Party City Holdco Inc. - Quarter Report: 2018 September (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

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

For the quarterly period ended September 30, 2018

OR

 

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

For the transition period from                      to                     

Commission file number 001-37344

 

 

Party City Holdco Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware		46-0539758
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
80 Grasslands Road Elmsford, NY		10523
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s telephone number, including area code:

(914) 345-2020

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer		☐		Accelerated filer		☒		Non-accelerated filer		☐
Smaller reporting company		☐						Emerging Growth Company		☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of October 25, 2018, 97,177,192 shares of the Registrant’s common stock were outstanding.

 

 

 

PARTY CITY HOLDCO INC.

Form 10-Q

September 30, 2018

TABLE OF CONTENTS

 

		Page
PART I
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets at September  30, 2018 and December 31, 2017			3
Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income for the Three Months ended September 30, 2018 and September 30, 2017			4
Condensed Consolidated Statements of Operations and Comprehensive Income for the Nine Months ended September 30, 2018 and September 30, 2017			5
Condensed Consolidated Statement of Stockholders’ Equity for the Nine Months ended September 30, 2018			6
Condensed Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2018 and September 30, 2017			7
Notes to Condensed Consolidated Financial Statements			8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 3. Quantitative and Qualitative Disclosures about Market Risk			35
Item 4. Controls and Procedures			35
PART II
Item 1. Legal Proceedings			36
Item 1A. Risk Factors			36
Item 6. Exhibits			36
Signature			37

 

2

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

		September 30, 2018				December 31, 2017
		(Note 2) (Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	48,097			$	54,291
Accounts receivable, net			171,428				140,980
Inventories, net			810,782				604,066
Prepaid expenses and other current assets			95,162				77,816
Total current assets			1,125,469				877,153
Property, plant and equipment, net			319,220				301,141
Goodwill			1,661,837				1,619,253
Trade names			568,326				568,681
Other intangible assets, net			60,064				75,704
Other assets, net			12,465				12,824
Total assets		$	3,747,381			$	3,454,756
LIABILITIES, REDEEMABLE SECURITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Loans and notes payable		$	415,419			$	286,291
Accounts payable			233,252				160,994
Accrued expenses			201,509				176,609
Income taxes payable			—				45,568
Current portion of long-term obligations			13,231				13,059
Total current liabilities			863,411				682,521
Long-term obligations, excluding current portion			1,622,969				1,532,090
Deferred income tax liabilities, net			171,134				175,836
Deferred rent and other long-term liabilities			91,554				91,929
Total liabilities			2,749,068				2,482,376
Redeemable securities			3,298				3,590
Commitments and contingencies
Stockholders’ equity:
Common stock (97,147,907 and 96,380,102 shares outstanding and 120,527,474 and 119,759,669 shares issued at September 30, 2018 and December 31, 2017, respectively)			1,205				1,198
Additional paid-in capital			922,197				917,192
Retained earnings			397,452				372,596
Accumulated other comprehensive loss			(39,353	)			(35,818	)
Total Party City Holdco Inc. stockholders’ equity before common stock held in treasury			1,281,501				1,255,168
Less: Common stock held in treasury, at cost (23,379,567 shares at September 30, 2018 and December 31, 2017)			(286,733	)			(286,733	)
Total Party City Holdco Inc. stockholders’ equity			994,768				968,435
Noncontrolling interests			247				355
Total stockholders’ equity			995,015				968,790
Total liabilities, redeemable securities and stockholders’ equity		$	3,747,381			$	3,454,756

See accompanying notes to unaudited condensed consolidated financial statements.

 

3

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS) INCOME

(Unaudited)

(In thousands, except share and per share data)

 

		Three Months Ended September 30,
		2018				2017
Revenues:
Net sales		$	550,840			$	557,350
Royalties and franchise fees			2,206				2,759
Total revenues			553,046				560,109
Expenses:
Cost of sales			349,641				357,523
Wholesale selling expenses			17,538				16,274
Retail operating expenses			103,833				100,739
Franchise expenses			862				3,636
General and administrative expenses			42,239				37,971
Art and development costs			5,573				5,898
Development stage expenses			1,622				680
Total expenses			521,308				522,721
Income from operations			31,738				37,388
Interest expense, net			27,705				23,228
Other expense, net			5,696				593
(Loss) income before income taxes			(1,663	)			13,567
Income tax expense			777				3,483
Net (loss) income			(2,440	)			10,084
Add: Net loss attributable to redeemable securities holder			(8	)			—
Less: Net loss attributable to noncontrolling interests			(28	)			—
Net (loss) income attributable to common shareholders of Party City Holdco Inc.		$	(2,420	)		$	10,084
Net (loss) income per share attributable to common shareholders of Party City Holdco Inc. – Basic		$	(0.03	)		$	0.08
Net (loss) income per share attributable to common shareholders of Party City Holdco Inc. – Diluted		$	(0.03	)		$	0.08
Weighted-average number of common shares-Basic			96,494,565				119,587,339
Weighted-average number of common shares-Diluted			96,494,565				120,912,849
Dividends declared per share		$	0.00			$	0.00
Comprehensive (loss) income		$	(2,003	)		$	15,329
Add: Comprehensive loss attributable to redeemable securities holder			(8	)			—
Less: Comprehensive loss attributable to noncontrolling interests			(35	)			—
Comprehensive (loss) income attributable to common shareholders of Party City Holdco Inc.		$	(1,976	)		$	15,329

 

4

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except share and per share data)

 

		Nine Months Ended September 30,
		2018				2017
Revenues:
Net sales		$	1,614,049			$	1,572,966
Royalties and franchise fees			7,832				9,020
Total revenues			1,621,881				1,581,986
Expenses:
Cost of sales			996,084				978,142
Wholesale selling expenses			53,581				47,946
Retail operating expenses			285,019				281,981
Franchise expenses			8,624				10,666
General and administrative expenses			136,230				125,763
Art and development costs			17,278				17,638
Development stage expenses			5,620				7,092
Total expenses			1,502,436				1,469,228
Income from operations			119,445				112,758
Interest expense, net			76,481				65,214
Other expense, net			9,076				860
Income before income taxes			33,888				46,684
Income tax expense			9,443				16,301
Net income			24,445				30,383
Add: Net income attributable to redeemable securities holder			402				—
Less: Net loss attributable to noncontrolling interests			(87	)			—
Net income attributable to common shareholders of Party City Holdco Inc.		$	24,934			$	30,383
Net income per share attributable to common shareholders of Party City Holdco Inc. – Basic		$	0.26			$	0.25
Net income per share attributable to common shareholders of Party City Holdco Inc. – Diluted		$	0.26			$	0.25
Weighted-average number of common shares-Basic			96,449,011				119,546,451
Weighted-average number of common shares-Diluted			97,684,290				120,907,979
Dividends declared per share		$	0.00			$	0.00
Comprehensive income		$	20,889			$	45,839
Add: Comprehensive income attributable to redeemable securities holder			402				—
Less: Comprehensive loss attributable to noncontrolling interests			(108	)			—
Comprehensive income attributable to common shareholders of Party City Holdco Inc.		$	21,399			$	45,839

See accompanying notes to unaudited condensed consolidated financial statements.

 

5

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(Unaudited)

(In thousands)

 

		Common Stock				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Loss				Total Party City  Holdco Inc. Stockholders’ Equity Before Common Stock Held In Treasury				Common Stock Held In Treasury				Total Party City Holdco Inc. Stockholders’ Equity				Non- Controlling Interests				Total Stockholders’ Equity
Balance at December 31, 2017		$	1,198			$	917,192			$	372,596			$	(35,818	)		$	1,255,168			$	(286,733	)		$	968,435			$	355			$	968,790
Cumulative effect of change in accounting principle, net (see Note 2)			—				—				(78	)			—				(78	)			—				(78	)			—				(78	)
Balance at December 31, 2017, as adjusted		$	1,198			$	917,192			$	372,518			$	(35,818	)		$	1,255,090			$	(286,733	)		$	968,357			$	355			$	968,712
Net income			—				—				24,532				—				24,532				—				24,532				(87	)			24,445
Net income attributable to redeemable securities holder			—				—				402				—				402				—				402				—				402
Stock option expense			—				1,492				—				—				1,492				—				1,492				—				1,492
Restricted stock units – time-based			1				721				—				—				722				—				722				—				722
Restricted stock units – performance-based			5				1,477				—				—				1,482				—				1,482				—				1,482
Director – non-cash compensation			—				196				—				—				196				—				196				—				196
Warrant expense			—				242				—				—				242				—				242				—				242
Exercise of stock options			1				877				—				—				878				—				878				—				878
Foreign currency adjustments			—				—				—				(4,888	)			(4,888	)			—				(4,888	)			(21	)			(4,909	)
Impact of foreign exchange contracts, net			—				—				—				1,353				1,353				—				1,353				—				1,353
Balance at September 30, 2018		$	1,205			$	922,197			$	397,452			$	(39,353	)		$	1,281,501			$	(286,733	)		$	994,768			$	247			$	995,015

See accompanying notes to unaudited condensed consolidated financial statements.

 

6

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

		Nine Months Ended September 30,
		2018				2017 (Adjusted, see Note 2)
Cash flows (used in) provided by operating activities:
Net income		$	24,445			$	30,383
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization expense			57,786				62,519
Amortization of deferred financing costs and original issuance discounts			9,834				3,699
Provision for doubtful accounts			726				432
Deferred income tax expense			1,075				3,221
Deferred rent			3,623				5,634
Undistributed income in unconsolidated joint ventures			(580	)			(92	)
Loss on disposal of assets			23				533
Non-employee equity based compensation			352				3,286
Stock option expense			1,492				3,852
Restricted stock units – time-based			722				—
Restricted stock units – performance-based			1,482				—
Director – non-cash compensation			196				—
Changes in operating assets and liabilities, net of effects of acquired businesses:
Increase in accounts receivable			(32,802	)			(25,370	)
Increase in inventories			(194,419	)			(46,292	)
Increase in prepaid expenses and other current assets			(13,890	)			(11,382	)
Increase (decrease) in accounts payable, accrued expenses and income taxes payable			53,744				(24,244	)
Net cash (used in) provided by operating activities			(86,191	)			6,179
Cash flows used in investing activities:
Cash paid in connection with acquisitions, net of cash acquired			(63,840	)			(72,804	)
Capital expenditures			(65,491	)			(47,916	)
Proceeds from disposal of property and equipment			22				26
Net cash used in investing activities			(129,309	)			(120,694	)
Cash flows provided by financing activities:
Repayment of loans, notes payable and long-term obligations			(417,281	)			(25,311	)
Proceeds from loans, notes payable and long-term obligations			636,884				129,150
Exercise of stock options			878				787
Debt issuance costs			(10,343	)			—
Net cash provided by financing activities			210,138				104,626
Effect of exchange rate changes on cash and cash equivalents			(772	)			3,339
Net decrease in cash and cash equivalents and restricted cash			(6,134	)			(6,550	)
Cash and cash equivalents and restricted cash at beginning of period			54,408				64,765
Cash and cash equivalents and restricted cash at end of period		$	48,274			$	58,215
Supplemental disclosure of cash flow information:
Cash paid during the period
Interest		$	77,371			$	60,871
Income taxes, net of refunds		$	56,683			$	65,002

See accompanying notes to unaudited condensed consolidated financial statements.

 

7

PARTY CITY HOLDCO INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Dollars in thousands, except per share)

Note 1 – Description of Business

Party City Holdco Inc. (the “Company” or “Party City Holdco”) is a vertically integrated supplier of decorated party goods. The Company designs, manufactures, sources and distributes party goods, including paper and plastic tableware, metallic and latex balloons, Halloween and other costumes, accessories, novelties, gifts and stationery. The Company’s retail operations include over 900 specialty retail party supply stores (including franchise stores) in the United States and Canada, operating under the name Party City, e-commerce websites, principally operating under the domain name PartyCity.com, and a network of approximately 250 temporary Halloween City stores, including approximately 50 jointly under the Halloween City and Toy City banners. In addition to the Company’s retail operations, it is also a global designer, manufacturer and distributor of decorated party supplies, with products found in over 40,000 retail outlets, including independent party supply stores, mass merchants, grocery retailers and dollar stores. The Company’s products are available in over 100 countries with the United Kingdom, Germany, Mexico, Australia and Canada among the largest end markets outside of the United States.

Party City Holdco is a holding company with no operating assets or operations. The Company owns 100% of PC Nextco Holdings, LLC (“PC Nextco”), which owns 100% of PC Intermediate Holdings, Inc. (“PC Intermediate”). PC Intermediate owns 100% of Party City Holdings Inc. (“PCHI”), which owns the Company’s operating subsidiaries.

Note 2 – Basis of Presentation and Recently Issued Accounting Pronouncements

The unaudited condensed consolidated financial statements of the Company include the accounts of the Company and its majority-owned and controlled entities. All intercompany balances and transactions have been eliminated in consolidation. The unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included in the unaudited condensed consolidated financial statements.

The majority of our retail operations define a fiscal year (“Fiscal Year”) as the 52-week period or 53-week period ended on the Saturday nearest December 31st of each year and define fiscal quarters (“Fiscal Quarter”) as the four interim 13-week periods following the end of the previous Fiscal Year, except in the case of a 53-week Fiscal Year when the fourth Fiscal Quarter is extended to 14 weeks. The condensed consolidated financial statements of the Company combine the Fiscal Quarters of our retail operations with the calendar quarters of our wholesale operations. The Company has determined the differences between the retail operation’s Fiscal Year and Fiscal Quarters and the calendar year and calendar quarters to be insignificant.

Operating results for interim periods are not necessarily indicative of the results to be expected for the year ending December 31, 2018. Our business is subject to substantial seasonal variations as our retail segment has historically realized a significant portion of its net sales, cash flows and net income in the fourth quarter of each year, principally due to its Halloween season sales in October and, to a lesser extent, other year-end holiday sales. We expect that this general pattern will continue. Our results of operations may also be affected by industry factors that may be specific to a particular period such as movement in and the general level of raw material costs. For further information see the consolidated financial statements, and notes thereto, included in the Company’s Form 10-K for the fiscal year ended December 31, 2017, as filed with the Securities and Exchange Commission on March 14, 2018.

Recently Issued Accounting Pronouncements

In June 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-07, “Compensation – Stock Compensation: Improvements to Nonemployee Share-Based Payment Accounting”. The ASU simplifies the accounting for non-employee share-based payments. The update is effective for the Company during the first quarter of 2019. The Company is in the process of evaluating the impact of the pronouncement on the Company’s consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities”. The pronouncement amends the existing hedge accounting model in order to enable entities to better portray the economics of their risk management activities in their financial statements. The update is effective for the Company during the first quarter of 2019. Although the Company continues to evaluate this pronouncement, it does not believe that it will have a material impact on the Company’s consolidated financial statements.

 

8

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows: Restricted Cash”. The pronouncement requires companies to show changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. The Company adopted the pronouncement, which requires retrospective application, during the first quarter of 2018. The impact of such adoption was immaterial to the Company’s consolidated financial statements. See Note 15 for further discussion.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments”. The pronouncement clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows. The Company adopted the pronouncement during the first quarter of 2018 and such adoption did not have a material impact on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, “Leases”. The ASU requires that companies recognize assets and liabilities for the rights and obligations created by the companies’ leases. The update is effective for the Company during the first quarter of 2019. The Company’s current lease portfolio is primarily comprised of store leases, manufacturing and distribution facility leases and office leases. Upon adoption of this standard, the Company expects to recognize a right of use asset and liability related to substantially all of its operating lease arrangements with terms of greater than twelve months. The Company has established a cross-functional team to implement the pronouncement and the team is finalizing its implementation of a new software solution and its assessment of the practical expedients and policy elections offered by the standard. Although the Company has not yet finalized its evaluation of the standard, or quantified an impact, it expects the adoption to have a significant impact on the Company’s consolidated balance sheet due to the recognition of the right of use asset and liability for the Company’s operating leases.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities”. The update impacts the accounting for equity investments and the recognition of changes in fair value of financial liabilities when the fair value option is elected. The Company adopted the pronouncement during the first quarter of 2018 and such adoption had no impact on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)”. The pronouncement contains a five-step model which replaces most existing revenue recognition guidance. The new standard became effective for the Company on January 1, 2018. The Company adopted the pronouncement using the modified retrospective approach. Therefore, on January 1, 2018, the Company adjusted its accounting for certain discounts which are related to the timing of payments by customers of its wholesale business and the Company recorded a cumulative-effect adjustment which reduced retained earnings by $46. Additionally, as of such date, the Company modified its accounting for certain metallic balloon sales of its wholesale segment and started to defer the recognition of revenue on such sales, and the related costs, until the balloons have been filled with helium. As a result, the Company recorded a cumulative-effect adjustment which increased retained earnings by $8. Finally, as of such date, the Company adjusted its accounting for certain discounts on wholesale sales of seasonal product and the Company recorded a cumulative-effect adjustment which reduced retained earnings by $40. See Note 14 for further discussion of the adoption of the pronouncement and the Company’s revenue recognition policy.

Note 3 – Inventories

Inventories consisted of the following:

 

		September 30, 2018				December 31, 2017
Finished goods		$	760,923			$	562,809
Raw materials			33,686				30,346
Work in process			16,173				10,911
		$	810,782			$	604,066

Inventories are valued at the lower of cost or net realizable value. The Company principally determines the cost of inventory using the weighted average method.

The Company estimates retail inventory shrinkage for the period between physical inventory dates on a store-by-store basis. Inventory shrinkage estimates can be affected by changes in merchandise mix and changes in actual shortage trends. The shrinkage rate from the most recent physical inventory, in combination with historical experience, is the basis for estimating shrinkage.

 

9

Note 4 – Income Taxes

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“the Act”) was signed into law. The Act significantly changed U.S. tax law, including lowering the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018, and implementing a one-time “deemed repatriation” tax on unremitted earnings accumulated in non-U.S. jurisdictions since 1986 (the “Transition Tax”). Due to the complexities of accounting for the Act, the SEC issued Staff Accounting Bulletin (“SAB”) No. 118 which allows entities to include a provisional estimate of the impact of the Act in its financial statements. Therefore, based on currently available information, during the fourth quarter of 2017, the Company recorded a provisional estimate of the impact of the Act, which included an income tax benefit of $90,965 related to the remeasurement of its domestic net deferred tax liabilities and deferred tax assets due to the lower U.S. corporate tax rate. Additionally, during the fourth quarter of 2017, the Company recorded a net income tax expense of $1,132 as its provisional estimate of the Transition Tax related to the deemed repatriation of unremitted earnings of foreign subsidiaries. The Company did not adjust these estimates during the first nine months of 2018.

While these amounts represent the Company’s best estimates of the impacts of the reduction in the federal corporate income tax rate and the deemed repatriation Transition Tax, the final impacts of the Act may differ from the Company’s estimates due to, among other things, changes in the Company’s interpretations and assumptions, additional guidance to be issued by the IRS, and actions the Company may take. As provided in SAB 118, any adjustments to these provisional amounts will be recorded as they are identified during the measurement period, which ends no later than December 22, 2018.

Additionally, the Act subjects a U.S. shareholder to current tax on “global intangible low-taxed income” (“GILTI”) of its controlled foreign corporations. GILTI is based on the excess of the aggregate of a U.S. shareholder’s pro rata share of net income of its controlled foreign corporations over a specified return. Given the complexity of the GILTI provisions, the Company is still evaluating the effects of the provisions. Therefore, during the nine months ended September 30, 2018, the Company has included an estimate of the tax on GILTI as a period cost in its full-year estimated effective income tax rate and it has not accounted for any tax on GILTI in its deferred balances.

Note 5 – Changes in Accumulated Other Comprehensive Loss

The changes in accumulated other comprehensive loss consisted of the following:

 

		Three Months Ended September 30, 2018
		Foreign Currency Adjustments				Impact of Foreign Exchange Contracts, Net of Taxes				Total, Net of Taxes
Balance at June 30, 2018		$	(40,917	)		$	1,120			$	(39,797	)
Other comprehensive income before reclassifications			419				217				636
Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive loss			—				(192	)			(192	)
Net current-period other comprehensive income			419				25				444
Balance at September 30, 2018		$	(40,498	)		$	1,145			$	(39,353	)

 

		Three Months Ended September 30, 2017
		Foreign Currency Adjustments				Impact of Foreign Exchange Contracts, Net of Taxes				Total, Net of Taxes
Balance at June 30, 2017		$	(41,650	)		$	(378	)		$	(42,028	)
Other comprehensive income (loss) before reclassifications			5,297				(281	)			5,016
Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income			—				229				229
Net current-period other comprehensive income (loss)			5,297				(52	)			5,245
Balance at September 30, 2017		$	(36,353	)		$	(430	)		$	(36,783	)

 

10

		Nine Months Ended September 30, 2018
		Foreign Currency Adjustments				Impact of Foreign Exchange Contracts, Net of Taxes				Total, Net of Taxes
Balance at December 31, 2017		$	(35,610	)		$	(208	)		$	(35,818	)
Other comprehensive (loss) income before reclassifications, net of income tax			(4,888	)			1,188				(3,700	)
Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income, net of income tax			—				165				165
Net current-period other comprehensive (loss) income			(4,888	)			1,353				(3,535	)
Balance at September 30, 2018		$	(40,498	)		$	1,145			$	(39,353	)

 

		Nine Months Ended September 30, 2017
		Foreign Currency Adjustments				Impact of Foreign Exchange Contracts, Net of Taxes				Total, Net of Taxes
Balance at December 31, 2016		$	(53,171	)		$	932			$	(52,239	)
Other comprehensive income (loss) before reclassifications, net of income tax			16,818				(1,077	)			15,741
Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income, net of income tax			—				(285	)			(285	)
Net current-period other comprehensive income (loss)			16,818				(1,362	)			15,456
Balance at September 30, 2017		$	(36,353	)		$	(430	)		$	(36,783	)

Note 6 – Capital Stock

At September 30, 2018, the Company’s authorized capital stock consisted of 300,000,000 shares of $0.01 par value common stock and 15,000,000 shares of $0.01 par value preferred stock.

Note 7 – Segment Information

Industry Segments

The Company has two identifiable business segments. The Wholesale segment designs, manufactures, sources and distributes decorated party goods, including paper and plastic tableware, metallic and latex balloons, Halloween and other costumes, accessories, novelties, gifts and stationery throughout the world. The Retail segment operates specialty retail party supply stores in the United States and Canada, principally under the names Party City, Halloween City and Toy City, and it operates e-commerce websites, principally through the domain name Partycity.com. The Retail segment also franchises both individual stores and franchise areas throughout the United States, Mexico and Puerto Rico, principally under the name Party City. The Company’s industry segment data for the three months ended September 30, 2018 and September 30, 2017 was as follows:

 

11

		Wholesale				Retail				Consolidated
Three Months Ended September 30, 2018
Revenues:
Net sales		$	424,569			$	375,680			$	800,249
Royalties and franchise fees			—				2,206				2,206
Total revenues			424,569				377,886				802,455
Eliminations			(249,409	)			—				(249,409	)
Net revenues		$	175,160			$	377,886			$	553,046
Income from operations		$	15,501			$	16,237			$	31,738
Interest expense, net											27,705
Other expense, net											5,696
Loss before income taxes										$	(1,663	)
		Wholesale				Retail				Consolidated
Three Months Ended September 30, 2017
Revenues:
Net sales		$	381,858			$	364,057			$	745,915
Royalties and franchise fees			—				2,759				2,759
Total revenues			381,858				366,816				748,674
Eliminations			(188,565	)			0				(188,565	)
Net revenues		$	193,293			$	366,816			$	560,109
Income from operations		$	22,808			$	14,580			$	37,388
Interest expense, net											23,228
Other income, net											593
Income before income taxes										$	13,567

The Company’s industry segment data for the nine months ended September 30, 2018 and September 30, 2017 was as follows:

 

		Wholesale				Retail				Consolidated
Nine Months Ended September 30, 2018
Revenues:
Net sales		$	988,129			$	1,150,609			$	2,138,738
Royalties and franchise fees			—				7,832				7,832
Total revenues			988,129				1,158,441				2,146,570
Eliminations			(524,689	)			—				(524,689	)
Net revenues		$	463,440			$	1,158,441			$	1,621,881
Income from operations		$	31,997			$	87,448			$	119,445
Interest expense, net											76,481
Other expense, net											9,076
Income before income taxes										$	33,888
		Wholesale				Retail				Consolidated
Nine Months Ended September 30, 2017
Revenues:
Net sales		$	929,255			$	1,103,127			$	2,032,382
Royalties and franchise fees			—				9,020				9,020
Total revenues			929,255				1,112,147				2,041,402
Eliminations			(459,416	)			—				(459,416	)
Net revenues		$	469,839			$	1,112,147			$	1,581,986
Income from operations		$	49,258			$	63,500			$	112,758
Interest expense, net											65,214
Other expense, net											860
Income before income taxes										$	46,684

 

12

Note 8 – Commitments and Contingencies

The Company is a party to certain claims and litigation in the ordinary course of business. The Company does not believe these proceedings will result, individually or in the aggregate, in a material adverse effect on its financial condition or future results of operations.

On April 5, 2016, a derivative complaint was filed in the Supreme Court for the State of New York, naming certain directors and executives as defendants, and naming the Company as a nominal defendant. The complaint seeks unspecified damages and costs, and corporate governance reforms, for alleged injury to the Company in connection with public filings related to the Company’s April 2015 IPO, compensation paid to executives, and the termination of the management agreement disclosed in the initial public offering-related public filings. The Company intends to vigorously defend itself against this action. The Company is unable, at this time, to determine whether the outcome of the litigation would have a material impact on its results of operations, financial condition or cash flows.

Note 9 – Derivative Financial Instruments

The Company is directly and indirectly affected by changes in certain market conditions. These changes in market conditions may adversely impact the Company’s financial performance and are referred to as market risks. The Company, when deemed appropriate, uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed through the use of derivative financial instruments are interest rate risk and foreign currency exchange rate risk.

Interest Rate Risk Management

As part of the Company’s risk management strategy, the Company periodically uses interest rate swap agreements to hedge the variability of cash flows on floating rate debt obligations. Accordingly, interest rate swap agreements are reflected in the consolidated balance sheets at fair value and the related gains and losses on these contracts are deferred in equity and recognized in interest expense over the same period in which the related interest payments being hedged are recognized in income. The Company did not utilize interest rate swap agreements during the nine months ended September 30, 2018 and the nine months ended September 30, 2017.

Foreign Exchange Risk Management

A portion of the Company’s cash flows are derived from transactions denominated in foreign currencies. In order to reduce the uncertainty of foreign exchange rate movements on transactions denominated in foreign currencies, including the British Pound Sterling, the Canadian Dollar, the Euro, the Malaysian Ringgit, the Australian Dollar, and the Mexican Peso, the Company enters into foreign exchange contracts with major international financial institutions. These forward contracts, which typically mature within one year, are designed to hedge anticipated foreign currency transactions, primarily inventory purchases and sales. For contracts that qualify for hedge accounting, the terms of the foreign exchange contracts are such that cash flows from the contracts should be highly effective in offsetting the expected cash flows from the underlying forecasted transactions.

The foreign currency exchange contracts are reflected in the condensed consolidated balance sheets at fair value. At September 30, 2018 and December 31, 2017, the Company had foreign currency exchange contracts that qualified for hedge accounting. No components of these agreements were excluded in the measurement of hedge effectiveness. As these hedges are 100% effective, there is no current impact on earnings due to hedge ineffectiveness. The Company anticipates that substantially all unrealized gains and losses in accumulated other comprehensive loss related to these foreign currency exchange contracts will be reclassified into earnings by June 2019.

The following table displays the fair values of the Company’s derivatives at September 30, 2018 and December 31, 2017:

 

Derivative Assets

Derivative Liabilities

Balance Sheet Line

Fair Value

Balance Sheet Line

Fair Value

Balance Sheet Line

Fair Value

Balance Sheet Line

Fair Value

Derivative Instrument

September 30, 2018

December 31, 2017

September 30, 2018

December 31, 2017

Foreign Exchange Contracts

(a

) PP

$

728

(a

) PP

$

95

(b

) AE

$

—

(b

) AE

$

99

 

(a)	PP = Prepaid expenses and other current assets

(b)	AE = Accrued expenses

 

13

The following table displays the notional amounts of the Company’s derivatives at September 30, 2018 and December 31, 2017:

 

Derivative Instrument		September 30, 2018				December 31, 2017
Foreign Exchange Contracts		$	10,743			$	21,672

Note 10 – Fair Value Measurements

The provisions of ASC Topic 820, “Fair Value Measurement”, define fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 established a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

 

•

Level 1 — Quoted prices in active markets for identical assets or liabilities.

 

•

Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

•

Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

During 2017, the Company acquired a 28% ownership interest in Punchbowl, Inc. (“Punchbowl”), a provider of digital greeting cards and digital invitations. At such time, the Company provided Punchbowl’s other investors with the ability to “put” their interest in Punchbowl to the Company at a future date. The Company is adjusting such put liability to fair value on a recurring basis. The liability represents a Level 3 fair value measurement as it is based on unobservable inputs.

During 2017, the Company and Ampology, a subsidiary of Trivergence, reached an agreement to form a new legal entity, Kazzam, LLC (“Kazzam”), for the purpose of designing, developing and launching an online exchange platform for party-related services. As part of Ampology’s compensation for designing, developing and launching the exchange platform, Ampology received an ownership interest in Kazzam. The interest has been recorded as redeemable securities in the mezzanine of the Company’s consolidated balance sheet as, in the future, Ampology has the right to cause the Company to purchase the interest. The mezzanine liability is adjusted to fair value on a recurring basis. The liability represents a Level 3 fair value measurement as it is based on unobservable inputs.

The following table shows assets and liabilities as of September 30, 2018 that are measured at fair value on a recurring basis:

 

		Level 1				Level 2				Level 3				Total as of September 30, 2018
Derivative assets		$	—			$	728			$	—			$	728
Derivative liabilities			—				—				—				—
Kazzam liability			—				—				3,298				3,298
Punchbowl put liability			—				—				299				299

The following table shows assets and liabilities as of December 31, 2017 that are measured at fair value on a recurring basis:

 

		Level 1				Level 2				Level 3				Total as of December 31, 2017
Derivative assets		$	—			$	95			$	—			$	95
Derivative liabilities			—				99				—				99
Kazzam liability			—				—				3,590				3,590
Punchbowl put liability			—				—				2,122				2,122

The majority of the Company’s non-financial instruments, which include goodwill, intangible assets, inventories and property, plant and equipment, are not required to be carried at fair value on a recurring basis. However, if certain triggering events occur (or at least annually for goodwill and indefinite-lived intangible assets), a non-financial instrument is required to be evaluated for impairment. If the Company determines that the non-financial instrument is impaired, the Company would be required to write down the non-financial instrument to its fair value. The carrying amounts for cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable, accrued expenses and other current liabilities approximated fair value at September 30, 2018 because of the short-term maturities of the instruments and/or their variable rates of interest.

 

14

The carrying amounts and fair values of borrowings under the Term Loan Credit Agreement and its senior notes as of September 30, 2018 are as follows:

 

		September 30, 2018
		Carrying Amount				Fair Value
Term Loan Credit Agreement		$	792,664			$	808,084
Senior Notes – due 2023			345,986				355,282
Senior Notes – due 2026			493,897				505,755

The fair values of the Term Loan Credit Agreement and the senior notes represent Level 2 fair value measurements as the debt instruments trade in inactive markets. The carrying amounts for other long-term debt approximated fair value at September 30, 2018 based on the discounted future cash flows of each instrument at rates currently offered for similar debt instruments of comparable maturity.

Note 11 – Earnings Per Share

Basic earnings per share are computed by dividing net income attributable to common shareholders of Party City Holdco Inc. by the weighted average number of common shares outstanding for the period. Diluted earnings per share are calculated based on the weighted average number of outstanding common shares plus the dilutive effect of stock options and warrants, as if they were exercised, and restricted stock units, as if they vested.

A reconciliation between basic and diluted income per share is as follows:

 

		Three Months Ended September 30, 2018				Three Months Ended September 30, 2017				Nine Months Ended September 30, 2018				Nine Months Ended September 30, 2017
Net (loss) income attributable to common shareholders of Party City Holdco Inc.		$	(2,420	)		$	10,084			$	24,934			$	30,383
Weighted average shares – Basic			96,494,565				119,587,339				96,449,011				119,546,451
Effect of dilutive securities:
Warrants			—				—				—				—
Restricted stock units			—				—				9,004				—
Stock options			—				1,325,510				1,226,275				1,361,528
Weighted average shares – Diluted			96,494,565				120,912,849				97,684,290				120,907,979
Net (loss) income per share attributable to common shareholders of Party City Holdco Inc. – Basic		$	(0.03	)		$	0.08			$	0.26			$	0.25
Net (loss) income per share attributable to common shareholders of Party City Holdco Inc. – Diluted		$	(0.03	)		$	0.08			$	0.26			$	0.25

During the three months ended September 30, 2018 and September 30, 2017, 4,157,559 stock options and 2,370,106 stock options, respectively, were excluded from the calculation of diluted earnings per share as they were anti-dilutive. Additionally, during the three months ended September 30, 2018 and September 30, 2017, 596,000 warrants and 596,000 warrants, respectively, were excluded from the calculation of diluted earnings per share as they were anti-dilutive. Further, during the three months ended September 30, 2018 and September 30, 2017, 191,033 restricted stock units and 0 restricted stock units, respectively, were excluded from the calculation of diluted earnings per share as they were anti-dilutive.

During the nine months ended September 30, 2018 and September 30, 2017, 2,354,244 stock options and 2,370,106 stock options, respectively, were excluded from the calculation of diluted earnings per share as they were anti-dilutive. Additionally, during both the nine months ended September 30, 2018 and the nine months ended September 30, 2017, 596,000 warrants were excluded from the calculation of diluted earnings per share as they were anti-dilutive. Further, during both the nine months ended September 30, 2018 and the nine months ended September 30, 2017, 0 restricted stock units were excluded from the calculation of diluted earnings per share as they were anti-dilutive.

 

15

Note 12 – Long-Term Obligations

Long-term obligations at September 30, 2018 and December 31, 2017 consisted of the following:

 

		September 30, 2018				December 31, 2017
Term Loan Credit Agreement		$	792,664			$	1,196,505
Capital lease obligations			3,653				3,276
Senior Notes - due 2026			493,897				—
Senior Notes - due 2023			345,986				345,368
Total long-term obligations			1,636,200				1,545,149
Less: current portion			(13,231	)			(13,059	)
Long-term obligations, excluding current portion		$	1,622,969			$	1,532,090

Term Loan Credit Agreement Amendment

During February 2018, the Company amended its Term Loan Credit Agreement. At the time of the amendment, all outstanding term loans were replaced with new term loans for the same principal amount. The applicable margin for ABR borrowings was lowered from 2.00% to 1.75% and the applicable margin for LIBOR borrowings was lowered from 3.00% to 2.75%. Additionally, based on the terms of the amendment, the ABR and LIBOR margins will drop to 1.50% and 2.50%, respectively, if the Company’s Senior Secured Leverage Ratio, as defined by the agreement, falls below 3.2 to 1.0.

As the Term Loan Credit Agreement is a loan syndication, the Company assessed, on a creditor-by-creditor basis, whether the refinancing should be accounted for as an extinguishment for each creditor and, during the first quarter of 2018, the Company wrote-off $186 of existing deferred financing costs, a $102 capitalized original issue discount and $58 of capitalized call premium. The write-offs were recorded in other expense in the Company’s consolidated statement of income and comprehensive income. The remaining deferred financing costs, original issue discount and capitalized call premium will continue to be amortized over the life of the Term Loan Credit Agreement, using the effective interest method. Additionally, in conjunction with the amendment, the Company incurred $856 of banker and legal fees, $800 of which were recorded in other expense during the first quarter of 2018. The rest of the costs are being amortized over the life of the debt. The write-offs of the deferred financing costs, original issuance discount and call premium were included in amortization of deferred financing costs and original issuance discount in the Company’s consolidated statement of cash flows.

August 2018 Refinancing

During August 2018, the Company executed a refinancing of its debt portfolio and issued $500,000 of new senior notes at an interest rate of 6.625%. The notes will mature in August 2026. The Company used the proceeds from the notes to: (i) reduce the outstanding balance under its existing ABL Facility, which is included in loans and notes payable on the Company’s condensed consolidated balance sheet, by $90,000 and (ii) voluntarily prepay $400,000 of the outstanding balance under its existing Term Loan Credit Agreement.    Additionally, as part of the refinancing, the Company extended the maturity of the ABL Facility to August 2023.

As the partial prepayment of the Term Loan Credit Agreement was in accordance with the terms of such agreement, at the time of such prepayment the Company wrote-off a pro-rata portion of the existing capitalized deferred financing costs and original issuance discounts, $1,824, for investors who did not participate in the new notes. Such amount was recorded in other expense in the Company’s consolidated statement of operations and comprehensive income and included in amortization of deferred financing costs and original issuance discounts in the Company’s consolidated statement of cash flows.

To the extent that investors in the Term Loan Credit Agreement participated in the new notes, the Company assessed whether the refinancing should be accounted for as an extinguishment on a creditor-by-creditor basis and wrote-off $968 of existing deferred financing costs and original issuance discounts. Such amount was recorded in other expense in the Company’s consolidated statement of operations and comprehensive income and included in amortization of deferred financing costs and original issuance discounts in the Company’s consolidated statement of cash flows.

Additionally, in conjunction with the issuance of the notes, the Company incurred third-party fees (principally banker fees). To the extent that such fees related to investors for whom their original debt was not extinguished, the Company expensed the portion of such fees, $2,270 in aggregate, that related to such investors. Such amount was recorded in other expense in the Company’s consolidated statement of operations and comprehensive income and included in financing activities in the Company’s consolidated statement of cash flows. The remainder of the third-party fees, $6,230, have been capitalized and will be amortized over the remaining life of the debt using the effective interest method.

Further, in conjunction with the extension of the ABL Facility, the Company compared the borrowing capacities of the pre-amendment facility and the post-amendment facility, on a creditor-by-creditor basis, and concluded that $29 of existing deferred

 

16

financing costs should be written-off. Such amount was recorded in other expense in the Company’s consolidated statement of operations and comprehensive income and included in amortization of deferred financing costs and original issuance discounts in the Company’s consolidated statement of cash flows. The remaining capitalized costs, and $986 of new third-party costs incurred in conjunction with the extension, are being amortized over the revised term of the ABL Facility.

Senior Notes – due 2026

Interest on the new notes is payable semi-annually in arrears on February 1st and August 1st of each year.

The notes are guaranteed, jointly and severally, on a senior basis by each of Party City Holdings Inc.’s existing and future domestic subsidiaries. The notes and the guarantees are general unsecured senior obligations and are effectively subordinated to all other secured debt to the extent of the assets securing such secured debt.

The indenture governing the notes contains certain covenants limiting, among other things and subject to certain exceptions, Party City Holdings Inc.’s ability to:

 

•

incur additional indebtedness or issue certain disqualified stock and preferred stock;

 

•

pay dividends or distributions, redeem or repurchase equity;

 

•

prepay subordinated debt or make certain investments;

 

•

engage in transactions with affiliates;

 

•

consolidate, merge or transfer all or substantially all of PCHI’s assets;

 

•

create liens; and

 

•

transfer or sell certain assets.

The indenture governing the notes also contains certain customary affirmative covenants and events of default.

On or after August 1, 2021, the Company may redeem the notes, in whole or in part, at the following (expressed as a percentage of the principal amount to be redeemed):

 

Twelve-month period beginning on August 1,		Percentage
2021			103.313	%
2022			101.656	%
2023 and thereafter			100.000	%

In addition, the Company may redeem up to 40% of the aggregate principal amount outstanding on or before August 1, 2021 with the cash proceeds from certain equity offerings at a redemption price of 106.625% of the principal amount. The Company may also redeem some or all of the notes before August 1, 2021 at a redemption price of 100% of the principal amount plus a premium that is defined in the indenture.

Also, if the Company experiences certain types of change in control, as defined, the Company may be required to offer to repurchase the notes at 101% of their principal amount.

Note 13 – Acquisitions

During March 2018, the Company acquired 11 franchise stores, which are located in Maryland, for total cash consideration of approximately $14,000. The Company is in the process of finalizing purchase accounting.

Additionally, during March 2018, the Company entered into an agreement to acquire 11 independent stores, which are located in Texas, for total consideration of approximately $6,000. The Company will take control of the stores one at a time over a period of approximately one year. The Company is in the process of finalizing purchase accounting for the stores for which it has already taken control.                

During July 2018, the Company acquired an additional 16 franchise stores, which are located in Pennsylvania, for total cash consideration of approximately $18,800. The Company is in the process of finalizing purchase accounting.

Also, during September 2018, the Company acquired an additional 21 franchise stores, which are located in Minnesota, North Dakota and Texas, for total cash consideration of approximately $22,900. The Company is in the process of finalizing purchase accounting.

 

17

During the three months ended September 30, 2018, the Company recorded a non-recurring $2,638 reduction to franchise intangible asset amortization expense as a result of recent franchise store acquisitions. Such amount was recorded in franchise expenses in the Company’s consolidated statement of operations and comprehensive income.

During 2017, the Company acquired 85% of the common stock of Granmark, S.A. de C.V., a Mexican manufacturer and wholesaler of party goods. Based on the terms of the acquisition agreement, the Company is required to acquire the remaining 15% interest over the next four years and it has recorded a liability for the estimated purchase price of such interest, $3,021 at September 30, 2018.

During 2017, the Company acquired 60% of Print Appeal, Inc. Based on the terms of the acquisition agreement, the Company will acquire the remaining 40% interest in Print Appeal over the next five years and the Company’s liability for the estimated purchase price of such interest was $2,312 at September 30, 2018.

Note 14 – Revenue from Contracts with Customers

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)”. The pronouncement contains a five-step model which replaces most existing revenue recognition guidance. The Company adopted the standard on January 1, 2018 via a modified retrospective approach and recognized the cumulative effect of the adoption as an adjustment to January 1, 2018 retained earnings.

Revenue Transactions - Retail

Revenue from retail store operations is recognized at the point of sale as control of the product is transferred to the customer at such time. Retail e-commerce sales are recognized when the consumer receives the product as control transfers upon delivery. Due to its extensive history operating as the largest party goods retailer in North America, the Company has sufficient history with which to estimate future retail sales returns and it uses the expected value method to estimate such activity.

The transaction price for the majority of the Company’s retail sales is based on either: 1) the item’s stated price or 2) the stated price adjusted for the impact of a coupon which can only be applied to such transaction. To the extent that the Company charges customers for freight costs on e-commerce sales, the Company records such amounts in revenue. The Company has chosen the pronouncement’s policy election which allows it to exclude all sales taxes and value-added taxes from revenue.

Under the terms of its agreements with its franchisees, the Company provides both: 1) brand value (via significant advertising spend) and 2) support with respect to planograms, in exchange for a royalty fee that ranges from 4% to 6% of the franchisees’ sales. The Company records the royalty fees at the time that the franchisees’ sales are recorded. Additionally, although the Company anticipates that future franchise store openings will be limited, when a franchisee opens a new store, the Company receives and records a one-time fee which is earned by the Company for its assistance with site selection and development of the new location. Both the sales-based royalty fee and the one-time fee are recorded in royalties and franchise fees in the Company’s consolidated statement of operations and comprehensive income.

Revenue Transactions - Wholesale

For most of the Company’s wholesale sales, control transfers upon the Company’s shipment of the product as: 1) legal title transfers on such date and 2) the Company has a present right to payment at such time. Wholesale sales returns are not significant as the Company generally only accepts the return of goods that were shipped to the customer in error or that were damaged when received by the customer. Additionally, due to its extensive history operating as a leading party goods wholesaler, the Company has sufficient history with which to estimate future sales returns and it uses the expected value method to estimate such activity.

In most cases, the determination of the transaction price is straight-forward as it is fixed based on the contract and/or purchase order. However, a limited number of customers receive volume-based rebates. Additionally, certain customers receive small discounts for early payment (generally 1% of the transaction price). Based on the business’ long history as a leading party goods wholesaler, the Company has sufficient history with which to estimate variable consideration for such volume-based rebates and early payment discounts. To the extent that the Company charges customers for freight costs, the Company records such amounts in revenue. The Company has chosen the pronouncement’s policy election which allows it to exclude all sales taxes and value-added taxes from revenue.

The majority of the sales for the Company’s wholesale business are due within 30 to 120 days from the transfer of control of the product and substantially all of the sales are collected within a year from such transfer. For all transactions for which the Company expects to collect the transaction price within a year from the transfer of control, the Company applies one of the pronouncement’s practical expedients and does not adjust the consideration for the effects of a significant financing component.

Judgments

Although most of the Company’s revenue transactions consist of fixed transaction prices and the transfer of control at either the point of sale (for retail) or when the product is shipped (for wholesale), certain transactions involve a limited number of judgments.

 

18

For transactions for which control transfers to the customer when the freight carrier delivers the product to the customer, the Company estimates the date of such receipt based on historical shipping times. Additionally, the Company utilizes historical data to estimate sales returns, volume-based rebates and discounts for early payments by customers. Due to its extensive history operating as a leading party goods retailer and wholesaler, the Company has sufficient history with which to estimate such amounts.

Other Revenue Topics

During the three and nine months ended September 30, 2018 and September 30, 2017, impairment losses recognized on receivables and contract assets arising from the Company’s contracts with customers were immaterial.

As a significant portion of the Company’s revenue is either: 1) part of a contract with an original expected duration of one year or less or 2) related to sales-based royalties promised in exchange for licenses of intellectual property, the Company has elected to apply the optional exemptions in paragraphs ASC 606-10-50-14 through ASC 606-10-50-14A.

Additionally, the Company has elected to apply the practical expedient which allows companies to recognize the incremental costs of obtaining a contract as an expense if the amortization period of the asset that the entity otherwise would have recognized would have been one year or less.    

Disaggregation of Revenue

The following table summarizes revenue from contracts with customers for the three months ended September 30, 2018 and September 30, 2017 and the nine months ended September 30, 2018 and September 30, 2017:

 

		Three Months Ended September 30, 2018				Three Months Ended September 30, 2017				Nine Months Ended September 30, 2018				Nine Months Ended September 30, 2017
Retail Net Sales:
Party City Stores		$	336,355			$	324,766			$	1,043,422			$	993,652
Global E-commerce			34,221				34,130				102,083				104,314
Temporary Stores			5,104				5,161				5,104				5,161
Total Retail Net Sales		$	375,680			$	364,057			$	1,150,609			$	1,103,127
Royalties and Franchise Fees			2,206				2,759				7,832				9,020
Total Retail Revenue		$	377,886			$	366,816			$	1,158,441			$	1,112,147
Wholesale Net Sales:
Domestic		$	88,287			$	98,801			$	247,243			$	264,496
International			86,873				94,492				216,197				205,343
Total Wholesale Net Sales		$	175,160			$	193,293			$	463,440			$	469,839
Total Consolidated Revenue		$	553,046			$	560,109			$	1,621,881			$	1,581,986

Financial Statement Impact of Adopting the Pronouncement

All of the Company’s revenue is recognized from contracts with customers and, therefore, is subject to the pronouncement.

The Company adopted the pronouncement using a modified retrospective approach and applied the guidance to all contracts as of January 1, 2018. On such date, the Company reduced its retained earnings by $78, reduced its accounts receivable by $141, increased its inventory by $11, reduced its accrued expenses by $26, increased its deferred tax asset by $28 and increased its income taxes payable by $2. The cumulative adjustment principally related to certain discounts within the Company’s wholesale business.

Additionally, the adoption of the pronouncement impacted the Company’s financial statements for the three and nine months ended September 30, 2018 as it decreased pre-tax income by $5 during the three month period and increased pre-tax income by $34 during the nine month period.

Note 15 – Cash, Cash Equivalents and Restricted Cash

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows: Restricted Cash”. The pronouncement requires companies to show changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in their statement of cash flows. The Company adopted the pronouncement, which requires retrospective application, during the first quarter of 2018.

 

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As a result, the Company’s statement of cash flows for the nine months ended September 30, 2017 has been adjusted to include $155 of restricted cash at December 31, 2016 and $72 of restricted cash at September 30, 2017. The restricted cash, which principally relates to funds that are required to be spent on advertising, is included in “prepaid expenses and other current assets” in the Company’s consolidated balance sheet. Therefore, in the Company’s adjusted consolidated statement of cash flows for the nine months ended September 30, 2017, the change in “prepaid expenses and other current assets” has been adjusted from a cash outflow of $11,299 to a cash outflow of $11,382.

The Company’s September 30, 2018 consolidated balance sheet included $48,097 of cash and cash equivalents and $177 of restricted cash and the Company’s December 31, 2017 consolidated balance sheet included $54,291 of cash and cash equivalents and $117 of restricted cash. Restricted cash is recorded in “prepaid expenses and other current assets”.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

References throughout this document to the “Company” include Party City Holdco Inc. and its subsidiaries. In this document the words “we,” “our,” “ours” and “us” refer only to the Company and its subsidiaries and not to any other person.

Business Overview

Our Company

We are the leading decorated party goods retailer by revenue in North America and, we believe, the largest vertically integrated supplier of decorated party goods globally by revenue. With over 900 locations (inclusive of franchised stores), we have the only coast-to-coast network of party superstores in the U.S. and Canada that make it easy and fun to enhance special occasions with a differentiated shopping experience and an unrivaled assortment of innovative and exciting merchandise offered at a compelling value. We also operate multiple e-commerce sites, principally under the domain name PartyCity.com. Further, we open a network of approximately 250 temporary Halloween City stores, including approximately 50 jointly under the Halloween City and Toy City banners.

In addition to our retail operations, we are also one of the largest global designers, manufacturers and distributors of decorated party supplies, with products found in over 40,000 retail outlets worldwide, including independent party supply stores, mass merchants, grocery retailers and dollar stores. Our products are available in over 100 countries with the United Kingdom, Germany, Mexico, Australia and Canada among the largest end markets for our products outside of the United States.

How We Assess the Performance of Our Company

In assessing the performance of our company, we consider a variety of performance and financial measures for our two operating segments, Retail and Wholesale. These key measures include revenues and gross profit, comparable retail same-store sales and operating expenses. We also review other metrics such as adjusted net income (loss), adjusted net income (loss) per common share – diluted and adjusted EBITDA. For a discussion of our use of these measures and a reconciliation of adjusted net income (loss) and adjusted EBITDA to net income (loss), please refer to “Financial Measures - Adjusted EBITDA,” “Financial Measures - Adjusted Net Income (Loss)” and “Financial Measures - Adjusted Net Income (Loss) Per Common Share – Diluted” below.

Segments

Our retail operations generate revenue primarily through the sale of Amscan, Designware, Anagram, Costumes USA and other party supplies through Party City, PartyCity.com, Halloween City and Toy City. During 2017, approximately 80% of the product that was sold by our retail operations was supplied by our wholesale operations.

Our wholesale revenues are generated from the sale of decorated party goods for all occasions, including paper and plastic tableware, accessories and novelties, costumes, metallic and latex balloons and stationery. Our products are sold at wholesale to party goods superstores, including our franchise stores, other party goods retailers, mass merchants, independent card stores, dollar stores and other retailers and distributors throughout the world.

Intercompany sales between the Wholesale and the Retail segment are eliminated, and the wholesale profits on intercompany sales are deferred and realized at the time the merchandise is sold to the retail consumer. For segment reporting purposes, certain general and administrative expenses and art and development costs are allocated based on total revenues.

Financial Measures

Revenues. Revenue from retail store operations is recognized at the point of sale as control of the product is transferred to the customer at such time. Retail e-commerce sales are recognized when the consumer receives the product as control transfers upon delivery. We estimate future retail sales returns and record a provision in the period in which the related sales are recorded based on historical information. Retail sales are reported net of taxes collected.

Under the terms of our agreements with our franchisees, we provide both: 1) brand value (via significant advertising spend) and 2) support with respect to planograms, in exchange for a royalty fee that ranges from 4% to 6% of the franchisees’ sales. The Company records the royalty fees at the time that the franchisees’ sales are recorded.

For most of our wholesale sales, control transfers upon the shipment of the product as: 1) legal title transfers on such date and 2) we have a present right to payment at such time. Wholesale sales returns are not significant as we generally only accept the return of

 

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goods that were shipped to the customer in error or that were damaged when received by the customer. Additionally, due to our extensive history operating as a leading party goods wholesaler, we have sufficient history with which to estimate future sales returns and we use the expected value method to estimate such activity.

Intercompany sales from our wholesale operations to our retail stores are eliminated in our consolidated total revenues.

Comparable Retail Same-Store Sales. The growth in same-store sales represents the percentage change in same-store sales in the period presented compared to the prior year. Same-store sales exclude the net sales of a store for any period if the store was not open during the same period of the prior year. Acquired stores are excluded from same-store sales until they are converted to the Party City format and included in our sales for the comparable period of the prior year. Comparable sales are calculated based upon stores that were open at least thirteen full months as of the end of the applicable reporting period. When a store is reconfigured or relocated within the same general territory, the store continues to be treated as the same store. If, during the period presented, a store was closed, sales from that store up to and including the closing day are included as same-store sales as long as the store was open during the same period of the prior year. Same-store sales for the Party City brand include North American retail e-commerce sales.

Cost of Sales. Cost of sales at wholesale reflects the production costs (i.e., raw materials, labor and overhead) of manufactured goods and the direct cost of purchased goods, inventory shrinkage at both retail and wholesale, inventory adjustments, inbound freight to our manufacturing and distribution facilities, distribution costs and outbound freight to get goods to our wholesale customers. At retail, cost of sales reflects the direct cost of goods purchased from third parties and the production or purchase costs of goods acquired from our wholesale operations. Retail cost of sales also includes inventory shrinkage, inventory adjustments, inbound freight, occupancy costs related to store operations (such as rent and common area maintenance, utilities and depreciation on assets) and all logistics costs associated with our retail e-commerce business.

Our cost of sales increases in higher volume periods as the direct costs of manufactured and purchased goods, inventory shrinkage and freight are generally tied to net sales. However, other costs are largely fixed or vary based on other factors and do not necessarily increase as sales volume increases. Changes in the mix of our products may also impact our overall cost of sales. The direct costs of manufactured and purchased goods are influenced by raw material costs (principally paper, petroleum-based resins and cotton), domestic and international labor costs in the countries where our goods are purchased or manufactured and logistics costs associated with transporting our goods. We monitor our inventory levels on an on-going basis in order to identify slow-moving goods.

Cost of sales related to sales from our wholesale segment to our retail segment are eliminated in our consolidated financial statements.

Wholesale Selling Expenses. Wholesale selling expenses include the costs associated with our wholesale sales and marketing efforts, including merchandising and customer service. Costs include the salaries and benefits of the related work force, including sales-based bonuses and commissions. Other costs include catalogues, showroom rent, travel and other operating costs. Certain selling expenses, such as sales-based bonuses and commissions, vary in proportion to sales, while other costs vary based on other factors, such as our marketing efforts, or are largely fixed and do not necessarily increase as sales volumes increase.

Retail Operating Expenses. Retail operating expenses include all of the costs associated with retail store operations, excluding occupancy-related costs included in cost of sales. Costs include store payroll and benefits, advertising, supplies and credit card costs. Retail expenses are largely variable but do not necessarily vary in proportion to net sales.

Franchise Expenses. Franchise expenses include the costs associated with operating our franchise network, including salaries and benefits of the administrative work force and other administrative costs. These expenses generally do not vary proportionally with royalties and franchise fees.

General and Administrative Expenses. General and administrative expenses include all operating costs not included elsewhere in the statement of operations and comprehensive income (loss). These expenses include payroll and other expenses related to operations at our corporate offices, including occupancy costs, related depreciation and amortization, legal and professional fees and data-processing costs. These expenses generally do not vary proportionally with net sales.

 

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Art and Development Costs. Art and development costs include the costs associated with art production, creative development and product management. Costs include the salaries and benefits of the related work force. These expenses generally do not vary proportionally with net sales.

Development Stage Expenses. Represents start-up activities related to Kazzam, LLC. See the 2017 Form 10-K for further discussion.

Adjusted EBITDA. We define EBITDA as net income (loss) before interest expense, net, income taxes, depreciation and amortization. We define Adjusted EBITDA as EBITDA, as further adjusted to eliminate the impact of certain items that we do not consider indicative of our core operating performance. We caution investors that amounts presented in accordance with our definition of Adjusted EBITDA may not be comparable to similar measures disclosed by other issuers, because not all issuers calculate Adjusted EBITDA in the same manner. We believe that Adjusted EBITDA is an appropriate measure of operating performance in addition to EBITDA because we believe it assists investors in comparing our performance across reporting periods on a consistent basis by eliminating the impact of items that we do not believe are indicative of our core operating performance. In addition, we use Adjusted EBITDA: (i) as a factor in determining incentive compensation, (ii) to evaluate the effectiveness of our business strategies, and (iii) because the credit facilities use Adjusted EBITDA to measure compliance with certain covenants.

Adjusted Net Income (Loss). Adjusted net income (loss) represents our net income (loss), adjusted for, among other items, intangible asset amortization, non-cash purchase accounting adjustments, amortization of deferred financing costs and original issue discounts, refinancing charges, equity based compensation and impairment charges. We present adjusted net income because we believe it assists investors in comparing our performance across reporting periods on a consistent basis by eliminating the impact of items that we do not believe are indicative of our core operating performance.

Adjusted Net Income (Loss) Per Common Share – Diluted. Adjusted net income (loss) per common share – diluted represents adjusted net income (loss) divided by the Company’s diluted weighted average common shares outstanding. We present the metric because we believe it assists investors in comparing our per share performance across reporting periods on a consistent basis by eliminating the impact of items that we do not believe are indicative of our core operating performance.

 

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Results of Operations

Three Months Ended September 30, 2018 Compared To Three Months Ended September 30, 2017

The following table sets forth the Company’s operating results and operating results as a percentage of total revenues for the three months ended September 30, 2018 and 2017.

 

		Three Months Ended September 30,
		2018								2017
		(Dollars in thousands)
Revenues:
Net sales		$	550,840				99.6	%		$	557,350				99.5	%
Royalties and franchise fees			2,206				0.4				2,759				0.5
Total revenues			553,046				100.0				560,109				100.0
Expenses:
Cost of sales			349,641				63.2				357,523				63.8
Wholesale selling expenses			17,538				3.2				16,274				2.9
Retail operating expenses			103,833				18.8				100,739				18.0
Franchise expenses			862				0.2				3,636				0.6
General and administrative expenses			42,239				7.6				37,971				6.8
Art and development costs			5,573				1.0				5,898				1.1
Development stage expenses			1,622				0.3				680				0.1
Total expenses			521,308				94.3				522,721				93.3
Income from operations			31,738				5.7				37,388				6.7
Interest expense, net			27,705				5.0				23,228				4.1
Other expense, net			5,696				1.0				593				0.1
(Loss) income before income taxes			(1,663	)			(0.3	)			13,567				2.4
Income tax expense			777				0.1				3,483				0.6
Net (loss) income			(2,440	)			(0.4	)			10,084				1.8
Add: Net loss attributable to redeemable securities holder			(8	)			(0.0	)			—				0.0
Less: Net loss attributable to noncontrolling interests			(28	)			(0.0	)			—				0.0
Net (loss) income attributable to common shareholders of Party City Holdco Inc.		$	(2,420	)			(0.4	)%		$	10,084				1.8	%
Net (loss) income per share attributable to common shareholders of Party City Holdco Inc. – Basic		$	(0.03	)						$	0.08
Net (loss) income per share attributable to common shareholders of Party City Holdco Inc. – Diluted		$	(0.03	)						$	0.08

Revenues

Total revenues for the third quarter of 2018 were $553.0 million and were $7.1 million, or 1.3%, lower than the third quarter of 2017. The following table sets forth the Company’s total revenues for the three months ended September 30, 2018 and 2017.

 

		Three Months Ended September 30,
		2018								2017
		Dollars in Thousands				Percentage of Total Revenues				Dollars in Thousands				Percentage of Total Revenues
Net Sales:
Wholesale		$	424,569				76.8	%		$	381,858				68.2	%
Eliminations			(249,409	)			(45.1	)%			(188,565	)			(33.7	)%
Net wholesale			175,160				31.7	%			193,293				34.5	%
Retail			375,680				67.9	%			364,057				65.0	%
Total net sales			550,840				99.6	%			557,350				99.5	%
Royalties and franchise fees			2,206				0.4	%			2,759				0.5	%
Total revenues		$	553,046				100.0	%		$	560,109				100.0	%

Retail

Retail net sales during the third quarter of 2018 were $375.7 million and increased $11.6 million, or 3.2%, compared to the third quarter of 2017. Retail net sales at our Party City stores totaled $336.4 million and were $11.6 million, or 3.6%, higher than 2017

 

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