    | (0.11  | )    |  | $ | (0.45  | ) |  | $ | (0.30  | ) |  | $ | (1.69  | ) |  | $ | (3.60  | )



|(1) |  | Gross profit is retail sales less cost of products sold and occupancy
costs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Fourth quarter 2002 net loss includes a provision of $263,000 ($0.14 per
basic and diluted share), reflecting the estimated remaining lease
obligations on our cross-dock facility and on a store, both of which we
had adopted a plan during December 2002 to subsequently close. This
provision was partially offset by the reversal of excess amounts in the
reserve. First quarter 2001 net loss includes $230,000 ($0.07 per basic
and diluted share, net of tax) related to the recovery of store closing
reserves. Fourth quarter 2001 loss includes approximately $108,000 ($0.06
per basic and diluted share) related to a charge to the store closing
reserves for the remaining lease obligation on a store that was
subsequently relocated. Fourth quarter 2001 loss also reflects the
recording of a valuation allowance on our deferred tax asset.
|   
|(3) |  | Basic and Diluted EPS reflect the retroactive restatement of our April
2001 one-for-three reverse stock split.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

F-19





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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.                                           
|                   |  |                                                                 
|Dated: May 1, 2003 |  |                                                                 
|                   |  |                                                                 
|                   |  | By: /s/ Yale T. Dolginow                                        
|                   |  |                                                                 
|                   |  | Yale T. Dolginow
Chairman, President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on May 1, 2003 by the following persons on behalf
of the registrant and in the capacities indicated.

|    |  |                    |                                                 |                                           
|--- |  | ------------------ | ----------------------------------------------- | ------------------------------------------
|    |  | SIGNATURE          |                                                 |                                           
|    |  |                    |                                                 |                                           
|/s/ |  | Yale T. Dolginow   |                                                 | Chairman of the Board, President and Chief
|    |  |                    | Executive Officer (principal executive officer)
|    |  | Yale T. Dolginow   |                                                 |                                           
|    |  |                    |                                                 |                                           
|/s/ |  | Diane C. Dolginow  |                                                 |                                           
|    |  |                    | Secretary and Director                         
|    |  | Diane C. Dolginow  |                                                 |                                           
|    |  |                    |                                                 |                                           
|/s/ |  | Jeffery S. Halpern |                                                 |                                           
|    |  |                    | Director                                       
|    |  | Jeffery S. Halpern |                                                 |                                           
|    |  |                    |                                                 |                                           
|/s/ |  | Martin A. Mayer    |                                                 |                                           
|    |  |                    | Director                                       
|    |  | Martin A. Mayer    |                                                 |                                           
|    |  |                    |                                                 |                                           
|/s/ |  | Richard W. Perkins |                                                 |                                           
|    |  |                    | Director                                       
|    |  | Richard W. Perkins |                                                 |                                           
|    |  |                    |                                                 |                                           
|/s/ |  | Diana G. Purcel    |                                                 | Vice President and Chief Financial Officer
|    |  |                    | (principal financial and accounting officer)   
|    |  | Diana G. Purcel    |                                                 |                                           





---



##### Table of Contents



CERTIFICATIONS

I, Yale T. Dolginow, President and Chief Executive Officer of Paper Warehouse,
Inc., certify that:

1.     I have reviewed this annual report on Form 10-K of Paper Warehouse, Inc.

2.     Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4.     The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:



| | a)     Designed such disclosure controls
and procedures to ensure that
material information relating to the
registrant, including its
consolidated subsidiaries, is made
known to us by others within those
entities, particularly during the
period in which this annual report
is being prepared;
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b)     Evaluated the effectiveness of
the registrants disclosure controls
and procedures as of a date within
90 days prior to the filing date of
this annual report (the Evaluation
Date); and                                                                                                  
|
| | c)     Presented in this annual report
our conclusions about the
effectiveness of the disclosure
controls and procedures based on our
evaluation as of the Evaluation
Date;                                                                                                                        

5.     The registrants other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrants auditors and the audit committee of
registrants board of directors (or persons performing the equivalent
functions):



| | a)     All significant deficiencies in the design or operation of internal controls
which could adversely affect the registrants ability to record, process,
summarize and report financial data and have identified for the registrants
auditors any material weaknesses in internal controls; and
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b)     Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls;
and                                                                                                                                        

6.     The registrants other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                     |                                                                              | 
|-------------------- | ---------------------------------------------------------------------------- | 
|Date: May 1, 2003    |                                                                             
|                     |                                                                              | 
|/s/ Yale T. Dolginow |                                                                             
|                     |                                                                             
|                     |                                                                              | 
|By:                  | Yale T. Dolginow
President and Chief Executive Officer
Paper Warehouse, Inc. | 





---



##### Table of Contents



CERTIFICATIONS

I, Diana G. Purcel, Vice President and Chief Financial Officer of Paper
Warehouse, Inc., certify that:

1.     I have reviewed this annual report on Form 10-K of Paper Warehouse, Inc.

2.     Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4.     The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:



| | a)     Designed such disclosure controls
and procedures to ensure that
material information relating to the
registrant, including its
consolidated subsidiaries, is made
known to us by others within those
entities, particularly during the
period in which this annual report
is being prepared;
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b)     Evaluated the effectiveness of
the registrants disclosure controls
and procedures as of a date within
90 days prior to the filing date of
this annual report (the Evaluation
Date); and                                                                                                  
|
| | c)     Presented in this annual report
our conclusions about the
effectiveness of the disclosure
controls and procedures based on our
evaluation as of the Evaluation
Date;                                                                                                                        

5.     The registrants other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrants auditors and the audit committee of
registrants board of directors (or persons performing the equivalent
functions):



| | a)     All significant deficiencies in the design or operation of internal controls
which could adversely affect the registrants ability to record, process,
summarize and report financial data and have identified for the registrants
auditors any material weaknesses in internal controls; and
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b)     Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls;
and                                                                                                                                        

6.     The registrants other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                    |                                                                                  | 
|------------------- | -------------------------------------------------------------------------------- | 
|Date: May 1, 2003   |                                                                                 
|                    |                                                                                  | 
|/s/ Diana G. Purcel |                                                                                 
|                    |                                                                                 
|                    |                                                                                  | 
|By:                 | Diana G. Purcel
Vice President and Chief Financial Officer
Paper Warehouse, Inc. | 





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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
For the fiscal year ended January 31, 2003

|         |      |                     |                                                                                                                                         |                  |                                                                                                                 
|-------- | ---- | ------------------- | --------------------------------------------------------------------------------------------------------------------------------------- | ---------------- | ----------------------------------------------------------------------------------------------------------------
|Item No. |      | Description of Item |                                                                                                                                         | Method of Filing
|         |      |                     |                                                                                                                                         |                 
|         | 3.1  |                     | Amended and Restated Articles of Incorporation                                                                                          |                  | Incorporated by
reference to the
Companys
Registration
Statement on Form
S-1 (File No.
333-36911)              
|         |      |                     |                                                                                                                                         |                  |                                                                                                                 
|         | 3.2  |                     | Amended and Restated By-laws                                                                                                            |                  | Incorporated by
reference to the
Companys
Registration
Statement on Form
S-1 (File No.
333-36911)              
|         |      |                     |                                                                                                                                         |                  |                                                                                                                 
|         | 4.1  |                     | Indenture, dated July 20, 1999, between the Company and
Norwest Bank Minnesota, N.A. relating to 9% Convertible
Subordinated Debentures |                  | Incorporated by
reference to the
Companys
Registration
Statement on Form
S-1 (File No.
333-79161)              
|         |      |                     |                                                                                                                                         |                  |                                                                                                                 
|         | 4.2  |                     | Form of 9% Subordinated Debentures due September 15, 2005                                                                               |                  | Incorporated by
reference to the
Companys
Registration
Statement on Form
S-1 (File No.
333-79161)              
|         |      |                     |                                                                                                                                         |                  |                                                                                                                 
|         | 10.1 |                     | 1997 Stock Option and Compensation Plan                                                                                                 |                  | Incorporated by
reference to the
Companys
Registration
Statement on Form
S-1 (File No.
333-36911)              
|         |      |                     |                                                                                                                                         |                  |                                                                                                                 
|         | 10.2 |                     | Directors Stock Option Plan                                                                                                            |                  | Incorporated by
reference to the
Companys
Registration
Statement on Form
S-1 (File No.
333-36911)              
|         |      |                     |                                                                                                                                         |                  |                                                                                                                 
|         | 10.3 |                     | 1998 Employee Stock Option Plan                                                                                                         |                  | Incorporated by reference to the
Companys Form 10-K for
fiscal year ended January
29, 1999 (File No. 000-23389)
|         |      |                     |                                                                                                                                         |                  |                                                                                                                 
|         | 10.4 |                     | First Amendment to 1997 Stock Option and Compensation Plan                                                                              |                  | Incorporated by
reference to the
Companys Form 10-K
for fiscal year
ended January 28,
2000 (File No.
000-23389)
|         |      |                     |                                                                                                                                         |                  |                                                                                                                 
|         | 10.5 |                     | Mortgage note dated April 8, 1999 between the Company
and Fortis Insurance Company                                                      |                  | Incorporated by
reference to the
Companys
Registration
Statement on Form
S-1 (File No.
333-79161)              
|         |      |                     |                                                                                                                                         |                  |                                                                                                                 
|         | 10.6 |                     | Mortgage and Security Agreement between the Company
and Fortis Insurance Company dated April 8, 1999                                    |                  | Incorporated by
reference to the
Companys
Registration
Statement on Form
S-1 (File No.
333-79161)              

E-1



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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K (continued)
For the fiscal year ended January 31, 2003

|         |       |                     |                                                                                                                                |                  |                                                                                                                 
|-------- | ----- | ------------------- | ------------------------------------------------------------------------------------------------------------------------------ | ---------------- | ----------------------------------------------------------------------------------------------------------------
|Item No. |       | Description of Item |                                                                                                                                | Method of Filing
|         |       |                     |                                                                                                                                |                 
|         | 10.7  |                     | Loan and Security Agreement between BankBoston Retail
Finance, Inc. and the Company dated June 7, 1999                         |                  | Incorporated by reference to
the Companys Registration
Statement on Form S-1 (File No. 333-79161)              
|         |       |                     |                                                                                                                                |                  |                                                                                                                 
|         | 10.8  |                     | First Amendment to Loan and Security Agreement between
BankBoston Retail Finance, Inc. and the Company dated
December 10, 1999 |                  | Incorporated by
reference to the
Companys Form 10-Q
for quarter ended
October 29, 1999
(File No.
000-23389)    
|         |       |                     |                                                                                                                                |                  |                                                                                                                 
|         | 10.9  |                     | Second Amendment to Loan and Security Agreement between
BankBoston Retail Finance, Inc. and the Company dated
March 17, 2000   |                  | Incorporated by
reference to the
Companys Form 10-K
for fiscal year
ended January 28,
2000 (File No.
000-23389)
|         |       |                     |                                                                                                                                |                  |                                                                                                                 
|         | 10.10 |                     | Third Amendment to Loan and Security Agreement between
BankBoston Retail Finance, Inc. and the Company dated
December 6, 2000  |                  | Incorporated by
reference to the
Companys Form 10-K
for fiscal year
ended February 2,
2001 (File No.
000-23389)
|         |       |                     |                                                                                                                                |                  |                                                                                                                 
|         | 10.11 |                     | Fourth Amendment to Loan and Security Agreement between
Fleet Retail Finance, Inc. and the Company dated April 17,
2001        |                  | Incorporated by
reference to the
Companys Form 10-K
for fiscal year
ended February 2,
2001 (File No.
000-23389)
|         |       |                     |                                                                                                                                |                  |                                                                                                                 
|         | 10.12 |                     | First Supplemental Indenture between the Company and
Norwest Bank, N. A. as trustee                                            |                  | Incorporated by
reference to the
Companys Form 10-Q
for quarter ended
April 28, 2000
(File No.
000-23389)      
|         |       |                     |                                                                                                                                |                  |                                                                                                                 
|         | 10.13 |                     | Amendment to 1998 Employee Stock Purchase Plan                                                                                 |                  | Incorporated by
reference to the
Companys Form 10-Q
for quarter ended
April 28, 2000
(File No.
000-23389)      
|         |       |                     |                                                                                                                                |                  |                                                                                                                 
|         | 10.14 |                     | Second Amendment to 1997 Stock Option and Compensation Plan                                                                    |                  | Incorporated by
reference to the
Companys Form 10-Q
for quarter ended
August 3, 2001
(File No.
000-23389)      
|         |       |                     |                                                                                                                                |                  |                                                                                                                 
|         | 10.15 |                     | Loan and Security Agreement Between Wells Fargo Retail
Finance LLC and the Company dated September 7, 2001                     |                  | Incorporated by
reference to the
Companys Form 8-K
dated October 2,
2001 (File No.
000-23389)                  

E-2



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##### Table of Contents



PAPER WAREHOUSE, INC. and SUBSIDIARIES
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K (continued)
For the fiscal year ended January 31, 2003

|         |       |                     |                                                                                                                               |                  |                                                                                                                 
|-------- | ----- | ------------------- | ----------------------------------------------------------------------------------------------------------------------------- | ---------------- | ----------------------------------------------------------------------------------------------------------------
|Item No. |       | Description of Item |                                                                                                                               | Method of Filing
|         |       |                     |                                                                                                                               |                 
|         | 10.16 |                     | First Amendment to Loan and Security Agreement Between
Wells Fargo Retail Finance LLC and the Company dated
December 12, 2001 |                  | Incorporated by
reference to the
Companys Form 10-K
for fiscal year
ended February 1,
2002 (File No.
000-23389)
|         |       |                     |                                                                                                                               |                  |                                                                                                                 
|         | 10.17 |                     | Second Amendment to Loan and Security Agreement Between
Wells Fargo Retail Finance LLC and the Company dated April
26, 2002   |                  | Incorporated by
reference to the
Companys Form 10-Q
for quarter ended
May 3, 2002 (File
No. 000-23389)         
|         |       |                     |                                                                                                                               |                  |                                                                                                                 
|         | 10.18 |                     | Third Amendment to Loan and Security Agreement Between
Wells Fargo Retail Finance LLC and the Company dated
August 30, 2002   |                  | Incorporated by
reference to the
Companys Form 10-Q
for quarter ended
August 2, 2002
(File No.
000-23389)      
|         |       |                     |                                                                                                                               |                  |                                                                                                                 
|         | 10.19 |                     | Second Supplemental Indenture between the Company and
U.S. Bank, N. A. as trustee dated October 15, 2002                      |                  | Incorporated by
reference to the
Companys Form 10-Q
for quarter ended
November 1, 2002
(File No.
000-23389)    
|         |       |                     |                                                                                                                               |                  |                                                                                                                 
|         | 10.20 |                     | Fourth Amendment to Loan and Security Agreement Between
Wells Fargo Retail Finance LLC and the Company dated May 1, 2003      |                  | Filed with this
Annual Report on
Form 10-K                                                                      
|         |       |                     |                                                                                                                               |                  |                                                                                                                 
|         | 12    |                     | Computation of Ratio of Earnings to Fixed Charges                                                                             |                  | Filed with this
Annual Report on
Form 10-K                                                                      
|         |       |                     |                                                                                                                               |                  |                                                                                                                 
|         | 21    |                     | Subsidiaries of Company                                                                                                       |                  | Incorporated by
reference to the
Companys Form 10-K
for fiscal year
ended January 28,
2000 (File No.
000-23389)
|         |       |                     |                                                                                                                               |                  |                                                                                                                 
|         | 23.1  |                     | Consent of Grant Thornton LLP                                                                                                 |                  | Filed with this
Annual Report on
Form 10-K                                                                      
|         |       |                     |                                                                                                                               |                  |                                                                                                                 
|         | 99.1  |                     | Certification of Chief Executive Officer                                                                                      |                  | Filed with this
Annual Report on
Form 10-K                                                                      
|         |       |                     |                                                                                                                               |                  |                                                                                                                 
|         | 99.2  |                     | Certification of Chief Financial Officer                                                                                      |                  | Filed with this
Annual Report on
Form 10-K                                                                      

E-3