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

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

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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 June 30, 2018

☐	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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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):

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 July 25, 2018, 96,477,447 shares of the Registrant’s common stock were outstanding.

PARTY CITY HOLDCO INC.

Form 10-Q

June 30, 2018

TABLE OF CONTENTS


	Page
PART I
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets at June 30, 2018 and December 31, 2017		3
Condensed Consolidated Statements of Operations and Comprehensive Income for the Three Months ended June 30, 2018 and June 30, 2017		4
Condensed Consolidated Statements of Operations and Comprehensive Income for the Six Months ended June 30, 2018 and June 30, 2017		5
Condensed Consolidated Statement of Stockholders’ Equity for the Six Months ended June 30, 2018		6
Condensed Consolidated Statements of Cash Flows for the Six Months ended June 30, 2018 and June 30, 2017		7
Notes to Condensed Consolidated Financial Statements		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		20
Item 3. Quantitative and Qualitative Disclosures about Market Risk		33
Item 4. Controls and Procedures		33
PART II
Item 1. Legal Proceedings		34
Item 1A. Risk Factors		34
Item 6. Exhibits		34
Signature		35

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)


	June 30, 2018			December 31, 2017
	(Note 2) (Unaudited)			(Note 2)
ASSETS
Current assets:
Cash and cash equivalents	$	51,461		$	54,291
Accounts receivable, net		130,067			140,980
Inventories, net		673,676			604,066
Prepaid expenses and other current assets		86,043			77,816

Total current assets		941,247			877,153
Property, plant and equipment, net		311,572			301,141
Goodwill		1,627,851			1,619,253
Trade names		568,422			568,681
Other intangible assets, net		71,587			75,704
Other assets, net		11,705			12,824

Total assets	$	3,532,384		$	3,454,756

LIABILITIES, REDEEMABLE SECURITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Loans and notes payable	$	379,519		$	286,291
Accounts payable		175,449			160,994
Accrued expenses		164,043			176,609
Income taxes payable		6,541			45,568
Current portion of long-term obligations		13,049			13,059

Total current liabilities		738,601			682,521
Long-term obligations, excluding current portion		1,528,263			1,532,090
Deferred income tax liabilities		177,891			175,836
Deferred rent and other long-term liabilities		89,742			91,929

Total liabilities		2,534,497			2,482,376
Redeemable securities		3,219			3,590
Commitments and contingencies
Stockholders’ equity:
Common stock (96,474,228 and 96,380,102 shares outstanding and 119,853,795 and 119,759,669 shares issued at June 30, 2018 and December 31, 2017, respectively)		1,199			1,198
Additional paid-in capital		919,845			917,192
Retained earnings		399,872			372,596
Accumulated other comprehensive loss		(39,797	)		(35,818	)

Total Party City Holdco Inc. stockholders’ equity before common stock held in treasury		1,281,119			1,255,168
Less: Common stock held in treasury, at cost (23,379,567 shares at June 30, 2018 and December 31, 2017)		(286,733	)		(286,733	)

Total Party City Holdco Inc. stockholders’ equity		994,386			968,435
Noncontrolling interests		282			355

Total stockholders’ equity		994,668			968,790

Total liabilities, redeemable securities and stockholders’ equity	$	3,532,384		$	3,454,756

See accompanying notes to unaudited condensed consolidated financial statements.

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except share and per share data)


	Three Months Ended June 30,
	2018			2017
Revenues:
Net sales	$	558,101		$	541,653
Royalties and franchise fees		2,910			3,225

Total revenues		561,011			544,878
Expenses:
Cost of sales		329,477			321,900
Wholesale selling expenses		17,256			16,045
Retail operating expenses		92,094			90,512
Franchise expenses		3,980			3,713
General and administrative expenses		45,326			39,655
Art and development costs		5,732			5,942
Development stage expenses		1,695			6,412

Total expenses		495,560			484,179

Income from operations		65,451			60,699
Interest expense, net		25,501			21,294
Other expense (income), net		2,532			(895	)

Income before income taxes		37,418			40,300
Income tax expense		9,370			15,318

Net income		28,048			24,982
Add: Net income attributable to redeemable securities holder		410			—
Less: Net loss attributable to noncontrolling interests		(29	)		—

Net income attributable to common shareholders of Party City Holdco Inc.	$	28,487		$	24,982

Net income per share attributable to common shareholders of Party City Holdco Inc.—Basic	$	0.30		$	0.21
Net income per share attributable to common shareholders of Party City Holdco Inc.—Diluted	$	0.29		$	0.21
Weighted-average number of common shares-Basic		96,453,884			119,528,147
Weighted-average number of common shares-Diluted		97,688,233			120,943,745
Dividends declared per share	$	0.00		$	0.00
Comprehensive income	$	18,825		$	31,985
Add: Comprehensive income attributable to redeemable securities holder		410			—
Less: Comprehensive loss attributable to noncontrolling interests		(55	)		—

Comprehensive income attributable to common shareholders of Party City Holdco Inc.	$	19,290		$	31,985

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except share and per share data)


	Six Months Ended June 30,
	2018			2017
Revenues:
Net sales	$	1,063,209		$	1,015,616
Royalties and franchise fees		5,626			6,261

Total revenues		1,068,835			1,021,877
Expenses:
Cost of sales		646,443			620,619
Wholesale selling expenses		36,043			31,672
Retail operating expenses		181,186			181,242
Franchise expenses		7,762			7,030
General and administrative expenses		93,991			87,792
Art and development costs		11,705			11,740
Development stage expenses		3,998			6,412

Total expenses		981,128			946,507

Income from operations		87,707			75,370
Interest expense, net		48,776			41,986
Other expense, net		3,380			267

Income before income taxes		35,551			33,117
Income tax expense		8,666			12,818

Net income		26,885			20,299
Add: Net income attributable to redeemable securities holder		410			—
Less: Net loss attributable to noncontrolling interests		(59	)		—

Net income attributable to common shareholders of Party City Holdco Inc.	$	27,354		$	20,299

Net income per share attributable to common shareholders of Party City Holdco Inc.—Basic	$	0.28		$	0.17
Net income per share attributable to common shareholders of Party City Holdco Inc.—Diluted	$	0.28		$	0.17
Weighted-average number of common shares-Basic		96,426,235			119,526,007
Weighted-average number of common shares-Diluted		97,669,309			120,903,032
Dividends declared per share	$	0.00		$	0.00
Comprehensive income	$	22,892		$	30,510
Add: Comprehensive income attributable to redeemable securities holder		410			—
Less: Comprehensive loss attributable to noncontrolling interests		(73	)		—

Comprehensive income attributable to common shareholders of Party City Holdco Inc.	$	23,375		$	30,510

See accompanying notes to unaudited condensed consolidated financial statements.

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						26,944						26,944						26,944			(59	)		26,885
Net income attributable to redeemable securities holder						410						410						410						410
Stock option expense				942								942						942						942
Restricted stock units – time-based				252								252						252						252
Restricted stock units – performance-based				593								593						593						593
Director – non-cash compensation				59								59						59						59
Warrant expense				326								326						326						326
Exercise of stock options		1		481								482						482						482
Foreign currency adjustments									(5,307	)		(5,307	)					(5,307	)		(14	)		(5,321	)
Impact of foreign exchange contracts, net									1,328			1,328						1,328						1,328

Balance at June 30, 2018	$	1,199	$	919,845	$	399,872		$	(39,797	)	$	1,281,119		$	(286,733	)	$	994,386		$	282		$	994,668

See accompanying notes to unaudited condensed consolidated financial statements.

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)


	Six Months Ended June 30,
	2018			2017 (Adjusted, see Note 2)
Cash flows (used in) provided by operating activities:
Net income	$	26,885		$	20,299
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization expense		40,812			41,825
Amortization of deferred financing costs and original issuance discounts		2,766			2,459
Provision for doubtful accounts		304			419
Deferred income tax expense		1,443			1,713
Deferred rent		1,155			2,915
Undistributed income in unconsolidated joint ventures		(301	)		(226	)
Loss on disposal of assets		24			528
Non-employee equity based compensation		365			3,265
Stock option expense		942			3,222
Restricted stock units—time-based		252			—
Restricted stock units—performance-based		593			—
Director—non-cash compensation		59			—
Changes in operating assets and liabilities, net of effects of acquired businesses:
Decrease in accounts receivable		8,791			20,823
Increase in inventories		(68,741	)		(5,328	)
(Increase) decrease in prepaid expenses and other current assets		(9,137	)		866
Decrease in accounts payable, accrued expenses and income taxes payable		(29,220	)		(40,462	)

Net cash (used in) provided by operating activities		(23,008	)		52,318
Cash flows used in investing activities:
Cash paid in connection with acquisitions, net of cash acquired		(21,325	)		(70,547	)
Capital expenditures		(44,406	)		(30,854	)
Proceeds from disposal of property and equipment		21			5

Net cash used in investing activities		(65,710	)		(101,396	)
Cash flows provided by financing activities:
Repayment of loans, notes payable and long-term obligations		(26,062	)		(76,978	)
Proceeds from loans, notes payable and long-term obligations		112,293			128,140
Exercise of stock options		482			67
Debt issuance costs		(56	)		—

Net cash provided by financing activities		86,657			51,229
Effect of exchange rate changes on cash and cash equivalents		(780	)		2,208

Net (decrease) increase in cash and cash equivalents and restricted cash		(2,841	)		4,359
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	$	51,567		$	69,124

Supplemental disclosure of cash flow information:
Cash paid during the period
Interest	$	49,489		$	34,770
Income taxes, net of refunds	$	46,617		$	49,588

See accompanying notes to unaudited condensed consolidated financial statements.

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, and e-commerce websites, principally operating under the domain name PartyCity.com. 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.

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 on their balance sheets 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 is in the process of evaluating the impact of the pronouncement on the Company’s consolidated financial statements.

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 did not have a material 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 was 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 tied 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:


	June 30, 2018		December 31, 2017
Finished goods	$	628,823	$	562,809
Raw materials		32,315		30,346
Work in process		12,538		10,911

	$	673,676	$	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.

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 six 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 and has not yet determined its accounting policy. Therefore, during the six months ended June 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.

The effective income tax rate for the six months ended June 30, 2018, 24.4%, is different from the statutory rate primarily due to state and foreign taxes.

Note 5 – Changes in Accumulated Other Comprehensive Loss

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


	Three Months Ended June 30, 2018
	Foreign Currency Adjustments			Impact of Foreign Exchange Contracts, Net of Taxes			Total, Net of Taxes
Balance at March 31, 2018	$	(30,204	)	$	(396	)	$	(30,600	)
Other comprehensive (loss) income before reclassifications		(10,713	)		1,398			(9,315	)
Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income		—			118			118

Net current-period other comprehensive (loss) income		(10,713	)		1,516			(9,197	)

Balance at June 30, 2018	$	(40,917	)	$	1,120		$	(39,797	)


	Three Months Ended June 30, 2017
	Foreign Currency Adjustments			Impact of Foreign Exchange Contracts, Net of Taxes			Total, Net of Taxes
Balance at March 31, 2017	$	(49,352	)	$	321		$	(49,031	)
Other comprehensive income (loss) before reclassifications		7,702			(509	)		7,193
Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income		0			(190	)		(190	)

Net current-period other comprehensive income (loss)		7,702			(699	)		7,003

Balance at June 30, 2017	$	(41,650	)	$	(378	)	$	(42,028	)


	Six Months Ended June 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		(5,307	)		971			(4,336	)
Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income, net of income tax		—			357			357

Net current-period other comprehensive (loss) income		(5,307	)		1,328			(3,979	)

Balance at June 30, 2018	$	(40,917	)	$	1,120		$	(39,797	)


	Six Months Ended June 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		11,521			(796	)		10,725
Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income, net of income tax		0			(514	)		(514	)

Net current-period other comprehensive income (loss)		11,521			(1,310	)		10,211

Balance at June 30, 2017	$	(41,650	)	$	(378	)	$	(42,028	)

Note 6 – Capital Stock

At June 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.

During the six months ended June 30, 2018, 90,420 shares of common stock were issued due to stock option exercises and 3,706 shares were issued to directors of the Company.

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 June 30, 2018 and June 30, 2017 was as follows:


	Wholesale			Retail		Consolidated
Three Months Ended June 30, 2018
Revenues:
Net sales	$	285,733		$	411,353	$	697,086
Royalties and franchise fees		—			2,910		2,910

Total revenues		285,733			414,263		699,996
Eliminations		(138,985	)		—		(138,985	)

Net revenues	$	146,748		$	414,263	$	561,011

Income from operations	$	11,148		$	54,303	$	65,451

Interest expense, net							25,501
Other expense, net							2,532

Income before income taxes						$	37,418


	Wholesale			Retail		Consolidated
Three Months Ended June 30, 2017
Revenues:
Net sales	$	276,705		$	399,801	$	676,506
Royalties and franchise fees		0			3,225		3,225

Total revenues		276,705			403,026		679,731
Eliminations		(134,853	)		0		(134,853	)

Net revenues	$	141,852		$	403,026	$	544,878

Income from operations	$	16,034		$	44,665	$	60,699

Interest expense, net							21,294
Other income, net							(895	)

Income before income taxes						$	40,300

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


	Wholesale			Retail		Consolidated
Six Months Ended June 30, 2018
Revenues:
Net sales	$	563,560		$	774,929	$	1,338,489
Royalties and franchise fees		—			5,626		5,626

Total revenues		563,560			780,555		1,344,115
Eliminations		(275,280	)		—		(275,280	)

Net revenues	$	288,280		$	780,555	$	1,068,835

Income from operations	$	16,496		$	71,211	$	87,707

Interest expense, net							48,776
Other expense, net							3,380

Income before income taxes						$	35,551


	Wholesale			Retail		Consolidated
Six Months Ended June 30, 2017
Revenues:
Net sales	$	547,397		$	739,070	$	1,286,467
Royalties and franchise fees		0			6,261		6,261

Total revenues		547,397			745,331		1,292,728
Eliminations		(270,851	)		0		(270,851	)

Net revenues	$	276,546		$	745,331	$	1,021,877

Income from operations	$	26,450		$	48,920	$	75,370

Interest expense, net							41,986
Other expense, net							267

Income before income taxes						$	33,117

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 six months ended June 30, 2018 and the six months ended June 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 June 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 June 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

June 30, 2018

December 31, 2017

June 30, 2018

December 31, 2017

Foreign Exchange Contracts

) PP

1,233

) PP

) AE

—

) AE

(a)	PP = Prepaid expenses and other current assets

(b)	AE = Accrued expenses

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


Derivative Instrument	June 30, 2018		December 31, 2017
Foreign Exchange Contracts	$	23,586	$	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 June 30, 2018 that are measured at fair value on a recurring basis:


	Level 1		Level 2		Level 3		Total as of June 30, 2018
Derivative assets	$	—	$	1,233	$	—	$	1,233
Derivative liabilities		—		0		—		0
Kazzam liability		—		—		3,219		3,219
Punchbowl put liability		—		—		268		268

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 June 30, 2018 because of the short-term maturities of the instruments and/or their variable rates of interest.

The carrying amounts and fair values of borrowings under the Term Loan Credit Agreement and the Senior Notes as of June 30, 2018 are as follows:


	June 30, 2018
	Carrying Amount		Fair Value
Term Loan Credit Agreement	$	1,192,253	$	1,203,242
Senior Notes		345,780		351,750

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 June 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 June 30, 2018		Three Months Ended June 30, 2017		Six Months Ended June 30, 2018		Six Months Ended June 30, 2017
Net income attributable to common shareholders of Party City Holdco Inc.	$	28,487	$	24,982	$	27,354	$	20,299
Weighted average shares - Basic		96,453,884		119,528,147		96,426,235		119,526,007
Effect of dilutive securities:
Warrants		—		—		—		—
Restricted stock units		—		—		—		—
Stock options		1,234,350		1,415,598		1,243,074		1,377,025

Weighted average shares - Diluted		97,688,233		120,943,745		97,669,309		120,903,032

Net income per share attributable to common shareholders of Party City Holdco Inc. - Basic	$	0.30	$	0.21	$	0.28	$	0.17

Net income per share attributable to common shareholders of Party City Holdco Inc. - Diluted	$	0.29	$	0.21	$	0.28	$	0.17

During the three months ended June 30, 2018 and June 30, 2017, 2,494,428 stock options and 2,417,613 stock options, respectively, were excluded from the calculation of diluted earnings per share as they were anti-dilutive. Additionally, during the three months ended June 30, 2018 and June 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 June 30, 2018 and June 30, 2017, 201,270 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 six months ended June 30, 2018 and June 30, 2017, 2,494,428 stock options and 2,417,613 stock options, respectively, were excluded from the calculation of diluted earnings per share as they were anti-dilutive. Additionally, during the six months ended June 30, 2018 and June 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 six months ended June 30, 2018 and June 30, 2017, 201,270 restricted stock units and 0 restricted stock units, respectively, were excluded from the calculation of diluted earnings per share as they were anti-dilutive.

Note 12 – Long-Term Obligations

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


	June 30, 2018			December 31, 2017
Term Loan Credit Agreement	$	1,192,253		$	1,196,505
Capital lease obligations		3,279			3,276
Senior Notes		345,780			345,368

Total long-term obligations		1,541,312			1,545,149
Less: current portion		(13,049	)		(13,059	)

Long-term obligations, excluding current portion	$	1,528,263		$	1,532,090

Term Loan Credit Agreement

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.

Note 13 – Acquisitions

During March 2018, the Company acquired 11 franchise stores, which are located in Maryland, for total 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 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 five years and it has recorded a liability for the estimated purchase price of such interest, $2,840 at June 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 $3,021 at June 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 overwhelming 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. 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 six months ended June 30, 2018 and June 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 June 30, 2018 and June 30, 2017 and the six months ended June 30, 2018 and June 30, 2017:


	Three Months Ended June 30, 2018		Three Months Ended June 30, 2017		Six Months Ended June 30, 2018		Six Months Ended June 30, 2017
Retail Net Sales:
Party City Stores	$	376,222	$	363,872	$	707,067	$	668,886
Global E-commerce		35,131		35,929		67,862		70,184

Total Retail Net Sales	$	411,353	$	399,801	$	774,929	$	739,070
Royalties and Franchise Fees		2,910		3,225		5,626		6,261

Total Retail Revenue	$	414,263	$	403,026	$	780,555	$	745,331

Wholesale Net Sales:
Domestic	$	79,397	$	81,354	$	158,956	$	165,695
International		67,351		60,498		129,324		110,851

Total Wholesale Net Sales	$	146,748	$	141,852	$	288,280	$	276,546


Total Consolidated Revenue	$	561,011	$	544,878	$	1,068,835	$	1,021,877

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 six months ended June 30, 2018 as it increased pre-tax income by $26 during the three month period and increased pre-tax income by $39 during the six 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.

As a result, the Company’s statement of cash flows for the six months ended June 30, 2017 has been adjusted to include $155 of restricted cash at December 31, 2016 and $106 of restricted cash at June 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 six months ended June 30, 2017, the change in “prepaid expenses and other current assets” has been adjusted from a cash inflow of $915 to a cash inflow of $866.

The Company’s June 30, 2018 consolidated balance sheet included $51,461 of cash and cash equivalents and $106 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”.

Note 16 - Related Party Transactions

In the normal course of business, the Company buys and sells party goods from/to certain equity method investees. Such activity is immaterial to the Company’s consolidated financial statements.

Note 17 – Subsequent Events

During July 2018, the Company acquired an additional 16 franchise stores, which are located in Pennsylvania, for total consideration of approximately $18,800.

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 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.

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 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.

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.

Results of Operations

Three Months Ended June 30, 2018 Compared To Three Months Ended June 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 June 30, 2018 and 2017.


	Three Months Ended June 30,
	2018					2017
	(Dollars in thousands)
Revenues:
Net sales	$	558,101		99.5	%	$	541,653		99.4	%
Royalties and franchise fees		2,910		0.5			3,225		0.6

Total revenues		561,011		100.0			544,878		100.0
Expenses:
Cost of sales		329,477		58.7			321,900		59.1
Wholesale selling expenses		17,256		3.1			16,045		2.9
Retail operating expenses		92,094		16.4			90,512		16.6
Franchise expenses		3,980		0.7			3,713		0.7
General and administrative expenses		45,326		8.1			39,655		7.3
Art and development costs		5,732		1.0			5,942		1.1
Development stage expenses		1,695		0.3			6,412		1.2

Total expenses		495,560		88.3			484,179		88.9

Income from operations		65,451		11.7			60,699		11.1
Interest expense, net		25,501		4.5			21,294		3.9
Other expense (income), net		2,532		0.5			(895	)	(0.2	)

Income before income taxes		37,418		6.7			40,300		7.4
Income tax expense		9,370		1.7			15,318		2.8

Net income		28,048		5.0			24,982		4.6
Add: Net income attributable to redeemable securities holder		410		0.1			—		0.0
Less: Net loss attributable to noncontrolling interests		(29	)	(0.0	)		—		0.0

Net income attributable to common shareholders of Party City Holdco Inc.	$	28,487		5.1	%	$	24,982		4.6	%

Net income per share attributable to common shareholders of Party City Holdco Inc. - Basic	$	0.30				$	0.21
Net income per share attributable to common shareholders of Party City Holdco Inc. - Diluted	$	0.29				$	0.21

Revenues

Total revenues for the second quarter of 2018 were $561.0 million and were $16.1 million, or 3.0%, higher than the second quarter of 2017. The following table sets forth the Company’s total revenues for the three months ended June 30, 2018 and 2017.


	Three Months Ended June 30,
	2018						2017
	Dollars in Thousands			Percentage of Total Revenues			Dollars in Thousands			Percentage of Total Revenues
Net Sales:
Wholesale	$	285,733			50.9	%	$	276,705			50.8	%
Eliminations		(138,985	)		(24.8	)%		(134,853	)		(24.8	)%

Net wholesale		146,748			26.2	%		141,852			26.0	%
Retail		411,353			73.3	%		399,801			73.4	%

Total net sales		558,101			99.5	%		541,653			99.4	%
Royalties and franchise fees		2,910			0.5	%		3,225			0.6	%

Total revenues	$	561,011			100.0	%	$	544,878			100.0	%

Retail

Retail net sales during the second quarter of 2018 were $411.4 million and increased $11.6 million, or 2.9%, compared to the second quarter of 2017. Retail net sales at our Party City stores totaled $376.2 million and were $12.4 million, or 3.4%, higher than 2017 principally due to the acquisition of franchise and independent stores. During the twelve months ended June 30, 2018, we acquired 24 franchise and independent stores, opened 13 new stores and closed 12 stores. Global retail e-commerce sales totaled $35.1 million during the second quarter of 2018 and were $0.8 million, or 2.2%, lower than during the corresponding quarter of 2017. The North American e-commerce sales that are included in our Party City brand comp decreased by 3.2% during the quarter. However, they increased by 17.0% when adjusting for the impact of our new “buy online, pick-up in store” program (as such sales are included in our store sales).

Same-store sales for the Party City brand (including North American retail e-commerce sales) increased by 0.1% during the second quarter of 2018 despite headwinds from a shift in the timing of Easter (first quarter 2018 versus second quarter 2017). Excluding the impact of e-commerce, same-store sales increased by 0.4%. Same-store sales percentages were not affected by foreign currency as such percentages are calculated in local currency.

Wholesale

Wholesale net sales during the second quarter of 2018 totaled $146.7 million and were $4.9 million, or 3.5%, higher than the second quarter of 2017. Net sales to domestic party goods retailers and distributors (including our franchisee network) totaled $57.1 million and were $3.6 million, or 5.9%, lower than during 2017. The decrease was largely due to our acquisition of 24 franchise and independent stores during the twelve months ended June 30, 2018; as post-acquisition sales to such stores (approximately $2.4 million during the second quarter of 2017) are now eliminated as intercompany sales. Net sales of metallic balloons to domestic distributors and retailers (including our franchisee network) totaled $22.2 million during the second quarter of 2018 and were $1.6 million, or 7.8%, higher than during the corresponding quarter of 2017. Our international sales (which include U.S. export sales and exclude U.S. import sales from foreign subsidiaries) totaled $67.4 million and were $6.9 million, or 11.3%, higher than in 2017. The increase was largely driven by continued strong performance in the U.K. and German markets and the impact of foreign currency translation (approximately $2 million).

Intercompany sales to our retail affiliates totaled $139.0 million during the second quarter of 2018 and were $4.1 million higher than during the corresponding quarter of 2017. Intercompany sales represented 48.6% of total wholesale sales during the second quarter of 2018, compared to 48.7% during the second quarter of 2017. The intercompany sales of our wholesale segment are eliminated against the intercompany purchases of our retail segment in the consolidated financial statements.

Royalties and franchise fees

Royalties and franchise fees for the second quarter of 2018 totaled $2.9 million and were $0.3 million lower than during the second quarter of 2017 due to the acquisition of franchise stores.

Gross Profit

The following table sets forth the Company’s gross profit for the three months ended June 30, 2018 and June 30, 2017.


	Three Months Ended June 30,
	2018					2017
	Dollars in Thousands		Percentage of Net Sales			Dollars in Thousands		Percentage of Net Sales
Retail	$	183,915		44.7	%	$	173,872		43.5	%
Wholesale		44,709		30.5			45,881		32.3

Total	$	228,624		41.0	%	$	219,753		40.6	%

The gross profit margin on net sales at retail during the second quarter of 2018 was 44.7%. Such percentage was 120 basis points higher than during the corresponding quarter of 2017. The increase was principally due to a higher POS margin, the realization of productivity initiatives positively impacting occupancy costs, and increased manufacturing share of shelf (i.e., the percentage of our retail product cost of sales manufactured by our wholesale segment). Our manufacturing share of shelf increased from 25.8% during the second quarter of 2017 to 27.6% during the second quarter of 2018, driven by higher sales of metallic balloons and the scaling of recent acquisitions in our wholesale business. Our wholesale share of shelf at our Party City stores and our North American retail e-commerce operations (i.e., the percentage of our retail product cost of sales supplied by our wholesale segment) was 78.1% during the quarter and was slightly lower than during the second quarter of 2017 due largely to product mix.

The gross profit on net sales at wholesale during the second quarters of 2018 and 2017 was 30.5% and 32.3%, respectively. The decrease was principally due to inflationary pressures in both distribution and labor costs.

Operating expenses

Wholesale selling expenses were $17.3 million during the second quarter of 2018 and $16.0 million during the corresponding quarter of 2017. The increase of $1.2 million was primarily due to foreign currency translation, inflation and, to a lesser extent, intangible asset amortization. Wholesale selling expenses were 11.8% and 11.3% of net wholesale sales during the second quarters of 2018 and 2017, respectively.

Retail operating expenses during the second quarter of 2018 were $92.1 million and were $1.6 million, or 1.7%, higher than the corresponding quarter of 2017. Increased advertising spend, the higher store count (discussed above) and the impact of inflation were mostly offset by further realized savings associated with improved productivity and efficiency in our stores. Retail operating expenses were 22.4% and 22.6% of net retail sales during the second quarters of 2018 and 2017, respectively.

Franchise expenses during the second quarters of 2018 and 2017 were $4.0 million and $3.7 million, respectively.

General and administrative expenses during the second quarter of 2018 totaled $45.3 million and were $5.7 million, or 14.3%, higher than in the second quarter of 2017. The increase was due to one-time third-party consultant costs and the impact of inflation. General and administrative expenses as a percentage of total revenues were 8.1% and 7.3% during the second quarters of 2018 and 2017, respectively.

Art and development costs were $5.7 million and $5.9 million during the second quarters of 2018 and 2017, respectively.

Development stage expenses represent start-up costs related to Kazzam (see the 2017 Form 10-K for further detail and a discussion of the charges recorded during 2017).

Interest expense, net

Interest expense, net, totaled $25.5 million during the second quarter of 2018, compared to $21.3 million during the second quarter of 2017. The variance principally relates to the impact of increasing LIBOR rates on our Term Loan Credit Agreement and our ABL Facility, as well as increased borrowings under our ABL Facility due to share repurchases during the fourth quarter of 2017.

Other expense (income), net

For the second quarter of 2018, other expense, net, totaled $2.5 million and principally related to corporate development costs and foreign currency transaction losses.

Income tax expense

The effective income tax rate for the three months ended June 30, 2018, 25.0%, is higher than the statutory rate primarily due to state and foreign taxes.

Six Months Ended June 30, 2018 Compared To Six Months Ended June 30, 2017

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


	Six Months Ended June 30,
	2018					2017
	(Dollars in thousands)
Revenues:
Net sales	$	1,063,209		99.5	%	$	1,015,616	99.4	%
Royalties and franchise fees		5,626		0.5			6,261	0.6

Total revenues		1,068,835		100.0			1,021,877	100.0
Expenses:
Cost of sales		646,443		60.5			620,619	60.7
Wholesale selling expenses		36,043		3.4			31,672	3.1
Retail operating expenses		181,186		17.0			181,242	17.8
Franchise expenses		7,762		0.7			7,030	0.7
General and administrative expenses		93,991		8.8			87,792	8.6
Art and development costs		11,705		1.1			11,740	1.1
Development stage expenses		3,998		0.4			6,412	0.6

Total expenses		981,128		91.8			946,507	92.6

Income from operations		87,707		8.2			75,370	7.4
Interest expense, net		48,776		4.6			41,986	4.1
Other expense, net		3,380		0.3			267	0.0

Income before income taxes		35,551		3.3			33,117	3.2
Income tax expense		8,666		0.8			12,818	1.2

Net income		26,885		2.5			20,299	2.0
Add: Net income attributable to redeemable securities holder		410		0.0			—	0.0
Less: Net loss attributable to noncontrolling interests		(59	)	(0.0	)		—	0.0

Net income attributable to common shareholders of Party City Holdco Inc.	$	27,354		2.6	%	$	20,299	2.0	%

Net income per share attributable to common shareholders of Party City Holdco Inc. - Basic	$	0.28				$	0.17
Net income per share attributable to common shareholders of Party City Holdco Inc. - Diluted	$	0.28				$	0.17

Revenues

Total revenues for the first six months of 2018 were $1,068.8 million and were $47.0 million, or 4.6%, higher than the corresponding period of 2017. The following table sets forth the Company’s total revenues for the six months ended June 30, 2018 and 2017.


	Six Months Ended June 30,
	2018						2017
	Dollars in Thousands			Percentage of Total Revenues			Dollars in Thousands			Percentage of Total Revenues
Net Sales:
Wholesale	$	563,560			52.7	%	$	547,397			53.6	%
Eliminations		(275,280	)		(25.8	)%		(270,851	)		(26.5	)%

Net wholesale		288,280			27.0	%		276,546			27.1	%
Retail		774,929			72.5	%		739,070			72.3	%

Total net sales		1,063,209			99.5	%		1,015,616			99.4	%
Royalties and franchise fees		5,626			0.5	%		6,261			0.6	%

Total revenues	$	1,068,835			100.0	%	$	1,021,877			100.0	%

Retail

Retail net sales during the first six months of 2018 were $774.9 million and increased $35.9 million, or 4.9%, compared to the corresponding period of 2017. Retail net sales at our Party City stores totaled $707.1 million and were $38.2 million, or 5.7%, higher than 2017 due to the acquisition of franchise and independent stores and increased same store sales, in part reflecting the favorable

impact of a shift in the calendar related to the timing of certain New Year’s Eve sales, which shifted into the first quarter of fiscal 2018. During the twelve months ended June 30, 2018, we acquired 24 franchise and independent stores, opened 13 new stores and closed 12 stores. Global retail e-commerce sales totaled $67.9 million during the first six months of 2018 and were $2.3 million, or 3.3%, lower than during the corresponding period of 2017. The North American e-commerce sales that are included in our Party City brand comp decreased by 6.5% during the period. However, they increased by 8.7% when adjusting for the impact of our new “buy online, pick-up in store” program (as such sales are included in our store sales).

Same-store sales for the Party City brand (including North American retail e-commerce sales) increased by 1.2% during the first six months of 2018. Excluding the impact of e-commerce, same-store sales increased by 1.9%. Same-store sales percentages were not affected by foreign currency as such percentages are calculated in local currency.

Wholesale

Wholesale net sales during the first six months of 2018 totaled $288.3 million and were $11.7 million, or 4.2%, higher than the first six months of 2017. Net sales to domestic party goods retailers and distributors (including our franchisee network) totaled $115.4 million and were $7.0 million, or 5.7%, lower than during 2017. The decrease was largely due to our acquisition of 61 franchise and independent stores during the eighteen months ended June 30, 2018; as post-acquisition sales to such stores (approximately $6 million during the first six months of 2017) are now eliminated as intercompany sales. Net sales of metallic balloons to domestic distributors and retailers (including our franchisee network) totaled $43.5 million during the first six months of 2018 and were $0.2 million higher than during the corresponding period of 2017 despite a headwind from certain Valentine’s Day shipments accelerating into the fourth quarter of 2017 (during the 2017 Valentine’s Day season the corresponding shipments took place during the first quarter of 2017). Our international sales (which include U.S. export sales and exclude U.S. import sales from foreign subsidiaries) totaled $129.3 million and were $18.5 million, or 16.7%, higher than in 2017. The increase was largely driven by the impact of foreign currency translation (approximately $7 million), continued strong performance in the U.K. and German markets and the acquisition of Granmark S.A. de C.V. (“Granmark”) in March 2017.

Intercompany sales to our retail affiliates totaled $275.3 million during the first six months of 2018 and were $4.4 million higher than during the corresponding period of 2017. Intercompany sales represented 48.8% of total wholesale sales during the first six months of 2018, compared to 49.5% during the first six months of 2017. The intercompany sales of our wholesale segment are eliminated against the intercompany purchases of our retail segment in the consolidated financial statements.

Royalties and franchise fees

Royalties and franchise fees for the first six months of 2018 totaled $5.6 million and were $0.6 million lower than during the first six months of 2017 due to the acquisition of franchise stores.

Gross Profit

The following table sets forth the Company’s gross profit for the six months ended June 30, 2018 and June 30, 2017.


	Six Months Ended June 30,
	2018					2017
	Dollars in Thousands		Percentage of Net Sales			Dollars in Thousands		Percentage of Net Sales
Retail	$	330,750		42.7	%	$	306,453		41.5	%
Wholesale		86,016		29.8	%		88,544		32.0	%

Total	$	416,766		39.2	%	$	394,997		38.9	%

The gross profit margin on net sales at retail during the first six months of 2018 was 42.7%. Such percentage was 120 basis points higher than during the corresponding period of 2017. The increase was principally due to leveraging the higher same-store sales, the realization of productivity initiatives positively impacting occupancy costs, a higher POS margin, and increased manufacturing share of shelf (i.e., the percentage of our retail product cost of sales manufactured by our wholesale segment). Our manufacturing share of shelf increased from 25.5% during the first six months of 2017 to 27.2% during the corresponding period of 2018, driven by higher sales of metallic balloons and the scaling up of recent acquisitions in our wholesale business. Our wholesale share of shelf at our Party City stores and our North American retail e-commerce operations (i.e., the percentage of our retail product cost of sales supplied by our wholesale segment) was 78.1% during the period and was slightly higher than during 2017.

The gross profit on net sales at wholesale during the first six months of 2018 and 2017 was 29.8% and 32.0%, respectively. The decrease was principally due to higher logistics and distribution costs, sales mix and, to a lesser extent, purchase accounting adjustments.

Operating expenses

Wholesale selling expenses were $36.0 million during the first six months of 2018 and $31.7 million during the corresponding period of 2017. The increase of $4.4 million, or 13.8%, was primarily due to approximately $1 million of selling costs at Granmark (acquired in March 2017), the impact of foreign currency translation (also approximately $1 million) and the impact of inflation. Wholesale selling expenses were 12.5% and 11.5% of net wholesale sales during the first six months of 2018 and 2017, respectively.

Retail operating expenses during the first six months of 2018 were $181.2 million and were consistent with the corresponding period of 2017. The higher store count (discussed above) and increased advertising spend were completely offset by lower labor costs realized as a result of increased productivity and efficiency in our stores. Retail operating expenses were 23.4% and 24.5% of net retail sales during the first six months of 2018 and 2017, respectively. The decrease was mostly due to increased sales and the improved labor productivity.

Franchise expenses during the first six months of 2018 and 2017 were $7.8 million and $7.0 million, respectively.

General and administrative expenses during the first half of 2018 totaled $94.0 million and were $6.2 million, or 7.1%, higher than in the first six months of 2017. Increased one-time third-party consultant costs, the impact of inflation and the impact of foreign currency translation were partially offset by the first quarter of 2017 including severance charges related to a Transition and Consulting Agreement which the Company entered into with Gerald Rittenberg. General and administrative expenses as a percentage of total revenues were 8.8% and 8.6% during the first six months of 2018 and 2017, respectively.

Art and development costs were $11.7 million during both the first six months of 2018 and the first six months of 2017.

Development stage expenses represent start-up costs related to Kazzam (see the 2017 Form 10-K for further detail and a discussion of the charges recorded during 2017).

Interest expense, net

Interest expense, net, totaled $48.8 million during the first six months of 2018, compared to $42.0 million during the first six months of 2017. The variance principally relates to the impact of increasing LIBOR rates on our Term Loan Credit Agreement and our ABL Facility, as well as increased borrowings under our ABL Facility due to share repurchases during the fourth quarter of 2017.

Other expense, net

For the first six months of 2018, other expense, net, totaled $3.4 million. Such amount principally consisted of corporate development costs, refinancing charges and foreign currency transaction losses.

Income tax expense

The effective income tax rate for the six months ended June 30, 2018, 24.4%, is higher than the statutory rate primarily due to state and foreign taxes.

Adjusted EBITDA, Adjusted Net Income and Adjusted Net Income per Common Share – Diluted

The Company presents adjusted EBITDA, adjusted net income and adjusted net income per common share - diluted as supplemental measures of its operating performance. The Company defines EBITDA as net income (loss) before interest expense, net, income taxes, depreciation and amortization and defines adjusted EBITDA as EBITDA, as further adjusted to eliminate the impact of certain items that the Company does not consider indicative of our core operating performance. These further adjustments are itemized below. Adjusted net income represents the Company’s 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, equity based compensation, and impairment charges. Adjusted net income per common share – diluted represents adjusted net income

divided by diluted weighted average common shares outstanding. The Company presents these measures as supplemental measures of its operating performance. You are encouraged to evaluate these adjustments and the reasons the Company considers them appropriate for supplemental analysis. In evaluating the measures, you should be aware that in the future the Company may incur expenses that are the same as, or similar to, some of the adjustments in this presentation. The Company’s presentation of adjusted EBITDA, adjusted net income and adjusted net income per common share-diluted should not be construed as an inference that the Company’s future results will be unaffected by unusual or non-recurring items. The Company presents the measures because the Company believes they assist investors in comparing the Company’s performance across reporting periods on a consistent basis by eliminating items that the Company does not believe are indicative of its core operating performance. In addition, the Company uses adjusted EBITDA: (i) as a factor in determining incentive compensation, (ii) to evaluate the effectiveness of its business strategies and (iii) because its credit facilities use adjusted EBITDA to measure compliance with certain covenants. The Company also believes that adjusted net income and adjusted net income per common share—diluted are helpful benchmarks to evaluate its operating performance.

Adjusted EBITDA, adjusted net income, and adjusted net income per common share—diluted have limitations as analytical tools. Some of these limitations are:

•

they do not reflect the Company’s cash expenditures or future requirements for capital expenditures or contractual commitments;

•

they do not reflect changes in, or cash requirements for, the Company’s working capital needs;

•

adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on the Company’s indebtedness;

•

although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and adjusted EBITDA does not reflect any cash requirements for such replacements;

•

non-cash compensation is and will remain a key element of the Company’s overall long-term incentive compensation package, although the Company excludes it as an expense when evaluating its core operating performance for a particular period;

•

they do not reflect the impact of certain cash charges resulting from matters the Company considers not to be indicative of its ongoing operations; and

•

other companies in the Company’s industry may calculate adjusted EBITDA, adjusted net income and adjusted net income per common share differently than the Company does, limiting its usefulness as a comparative measure.

Because of these limitations, adjusted EBITDA, adjusted net income and adjusted net income per common share – diluted should not be considered in isolation or as substitutes for performance measures calculated in accordance with GAAP. We compensate for these limitations by relying primarily on our GAAP results and using adjusted EBITDA, adjusted net income and adjusted net income per common share – diluted only on a supplemental basis. The reconciliations from net income (loss) to adjusted EBITDA and income (loss) before income taxes to adjusted net income (loss) for the periods presented are as follows:


	Three Months Ended June 30, 2018			Three Months Ended June 30, 2017			Six Months Ended June 30, 2018			Six Months Ended June 30, 2017
(Dollars in thousands)
Net income	$	28,048		$	24,982		$	26,885		$	20,299
Interest expense, net		25,501			21,294			48,776			41,986
Income taxes		9,370			15,318			8,666			12,818
Depreciation and amortization		20,255			21,124			40,812			41,825

EBITDA		83,174			82,718			125,139			116,928
Non-cash purchase accounting adjustments		1,098			3,000			542			4,850
Restructuring, retention and severance (a)		(457	)		813			2,154			8,627
Deferred rent (b)		787			2,552			1,155			2,915
Closed store expense (c)		793			1,512			2,605			2,879
Foreign currency losses (gains), net		505			(1,183	)		442			(1,720	)
Stock option expense (d)		482			824			942			3,222
Restricted stock units expense—time-based (e)		252			—			252			—
Restricted stock units expense—performance-based (f)		593			—			593			—
Non-employee equity based compensation (g)		104			3,265			365			3,265
Undistributed income in unconsolidated joint ventures		(90	)		(942	)		(301	)		(226	)
Corporate development (h)		2,778			3,721			5,352			4,444
Non-recurring consulting charges (i)		6,869			—			11,619			—
Refinancing charges (j)		—			—			1,146			—
Other		(282	)		260			(251	)		478

Adjusted EBITDA	$	96,606		$	96,540		$	151,754		$	145,662


	Three Months Ended June 30, 2018		Three Months Ended June 30, 2017		Six Months Ended June 30, 2018		Six Months Ended June 30, 2017
(Dollars in thousands, except per share amounts)
Income before income taxes	$	37,418	$	40,300	$	35,551	$	33,117
Intangible asset amortization		3,705		4,112		7,368		7,825
Non-cash purchase accounting adjustments		1,668		3,920		963		5,924
Amortization of deferred financing costs and original issuance discounts (j)		1,210		1,226		2,766		2,459
Restructuring, retention and severance (a)		—		—		—		7,814
Non-employee equity based compensation (g)		104		3,265		365		3,265
Refinancing charges (j)		—		—		800		—
Non-recurring consulting charges (i)		6,869		—		11,619		—
Stock option expense (d)		482		824		942		3,222
Restricted stock units expense—performance-based (f)		593		—		593		—

Adjusted income before income taxes		52,049		53,647		60,967		63,626
Adjusted income tax expense (k)		12,813		20,318		14,849		24,246

Adjusted net income	$	39,236	$	33,329	$	46,118	$	39,380

Adjusted net income per common share – diluted	$	0.40	$	0.28	$	0.47	$	0.33

Weighted-average number of common shares-diluted		97,688,233		120,943,745		97,669,309		120,903,032

(a)

On March 15, 2017, the Company and its then Chairman of the Board of Directors, Gerald Rittenberg, entered into a Transition and Consulting Agreement under which Mr. Rittenberg’s employment as Executive Chairman of the Company terminated effective March 31, 2017. As a result of the agreement, the Company recorded a $4.5 million severance charge in general and administrative expenses during the first quarter of 2017. Additionally, during the three months ended March

31, 2017, the Company recorded a $3.3 million severance charge related to the restructuring of its Retail segment. See the 2017 Form 10-K for further discussion. The adjustment to “Adjusted EBITDA” during 2018 principally relates to costs incurred while moving one of the Company’s domestic manufacturing facilities to a new location.

(b)	The deferred rent adjustment reflects the difference between accounting for rent and landlord incentives in accordance with GAAP and the Company’s actual cash outlay for such items.

(c)	Principally charges incurred related to closing underperforming stores.

(d)	Represents non-cash charges related to stock options.

(e)	Non-cash charges for restricted stock units that vest based on service conditions.

(f)	Non-cash charges for restricted stock units that vest based on performance conditions.

(g)	Principally represents shares of Kazzam awarded to Ampology as compensation for Ampology’s services. See the 2017 Form 10-K for further discussion.

(h)	Primarily represents start-up costs for Kazzam (see the 2017 Form 10-K for further discussion) and third-party costs related to acquisitions (principally legal expenses).

(i)	Primarily non-recurring consulting charges related to the Company’s retail operations.

(j)

During February 2018, the Company amended the Term Loan Credit Agreement. In conjunction with the amendment, the Company wrote-off $0.3 million of capitalized deferred financing costs, original issue discounts and call premiums. The amounts are included in “Refinancing charges” in the adjusted EBITDA table above and in “Amortization of deferred financing costs and original issuance discounts” in the adjusted net income table above (consistent with the presentation in the Company’s condensed consolidated statement of cash flows included elsewhere in this Quarterly Report on Form 10-Q). Further, in conjunction with the amendment, the Company expensed $0.8 million of investment banking and legal fees. These amounts are included in “Refinancing charges” in the tables above.

(k)

Represents income tax expense/benefit after excluding the specific tax impacts for each of the pre-tax adjustments. The tax impacts for each of the adjustments were determined by applying to the pre-tax adjustments the effective income tax rates for the specific legal entities in which the adjustments were recorded.

Liquidity

The Company’s indebtedness principally consists of: (i) a senior secured term loan facility (“Term Loan Credit Agreement”), (ii) a $540 million asset-based revolving credit facility (with a seasonal increase to $640 million during a certain period of each calendar year) (“ABL Facility”), (iii) $350 million of 6.125% senior notes and (iv) $500 million of 6.625% senior notes (issued during August 2018).

We expect that cash generated from operating activities and availability under our credit agreements will be our principal sources of liquidity. Based on our current level of operations, we believe that these sources will be adequate to meet our liquidity needs for at least the next 12 months. We cannot assure you, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under the ABL Facility and the Term Loan Credit Agreement in amounts sufficient to enable us to repay our indebtedness or to fund our other liquidity needs.

Cash Flow

Net cash used in operating activities totaled $23.0 million during the six months ended June 30, 2018. Net cash provided by operating activities totaled $52.3 million during the six months ended June 30, 2017. Net cash flows provided by operating activities before changes in operating assets and liabilities were $75.3 million during 2018, compared to $76.4 million during 2017. Changes in operating assets and liabilities during 2018 and 2017 resulted in the use of cash of $98.3 million and $24.1 million, respectively. The use of cash was greater during 2018 principally due to the timing of inventory receipts, 2017 benefitting from Halloween carryover inventory from the 2016 Halloween selling season and, to a lesser extent, higher interest payments.

Net cash used in investing activities totaled $65.7 million during the six months ended June 30, 2018, as compared to $101.4 million during the six months ended June 30, 2017. Investing activities during 2018 included $21.3 million paid in connection with acquisitions, principally related to franchise stores (see Note 13 to the consolidated financial statements for further detail). Capital expenditures during the six months ended June 30, 2018 and 2017 were $44.4 million and $30.9 million, respectively. Retail capital expenditures totaled $25.7 million during 2018 and principally related to initiatives for improving store performance, investments in new stores and spending on store conversions. Wholesale capital expenditures during 2018 totaled $18.7 million and primarily related to printing plates and dies, as well as machinery and equipment at the Company’s manufacturing operations and main distribution center.

Net cash provided by financing activities was $86.7 million and $51.2 million during the six months ended June 30, 2018 and June 30, 2017, respectively. An increase in cash used in operating activities (see above) and increased capital expenditures (see above) were partially offset by higher acquisition activity in 2017.

At June 30, 2018, the Company had approximately $111 million of availability under its ABL Facility, after considering borrowing base restrictions.

Contractual Obligations

Other than as described above under “Liquidity and Capital Resources”, there were no material changes to our future minimum contractual obligations as of December 31, 2017 as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017.

Off Balance Sheet Arrangements

We had no off balance sheet arrangements during the six months ended June 30, 2018 and the year ended December 31, 2017.

Seasonality

Wholesale Operations

Despite a concentration of holidays in the fourth quarter of the year, as a result of our expansive product lines, customer base and increased promotional activities, the impact of seasonality on the quarterly results of our wholesale operations has been limited. However, due to Halloween, the inventory balances of our wholesale operations are slightly higher during the third quarter than during the remainder of the year. Additionally, Halloween products sold to retailers and other distributors result in slightly higher accounts receivable balances during the quarter.

Retail Operations

Our retail operations are subject to significant seasonal variations. Historically, this segment has realized a significant portion of its revenues, cash flow and net income in the fourth quarter of the year, principally due to our Halloween sales in October and, to a lesser extent, year-end holiday sales.

Cautionary Note Regarding Forward-Looking Statements

From time to time, including in this filing and, in particular, the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we make “forward-looking statements” within the meaning of federal and state securities laws. Disclosures that use words such as the company “believes,” “anticipates,” “expects,” “estimates,” “intends,” “will,” “may” or “plans” and similar expressions are intended to identify forward-looking statements. These forward-looking statements reflect our current expectations and are based upon data available to us at the time the statements were made. An example of a forward-looking statement is our belief that our cash generated from operating activities and availability under our credit facilities will be adequate to meet our liquidity needs for at least the next 12 months. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. These risks, as well as other risks and uncertainties, are detailed in the section titled “Risk Factors” included in our Annual Report on Form 10-K filed with the SEC on March 14, 2018 and elsewhere in this report. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. All forward-looking statements are qualified by these cautionary statements and are made only as of the date of this filing. Any such forward-looking statements, whether made in this filing or elsewhere, should be considered in context with the various disclosures made by us about our business. The following risks related to our business, among others, could cause actual results to differ materially from those described in the forward-looking statements:

•

our ability to compete effectively in a competitive industry;

•

fluctuations in commodity prices;

•

our ability to appropriately respond to changing merchandise trends and consumer preferences;

•

successful implementation of our store growth strategy;

•

decreases in our Halloween sales;

•

unexpected or unfavorable consumer responses to our promotional or merchandising programs;

•

failure to comply with existing or future laws relating to our marketing programs, e-commerce initiatives and the use of consumer information;

•

disruption to the transportation system or increases in transportation costs;

•

product recalls or product liability;

•

economic slowdown affecting consumer spending and general economic conditions;

•

loss or actions of third party vendors and loss of the right to use licensed material;

•

disruptions at our manufacturing facilities;

•

failure by suppliers or third-party manufacturers to follow acceptable labor practices or to comply with other applicable laws and guidelines;

•

our international operations subjecting us to additional risks;

•

potential litigation and claims;

•

lack of available additional capital;

•

our inability to retain or hire key personnel;

•

risks associated with leasing substantial amounts of space;

•

failure of existing franchisees to conduct their business in accordance with agreed upon standards;

•

adequacy of our information systems, order fulfillment and distribution facilities;

•

our ability to adequately maintain the security of our electronic and other confidential information;

•

our inability to successfully identify and integrate acquisitions;

•

adequacy of our intellectual property rights;

•

risks related to our substantial indebtedness; and

•

the other factors set forth under “Risk Factors” in our Annual Report on Form 10-K, filed with the SEC on March 14, 2018.

Except as required by law, we undertake no obligation to update publicly any forward-looking statements after the date of this filing to conform these statements to actual results or to changes in our expectations.

You should read this filing with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no material changes in our market risks since December 31, 2017 as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017.

Item 4. Controls and Procedures

We have carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended (the “Act”)) as of June 30, 2018. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Act is: (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms; and (ii) accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosures.

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Act) during the quarter ended June 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II-OTHER INFORMATION

Item 1. Legal Proceedings

Information in response to this Item is incorporated herein by reference from Note 8, Commitments and Contingencies, to our Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.

Item 1A. Risk Factors

There have been no material changes to the risk factors disclosed under the heading “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on March 14, 2018, except as noted below.

Concentration of ownership by investment funds affiliated with Thomas H. Lee Partners, L.P. (“THL”) could limit other stockholders’ ability to influence the outcome of key transactions, including a change of control.

THL beneficially owns approximately 47% of our outstanding common stock as of July 25, 2018. As a result, THL will be able to exert a significant degree of influence over our business and affairs, including any determinations with respect to mergers or other business combinations, the acquisition or disposition of assets, the incurrence of indebtedness, the issuance of any additional common stock or other equity securities, the repurchase or redemption of common stock and the payment of dividends. Similarly, THL may effectively control matters submitted to a vote of our stockholders without the consent of our other stockholders, may have the power to prevent a change in our control and could take other actions that might be favorable to them.

Item 6. Exhibits



3.1		Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to Party City Holdco Inc.’s Form 8-K dated April 21, 2015)

3.2		Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to Party City Holdco Inc.’s Form 8-K dated April 21, 2015)

31.1*		Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2*		Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1*		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2*		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101*		Interactive Data Files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets at June 30, 2018 and December 31, 2017; (ii) Condensed Consolidated Statements of Operations and Comprehensive Income for the three month periods ended June 30, 2018 and June 30, 2017; (iii) Condensed Consolidated Statements of Operations and Comprehensive Income for the six month periods ended June 30, 2018 and June 30, 2017; (iv) Condensed Consolidated Statement of Stockholders’ Equity for the six month period ended June 30, 2018; (v) Condensed Consolidated Statements of Cash Flows for the six month periods ended June 30, 2018 and June 30, 2017; and (vi) Notes to the Condensed Consolidated Financial Statements.

*		Filed herewith.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.

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