Item 1.
Business
Overview
Party City Holdco is a Delaware corporation formed in 2012. It has no operating assets or operations. Party City Holdco 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”). PCHI or its direct or indirect subsidiaries conduct most of our operations. The Company’s principal executive offices are located at 80 Grasslands Road, Elmsford, New York 10523.
We are the leading party goods company by revenue in North America and, we believe, the largest vertically integrated supplier of decorated party goods globally by revenue. The Company is a popular one-stop
shopping destination for party supplies, balloons, and costumes. In addition to being a great retail brand, the Company is a global, world-class organization that combines state-of-the-art
manufacturing and sourcing operations, and sophisticated wholesale operations complemented by a multi-channel retailing strategy and e-commerce
retail operations. The Company is a leading player in its category and vertically integrated in its breadth and depth. 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 throughout the world. The Company’s retail operations include approximately 875 specialty retail party supply stores
(including franchise stores) throughout the United States and Mexico operating under the names Party City and Halloween City, and e-commerce
websites, including through the domain name PartyCity.com and others.
In addition to our retail operations, we are also one of the largest global designers, manufacturers and distributors of decorated consumer party products, with items found in over 40,000 retail outlets worldwide, including independent party supply stores, mass merchants, grocery retailers, e-commerce
merchandisers and dollar stores. Our products are available in over 100 countries with the United Kingdom (“U.K.”), Canada, Germany, Mexico and Australia among the largest end markets for our products outside of the United States.
The 2005 combination of Amscan, which focused on the wholesale market, and Party City, which focused on the retail market, represented an important step in our evolution. Since the acquisition of Party City, we have steadily increased the selection of Amscan merchandise offered in our Party City stores from approximately 25% in 2005 to approximately 80% in 2019, additionally allowing us to capture multiple levels of gross margin on a significant portion of our retail sales. During 2019, 80% of the product that was sold by our retail operations was supplied by our wholesale operations with 24% of the product self-manufactured and 56% procured externally.
Industry Overview
We operate in the broadly defined retail party goods industry, which includes a $9 billion Halloween market. The party goods industry includes decorative paper and plastic tableware, costumes, decorations, accessories and balloons, all of which are supported by a range of suppliers from commodity paper goods producers to party goods manufacturers.
The retail landscape for decorated party goods is comprised primarily of party superstores, mass merchants, e-commerce
merchandisers, craft stores, grocery retailers, and dollar stores. The party superstore is a preferred destination for party goods shoppers, similar to the dominance of specialty retailers in other categories such as home improvement. This is typically due to the superstore chain’s ability to offer a wider variety of merchandise at more compelling prices in a convenient setting as well as the knowledgeable staff often found at superstores. Other retailers that cater to the party goods market typically offer a limited assortment of party supplies and seasonal items. Mass and e-commerce
retailers tend to focus primarily on juvenile and seasonal party goods, greeting cards and gift wrap. Mass and e-commerce
retailers also maintain a significant share of the market for packaged Halloween costumes. Craft stores tend to focus on decorations and seasonal merchandise; and dollar stores on general and seasonal party goods items.
Sales of party goods are fueled by everyday events such as birthdays, baby showers, weddings and anniversaries, as well as seasonal events such as holidays and other special occasions. As a result of numerous and diverse occasions, the U.S. party goods market enjoys broad demographic appeal.
Segments
We have two reporting segments: Retail and Wholesale. In 2019, we generated 74.6% of our total revenues from our retail segment and 25.4% of our total revenues from our wholesale segment.
Our retail operations generate revenue primarily through the sale of our party supplies, which are sold under the Amscan, Designware, Anagram and Costumes USA brand names, through our Party City stores, Halloween City stores and PartyCity.com.
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 and gift stores, dollar stores and e-commerce
merchandisers.
Financial information about our industry segments and geographic segments is provided in Note 19, Segment Information, to our consolidated financial statements in Part II, Item 8, “Financial Statements and Supplementary Data,” in this Annual Report on Form 10-K.
Retail Operations
Overview
After opening its first company-owned store in 1986, Party City has grown to become what we believe is the largest operator of owned and franchised party superstores by revenue in the United States. At the time of the combination of Party City and Amscan in 2005, Party City’s network consisted of 502 stores, including 254 franchised locations. The Party City network of stores has expanded since 2005 and is now approximately 875 superstore locations in the United States (inclusive of franchised stores). During the year ended December 31, 2019, the Company performed a comprehensive review of its store locations aimed at improving the overall productivity of such locations (“store optimization program”) and, after careful consideration and evaluation of the store locations, the Company made the decision to accelerate the optimization of its store portfolio with the closure of approximately 55 stores which are primarily located in close proximity to other Party City stores. These closings should provide the Company with capital flexibility to expand into underserved markets. On October 1, 2019, as part of the store optimization program, the Company sold its Canadian-based Party City stores to a Canadian-based retailer and entered into a 10-year
supply agreement under which the acquirer agreed to purchase product from the Company for such Party City stores, as well as the acquirer’s other stores.
The following table shows the change in our company-owned Party City store network over the past three years (with the Canadian-based stores reflected in the 100 closed stores):
E-commerce
Our websites, including PartyCity.com, offer a convenient, user-friendly and secure online shopping option for our customers. In addition to the ability to order products, our websites provide a substantial amount of content about our party products, party planning ideas and promotional offers. The websites are also one of our key marketing vehicles, specifically as they relate to social media marketing initiatives.
Additionally, during 2019, the Company expanded its 2018 pilot program under which it sells a selection of its products via a Party City storefront on Amazon Marketplace.
Retail Advertising and Marketing
Our advertising focuses on promoting specific seasonal occasions and general party themes, with a strong emphasis on the breadth and depth of our products and our price-value proposition, with the goal of increasing customer traffic and further building our brand.
Competition at Retail
In our retail segment, our stores and e-commerce
operations compete primarily on the basis of product assortment, customer convenience and value and, with regards to our stores, location and layout. Although we
compete with a variety of smaller and larger retailers, including, but not limited to, independent party goods supply stores, specialty stores, dollar stores, e-commerce
merchandisers, warehouse/merchandise clubs, drug stores, and mass merchants, we believe that, based on our revenues and strong brand awareness with our customers, we maintain a leading position in the party goods business by offering a wider breadth of merchandise than most competitors and a greater selection within merchandise classes, at a compelling value. We are one of only a few vertically integrated suppliers of decorated party goods. While some of our competitors in our markets may have greater financial resources, we believe that our significant buying power, which results from the size of our retail store network and the breadth of our assortment, is an important competitive advantage. Many of our retail competitors are also customers of our wholesale business.
Retail Seasonality
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. Halloween business represents approximately 20% of our total domestic retail sales. To maximize our seasonal opportunity, we operate a chain of temporary Halloween stores, under the Halloween City banner, during the months of September and October of each year.
Franchise Operations
We have franchised stores throughout the United States, Mexico and Puerto Rico run by franchisees utilizing our format, design specifications, methods, standards, operating procedures, systems and trademarks. Our wholesale sales to franchised stores generally mirror, with respect to relative size, mix and category, those to our company-owned stores. The following table shows the change in our franchise-owned store network over the past three years:
We are not currently marketing, nor do we plan to market, new franchise territories in the United States. During 2015, the Company entered into an agreement with a subsidiary of Grupo Oprimax to franchise the Party City concept throughout Mexico. Under the terms of the agreement, Grupo Oprimax has the opportunity to exclusively open and operate Party City stores in Mexico based on satisfaction of certain conditions.
We receive revenue from our franchisees, consisting of an initial one-time
fee and ongoing royalty fees generally ranging from 4% to 6% of net sales. In exchange for these franchise fees, franchisees principally receive brand value and company support with respect to planograms. Each franchisee has a mandated advertising budget, which consists of a minimum initial store opening promotion and ongoing local advertising and promotions. Additionally, franchisees must pay 1% to 2.25% of net sales to a group advertising fund to cover common advertising materials. Our franchise agreements provide us with a right of first refusal should any franchisee look to dispose of its operations.
Current franchise agreements provide for an assigned area or territory that typically equals a three or four-mile radius from the franchisee’s store location and the right to use the Party City®
logo and trademark. In addition, certain agreements with our franchisees and other business partners contain geographic limitations on opening new stores. For most stores, the franchisee or the majority owner of a corporate franchisee devotes full time to the management, operation and on-premises
supervision of the stores or groups of stores.
Wholesale Operations
Overview
We currently offer over 400 party goods ensembles, which range from approximately five to 50 design-coordinated items spanning tableware, accessories, novelties, balloons and decorations. The breadth of these ensembles enables retailers to promote additional sales of related products for every occasion. To enhance our customers’ celebrations of life’s important events, we market party goods ensembles for a wide variety of occasions, including seasonal and religious holidays, special events and themed celebrations.
Our Amscan, Anagram, Costumes USA and Designware branded products are offered in over 40,000 retail outlets worldwide, ranging from party goods superstores (including our franchise stores), other party goods retailers, mass merchants, independent card and gift stores, dollar stores and e-commerce
merchandisers. We have long-term relationships with many of our wholesale customers.
The table below shows the breakdown of our total wholesale sales by channel for the year ended December 31, 2019:
Product Lines
The following table sets forth the principal products we distribute by product category, and the corresponding percentage of revenue that each category represents:
Wholesale Sales by Product for the Year Ended
December 31, 2019
Our product line spans a wide variety of ways to celebrate everyday events including from birthdays to theme parties to sporting events. Additionally, we offer seasonal product throughout the year to decorate and dress-up
for holidays such as Halloween, New Year’s Eve and Mardi Gras. Our product offering is designed to
provide everything needed to throw an amazing event and capture life’s special moments including a wide range of decór, tabletop, balloons & wearable product formats for the following occasions and more:
Current Product Offering
Wholesale Manufactured Products
We manufacture items representing approximately 42% of our net sales at wholesale (including sales to our retail operations). Generally, our manufacturing facilities are highly automated and produce paper and plastic plates and cups, paper napkins, metallic and latex balloons, injection molded product, costumes, pinatas and other party and novelty items at globally competitive costs. State-of-the-art
printing, forming, folding and packaging equipment support most of these manufacturing operations. Given our size and sales volume, we are generally able to operate our manufacturing equipment on the basis of at least two shifts per day, thus lowering production costs per unit. In select cases, we use available capacity to manufacture products for third parties, which allows us to maintain a satisfactory level of equipment utilization.
The table below summarizes our principal manufacturing facilities:
(1) The square footage represents an industrial park, which includes a 48,455 square foot office and warehouse.
Complementing our manufacturing facilities, we have a diverse global network of third-party suppliers that supports our strategy of consistently offering a broad selection of high quality, innovative and competitively priced product. We have relationships that exceed twenty years with many of our vendors and often represent a significant portion of their overall business. They generally produce items designed by and created for us, are located in Asia, and are managed by our sourcing office in Hong Kong. We actively work with our third-party suppliers to ensure product cost, quality and safety.
The principal raw materials used in manufacturing our products are paper, petroleum-based resin and cotton. While we currently purchase such raw material from a relatively small number of sources, paper, resin and cotton are available from numerous sources. Therefore, we believe our current suppliers could be replaced without adversely affecting our manufacturing operations in any material respect.
Wholesale Product Safety and Quality Assurance
We are subject to regulatory requirements in the United States and internationally, and we believe that all products that we manufacture and source comply with the requirements in the markets in which they are sold. Third-party manufactured products are tested both at the manufacturing site and upon arrival at our distribution centers. We have a full-time staff of professionals in the United States, Asia and Europe dedicated to product safety and quality assurance.
Wholesale Distribution and Systems
We ship our products directly to retailers and distributors throughout the world from our distribution facilities, as well as directly from our domestic and international factories. Our electronic order entry and information systems allow us to manage our inventory with minimal obsolescence while maintaining strong fill rates and quick order turnaround time.
Our main distribution facility for domestic party customers is located in Chester, New York, with nearly 900,000 square feet under one roof. This state-of-the-art
facility serves as the main point of distribution for our Amscan-branded products and utilizes a paperless, pick-by-light
system, a Goods-To-Person
(OSR) picking system, offering superior inventory management and turnaround times as short as 48 hours.
We also utilize a bypass system which allows us to ship products directly from selected third-party suppliers to our company-owned and franchised stores, thus bypassing our distribution facilities. In addition to lowering our distribution costs, this bypass system enhances our warehouse capacity.
The distribution center for our main retail e-commerce
platform is located in Naperville, Illinois. We also have other distribution centers in the U.K., Germany and Mexico in order to support our international customers.
Wholesale Customers
We have a diverse third-party customer base at wholesale. During 2019, no individual third-party customer accounted for more than 10% of our total third-party sales at wholesale.
Competition at Wholesale
In our wholesale segment, we compete primarily on the basis of diversity and quality of our product designs, breadth of product line, product availability, price, reputation and customer service. Although we have many competitors with respect to one or more of our products, we believe that there are no competitors who design, manufacture, source and distribute products with the complexity of design and breadth of product lines that we do. Furthermore, our design and manufacturing processes create efficiencies in manufacturing that few of our competitors can achieve in the production of numerous coordinated products in multiple design types. Competitors include smaller independent manufacturers and distributors, as well as divisions or subsidiaries of large companies. Certain of these competitors control various party goods product licenses for widely recognized images, such as cartoon or motion picture characters, which could provide them with a competitive advantage. However, we control a strong portfolio of character licenses for use in the design and production of our metallic balloons and we have access to a strong portfolio of character and other licenses for party goods.
Information Systems
We continually evaluate and upgrade our information systems to enhance the quantity, quality and timeliness of information available to management and to improve the efficiency of our manufacturing and distribution facilities, as well as our service at the store level. We have implemented merchandise replenishment software to complement our distribution, planning and allocation processes. The system enhances the store replenishment function by improving in-stock
positions, leveraging our distribution infrastructure and allowing us to become more effective in our use of store labor. We have implemented a Point of Sale system and upgraded merchandising systems to standardize technology across all of our domestic retail temporary and permanent superstores.
Employees
As of December 31, 2019, the Company had approximately 10,400 full-time employees and 7,900 part-time employees, none of whom is covered by a collective bargaining agreement. We consider our relationship with our employees to be good.
Intellectual Property
We own the copyrights in the designs we create and use on our products and various trademarks and service marks used on or in connection with our products. It is our practice to register our copyrights with the United States Copyright Office and our trademarks and service marks with the United States Patent and Trademark Office, or with other foreign jurisdictions, to the extent we deem necessary. In addition, we rely on unregistered common law trademark rights and unregistered copyrights under applicable U.S. law to distinguish and/or protect our products, services and branding. We do not believe that the loss of copyrights or trademarks with respect to any particular product or products would have a material adverse effect on our business. We hold numerous intellectual property licenses from third parties, allowing us to use various third-party cartoon and other characters and designs on our products, and the images on our metallic balloons and costumes are principally covered by these licenses. None of these licenses is individually material to our aggregate business. We also own patents relating to display racks and balloon weights, none of which are individually material to our aggregate business.
We permit our franchisees to use a number of our trademarks and service marks, including Party City, The Discount Party Super Store, Party America, Oh, It’s On, Nobody has More Party for Less and Halloween City.
Government Regulation
As a franchisor, we must comply with regulations adopted by the Federal Trade Commission, such as the Trade Regulation Rule on Franchising, which requires us, among other things, to furnish prospective franchisees with a franchise offering circular. We also must comply with a number of state laws that regulate the offer and sale of our franchises and certain substantive aspects of franchisor-franchisee relationships. These laws vary in their application and in their regulatory requirements. State laws that regulate the offer and sale of franchises typically require us to, among other things, register before the offer and sale of a franchise can be made in that state and to provide a franchise offering circular to prospective franchisees.
State laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states. Those laws regulate the franchise relationship, for example, by restricting a franchisor’s rights with regard to the termination, transfer and renewal of a franchise agreement (for example, by requiring “good cause” to exist as a basis for the termination and the franchisor’s decision to refuse to permit the franchisee to exercise its transfer or renewal rights), by requiring the franchisor to give advance notice to the franchisee of the termination and give the franchisee an opportunity to cure most defaults. To date, those laws have not precluded us from seeking franchisees in any given area and have not had a material adverse effect on our operations.
Our wholesale and retail segments must also comply with applicable regulations adopted by federal agencies, including product safety regulations, and with licensing and other regulations enforced by state and local health, sanitation, safety, fire and other departments. Difficulties or failures in obtaining the required licenses or approvals can delay and sometimes prevent the opening of a new store or the shutting down of an existing store.
Our manufacturing operations, stores and other facilities must comply with applicable environmental, health and safety regulations, although the cost of complying with these regulations to date has not been material. More stringent and varied requirements of local governmental bodies with respect to zoning, land use, and environmental factors can delay, and sometimes prevent, development of new stores in particular locations. Our stores must comply with the Fair Labor Standards Act and various state laws governing various matters such as minimum wages, overtime and other working conditions. Our stores must also comply with the provisions of the Americans with Disabilities Act, which requires that employers provide reasonable accommodation for employees with disabilities and that stores must be accessible to customers with disabilities.
Available Information
We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and in accordance therewith, we file reports, proxy and information statements and other information with the SEC. Our Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K,
and other information to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available through the investor relations section of our website at www.partycity.com
or investor.partycity.com. Reports are available free of charge as soon as reasonably practicable after we electronically file them with, or furnish them to, the SEC. The information contained on our website is not incorporated by reference into this Annual Report on Form 10-K.
The SEC maintains an Internet site that contains our reports, proxy and information statements, and other information that we file electronically with the SEC at www.sec.gov.
Item 1A.
Item 1A.
Risk Factors
The following risk factors may be important to understanding any statement in this Annual Report on Form 10-K
or elsewhere. Our business, financial condition and operating results can be affected by a number of factors, whether currently known or unknown, including but not limited to those described below. Any one or more of such factors could directly or indirectly cause our actual results of operations and financial condition to vary materially from past or anticipated future results of operations and financial condition. Any of these factors, in whole or in part, could materially and adversely affect our business, financial condition, results of operations and stock price.
We operate in a competitive industry, and our failure to compete effectively could cause us to lose our market share, revenues and growth prospects.
Our wholesale segment competes with many other manufacturers and distributors, including smaller, independent manufacturers and distributors and divisions or subsidiaries of larger companies with greater financial and other resources than we have. Some of our competitors control licenses for widely recognized images and have broader access to mass market retailers that could provide them with a competitive advantage.
The party goods retail industry is large and highly fragmented. Our retail stores compete with a variety of smaller and larger retailers including, but not limited to, independent party goods supply stores, specialty stores, warehouse/merchandise clubs, drug stores, dollar stores, mass merchants and e-commerce
merchants. We face competition from internet-based retailers in addition to store-based retailers. These internet-based retailers may have a significant collective online presence and may be able to offer similar products to those that we sell, which may result in increased price competition. We compete, among other ways, on the basis of product mix and availability, customer convenience, quality, price and, with respect to our retail stores, location and store layout. We may not be able to continue to compete successfully against existing or future competitors in the retail space. Expansion into markets served by our competitors and entry of new competitors or expansion of existing competitors into our markets could materially adversely affect our business, results of operations, cash flows and financial performance.
We must remain competitive in the areas of quality, price, breadth of selection, customer service and convenience. Competing effectively may require us to reduce our prices or increase our costs, which could lower our margins and adversely affect our revenues and growth prospects.
Our business may be adversely impacted by helium shortages.
Although not used in the actual manufacture of our products, helium gas is currently used to inflate the majority of our metallic balloons and a portion of our latex balloons. We rely upon the exploration and refining of natural gas to ensure adequate supplies of helium as helium is a by-product
of the natural gas production process. Helium shortages can adversely impact the financial performance of our retail and wholesale operations.
During the middle of 2018, helium supplies tightened due to various factors. As a result, our balloon sales and gross margins were negatively impacted. In 2019 the negative impact of helium shortages was felt across the business on both the top and bottom line including a 210-basis
point headwind to third quarter brand comparable sales. Although, we are encouraged that our retail operations approached a 100% in-stock
helium position at the end of 2019, helium supplies could be impacted in the future which could result in shortages that could have a material impact on our results.
Because we rely heavily on our own manufacturing operations and those of our suppliers, disruptions at manufacturing facilities could adversely affect our business, results of operations, cash flows and financial performance.
Any significant disruption in manufacturing facilities, in the United States or abroad, for any reason, including regulatory requirements, unstable labor relations, public health crises, including the occurrence of a
contagious disease or illness, such as the flu or COVID-19, the
loss of certifications, power interruptions, fires, hurricanes, war or other forces of nature, could disrupt our supply of products, adversely affecting our business, results of operations, cash flows and financial performance. For example, the recent spread of the COVID-19 and related quarantines and work and travel restrictions in China and other countries has disrupted, and may continue to disrupt, production for certain of our suppliers and our own manufacturing operations, and the extent to which these events will affect our results of operations and financial position remains uncertain. The occurrence of one or more natural disasters, or other disruptive geo-political
events, could also result in increases in fuel (or other energy) prices or a fuel shortage, the temporary or permanent closure of one or more of manufacturing or distribution centers, the temporary lack of an adequate work force in a market, the temporary or long-term disruption in the supply of products from some local and overseas suppliers, the temporary disruption in the transport of goods from overseas or delays in the delivery of goods to our distribution centers or stores or to third parties who purchase from us. If one or more of these events occurred, our revenues and profitability would be reduced.
A decrease in our Halloween sales could have a material adverse effect on our operating results for the year.
Our retail business realizes a significant portion of its revenues, net income and cash flows in September and October, principally due to Halloween sales. We believe that this general pattern will continue in the future. An economic downturn, or adverse weather, during this period could adversely affect us to a greater extent than at other times of the year. Any unanticipated decrease in demand for our products during the Halloween season could require us to maintain excess inventory or sell excess inventory at substantial markdowns, which could have a material adverse effect on our business, profitability, ability to repay any indebtedness and our brand image. In addition, our sales during the Halloween season could be affected by online competition, if we open fewer Halloween City stores, are not able to find sufficient and adequate lease space for our temporary Halloween City stores or if we are unable to hire qualified temporary personnel to adequately staff these stores and our distribution facility during the Halloween season, whether due to labor market conditions or a failure in our internal recruiting and staffing processes. Failure to have proper lease space and adequate personnel could hurt our business, financial condition and results of operations.
Our failure to appropriately respond to changing merchandise trends and consumer preferences could significantly harm our customer relationships and financial performance.
As a manufacturer, distributor and retailer of consumer goods, our products must appeal to a broad range of consumers whose preferences are constantly changing. We also sell certain licensed products, with images such as cartoon or motion picture characters, which are in great demand for short time periods, making it difficult to project our inventory needs for these products. In addition, we may not be able to obtain the licenses for certain popular characters and could lose market share to competitors who are able to obtain those licenses. Additionally, if consumers’ demand for single-use,
disposable party goods were to diminish in favor of reusable products for environmental or other reasons, our sales could decline.
The success of our business depends upon many factors, such as our ability to accurately predict the market for our products and our customers’ purchasing habits, to identify product and merchandise trends, to innovate and develop new products, to manufacture and deliver our products in sufficient volumes and in a timely manner and to differentiate our product offerings from those of our competitors. We may not be able to continue to offer assortments of products that appeal to our customers or respond appropriately to consumer demands. We could misinterpret or fail to identify trends on a timely basis. Our failure to anticipate, identify or react appropriately to changes in consumer tastes could, among other things, lead to excess inventories and significant markdowns or a shortage of products and lost sales. Our failure to do so could harm our customer relationships and financial performance.
Our business may be adversely affected by material fluctuations in commodity prices.
The costs of our key raw materials (paper, petroleum-based resin and cotton) fluctuate. In general, we absorb movements in raw material costs that we consider temporary or insignificant. However, cost increases that are considered other than temporary may require us to increase our prices to maintain our margins. Raw material prices may increase in the future and we may not be able to pass on these increases to our customers. A significant increase in the price of raw materials that we cannot pass on to customers could have a material adverse effect on our results of operations and financial performance. In addition, the interruption in supply of certain key raw materials essential to the manufacturing of our products may have an adverse impact on our and our suppliers’ abilities to manufacture the products necessary to maintain our existing customer relationships. As a result, significant changes in commodity prices, foreign currency exchange rates, the imposition of tariffs on imported products or interest rates, and effects from public health crises, including the occurrence of a contagious disease or illness, such as
COVID-19, could have a substantial adverse effect on our financial condition or results of operations.
We may not be able to successfully implement our business strategy.
Our ability to increase our sales depends on many factors including, among others, our ability to:
• implement our path to becoming a party platform that is a technology-enabled, one-stop-shop
that provides end-to-end
services based on predicting customer needs and wants;
• grow our e-commerce
business;
• implement new retail programs that could include but are not limited to loyalty rewards, new formats for existing stores, fewer skus and less inventory;
• identify suitable store locations, including temporary lease space for our Halloween City location, the availability of which is largely outside of our control;
• negotiate and secure acceptable lease terms, desired tenant allowances and assurances from operators and developers that they can complete the project, which depend in part on the financial resources of the operators and developers;
• obtain or maintain adequate capital resources on acceptable terms;
• manufacture and source sufficient levels of inventory at acceptable costs;
• hire, train and retain an expanded workforce of store managers and other store-level personnel, many of whom are in entry-level or part-time positions with historically high rates of turnover;
• successfully integrate new stores/e-commerce
operations into our existing control structure and operations, including information system integration;
• maintain adequate manufacturing and distribution facilities, information system and other operational system capabilities;
• identify and satisfy the merchandise and other preferences of our customers in new geographic areas and markets;
• gain brand recognition and acceptance in new markets; and
• address competitive, merchandising, marketing, distribution and other challenges encountered in connection with expansion into new geographic areas and markets, including geographic restrictions on the opening of new stores/e-commerce
operations based on certain agreements with our franchisees and other business partners.
As we expand our e-commerce
operations and, to the extent that any new store openings are in markets in which we have existing operations, we may experience reduced sales at existing stores. In addition, there can be no assurance that any newly opened stores or expanded e-commerce
operations will achieve sales or profitability levels comparable to those of our existing operations in the time frame assumed by us. If our new operations fail
to achieve, or are unable to sustain, acceptable net sales and profitability levels, our business may be materially harmed and we may incur significant costs associated with closing those operations. Our failure to effectively address challenges such as these could adversely affect our ability to successfully open and operate new operations in a timely and cost-effective manner, and could have a material adverse effect on our business, results of operations and financial condition.
Unexpected or unfavorable consumer responses to our promotional or merchandising programs could materially adversely affect our business, results of operations, cash flows and financial performance.
Brand recognition, quality and price have a significant influence on consumers’ choices among competing products and brands. Advertising, promotion, merchandising and the cadence of new product introductions also have a significant impact on consumers’ buying decisions. If we misjudge consumer responses to our existing or future promotional activities, this could have a material adverse impact on our business, results of operations, cash flow and financial performance.
Our marketing programs, e-commerce
initiatives and use of consumer information are governed by an evolving set of laws and enforcement trends and unfavorable changes in those laws or trends, or our failure to comply with existing or future laws, could substantially harm our business and results of operations.
We collect, maintain and use data provided to us through our online activities and other customer interactions in our business. Our current and future marketing programs depend on our ability to collect, maintain and use this information, and our ability to do so is subject to certain contractual restrictions in third-party contracts as well as evolving international, federal and state laws and enforcement trends. We strive to comply with all applicable laws and other legal obligations relating to privacy, data protection and consumer protection, including those relating to the use of data for marketing purposes. It is possible, however, that these requirements may be interpreted and applied in a manner that is inconsistent from one jurisdiction to another, may conflict with other rules or may conflict with our practices. If so, we may suffer damage to our reputation and be subject to proceedings or actions against us by governmental entities or others. Any such proceeding or action could hurt our reputation, force us to spend significant amounts to defend our practices, distract our management, increase our costs of doing business and result in monetary liability.
In addition, as data privacy and marketing laws change, we may incur additional costs to ensure we remain in compliance with such laws. If applicable data privacy and marketing laws become more restrictive at the federal or state level, our compliance costs may increase, our ability to effectively engage customers via personalized marketing may decrease, our investment in our e-commerce
platform may not be fully realized, our opportunities for growth may be curtailed by our compliance capabilities or reputational harm and our potential liability for security breaches may increase.
For example, in 2018 California enacted the California Consumer Privacy Act (“CCPA”), which broadly regulates the sale of the consumer information of California residents and grants California residents certain rights to, among other things, access and delete data about them in certain circumstances. CCPA went into effect on January 1, 2020, and compliance with the CCPA may increase the cost to us of operating in California. Other states are considering similar proposals. Such attempts by the states to regulate have the potential to create a patchwork of differing and/or conflicting state regulations.
Disruption to the transportation system or increases in transportation costs may negatively affect our operating results.
We rely upon various means of transportation, including shipments by air, sea, rail and truck, to deliver products to our distribution centers from vendors and manufacturers and from other distribution centers to our stores, as well as for direct shipments from vendors to stores and sales to third-party customers. Independent third parties with whom we conduct business may employ personnel represented by labor unions. Labor
stoppages, shortages or capacity constraints in the transportation industry, disruptions to the national and international transportation infrastructure, public health crises, fuel shortages or transportation cost increases could adversely affect our business, results of operations, cash flows and financial performance. In particular, if the current COVID-19
outbreak continues and results in a prolonged period of travel restrictions, we could experience global supply disruptions. If we experience supply disruptions, we may not be able to develop alternate sourcing quickly, which could adversely affect our operations.
Product recalls and/or product liability may adversely impact our business, merchandise offerings, reputation, results of operations, cash flow and financial performance.
We may be subject to product recalls if any of the products that we manufacture or sell are believed to cause injury or illness. In addition, as a retailer of products manufactured by third parties, we may also be liable for various product liability claims for products we do not manufacture. Indemnification provisions that we may enter into are typically limited by their terms and depend on the creditworthiness of the indemnifying party and its insurer and the absence of significant defenses. We may be unable to obtain full recovery from the insurer or any indemnifying third party in respect of any claims against us in connection with products manufactured by such third party. In addition, if our vendors fail to manufacture or import merchandise that adheres to our quality control standards or standards established by applicable law, our reputation and brands could be damaged, potentially leading to an increase in customer litigation against us. Furthermore, to the extent we are unable to replace any recalled products, we may have to reduce our merchandise offerings, resulting in a decrease in sales, especially if a recall occurs near or during a peak seasonal period. If our vendors are unable or unwilling to recall products failing to meet our quality standards, we may be required to recall those products at a substantial cost to us.
Our business is sensitive to consumer spending and general economic conditions, and other factors beyond our control, including adverse weather conditions or the outbreak of disease, and an economic slowdown could adversely affect our financial performance.
In general, our retail sales, and the retail sales of our business partners to whom we sell, represent discretionary spending by our customers and our business partners’ customers. Discretionary spending is affected by many factors, such as general business conditions, interest rates, availability of consumer credit, unemployment levels, taxation, weather, hurricanes, public health crises, including the occurrence of a contagious disease or illness, such as the flu or COVID-19, and consumer confidence in future economic conditions. Our customers’ purchases and our business partners’ customers’ purchases of discretionary items, including our products, often decline during periods when disposable income is lower or during periods of actual or perceived unfavorable economic conditions or as a result of geopolitical events or widespread health emergencies. Geopolitical events, such as the threat of terrorism or cyber-attacks, and widespread health emergencies, such as COVID-19 or other pandemics or epidemics, could cause people to avoid our stores or decide not to host or attend gatherings or other events. If this occurs, our revenues and profitability will decline. In addition, economic downturns may make it difficult for us to accurately forecast future demand trends, which could cause us to purchase excess inventories, resulting in increases in our inventory carrying cost, or insufficient inventories, resulting in our inability to satisfy our customer demand and potential loss of market share.
Our business may be adversely affected by the loss or actions of our third-party vendors.
Our ability to find new qualified vendors who meet our standards and supply products in a timely and efficient manner can be a significant challenge, especially for goods sourced from outside the United States. Many of our vendors currently provide us with incentives such as volume purchasing allowances and trade discounts. If our vendors were to reduce or discontinue these incentives, costs would increase. Should we be unable to pass cost increases to consumers, our profitability would be reduced.
Our business and results of operations may be harmed if our suppliers or third-party manufacturers fail to follow acceptable labor practices or to comply with other applicable laws and guidelines.
Many of the products sold in our stores and on our websites are manufactured outside of the United States, which may increase the risk that the labor, manufacturing safety and other practices followed by the manufacturers of these products may differ from those generally accepted in the United States as well as those with which we are required to comply under many of our image or character licenses. Although we require each of our vendors to sign a purchase order and vendor agreement that requires adherence to accepted labor practices and compliance with labor, manufacturing safety and other laws and we test merchandise for product safety standards, we do not supervise, control or audit our vendors or the manufacturers that produce the merchandise we sell to our customers. The violation of labor, manufacturing safety or other laws by any of our vendors or manufacturers, or the divergence of the labor practices followed by any of our vendors or manufacturers from those generally accepted in the United States could interrupt or otherwise disrupt the shipment of finished products to us, damage our brand image, subject us to boycotts by our customers or activist groups or cause some of our licensors of popular images to terminate their licenses to us. Our future operations and performance will be subject to these factors, which are beyond our control and could materially hurt our business, financial condition and results of operations or require us to modify our current business practices or incur increased costs.
Changes in regulations or enforcement, or our failure to comply with existing or future regulations, may adversely impact our business.
We are subject to federal, state and local regulations with respect to our operations in the United States. Additionally, we are subject to regulations in the foreign countries in which we operate and such regulations are increasingly distinct from those in the United States. Further, we may be subject to greater international regulation if we expand our business internationally. There are a number of legislative and regulatory initiatives that could adversely impact our business if they are enacted or enforced. Those initiatives include increased or new tariffs on imported products, wage or workforce issues (such as minimum-wage requirements, overtime and other working conditions and citizenship requirements), collective bargaining matters, environmental regulation, price and promotion regulation, trade regulations, data and privacy protection and others.
Proposed changes in tax regulations may also change our effective tax rate as our business is subject to a combination of applicable tax rates in the various countries, states and other jurisdictions in which we operate. New accounting pronouncements and interpretations of existing accounting rules and practices have occurred and may occur in the future. A change in accounting standards or practices can have a significant effect on our reported results of operations. Failure to comply with legal requirements could result in, among other things, increased litigation risk that could affect us adversely by subjecting us to significant monetary damages and other remedies or by increasing our litigation expenses, administrative enforcement actions, fines and civil and criminal liability. If such issues become more expensive to address, or if new issues arise, they could increase our expenses, generate negative publicity, or otherwise adversely affect us.
Certain aspects of recent U.S. federal income tax reform could negatively affect us.
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Act”) was signed into law. The Act resulted in an overall benefit to us because it reduced our marginal U.S. federal income rate to 21%, effective January 1, 2018, and generally allows us to immediately deduct 100% of the cost of tangible, depreciable property that we acquire and place into service on or before January 1, 2023 for federal income tax purposes.
Certain aspects of the Act, however, could negatively affect us. For example, under the Act, we will generally not be able to deduct our business interest expense to the extent that it exceeds 30% of our Adjusted Taxable Income for our 2018 through 2021 tax years or 30% of our EBIT thereafter. However, such non-deductible
interest will be available for an indefinite carryforward.
Additionally, under the Act, we will be subject to a tax on global intangible low-taxed
income and are required to pay a one-time
transition tax on the previously untaxed deferred foreign earnings that our foreign subsidiaries have accrued since 1986 at a rate of 15.5% for cash and cash-equivalent profits and 8% on other reinvested foreign earnings (the “Transition Tax”). We have elected to pay this Transition Tax over eight annual installments without interest.
Our international operations subject us to additional risks, which risks and related costs may differ in each country in which we do business and may cause our profitability to decline.
We conduct our business in a number of foreign countries, including contracting with manufacturers and suppliers located outside of the United States, many of which are located in Asia. We have expanded our international operations through numerous acquisitions and we plan to continue our expansion through additional acquisitions, investments in joint ventures and organic growth. Our operations and financial condition may be adversely affected if the markets in which we compete or source our products are affected by changes in political, economic or other factors. These factors, over which we have no control, may include:
• recessionary or expansive trends in international markets;
• changes in foreign currency exchange rates, principally fluctuations in the British Pound Sterling, the Canadian Dollar, the Euro, the Malaysian Ringgit, the Mexican Peso and the Australian Dollar;
• hyperinflation or deflation in the foreign countries in which we operate;
• work stoppages or other employee rights issues;
• the imposition of restrictions on currency conversion or the transfer of funds;
• transportation delays and interruptions;
• increases in the taxes we pay and other changes in applicable tax laws;
• difficulty enforcing our intellectual property and competition against counterfeit goods;
• public health crises, including the occurrence of a contagious disease or illness such as the COVID-19
outbreak;
• legal and regulatory changes and the burdens and costs of our compliance with a variety of laws, including new or additional trade restrictions, tariffs and changes in environmental regulations; and
• political and economic instability.
We face risks arising from the results of the public referendum held in United Kingdom and its membership in the European Union.
We have wholesale and ecommerce retail operations located in the United Kingdom (the “UK”). On June 23, 2016, the UK held a referendum in which voters approved an exit from the European Union (“EU”), commonly referred to as “Brexit.” The withdrawal of the UK from the EU took effect on January 31, 2020, and the UK is now in a period of transition until the end of 2020. The transition period maintains all existing trading arrangements.
The ongoing developments following from the UK’s public referendum vote to exit from the EU could cause disruptions to and create uncertainty surrounding our business in the UK. Negotiations have commenced to determine the terms of the UK’s future relationship with the EU, including the terms of trade between the UK and the EU. The effects of Brexit will depend upon any agreements the UK makes to retain access to EU markets. The measures could potentially adversely change tax benefits or liabilities in these or other jurisdictions and could disrupt some of the markets and jurisdictions in which we operate. In addition, Brexit could lead to legal uncertainty and potentially divergent national laws and regulations as the UK determines which EU laws to
replace or replicate. In addition, the announcement of Brexit has caused significant volatility in global stock markets and currency exchange rate fluctuations and the Brexit negotiations may continue to cause significant volatility. The progress and outcomes of Brexit negotiations also may create global economic uncertainty. Any of these effects of Brexit, among others, could materially adversely affect our business, financial condition, and results of operations.
International trade disputes and the U.S. government’s trade policy could adversely affect our business.
International trade disputes could result in tariffs and other protectionist measures that could adversely affect our business. Tariffs could increase the cost of our products and the components and raw materials that go into making them. These increased costs could adversely impact the gross margin that we earn on our products. Countries may also adopt other protectionist measures that could limit our ability to offer our products and services, including, but not limited to, the Trump Administration’s tariffs on China and China’s retaliatory tariffs on certain products from the U.S. Political uncertainty surrounding international trade disputes and protectionist measures could also have a negative effect on consumer confidence and spending, which could adversely affect our business.
The U.S. government has indicated its intent to adopt a new approach to trade policy and in some cases to renegotiate, or potentially terminate, certain existing bilateral or multi-lateral trade agreements. It has also initiated tariffs on certain foreign goods and has raised the possibility of imposing significant, additional tariff increases or expanding the tariffs to capture other types of goods.
The Company has adopted a mitigation strategy that includes price increases, product re-engineering,
transitioning product out of China, renegotiating pricing with Chinese vendors or encouraging them to move to other countries. As a result of this strategy, as well as the elimination of Lists 4a and 4b from the tariffs on China, recent tariffs have not had a material impact on the Company’s operating results. However, to the extent that significant additional tariffs are imposed, depending on the extent of such tariffs, they could have a material impact on our operating results in the future.
In response to the U.S. government’s actions, certain foreign governments have imposed retaliatory tariffs on goods that their countries import from the United States. Changes in U.S. trade policy could result in one or more foreign governments adopting responsive trade policies that, depending on the scope of the policies, could make it more difficult or costly for us to do business in those countries.
We cannot predict the extent to which the United States or other countries will impose quotas, duties, tariffs, taxes or other similar restrictions upon the import or export of our products in the future, nor can we predict future trade policy or the terms of any renegotiated trade agreements and their impact on our business. The adoption and expansion of trade restrictions, the occurrence of a trade war, or other governmental action related to tariffs or trade agreements or policies has the potential to adversely impact demand for our products, our costs, our customers, our suppliers, and the U.S. economy, which in turn could have a material adverse effect on our business, operating results and financial condition.
We may face risks associated with litigation and claims.
From time to time, we may become involved in other legal proceedings relating to the conduct of our business, including but not limited to, employee-related and consumer matters. Additionally, as a retailer and manufacturer of decorated party goods, we have been and may continue to be subject to product liability claims if the use of our products, whether manufactured by us or third party manufacturers, is alleged to have resulted in injury or if our products include inadequate instructions or warnings. Such matters can be time-consuming, divert management’s attention and resources and cause us to incur significant expenses. Due to the uncertainties of litigation, we can give no assurance that we will prevail on all claims made against us in the lawsuits that we currently face or that additional claims will not be made against us in the future. Furthermore, because litigation
is inherently uncertain, there can be no assurance that the results of any of these actions will not have a material adverse effect on our business, results of operations or financial condition.
We may require additional capital to fund our business, which may not be available to us on satisfactory terms or at all.
We currently rely on cash generated by operations and borrowings available under the credit facilities to meet our working capital needs. However, if we are unable to generate sufficient cash from operations or if borrowings available under the credit facilities are insufficient, we may be required to adopt one or more alternatives to raise cash, such as incurring additional indebtedness, selling our assets, seeking to raise additional equity capital or restructuring, which alternatives may not be available to us on satisfactory terms or at all. Any of the foregoing could have a material adverse effect on our business.
Our success depends, in large part, on our senior management team.
The success of our business depends, to a large extent, on the continued service of our senior management team and the ability to integrate new senior management. We may not be able to adequately mitigate the negative impact on our business and competitive position that a change of senior leadership could have, as we may not be able to find management personnel internally or externally with similar experience and industry knowledge to replace the individual on a timely basis. We do not maintain key life insurance on any of our senior officers.
Our supply of qualified personnel and our labor costs depend in part on factors outside of our control.
As our business expands, we believe that our future success will depend greatly on our continued ability to attract, motivate and retain qualified personnel who are able to successfully meet the needs of our business. Although we generally have been able to meet our staffing requirements in the past, our ability to meet our labor needs while controlling costs is subject to external factors, such as unemployment levels, labor market conditions, minimum wage legislation and changing demographics. Recently, various legislative movements have sought to increase the federal minimum wage in the United States, as well as the minimum wage in a number of individual states. As federal or state minimum wage rates increase, we may need to increase not only the wage rates of our minimum wage employees, but also the wages paid to our other hourly employees as well. Our inability to meet our staffing requirements in the future at costs that are favorable to us, or at all, could impair our ability to increase revenue, and our customers could experience lower levels of customer service.
We are subject to risks associated with leasing substantial amounts of space.
We lease all of our company-owned stores, our corporate headquarters and most of our distribution facilities. Payments under our leases account for a significant portion of our operating expenses and we expect payment obligations under our leases to account for a significant portion of our future operating expenses. The majority of our store leases contain provisions for base rent and a small number of store leases contain provisions for base rent, plus percentage rent based on sales in excess of an agreed upon minimum annual sales level. Our continued growth and success depends in part on our ability to renew leases for successful stores and negotiate leases for new stores, including temporary leases for our Halloween City stores. There is no assurance that we will be able to negotiate leases at similar or favorable terms, and we may decide not to enter a market or be forced to exit a market if a favorable arrangement cannot be made. If an existing or future store is not profitable and we decide to close it, we may nonetheless be committed to perform our obligations under the applicable lease, including, among other things, paying the base rent for the balance of the lease term. Moreover, even if a lease has an early cancellation clause, we may not satisfy the contractual requirements for early cancellation under the lease.
Our business could be harmed if our existing franchisees do not conduct their business in accordance with agreed upon standards.
Our success depends, in part, upon the ability of our franchisees to operate their stores and promote and develop our store concept. Although our franchise agreements include certain operating standards, all franchisees operate independently and their employees are not our employees. We provide certain training and support to our franchisees, but the quality of franchise store operations may be diminished by any number of factors beyond our control. Consequently, franchisees may not successfully operate stores in a manner consistent with our standards and requirements, or may not hire and train qualified managers and other store personnel. If they do not, our image, brand and reputation could suffer.
Our information systems, order fulfillment and distribution facilities may prove inadequate or may be disrupted.
We depend on our management information systems for many aspects of our business. We will be materially adversely affected if our management information systems are disrupted or we are unable to improve, upgrade, maintain and expand our systems. In particular, we believe our perpetual inventory, automated replenishment and stock ledger systems are necessary to properly forecast, manage and analyze our inventory levels, margins and merchandise ordering quantities. We may fail to properly optimize the effectiveness of these systems, or to adequately support and maintain the systems. Moreover, we may not be successful in developing or acquiring technology that is competitive and responsive to our customers and might lack sufficient resources to make the necessary investments in technology needs and to compete with our competitors, which could have a material adverse impact on our business, results of operations, cash flows and financial performance.
In addition, we may not be able to prevent a significant interruption in the operation of our electronic order entry and information systems, e-commerce
platforms or manufacturing and distribution facilities due to natural disasters, accidents, systems failures or other events. Any significant interruption in the operation of these facilities, including an interruption caused by our failure to successfully expand or upgrade our systems or manage our transition to utilizing the expansions or upgrades, could reduce our ability to receive and process orders and provide products and services to our stores, third-party stores, and other customers, which could result in lost sales, cancelled sales and a loss of loyalty to our brand.
We may fail to adequately maintain the security of our electronic and other confidential information.
We have become increasingly centralized and dependent upon automated information technology processes. In addition, a portion of our business operations is conducted over the internet. We could experience operational problems with our information systems and e-commerce
platforms as a result of system failures, viruses, computer “hackers” or other causes. Any material disruption or slowdown of our systems could cause information, including data related to customer orders, to be lost or delayed, which could-especially if the disruption or slowdown occurred during a peak sales season-result in delays in the delivery of merchandise to our stores and customers or lost sales, which could reduce demand for our merchandise and cause our sales to decline.
In addition, in the ordinary course of our business, we collect and store certain personal information from individuals, such as our customers and suppliers, and our employees, and we process customer payment card and check information, including via our e-commerce
platforms. Computer hackers may attempt to penetrate our computer system, payment card terminals or other payment systems and, if successful, misappropriate personal information, payment card or check information or confidential Company business information. In particular, the techniques used by criminals to obtain unauthorized access to sensitive data change frequently and often are not recognized until launched against a target; accordingly, we may be unable to anticipate these techniques or implement adequate preventative measures. In addition, a Company employee, contractor or other third party with whom we do business may attempt to circumvent our security measures in order to obtain such information
and may purposefully or inadvertently cause a breach involving such information. Any failure to maintain the security of our customers’ confidential information, or data belonging to us or our suppliers, could put us at a competitive disadvantage, result in deterioration in our customers’ confidence in us, subject us to potential litigation and liability, and fines and penalties, resulting in a possible material adverse impact on our business, results of operations, cash flows and financial performance. While we maintain insurance coverage that may, subject to policy terms and conditions, cover certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses and would not remedy damage to our reputation. There can be no assurance that we will not suffer a criminal attack in the future, that unauthorized parties will not gain access to personal information, or that any such incident will be discovered in a timely manner.
Historically we have made a number of acquisitions, and we may make more acquisitions in the future as part of our growth strategy. Future acquisitions or investments could disrupt our ongoing business, distract management and employees, increase our expenses and adversely affect our business. In addition, we may not be able to identify suitable acquisitions.
We have made a number of recent acquisitions which have contributed to our growth. Acquisitions require significant capital resources and can divert management’s attention from our existing business. Acquisitions also entail an inherent risk that we could become subject to contingent or other liabilities, including liabilities arising from events or conduct predating the acquisition, that were not known to us at the time of acquisition. We may also incur significantly greater expenditures in integrating an acquired business than we had anticipated at the time of the acquisition, which could impair our ability to achieve anticipated cost savings and synergies. Acquisitions may also have unanticipated tax and accounting ramifications. Furthermore, acquisitions might consume a significant portion of our senior management team’s time and efforts with issues unrelated to advancing our core business strategies and operation issues. Our failure to successfully identify and consummate acquisitions or to manage and integrate the acquisitions we make could have a material adverse effect on our business, financial condition or results of operations.
In addition, we may not be able to:
• identify suitable acquisition candidates;
• consummate acquisitions on acceptable terms;
• successfully integrate any acquired business into our operations or successfully manage the operations of any acquired business; or
• retain an acquired company’s significant customer relationships, goodwill and key personnel or otherwise realize the intended benefits of an acquisition.
In the event that the operations of an acquired business do not meet our performance expectations, we have in the past and may in the future restructure the acquired business or write-off
the value of some or all of the assets of the acquired business.
Our intellectual property rights may be inadequate to protect our business.
We hold a variety of United States trademarks, service marks, patents, copyrights, and registrations and applications therefor, as well as a number of foreign counterparts thereto and/or independent foreign intellectual property asset registrations. In some cases, we rely solely on unregistered common law trademark rights and unregistered copyrights under applicable United States law to distinguish and/or protect our products, services and branding from the products, services and branding of our competitors. We cannot assure you that no one will challenge our intellectual property rights in the future. In the event that our intellectual property rights are successfully challenged by a third party, we could be forced to re-brand,
re-design
or discontinue the sale of certain of our products or services, which could result in loss of brand recognition and/or sales and could require us to devote resources to advertising and marketing new branding or re-designing
our products. Further, we
cannot assure you that competitors will not infringe our intellectual property rights, or that we will have adequate resources to enforce these rights. We also permit our franchisees to use a number of our trademarks and service marks, including Party City, The Discount Party Super Store, Nobody Has More Party for Less, Party America and Halloween City. Our failure to properly control our franchisees’ use of such trademarks could adversely affect our ability to enforce them against third parties. A loss of any of our material intellectual property rights could have a material adverse effect on our business, financial condition and results of operations.
We license from many third parties and do not own the intellectual property rights necessary to sell products capturing many popular images, such as cartoon or motion picture characters. While none of these licenses is individually material to our aggregate business, a large portion of our business depends on the continued ability to license the intellectual property rights to these images in the aggregate. Any injury to our reputation or our inability to comply with, in many cases, stringent licensing guidelines in these agreements may adversely affect our ability to maintain these relationships. A termination of any of our significant intellectual property licenses, or any other similarly material limitation on our ability to use certain licensed material may prevent us from manufacturing and distributing certain licensed products and could cause our customers to purchase these products from our competitors. In addition, we may be unable to renew some of our significant intellectual property licenses on terms favorable to us or at all. A large aggregate loss of our right to use intellectual property under our license agreements could have a material adverse effect on our business, financial condition and results of operations.
We also face the risk of claims that we have infringed third parties’ intellectual property rights, which could be expensive and time consuming to defend, cause us to cease using certain intellectual property rights, redesign certain products or packaging or cease selling certain products or services, result in our being required to pay significant damages or require us to enter into costly royalty or licensing agreements in order to obtain the rights to use third parties’ intellectual property rights, which royalty or licensing agreements may not be available at all, any of which could have a negative impact on our operating profits and harm our future prospects.
Our substantial indebtedness and lease obligations could adversely affect our financial flexibility and our competitive position.
As of December 31, 2019, we had total indebtedness of $1,704.9 million, net of deferred financing costs, capitalized call premiums and original issue discounts. Additionally, we had $355.9 million of borrowing capacity available under our asset-based revolving credit facility (“ABL Facility”, collectively with our senior secured term loan facility, the “Senior Credit Facilities”).
As of December 31, 2019, we had outstanding approximately $845.7 million in aggregate principal amount of indebtedness under the Senior Credit Facilities, net of deferred financing costs, capitalized call premiums and original issue discounts. Such indebtedness bears interest at a floating rate.
We also have, and will continue to have, significant lease obligations. As of December 31, 2019, our minimum aggregate rental obligation under operating leases for fiscal 2020 through 2024 totaled $782.0 million. See Note 26 to the consolidated financial statements in Item 8 for further discussion.
Our substantial level of indebtedness increases the possibility that we may be unable to generate cash sufficient to pay, when due, the principal of, interest on or other amounts due in respect of our indebtedness. For example, it could:
• make it more difficult for us to satisfy our obligations with respect to our indebtedness and any failure to comply with the obligations under any of our debt instruments, including restrictive covenants, could result in an event of default under the agreements governing such other indebtedness;
• require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing funds available for working capital, capital expenditures, acquisitions, selling and marketing efforts, product development and other purposes;
• increase our vulnerability to adverse economic and industry conditions, which could place us at a competitive disadvantage compared to our competitors that have relatively less indebtedness;
• limit our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate;
• expose us to the risk of increasing rates as certain of our borrowings, including under the Senior Credit Facilities, will be at variable interest rates;
• restrict us from making strategic acquisitions or cause us to make non-strategic
divestitures; and
• limit our ability to borrow additional funds, or to dispose of assets to raise funds, if needed, for working capital, capital expenditures, acquisitions, product development and other corporate purposes.
The occurrence of any one of these events could have an adverse effect on our business, financial condition, results of operations, prospects and ability to satisfy our obligations under our indebtedness.
Restrictions under our existing and future indebtedness may prevent us from taking actions that we believe would be in the best interest of our business.
The agreements governing our existing indebtedness contain and the agreements governing our future indebtedness will likely contain customary restrictions on us or our subsidiaries, including covenants that, among other things and subject to certain exceptions, restrict us or our subsidiaries, as the case may be, from:
• incurring additional indebtedness or issuing disqualified stock;
• paying dividends or distributions on, redeeming, repurchasing or retiring our capital stock;
• making payments on, or redeeming, repurchasing or retiring indebtedness;
• making investments, loans, advances or acquisitions;
• entering into sale and leaseback transactions;
• engaging in transactions with affiliates;
• creating liens;
• transferring or selling assets;
• guaranteeing indebtedness;
• creating restrictions on the payment of dividends or other amounts to us from our subsidiaries; and
• consolidating, merging or transferring all or substantially all of our assets and the assets of our subsidiaries.
In addition, the ABL Facility requires us to comply, under specific circumstances, including certain types of acquisitions, with a minimum fixed charge coverage ratio covenant of 1.00 to 1.00. Our ability to comply with this covenant can be affected by events beyond our control and we may not be able to satisfy them. A breach of this covenant would be an event of default. If an event of a default occurs under the ABL Facility, the ABL Facility lenders could elect to declare all amounts outstanding under the ABL Facility to be immediately due and payable or terminate their commitments to lend additional money, which would also lead to an event of default under the senior secured term loan facility (“the Term Loan Credit Agreement”) and would lead to an event of default under our senior notes if any of the Senior Credit Facilities were accelerated. If the indebtedness under the Senior Credit Facilities or our other indebtedness were to be accelerated, our assets may not be sufficient to repay such indebtedness in full. We have pledged a significant portion of our assets as collateral under the Senior Credit Facilities.
We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.
Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness.
If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure or refinance our indebtedness. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. The terms of existing or future debt instruments may restrict us from adopting some of these alternatives. In addition, any failure to make payments of interest and principal on our outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. The Senior Credit Facilities and the indentures governing the senior notes restrict our ability to dispose of assets and use the proceeds from the disposition. We may not be able to consummate those dispositions or obtain the proceeds that we could realize from them and the proceeds may not be adequate to meet any debt service obligations then due. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations.
Our ability to repay our debt is affected by the cash flow generated by our subsidiaries.
Our subsidiaries own substantially all of our assets and conduct substantially all of our operations. Accordingly, repayment of our indebtedness will be dependent on the generation of cash flow by our subsidiaries and their ability to make such cash available to us, by dividend, debt repayment or otherwise. Our subsidiaries may not be able to, or may not be permitted to, make distributions to enable us to make payments in respect of our indebtedness. Each subsidiary is a distinct legal entity and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from our subsidiaries. While the indentures governing the senior notes limit the ability of our subsidiaries to incur consensual restrictions on their ability to pay dividends or make other intercompany payments to us, these limitations are subject to certain qualifications and exceptions.
In addition, under certain circumstances, legal restrictions may limit our ability to obtain cash from our subsidiaries. Under the Delaware General Corporation Law (the “DGCL”), our subsidiaries organized in the State of Delaware may only make dividends (i) out of their “surplus” as defined in the DGCL or (ii) if there is no such surplus, out of their net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Under fraudulent transfer laws, certain of our subsidiaries may not pay dividends if the relevant entity is insolvent or is rendered insolvent thereby. The measures of insolvency for purposes of these fraudulent transfer laws vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, an entity would be considered insolvent if:
• the sum of its debts, including contingent liabilities, was greater than the fair saleable value of all of its assets;
• the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or
• it could not pay its debts as they became due.
While we believe that we and our relevant subsidiaries currently have surplus and are not insolvent, there can otherwise be no assurance that we and these subsidiaries will not become insolvent or will be permitted to make dividends in the future in compliance with these restrictions in amounts needed to service our indebtedness.
Significant interest rate changes could affect our profitability and financial performance.
Our earnings are affected by changes in interest rates as a result of our variable rate indebtedness under the ABL Facility and the Term Loan Credit Agreement. The interest rate swap agreements that we use to manage the risk associated with fluctuations in interest rates (if any) may not be able to fully eliminate our exposure to these changes.
The transition away from LIBOR may adversely affect our cost to obtain financing.
On July 27, 2017, the U.K. Financial Conduct Authority announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. As a result, LIBOR may be discontinued. While there is no consensus on what rate or rates may become accepted alternatives to LIBOR, the Alternative Reference Rates Committee, a steering committee comprised of U.S. financial market participants, selected and the Federal Reserve Bank of New York started in May 2018 to publish the Secured Overnight Finance Rate (“SOFR”) as an alternative to LIBOR. SOFR is a broad measure of the cost of borrowing cash in the overnight U.S. treasury repo market. At this time, it is not possible to predict whether the SOFR or another reference rate will become an accepted alternative to LIBOR. The manner and impact of this transition may materially adversely affect the trading market for LIBOR-based loans, including our Term Loan Credit Agreement, as well as the applicable interest rate on and the amount of interest paid on our current or future debt obligations, including our Senior Credit Facilities.
Maintaining and improving our financial controls and the requirements of being a public company may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members.
As a public company, we are subject to the reporting and other requirements of the Exchange Act, the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the New York Stock Exchange (the “NYSE”) rules. The requirements of these rules and regulations have increased and will continue to significantly increase our legal and financial compliance costs, including costs associated with the hiring of additional personnel, making some activities more difficult, time-consuming or costly, and may also place undue strain on our personnel, systems and resources. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and financial condition.
The Sarbanes-Oxley Act requires, among other things, that we maintain disclosure controls and procedures and internal control over financial reporting. Ensuring that we have adequate internal financial and accounting controls and procedures in place is a costly and time-consuming effort that needs to be re-evaluated
frequently. We test our internal controls in order to comply with the requirements of Section 404 of the Sarbanes-Oxley Act (“Section 404”). Section 404 requires that we evaluate our internal control over financial reporting to enable management to report on, and our independent auditors to audit, the effectiveness of those controls. Both we and our independent registered public accounting firm test our internal controls in connection with the Section 404 requirements and could, as part of that testing, identify material weaknesses, significant deficiencies or other areas for further attention or improvement.
Implementing any appropriate changes to our internal controls may require specific compliance training for our directors, officers and employees, require the hiring of additional finance, accounting and other personnel, entail substantial costs to modify our existing accounting systems, and take a significant period of time to complete. These changes may not, however, be effective in maintaining the adequacy of our internal controls,
and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. Moreover, adequate internal controls are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to satisfy the requirements of Section 404 on a timely basis could result in the loss of investor confidence in the reliability of our financial statements, which in turn could cause the market value of our common stock to decline.
Various rules and regulations applicable to public companies make it more difficult and more expensive for us to maintain directors’ and officers’ liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to maintain coverage. If we are unable to maintain adequate directors’ and officers’ liability insurance, our ability to recruit and retain qualified officers and directors, especially those directors who may be deemed independent for purposes of the NYSE rules, will be significantly curtailed.
The market price of our common stock could decline due to the large number of outstanding shares of our common stock eligible for future sale.
Sales of substantial amounts of our common stock in the public market in future offerings, or the perception that these sales could occur, could cause the market price of our common stock to decline. These sales could also make it more difficult for us to sell equity or equity-related securities in the future, at a time and price that we deem appropriate. In addition, the additional sale of our common stock by our officers, directors or significant shareholders in the public market, or the perception that these sales may occur, could cause the market price of our common stock to decline.
We may issue shares of our common stock or other securities from time to time as consideration for, or to finance, future acquisitions and investments or for other capital needs. We cannot predict the size of future issuances of our shares or the effect, if any, that future sales and issuances of shares would have on the market price of our common stock. If any such acquisition or investment is significant, the number of shares of common stock or the number or aggregate principal amount, as the case may be, of other securities that we may issue may in turn be substantial and may result in additional dilution to our stockholders. We may also grant registration rights covering shares of our common stock or other securities that we may issue in connection with any such acquisitions and investments.
To the extent that any of us, our executive officers or our directors sell, or indicate an intent to sell, substantial amounts of our common stock in the public market, the trading price of our common stock could decline significantly.
Anti-takeover provisions in our charter documents and Delaware law might discourage, delay or prevent a change in control of our company.
Our amended and restated certificate of incorporation or bylaws contain provisions that may make the acquisition of our company more difficult without the approval of our board of directors. These provisions include:
• advance notice requirements for stockholder proposals and director nominations;
• the sole ability of the board of directors to fill a vacancy created by the expansion of the board of directors;
• the required approval of holders of at least 75% of our outstanding shares of capital stock entitled to vote generally at an election of the directors to remove directors only for cause;
• the required approval of holders of at least 662
/3
% of our outstanding shares of capital stock entitled to vote at an election of directors to adopt, amend or repeal our bylaws, or amend or repeal certain provisions of our amended and restated certificate of incorporation;
• limitations on the ability of stockholders to call special meetings and take action by written consent; and
• provisions that reproduce much of the provisions that limit the ability of “interested stockholders” from engaging in specified business combinations with us absent prior approval of the board of directors or holders of 662
/3
% of our voting stock.
The existence of the foregoing provisions and anti-takeover measures could limit the price that investors might be willing to pay in the future for shares of our common stock. They could also deter potential acquirers of our company, thereby reducing the likelihood that you could receive a premium for your common stock in the acquisition.
Our amended and restated certificate of incorporation designates courts in the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.
Our amended and restated certificate of incorporation provides that, subject to limited exceptions, the Court of Chancery of the State of Delaware will be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers or other employees to us or our stockholders, (iii) any action asserting a claim against us arising pursuant to any provision of the DGCL, our amended and restated certificate of incorporation or our amended and restated bylaws or (iv) any other action asserting a claim against us that is governed by the internal affairs doctrine (each, a “Covered Proceeding”). In addition, our amended and restated certificate of incorporation provides that if any action the subject matter of which is a Covered Proceeding is filed in a court other than the specified Delaware courts without the approval of our board of directors (each, a “Foreign Action”), the claiming party will be deemed to have consented to (i) the personal jurisdiction of the specified Delaware courts in connection with any action brought in any such courts to enforce the exclusive forum provision described above and (ii) having service of process made upon such claiming party in any such enforcement action by service upon such claiming party’s counsel in the Foreign Action as agent for such claiming party. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock shall be deemed to have notice of and to have consented to these provisions. These provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and employees. Alternatively, if a court were to find these provisions of our amended and restated certificate of incorporation inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business and financial condition.
Because we have no current plans to pay cash dividends on our common stock for the foreseeable future, you may not receive any return on investment unless you sell your common stock for a price greater than you paid.
We plan to retain future earnings, if any, for future operation, expansion and debt repayment and have no current plans to pay any cash dividends for the foreseeable future. Any decision to declare and pay dividends in the future will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, financial condition, cash requirements, contractual restrictions and other factors that our board of directors may deem relevant. In addition, our ability to pay dividends may be limited by covenants of any existing and future outstanding indebtedness we or our subsidiaries incur. As a result, you may not receive any return on an investment in our common stock unless you sell our common stock for a price greater than you paid.
Item 1B.
Item 1B.
Unresolved Staff Comments
Not applicable.
Item 2.
Item 2.
Properties
The Company maintains the following facilities for its corporate and retail headquarters and to conduct its principal design, manufacturing and distribution operations:
Location
Principal Activity
Square Feet
Owned or Leased
(With Expiration Date)
Elmsford, New York
Executive and other corporate offices, showrooms, design and art production for party products
146,346 square feet
Leased(1)
Rockaway, New Jersey
Retail corporate offices
106,000 square feet
Leased (expiration date:
July 31, 2022)
Antananarivo, Madagascar
Manufacture of costumes
41,000 square feet
Leased (expiration date:
December 31, 2023)
Dallas, Texas
Manufacture/personalization of cups and napkins
54,413 square feet
Leased (expiration date:
October 31, 2022)
East Providence, Rhode Island
Manufacture and distribution of plastic plates, cups and bowls
229,230 square feet(2)
Leased (expiration date:
February 28, 2033)
Eden Prairie, Minnesota
Manufacture of metallic balloons and accessories
115,600 square feet
Leased (expiration date:
June 30, 2039)
Los Lunas, New Mexico
Manufacture of injection molded plastics
85,055 square feet
Leased (expiration date:
6/30/2039)
Louisville, Kentucky
Manufacture and distribution of paper plates
213,958 square feet
Leased (expiration date:
March 31, 2025)
Melaka, Malaysia
Manufacture and distribution of latex balloons
100,000 square feet
Leased (expiration date:
January 31, 2020)
Monterrey, Mexico
Manufacture and distribution of party products
355,500 square feet
Leased (expiration date:
March 3, 2027)
Newburgh, New York
Manufacture of paper napkins and cups
248,000 square feet
Leased (expiration date:
July 31, 2027)
Tijuana, Mexico
Manufacture and distribution of party products
135,000 square feet
Leased(3)
Chester, New York
Distribution of party products
896,000 square feet
Leased (expiration date:
June 30, 2039)
Edina, Minnesota
Distribution of metallic balloons and accessories
122,312 square feet
Leased (expiration date:
March 31, 2021)
Kirchheim unter Teck, Germany
Distribution of party goods
215,000 square feet
Owned
Milton Keynes, Buckinghamshire, England
Distribution of party products throughout Europe
130,858 square feet
Leased (expiration date:
December 31, 2022)
Naperville, Illinois
Distribution of party goods for e-commerce
sales
440,343 square feet
Leased (expiration date:
December 31, 2033)
(1) Property is comprised of two buildings with various lease expiration dates through December 31, 2027.
(2) This figure represents an industrial park, which includes a 48,455 square foot office and warehouse.
(3) Property is comprised of two buildings with various lease expiration dates through March 31, 2022.
In addition to the facilities listed above, we maintain a smaller distribution facility in the United Kingdom, smaller manufacturing facilities in Minnesota, small administrative offices in California, Australia, and the United Kingdom, and sourcing offices in China, Hong Kong, India, Indonesia and Vietnam. We also maintain warehouses in Colorado, Florida, Georgia, Michigan, Minnesota, New Jersey and New York and showrooms in Georgia, Nevada, and the United Kingdom.
As of December 31, 2019, Company-owned and franchised permanent stores were located in the following states and Puerto Rico:
Additionally, at December 31, 2019, there were eight franchise stores in Mexico.
In 2019, we operated 249 temporary stores in the U.S., principally under the Halloween City banner, and approximately 25 temporary stores in the U.K. and Ireland. We operate such stores under short-term leases with terms of approximately four to six months.
We lease the property for all of our company-operated stores, which generally range in size from 10,000 square feet to 15,000 square feet. We do not believe that any individual store property is material to our financial condition or results of operations. Of the leases for the company-owned stores at December 31, 2019, 38 expire in 2020, 79 expire in 2021, 91 expire in 2022, 135 expire in 2023, 101 expire in 2024 and the balance expire in 2025 or thereafter. We have options to extend many of these leases for a minimum of five years.
We believe that our properties have been adequately maintained, are in generally good condition and are suitable for our business as presently conducted. We believe our existing manufacturing facilities provide sufficient production capacity for our present needs and for our anticipated needs in the foreseeable future. To the extent such capacity is not needed for the manufacture of our products, we generally use such capacity for the manufacture of products for others pursuant to terminable agreements. All manufacturing and distribution facilities generally are used on a basis of two shifts per day. We also believe that, upon the expiration of our current leases, we will be able either to secure renewal terms or to enter into leases for alternative locations at market terms.
Item 3.
Item 3.
Legal Proceedings
From time to time, we are subject to various legal proceedings and claims that arise in the ordinary course of our business activities. The Company does not believe that any pending proceedings of which it is aware will result, individually or in the aggregate, in a material adverse effect upon its financial condition or future results of operations.
Item 4.
Item 4.
Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s common stock is listed on the NYSE under the symbol “PRTY”.
As of the close of business on February 28, 2020, there were 34 holders of record of the Company’s common stock, which does not reflect those shares held beneficially or those shares held in “street” name. Accordingly, the number of beneficial owners of our common stock exceeds this number.
Dividend Policy
Most of the Company’s indebtedness contains restrictions on the Company’s activities, including paying dividends on its capital stock and restricting dividends or other payments to the Company. See Note 12, Long-Term Obligations, of Item 8, “Financial Statements and Supplementary Data,” in this Annual Report on Form 10-K
for further discussion. The Company currently intends to retain all of its future earnings, if any, to finance operations, development and growth of its business and repay indebtedness. Any future determination relating to our dividend policy will be made at the discretion of the Company’s board of directors and will depend on a number of factors, including future earnings, capital requirements, financial conditions, future prospects, contractual restrictions and covenants and other factors that the board of directors may deem relevant.
Securities Authorized for Issuance Under Equity Compensation Plans
(1) Column (a) includes 6,318,717 outstanding stock options and 1,053,250 restricted stock units. The restricted stock units amount assumes that the maximum number of shares ultimately vest for awards that are performance-based. Additionally, the stock options amount assumes that all performance-based stock options vest. The weighted-average exercise price in column (b) takes into account the restricted stock units, which have no exercise price. The weighted average exercise price solely with respect to stock options outstanding under the approved plans is $8.95.
Stock Performance Graph
The line graph below compares the cumulative total stockholder return on the Company’s common stock with the S&P 500 Index and the Dow Jones U.S. Specialty Retailers Index for the period from the completion of our initial public offering on April 16, 2015 through December 31, 2019. The graph assumes an investment of $100 made at the closing of trading on April 16, 2015 in (i) the Company’s common stock, (ii) the stocks comprising the S&P 500 Index and (iii) the stocks comprising the Dow Jones U.S. Specialty Retailers Index. All values assume reinvestment of the full amount of all dividends, if any, into additional shares of the same class of equity securities at the frequency with which dividends were paid on such securities during the applicable time period. The stock price performance included in the line graph below is not necessarily indicative of future stock price performance. The stock performance graph shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing by us under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate the graph by reference in such filing.
Item 6.
Item 6.
Selected Consolidated Financial Data
The following table sets forth selected historical consolidated financial data for the periods and as of the dates indicated below. Our selected historical consolidated financial data as of December 31, 2018 and December 31, 2019 and for the years ended December 31, 2017, December 31, 2018 and December 31, 2019 presented in this table has been derived from our historical audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Our selected historical consolidated financial data for the years ended December 31, 2015 and December 31, 2016 were derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K.
The historical results presented below are not necessarily indicative of the results to be expected for any future period. The following information should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our financial statements and the notes thereto contained in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.
(1) The acquisitions of Travis Designs Limited (“Travis”) and Accurate Custom Injection Molding Inc. (“ACIM”) are included in the financial statements from their acquisition dates (first quarter 2015 and third quarter 2015, respectively).
(2) The acquisitions of nineteen franchise stores and Festival S.A. are included in the financial statements from their acquisition dates during the first quarter of 2016.
(3) The acquisitions of thirty-six
franchise stores and Granmark S.A. de C.V. (“Granmark”) are included in the financial statements from their acquisition dates during the first quarter of 2017. The acquisition of Print Appeal, Inc. (“Print Appeal”) is included in the financial statements from its acquisition date during the third quarter of 2017.
(4) The acquisitions of eleven franchise stores are included in the financial statements from their acquisition dates during the first quarter of 2018. Additionally, the acquisitions of thirty-seven franchise stores are included in the financial statements from their acquisition dates during the third quarter of 2018.
(5) During the year ended December 31, 2019, the financial statements reflect store impairment and restructuring charges associated with the closure of approximately 55 stores. Refer to (11)(p)(r) for further detail regarding 2019 results.
(6) In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 by reducing January 1, 2018 retained earnings by $0.1 million. See the Notes to Consolidated Financial Statements of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion.
(7) During the first quarter of 2017, the Company and Ampology, a subsidiary of Trivergence, reached an agreement to form a new legal entity (Kazzam, LLC) for the purpose of designing, developing and launching an online exchange platform for party-related services. The website allows consumers to select, schedule and pay for various services (including entertainment, activities and food) all through a single portal. During 2017, 2018 and 2019, Kazzam incurred $9.0 million, $7.0 million and $11.0 million of start-up
expenses, respectively, which are recorded in development stage expenses in the Company’s consolidated statement of operations and comprehensive (loss) income.
(8) During April 2015, in conjunction with the Company’s initial public offering, the Company paid a 2% prepayment penalty, or $7.0 million, in order to redeem $350.0 million of senior PIK toggle notes (the “Nextco Notes”) issued by the Company’s wholly-owned subsidiaries, PC Nextco and PC Nextco Finance, Inc., and paid a management agreement termination fee of $30.7 million to affiliates of THL and Advent. The Company recorded the prepayment penalty and termination fee in other expense, net. Additionally, in conjunction with the redemption of the Nextco Notes, the Company wrote off $8.6 million of capitalized debt issuance costs and original issuance discounts. The write-off
was also recorded in other expense, net.
During August 2015, PCHI redeemed all $700 million of its 8.875% senior notes (“Old Senior Notes”) and refinanced its existing $1,125 million senior secured term loan facility (“Old Term Loan Credit Agreement”) and $400 million asset-based revolving credit facility (“Old ABL Facility”) with new indebtedness consisting 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”) and (iii) $350 million of 6.125% senior notes (“6.125% Notes”). The redemption price for the Old Senior Notes was 6.656% of the principal amount, or $46.6 million. The Company recorded such amount in other expense, net. Additionally, in conjunction with the refinancing, the Company wrote-off
$22.7 million of previously capitalized deferred financing costs, original issuance discounts and call premiums and also recorded such amount in other expense, net. Further, in conjunction with the refinancing of the term loans, the Company incurred banker and legal fees, $9.8 million of which was recorded in other expense, net.
During August 2018, PCHI executed a refinancing of its debt portfolio and issued $500 million of new senior notes at an interest rate of 6.625%. The Company used the proceeds from the notes to: (i) reduce the outstanding balance under its existing ABL Facility by $90 million and (ii) voluntarily prepay $400 million 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 (subject to a springing maturity at an earlier date if the maturity date of certain of our other debt has not been extended or refinanced). As the partial prepayment of the Term Loan Credit Agreement was in accordance with the terms of such agreement, at the time of such prepayment the Company wrote-off
a pro-rata
portion of the existing capitalized deferred financing costs and original issuance discounts, $1.8 million, for investors who did not participate in the new notes. To the extent that investors in the Term Loan Credit Agreement participated in the new notes, the Company assessed whether the refinancing should be accounted for as an extinguishment on a creditor-by-creditor
basis and wrote-off
$1.0 million of existing deferred financing costs and original issuance discounts. Additionally, in conjunction with the issuance of the notes, the Company incurred third-party fees (principally banker fees). To the extent that such fees related to investors for whom their original debt was not extinguished, the Company expensed the portion of such fees, $2.3 million in aggregate, that related to such investors.
(9)
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. During 2017 the Company recorded a provisional estimate of the
impact of the Act, which included an income tax benefit of $91.0 million related to the remeasurement of its domestic deferred tax liabilities and deferred tax assets due to the lower U.S. corporate tax rate. Additionally, during 2017, the Company recorded an income tax expense of $1.1 million as its provisional estimate of the Transition Tax related to the deemed repatriation of unremitted earnings of foreign subsidiaries. During the fourth quarter of 2018, the Company finalized its assessment of the impact of the Act on the Company’s domestic deferred tax liabilities and deferred tax assets and recorded an additional income tax benefit of $2.0 million. Additionally, during such quarter, the Company finalized its assessment of the Transition Tax and recorded additional income tax expense of $0.2 million. See Note 17, Income Taxes, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion.
(10)
See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity,” for a discussion of cash flows.
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 2018.
(11)
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, refinancing charges, 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. The Company compensates for these limitations by relying primarily on its GAAP results and using the metrics only on a supplemental basis. The reconciliations from net income (loss) to adjusted EBITDA and adjusted net income for the periods presented follow (dollars in thousands, except per share amounts):
(a) In 2012, the Company entered into a management agreement with two of its investors under which the investors provided advice to the Company on, among other things, financing, operations, acquisitions and dispositions. Under the agreement, the investors were paid an annual management fee for such services. In connection with the Company’s initial public offering in April 2015, the management agreement was terminated and the Company paid the investors a termination fee. Such amount, $30.7 million, was recorded in other expense, net.
(b) 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 $3.9 million severance charge in general and administrative expenses during 2017. Such amount is included in “Other Restructuring, Retention and Severance” in the Adjusted EBITDA table above and in “Executive Severance” in the Adjusted Net Income table above. Additionally, during 2017, the Company recorded a $3.2 million severance charge related to a restructuring of its Retail segment. Such amount is included in “Other Restructuring, Retention and Severance” in the Adjusted EBITDA table above and in “Restructuring” in the Adjusted Net Income table above. Further, during 2018, the Company recorded $0.8 million of senior executive severance. Such amount is included in “Other Restructuring, Retention and Severance” in the Adjusted EBITDA table above and in “Executive Severance” in the Adjusted Net Income table above. Finally, the 2017 and 2018 “Other Restructuring, Retention and
Severance” amounts in the “Adjusted EBITDA” table above also include costs incurred while moving one of the Company’s domestic manufacturing facilities to a new location. For the year ended December 31, 2019, amounts expensed principally relate to executive severance and the write-off
of inventory for a section of the Company’s Party City stores that were restructured.
(c) During August 2018, the Company executed a refinancing of its debt portfolio and issued $500 million 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 million and (ii) voluntarily prepay $400 million 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 (subject to a springing maturity at an earlier date if the maturity date of certain of our other debt has not been extended or refinanced). As the partial prepayment of the Term Loan Credit Agreement was in accordance with the terms of such agreement, at the time of such prepayment the Company wrote-off
a pro-rata
portion of the existing capitalized deferred financing costs and original issuance discounts, $1.8 million, for investors who did not participate in the new notes. To the extent that investors in the Term Loan Credit Agreement participated in the new notes, the Company assessed whether the refinancing should be accounted for as an extinguishment on a creditor-by-creditor
basis and wrote-off
$1.0 million of existing deferred financing costs and original issuance discounts. Additionally, in conjunction with the issuance of the notes, the Company incurred third-party fees (principally banker fees). To the extent that such fees related to investors for whom their original debt was not extinguished, the Company expensed the portion of such fees, $2.3 million in aggregate, that related to such investors. Such 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.
Additionally, 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. Further, in conjunction with the February 2018 amendment, the Company expensed $0.8 million of investment banking and legal fees. Such 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.
During 2015, the Company redeemed all $700 million of its 8.875% senior notes and refinanced its $1,125 million senior secured term loan facility and $400 million asset-based revolving credit facility with new indebtedness. Additionally, during 2015, the Company used proceeds from the initial public offering to redeem outstanding notes. See the Company’s 2015 Form 10-K
for a discussion of the charges that were recorded in conjunction with such refinancings.
(d) 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.
(e) Principally represents third-party costs related to acquisitions (primarily legal expenses and diligence fees). Such costs are excluded from the definition of “Consolidated Adjusted EBITDA” that is utilized for certain covenants in the Company’s credit agreements. Additionally, 2017, 2018, and 2019 include start-up
costs for Kazzam (see Note 25, Kazzam LLC., of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion).
(f) Principally charges incurred related to closing underperforming stores.
(g) Represents non-cash
charges related to stock options.
(h) Principally represents shares of Kazzam awarded to Ampology as compensation for Ampology’s services. See Note 25, Kazzam LLC., of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion.
(i) Non-cash
charges for restricted stock units that vest based on service conditions.
(j) Primarily non-recurring
consulting charges related to the Company’s retail operations.
(k) Non-recurring
legal settlements/costs.
(l) Represents the non-cash
amortization of intangible assets.
(m) Includes the non-cash
amortization of deferred financing costs, original issuance discounts and capitalized call premiums. Additionally, certain years include charges related to debt refinancings. See note (c) for further discussion.
(n) 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.
(o) 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. Due to the complexities of accounting for the Act, the SEC issued Staff Accounting Bulletin No. 118 which allows entities to include a provisional estimate of the impact of the Act in its 2017 financial statements. Therefore, based on then currently available information, during 2017 the Company recorded a provisional estimate of the impact of the Act, which included an income tax benefit of $91.0 million related to the remeasurement of its domestic deferred tax liabilities and deferred tax assets due to the lower U.S. corporate tax rate. During the fourth quarter of 2018, the Company finalized its assessment of the impact of the Act on such domestic deferred tax liabilities and deferred tax assets and recorded an additional income tax benefit of $2.0 million. As the Act is a significant and non-recurring
event which is impacting the comparability of the Company’s financial statements, the Company has excluded the impact of the adjustments from its adjusted net income and adjusted earnings per share.
(p) During June 2019, the Company reported a $58.4 million gain from the sale and leaseback of its main distribution center in Chester, New York and its metallic balloons manufacturing facility in Eden Prairie, Minnesota. The aggregate sale price for the three properties was $128.0 million. Simultaneous with the sale, the Company entered into twenty-year leases for each of the facilities.
(q) During the year ended December 31, 2019, the Company performed a comprehensive review of its store locations aimed at improving the overall productivity of such locations (“store optimization program”) and made the decision to accelerate the optimization of its store portfolio with the closure of approximately 55 stores which are primarily located in close proximity to other Party City stores. In conjunction with the store optimization program, the Company recorded the following charges: inventory reserves: $21.3 million, operating lease asset impairment: $14.9 million, property plant and equipment impairment: $4.7 million, labor and other costs related to closing the stores: $8.7 million and severance: $0.7 million. The charge for inventory reserves was recorded in cost of sales in the Company’s statement of operations and comprehensive (loss) income. The other charges were recorded in store impairment and restructuring charges in the Company’s statement of operations and comprehensive (loss) income. See Note 3, Store Impairment and Restructuring Charges, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion. Additionally, during the process of liquidating the inventory in such stores, the Company lost margin of $8.5 million.
(r) As a result of a sustained decline in market capitalization, the Company recognized a non-cash
pre-tax
goodwill impairment charge during the year ended December 31, 2019 of $562.6 million. This includes a non-cash pre-tax trade name intangibles impairment charge of $6.6 million (see Note 4, Goodwill, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion).
(s) The Company recorded a $2.9 million gain on sale of its Canadian-based Party City stores, which is reported in Other expense, net on the Consolidated Statement of Operations and Comprehensive (Loss) Income.
(t) Represents a loss on sale of ownership interest in Punchbowl (see Note 21, Fair Value Measurements, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion) and certain property, plant and equipment, and a write-off
of goodwill related to the Company’s sale of its Canadian-based Party City stores.
(12) Party City brand comp sales include North American e-commerce
sales.
(13) Represents the percentage of product costs included in cost of goods sold by our Party City stores and North American retail e-commerce
operations which relate to products supplied by our wholesale operations.
(14) Amount for 2014 adjusted to reflect the Company’s retrospective adoption during the fourth quarter of 2015 of FASB ASU 2015-03,
“Simplifying the Presentation of Debt Issuance Costs”. Deferred financing costs in the amount of $44.4 million were reclassified from “other assets” to debt as of December 31, 2014.
(15) Excludes redeemable common securities.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Business Overview
Our Company
We are the leading party goods company by revenue in North America and, we believe, the largest vertically integrated supplier of decorated party goods globally by revenue. The Company is a popular one-stop
shopping destination for party supplies, balloons, and costumes. In addition to being a great retail brand, the Company is a global, world-class organization that combines state-of-the-art
manufacturing and sourcing operations, and sophisticated wholesale operations complemented by a multi-channel retailing strategy and e-commerce
retail operations. The Company is a leading player in its category and vertically integrated in its breadth and depth. 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 throughout the world. The Company’s retail operations include approximately 875 specialty retail party supply stores (including franchise stores) throughout the United States and Mexico operating under the names Party City and Halloween City, and e-commerce
websites, including through the domain name PartyCity.com and others.
In addition to our retail operations, we are also one of the largest global designers, manufacturers and distributors of decorated consumer party products, with items found in over 40,000 retail outlets worldwide, including independent party supply stores, mass merchants, grocery retailers, e-commerce
merchandisers and dollar stores. Our products are available in over 100 countries with the United Kingdom (“U.K.”), Canada, Germany, Mexico and Australia 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 Item 6, “Selected Consolidated Financial Data.”
Segments
Our retail segment generates revenue primarily through the sale of our party supplies, which are sold under the Amscan, Designware, Anagram and Costumes USA brand names through Party City, Halloween City and PartyCity.com. During 2019, 80% of the product that was sold by our retail segment was supplied by our wholesale segment and 24% of the product that was sold by our retail segment was self-manufactured.
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 and gift stores, dollar stores and e-commerce
merchandisers.
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, 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 segment. 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 (loss) income. 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.
Development stage expenses represent start-up
activities related to Kazzam, LLC (“Kazzam”). See Note 25, Kazzam LLC., of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on 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, 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.
Factors Affecting Our Results
Important events that have impacted or will impact the results presented in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” include:
Store Impairment and Restructuring Charges.
During the year ended December 31, 2019, the Company performed a comprehensive review of its store locations aimed at improving the overall productivity of such locations (“store optimization program”) and, after careful consideration and evaluation of the store locations, the Company made the decision to accelerate the optimization of its store portfolio with the closure of approximately 55 stores which are primarily located in close proximity to other Party City stores. These closings should provide the Company with capital flexibility to expand into underserved markets.
COVID-19
. Near-term global economic growth has been adversely impacted by the emergence of COVID-19
in China, and then in several other countries and regions including the United States, Japan and Europe. As a result of this public health concern, a significant amount of global commerce has been affected due to travel restrictions, quarantines, and similar measures. We are continuing to monitor and assess the effects of COVID-19
outbreak on our operations.
Goodwill Impairment.
During the three months ended September 30, 2019, and the three months ended December 31, 2019, the Company identified an impairment indicator associated with its market capitalization and performed impairment tests on the goodwill at its wholesale and retail reporting units and its other indefinite lived intangible assets as of September 30, 2019 and December 31, 2019. The Company recognized non-cash pre-tax goodwill impairment charges at September 30, 2019 of $224.1 million and $35.0 million and at December 31, 2019, of $271.5 million and $25.4 million, against the goodwill associated with its retail and wholesale reporting units, respectively. In conjunction with its annual review, the Company recognized non-cash pre-tax tradename intangibles impairment of $6.6 million.
Sale/Leaseback Transaction
. In June 2019, the Company sold its main distribution center in Chester, New York, its metallic balloons manufacturing facility in Eden Prairie, Minnesota and its injection molded plastics manufacturing facility in Los Lunas, New Mexico. Simultaneously, the Company entered into twenty-year leases for each of the facilities. The aggregate sale price was $128.0 million and, during the year ended December 31, 2019, the Company recorded a $58.4 million gain on the sale, net of transaction costs, in the Company’s condensed consolidated statement of operations and comprehensive loss.
Sale of Canadian-based Party City Stores
. On October 1, 2019, the Company sold its Canadian-based Party City stores to a Canadian-based retailer for $131.7 million and entered into a 10-year supply agreement under which the acquirer agreed to purchase product from the Company for such Party City stores, as well as the acquirer’s other stores. The Company used the net proceeds to paydown debt.
ABL Facility
. During April 2019, the Company amended the ABL Facility. Such amendment removed the seasonal component and made the Facility a $640.0 million Facility on a year-round basis.
Refinancing
. During August 2018, the Company executed a refinancing of its debt portfolio and issued $500 million 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 million and (ii) voluntarily prepay $400 million 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 (subject to a springing maturity at an earlier date if the maturity date of certain of our other debt has not been extended or refinanced). As the partial prepayment of the Term Loan Credit Agreement was in accordance with the terms of such agreement, at the time of such prepayment the Company wrote-off a pro-rata portion of the existing capitalized deferred financing costs and original issuance discounts, $1.8 million, for investors who did not participate in the new notes. To the extent that investors in the Term Loan Credit
Agreement participated in the new notes, the Company assessed whether the refinancing should be accounted for as an extinguishment on a creditor-by-creditor basis and wrote-off $1.0 million of existing deferred financing costs and original issuance discounts. Additionally, in conjunction with the issuance of the notes, the Company incurred third-party fees (principally banker fees). To the extent that such fees related to investors for whom their original debt was not extinguished, the Company expensed the portion of such fees, $2.3 million in aggregate, that related to such investors. All charges were recorded in “other expense, net” in the Company’s consolidated statement of operations and comprehensive (loss) income.
Acquisitions
. During 2018, we acquired 58 franchise and independent stores. The acquisitions increased net sales for our retail segment by approximately $67 million versus 2017. Additionally, these acquisitions decreased our third-party wholesale sales by $20 million as post-acquisition wholesale sales to such stores are now eliminated as intercompany sales.
Tax Reform
. 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”). During 2017 the Company recorded a provisional estimate of the impact of the Act, which included an income tax benefit of $91.0 million related to the remeasurement of its domestic deferred tax liabilities and deferred tax assets due to the lower U.S. corporate tax rate. Additionally, during 2017, the Company recorded income tax expense of $1.1 million as its provisional estimate of the Transition Tax related to the deemed repatriation of unremitted earnings of foreign subsidiaries. During the fourth quarter of 2018, the Company finalized its assessment of the impact of the Act on the Company’s domestic deferred tax liabilities and deferred tax assets and recorded an additional income tax benefit of $2.0 million. Additionally, during such quarter, the Company finalized its assessment of the Transition Tax and recorded additional income tax expense of $0.2 million.
Results of Operations
The following tables set forth our operating results and operating results as a percentage of total revenues for the years ended December 31, 2019 and 2018.
Revenues
Total revenues for 2019 were $2,348.8 million and were $78.7 million, or 3.2%, lower than 2018. The following table sets forth the Company’s total revenues for the years ended December 31, 2019 and 2018.
Retail
Retail net sales during 2019 were $1,742.1 million and decreased $60.7 million, or 3.4%, compared to 2018. Retail net sales at our Party City stores totaled $1,527.5 million and were $55.7 million, or 3.5%, lower than 2018 principally due to the negative impact of helium shortages, the sale of our 65 Canadian retail stores prior to the Halloween season, the impact of reduced sales from 55 stores identified for closure in conjunction with our 2019 store optimization program, and soft Halloween sales at both our Party City and temporary Halloween stores. Global retail e-commerce sales totaled $162.4 million during 2019 and were $8.0 million, or 5.2%, higher than during 2018. Sales at our temporary Halloween stores (principally Halloween City) totaled $47.4 million and were $15.1 million lower than 2018. During 2019, sales at other store formats totaled $4.7 million.
Same-store sales for the Party City brand (including North American retail e-commerce
sales) decreased by 3.0% during 2019. Excluding the impact of e-commerce,
same-store sales decreased by 3.5%. Same-store sales percentages were not affected by foreign currency as such percentages are calculated in local currency.
Wholesale
Wholesale net sales during 2019 totaled $597.4 million and were $16.2 million, or 2.6%, lower than 2018. Net sales to domestic party goods retailers and distributors (including our franchisee network) totaled $231.7 million and were $8.7 million, or 3.6%, lower than during 2018. The decrease reflects our acquisition of franchise and independent stores throughout 2019; as post-acquisition sales to such stores in 2019 (approximately $13.7 million during the corresponding periods of 2018) were eliminated as intercompany sales. Net sales of metallic balloons to domestic distributors and retailers (including our franchisee network) totaled $78.3 million during 2019 and were $9.2 million, or 10.6%, lower than during 2018 principally due to the ongoing helium shortage. Our international sales (which include U.S. export sales and exclude U.S. import sales from foreign subsidiaries) totaled $287.4 million and were $1.7 million, or 0.6%, higher than in 2018 as sales growth of $12.3 million in constant currency was offset by a negative foreign currency impact of $10.6 million.
Intercompany sales to our retail affiliates totaled $642.7 million during 2019 and were $69.2 million lower than during the prior year. The decrease in 2019 intercompany sales principally reflects a lower store count compared to 2018 and a general reduction in retail purchases, in consideration of higher carryover inventory levels from the previous Halloween selling season. Intercompany sales represented 51.8% of total wholesale sales during 2019, compared to 53.7% during 2018. 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 during 2019 totaled $9.3 million and were $1.8 million lower than during 2018, reflecting the decreasing franchise store count as a results of our franchise store acquisitions.
Gross Profit
The following table sets forth the Company’s gross profit for the years ended December 31, 2019 and December 31, 2018.
The gross profit margin on net sales at retail during 2019 was 40.0% or 440 basis points lower than during 2018. The decrease reflects a combination of markdowns in conjunction with the Company’s “store optimization program” and provisions against inventory recorded in conjunction with such program (see “operating expenses” below for further discussion), the impact of an aggressive coupon program during the second half of 2019, the impact of the helium shortage on costs and sales mix, and a flow through of higher freight and distribution costs during the first three quarters of 2019, related to product acquired from the Company’s wholesale operations during the second half of 2018, as the China tariffs caused non-recurring
logistical challenges. The manufacturing share of shelf at retail (i.e., the percentage of our retail product cost of sales manufactured by our wholesale segment) increased from 22.9% during 2018 to 23.5% during 2019, driven by 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 79.6% during 2019 compared to 78.9% during 2018.
The gross profit on net sales at wholesale during 2019 and 2018 was 23.8% and 29.3%, respectively. The decrease in comparison to 2018 principally reflects a decrease in high-margin sales of metallic balloons and higher margin sales to franchisees (due to the store acquisitions noted above) as well as, the deleveraging of distribution and manufacturing costs and the impact of foreign currency.
Operating expenses
Wholesale selling expenses totaled $67.1 million during 2019 compared to $71.5 million during 2018. The decrease of $4.4 million, or 6.2%, was due partially to the impact of foreign currency translation.
Retail operating expenses during 2019 were $440.4 million and were $14.4 million, or 3.4%, higher than in 2018. The increase was principally due to higher advertising, ecommerce and information technology related expenses compared to 2018. Retail operating expenses were 25.3% and 23.6% of net retail sales during 2019 and 2018, respectively.
Franchise expenses during both 2019 and 2018 were $13.2 million.
General and administrative expenses during 2019 totaled $177.7 million and were $4.9 million, or 2.8%, higher than in 2018. The increase for 2019 was principally due to increase legal and settlement costs. General and administrative expenses as a percentage of total revenues were 7.6% and 7.1% during 2019 and 2018, respectively.
Art and development costs were consistent at $23.2 million and $23.4 million during 2019 and 2018, respectively.
Development stage expenses represent start-up
costs related to Kazzam (see Note 25, Kazzam LLC., of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion).
Interest expense, net
Interest expense, net, totaled $114.9 million during 2019, compared to $105.7 million during 2018. The increase in interest principally reflects the full year impact of the Company’s August 2018 refinancing as well as the impact of average borrowings and average rates under our ABL credit facility and Term Loan (see Note 11, Loans and Notes Payable, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion).
Other expense, net
Other expense, net, totaled $1.9 million during 2019 and $11.0 million during 2018. The net decrease was principally due to non-recurring
costs in 2018 associated with the Company’s August 2018 debt refinancing, including the write-off
of $2.8 million of existing capitalized deferred finance costs and original issue discounts and the incurrence of $2.3 million in related third party fees.
Income tax expense
The effective income tax rate for the year ended December 31, 2019, 0.2%, is different from the statutory rate, 21%, primarily due to the goodwill impairment charge of $556.1 million, and the tax effects of the sale of the Canada Party City stores. See Note 17, Income Tax, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion.
Gain on sale/leaseback transaction
In June 2019, the Company reported a $58.4 million gain from the sale and leaseback of its main distribution center in Chester, New York and its metallic balloons manufacturing facility in Eden Prairie, Minnesota. The aggregate sale price for the three properties was $128.0 million. Simultaneous with the sale, the Company entered into twenty-year leases for each of the facilities.
Store impairment and restructuring charges
During 2019, the Company performed a comprehensive review of its store locations aimed at improving the overall productivity of such locations (“store optimization program”). Each year, the Company typically closes approximately 10 Party City stores as part of its typical network rationalization process and in response to ongoing consumer, market and economic changes that naturally arise in the business. After careful consideration and evaluation of the store locations, the Company made the decision to accelerate the optimization of its store portfolio with the closure of approximately 55 stores which are primarily located in close proximity to other Party City stores. These closings should provide the Company with capital flexibility to expand into underserved markets. In conjunction with the store optimization program, during the 2019, the Company recorded a $14.9 million impairment charge for its operating lease asset, a $4.7 million impairment charge for property, plant and equipment, $8.7 million of labor and other costs related to closing the stores and $0.7 million of severance. See Note 3, Store Impairment and Restructuring Charges, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K
for further discussion.
Impairment of intangible assets
Goodwill and intangibles impairment charges for 2019 totaled $562.6 million. The non-cash pre-tax goodwill impairment charges were the result of a sustained decline in the Company’s market capitalization. This includes Halloween City tradename impairment charge of $6.6 million, which was a result of Company’s decision to lower the number of temporary stores opened each year. There was no goodwill or tradename impairment for 2018. See Note 4, Goodwill, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion.
The following tables set forth our operating results and operating results as a percentage of total revenues for the years ended December 31, 2018 and 2017.
Revenues
Total revenues for the year ended December 31, 2018 were $2,427.5 million and were $55.9 million or 2.4% higher than 2017. The following table sets forth our total revenues for the years ended December 31, 2018 and 2017.
Retail
Retail net sales during 2018 were $1,802.8 million and increased $74.2 million, or 4.3%, compared to 2017. Retail net sales at our Party City stores totaled $1,583.1 million and were $61.4 million, or 4.0%, higher than 2017 due largely to the acquisition of franchise and independent stores. During the year ended December 31, 2018, we acquired 58 franchise and independent stores, opened 15 new stores and closed 10 stores. Global retail e-commerce
sales totaled $154.5 million during 2018 and were $2.0 million, or 1.3%, higher than during the corresponding period of 2017. The North American e-commerce
sales that are included in our Party City brand comp increased by 0.6% during the year. However, they increased by 17.5% when adjusted for the impact of our “buy online, pick-up
in store” program (as such sales are included in our store sales). Sales at our temporary stores (principally Halloween City) totaled $65.2 million and were $10.8 million higher than during 2017 driven by Halloween City sales per store increasing 14.1% versus the month of fiscal October 2017.
Same-store sales for the Party City brand (including North American retail e-commerce
sales) decreased by 0.7% during 2018. Excluding the impact of e-commerce,
same-store sales decreased by 0.8%. Same-store sales percentages were not affected by foreign currency as such percentages are calculated in local currency.
Wholesale
Wholesale net sales during 2018 totaled $613.6 million and were $15.8 million, or 2.5%, lower than 2017. Net sales to domestic party goods retailers and distributors (including our franchisee network) totaled $240.5 million and were $24.5 million, or 9.2%, lower than during 2017. The decrease was principally due to our acquisition of 58 franchise and independent stores during the year ended December 31, 2018; as post-acquisition sales to such stores (approximately $20 million during the corresponding period of 2017) are now eliminated as intercompany sales. Net sales of metallic balloons to domestic distributors and retailers (including our franchisee network) totaled $87.5 million during 2018 and were $1.4 million, or 1.6%, higher than during 2017. Our international sales (which include U.S. export sales and exclude U.S. import sales from foreign subsidiaries) totaled $285.6 million and were $7.3 million, or 2.6%, higher than in 2017. The increase was driven by continued strong performance across European markets and the acquisition of Granmark S.A. de C.V. (“Granmark”) in March 2017 and the impact of foreign currency translation (approximately $2 million).
Intercompany sales to our retail affiliates totaled $711.9 million during 2018 and were $81.2 million higher than during the prior year principally due to the higher corporate store count in 2018 and intercompany sales
during 2017 being impacted by carryover inventory from the 2016 Halloween selling season. Intercompany sales represented 53.7% of total wholesale sales during 2018, compared to 50.0% during 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 during 2018 totaled $11.1 million and were $2.5 million lower than during 2017 due to the acquisition of franchise stores.
Gross Profit
The following table sets forth the Company’s gross profit for the years ended December 31, 2018 and December 31, 2017.
The gross profit margin on net sales at retail during 2018 was 44.4%. Such percentage was 20 basis points higher than during the corresponding period of 2017. The increase was principally due to the continued 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 22.6% during 2017 to 22.9% during 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 78.9% during 2018 and was slightly lower than during 2017.
The gross profit on net sales at wholesale during 2018 and 2017 was 29.3% and 31.7%, respectively. The decrease was principally due to higher logistics and distribution costs and rising commodity costs.
Operating expenses
Wholesale selling expenses were $71.5 million during 2018 and $65.4 million during the corresponding period of 2017. The increase of $6.1 million, or 9.4%, was primarily due to selling costs at Granmark (acquired in March 2017), the impact of foreign currency translation (approximately $1 million) and the impact of wage inflation.
Retail operating expenses during 2018 were $426.0 million and were $10.8 million, or 2.6%, higher than the corresponding period of 2017. The higher store count (discussed above), increased advertising spend and the impact of wage inflation were partially offset by lower labor costs realized as a result of increased productivity and efficiency in our stores. Retail operating expenses were 23.6% and 24.0% of net retail sales during 2018 and 2017, respectively. The decrease was mostly due to the improved labor productivity.
Franchise expenses during 2018 and 2017 were $13.2 million and $15.0 million, respectively. The decrease was principally due to a non-recurring
reduction to franchise intangible asset amortization expense as a result of recent franchise store acquisitions.
General and administrative expenses during 2018 totaled $172.8 million and were $4.4 million, or 2.6%, higher than in 2017. Increased one-time
third-party consultant costs and the impact of inflation were partially offset by lower incentive compensation costs and 2017 including severance charges related to a Transition and Consulting Agreement entered into with Gerald Rittenberg. General and administrative expenses as a percentage of total revenues was 7.1% during both 2018 and 2017.
Art and development costs were $23.4 million during 2018 and were principally consistent with 2017.
Development stage expenses represent start-up
costs related to Kazzam (see Note 25, Kazzam, LLC, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion).
Interest expense, net
Interest expense, net, totaled $105.7 million during 2018, compared to $87.4 million during 2017. The increase principally relates to the impact of increasing LIBOR rates on our Term Loan Credit Agreement and our ABL Facility, increased borrowings under our ABL Facility due to share repurchases during the fourth quarter of 2017 and, to a lesser extent, the impact of the Company’s August 2018 refinancing (see Note 12, Long-Term Obligations, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion).
Other expense, net
Other expense, net, totaled $11.0 million during 2018 and $4.6 million during 2017. The increase was principally due to non-recurring
costs associated with the Company’s August 2018 debt refinancing:
During August 2018, the Company executed a refinancing of its debt portfolio and issued $500 million 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 million and (ii) voluntarily prepay $400 million of the outstanding balance under its existing Term Loan Credit Agreement. Additionally, as part of the refinancing, the Company extended the maturity of the ABL Facility to August 2023. As the partial prepayment of the Term Loan Credit Agreement was in accordance with the terms of such agreement, at the time of such prepayment the Company wrote-off
a pro-rata
portion of the existing capitalized deferred financing costs and original issuance discounts, $1.8 million, for investors who did not participate in the new notes. To the extent that investors in the Term Loan Credit Agreement participated in the new notes, the Company assessed whether the refinancing should be accounted for as an extinguishment on a creditor-by-creditor
basis and wrote-off
$1.0 million of existing deferred financing costs and original issuance discounts. Additionally, in conjunction with the issuance of the notes, the Company incurred third-party fees (principally banker fees). To the extent that such fees related to investors for whom their original debt was not extinguished, the Company expensed the portion of such fees, $2.3 million in aggregate, that related to such investors.
Income tax expense
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 No. 118 which allows entities to include a provisional estimate of the impact of the Act in its 2017 financial statements. Therefore, based on then currently available information, during 2017 the Company recorded a provisional estimate of the impact of the Act, which included an income tax benefit of $91.0 million related to the remeasurement of its domestic deferred tax liabilities and deferred tax assets due to the lower U.S. corporate tax rate. Additionally, during 2017, the Company recorded income tax expense of $1.1 million as its provisional estimate of the Transition Tax related to the deemed
repatriation of unremitted earnings of foreign subsidiaries. During the fourth quarter of 2018, the Company finalized its assessment of the impact of the Act on the Company’s domestic deferred tax liabilities and deferred tax assets and recorded an additional income tax benefit of $2.0 million. Additionally, during such quarter, the Company finalized its assessment of the Transition Tax and recorded additional income tax expense of $0.2 million.
The effective income tax rate for the year ended December 31, 2018, 24.0%, is higher than the statutory rate, 21.0%, primarily due to state taxes. See Note 17, Income Taxes, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion.
Liquidity and Capital Resources
During August 2015, PCHI redeemed its $700.0 million Old Senior Notes and refinanced its existing $1,125.0 million Old Term Loan Credit Agreement and $400.0 million Old ABL Facility with new indebtedness consisting of: (i) a senior secured term loan facility (“Term Loan Credit Agreement”), (ii) a $540.0 million asset-based revolving credit facility (with a seasonal increase to $640.0 million during a certain period of each calendar year) (“ABL Facility”) and (iii) $350.0 million of 6.125% senior notes (“6.125% Senior Notes”). During August 2018, the Company executed a refinancing of its debt portfolio and issued $500 million of new senior notes at an interest rate of 6.625% (“6.625% Senior Notes”). The Company used the proceeds from the 6.625% Senior Notes to: (i) reduce the outstanding balance under the ABL Facility by $90 million and (ii) voluntarily prepay $400 million of the outstanding balance under the Term Loan Credit Agreement. Additionally, as part of the refinancing, the Company extended the maturity of the ABL Facility to August 2023 (subject to a springing maturity at an earlier date if the maturity date of certain of our other debt has not been extended or refinanced).
ABL Facility
Prior to April 2019, PCHI had a $540.0 million asset-based revolving credit facility (with a seasonal increase to $640.0 million during a certain period of each calendar year) (“ABL Facility”). During April 2019, PCHI amended the ABL Facility. Such amendment removed the seasonal component and made the facility a $640.0 million facility on a year-round basis. The ABL Facility matures during August 2023 (subject to a springing maturity at an earlier date if the maturity date of certain of the Company’s other debt has not been extended or refinanced). It provides for (a) revolving loans, subject to a borrowing base described below, and (b) letters of credit, in an aggregate face amount at any time outstanding not to exceed $50.0 million.
Under the ABL Facility, the borrowing base at any time equals (a) a percentage of eligible trade receivables, plus (b) a percentage of eligible inventory, plus (c) a percentage of eligible credit card receivables, less (d) certain reserves.
The ABL Facility generally provides for two pricing options: (i) an alternate base interest rate (“ABR”) equal to the greater of (a) the prime rate, (b) the federal funds rate plus 0.5% or (c) the LIBOR rate plus 1%, in each case, on the date of such borrowing or (ii) a LIBOR based interest rate, in each case plus an applicable margin. The applicable margin ranges from 0.25% to 0.50% with respect to ABR borrowings and from 1.25% to 1.50% with respect to LIBOR borrowings.
In addition to paying interest on outstanding principal, PCHI is required to pay a commitment fee of 0.25% per annum in respect of unutilized commitments. PCHI must also pay customary letter of credit fees.
All obligations under the ABL Facility are jointly and severally guaranteed by PC Intermediate, PCHI and each existing and future domestic subsidiary of PCHI. PCHI and each guarantor has secured its obligations, subject to certain exceptions and limitations, including obligations under its guaranty, as applicable, by a first-priority
lien on its accounts receivable, inventory, cash and certain related assets and a second-priority lien on substantially all of its other assets.
The facility contains negative covenants that, among other things and subject to certain exceptions, restrict the ability of PCHI to:
• incur additional indebtedness;
• pay dividends on capital stock or redeem, repurchase or retire capital stock;
• make certain investments, loans, advances and acquisitions;
• engage in transactions with affiliates;
• create liens; and
• transfer or sell certain assets.
In addition, PCHI must comply with a fixed charge coverage ratio if excess availability under the ABL Facility on any day is less than the greater of: (a) 10% of the lesser of the aggregate commitments and the then borrowing base under the ABL Facility and (b) $40.0 million. The fixed charge coverage ratio is the ratio of (i) Adjusted EBITDA (as defined in the facility) minus maintenance-related capital expenditures (as defined in the facility) to (ii) fixed charges (as defined in the facility).
The ABL Facility also contains certain customary affirmative covenants and events of default.
In connection with entering into and amending the ABL Facility, PCHI incurred and capitalized third-party costs. All capitalized costs are being amortized over the life of the ABL Facility and are included in loans and notes payable in the Company’s consolidated balance sheet. The balance of related unamortized financing costs at December 31, 2019 was $2.0 million.
Borrowings under the ABL Facility totaled $129.4 million at December 31, 2019. The weighted average interest rate for such borrowings was 5.19% at December 31, 2019. Outstanding standby letters of credit totaled $25.1 million at December 31, 2019 and, after considering borrowing base restrictions, at December 31, 2019 PCHI had $355.9 million of available borrowing capacity under the terms of the facility.
Term Loan Credit Agreement
The Term Loan Credit Agreement, as amended, provides for two pricing options for outstanding loans: (i) an ABR for any day, a rate per annum equal to the greater of (a) the prime rate in effect on such day, (b) the federal funds effective rate in effect on such day plus 0.5%, (c) the adjusted LIBOR rate plus 1% and (d) 1.75% or (ii) the LIBOR rate, with a LIBOR floor of 0.75%, in each case plus an applicable margin. The applicable margin for ABR and LIBOR borrowings are 1.75% and 2.75%, respectively, and will drop to 1.50% and 2.50%, respectively, if PCHI’s Senior Secured Leverage Ratio, as defined by the agreement, falls below 3.2 to 1.0.
The term loans under the Term Loan Credit Agreement mature on August 19, 2022. The Company is required to repay installments on the loans in quarterly principal amounts of 0.25%, with the remaining amount payable on the maturity date.
Additionally, outstanding term loans are subject to mandatory prepayment, subject to certain exceptions, with (i) 100% of net proceeds above a threshold amount of certain asset sales/insurance proceeds, subject to reinvestment rights and certain other exceptions, (ii) 100% of the net cash proceeds of any incurrence of debt other than debt permitted under the Term Loan Credit Agreement, and (iii) 50% of Excess Cash Flow, as defined in the agreement, if any (reduced to 25% if PCHI’s first lien leverage ratio (as defined in the agreement) is less than 3.50 to 1.00, but greater than 2.50 to 1.00, and 0% if PCHI’s first lien leverage ratio is less than 2.50 to 1.00).
The term loans may be voluntarily prepaid at any time without premium or penalty, other than customary breakage costs with respect to loans based on the LIBOR rate.
All obligations under the agreement are jointly and severally guaranteed by PC Intermediate, PCHI and each existing and future domestic subsidiary of PCHI. PCHI and each guarantor has secured its obligations, subject to certain exceptions and limitations, by a first-priority lien on substantially all of its assets (other than accounts receivable, inventory, cash and certain related assets), including a pledge of all of the capital stock held by PC Intermediate, PCHI and each guarantor, and a second-priority lien on its accounts receivable, inventory, cash and certain related assets.
The Term Loan Credit Agreement contains certain customary affirmative covenants and events of default. Additionally, it contains negative covenants which, among other things and subject to certain exceptions, restrict the ability of PCHI to:
• incur additional indebtedness;
• pay dividends on capital stock or redeem, repurchase or retire capital stock;
• make certain investments, loans, advances and acquisitions;
• engage in transactions with affiliates;
• create liens; and
• transfer or sell certain assets.
At December 31, 2019, the principal amount of term loans outstanding under the Term Loan Credit Agreement was $725.1 million. Such amount is recorded net of original issue discounts, capitalized call premiums and deferred financing costs on the Company’s consolidated balance sheet. At December 31, 2019, original issue discounts, capitalized call premiums and deferred financing costs totaled $6.5 million. At December 31, 2019, all outstanding borrowings were based on LIBOR and were at a weighted average interest rate of 4.22%.
6.125% Senior Notes-Due 2023 (“6.125% Senior Notes”)
The 6.125% Senior Notes mature on August 15, 2023. Interest on the notes is payable semi-annually in arrears on February 15 and August 15 of each year.
The notes are guaranteed, jointly and severally, on a senior basis by each of PCHI’s existing and future wholly-owned domestic subsidiaries. The notes and the guarantees are general unsecured senior obligations and are effectively subordinated to all other secured debt to the extent of the assets securing such secured debt.
The indenture governing the 6.125% Senior Notes contains certain covenants limiting, among other things and subject to certain exceptions, PCHI’s ability to:
• incur additional indebtedness or issue certain disqualified stock and preferred stock;
• pay dividends or distributions, redeem or repurchase equity;
• prepay subordinated debt or make certain investments;
• engage in transactions with affiliates;
• consolidate, merge or transfer all or substantially all of PCHI’s assets;
• create liens; and
• transfer or sell certain assets.
The indenture governing the notes also contains certain customary affirmative covenants and events of default.
The Company may redeem the 6.125% Senior Notes, in whole or in part, at the following (expressed as a percentage of the principal amount to be redeemed):
Also, if the Company experiences certain types of change in control, as defined, the Company may be required to offer to repurchase the 6.125% Senior Notes at 101% of their principal amount.
In connection with issuing the 6.125% Senior Notes, the Company incurred and capitalized third-party costs. Capitalized costs are being amortized over the life of the debt and are included in long-term obligations, excluding current portion, in the Company’s consolidated balance sheet. At December 31, 2019, $3.0 million of costs were capitalized.
6.625% Senior Notes-Due 2026 (“6.625% Senior Notes”)
The 6.625% Senior Notes mature on August 1, 2026. Interest on the notes is payable semi-annually in arrears on February 1st and August 1st of each year.
The 6.625% Senior Notes are guaranteed, jointly and severally, on a senior basis by each of PCHI’s existing and future wholly-owned domestic subsidiaries. The notes and the guarantees are general unsecured senior obligations and are effectively subordinated to all other secured debt to the extent of the assets securing such secured debt.
The indenture governing the notes contains certain covenants limiting, among other things and subject to certain exceptions, PCHI’s ability to:
• incur additional indebtedness or issue certain disqualified stock and preferred stock;
• pay dividends or distributions, redeem or repurchase equity;
• prepay subordinated debt or make certain investments;
• engage in transactions with affiliates;
• consolidate, merge or transfer all or substantially all of PCHI’s assets;
• create liens; and
• transfer or sell certain assets.
The indenture governing the notes also contains certain customary affirmative covenants and events of default.
On or after August 1, 2021, the Company may redeem the notes, in whole or in part, at the following (expressed as a percentage of the principal amount to be redeemed):
In addition, the Company may redeem up to 40% of the aggregate principal amount outstanding on or before August 1, 2021 with the cash proceeds from certain equity offerings at a redemption price of 106.625% of
the principal amount. The Company may also redeem some or all of the notes before August 1, 2021 at a redemption price of 100% of the principal amount plus a premium that is defined in the indenture governing the 6.625% Senior Notes.
Also, if the Company experiences certain types of change in control, as defined, the Company may be required to offer to repurchase the notes at 101% of their principal amount.
Other Credit Agreements
At December 31, 2019 and December 31, 2018, borrowings under the foreign facilities totaled $1.4 million and $1.7 million, respectively.
Other Indebtedness
Additionally, we have entered into various finance leases for machinery and equipment. At December 31, 2019 and December 31, 2018 the balances of such leases in our consolidated balance sheets were $15.0 million and $3.8 million, respectively. We also have numerous non-cancelable
operating leases for retail store sites, as well as leases for offices, distribution facilities and manufacturing facilities. These leases generally contain renewal options and require us to pay real estate taxes, utilities and related insurance costs.
Liquidity
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. See “Risk Factors-We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful
.”
Cash Flow Data-Year Ended December 31, 2019, Compared to Year Ended December 31, 2018
Net cash provided by operating activities totaled $43.7 million during 2019. Net cash provided by operating activities totaled $101.9 million during 2018. Net cash flows provided by operating activities before changes in operating assets and liabilities were $24.8 million during 2019, compared to $226.4 million during 2018. Changes in operating assets and liabilities during 2019 resulted in a source of cash of $18.9 million. Changes in operating assets and liabilities during 2018 resulted in a use of cash of $124.5 million (see Note 2, Summary of Significant Accounting Policies and Note 27, Restricted Cash, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion). The operating assets and liabilities year over year change was principally due to a reduction in inventory offset by a reduction in accounts payable.
Net cash provided by investing activities totaled $163.7 million during 2019, as compared to $150.9 million used in 2018. Investing activities during 2019 included $18.1 million paid in connection with acquisitions of foreign online retailers and franchise stores (see Note 9, Acquisitions, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion). Capital expenditures during 2019 and 2018 were $61.7 million and $85.7 million, respectively. In addition, in 2019 our cash flow includes proceeds from disposal of assets of $246.3 million. Retail capital expenditures totaled $32.2 million during 2019 and principally related to initiatives for improving store performance, web re-platforming,
investments in new stores and spending on store conversions. Wholesale capital expenditures during 2019 totaled $29.5 million and primarily related to printing plates and dyes, as well as machinery and equipment at the Company’s manufacturing operations and main distribution center.
Net cash used in financing activities was $237.7 million during 2019. Net cash provided by financing activities was $56.2 million during 2018. The change in net cash used in financing activities was due to a paydown of debt using the net proceeds received from the Sale/Leaseback Transaction (see Note 5, Sale/Leaseback Transaction, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion) and the sale of Canadian-based Party City stores (see Note 6, Disposition of Assets, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion).
Cash Flow Data-Year Ended December 31, 2018 Compared to Year Ended December 31, 2017
Net cash provided by operating activities totaled $101.9 million during 2018. Net cash provided by operating activities totaled $267.9 million during 2017. Net cash flows provided by operating activities before changes in operating assets and liabilities were $226.4 million during 2018, compared to $219.3 million during 2017. Changes in operating assets and liabilities during 2018 resulted in a use of cash of $124.5 million. Changes in operating assets and liabilities during 2017 resulted in a source of cash of $48.6 million. The operating assets and liabilities year over year change was principally due to: 2017 benefitting from Halloween carryover inventory from the 2016 Halloween selling season, the increased store count in 2018 and higher interest payments during 2018.
Net cash used in investing activities totaled $150.9 million during 2018, as compared to $141.6 million during 2017. Investing activities during 2018 included $65.3 million paid in connection with acquisitions, principally related to franchise stores (see Note 9, Acquisitions, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion). Capital expenditures during 2018 and 2017 were $85.7 million and $67.0 million, respectively. Retail capital expenditures totaled $51.8 million during 2018 and principally related to initiatives for improving store performance, web re-platforming,
investments in new stores and spending on store conversions. Wholesale capital expenditures during 2018 totaled $33.9 million and primarily related to printing plates and dyes, as well as machinery and equipment at the Company’s manufacturing operations and main distribution center.
Net cash provided by financing activities was $56.2 million during 2018. Net cash used in financing activities was $140.0 million during 2017. The change in net cash provided by/used in financing activities was necessary due to higher cash used in operating activities (see above for further detail).
Tabular Disclosure of Contractual Obligations
Our contractual obligations at December 31, 2019 are summarized by the year in which the payments are due in the following table (amounts in thousands):
(a) See Item 8, “Financial Statements and Supplementary Data,” for further detail.
(b) As a result of the Act, the U.S. is transitioning from a worldwide system of international taxation to a territorial tax system, thereby eliminating the U.S. federal tax on foreign earnings. However, the Act
requires a one-time
deemed repatriation tax on such earnings and, accordingly, we have recorded a liability related to such requirement. See Note 17, Income Taxes, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion.
Not included in the above table are borrowings under the ABL Facility of $129.4 million, with a maturity date of 2023, and borrowings under our foreign credit facilities of $1.4 million.
Not included in the above table are $4.9 million of net potential cash obligations associated with unrecognized tax benefits due to the high degree of uncertainty regarding the timing of future cash outflows associated with such obligations. Refer to the notes to the consolidated financial statements which are included elsewhere in this Annual Report on Form 10-K
for further information related to unrecognized tax benefits.
Additionally, not included in the above table are expected interest payments associated with the Term Loan Credit Agreement and the senior notes, of approximately $104.1 million in 2020, $102.0 million in 2021, $99.3 million in 2022, $99.3 million in 2023 and $88.0 million thereafter. Interest payments are estimates based on our debt’s scheduled maturities and stated interest rates or, for variable rate debt, interest rates as of December 31, 2019. Our estimates do not reflect interest payments on the credit facilities or the possibility of additional interest from the refinancing of our debt as such amounts are not determinable.
Off-Balance
Sheet Arrangements
We do not have any off-balance
sheet arrangements.
Effects of Inflation
Although we expect that our operating results will be influenced by general economic conditions, we do not believe that inflation has had a material effect on our results of operations during the periods presented. However, there can be no assurance that our business will not be affected by inflation in the future.
Critical Accounting Policies and Procedures
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the appropriate application of certain accounting policies, many of which require estimates and assumptions about future events and their impact on amounts reported in the financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the consolidated financial statements included herein.
We believe our application of accounting policies, and the estimates inherently required by these policies, are reasonable. These accounting policies and estimates are constantly re-evaluated
and adjustments are made when facts and circumstances dictate a change. Historically, we have found the application of accounting policies to be reasonable, and actual results generally do not differ materially from those determined using necessary estimates.
Revenue Recognition
Revenue Transactions-Retail
Revenue from retail store operations is recognized at the point of sale as control of the product is transferred to the customer at such time. Retail e-commerce
sales are recognized when the consumer receives the product as control transfers upon delivery. Due to its extensive history operating as the largest party goods retailer in North America, the Company has sufficient history with which to estimate future retail sales returns and it uses the expected value method to estimate such activity.
The transaction price for the majority of the Company’s retail sales is based on either: 1) the item’s stated price or 2) the stated price adjusted for the impact of a coupon which can only be applied to such transaction. To the extent that the Company charges customers for freight costs on e-commerce
sales, the Company records such amounts in revenue. The Company excludes 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 (loss) income.
Revenue Transactions-Wholesale
For most of the Company’s wholesale sales, control transfers upon the Company’s shipment of the product. 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.
In most cases, the determination of the transaction price is fixed based on the contract and/or purchase order. To the extent that the Company charges customers for freight costs, the Company records such amounts in revenue. The Company excludes 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 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. Due to its extensive history operating as a leading party goods retailer, the Company has sufficient history with which to estimate such amounts.
Product Royalty Agreements
We enter into product royalty agreements that allow us to use licensed designs on certain of our products. These contracts require us to pay royalties, generally based on the sales of such product and may require guaranteed minimum royalties, a portion of which may be paid in advance. We match royalty expense with revenue by recording royalties at the time of sale, at the greater of the contractual rate or an effective rate calculated based on the guaranteed minimum royalty and our estimate of sales during the contract period. Guaranteed minimum royalties paid in advance are recorded in the consolidated balance sheets in either prepaid expenses and other current assets or other assets, depending on the nature of the royalties.
Allowance for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers and franchisees to make required payments. Judgment is required in assessing the ultimate realization of these receivables, including consideration of our history of receivable write-offs, the level of past due accounts and the economic status of our customers. In an effort to identify adverse trends relative to customer economic status, we assess the financial health of the markets we operate in and perform periodic credit evaluations of our customers and ongoing reviews of account balances and aging of receivables. Amounts are considered past due when payment has not been received within the time frame of the credit terms extended. Write-offs are charged directly against the allowance for doubtful accounts and occur only after all collection efforts have been exhausted. Because we cannot predict future changes in economic conditions and in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates and could impact our allowance for doubtful accounts.
Inventories
Inventories are valued at the lower of cost and net realizable value. In assessing the ultimate realization of inventories, we are required to make judgments regarding, among other things, future demand and market conditions, current inventory levels and the impact of the possible discontinuation of product designs.
We principally determine the cost of inventory using the weighted average method.
We estimate retail inventory shrinkage for the period between physical inventory dates on a store-by-store
basis. Our inventory shrinkage estimate 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.
Long-Lived and Intangible Assets (including Goodwill)
We review the recoverability of our long-lived assets, including finite-lived intangible assets, whenever facts and circumstances indicate that the carrying amount may not be fully recoverable. For purposes of recognizing and measuring impairment, we evaluate long-lived assets/asset groups, other than goodwill, based upon the lowest level of independent cash flows ascertainable to evaluate impairment. If an impairment indicator exists, we compare the undiscounted future cash flows of the asset/asset group to the carrying value of the asset/asset group. If the sum of the undiscounted future cash flows is less than the carrying value of the asset/asset group, we would calculate discounted future cash flows based on market participant assumptions. If the sum of discounted cash flows is less than the carrying value of the asset/asset group, we would recognize an impairment loss. The impairment related to long-lived assets is measured as the amount by which the carrying amount of the asset(s) exceeds the fair value of the asset(s). When fair values are not readily available, we estimate fair values using discounted expected future cash flows. Such estimates of fair value require significant judgment, and actual fair value could differ due to changes in the expectations of cash flows or other assumptions, including discount rates.
In the evaluation of the fair value and future benefits of finite long-lived assets attached to retail stores, we perform our cash flow analysis generally on a store-by-store
basis. Various factors including future sales growth and profit margins are included in this analysis. To the extent these future projections or strategies change, the conclusion regarding impairment may differ from the current estimates.
Goodwill is reviewed for potential impairment on an annual basis or more frequently if circumstances indicate a possible impairment.
For purposes of testing goodwill for impairment, reporting units are determined by identifying individual operating segments within our organization which constitute a business for which discrete financial information is available and is reviewed by management. Components within an operating segment are aggregated to the extent that they have similar economic characteristics. Based on this evaluation, we have determined that our operating segments, wholesale and retail, represent our reporting units for the purposes of our goodwill impairment test.
If it is concluded that it is more likely than not that the fair value of a reporting unit is less than its carrying value, we estimate the fair value of the reporting unit using a combination of a market approach and an income approach. If such carrying value exceeds the fair value, an impairment loss will be recognized in an amount equal to such excess. The fair value of a reporting unit refers to the amount at which the unit as a whole could be sold in a current transaction between willing parties. The determination of such fair value is subjective, and actual fair value could differ due to changes in the expectations of cash flows or other assumptions including discount rates.
Income Taxes
Temporary differences arising from differing treatment of income and expense items for tax and financial reporting purposes result in deferred tax assets and liabilities that are recorded on the balance sheet. These balances, as well as income tax expense, are determined through management’s estimations, interpretation of tax law for multiple jurisdictions and tax planning. However, inherent in the measurement of deferred balances are certain judgments and interpretations of enacted tax laws and published guidance with respect to applicability to our operations. If our actual results differ from estimated results due to changes in tax laws or tax planning, our effective tax rate and tax balances could be affected. As such, these estimates may require adjustment in the future as additional facts become known or as circumstances change. A valuation allowance is established against deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will not be realized.
During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. Accounting Standards Codification Topic 740 prescribes a comprehensive model of how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. In accordance with these requirements, we recognize a tax benefit when a tax position is more-likely-than-not
to be sustained upon examination, based solely on its technical merits. We measure the recognized tax benefit as the largest amount of tax benefit that has greater than a 50% likelihood of being realized upon the ultimate settlement with a taxing authority. We reverse previously recognized tax benefits if we determine that the tax position no longer meets the more-likely-than-not
threshold of being sustained. We accrue interest and penalties related to unrecognized tax benefits in income tax expense.
Stock-Based Compensation
Accounting for stock-based compensation requires measurement of compensation cost for all stock-based awards at fair value on the date of grant and recognition of compensation expense over the service period for awards which are expected to vest.
The value of our stock-based awards is recognized as expense over the service period, net of estimated forfeitures. The estimation of stock awards that will ultimately vest requires judgment and to the extent that actual results or updated estimates differ from our current estimates such revisions will be recorded as cumulative adjustments in the periods during which the estimates are revised. Actual results and future estimates may differ significantly from our current estimates.
The Company grants restricted stock units which vest if certain cash flow and earnings per share targets are met. We recognize compensation expense for such awards if it is probable that the awards will vest. Determining whether it is probable that such awards will vest requires judgment and to the extent that actual results, or revised estimates, differ from our current estimates, such revisions will be recorded as cumulative adjustments in the periods during which the estimates are changed. Actual results and future estimates may differ significantly from our current estimates.
Recently Issued Accounting Pronouncements
In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-13,
“Fair Value Measurement (Topic 820)-Disclosure Framework-Changes to the
Disclosure Requirements for Fair Value Measurement”. The new guidance improves and clarifies the fair value measurement disclosure requirements of ASC 820. The new disclosure requirements include the disclosure of the changes in unrealized gains or losses included in other comprehensive (loss) income for recurring Level 3 fair value measurements held at the end of the reporting period and the explicit requirement to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. The other provisions of ASU 2018-13
also include eliminated and modified disclosure requirements. The guidance is effective for fiscal years beginning after December 15, 2019, with early adoption permitted, including in an interim period for which financial statements have not been issued or made available for issuance. The Company has evaluated the impact of the adoption of this ASU and determined that it will have no significant impact on its condensed consolidated financial statements.
In June 2018, the FASB issued 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 Company adopted the update during the first quarter of 2019. The pronouncement requires companies to record the impact of adoption, if any, as a cumulative-effect adjustment to retained earnings as of the adoption date. Therefore, on January 1, 2019, the Company decreased retained earnings by $0.5 million. Additionally, the Company increased additional paid-in
capital by $0.7 million and recorded a $0.2 million deferred income tax asset.
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 Company adopted the update during the first quarter of 2019 and such adoption had no impact on the Company’s consolidated financial statements.
In January 2017 the FASB issued ASU No. 2017-04,
“Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”, which eliminates the requirement to measure a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Under the amendments in ASU 2017-04,
an entity will perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity will recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized will not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity will consider income tax effects from any tax-deductible
goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The Company adopted ASU No. 2017-04
during the first quarter of 2019.
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 27, Restricted Cash, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K 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 June 2016, the FASB issued ASU 2016-13,
“Financial Instruments-Credit Losses”. The ASU changes how entities will account for credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The pronouncement is effective for the Company during the first quarter of 2020. The Company is still evaluating the impact of the ASU on its consolidated financial statements, but does not expect it to have a material impact on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02,
“Leases”. The ASU requires that companies recognize assets and liabilities for the rights and obligations created by companies’ leases. The Company’s lease portfolio is primarily comprised of store leases, manufacturing and distribution facility leases, warehouse leases and office leases. Most of the leases are operating leases.
The Company adopted the new lease standard during the first quarter of 2019 and, to the extent required by the pronouncement, recognized a right of use asset and liability for its operating lease arrangements with terms of greater than twelve months. See Item 8, “Financial Statements and Supplementary Data,” Consolidated Balance Sheets at December 31, 2019 for the impact of such adoption. The pronouncement provided companies with a transition option under which they could opt to continue to apply legacy lease guidance in comparative periods. The Company elected such option. The Company’s December 31, 2018 consolidated balance sheet includes a $74.5 million deferred rent liability in other long-term liabilities and a $7.2 million deferred rent liability in accrued expenses. In the Company’s December 31, 2019 consolidated balance sheet, such accounts reduce the operating lease asset. Additionally, in the Company’s December 31, 2018 consolidated balance sheet, other intangible assets, net, includes a $3.9 million intangible asset related to favorable leases and prepaid expenses and other current assets includes a $2.6 million asset related to capitalized broker costs. In the Company’s December 31, 2019 consolidated balance sheet, such assets are included in the operating lease asset. The pronouncement had no impact on the Company’s consolidated statement of operations and comprehensive loss and it did not impact the Company’s compliance with its debt covenants. Additionally, the standard requires companies to make certain disclosures. See Note 26, Leases, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion.
In January 2016, the FASB issued ASU 2016-01,
“Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities”. The update impacts the accounting for equity investments and the recognition of changes in fair value of financial liabilities when the fair value option is elected. The Company adopted the pronouncement during the first quarter of 2018 and such adoption had no impact on the Company’s consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09,
“Revenue from Contracts with Customers (Topic 606)”. The pronouncement contains a five-step model which replaces most existing revenue recognition guidance. The new standard became effective for the Company on January 1, 2018. The Company adopted the pronouncement using the modified retrospective approach. Therefore, on January 1, 2018, the Company adjusted its accounting for certain discounts which are related to the timing of payments by customers of its wholesale business and the Company recorded a cumulative-effect adjustment which reduced retained earnings by $46. Additionally, as of such date, the Company modified its accounting for certain metallic balloon sales of its wholesale segment and started to defer the recognition of revenue on such sales, and the related costs, until the balloons have been filled with helium. As a result, the Company recorded a cumulative-effect adjustment which increased retained earnings by less than $0.1 million. 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 less than $0.1 million. See Note 24, Revenue from Contracts with Customers, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further discussion of the adoption of the pronouncement and the Company’s revenue recognition policy.
Quarterly Results
Despite a concentration of holidays in the fourth quarter of the year, as a result of our expansive product lines and customer base and increased promotional activities, the impact of seasonality on the quarterly results of our wholesale segment has been limited. Our retail segment is subject to significant seasonal variations. Historically, our retail 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. The table below sets forth our historical revenues, gross profit, income (loss) from operations, net
income (loss), net income (loss) attributable to common shareholders of Party City Holdco Inc. and net income (loss) per share attributable to common shareholders of Party City Holdco Inc. (Basic and Diluted) for each of the last twelve quarters (dollars in thousands):
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
As a result of our variable rate ABL Facility and Term Loan Credit Agreement, our earnings are affected by changes in interest rates.
The Term Loan Credit Agreement provides for two pricing options for outstanding loans: (i) an ABR for any day, a rate per annum equal to the greater of (a) the prime rate in effect on such day, (b) the federal funds effective rate in effect on such day plus 0.5%, (c) the adjusted LIBOR rate plus 1% and (d) 1.75% or (ii) the LIBOR rate, with a LIBOR floor of 0.75%, in each case plus an applicable margin.
If market interest rates for our variable rate indebtedness had averaged 2% more than the actual market interest rates during the year ended December 31, 2019, our interest expense for the year would have increased by $22.6 million.
This amount is determined by considering the impact of the hypothetical interest rates on our borrowings. This analysis does not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management could potentially take action to mitigate our exposure to the change. However, due to the uncertainty of the specific actions that we would take and their possible effects, the sensitivity analysis assumes no changes in our financial structure.
Foreign Currency Risk
As a result of the sale of our products in foreign markets, our earnings are affected by fluctuations in the value of the U.S. Dollar (“USD”) when compared to the values of foreign currencies. Specifically, foreign currency fluctuations impact us in four ways:
1) Certain foreign subsidiaries purchase product or raw materials in U.S. Dollars and sell such product in their local currencies. To the extent that the subsidiaries cannot adjust their local currency selling prices to reflect the strengthening of the U.S. Dollar, the subsidiaries’ gross margins are negatively impacted when the related product is sold. The subsidiaries that are impacted by this risk principally operate in the Canadian dollar, Euro, British Pound Sterling, Australian dollar and Mexican Peso. British Pound Sterling-based subsidiaries purchase approximately $33 million of USD-denominated
product per year. Euro-based subsidiaries purchase approximately $35 million of USD-denominated
product per year. Canadian dollar-based subsidiaries purchase approximately $28 million of USD-denominated
product per year. Australian Dollar-based subsidiaries purchase approximately $12 million of USD-denominated
product per year. Mexican Peso-based subsidiaries purchase approximately $4 million of USD-denominated
raw materials/finished goods per year.
2) Certain foreign subsidiaries sell product in U.S. Dollars and manufacture/purchase such product in their local currencies. To the extent that the subsidiaries cannot adjust their selling prices to reflect the weakening of the U.S. Dollar, the subsidiaries’ gross margins are negatively impacted when sales occur. The subsidiaries that are impacted by this risk principally operate in the Malaysian Ringgit. Ringgit-based subsidiaries sell approximately $20 million of product in U.S. Dollars on an annual basis.
We periodically enter into foreign currency forward contracts to hedge against a portion of the earnings impact of the risks discussed in points 1. and 2. See Note 22, Derivative Financial Instruments, of Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for further detail of our existing contracts. Although we periodically enter into such contracts, we (1) may not be able to achieve hedge effectiveness in order to qualify for “hedge accounting” treatment and, therefore, would record any gain or loss on the mark-to-market
of open contracts in our statement of income and (2) may not be able to hedge such risks completely or permanently.
3) During our financial statement close process, we adjust open receivables and payables that are not in the functional currencies of our subsidiaries to the latest foreign currency exchange rates. These receivables and payables are principally generated through the sales and inventory purchases discussed in points 1. and 2. above. The gains and losses created by such adjustments are primarily recorded in our statement of income.
4) Additionally, the financial statements of foreign subsidiaries with functional currencies other than the U.S. Dollar are translated into U.S. Dollars during our financial statement close process. To the extent that the U.S. Dollar fluctuates versus such functional currencies, our consolidated financial statements are impacted. Based on the loss from operations for such subsidiaries for the year ended December 31, 2019, a uniform 10% change in such exchange rates versus the U.S. Dollar would have impacted our consolidated loss from operations for the year by approximately ($0.5) million.
Item 8.
Item 8.
Financial Statements and Supplementary Data
PARTY CITY HOLDCO INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2019 and December 31, 2018
Consolidated Statements of Operations and Comprehensive (Loss) Income for the years ended December 31, 2019, December 31, 2018 and December 31, 2017
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2019, December 31, 2018 and December 31, 2017
Consolidated Statements of Cash Flows for the years ended December 31, 2019, December 31, 2018 and December 31, 2017
Notes to Consolidated Financial Statements
Financial Statement Schedules for the years ended December 31, 2019, December 31, 2018 and December 31, 2017:
Schedule I-Condensed Financial Information
Schedule II-Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Party City Holdco Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Party City Holdco Inc. and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations and comprehensive (loss) income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and financial statement schedules listed in the Index at Item 15 (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 12, 2020 expressed an unqualified opinion thereon.
Adoption of New Accounting Standards
ASU No. 2016-02
As discussed in Note 2 and Note 26 to the consolidated financial statements, effective January 1, 2019 the Company changed its method of accounting for leases due to the adoption of ASU No. 2016-02,
Leases (Topic 842).
ASU No. 2014-09
As discussed in Note 2 and Note 24 to the consolidated financial statements, effective January 1, 2018 the Company changed its method for recognizing revenue due to the adoption of ASU No. 2014-09,
Revenue from Contracts with Customers (Topic 606).
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 1998.
New York, New York
March 12, 2020
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Party City Holdco Inc.
Opinion on Internal Control Over Financial Reporting
We have audited Party City Holdco Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Party City Holdco Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, the related consolidated statements of operations and comprehensive (loss) income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and financial statement schedules listed in the Index at Item 15 and our report dated March 12, 2020 expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Ernst & Young LLP
New York, New York
March 12, 2020
PARTY CITY HOLDCO INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
See accompanying notes to consolidated financial statements.
PARTY CITY HOLDCO INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS) INCOME
(In thousands, except share and per share data)
See accompanying notes to consolidated financial statements.
PARTY CITY HOLDCO INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2017, December 31, 2018 and December 31, 2019
(In thousands)
PARTY CITY HOLDCO INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See accompanying notes to consolidated financial statements.
PARTY CITY HOLDCO INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share)
Note 1-Organization, Description of Business and Basis of Presentation
Party City Holdco Inc. (the “Company” or “Party City Holdco”) is the leading party goods company by revenue in North America and, we believe, the largest vertically integrated supplier of decorated party goods globally by revenue. The Company is a popular one-stop shopping destination for party supplies, balloons, and costumes. In addition to being a great retail brand, the Company is a global, world-class organization that combines state-of-the-art manufacturing and sourcing operations, and sophisticated wholesale operations complemented by a multi-channel retailing strategy and e-commerce retail operations. The Company is a leading player in its category and vertically integrated in its breadth and depth
. 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
througho
ut
the world.
The Company’s retail operations include approximately 875 specialty retail party supply stores (including franchise stores) throughout
the United States
and
Mexico
operating under the names
Party City and Halloween City, and
e-commerce
websites, including through
the domain name PartyCity.com and others.
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 most of the Company’s operating subsidiaries.
Note 2-Summary of Significant Accounting Policies
Consolidated Financial Statements
The consolidated financial statements of the Company include the accounts of all majority-owned subsidiaries and controlled entities. All intercompany balances and transactions have been eliminated.
The Company’s 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 their 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 consolidated financial statements of the Company combine the Fiscal Year and Fiscal Quarters of the Company’s retail operations with the calendar year and calendar quarters of the Company’s wholesale operations, as the differences are not significant.
Use of Estimates
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Management periodically evaluates estimates used in the preparation of the consolidated financial statements for continued reasonableness. Appropriate adjustments, if any, to the estimates used are made prospectively based on such periodic evaluations.
Cash Equivalents
Highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents. All credit card transactions that process in less than seven days are classified as cash and cash equivalents.
Inventories
Inventories are valued at the lower of cost and net realizable value. In assessing the ultimate realization of inventories, the Company makes judgments regarding, among other things, future demand and market conditions, current inventory levels and the impact of the possible discontinuation of product designs.
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.
Allowance for Doubtful Accounts
The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of the Company’s customers to make required payments. Judgment is required in assessing the ultimate realization of these receivables, including consideration of the Company’s history of receivable write-offs, the level of past due accounts and the economic status of the Company’s customers. In an effort to identify adverse trends relative to customer economic status, the Company assesses the financial health of the markets it operates in and performs periodic credit evaluations of its customers and ongoing reviews of account balances and aging of receivables. Amounts are considered past due when payment has not been received within the time frame of the credit terms extended. Write-offs are charged directly against the allowance for doubtful accounts and occur only after all collection efforts have been exhausted. At December 31, 2019 and 2018, the allowance for doubtful accounts was $4,786 and $2,933, respectively.
Long-Lived and Intangible Assets (including Goodwill)
Property, plant and equipment are stated at cost.
The Company reviews the recoverability of its finite long-lived assets, including finite-lived intangible assets, whenever facts and circumstances indicate that the carrying amount may not be fully recoverable. For purposes of recognizing and measuring impairment, the Company evaluates long-lived assets/asset groups, other than goodwill, based upon the lowest level of independent cash flows ascertainable to evaluate impairment. If an impairment indicator exists, we compare the undiscounted future cash flows of the asset/asset group to the carrying value of the asset/asset group. If the sum of the undiscounted future cash flows is less than the carrying value of the asset/asset group, we would calculate discounted future cash flows based on market participant assumptions. If the sum of discounted cash flows is less than the carrying value of the asset/asset group, we would recognize an impairment loss. The impairment related to long-lived assets is measured as the amount by which the carrying amount of the asset(s) exceeds
the fair value of the asset(s).
In the evaluation of the fair value and future benefits of finite long-lived assets attached to retail stores, the Company performs its cash flow analysis generally on a
store-by-store
basis. Various factors including future sales growth and profit margins are included in this analysis.
The Company evaluates the goodwill associated with its acquisitions, and other intangibles with indefinite lives, for impairment as of the first day of its fourth quarter based on current and projected performance, or more frequently if circumstances indicate a possible impairment. For purposes of testing goodwill for impairment, reporting units are determined by identifying operating segments within the Company’s organization which constitute a business for which discrete financial information is available and is reviewed by management. Components within
an operating segment are aggregated to the extent that they have similar economic characteristics. Based on this evaluation, the Company has determined that its operating segments, wholesale and retail, represent reporting units for the purposes of its goodwill impairment test.
If it is concluded that it is more likely than not that the fair value of a reporting unit is less than its carrying value, the Company estimates the fair value of the reporting unit using a combination of a market approach and an income approach. If such carrying value exceeds the fair value an impairment loss will be recognized in an amount equal to such excess. The fair value of a reporting unit refers to the amount at which the unit as a whole could be sold in a current transaction between willing parties.
Our Trade names are treated as indefinite-lived intangible assets and, therefore are not amortized, but rather are tested for impairment annually in the fourth fiscal quarter, unless there are events requiring an earlier assessment or changes in circumstances during an interim period providing impairment indicators are present. When performing a quantitative impairment assessment of our Trade name indefinite-lived intangible assets, the fair value of the Trade names is estimated using a discounted cash flow analysis based on the “relief from royalty” method, assuming that a third party would be willing to pay a royalty in lieu of ownership for this intangible asset. This approach is dependent on many factors, including estimates of future growth, royalty rates, and discount rates. Actual future results may differ from these estimates. Impairment loss is recognized when the estimated fair value of the indefinite-lived intangible asset is less than its carrying amount.
Deferred Financing Costs
Deferred financing costs are netted against amounts outstanding under the related debt instruments. They are amortized to interest expense over the terms of the instruments using the effective interest method.
Equity Method Investments
The Company has an investment in Convergram Mexico, S. De R.L. De C.V., a joint venture distributing metallic balloons, principally in Mexico and Latin America. The Company accounts for its 49.9% investment in the joint venture using the equity method of accounting.
The Company’s investments are included in other assets on the consolidated balance sheet and the results of the investees’ operations are included in other expense in the consolidated statement of operations and comprehensive (loss) income (see Note 14, Other Expense, net).
Insurance Accruals
The Company maintains certain self-insured workers’ compensation and general liability insurance plans. The Company estimates the required liability for claims under such plans based upon various assumptions, which include, but are not limited to, historical loss experience, projected loss development factors, actual payroll and other data. The required liability is also subject to adjustment in the future based upon changes in claims experience, including changes in the number of incidents (frequency) and changes in the ultimate cost per incident (severity).
Revenue Recognition
Retail
Revenue from retail store operations is recognized at the point of sale as control of the product is transferred to the customer at such time. Retail e-commerce
sales are recognized when the consumer receives the product as control transfers upon delivery. Due to its extensive history operating as the largest party goods retailer in North America, the Company has sufficient history with which to estimate future retail sales returns and it uses the expected value method to estimate such activity.
The transaction price for the majority of the Company’s retail sales is based on either: 1) the item’s stated price or 2) the stated price adjusted for the impact of a coupon which can only be applied to such transaction. To the extent that the Company charges customers for freight costs on e-commerce sales, the Company records such amounts in revenue. The Company excludes 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 (loss) income.
Wholesale
For most of the Company’s wholesale sales, control transfers upon the Company’s shipment of the product. 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.
In most cases, the determination of the transaction price is fixed based on the contract and/or purchase order. To the extent that the Company charges customers for freight costs, the Company records such amounts in revenue. The Company excludes 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 does not adjust the consideration for the effects of a significant financing component.
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, inventory adjustments, inbound freight to the Company’s manufacturing and distribution facilities, distribution costs and outbound freight to transfer goods to the Company’s wholesale customers. At retail, cost of sales reflects the direct costs of goods purchased from third parties and the production costs/purchase costs of goods acquired from the Company’s wholesale operations. Retail cost of sales also includes inventory shrinkage, inventory adjustments, inbound freight, occupancy costs related to store operations (such as rent, utilities and common area maintenance), depreciation on assets and all logistics costs (i.e., handling and distribution costs) associated with the Company’s e-commerce
business.
Retail Operating Expenses
Retail operating expenses include costs associated with the operation of the Company’s retail stores (with the exception of occupancy costs, which are included in cost of sales). Retail operating expenses principally consist of employee compensation and benefits, advertising, supplies expense and credit card fees.
Shipping and Handling
Outbound shipping costs billed to customers are included in net sales. The costs of shipping and handling incurred by the Company are included in cost of sales.
Product Royalty Agreements
The Company enters into product royalty agreements that allow the Company to use licensed designs on certain of its products. These contracts require the Company to pay royalties, generally based on the sales of such
product, and may require guaranteed minimum royalties, a portion of which may be paid in advance. The Company matches royalty expense with revenue by recording royalties at the time of sale, at the greater of the
contractual rate or an effective rate calculated based on the guaranteed minimum royalty and the Company’s estimate of sales during the contract period. If a portion of the guaranteed minimum royalty is determined to be unrecoverable, the unrecoverable portion is charged to expense at that time. Guaranteed minimum royalties paid in advance are recorded in the consolidated balance sheets in either prepaid expenses and other current assets or other assets, depending on the nature of the royalties.
Catalog Costs
The Company expenses costs associated with the production of catalogs when incurred.
Advertising
Advertising costs are expensed as incurred. Retail advertising expenses for the years ended December 31, 2019, December 31, 2018, and December 31, 2017 were $72,518, $68,756, and $61,187, respectively.
Variable Interest Entities
When determining whether a legal entity should be consolidated, the Company first determines whether it has a variable interest in the legal entity. If a variable interest exists, the Company determines whether the legal entity is a variable interest entity due to either: 1) a lack of sufficient equity to finance its activities, 2) the equity holders lacking the characteristics of a controlling financial interest, or 3) the legal entity being structured with non-substantive
voting rights. If the Company concludes that the legal entity is a variable interest entity, the Company next determines whether it is the primary beneficiary due to it possessing both: 1) the power to direct the activities of a variable interest entity that most significantly impact the variable interest entity’s economic performance, and 2) the obligation to absorb losses of the variable interest entity that potentially could be significant to the variable interest entity or the right to receive benefits from the variable interest entity which could be significant to the variable interest entity. If the Company concludes that it is the primary beneficiary, it consolidates the legal entity.
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. Although the Company currently only owns
26% of
Kazzam’s equity, the Company has concluded that: a)
Kazzam is a variable interest entity as it has insufficient equity at risk, and b) the Company is its primary beneficiary. Therefore, the Company has consolidated
Kazzam into the Company’s financial statements.
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. On a recurring basis, the mezzanine liability is adjusted to the greater of: a) the interest’s carrying amount under Accounting Standards Codification (“ASC”) Topic 810, “Consolidation”, or b) the fair value of the interest.
In January 2020, the Company and Ampology terminated certain services agreements and warrants that Ampology had in the Company stock. The parties concurrently entered into an interim transition agreement.
Art and Development Costs
Art and development costs are primarily internal costs that are not easily associated with specific designs, some of which may not reach commercial production. Accordingly, the Company expenses these costs as incurred.
Derivative Financial Instruments
ASC Topic 815, “Accounting for Derivative Instruments and Hedging Activities”, requires that all derivative financial instruments be recognized on the balance sheet at fair value and establishes criteria for both the designation and effectiveness of hedging activities. The Company uses derivatives in the management of interest rate and foreign currency exposure. ASC Topic 815 requires the Company to formally document the assets, liabilities or other transactions the Company designates as hedged items, the risk being hedged and the relationship between the hedged items and the hedging instruments. The Company must measure the effectiveness of the hedging relationship at the inception of the hedge and on an on-going
basis.
If derivative financial instruments qualify as fair value hedges, the gain or loss on the instrument and the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in net income during the period of the change in fair values. For derivative financial instruments that qualify as cash flow hedges (i.e
., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of accumulated other comprehensive (loss) income and reclassified into net income in the same period or periods during which the hedged transaction affects earnings. The ineffective portion of a cash flow hedge, if any, is determined based on the dollar-offset method (i.e
., the gain or loss on the derivative financial instrument in excess of the cumulative change in the present value of future cash flows of the hedged item) and is recognized in net income during the period of change. As long as hedge effectiveness is maintained, interest rate swap arrangements and foreign currency exchange agreements qualify for hedge accounting as cash flow hedges (see Note 22, Derivative Financial Instruments).
Income Taxes
Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities (and operating loss and tax credit carryforwards) applying enacted statutory tax rates in effect for the years in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance when, in the judgment of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Stock-Based Compensation
Accounting for stock-based compensation requires measurement of compensation cost for all stock-based awards at fair value on the date of grant and recognition of compensation expense over the service period for awards expected to vest.
Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss consists of the Company’s foreign currency adjustments and the impact of interest rate swap and foreign exchange contracts that qualify as hedges (see Note 22, Derivative Financial Instruments and Note 23, Changes in Accumulated Other Comprehensive Loss).
Foreign Currency Transactions and Translation
The functional currencies of the Company’s foreign operations are the local currencies in which they operate. Foreign currency exchange gains or losses resulting from receivables or payables in currencies other than the functional currencies generally are recognized in the Company’s statement of operations and comprehensive (loss) income. The balance sheets of foreign subsidiaries are translated into U.S. dollars at the exchange rates in effect on the balance sheet date. The results of operations of foreign subsidiaries are translated into U.S. dollars at the average exchange rates effective for the periods presented. The differences from historical exchange rates are recorded as comprehensive (loss) income and are included as a component of accumulated other comprehensive loss.
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:
During the year ended December 31, 2019, restricted stock, restricted stock units, stock options, and warrants were not included in the calculation of
diluted net
loss per share attributable to common shareholders of Party City Holdco Inc.
During the years ended December 31, 2018, and December 31, 2017, 2,394,868 stock options and 2,392,150 stock options, respectively, were excluded from the calculations
of net income per share attributable to common shareholders of Party City Holdco Inc.-diluted as they were anti-dilutive. Additionally, during
each of
the years ended December 31, 2018, and December 31, 2017, 596,000 warrants were excluded from the calculations of net income per share attributable to common shareholders of Party City Holdco Inc.-diluted as they were anti-dilutive. Further, during the years ended December 31, 2018, and December 31, 2017, 141,400 restricted stock units and 0 restricted stock units, respectively, were excluded from the calculations of net income per share attributable to common shareholders of Party City Holdco Inc.-diluted as they were anti-dilutive.
Recently Issued Accounting Pronouncements
In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-13,
“Fair Value Measurement (Topic 820)-Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement”. The new guidance improves and clarifies the fair value measurement disclosure requirements of ASC 820. The new disclosure requirements include the disclosure of the changes in unrealized gains or losses included in other comprehensive (loss) income for recurring Level 3 fair value measurements held at the end of the reporting period and the explicit requirement to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. The other provisions of ASU 2018-13
also include eliminated and modified disclosure requirements. The guidance is
effective for fiscal years beginning after December 15, 2019, with early adoption permitted, including in an interim period for which financial statements have not been issued or made available for issuance. The Company has evaluated the impact of the adoption of this ASU and determined that it will have no significant impact on its condensed consolidated financial statements.
In June 2018, the FASB issued 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 Company adopted the update during the first quarter of 2019. The pronouncement requires companies to record the impact of adoption, if any, as a cumulative-effect adjustment to retained earnings as of the adoption date. Therefore, on January 1, 2019, the Company decreased retained earnings by $503. Additionally, the Company increased additional paid-in
capital by $662 and recorded a $159 deferred income tax asset.
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 Company adopted the update during the first quarter of 2019 and such adoption had no impact on the Company’s consolidated financial statements.
In January 2017 the FASB issued ASU No. 2017-04,
“Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”, which eliminates the requirement to measure a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Under the amendments in ASU 2017-04,
an entity will perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity will recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized will not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity will consider income tax effects from any tax-deductible
goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The Company adopted ASU No. 2017-04
during the first quarter of 2019.
See Note 4.
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 27, Restricted Cash, 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 June 2016, the FASB issued ASU 2016-13,
“Financial Instruments-Credit Losses”. The ASU changes how entities will account for credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The pronouncement is effective for the Company during the first quarter of 2020. The Company is still evaluating the impact of the ASU on its consolidated financial statements, but does not expect it to have a material impact on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02,
“Leases”. The ASU requires that companies recognize assets and liabilities for the rights and obligations created by companies’ leases. The Company’s lease portfolio is primarily comprised of store leases, manufacturing and distribution facility leases, warehouse leases and office leases. Most of the leases are operating leases.
The Company adopted the new lease standard during the first quarter of 2019 and, to the extent required by the pronouncement, recognized a right of use asset and liability for its operating lease arrangements with terms of greater than twelve months. See the Company’s December 31, 2019 consolidated balance sheet for the impact of such adoption.
The pronouncement provided companies with a transition option under which they could opt to continue to apply legacy lease guidance in comparative periods. The Company elected such option. The Company’s December 31, 2018 consolidated balance sheet includes a $74,464 deferred rent liability in other long-term liabilities and a $7,170 deferred rent liability in accrued expenses. In the Company’s December 31, 2019 consolidated balance sheet, such accounts reduce the operating lease asset. Additionally, in the Company’s December 31, 2018 consolidated balance sheet, other intangible assets, net, includes a $3,904 intangible asset related to favorable leases and prepaid expenses and other current assets includes a $2,552 asset related to capitalized broker costs. In the Company’s December 31, 2019 consolidated balance sheet, such assets are included in the operating lease asset.
The pronouncement had no impact on the Company’s consolidated statement of operations and comprehensive loss and it did not impact the Company’s compliance with its debt covenants. Additionally, the standard requires companies to make certain disclosures. See Note 26, Leases.
In January 2016, the FASB issued ASU 2016-01,
“Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities”. The update impacts the accounting for equity investments and the recognition of changes in fair value of financial liabilities when the fair value option is elected. The Company adopted the pronouncement during the first quarter of 2018 and such adoption had no impact on the Company’s consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09,
“Revenue from Contracts with Customers (Topic 606)”. The pronouncement contains a five-step model which replaces most existing revenue recognition guidance. The new
standard became effective for the Company on January 1, 2018. The Company adopted the pronouncement using the modified retrospective approach. Therefore, on January 1, 2018, the Company adjusted its accounting for certain discounts which are related to the timing of payments by customers of its wholesale business and the Company recorded a cumulative-effect adjustment which reduced retained earnings by $
46. Additionally, as of such date, the Company modified its accounting for certain metallic balloon sales of its wholesale segment and started to defer the recognition of revenue on such sales, and the related costs, until the balloons have been filled with helium. As a result, the Company recorded a cumulative-effect adjustment which increased retained earnings by $
8. Finally, as of such date, the Company adjusted its accounting for certain discounts on wholesale sales of seasonal product and the Company recorded a cumulative-effect adjustment which reduced retained earnings by $
40.
See Note 24, Revenue from Contracts with Customers, for further discussion of the adoption of the pronouncement and the Company’s revenue recognition policy.
Note 3-Store Impairment and Restructuring charges
Each year, the Company typically closes approximately ten Party City stores as part of its typical network rationalization process and in response to ongoing consumer, market and economic changes that naturally arise in the business. During the year
ended December 31
, 2019, the Company performed a comprehensive review of its store locations aimed at improving the overall productivity of such locations (“store optimization program”) and, after careful consideration and evaluation of the store locations, the Company made the decision to accelerate the optimization of its store portfolio with the closure of approximately 55 stores which are primarily located in close proximity to other Party City stores. These closings
are expected to provide the Company with capital flexibility to expand into underserved markets.
In conjunction with the store optimization program, during the year ended December 31, 2019, the Company recorded the following charges:
Such amounts represent the Company’s best estimate of the total charges that are expected to be recorded for such items. As the Company closes the stores, it records charges for common area maintenance, insurance and taxes to be paid subsequent to such closures in accordance with the stores’ lease agreements. However, such amounts are immaterial.
The fair values of the operating lease assets and property, plant and equipment were determined based on estimated future discounted cash flows for such assets using market participant assumptions, including data on the ability to sub-lease
the stores.
The charge for inventory reserves represents inventory that is disposed of following the closures of the stores and inventory that is sold below cost prior to such closures. The charge for inventory reserves was recorded in cost of sales in the Company’s statement of operations and comprehensive loss. The other charges were recorded in Store impairment and restructuring charges in the Company’s statement of operations and comprehensive loss.
The Company cannot guarantee that it will be able to achieve the anticipated benefits from the store optimization program. If the Company is unable to achieve such benefits, its results of operations and financial condition could be affected.
Note 4-Goodwill
The Company reviews goodwill and other intangibles that have indefinite lives for impairment annually as of October 1 or when events or changes in circumstances indicate the carrying value of these assets might exceed their current fair values. Impairment testing is based upon the best information available including estimates of fair value which incorporate assumptions marketplace participants would use in making their estimates of fair value. Significant assumptions and estimates are required, including, but not limited to, projecting future cash flows, determining appropriate discount rates and terminal growth rates, and other assumptions, to estimate the fair value of goodwill and indefinite lived intangible assets. Although the Company believes the assumptions and estimates made are reasonable and appropriate, different assumptions and estimates could materially impact its reported financial results.
During the three months ended September 30, 2019, and the three months ended December 31, 2019, the Company identified an impairment indicator associated with its market capitalization and performed impairment tests on the goodwill at its wholesale and retail reporting units and its other indefinite lived intangible assets as of September 30, 2019 and December 31, 2019. The Company recognized non-cash pre-tax goodwill impairment charges at September 30, 2019 of
$224,100 and $35,000 and at December 31, 2019, of $271,500 and $25,400, against the goodwill associated with its retail and wholesale reporting units, respectively.
Note 5-Sale/Leaseback Transaction
In June 2019, the Company sold its main distribution center in Chester, New York, its metallic balloons manufacturing facility in Eden Prairie, Minnesota and its injection molded plastics manufacturing facility in Los Lunas, New Mexico. Simultaneously, the Company entered into twenty-year leases for each of the facilities. The aggregate sale price was $128,000 and, during the year
ended December 31
, 2019, the Company recorded a $58,381 gain on the sale, net of transaction costs, in the Company’s condensed consolidated statement of operations and comprehensive loss.
Under the terms of the lease agreements, the Company will pay total rent of $8,320 during the first year and the annual rent will increase by 2% thereafter.
The Chester and Eden Prairie leases are being accounted for as operating leases and the sale of such properties is included in the gain above.
However, for the Los Lunas property, the present value of the lease payments is greater than substantially all of the fair value of the assets. Therefore, the lease is a finance lease and sale accounting treatment is prohibited. As such, the Company accounted for the proceeds as a financing lease. As of December 31, 2019, $11,990 is recorded in long-term obligations in the Company’s consolidated balance sheet.
In conjunction with the sale/leaseback transaction, the Company amended its Term Loan Credit Agreement. The amendment required the Company to use half of the proceeds from the transaction, net of costs, to paydown
part of the outstanding balance under such debt agreement. Additionally, the amendment required the Company to pay an immaterial “consent fee” to the lenders. As the Term Loan Credit Agreement is a loan syndication, the Company assessed, on a creditor-by-creditor
basis, whether the amendment should be accounted for as an extinguishment or a modification. The Company concluded that, for each creditor, the amendment should be accounted for as a modification. Therefore, no capitalized deferred financing costs or original issuance discounts were written off in conjunction with the amendment.
During June 2019, the Company used proceeds from the sale (net of costs) of $125,864
to paydown outstanding Term Loan debt of $62,770 with the balance used to paydown the ABL. See Note 12.
Note 6-Disposition of Assets
On October 1, 2019, the Company sold its Canadian-based Party City stores to a Canadian-based retailer for $131,711 and entered into a 10-year
supply agreement under which the acquirer agreed to purchase product from the Company for such Party City stores, as well as the acquirer’s other stores. The Company will use
the net proceeds to paydown debt. For the years ended December 31, 2019, 2018, and 2017, the Canadian-based Party City stores had pre-tax
income of $2,631, $10,737, and $8,947, respectively.
The Company recorded a $2,873 gain on sale
of assets
, which is reported in Other expense, net on the Consolidated Statement of Operations and Comprehensive
(L
oss)
Income.
Note 7-Inventories, Net
Inventories consisted of the following:
See Note 2, Summary of Significant Accounting Policies, for a discussion of the Company’s accounting policies for inventories.
Note 8-Property, Plant and Equipment, Net
Property, plant and equipment, net consisted of the following:
Depreciation expense related to property, plant and equipment, including assets under finance
leases, was $67,016, $66,304, and $68,209, for the years ended December 31, 2019, December 31, 2018, and December 31, 2017, respectively. Assets under finance
leases are principally included in machinery and equipment in the table above.
See Note 3 for detail regarding property, plant and equipment impairment.
Note 9-Acquisitions
During March 2018, the Company acquired 11 franchise stores, which are located in Maryland, for total consideration (including non-cash
consideration) of approximately $17,000. The following summarizes the fair values of the major classes of assets acquired and liabilities assumed: inventories of $3,500, property, plant and equipment of $200, a reacquired right intangible asset in the amount of $4,000, and an asset in the amount of $100 due to leases that are favorable when compared to market rates.
Also, during July 2018, the Company acquired an additional 16 franchise stores, which are located in Pennsylvania, for total consideration (including non-cash
consideration) of approximately $20,500. The following summarizes the fair values of the major classes of assets acquired and liabilities assumed: inventories of $4,200, property, plant and equipment of $500, a reacquired right intangible asset in the amount of $3,400, and an asset in the amount of $500 due to leases that are favorable when compared to market rates.
Additionally, during September 2018, the Company acquired 21 franchise stores, which are located in Minnesota, North Dakota and Texas, for total consideration (including non-cash
consideration) of approximately
$26,300. The following summarizes the fair values of the major classes of assets acquired and liabilities assumed: inventories of $7,500, property, plant and equipment of $500, a reacquired right intangible asset in the amount of $7,300, and an asset in the amount of $200 due to leases that are favorable when compared to market rates.
The allocation of the purchase price for the business combinations
was based on the Company’s estimate of the fair value of the assets acquired and liabilities assumed. Goodwill, which is tax-deductible,
arose due to numerous factors, including the wholesale profit generated via the sale of product from the Company’s wholesale operations through the acquired
stores. Goodwill also arose due to: the value to the Company of customers knowing that there are party stores in the locations (when the Company opens a new store, sales are initially lower than those of mature stores and increase over time), the Company’s ability to run the stores more efficiently than the franchisee based on the Company’s experience with its corporate-owned stores and the assembled workforce at the acquired
stores.
Also, during 2018, the Company entered into an agreement to acquire 11 independent stores, which are located in Texas. The Company will take control of the stores one at a time over a period of approximately two years. During 2018, the Company took control of eight of the 11 stores, for total business combination consideration of approximately $4,400. The
allocation of the purchase price was based on
the Company’s
estimate of
the fair value
of the
assets acquired and liabilities assumed
. Goodwill, which is tax-deductible,
arose due to numerous factors, including the wholesale profit generated via the sale of product from the Company’s wholesale operations through the stores. Due to the fact that the stores were independent stores and, therefore, possessed a relatively small percentage of inventory that came from the Company’s wholesale operations, going forward the Company will significantly increase such percentage. Additionally, goodwill arose due to: the value to the Company of customers knowing that there are party stores in the locations, the Company’s ability to run the stores more efficiently than the current operator based on the Company’s experience with its corporate-owned stores and the assembled workforce at the eight stores.
In 2019 the Company acquired the remainder of the 11 stores.
In November 2019
the Company acquired all of the stock of two European-based online retailers, Livario GmbH and Webdots GmbH, for total cash consideration of approximately
$9 million.
Pro forma financial information has not been presented because the impact of the acquisitions individually, and in the aggregate, is not material to the Company’s consolidated financial results.
Note 10-Intangible Assets
The Company had the following other identifiable finite-lived
intangible assets:
The Company is amortizing the majority of its intangible assets utilizing accelerated patterns based on the discounted cash flows that were used to value such assets. The amortization expense for finite-lived intangible
assets for the years ended December 31, 2019, December 31, 2018, and December 31, 2017 was $
14,100, $
12,271, and $
16,959, respectively. Estimated amortization expense for each of the next five years will be approximately $
10,720, $
8,803, $
5,975,
$4,658,
and $
4,036, respectively.
In addition to the Company’s finite-lived intangible assets, the Company
has recorded indefinite-lived intangible assets for the Party City trade name, the Amscan trade name, the Halloween City trade name, the
Christys
trade name, the Granmark trade name, the partycity.com domain name and the partydelights.co.uk domain name. During 2019, the Company recorded a Halloween City tradename impairment charge of $6,575.
Note 11-Loans and Notes Payable
ABL Facility
Prior to April 2019, the Company had a $540,000 asset-based revolving credit facility (with a seasonal increase to $640,000 during a certain period of each calendar year) (“ABL Facility”)
. During April 2019, the Company amended the ABL Facility. Such amendment removed the seasonal component and made the facility a $640,000 facility on a year-round basis. The ABL
Facility
matures
during August 2023 (subject to a springing maturity at an earlier date if the maturity date of certain of the Company’s other debt has not been extended or refinanced). It provides for (a) revolving loans, subject to a borrowing base described below, and (b) letters of credit, in an aggregate face amount at any time outstanding not to exceed $50,000.
Under the ABL Facility, the borrowing base at any time equals (a) a percentage of eligible trade receivables, plus (b) a percentage of eligible inventory, plus (c) a percentage of eligible credit card receivables, less (d) certain reserves.
The ABL Facility generally provides for two pricing options: (i) an alternate base interest rate (“ABR”) equal to the greater of (a) the prime rate, (b) the federal funds rate plus 0.5% or (c) the LIBOR rate plus 1%, in each case, on the date of such borrowing or (ii) a LIBOR based interest rate, in each case plus an applicable margin. The applicable margin ranges from 0.25% to 0.50% with respect to ABR borrowings and from 1.25% to 1.50% with respect to LIBOR borrowings.
In addition to paying interest on outstanding principal, the Company is required to pay a commitment fee of 0.25% per annum in respect of unutilized commitments. The Company must also pay customary letter of credit fees.
All obligations under the ABL Facility are jointly and severally guaranteed by PC Intermediate, PCHI and each existing and future domestic subsidiary of PCHI. PCHI and each guarantor has secured its obligations, subject to certain exceptions and limitations, including obligations under its guaranty, as applicable, by a first-priority lien on its accounts receivable, inventory, cash and certain related assets and a second-priority lien on substantially all of its other assets.
The facility contains negative covenants that, among other things and subject to certain exceptions, restrict the ability of PCHI to:
•
incur additional indebtedness;
•
pay dividends on capital stock or redeem, repurchase or retire capital stock;
•
make certain investments, loans, advances and acquisitions;
•
engage in transactions with affiliates;
•
create liens; and
•
transfer or sell certain assets.
In addition, PCHI must comply with a fixed charge coverage ratio if excess availability under the ABL Facility on any day is less than the greater of: (a) 10% of the lesser of the aggregate commitments and the then borrowing base under the ABL Facility and (b) $40,000. The fixed charge coverage ratio is the ratio of (i) Adjusted EBITDA (as defined in the facility) minus maintenance-related capital expenditures (as defined in the facility) to (ii) fixed charges (as defined in the facility).
The ABL Facility also contains certain customary affirmative covenants and events of default.
In connection with entering into and amending the ABL Facility, the Company incurred and capitalized third-party costs. All capitalized costs are being amortized over the life of the ABL Facility and are included in loans and notes payable in the Company’s consolidated balance sheet. The balance of related unamortized financing costs at December 31, 2019 was $1,992.
Borrowings under the ABL Facility totaled $129,350 at December 31, 2019. The weighted average interest rate for such borrowings was 5.19% at December 31, 2019. Outstanding standby letters of credit totaled $25,128 at December 31, 2019 and, after considering borrowing base restrictions, at December 31, 2019 PCHI had $350,033 of available borrowing capacity under the terms of the facility.
Other Credit Agreements
The Company’s subsidiaries have also entered into several foreign asset-based and overdraft credit facilities that provide the Company with additional borrowing capacity. At December 31, 2019 and 2018, there were $1,447 and $1,710 borrowings outstanding under the foreign facilities, respectively. The facilities contain customary affirmative and negative covenants.
Note 12-Long-Term Obligations
Long-term obligations consisted of the following:
Debt Amendments and Refinancing
The Term Loan Credit Agreement was amended in February 2018, lowering ABR and LIBOR margins to their current levels. 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 or a modification for each creditor and, during 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 operations and comprehensive (loss) 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 2018. The rest of the costs are being amortized over the term of the debt.
During August 2018, the Company executed a refinancing of its debt portfolio and issued $500,000 of new 6.625%
senior notes,
matu
ring
in 2026. The Company used the proceeds from the notes to: (i) reduce the outstanding balance under its existing ABL Facility, which is included in loans and notes payable on the
Company’s condensed consolidated balance sheet, by $90,000 and (ii) voluntarily prepay $400,000 of the
outstanding principal 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 (subject to a springing maturity at an earlier date if the maturity date of certain of the Company’s other debt has not been extended or refinanced).
As the partial prepayment of the Term Loan Credit Agreement was in accordance with the terms of such agreement, at the time of such prepayment the Company wrote-off
a pro-rata
portion of the existing capitalized deferred financing costs and original issuance discounts, $1,824, for investors who did not participate in the new notes. Such amount was recorded in other expense in the Company’s consolidated statement of operations and comprehensive (loss
)
income.
To the extent that investors in the Term Loan Credit Agreement participated in the new notes, the Company assessed whether the refinancing should be accounted for as an extinguishment on a creditor-by-creditor
basis and wrote-off
$968 of existing deferred financing costs and original issuance discounts. Such amount was recorded in other expense in the Company’s consolidated statement of operations and comprehensive (loss)
income.
Additionally, in conjunction with the issuance of the notes, the Company incurred third-party fees (principally banker fees). To the extent that such fees related to investors for whom their original debt was not extinguished, the Company expensed the portion of such fees, $2,270 in aggregate, that related to such investors.
Such amount was
recorded in other expense in the Company’s consolidated statement of operations and comprehensive (loss) income. The remainder of the third-party fees, $
6,230, have been capitalized and will be amortized over the remaining life of the debt using the effective interest method.
Further, in conjunction with the extension of the ABL Facility, the Company compared the borrowing capacities of the pre-amendment
facility and the post-amendment facility, on a creditor-by-creditor
basis, and concluded that $29 of existing deferred financing costs should be written-off.
Such amount was recorded in other expense in the Company’s consolidated statement of operations and comprehensive (loss)
income. The remaining capitalized costs, and $986 of new third-party costs incurred in conjunction with the extension, are being amortized over the revised term of the ABL Facility.
During June 2019, in conjunction with a sale/leaseback transaction, the Company amended the Term Loan Credit Agreement and financed its Los Lunas, New Mexico facility. See Note 5, Sales/Leaseback Transaction, for further detail. The finance lease obligations above
include $11,990 related to the Los Lunas, New Mexico facility.
Term Loan Credit Agreement
The Term Loan Credit Agreement, as amended,
provides for two pricing options for outstanding loans: (i) an ABR for any day, a rate per annum equal to the greater of (a) the prime rate in effect on such day, (b) the federal funds effective rate in effect on such day plus 0.5%, (c) the adjusted LIBOR rate plus 1% and (d) 1.75% or (ii) the LIBOR rate, with a LIBOR floor of 0.75%, in each case plus an applicable margin. The applicable margin for ABR and
LIBOR borrowings are
1.75% and
2.75%,
respectively, and will drop to 1.50% and 2.50%, respectively,
if
PCHI’s Senior Secured Leverage Ratio,
as defined by the agreement
, falls below 3.2 to 1.0
.
The term loans under the Term Loan Credit Agreement mature on August 19, 2022. The Company is required to repay installments on the loans in quarterly principal amounts of 0.25%, with the remaining amount payable on the maturity date.
Additionally, outstanding term loans are subject to mandatory prepayment, subject to certain exceptions, with (i) 100% of net proceeds above a threshold amount of certain asset sales/insurance proceeds, subject to
reinvestment rights and certain other exceptions, (ii)
100% of the net cash proceeds of any incurrence of debt other than debt permitted under the Term Loan Credit Agreement, and (iii)
50% of Excess Cash Flow, as defined
in the agreement, if any (reduced to
25% if PCHI’s first lien leverage ratio (as defined in the agreement) is less than
3.50 to
1.00, but greater than
2.50 to
1.00, and
0% if PCHI’s first lien leverage ratio is less than
2.50 to
1.00). As indicated in Note 5, the Company paid down Term Loan debt of $62,770. Additionally, in connection with the 2019 sale leaseback transaction and the sale of its Canadian retail operations, the Company is obligated to use net proceeds that remain uninvested on the anniversary date of each transaction to pay its term loan principal. Although there is no assurance that net proceeds will remain uninvested at the 2020 anniversary dates, the Company has classified an additional $58,000 of term loan principal as the current portion of long-term debt.
The term loans may be voluntarily prepaid at any time without premium or penalty, other than customary breakage costs with respect to loans based on the LIBOR rate.
All obligations
under the agreement are jointly and severally guaranteed by PC Intermediate, PCHI and each existing and future domestic subsidiary of PCHI. PCHI and each guarantor has secured its obligations, subject to certain exceptions and limitations, by a first-priority lien on substantially all of its assets (other than accounts receivable, inventory, cash and certain related assets), including a pledge of all of the capital stock held by PC Intermediate, PCHI and each guarantor, and a second-priority lien on its accounts receivable, inventory, cash and certain related assets.
The Term Loan Credit Agreement contains certain customary affirmative covenants and events of default. Additionally, it contains negative covenants which, among other things and subject to certain exceptions, restrict the ability of PCHI to:
• incur additional indebtedness;
• pay dividends on capital stock or redeem, repurchase or retire capital stock;
• make certain investments, loans, advances and acquisitions;
• engage in transactions with affiliates;
• create liens; and
• transfer or sell certain assets.
At December 31, 2019, the principal amount of term loans outstanding under the Term Loan Credit Agreement was $725,131. Such amount is recorded net of original issue discounts, capitalized call premiums and deferred financing costs on the Company’s consolidated balance sheet. At December 31, 2019, original issue discounts, capitalized call premiums and deferred financing costs totaled $6,535. At December 31, 2019, all outstanding borrowings were based on LIBOR and were at a weighted average interest rate of 4.22%.
6.125% Senior Notes-Due 2023 (“6.125% Senior Notes”)
The 6.125% Senior Notes mature on August 15, 2023. Interest on the notes is payable semi-annually in arrears on February 15 and August 15 of each year.
The notes are guaranteed, jointly and severally, on a senior basis by each of PCHI’s existing and future wholly-owned domestic subsidiaries. The notes and the guarantees are general unsecured senior obligations and are effectively subordinated to all other secured debt to the extent of the assets securing such secured debt.
The indenture governing the notes contains certain covenants limiting, among other things and subject to certain exceptions, PCHI’s ability to:
•
incur additional indebtedness or issue certain disqualified stock and preferred stock;
•
pay dividends or distributions, redeem or repurchase equity;
•
prepay subordinated debt or make certain investments;
•
engage in transactions with affiliates;
•
consolidate, merge or transfer all or substantially all of PCHI’s assets;
•
create liens; and
•
transfer or sell certain assets.
The indenture governing the notes also contains certain customary affirmative covenants and events of default.
The Company may redeem the notes, in whole or in part, at the following (expressed as a percentage of the principal amount to be redeemed):
Also, if the Company experiences certain types of change in control, as defined, the Company may be required to offer to repurchase the Senior Notes at 101% of their principal amount.
In connection with issuing the notes, the Company incurred and capitalized third-party costs. Capitalized costs are being amortized over the life of the debt and are included in long-term obligations, excluding current portion, in the Company’s consolidated balance sheet. At December 31, 2019,
$2,985 of costs were capitalized.
6.625% Senior Notes-Due 2026 (“6.625% Senior Notes”)
The 6.625% Senior Notes mature on August 1, 2026. Interest on the notes is payable semi-annually in arrears on February 1st and August 1st of each year.
The notes are guaranteed, jointly and severally, on a senior basis by each of PCHI’s existing and future wholly-owned domestic subsidiaries. The notes and the guarantees are general unsecured senior obligations and are effectively subordinated to all other secured debt to the extent of the assets securing such secured debt.
The indenture governing the notes contains certain covenants limiting, among other things and subject to certain exceptions, PCHI’s ability to:
•
incur additional indebtedness or issue certain disqualified stock and preferred stock;
•
pay dividends or distributions, redeem or repurchase equity;
•
prepay subordinated debt or make certain investments;
•
engage in transactions with affiliates;
•
consolidate, merge or transfer all or substantially all of PCHI’s assets;
•
create liens; and
•
transfer or sell certain assets.
The indenture governing the notes also contains certain customary affirmative covenants and events of default.
On or after August 1, 2021, the Company may redeem the notes, in whole or in part, at the following (expressed as a percentage of the principal amount to be redeemed):
In addition, the Company may redeem up to
40% of the aggregate principal amount outstanding on or before August 1, 2021 with the cash proceeds from certain equity offerings at a redemption price of 106.625% of the principal amount. The Company may also redeem some or all of the notes before August 1, 2021 at a redemption price of 100% of the principal amount plus a premium that is defined in the indenture.
Also, if the Company experiences certain types of change in control, as defined, the Company may be required to offer to repurchase the notes at 101% of their principal amount.
In connection with issuing the notes, the Company incurred and capitalized third-party costs. Capitalized costs are being amortized over the life of the debt and are included in long-term obligations, excluding current portion, in the Company’s consolidated balance sheet. At December 31, 2019, $5,090 of costs were capitalized.
Finance Lease Obligations
Additionally, the Company has entered into various finance leases for building, machinery
and equipment. At December 31, 2019 and December 31, 2018 the balances of such leases were $14,990 and $3,815, respectively.
Other
Subject to certain exceptions, PCHI may not make certain payments, including the payment of dividends to its shareholders (“restricted payments”), unless certain conditions are met under the terms of the indentures governing the senior notes, the ABL Facility and the Term Loan Credit Agreement. As of December 31, 2019, the most restrictive of these conditions existed in the Term Loan Credit Agreement, which limits restricted payments based on PCHI’s consolidated net income and leverage ratios. As of December 31, 2019, PCHI had $141,694 of capacity under the debt instrument to make restricted payments. PCHI’s parent companies, PC Intermediate, PC Nextco and Party City Holdco, have no assets or operations other than their investments in their subsidiaries and income from those subsidiaries.
At December 31, 2019, maturities of long-term obligations consisted of the following:
Note 13-Capital Stock
At December 31, 2019, 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.
The changes in common shares outstanding during the three years ended December 31, 2017, December 31, 2018, and December 31, 2019 were as follows:
During the year ended December 31, 2019, the Company purchased
15,679 treasury shares for
$156 from its employees to cover federal and state and other tax withholdings associated with the vesting of restricted stock and restricted stock units. Additionally, during the year ended December 31, 2018, the Company acquired
3,785,658 treasury shares for $40,197. The shares are included in “common stock held in treasury” in the Company’s consolidated balance sheet.
Note 14-Other Expense, net
Note 15-Employee Benefit Plans
Certain subsidiaries of the Company maintain defined contribution plans for eligible employees. The plans require the subsidiaries to match from approximately 11% to 100% of voluntary employee contributions to the plans, not to exceed a maximum amount of the employee’s annual salary, ranging from 5% to 6%. Expense for the plans for the years ended December 31, 2019, December 31, 2018, and December 31, 2017 totaled $7,944, $6,454, and $6,565, respectively.
Note 16-Equity Incentive Plans
Party City Holdco has adopted the Amended and Restated 2012 Omnibus Equity Incentive Plan (the “2012 Plan”) under which it can grant incentive awards in the form of stock appreciation rights, restricted stock,
restricted stock units and
common stock options to certain directors, officers, employees and consultants of Party City Holdco and its affiliates. A committee of Party City Holdco’s Board of Directors, or the Board itself in the absence of a committee, is authorized to make grants and various other decisions under the 2012 Plan. The maximum number of shares reserved under the 2012 Plan is 15,316,000 shares.
Time-based options
Party City Holdco grants time-based options to key eligible employees and outside directors. In conjunction with the options, the Company recorded compensation expense of $1,319, $1,744, and $5,309 during the years ended December 31, 2019, December 31, 2018, and December 31, 2017, respectively.
The fair value of time-based options granted during the year ended December 31, 2019 was estimated on the grant date using a Black-Scholes option valuation model based on the assumptions in the following table:
As Party City Holdco’s stock only recently started trading publicly, the Company determined volatility based on the average historical volatility of guideline companies. Additionally, as there is not sufficient historical exercise data to provide a reasonable basis for determining the expected terms of the options, the Company estimated such expected terms based on the assumption that options will be exercised at the mid-point
of the vesting of the options and the completion of the contractual lives of such options.
The Company has based its estimated forfeiture rate on historical forfeitures for time-based options as the number of options given to each of the various levels of management is principally consistent with historical grants and forfeitures are expected to be materially consistent with past experience.
The Company’s time-based options principally vest 20% on each anniversary date. The Company records compensation expense for such options on a straight-line basis. As of December 31, 2019, there was $1,893 of unrecognized compensation cost, which will be recognized over a weighted-average period of approximately 30 months.
Performance-based options
During 2013, Party City Holdco granted performance-based stock options to key employees and independent directors. For performance-based options, vesting is contingent upon Thomas H. Lee Partners, L.P. (“THL”) achieving specified investment returns when it sells its ownership stake in Party City Holdco. Since the sale of all
THL’s shares cannot be assessed as probable before it occurs, no compensation expense has been recorded for the performance-based options that have been granted. As of December 31, 2019, 2,808,400 performance-based options were outstanding.
Based on a Monte Carlo simulation and the following assumptions, the options have an average grant date fair value of $3.09 per option:
As Party
City Holdco’s stock was not publicly traded when the performance-based options were granted, the Company determined volatility based on the average historical volatility of guideline companies.
The following table summarizes the changes in outstanding stock options for the years ended December 31, 2017, December 31, 2018, and December 31, 2019.
The intrinsic value of options exercised was $1,254, $3,351 and $1,972 for the years ended December 31, 2019, December 31, 2018, and December 31, 2017, respectively. The fair value of options vested was $2,118, $2,819, and $4,354, during the years ended December 31, 2019, December 31, 2018, and December 31, 2017, respectively.
Restricted stock and Restricted Stock Units
During 2018, the Company started granting restricted stock and restricted stock units to certain executives, senior leaders and the Company’s independent directors. To the extent that the awards vest, the participants receive shares of the Company’s stock.
Of the awards that were granted, 358,506 awards vest solely based on service conditions. To the extent that such awards vest, one share of stock is issued for each award.
Additionally, the Company granted awards which vest if certain cash flow and earnings per share targets are met. Depending on the achievement of such targets, a maximum of 2,834,390 shares could be issued due to such awards.
The service-based awards vested 1/3 on January 1, 2019 and will vest 1/3 each on January 1, 2020 and January 1, 2021. During the years
ended December 31, 2019 and December 31,
2018, the Company recorded $2,033 and
$1,174 of compensation expense related to the service-based awards, respectively
.
The performance-based awards vest if certain cash flow and earnings per share targets are met for the three-year period from January 1, 2018 to December 31, 2020. The Company recognizes compensation expense for
such awards if it is probable that the performance conditions will be achieved. Based on the Company’s results for the year ended December 31, 2019 and December 31, 2018 and its projections for the year ending December 31, 2020, as of December 31, 2019 the Company concluded that it was not probable that such performance conditions will be met and, therefore, the Company did not record any compensation expense for the awards during the years ended December 31, 2019 and December 31, 2018.
The Company has based its estimated forfeiture rate for the restricted stock units and restricted stock
on historical forfeitures for the Company’s time-based stock options as the number of awards given to each of the various levels of management is principally consistent with historical stock option grants and forfeitures are expected to be materially consistent with past experience.
As of December 31, 2019 and December 31, 2018, there were $2,158 and
$
1,817 of unrecognized compensation cost for the service-based awards, respectively
.
Note 17-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”). I
n
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,
and
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. During the fourth quarter of 2018, the Company finalized its assessment of the impact of the Act on the Company’s domestic net deferred tax liabilities and deferred tax assets and recorded an income tax benefit of $2,049,
as well as
additional income tax expense of $151 related to the Transition Tax
.
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. The Company has elected to account for GILTI in the year during which the tax is incurred.
A summary of domestic and foreign income before income taxes follows:
The income tax expense (benefit) consisted of the following:
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
Deferred income tax assets and liabilities consisted of the following:
(1) In accordance with ASC 842, deferred rent and lease incentives are part of the Lease Right of Use Assets as of 2019.
The Company nets all of its deferred income tax assets and liabilities on a jurisdictional basis and classifies them as noncurrent on the balance sheet. In the Company’s December 31, 2019 consolidated balance sheet,
$20 was included in “other assets, net” and $126,081 was included in deferred income tax liabilities. In the Company’s December 31, 2018 consolidated balance sheet,
$
1,008 was included in “other assets, net” and $
174,427 was included in deferred income tax liabilities.
Management assesses the available positive and negative evidence to estimate if sufficient taxable income will be generated to realize existing deferred tax assets. On the basis of this evaluation, a valuation allowance was recorded to reduce the total deferred tax assets to an amount that will, more-likely-than-not,
be realized in the future. The change in the
valuation allowance
primarily relates
to carryfor
wards
of
foreign and state
net operating losses,
and the ending balance also includes
foreign tax credit carryforwards.
As of December 31, 2019, the Company had foreign tax-effected
net operating loss carryforwards in Germany of $9,134, the United Kingdom of $4,269, and Australia of $599, all of which have an unlimited carryforward; as well as $1,872 from other foreign countries, which expire at different dates. In addition, the U.S. federal net operating loss carryforwards begin to expire in 2032, the U.S. state net operating loss carryforwards begin to expire in 2022 and the foreign tax credit carryforwards begin to expire in 2020.
The difference between the Company’s effective income tax rate and the U.S. statutory income tax rate is as follows:
Transition
Tax on Unremitted Foreign Earnings:
As a result of the Act, the U.S. transitioned from a worldwide system of international taxation
to a territorial tax system, thereby eliminating the U.S. federal tax on foreign earnings. However, the Act required a one-time
deemed repatriation tax on such earnings and, accordingly, during the fourth quarter of 2017, the Company provisionally recorded a Transition Tax of $11,500 related to such requirement. Prior to the fourth quarter of 2017, the Company recorded deferred income tax liabilities for certain foreign earnings which were expected to be remitted to the U.S. in future periods. Therefore, the expense that was recorded due to the deemed repatriation tax, $11,500, was mostly offset by the reversal of previously recorded deferred income tax liabilities on unremitted foreign earnings, $10,368. During the fourth quarter of 2018, the Company finalized its assessment of the Transition Tax and recorded additional income tax expense of $151. At December 31, 2019,
$4,205 of the Transition Tax remains unpaid and is recorded in “O
ther long-term liabilities” in the Company’s consolidated balance sheet. The Company has elected to pay the
Transition
Tax over eight annual installments without interest. A deferred tax liability, in the amount of $1,177, is recorded on the Company’s consolidated balance sheet due to the impact of foreign withholding taxes and state income taxes on the future repatriation of certain foreign earnings. No provision has been made for deferred taxes related to any other remaining historical outside basis differences in the Company’s non-U.S.
subsidiaries.
Effect of the Act on Federal Deferred Income Tax Assets and Liabilities:
The deferred federal income tax benefit for the year ended December 31, 2017 includes a $90,965 provisional benefit due to the Act changing the U.S. corporate income tax rate from 35% to 21%. During the fourth quarter of 2018, the Company finalized its assessment of the impact of the Act on the Company’s domestic net deferred tax liabilities and deferred tax assets and recorded an income tax benefit of $2,049. See above for further discussion.
Goodwill Impairment:
During the third and fourth
quarters
of 2019, the Company recognized non-cash
goodwill impairment charges
totaling
$556,056. No tax benefit was recognized on $455,689 of the charge, resulting in a 17.9% unfavorable impact to the income tax rate.
Other differences between the effective income tax rate and the federal statutory income tax rate are composed primarily of reserves for unrecognized tax benefits, non-deductible
meals and entertainment expenses, benefits related to the exercise of stock options, and the Work Opportunity Tax Credit.
The following table summarizes the activity related to the Company’s gross unrecognized tax benefits:
The Company’s total unrecognized tax benefits that, if recognized, would impact the Company’s effective tax rate were $4,891 and $1,320 at December 31, 2019 and 2018, respectively. As of December 31, 2019, it is reasonably possible that the total amount of unrecognized tax benefits could
decrease by approximately $3,000
within the next 12 months.
The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company has accrued $618 and $129 for the potential payment of interest and penalties at December 31, 2019 and 2018, respectively. Such amounts are not included in the table above.
The IRS is currently conducting an examination of the year ended December 31, 2015. For U.S. state income tax purposes, tax years 2015
generally remain open; whereas for non-U.S.
income tax purposes, tax years 2014
generally remain open.
Note 18-Commitments, Contingencies and Related Party Transactions
Litigation
The Company is a party to certain claims and litigation in the ordinary course of business. The Company does not believe that any of these proceedings will result, individually or in the aggregate, in a material adverse effect upon its financial condition or future results of operations.
Product Royalty Agreements
The Company has entered into product royalty agreements, with various licensors of copyrighted and trademarked characters and designs, which are used on the Company’s products, which require royalty payments based on sales of the Company’s products, and, in some cases, include annual minimum royalties.
At December 31, 2019, the Company’s commitment to pay future minimum product royalties was as follows:
Product royalty expense for the years ended December 31, 2019, December 31, 2018, and December 31, 2017 was $48,170, $51,002, and $46,242, respectively.
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 19-Segment Information
Industry Segments
The Company has two identifiable business segments. The Wholesale segment designs, manufactures, contracts for manufacture and distributes party goods, including paper and plastic tableware, metallic and latex balloons, Halloween and other costumes, accessories, novelties and stationery throughout the world. The Retail segment operates specialty retail party supply stores in the United States, principally under the names Party City and Halloween City, and it operates e-commerce
websites, principally through the domain name PartyCity.com.
The Company’s industry segment data for the years ended December 31, 2019, December 31, 2018, and December 31, 2017 are as follows:
Geographic Segments
Export sales of metallic balloons of $22,728, $23,567, and $22,812 during the years ended December 31, 2019, December 31, 2018, and December 31, 2017, respectively, are included in domestic sales to unaffiliated customers below. Intercompany sales between geographic areas primarily consist of sales of finished goods and are generally made at cost plus a share of operating profit.
The Company’s geographic area data follows:
Note 20-Quarterly Results (Unaudited)
Despite a concentration of holidays in the fourth quarter of the year, as a result of the Company’s expansive product lines and customer base and increased promotional activities, the impact of seasonality on the quarterly results of the Company’s wholesale operations has been limited. However, due to Halloween and Christmas, the inventory balances of the Company’s wholesale operations are slightly higher during the third quarter than during the remainder of the year. Additionally, the promotional activities of the Company’s wholesale business, including special dating terms, particularly with respect to Halloween products sold to retailers and other distributors, result in slightly higher accounts receivable balances during the third quarter. The Company’s retail operations are subject to significant seasonal variations. Historically, the Company’s retail operations have realized a significant portion of their revenues, cash flow and net income in the fourth quarter of the year, principally due to Halloween sales in October and, to a lesser extent, year-end
holiday sales.
The following
table sets forth our historical revenues, gross profit, (loss) income from operations, net (loss) income, net (loss) income attributable to common shareholders of Party City Holdco Inc., and net (loss) income per share attributable to common shareholders of Party City Holdco Inc.-Basic and Diluted for each of the following quarters:
Note 21-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. Additionally, at such time, the Company received the ability to “call” the interest of the other investors. During the twelve months ended December 31, 2019, the option was terminated, and the Company wrote off its asset related to the call option and reversed its liability related to the put option. Prior to such time, the Company had been adjusting the put liability to fair value on a recurring basis. The liability represented a Level 3 fair value measurement as it was based on unobservable inputs. In November 2019, the Company sold its ownership interest in Punchbowl. The Company recorded a net charge of $2,169 in other expenses, net for the option termination and the sale of its ownership interest.
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. On a recurring basis, the liability
is adjusted to the greater of the current fair value or the original fair value at the time at which the ownership interest was issued (adjusted for any subsequent changes in the ownership interest percentage). As of December 31, 2019 and December 31, 2018 the original value was greater than the fair value, thus a table is not provided for December 31,
2019. In addition, the Company has no material derivative assets and liabilities as of
December 31, 2019.
The following table shows assets and liabilities as of December 31, 2018 that are measured at fair value on a recurring basis:
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 December 31, 2019 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 December 31, 2019 are as follows:
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 December 31, 2019 based on the discounted future cash flows of each instrument at rates currently offered for similar debt instruments of comparable maturity.
Note 22-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 years ended December 31, 2019, December 31, 2018, and December 31, 2017.
Foreign Exchange Risk Management
A portion of the Company’s cash flows is 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 consolidated balance sheets at fair value. At December 31, 2019 and 2018, 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 March 2020.
The following table displays the fair values of the Company’s derivatives at December 31, 2019 and December 31, 2018:
(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 December 31, 2019 and December 31, 2018:
Note 23-Changes in Accumulated Other Comprehensive Loss
The changes in accumulated other comprehensive loss consisted of the following:
Note 24-Revenue from Contracts with Customers
In May 2014, the FASB issued ASU 2014-09,
“Revenue from Contracts with Customers (Topic 606)”. The pronouncement contains a five-step model which replaces most existing revenue recognition guidance. The Company adopted the standard on January 1, 2018 via a modified retrospective approach and recognized the cumulative effect of the adoption as an adjustment to January 1, 2018 retained earnings.
Revenue Transactions-Retail
Revenue from retail store operations is recognized at the point of sale as control of the product is transferred to the customer at such time. Retail e-commerce
sales are recognized when the consumer receives the product as control transfers upon delivery. Due to its extensive history operating as the largest party goods retailer in North America, the Company has sufficient history with which to estimate future retail sales returns and it uses the expected value method to estimate such activity.
The transaction price for the majority of the Company’s retail sales is based on either: 1) the item’s stated price or 2) the stated price adjusted for the impact of a coupon which can only be applied to such
transaction. To the extent that the Company charges customers for freight costs on e-commerce
sales, the Company records such amounts in revenue. The Company has chosen the pronouncement’s policy election which allows it to exclude all sales taxes and value-added taxes from revenue.
Under the terms of its agreements with its franchisees, the Company provides both: 1) brand value (via significant advertising spend) and 2) support with respect to planograms, in exchange for a royalty fee that ranges from 4% to 6% of the franchisees’ sales. The Company records the royalty fees at the time that the franchisees’ sales are recorded. Additionally, although the Company anticipates that future franchise store openings will be limited, when a franchisee opens a new store, the Company receives and records a one-time
fee which is earned by the Company for its assistance with site selection and development of the new location. Both the sales-based royalty fee and the one-time
fee are recorded in royalties and franchise fees in the Company’s consolidated statement of operations and comprehensive (loss)
income.
Revenue Transactions-Wholesale
For most of the Company’s wholesale sales, control transfers upon the Company’s shipment of the product. 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.
In most cases, the determination of the transaction price is fixed based on the contract and/or purchase order. 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. Due to its extensive history operating as a leading party goods retailer, the Company has sufficient history with which to estimate such amounts.
Other Revenue Topics
During the years ended December 31, 2019, December 31, 2018, and December 31, 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 years ended December 31, 2019, December 31, 2018, and December 31, 2017:
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 year ended December 31, 2018
as it decreased pre-tax
income by $22 during the period.
Note 25-Kazzam, LLC
During the first quarter of 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. The website allows consumers to select, schedule and pay for various services (including entertainment, activities and food) all through a single portal.
Although the Company currently owns only 26% of Kazzam’s equity, the Company has concluded that: a) Kazzam is a variable interest entity as it has insufficient equity at risk, and b) the Company is its primary beneficiary. Therefore, the Company has consolidated Kazzam into the Company’s financial statements. Further, as the Company is currently funding all of Kazzam’s start-up
activities via a loan to Kazzam (which will be repaid when the venture is profitable), the Company is recording 100% of Kazzam’s operating results in “development stage expenses” in the Company’s consolidated statement of operations and comprehensive (loss)
income.
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 in 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.
In January 2020, the Company and Ampology terminated certain services agreements and warrants that Ampology had in the Company stock. The parties concurrently entered into an interim transition agreement for which expenses are recorded
as development stage expenses.
Note 26-Leases
In February 2016, the FASB issued ASU 2016-02,
“Leases”. The ASU requires that companies recognize assets and liabilities for the rights and obligations created by the companies’ leases. The update was effective for the Company during the first quarter of 2019.
The FASB has provided companies with a transition option under which they can opt to continue to apply the legacy guidance, including its disclosure requirements, in the comparative periods presented in the year during which they adopt the new lease standard. Entities that elect the option only make annual disclosures for the comparative periods as legacy guidance does not require interim disclosures. The Company has elected this transition option.
Practical Expedients/Policy Elections
Under the new standard, companies may elect the following practical expedients, which must be elected as a package and applied consistently to all leases:
1. An entity need not reassess whether any expired or existing contracts are or contain leases.
2. An entity need not reassess the lease classification for any expired or existing leases.
3. An entity need not reassess initial direct costs for any existing leases.
The Company elected this package of practical expedients.
Under the new standard, an entity may also elect a practical expedient to use hindsight in determining the lease term and in assessing impairment of the entity’s right-of-use
assets. The Company did not elect this practical expedient.
Additionally
, under the new standard, lessees can make an accounting policy election (by class of underlying asset to which the right of use relates) to apply accounting similar to legacy accounting to leases that meet the new standard’s definition of a “short-term lease” (a lease that, at the commencement date, has a lease term of twelve months or less and does not include an option to purchase the
underlying asset that the lessee is reasonably certain to exercise). The Company has made this election for all classes of underlying assets.
Further, the new standard provides a practical expedient that permits lessees to make an accounting policy election (by class of underlying asset) to account for each separate lease component of a contract and its associated non-lease
components as a single lease component. The Company has elected this expedient for all asset classes, with the exception of its real estate.
Lease Population
The Company’s lease portfolio is primarily comprised of real estate leases for its permanent Party City stores. The Company also leases manufacturing facilities, distribution facilities, warehouse space and office space. Additionally, the Company enters into short leases (generally less than four months) in order to operate its temporary stores. Further, the Company enters into leases of equipment, copiers, printers and automobiles.
Substantially all of the Company’s leases are operating leases.
The Company’s finance leases are immaterial. The right-of-use
asset for the Company’s finance leases is included in Property, plant and equipment, net on the Company’s consolidated balance sheet. The liabilities for the Company’s finance leases are included in Current portion of long-term obligations and Long-term obligations, excluding current portion, on the Company’s consolidated balance sheet.
The Company’s sub-leases
are also immaterial.
Variable Lease Payments
A limited number of the Company’s store leases require rent to be paid based on sales levels. The Company’s cost for such leases is immaterial. Variable lease consideration is not included in lease payments until the contingency is resolved.
Additionally, for most store leases, the Company pays variable taxes and insurance.
Renewal Options
Many of the Company’s store leases, and certain of the Company’s other leases, contain renewal options. However, the renewal periods are generally not included in the right-of-use
assets and lease liabilities for such leases as exercise of the options is not reasonably certain.
Discount Rates
The Company is unable to determine the discount rates that are implicit in its operating leases. Therefore, for such leases, the Company is utilizing its incremental borrowing rate.
For leases that existed as of January 1, 2019, the Company determined the applicable
incremental borrowing rates for such leases based on the remaining lease terms for the leases as of such date.
Quantitative Disclosures
During the year
ended December
, 2019, the Company’s operating lease cost was $204,466. Such amount excludes impairment charges recorded in conjunction with the Company’s store optimization program (see Note 3, Store Impairment and Restructuring Charges).
The Company’s variable lease cost during the year
ended December
, 2019 was $30,817.
During the year
ended December
, 2019, cash paid for amounts included in the measurement of operating lease liabilities was $197,574.
During the year
ended December
, 2019, right-of-use
assets obtained in exchange for new operating lease liabilities were $195,687.
As of December
, 2019, the weighted-average remaining lease term for operating leases was eight years and the weighted-average discount rate for operating leases was 6.7%.
As of December
, 2019, the future cash flows for the Company’s operating leases were:
Note 27-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 year ended December 31, 2017 has been adjusted to include $155 of restricted cash at December 31, 2016 and $117 of restricted cash at December 31, 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 year ended December 31, 2017, the change in “prepaid expenses and other current assets” has been adjusted from a cash outflow of $9,079 to a cash outflow of $9,117.
The
Company’s December 31, 2019 consolidated balance sheet included
$34,917 of cash and
cash equivalents
and $259 of restricted cash, and
the
Company’s December 31, 2018 consolidated balance sheet included $58,909 of cash and cash equivalents and $310 of restricted cash.
Restricted cash is recorded in “prepaid expenses and other current assets”.
SCHEDULE I-CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARTY CITY HOLDCO INC.
(Parent company only)
CONDENSED BALANCE SHEETS
(Dollars in thousands)
See accompanying notes to these condensed financial statements.
PARTY CITY HOLDCO INC.
(Parent company only)
CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS) INCOME
(Dollars in thousands)
See accompanying notes to these condensed financial statements.
PARTY CITY HOLDCO INC.
(Parent company only)
CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
See accompanying notes to these condensed financial statements.
PARTY CITY HOLDCO INC. (Parent company only)
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands)
Note 1-Basis of presentation and description of registrant
Party City Holdco Inc. (“Party City Holdco”) Schedule I, Condensed Financial Information of Registrant, provides all parent company information that is required to be presented in accordance with the SEC rules and regulations for financial statement schedules. The consolidated financial statements of Party City Holdco are included elsewhere. The parent-company financial statements should be read in conjunction with the consolidated financial statements and the notes thereto.
Party City Holdco does not conduct any separate operations and acts only as a holding company. Its share of the net income of its unconsolidated subsidiaries is included in its statements of income using the equity method.
Since all material stock requirements, dividends and guarantees of the registrant have been disclosed in the consolidated financial statements, the information is not required to be repeated in this schedule.
Note 2-Dividends from subsidiaries
No cash dividends were paid to Party City Holdco by its subsidiaries during the years included in these financial statements.
SCHEDULE II
PARTY CITY HOLDCO INC.
VALUATION AND QUALIFYING ACCOUNTS
The Years Ended December 31, 2017, December 31, 2018, and December 31, 2019
(Dollars in thousands)
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2019. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e)
and 15d-15(e)
under the Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on the evaluation of our disclosure controls and procedures as of December 31, 2019, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f)
and 15d-15(f) promulgated under the Exchange Act, as a process designed by, or under the supervision of a company’s chief executive officer and chief financial officer, or persons performing similar functions, and effected by a company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
• pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company;
• provide reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
• provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the consolidated financial statements.
In designing and evaluating our disclosure controls and procedures, we and our management recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their stated objectives. We review on an ongoing basis and document our disclosure controls and procedures, and our internal control over financial reporting, and we may from time to time make changes in an effort to enhance their effectiveness and ensure that our systems evolve with our business.
Under the supervision of our Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of our internal control over financial reporting based on the framework in Internal Control-
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on the evaluation performed, management concluded that its internal control over financial reporting, based on the COSO framework, was effective, at the reasonable assurance level, as of December 31, 2019. Our independent registered public accounting firm, Ernst & Young LLP, issued an attestation report on the effectiveness of our internal control over financial reporting. The Ernst & Young LLP report is included in Item 8 of this Annual Report on Form 10-K.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f)
and 15d-15(f)
under the Exchange Act) during the quarter ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information
On March 11, 2020, Brad Weston was appointed as the Chief Executive Officer of Party City Holdco Inc. (the “Company”) and Party City Holdings Inc. (“Holdings”), replacing James Harrison, who will retire as the Chief Executive Officer of the Company and Holdings. The transitions are each effective April 1, 2020. Mr. Harrison will remain employed as the Vice Chairman of the Company and Holdings, providing certain strategic and advisory services and reporting to the board of directors of the Company (the “Board”). Mr. Weston was also elected to the Board, effective April 1, 2020.
Mr. Weston, age 54, has served as President of the Company and Chief Executive Officer of Party City Retail Group since July 2019. Previously, Mr. Weston served as the President and Chief Officer Petco Holdings Inc. (“Petco”) from January 2017 through June 2018. Before that, he served in a number of other roles at Petco, holding the position of President and Chief Merchandising Officer from June 2015 to January 2018 and earlier as Executive Vice President and Chief Merchandising Officer from 2012 through June 2015. Prior to joining Petco, Mr. Weston spent five years in a variety of roles at Dick’s Sporting Goods, most recently as Chief Merchandising Officer. Mr. Weston started his career at May Department Stores, where he held numerous roles of increasing responsibility from 1988 through 2006. Mr. Weston currently serves on the board of directors of Boot Barn Holdings, Inc. and the National Retail Federation. Mr. Weston holds a bachelor of science degree in business administration from the University of California, Berkeley
In connection with his promotion to Chief Executive Officer of the Company and Holdings, Mr. Weston has entered into an amended and restated employment agreement with the Company and Holdings, dated as of March 11, 2020 and effective April 1, 2020. Under his amended and restated employment agreement, Mr. Weston’s base salary was increased to $1,050,000. The other material terms of Mr. Weston’s employment agreement remained the same.
Mr. Harrison also entered into an amended and restated employment agreement with the Company and Holdings, dated as of March 11, 2020 and effective April 1, 2020. Under his amended and restated employment agreement, Mr. Harrison will serve as the Vice Chairman of the Company and Holdings through December 31, 2021, unless earlier terminated as provided for in the agreement (the “Initial Employment Period”). The parties may extend the Initial Employment Period (or any subsequent renewal) by one year upon mutual written agreement. The Initial Employment Period, along with any subsequent renewal period, is referred to as the “Employment Period.”
During the Employment Period, Mr. Harrison will receive an annual base salary of $750,000. Mr. Harrison will be eligible for an annual bonus for 2020, with a target amount of $277,169 and a maximum amount of $554,339, reflecting his annual base salary and target annual bonus for the portion of 2020 during which he served as the Chief Executive Officer of the Company and Holdings. He will receive a grant of 200,000 stock options (the “2020 Option Grant”) with a per share exercise price equal to the greater of $3.00 per share or the
closing price of a share of the Company’s stock on March 31, 2020, with 50% of the 2020 Option Grant vesting on December 31, 2020 and the remaining 50% of the 2020 Option Grant vesting on December 31, 2021, in each case, generally subject to Mr. Harrison’s continued employment through the applicable vesting date. Any vested stock options held by Mr. Harrison as of April 1, 2020 will remain exercisable until their expiration date (unless Mr. Harrison’s employment is terminated for cause (or the Board determines cause exists at the time his employment terminates) or he breaches his restrictive covenants, in which cases his options would be forfeited). Any restricted stock units (including performance stock units) of the Company held by Mr. Harrison as of April 1, 2020 will remain eligible to vest during the Employment Period and, if he remains employed through December 31, 2021, remain eligible to vest (subject to their otherwise applicable terms) thereafter as if he had remained employed with the Company and Holdings.
If Mr. Harrison’s employment is terminated by the Company and Holdings without cause during the Employment Period, subject to his execution and non-revocation of a release of claims, he will continue to receive his annual base salary through the end of the Employment Period and his 2020 Option Grant, other stock options and restricted stock units (including performance stock units) will remain eligible to vest as if he had remained employed through each applicable vesting date. Mr. Harrison will be subject to non-competition, non-solicitation and non-disparagement restrictions during his employment and for a period of 24 months thereafter and will be subject to a perpetual restriction on the disclosure of confidential information.
The foregoing is only a brief description of the material terms of the amended and restated employment agreements for Mssrs. Harrison and Weston and is qualified in its entirety by reference to the amended and restated employment agreements for Mssrs. Harrison and Weston, filed as Exhibit 10.2 and Exhibit 10.30 hereto, respectively.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
Executive Officers of the Registrant
The information required by this item will be set forth in our proxy statement for our 2020 Annual Meeting of shareholders (to be filed within 120 days after December 31, 2019) (the “Proxy Statement”), and is incorporated herein by reference.
Item 11.
Item 11.
Executive Compensation
Information required by this item will be set forth in our Proxy Statement, and is incorporated herein by reference.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information required by this item will be set forth in our Proxy Statement, and is incorporated herein by reference.
Item 13.
Item 13.
Certain Relationships and Related Party Transactions and Director Independence
Information required by this item will be set forth in our Proxy Statement, and is incorporated herein by reference.
Item 14.
Item 14.
Principal Accountant Fees and Services
Information required by this item will be set forth in our Proxy Statement, and is incorporated herein by reference.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
The following documents are filed as part of this report.
1. Financial Statements
. The financial statements are set forth under Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.
2. Financial Statement Schedules
. Schedule I, Condensed Financial Information of Registrant, and Schedule II, Valuation and Qualifying Accounts, is filed as part of this Annual Report on Form 10-K
and should be read in conjunction with the financial statements and notes thereto contained in Item 8, “Financial Statements and Supplementary Data.”
All other financial statements and financial statement schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instruction, are not material or are not applicable and, therefore, have been omitted.
3.
Exhibits
.
Exhibit Index
† Management contract of compensatory plan or arrangement
* Filed herewith.
Item 16.
Form 10-K
Summary
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: March 12, 2020
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
Signature
Title
Date
/s/ James M. Harrison
James M. Harrison
Chief Executive Officer and Director
(Principal Executive Officer)
March 12, 2020
/s/ Todd Vogensen
Todd Vogensen
Chief Financial Officer
(Principal Financial Officer)
March 12, 2020
/s/ Michael A. Correale
Michael A. Correale
Chief Accounting Officer
(Principal Accounting Officer)
March 12, 2020
/s/ Norman S. Matthews
Norman S. Matthews
Chairman of the Board and Director
March 12, 2020
/s/ Todd M. Abbrecht
Todd M. Abbrecht
Director
March 12, 2020
/s/ Steven J. Collins
Steven J. Collins
Director
March 12, 2020
/s/ James G. Conroy
James G. Conroy
Director
March 12, 2020
/s/ William S. Creekmuir
William S. Creekmuir
Director
March 12, 2020
/s/ John A. Frascotti
John A. Frascotti
Director
March 12, 2020
/s/ Lisa K. Klinger
Lisa K. Klinger
Director
March 12, 2020
/s/ Michelle Millstone-Shroff
Michelle Millstone-Shroff
Director
March 12, 2020
/s/ Morry J. Weiss
Morry J. Weiss
Director
March 12, 2020