UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form10-Q

 

 

(Mark One)

☒

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

For the quarterly period ended SeptemberJune 30, 20172018

OR

 

☐

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

For the transition period from    to    

Commission file number001-37344

 

 

Party City Holdco Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware 46-0539758

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

80 Grasslands Road Elmsford, NY 10523
(Address of Principal Executive Offices) (Zip Code)

Registrant’s telephone number, including area code:

(914) 345-2020

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of RegulationS-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

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

 

Large accelerated filer ☐  Accelerated filer ☒
Non-accelerated filer ☐  (Do not check if a smaller reporting company)  Smaller reporting company ☐
   Emerging Growth Company ☐

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

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

As of November 1, 2017, 119,730,069July 25, 2018, 96,477,447 shares of the Registrant’s common stock were outstanding.

 

 

 

PARTY CITY HOLDCO INC.

Form10-Q

SeptemberJune  30, 20172018

TABLE OF CONTENTS

 

   Page 

PART I

  

Item 1. Condensed Consolidated Financial Statements (Unaudited)

  

Condensed Consolidated Balance Sheets at SeptemberJune  30, 20172018 and December 31, 20162017

   3 

Condensed Consolidated Statements of Operations and Comprehensive Income for the Three Months ended SeptemberJune 30, 20172018 and SeptemberJune 30, 20162017

   4 

Condensed Consolidated Statements of Operations and Comprehensive Income for the NineSix Months ended SeptemberJune 30, 20172018 and SeptemberJune 30, 20162017

   5 

Condensed Consolidated Statement of Stockholders’ Equity for the NineSix Months ended SeptemberJune 30, 20172018

   6 

Condensed Consolidated Statements of Cash Flows for the NineSix Months ended SeptemberJune 30, 20172018 and SeptemberJune 30, 20162017

   7 

Notes to Condensed Consolidated Financial Statements

   8 

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

   1820 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

   3033 

Item 4. Controls and Procedures

   3033 

PART II

  

Item 1. Legal Proceedings

   3234 

Item 1A. Risk Factors

   3234 

Item 6. Exhibits

   3234 

Signature

   3335 

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

  September 30,
2017		 December 31,
2016		   June 30,
2018		 December 31,
2017		 
  (Note 2) (Unaudited) (Note 2)   (Note 2) (Unaudited) (Note 2) 

ASSETS

      

Current assets:

      

Cash and cash equivalents

  $58,143  $64,610   $51,461  $54,291 

Accounts receivable, net

   169,059  134,091    130,067  140,980 

Inventories, net

   687,254  613,868    673,676  604,066 

Prepaid expenses and other current assets

   84,859  68,255    86,043  77,816 
  

 

  

 

   

 

  

 

 

Total current assets

   999,315  880,824    941,247  877,153 

Property, plant and equipment, net

   298,758  292,904    311,572  301,141 

Goodwill

   1,631,806  1,572,568    1,627,851  1,619,253 

Trade names

   567,507  566,599    568,422  568,681 

Other intangible assets, net

   65,023  76,581    71,587  75,704 

Other assets, net

   12,703  4,502    11,705  12,824 
  

 

  

 

   

 

  

 

 

Total assets

  $3,575,112  $3,393,978   $3,532,384  $3,454,756 
  

 

  

 

   

 

  

 

 

LIABILITIES, REDEEMABLE SECURITIES AND STOCKHOLDERS’ EQUITY

      

Current liabilities:

      

Loans and notes payable

  $241,339  $120,138   $379,519  $286,291 

Accounts payable

   169,130  163,415    175,449  160,994 

Accrued expenses

   184,115  149,683    164,043  176,609 

Income taxes payable

   —    46,675    6,541  45,568 

Current portion of long-term obligations

   13,064  13,348    13,049  13,059 
  

 

  

 

   

 

  

 

 

Total current liabilities

   607,648  493,259    738,601  682,521 

Long-term obligations, excluding current portion

   1,534,146  1,539,604    1,528,263  1,532,090 

Deferred income tax liabilities

   282,376  278,819    177,891  175,836 

Deferred rent and other long-term liabilities

   80,389  65,507    89,742  91,929 
  

 

  

 

   

 

  

 

 

Total liabilities

   2,504,559  2,377,189    2,534,497  2,482,376 

Redeemable securities

   3,000   —      3,219  3,590 

Commitments and contingencies

      

Stockholders’ equity:

      

Common stock (119,662,869 and 119,515,894 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively)

   1,197  1,195 

Common stock (96,474,228 and 96,380,102 shares outstanding and 119,853,795 and 119,759,669 shares issued at June 30, 2018 and December 31, 2017, respectively)

   1,199  1,198 

Additionalpaid-in capital

   915,090  910,167    919,845  917,192 

Retained earnings

   188,049  157,666    399,872  372,596 

Accumulated other comprehensive loss

   (36,783)  (52,239)    (39,797)  (35,818) 
  

 

  

 

 

Total Party City Holdco Inc. stockholders’ equity before common stock held in treasury

   1,281,119  1,255,168 

Less: Common stock held in treasury, at cost (23,379,567 shares at June 30, 2018 and December 31, 2017)

   (286,733)  (286,733) 
  

 

  

 

 

Total Party City Holdco Inc. stockholders’ equity

   994,386  968,435 

Noncontrolling interests

   282  355 
  

 

  

 

   

 

  

 

 

Total stockholders’ equity

   1,067,553  1,016,789    994,668  968,790 
  

 

  

 

   

 

  

 

 

Total liabilities, redeemable securities and stockholders’ equity

  $3,575,112  $3,393,978   $3,532,384  $3,454,756 
  

 

  

 

   

 

  

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except share and per share data)

 

  

Three Months Ended

September 30,

   

Three Months Ended

June 30,

 
  2017   2016   2018 2017 

Revenues:

       

Net sales

  $557,350   $553,382   $558,101  $541,653 

Royalties and franchise fees

   2,759    3,568    2,910  3,225 
  

 

   

 

   

 

  

 

 

Total revenues

   560,109    556,950    561,011  544,878 

Expenses:

       

Cost of sales

   357,523    356,662    329,477  321,900 

Wholesale selling expenses

   16,274    14,739    17,256  16,045 

Retail operating expenses

   100,739    100,746    92,094  90,512 

Franchise expenses

   3,636    3,370    3,980  3,713 

General and administrative expenses

   37,971    38,972    45,326  39,655 

Art and development costs

   5,898    5,543    5,732  5,942 

Development stage expenses

   680    —      1,695  6,412 
  

 

   

 

   

 

  

 

 

Total expenses

   522,721    520,032    495,560  484,179 
  

 

   

 

   

 

  

 

 

Income from operations

   37,388    36,918    65,451  60,699 

Interest expense, net

   23,228    22,424    25,501  21,294 

Other expense (income), net

   593    (905)    2,532  (895) 
  

 

   

 

   

 

  

 

 

Income before income taxes

   13,567    15,399    37,418  40,300 

Income tax expense

   3,483    5,219    9,370  15,318 
  

 

   

 

   

 

  

 

 

Net income

  $10,084   $10,180    28,048  24,982 

Add: Net income attributable to redeemable securities holder

   410   —   

Less: Net loss attributable to noncontrolling interests

   (29)   —   
  

 

   

 

   

 

  

 

 

Comprehensive income

  $15,329   $6,028 

Net income per common share-Basic

  $0.08   $0.09 

Net income per common share-Diluted

  $0.08   $0.08 

Net income attributable to common shareholders of Party City Holdco Inc.

  $28,487  $24,982 
  

 

  

 

 

Net income per share attributable to common shareholders of Party City Holdco Inc.—Basic

  $0.30  $0.21 

Net income per share attributable to common shareholders of Party City Holdco Inc.—Diluted

  $0.29  $0.21 

Weighted-average number of common shares-Basic

   119,587,339    119,406,751    96,453,884  119,528,147 

Weighted-average number of common shares-Diluted

   120,912,849    120,472,297    97,688,233  120,943,745 

Dividends declared per share

  $0.00   $0.00   $0.00  $0.00 

Comprehensive income

  $18,825  $31,985 

Add: Comprehensive income attributable to redeemable securities holder

   410   —   

Less: Comprehensive loss attributable to noncontrolling interests

   (55)   —   
  

 

  

 

 

Comprehensive income attributable to common shareholders of Party City Holdco Inc.

  $19,290  $31,985 
  

 

  

 

 

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except share and per share data)

 

  

Nine Months Ended

September 30,

   

Six Months Ended

June 30,

 
  2017   2016   2018 2017 

Revenues:

       

Net sales

  $1,572,966   $1,523,094   $1,063,209  $1,015,616 

Royalties and franchise fees

   9,020    11,009    5,626  6,261 
  

 

   

 

   

 

  

 

 

Total revenues

   1,581,986    1,534,103    1,068,835  1,021,877 

Expenses:

       

Cost of sales

   978,142    952,294    646,443  620,619 

Wholesale selling expenses

   47,946    45,854    36,043  31,672 

Retail operating expenses

   281,981    278,070    181,186  181,242 

Franchise expenses

   10,666    10,507    7,762  7,030 

General and administrative expenses

   125,763    115,828    93,991  87,792 

Art and development costs

   17,638    16,596    11,705  11,740 

Development stage expenses

   7,092    —      3,998  6,412 
  

 

   

 

   

 

  

 

 

Total expenses

   1,469,228    1,419,149    981,128�� 946,507 
  

 

   

 

   

 

  

 

 

Income from operations

   112,758    114,954    87,707  75,370 

Interest expense, net

   65,214    67,857    48,776  41,986 

Other expense (income), net

   860    (4,107) 

Other expense, net

   3,380  267 
  

 

   

 

   

 

  

 

 

Income before income taxes

   46,684    51,204    35,551  33,117 

Income tax expense

   16,301    18,903    8,666  12,818 
  

 

   

 

   

 

  

 

 

Net income

  $30,383   $32,301    26,885  20,299 

Add: Net income attributable to redeemable securities holder

   410   —   

Less: Net loss attributable to noncontrolling interests

   (59)   —   
  

 

   

 

   

 

  

 

 

Comprehensive income

  $45,839   $22,355 

Net income per common share-Basic

  $0.25   $0.27 

Net income per common share-Diluted

  $0.25   $0.27 

Net income attributable to common shareholders of Party City Holdco Inc.

  $27,354  $20,299 
  

 

  

 

 

Net income per share attributable to common shareholders of Party City Holdco Inc.—Basic

  $0.28  $0.17 

Net income per share attributable to common shareholders of Party City Holdco Inc.—Diluted

  $0.28  $0.17 

Weighted-average number of common shares-Basic

   119,546,451    119,340,610    96,426,235  119,526,007 

Weighted-average number of common shares-Diluted

   120,907,979    120,312,492    97,669,309  120,903,032 

Dividends declared per share

  $0.00   $0.00   $0.00  $0.00 

Comprehensive income

  $22,892  $30,510 

Add: Comprehensive income attributable to redeemable securities holder

   410   —   

Less: Comprehensive loss attributable to noncontrolling interests

   (73)   —   
  

 

  

 

 

Comprehensive income attributable to common shareholders of Party City Holdco Inc.

  $23,375  $30,510 
  

 

  

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(Unaudited)

(In thousands, except share data)thousands)

 

  Common
Shares		   Common
Stock		   Additional
Paid-in
Capital		   Retained
Earnings		   Accumulated
Other
Comprehensive
Loss		 Total
Stockholders’
Equity		  Common
Stock		 Additional
Paid-in
Capital		 Retained
Earnings		 Accumulated
Other
Comprehensive
Loss		 Total Party
City Holdco
Inc.
Stockholders’
Equity
Before
Common
Stock Held In
Treasury		 Common
Stock Held In
Treasury		 Total Party
City Holdco
Inc.
Stockholders’
Equity		 Non-
Controlling
Interests		 Total
Stockholders’
Equity		 

Balance at December 31, 2016

   119,515,894   $1,195   $910,167   $157,666   $(52,239)  $1,016,789 

Balance at December 31, 2017

 $1,198  $917,192  $372,596  $(35,818)  $1,255,168  $(286,733)  $968,435  $355  $968,790 

Cumulative effect of change in accounting principle, net (see Note 2)

   (78)   (78)   (78)   (78) 
 

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Balance at December 31, 2017, as adjusted

 $1,198  $917,192  $372,518  $(35,818)  $1,255,090  $(286,733)  $968,357  $355  $968,712 

Net income

         30,383    30,383    26,944   26,944   26,944  (59)  26,885 

Employee equity based compensation

       3,852      3,852 

Net income attributable to redeemable securities holder

   410   410   410   410 

Stock option expense

  942    942   942   942 

Restricted stock units – time-based

  252    252   252   252 

Restricted stock units –performance-based

  593    593   593   593 

Director –non-cash compensation

  59    59   59   59 

Warrant expense

       286      286   326    326   326   326 

Exercise of stock options

   146,975    2    785      787  1  481    482   482   482 

Foreign currency adjustments

           16,818  16,818     (5,307)  (5,307)   (5,307)  (14)  (5,321) 

Impact of foreign exchange contracts, net of taxes

           (1,362)  (1,362) 

Impact of foreign exchange contracts, net

    1,328  1,328   1,328   1,328 
  

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Balance at September 30, 2017

   119,662,869   $1,197   $915,090   $188,049   $(36,783)  $1,067,553 

Balance at June 30, 2018

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

 

   

 

   

 

   

 

   

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

PARTY CITY HOLDCO INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

  

Nine Months Ended

September 30,

   

Six Months Ended

June 30,

 
  2017 2016   2018 2017 (Adjusted, see Note 2) 

Cash flows provided by operating activities:

   

Cash flows (used in) provided by operating activities:

   

Net income

  $30,383  $32,301   $26,885  $20,299 

Adjustments to reconcile net income to net cash provided by operating activities:

   

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

   

Depreciation and amortization expense

   62,519  61,186    40,812  41,825 

Amortization of deferred financing costs and original issuance discounts

   3,699  3,821    2,766  2,459 

Provision for doubtful accounts

   432  429    304  419 

Deferred income tax expense

   3,221  933    1,443  1,713 

Deferred rent

   5,634  12,240    1,155  2,915 

Undistributed (income) loss in unconsolidated joint ventures

   (92)  380 

Undistributed income in unconsolidated joint ventures

   (301)  (226) 

Loss on disposal of assets

   533  14    24  528 

Non-employee equity based compensation

   3,286   —      365  3,265 

Employee equity based compensation

   3,852  2,829 

Stock option expense

   942  3,222 

Restricted stock units—time-based

   252   —   

Restricted stock units—performance-based

   593   —   

Director—non-cash compensation

   59   —   

Changes in operating assets and liabilities, net of effects of acquired businesses:

      

Increase in accounts receivable

   (25,370)  (46,576) 

Decrease in accounts receivable

   8,791  20,823 

Increase in inventories

   (46,292)  (108,882)    (68,741)  (5,328) 

Increase in prepaid expenses and other current assets

   (11,299)  (15,046) 

(Decrease) increase in accounts payable, accrued expenses and income taxes payable

   (24,244)  79,848 

(Increase) decrease in prepaid expenses and other current assets

   (9,137)  866 

Decrease in accounts payable, accrued expenses and income taxes

payable

   (29,220)  (40,462) 
  

 

  

 

   

 

  

 

 

Net cash provided by operating activities

   6,262  23,477 

Net cash (used in) provided by operating activities

   (23,008)  52,318 

Cash flows used in investing activities:

      

Cash paid in connection with acquisitions, net of cash acquired

   (72,804)  (31,820)    (21,325)  (70,547) 

Capital expenditures

   (47,916)  (57,324)    (44,406)  (30,854) 

Proceeds from disposal of property and equipment

   26  31    21  5 
  

 

  

 

   

 

  

 

 

Net cash used in investing activities

   (120,694)  (89,113)    (65,710)  (101,396) 

Cash flows provided by financing activities:

      

Repayment of loans, notes payable and long-term obligations

   (25,311)  (28,158)    (26,062)  (76,978) 

Proceeds from loans, notes payable and long-term obligations

   129,150  97,943    112,293  128,140 

Excess tax benefit from stock options

   —    526 

Exercise of stock options

   787  1,281    482  67 

Debt issuance costs

   —    (44)    (56)   —   
  

 

  

 

   

 

  

 

 

Net cash provided by financing activities

   104,626  71,548    86,657  51,229 

Effect of exchange rate changes on cash and cash equivalents

   3,339  (1,214)    (780)  2,208 
  

 

  

 

   

 

  

 

 

Net (decrease) increase in cash and cash equivalents

   (6,467)  4,698 

Cash and cash equivalents at beginning of period

   64,610  42,919 

Net (decrease) increase in cash and cash equivalents and restricted cash

   (2,841)  4,359 

Cash and cash equivalents and restricted cash at beginning of period

   54,408  64,765 
  

 

  

 

   

 

  

 

 

Cash and cash equivalents at end of period

  $58,143  $47,617 

Cash and cash equivalents and restricted cash at end of period

  $51,567  $69,124 
  

 

  

 

   

 

  

 

 

Supplemental disclosure of cash flow information:

      

Cash paid during the period

      

Interest

  $60,871  $71,095   $49,489  $34,770 

Income taxes, net of refunds

  $65,002  $26,103   $46,617  $49,588 

See accompanying notes to unaudited condensed consolidated financial statements.

PARTY CITY HOLDCO INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Dollars in thousands, except per share)

Note 1 – Description of Business

Party City Holdco Inc. (the “Company” or “Party City Holdco”) is a vertically integrated supplier of decorated party goods. The Company designs, manufactures, sources and distributes party goods, including paper and plastic tableware, metallic and latex balloons, Halloween and other costumes, accessories, novelties, gifts and stationery throughout the world.stationery. The Company’s retail operations include over 900 specialty retail party supply stores (including approximately 150 franchise stores) in the United States and Canada, operating under the namesname Party City and Halloween City, ande-commerce websites, principally throughoperating under the domain name PartyCity.com. Party City Holdco franchises both individualIn addition to the Company’s retail operations, it is also a global designer, manufacturer and distributor of decorated party supplies, with products found in over 40,000 retail outlets, including independent party supply stores, mass merchants, grocery retailers and franchise areas throughoutdollar stores. The Company’s products are available in over 100 countries with the United States,Kingdom, Germany, Mexico, Australia and Puerto Rico, principally underCanada among the name Party City.largest end markets outside of the United States.

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

Note 2 – Basis of Presentation and Recently Issued Accounting Pronouncements

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

The majority of our retail operations define a fiscal year (“Fiscal Year”) as the52-week period or53-week period ended on the Saturday nearest December 31st of each year and define fiscal quarters (“Fiscal Quarter”) as the four interim13-week periods following the end of the previous Fiscal Year, except in the case of a53-week Fiscal Year when the fourth Fiscal Quarter is extended to 14 weeks. The condensed consolidated financial statements of the Company combine the Fiscal Quarters of our retail operations with the calendar quarters of our wholesale operations. The Company has determined the differences between the retail operation’s Fiscal Year and Fiscal Quarters and the calendar year and calendar quarters to be insignificant.

Operating results for interim periods are not necessarily indicative of the results to be expected for the year ending December 31, 2017.2018. Our business is subject to substantial seasonal variations as our retail segment has historically realized a significant portion of its net sales, cash flows and net income in the fourth quarter of each year, principally due to its Halloween season sales in October and, to a lesser extent, otheryear-end holiday sales. We expect that this general pattern will continue. Our results of operations may also be affected by industry factors that may be specific to a particular period such as movement in and the general level of raw material costs. For further information see the consolidated financial statements, and notes thereto, included in the Company’s Form10-K for the fiscal year ended December 31, 2016,2017, as filed with the Securities and Exchange Commission on March 16, 2017.14, 2018.

Recently Issued Accounting Pronouncements

In August 2017,June 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)2018-07, “Compensation – Stock Compensation: Improvements to Nonemployee Share-Based Payment Accounting”. The ASU simplifies the accounting fornon-employee share-based payments. The update is effective for the Company during the first quarter of 2019. The Company is in the process of evaluating the impact of the pronouncement on the Company’s consolidated financial statements.                

In August 2017, the FASB issued ASU2017-12, “Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities”. The pronouncement amends the existing hedge accounting model in order to enable entities to better portray the economics of their risk management activities in their financial statements.    The update is effective for the Company during the first quarter of 2019. Although the Company continues to evaluate this pronouncement, it does not believe that it will have a material impact on the Company’s consolidated financial statements.

In November 2016, the FASB issued ASU2016-18, “Statement of Cash Flows: Restricted Cash”. The pronouncement clarifies how entities should presentrequires companies to show changes in the total of cash, cash equivalents, restricted cash onand restricted cash equivalents in the statement of cash flows. The update is effective forCompany adopted the Companypronouncement, which requires retrospective application, during the first quarter of 2018. The Company is in the process of evaluating the impact of the pronouncement onsuch adoption was immaterial to the Company’s consolidated financial statements. See Note 15 for further discussion.

In August 2016, the FASB issued ASU2016-15, “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 update is effective for the Company during the first quarter of 2018. The Company is in the process of evaluating the impact of the pronouncement on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU2016-09, “Compensation – Stock Compensation: Improvements to Employee Share-Based Payment Accounting”. The pronouncement simplifies several aspects of the accounting for share-based payment transactions. The Company adopted the pronouncement during the first quarter of 20172018 and such adoption did not have a material impact on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU2016-02, “Leases”. The ASU requires that companies recognize on their balance sheets assets and liabilities for the rights and obligations created by the companies’ leases. The update is effective for the Company during the first quarter of 2019. The Company is in the process of evaluating the impact of the pronouncement on the Company’s consolidated financial statements.

In January 2016, the FASB issued ASU2016-01, “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 pronouncement will be effective for the Company during the first quarter of 2018. Although the Company continues to evaluate this pronouncement, it does not believe that it will have a material impact on the Company’s consolidated financial statements.

In July 2015, the FASB issued ASU2015-11, “Inventory: Simplifying the Measurement of Inventory”. The update changes the measurement principle for inventory from the lower of cost or market to lower of cost and net realizable value. The Company adopted the pronouncement during the first quarter of 20172018 and such adoption did not have a material impact on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU2014-09, “Revenue from Contracts with Customers (Topic 606)”. The pronouncement contains a five-step model which replaces most existing revenue recognition guidance. The new standard iswas effective for the Company during the first quarter of 2018. The pronouncement can be applied retrospectively to prior reporting periods or through a cumulative-effect adjustment as of the date of adoption.on January 1, 2018 The Company has decided to adoptadopted the pronouncement using the modified retrospective approach. AlthoughTherefore, on January 1, 2018, the Company continues to evaluate the pronouncement and it might impact theadjusted its accounting for certain discounts which are tied to the timing of payments by customers of its wholesale business and rebates withinthe Company recorded a cumulative-effect adjustment which reduced retained earnings by $46. Additionally, as of such date, the Company modified its accounting for certain metallic balloon sales of its wholesale segment and started to defer the recognition of revenue on such sales, and the related costs, until the balloons have been filled with helium. As a result, the Company recorded a cumulative-effect adjustment which increased retained earnings by $8. Finally, as of such date, the Company adjusted its accounting for certain discounts on wholesale sales of seasonal product and the Company recorded a cumulative-effect adjustment which reduced retained earnings by $40. See Note 14 for further discussion of the adoption of the pronouncement and the Company’s wholesale business, the Company does not believe that the pronouncement will have a material impact on its consolidated financial statements.revenue recognition policy.

Note 3 – Inventories

Inventories consisted of the following:

 

  September 30,
2017		   December 31,
2016		   June 30, 2018   December 31, 2017 

Finished goods

  $646,486   $581,277   $628,823   $562,809 

Raw materials

   30,395    23,222    32,315    30,346 

Work in process

   10,373    9,369    12,538    10,911 
  

 

   

 

   

 

   

 

 
  $687,254   $613,868   $673,676   $604,066 
  

 

   

 

   

 

   

 

 

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

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

Note 4 – Income Taxes

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“the Act”) was signed into law. The Act significantly changed U.S. tax law, including lowering the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018, and implementing aone-time “deemed repatriation” tax on unremitted earnings accumulated innon-U.S. jurisdictions since 1986 (the “Transition Tax”). Due to the complexities of accounting for the Act, the SEC issued Staff Accounting Bulletin (“SAB”) No. 118 which allows entities to include a provisional estimate of the impact of the Act in its financial statements. Therefore, based on currently available information, during the fourth quarter of 2017, the Company recorded a provisional estimate of the impact of the Act, which included an income

tax benefit of $90,965 related to the remeasurement of its domestic net deferred tax liabilities and deferred tax assets due to the lower U.S. corporate tax rate. Additionally, during the fourth quarter of 2017, the Company recorded a net income tax expense of $1,132 as its provisional estimate of the Transition Tax related to the deemed repatriation of unremitted earnings of foreign subsidiaries. The Company did not adjust these estimates during the first six months of 2018.

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

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

The effective income tax rate for the ninesix months ended SeptemberJune 30, 2017, 34.9%2018, 24.4%, is lower thandifferent from the effectivestatutory rate for the nine months ended September 30, 2016, 36.9%, principallyprimarily due to discrete items related to uncertain tax positions, stock option exercisesstate andreturn-to-provision adjustments. The impact of such items was partially offset by the effect of state tax rate changes on deferred tax liabilities. foreign taxes.

Note 5 – Changes in Accumulated Other Comprehensive Loss

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

 

   Three Months Ended September 30, 2017 
   Foreign
Currency
Adjustments		   Impact of
Foreign
Exchange
Contracts,
Net of Taxes		   Total,
Net of Taxes		 

Balance at June 30, 2017

  $(41,650)   $(378)   $(42,028) 

Other comprehensive income (loss) before reclassifications

   5,297    (281)    5,016 

Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income

   —      229    229 
  

 

 

   

 

 

   

 

 

 

Net current-period other comprehensive income (loss)

   5,297    (52)    5,245 
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2017

  $(36,353)   $(430)   $(36,783) 
  

 

 

   

 

 

   

 

 

 
   Three Months Ended June 30, 2018 
   Foreign Currency
Adjustments		   Impact of Foreign
Exchange Contracts,
Net of Taxes		   Total, Net
of Taxes		 

Balance at March 31, 2018

  $(30,204)   $(396)   $(30,600) 

Other comprehensive (loss) income before reclassifications

   (10,713)    1,398    (9,315) 

Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income

   —      118    118 
  

 

 

   

 

 

   

 

 

 

Net current-period other comprehensive (loss) income

   (10,713)    1,516    (9,197) 
  

 

 

   

 

 

   

 

 

 

Balance at June 30, 2018

  $(40,917)   $1,120   $(39,797) 
  

 

 

   

 

 

   

 

 

 

 

   Three Months Ended September 30, 2016 
   Foreign
Currency
Adjustments		   Impact of
Foreign
Exchange
Contracts,
Net of Taxes		   Total,
Net of Taxes		 

Balance at June 30, 2016

  $(39,500)   $916   $(38,584) 

Other comprehensive loss before reclassifications

   (3,537)    (470)    (4,007) 

Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income, net

   —      (145)    (145) 
  

 

 

   

 

 

   

 

 

 

Net current-period other comprehensive loss, net

   (3,537)    (615)    (4,152) 
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2016

  $(43,037)   $301   $(42,736) 
  

 

 

   

 

 

   

 

 

 
   Three Months Ended June 30, 2017 
   Foreign Currency
Adjustments		   Impact of Foreign
Exchange Contracts,
Net of Taxes		   Total, Net
of Taxes		 

Balance at March 31, 2017

  $(49,352)   $321   $(49,031) 

Other comprehensive income (loss) before reclassifications

   7,702    (509)    7,193 

Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income

   0    (190)    (190) 
  

 

 

   

 

 

   

 

 

 

Net current-period other comprehensive income (loss)

   7,702    (699)    7,003 
  

 

 

   

 

 

   

 

 

 

Balance at June 30, 2017

  $(41,650)   $(378)   $(42,028) 
  

 

 

   

 

 

   

 

 

 

   Six Months Ended June 30, 2018 
   Foreign Currency
Adjustments		   Impact of Foreign
Exchange Contracts,
Net of Taxes		   Total, Net
of Taxes		 

Balance at December 31, 2017

  $(35,610)   $(208)   $(35,818) 

Other comprehensive (loss) income before reclassifications, net of income tax

   (5,307)    971    (4,336) 

Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income, net of income tax

   —      357    357 
  

 

 

   

 

 

   

 

 

 

Net current-period other comprehensive (loss) income

   (5,307)    1,328    (3,979) 
  

 

 

   

 

 

   

 

 

 

Balance at June 30, 2018

  $(40,917)   $1,120   $(39,797) 
  

 

 

   

 

 

   

 

 

 

 

   Nine Months Ended September 30, 2017 
   Foreign
Currency
Adjustments		   Impact of
Foreign
Exchange
Contracts,
Net of Taxes		   Total,
Net of Taxes		 

Balance at December 31, 2016

  $(53,171)   $932   $(52,239) 

Other comprehensive income (loss) before reclassifications, net of income tax

   16,818    (1,077)    15,741 

Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income, net of income tax

   —      (285)    (285) 
  

 

 

   

 

 

   

 

 

 

Net current-period other comprehensive income (loss)

   16,818    (1,362)    15,456 
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2017

  $(36,353)   $(430)   $(36,783) 
  

 

 

   

 

 

   

 

 

 

   Nine Months Ended September 30, 2016 
   Foreign
Currency
Adjustments		   Impact of
Foreign
Exchange
Contracts,
Net of Taxes		   Total,
Net of Taxes		 

Balance at December 31, 2015

  $(33,401)   $611   $(32,790) 

Other comprehensive (loss) income before reclassifications, net of income tax

   (9,636)    183    (9,453) 

Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income, net of income tax

   —      (493)    (493) 
  

 

 

   

 

 

   

 

 

 

Net current-period other comprehensive loss

   (9,636)    (310)    (9,946) 
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2016

  $(43,037)   $301   $(42,736) 
  

 

 

   

 

 

   

 

 

 
   Six Months Ended June 30, 2017 
   Foreign Currency
Adjustments		   Impact of Foreign
Exchange Contracts,
Net of Taxes		   Total, Net
of Taxes		 

Balance at December 31, 2016

  $(53,171)   $932   $(52,239) 

Other comprehensive income (loss) before reclassifications, net of income tax

   11,521    (796)    10,725 

Amounts reclassified from accumulated other comprehensive loss to the condensed consolidated statement of operations and comprehensive income, net of income tax

   0    (514)    (514) 
  

 

 

   

 

 

   

 

 

 

Net current-period other comprehensive income (loss)

   11,521    (1,310)    10,211 
  

 

 

   

 

 

   

 

 

 

Balance at June 30, 2017

  $(41,650)   $(378)   $(42,028) 
  

 

 

   

 

 

   

 

 

 

Note 6 – Capital Stock

At SeptemberJune 30, 2017,2018, the Company’s authorized capital stock consisted of 300,000,000 shares of $0.01 par value common stock and 15,000,000 shares of $0.01 par value preferred stock.

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

Note 7 – Segment Information

Industry Segments

The Company has two identifiable business segments. The Wholesale segment designs, manufactures, sources and distributes decorated party goods, including paper and plastic tableware, metallic and latex balloons, Halloween and other costumes, accessories, novelties, gifts and stationery throughout the world. The Retail segment operates specialty retail party supply stores in the United States and Canada, principally under the names Party City, Halloween City and HalloweenToy City, and it operatese-commerce websites, principally through the domain name Partycity.com. The Retail segment also franchises both individual stores and franchise areas throughout the United States, Mexico and Puerto Rico, principally under the name Party City. The Company’s industry segment data for the three months ended SeptemberJune 30, 20172018 and SeptemberJune 30, 20162017 was as follows:

   Wholesale   Retail   Consolidated 

Three Months Ended September 30, 2017

      

Revenues:

      

Net sales

  $381,858   $364,057   $745,915 

Royalties and franchise fees

   —      2,759    2,759 
  

 

 

   

 

 

   

 

 

 

Total revenues

   381,858    366,816    748,674 

Eliminations

   (188,565)    —      (188,565) 
  

 

 

   

 

 

   

 

 

 

Net revenues

  $193,293   $366,816   $560,109 
  

 

 

   

 

 

   

 

 

 

Income from operations

  $22,808   $14,580   $37,388 
  

 

 

   

 

 

   

Interest expense, net

       23,228 

Other expense, net

       593 
      

 

 

 

Income before income taxes

      $13,567 
      

 

 

 
   Wholesale   Retail   Consolidated 

Three Months Ended September 30, 2016

      

Revenues:

      

Net sales

  $416,387   $347,557   $763,944 

Royalties and franchise fees

   —      3,568    3,568 
  

 

 

   

 

 

   

 

 

 

Total revenues

   416,387    351,125    767,512 

Eliminations

   (210,562)    —      (210,562) 
  

 

 

   

 

 

   

 

 

 

Net revenues

  $205,825   $351,125   $556,950 
  

 

 

   

 

 

   

 

 

 

Income from operations

  $35,532   $1,386   $36,918 
  

 

 

   

 

 

   

Interest expense, net

       22,424 

Other income, net

       (905) 
      

 

 

 

Income before income taxes

      $15,399 
      

 

 

 

   Wholesale   Retail   Consolidated 

Three Months Ended June 30, 2018

      

Revenues:

      

Net sales

  $285,733   $411,353   $697,086 

Royalties and franchise fees

   —      2,910    2,910 
  

 

 

   

 

 

   

 

 

 

Total revenues

   285,733    414,263    699,996 

Eliminations

   (138,985)    —      (138,985) 
  

 

 

   

 

 

   

 

 

 

Net revenues

  $146,748   $414,263   $561,011 
  

 

 

   

 

 

   

 

 

 

Income from operations

  $11,148   $54,303   $65,451 
  

 

 

   

 

 

   

Interest expense, net

       25,501 

Other expense, net

       2,532 
      

 

 

 

Income before income taxes

      $37,418 
      

 

 

 
   Wholesale   Retail   Consolidated 

Three Months Ended June 30, 2017

      

Revenues:

      

Net sales

  $276,705   $399,801   $676,506 

Royalties and franchise fees

   0    3,225    3,225 
  

 

 

   

 

 

   

 

 

 

Total revenues

   276,705    403,026    679,731 

Eliminations

   (134,853)    0    (134,853) 
  

 

 

   

 

 

   

 

 

 

Net revenues

  $141,852   $403,026   $544,878 
  

 

 

   

 

 

   

 

 

 

Income from operations

  $16,034   $44,665   $60,699 
  

 

 

   

 

 

   

Interest expense, net

       21,294 

Other income, net

       (895) 
      

 

 

 

Income before income taxes

      $40,300 
      

 

 

 

The Company’s industry segment data for the ninesix months ended SeptemberJune 30, 2018 and June 30, 2017 and September 30, 2016 was as follows:

 

  Wholesale   Retail   Consolidated   Wholesale   Retail   Consolidated 

Nine Months Ended September 30, 2017

      

Six Months Ended June 30, 2018

      

Revenues:

            

Net sales

  $929,255   $1,103,127   $2,032,382   $563,560   $774,929   $1,338,489 

Royalties and franchise fees

   —      9,020    9,020    —      5,626    5,626 
  

 

   

 

   

 

   

 

   

 

   

 

 

Total revenues

   929,255    1,112,147    2,041,402    563,560    780,555    1,344,115 

Eliminations

   (459,416)    —      (459,416)    (275,280)    —      (275,280) 
  

 

   

 

   

 

   

 

   

 

   

 

 

Net revenues

  $469,839   $1,112,147   $1,581,986   $288,280   $780,555   $1,068,835 
  

 

   

 

   

 

   

 

   

 

   

 

 

Income from operations

  $49,258   $63,500   $112,758   $16,496   $71,211   $87,707 
  

 

   

 

     

 

   

 

   

Interest expense, net

       65,214        48,776 

Other expense, net

       860        3,380 
      

 

       

 

 

Income before income taxes

      $46,684       $35,551 
      

 

       

 

 
  Wholesale   Retail   Consolidated   Wholesale   Retail   Consolidated 

Nine Months Ended September 30, 2016

      

Six Months Ended June 30, 2017

      

Revenues:

            

Net sales

  $945,071   $1,043,212   $1,988,283   $547,397   $739,070   $1,286,467 

Royalties and franchise fees

   —      11,009    11,009    0    6,261    6,261 
  

 

   

 

   

 

   

 

   

 

   

 

 

Total revenues

   945,071    1,054,221    1,999,292    547,397    745,331    1,292,728 

Eliminations

   (465,189)    —      (465,189)    (270,851)    0    (270,851) 
  

 

   

 

   

 

   

 

   

 

   

 

 

Net revenues

  $479,882   $1,054,221   $1,534,103   $276,546   $745,331   $1,021,877 
  

 

   

 

   

 

   

 

   

 

   

 

 

Income from operations

  $65,669   $49,285   $114,954   $26,450   $48,920   $75,370 
  

 

   

 

     

 

   

 

   

Interest expense, net

       67,857        41,986 

Other income, net

       (4,107) 

Other expense, net

       267 
      

 

       

 

 

Income before income taxes

      $51,204       $33,117 
      

 

       

 

 

Note 8 – Commitments and Contingencies

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

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

Note 9 – Derivative Financial Instruments

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

Interest Rate Risk Management

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

Foreign Exchange Risk Management

A portion of the Company’s cash flows isare 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, and the Australian Dollar, and the Mexican Peso, the Company enters into foreign exchange contracts with major international financial institutions. These forward contracts, which typically mature within one year, are designed to hedge anticipated foreign currency transactions, primarily inventory purchases and sales. For contracts that qualify for hedge accounting, the terms of the foreign exchange contracts are such that cash flows from the contracts should be highly effective in offsetting the expected cash flows from the underlying forecasted transactions.

The foreign currency exchange contracts are reflected in the condensed consolidated balance sheets at fair value. The fair value of the foreign currency exchange contracts is the estimated amount that the counterparties would receive or pay to terminate the foreign currency exchange contracts at the reporting date, taking into account current foreign exchange spot rates. At SeptemberJune 30, 20172018 and December 31, 2016,2017, the Company had certain 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 wereare 100% effective, there wasis no current impact on earnings due to hedge ineffectiveness. The Company anticipates that substantially all unrealized gains and losses in accumulated other comprehensive loss related to these foreign currency exchange contracts will be reclassified into earnings by June 2018.2019.

The following table displays the fair values of the Company’s derivatives at SeptemberJune 30, 20172018 and December 31, 2016:2017:

 

  Derivative Assets   Derivative Liabilities   Derivative Assets   Derivative Liabilities 
  Balance
Sheet
Line		 Fair
Value		   Balance
Sheet
Line		 Fair
Value		   Balance
Sheet
Line		 Fair
Value		   Balance
Sheet
Line		 Fair
Value		   Balance
Sheet
Line		 Fair
Value		   Balance
Sheet
Line		 Fair
Value		   Balance
Sheet
Line		 Fair
Value		   Balance
Sheet
Line		 Fair
Value		 

Derivative Instrument

  September 30, 2017   December 31, 2016   September 30, 2017   December 31, 2016   June 30, 2018   December 31, 2017   June 30, 2018   December 31, 2017 

Foreign Exchange Contracts

   (a) PP  $—      (a) PP  $697    (b) AE  $355    (b) AE  $215    (a) PP  $1,233    (a) PP  $95    (b) AE  $—    (b) AE  $99 
   

 

    

 

    

 

    

 

    

 

    

 

    

 

    

 

 

 

(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 SeptemberJune 30, 20172018 and December 31, 2016:2017:

 

Derivative Instrument

  September 30,
2017		   December 31,
2016		   June 30, 2018   December 31, 2017 

Foreign Exchange Contracts

  $6,875   $22,502   $23,586   $21,672 
  

 

   

 

   

 

   

 

 

Note 10 – Fair Value Measurements

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

 

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

 

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

 

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

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

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

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

   Level 1   Level 2   Level 3   Total as of
June 30, 2018		 

Derivative assets

  $—     $1,233   $—     $1,233 

Derivative liabilities

   —      0    —      0 

Kazzam liability

   —      —      3,219    3,219 

Punchbowl put liability

   —      —      268    268 

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

 

   Level 1   Level 2   Level 3   Total as of
September 30,
2017		 

Noncontrolling interests liabilities

  $—     $—     $6,016   $6,016 

Derivative assets

   —      —      —      —   

Derivative liabilities

   —      355    —      355 

   Level 1   Level 2   Level 3   Total as of
December 31, 2017		 

Derivative assets

  $—     $95   $—     $95 

Derivative liabilities

   —      99    —      99 

Kazzam liability

   —      —      3,590    3,590 

Punchbowl put liability

   —      —      2,122    2,122 

The following table showsmajority of theCompany’s non-financial instruments, which include goodwill, intangible assets, inventories and liabilities as of December 31, 2016 thatproperty, plant and equipment, are measurednot required to be carried at fair value on a recurring basis:

   Level 1   Level 2   Level 3   Total as of
December 31,
2016		 

Noncontrolling interests liabilities

  $—     $—     $—     $—   

Derivative assets

   —      697    —      697 

Derivative liabilities

   —      215    —      215 

In addition to assetsbasis. However, if certain triggering events occur (or at least annually for goodwill and liabilities that are recorded at fair value on indefinite-lived intangible assets),a recurring basis, the Companynon-financial instrument is required to record other assets and liabilities atbe evaluated for impairment. If the Company determines thatthe non-financial instrument is impaired, the Company would be required to write downthe non-financial instrument to its fair value on a nonrecurring basis, generally as a result of impairment charges. No impairment charges were recorded during the nine months ended September 30, 2017 or the nine months ended September 30, 2016.

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 SeptemberJune 30, 20172018 because of the short-term maturities of the instruments and/or their variable rates of interest.

The carrying amountamounts and fair valuevalues of the Company’s borrowings under its senior secured term loan facility (“the Term Loan Credit Agreement”)Agreement and its $350,000the Senior Notes as of 6.125% senior notes (“Senior Notes”)June 30, 2018 are as follows:

 

  September 30, 2017   June 30, 2018 
  Carrying
Amount		   Fair
Value		   Carrying Amount   Fair Value 

Term Loan Credit Agreement

  $1,198,750   $1,220,406   $1,192,253   $1,203,242 

Senior Notes

   345,162    364,809    345,780    351,750 

The fair values of the Term Loan Credit Agreement and the Senior Notes represent Level 2 fair value measurements as the debt instruments trade in inactive markets.

The carrying amounts for other long-term debt approximated fair value at SeptemberJune 30, 20172018 based on the discounted future cash flows of each instrument at rates currently offered for similar debt instruments of comparable maturity.

During August 2015, the Company acquired 75% of the operations of Accurate Custom Injection Molding Inc. (“ACIM”). Based on the terms of the acquisition agreement, the Company will acquire the remaining 25% interest in ACIM over the next seven years and the Company’s liability for the estimated purchase price of such interest was $0 at September 30, 2017. The liability represents a Level 3 fair value measurement as it is based on unobservable inputs.

During March 2017, the Company acquired 85% of the common stock of Granmark, S.A. de C.V., a Mexican manufacturer and wholesaler of party goods. See Note 13 for further discussion of the acquisition. Based on the terms of the acquisition agreement, the Company is required to acquire the remaining 15% interest over the next five years and it has recorded a liability for the estimated purchase price of such interest, $3,342 at September 30, 2017. The liability represents a Level 3 fair value measurement as it is based on unobservable inputs.

During July 2017, the Company acquired 60% of Print Appeal, Inc. (“Print Appeal”). See Note 13 for further discussion of the acquisition. Based on the terms of the acquisition agreement, the Company will acquire the remaining 40% interest in Print Appeal over the next six years and the Company’s liability for the estimated purchase price of such interest was $2,674 at September 30, 2017. The liability represents a Level 3 fair value measurement as it is based on unobservable inputs.

Note 11 – Earnings Per Share

Basic earnings per share are computed by dividing net income available forattributable to common stockholdersshareholders 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.exercised, and restricted stock units, as if they vested.

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

 

   Three Months
Ended
September 30,
2017		   Three Months
Ended
September 30,
2016		   Nine Months
Ended
September 30,
2017		   Nine Months
Ended
September 30,
2016		 

Net income

  $10,084   $10,180   $30,383   $32,301 

Weighted average shares—Basic

   119,587,339    119,406,751    119,546,451    119,340,610 

Effect of dilutive securities:

        

Warrants

   —      —      —      —   

Stock options

   1,325,510    1,065,546    1,361,528    971,882 
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares—Diluted

   120,912,849    120,472,297    120,907,979    120,312,492 
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per common share—Basic

  $0.08   $0.09   $0.25   $0.27 
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per common share—Diluted

  $0.08   $0.08   $0.25   $0.27 
  

 

 

   

 

 

   

 

 

   

 

 

 
   Three Months Ended
June 30, 2018		   Three Months Ended
June 30, 2017		   Six Months Ended
June 30, 2018		   Six Months Ended
June 30, 2017		 

Net income attributable to common shareholders of Party City Holdco Inc.

  $28,487   $24,982   $27,354   $20,299 

Weighted average shares - Basic

   96,453,884    119,528,147    96,426,235    119,526,007 

Effect of dilutive securities:

        

Warrants

   —      —      —      —   

Restricted stock units

   —      —      —      —   

Stock options

   1,234,350    1,415,598    1,243,074    1,377,025 
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares - Diluted

   97,688,233    120,943,745    97,669,309    120,903,032 
  

 

 

   

 

 

   

 

 

   

 

 

 

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

  $0.30   $0.21   $0.28   $0.17 
  

 

 

   

 

 

   

 

 

   

 

 

 

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

  $0.29   $0.21   $0.28   $0.17 
  

 

 

   

 

 

   

 

 

   

 

 

 

During the three months ended SeptemberJune 30, 2018 and June 30, 2017, and September 30, 2016, 2,370,1062,494,428 stock options and 2,276,6952,417,613 stock options, respectively, were excluded from the calculation of net incomediluted earnings per common share – diluted as they were anti-dilutive. Additionally, during the three months ended SeptemberJune 30, 20172018 and SeptemberJune 30, 2016,2017, 596,000 warrants and 0596,000 warrants, respectively, were excluded from the calculation of net incomediluted earnings per common share – diluted as they were anti-dilutive. Further, during the three months ended June 30, 2018 and June 30, 2017, 201,270 restricted stock units and 0 restricted stock units, respectively, were excluded from the calculation of diluted earnings per share as they were anti-dilutive.

During the ninesix months ended SeptemberJune 30, 2018 and June 30, 2017, and September 30, 2016, 2,370,1062,494,428 stock options and 2,276,6952,417,613 stock options, respectively, were excluded from the calculation of net incomediluted earnings per common share – diluted as they were anti-dilutive. Additionally, during the ninesix months ended SeptemberJune 30, 20172018 and SeptemberJune 30, 2016,2017, 596,000 warrants and 0596,000 warrants, respectively, were excluded from the calculation of net incomediluted earnings per common share – diluted as they were anti-dilutive. Further, during the six months ended June 30, 2018 and June 30, 2017, 201,270 restricted stock units and 0 restricted stock units, respectively, were excluded from the calculation of diluted earnings per share as they were anti-dilutive.

Note 12 – Long-Term Obligations

Long-term obligations at SeptemberJune 30, 20172018 and December 31, 20162017 consisted of the following:

 

  September 30,
2017		   December 31,
2016		   June 30,
2018		   December 31,
2017		 

Term Loan Credit Agreement

  $1,198,750   $1,205,496   $1,192,253   $1,196,505 

Capital lease obligations

   3,298    2,912    3,279    3,276 

Senior Notes

   345,162    344,544    345,780    345,368 
  

 

   

 

   

 

   

 

 

Total long-term obligations

   1,547,210    1,552,952    1,541,312    1,545,149 

Less: current portion

   (13,064)    (13,348)    (13,049)    (13,059) 
  

 

   

 

   

 

   

 

 

Long-term obligations, excluding current portion

  $1,534,146   $1,539,604   $1,528,263   $1,532,090 
  

 

   

 

   

 

   

 

 

Term Loan Credit Agreement

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

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

Note 13 – Acquisitions

During January 2017,March 2018, the Company acquired 1811 franchise stores, which are located mostly in Louisiana and Alabama,Maryland, for total consideration of approximately $15,000.$14,000. The Company is in the process of finalizing purchase accounting.

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

During March 2017, the Company acquired 85% of the common stock of Granmark, S.A. de C.V. (“Granmark”), a Mexican manufacturer and wholesaler of party goods, for total consideration of approximately $22,000 (exclusive of $5,600 of cash acquired). On the acquisition date, Granmark had $6,456 of debt outstanding under various revolving credit facilities. The majority of the balance was repaid during the first quarter of 2017. The Company is in the process of finalizing purchase accounting.goods. Based on the terms of the acquisition agreement, the Company is required to acquire the remaining 15% interest over a three tothe next five year periodyears and it has recorded a liability for the estimated purchase price of such interest, $3,342$2,840 at SeptemberJune 30, 2017.

Also, during March 2017, the Company acquired an additional 18 franchise stores, which are located in North Carolina and South Carolina, for total consideration of approximately $31,000. The Company is in the process of finalizing purchase accounting.2018.

During April 2017, the Company paid approximately $3,500 for a 28% ownership interest in Punchbowl, Inc., a provider of digital greeting cards and digital invitations. The Company is accounting for the investment under the equity method of accounting.

During July 2017, the Company acquired 60% of the common stock of Print Appeal, Inc., a wholesaler of personalized cups, napkins, and other items, for total consideration of approximately $2,800. The Company is in the process of finalizing purchase accounting. Based on the terms of the acquisition agreement, the Company is required towill acquire the remaining 40% interest in Print Appeal over a four to six year periodthe next five years and it has recorded athe Company’s liability for the estimated purchase price of such interest $2,674was $3,021 at SeptemberJune 30, 2017.2018.

Note 14 – Organizational RestructuringRevenue from Contracts with Customers

On March 15, 2017,In May 2014, the FASB issued ASU2014-09, “Revenue from Contracts with Customers (Topic 606)”. The pronouncement contains a five-step model which replaces most existing revenue recognition guidance. The Company and its Chairman ofadopted the Board of Directors (“the Board”), 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. Beginning on April 1, 2017 and continuing through December 31, 2020, unless earlier terminated as provided for in the agreement (the “Consulting Period”), Mr. Rittenberg will serve on a part-time basis asa non-employee senior adviser to the Company. Additionally, Mr. Rittenberg will remain as Chairman of the Board through the end of his existing director term (the Company’s 2018 annual meeting of shareholders) and, subsequently, he will be nominated by the Board to serve asa non-employee member of such Board throughout the remainder of the Consulting Period.

Under the Transition and Consulting Agreement, Mr. Rittenberg will receive payments from April 1, 2017 through December 31, 2017 in amounts equal to his base salary had he remained employed as Executive Chairman during such period (i.e., pay at an annual rate equal to $2,090). Additionally, he will remain eligible to receive an annual bonus for full-year 2017 based on the terms of the Company’s 2017 bonus plan and the terms of his previous employment agreement (a target amount equal to 80% of his 2017 base salary). Further, during 2018, Mr. Rittenberg will receive severance payments aggregating $2,049, which will be made in four equal quarterly installments. Finally, beginningstandard 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. Retaile-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 remainder of the Consulting Period, Mr. Rittenberg will receive payments equal to $40 per month in consideration for his consulting services.

Additionally, under the Transition and Consulting Agreement, during the Consulting Period, Mr. Rittenberg’s existing unvested stock options will remain eligible to vest in accordance with their original terms and Mr. Rittenberg’s existing vested stock options will remain outstanding (also, in accordance with their original terms).

As a result of the Transition and Consulting Agreement, the Company recorded a $4,296 severance charge in general and administrative expenses during the nine months ended September 30, 2017. Such amount represents: (1) the amount that he will be paid from April 1, 2017 – December 31, 2017 that is above and beyond the fair value ($40 per month) of his consulting services during such period, $1,207, (2) an estimate of his bonus for the period from April 1, 2017 – December 31, 2017, $1,040, and (3) the severance to be paid during 2018, $2,049. Throughout the Consulting Period, the Company will record $40 per month in general and administrative expenses, such amount representing the fair value of his consulting services.

Additionally, as a result of the Transition and Consulting Agreement: (1) allowing Mr. Rittenberg’s existing unvested stock options to continue vesting (such options would have been forfeited had he left the Company) and (2) allowing his existing vested stock options to remain outstanding (had he left the Company, he would have only had 60 days to exercise vested options), during the three months ended March 31, 2017 the Company recorded a $1,362 charge in general and administrative expenses due to the modification of such options.

Also, during the nine months ended September 30, 2017, the Company recorded a $3,195 severance charge related to the restructuring of its Retail segment. Of such amount, $2,291 was recorded in retail operating expenses and $904 was recorded in general and administrative expenses. Theoverwhelming majority of the severance was paid duringCompany’s retail sales is based on either: 1) the second quarteritem’s stated price or 2) the stated price adjusted for the impact of 2017.

Note 15 – Kazzam, LLC

Duringa coupon which can only be applied to such transaction. To the first quarter of 2017,extent that the Company charges customers for freight costs one-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 Ampology,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 subsidiaryroyalty fee that ranges from 4% to 6% of Trivergence, reached an agreement to formthe 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 legal entity, Kazzam, LLC (“Kazzam”), for the purpose of designing, developing and launching an online exchange platform for party-related services. The website will allow consumers to select, schedule and pay for various services (including entertainment, activities and food) all through a single portal.

Althoughstore, the Company currently only owns 30% of Kazzam’s equity,receives and records aone-time fee which is earned by the Company has concluded that: a) Kazzam is a variable interest entity as it has insufficient equity at riskfor its assistance with site selection and b)development of the Company is its primary beneficiary. Therefore,new location. Both the Company has consolidated Kazzam intosales-based royalty fee and the Company’s financial statements. Further, as the Company is currently funding all of Kazzam’sstart-upone-time activities via a loan to Kazzam (which will be repaid when the venture is profitable), the Company is recording 100% of Kazzam’s operating resultsfee are recorded in “development stage expenses”royalties and franchise fees in the Company’s consolidated statement of operations and comprehensive income.

Revenue Transactions - Wholesale

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

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

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

Judgments

Although most of the Company’s revenue transactions consist of fixed transaction prices and the transfer of control at either the point of sale (for retail) or when the product is shipped (for wholesale), certain transactions involve a limited number of judgments. For transactions for which control transfers to the customer when the freight carrier delivers the product to the customer, the Company estimates the date of such receipt based on historical shipping times. Additionally, the Company utilizes historical data to estimate sales returns, volume-based rebates and discounts for early payments by customers. Due to its extensive history operating as a leading party goods retailer and wholesaler, the Company has sufficient history with which to estimate such amounts.

Other Revenue Topics

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

As a significant portion of the Company’s revenue is either: 1) part of Ampology’s compensationa contract with an original expected duration of one year or less or 2) related to sales-based royalties promised in exchange for designing, developing and launchinglicenses of intellectual property, the exchange platform, AmpologyCompany has receivedelected to apply the optional exemptions in paragraphs ASC606-10-50-14 through ASC606-10-50-14A.

Additionally, the Company has elected to apply the practical expedient which allows companies to recognize the incremental costs of obtaining a 70% ownership interest in Kazzam and a warrant to acquire 596,000 sharescontract as an expense if the amortization period of Party City Holdco Inc. stock. During the nineasset that the entity otherwise would have recognized would have been one year or less.    

Disaggregation of Revenue

The following table summarizes revenue from contracts with customers for the three months ended SeptemberJune 30, 2018 and June 30, 2017 Kazzamand the six months ended June 30, 2018 and June 30, 2017:

   Three Months
Ended
June 30,
2018		   Three Months
Ended
June 30,
2017		   Six Months
Ended
June 30,
2018		   Six Months
Ended
June 30,
2017		 

Retail Net Sales:

        

Party City Stores

  $376,222   $363,872   $707,067   $668,886 

GlobalE-commerce

   35,131    35,929    67,862    70,184 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Retail Net Sales

  $411,353   $399,801   $774,929   $739,070 

Royalties and Franchise Fees

   2,910    3,225    5,626    6,261 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Retail Revenue

  $414,263   $403,026   $780,555   $745,331 
  

 

 

   

 

 

   

 

 

   

 

 

 

Wholesale Net Sales:

        

Domestic

  $79,397   $81,354   $158,956   $165,695 

International

   67,351    60,498    129,324    110,851 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Wholesale Net Sales

  $146,748   $141,852   $288,280   $276,546 
  

 

 

   

 

 

   

 

 

   

 

 

 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Consolidated Revenue

  $561,011   $544,878   $1,068,835   $1,021,877 
  

 

 

   

 

 

   

 

 

   

 

 

 

Financial Statement Impact of Adopting the Pronouncement

All of the Company’s revenue is recognized $3,000from 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 expenseJanuary 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 fair valueCompany’s wholesale business.

Additionally, the adoption of the 70% interest. Additionally,pronouncement impacted the Company’s financial statements for the three and six months ended June 30, 2018 as it increasedpre-tax income by $26 during suchthe three month period Kazzam recorded $286and increasedpre-tax income by $39 during the six month period.

Note 15 – Cash, Cash Equivalents and Restricted Cash

In November 2016, the FASB issued ASU2016-18, “Statement of expense relatedCash Flows: Restricted Cash”. The pronouncement requires companies to the warrant. The amounts were recorded in “development stage expenses”show changes in the Company’s consolidatedtotal of cash, cash equivalents, restricted cash and restricted cash equivalents in their statement of operations and comprehensive income.cash flows. The 70% interestCompany adopted the pronouncement, which requires retrospective application, during the first quarter of 2018.

As a result, the Company’s statement of cash flows for the six months ended June 30, 2017 has been recorded as redeemable securitiesadjusted to include $155 of restricted cash at December 31, 2016 and $106 of restricted cash at June 30, 2017. The restricted cash, which principally relates to funds that are required to be spent on advertising, is included in “prepaid expenses and other current assets” in the Company’s consolidated balance sheet as,sheet. Therefore, in the future, AmpologyCompany’s adjusted consolidated statement of cash flows for the six months ended June 30, 2017, the change in “prepaid expenses and other current assets” has been adjusted from a cash inflow of $915 to a cash inflow of $866.

The Company’s June 30, 2018 consolidated balance sheet included $51,461 of cash and cash equivalents and $106 of restricted cash and the right to causeCompany’s December 31, 2017 consolidated balance sheet included $54,291 of cash and cash equivalents and $117 of restricted cash. Restricted cash is recorded in “prepaid expenses and other current assets”.                

Note 16 - Related Party Transactions

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

Note 17 – Subsequent Events

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

During August 2018, the Company executed a refinancing of its debt portfolio and issued $500,000 of new senior notes at an interest rate of 6.625%. The warrant has an exercise pricenotes will mature in August 2026. The Company used the proceeds from the notes to: (i) reduce the outstanding balance under its existing ABL Facility by $90,000 and (ii) voluntarily prepay $400,000 of $15.60 and a fair valuethe outstanding balance under its existing Term Loan Credit Agreement. Additionally, as part of $2,544, which is being amortized over four years.the refinancing, the Company extended the maturity of the ABL Facility to August 2023.    

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

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

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

Business Overview

Our Company

We are the leading decorated party goods retailer by revenue in North America and, we believe, the largest vertically integrated supplier of decorated party goods globally by revenue. With over 900 locations (inclusive of approximately 150 franchised stores), we have the onlycoast-to-coast network of party superstores in the U.S. and Canada that make it easy and fun to enhance special occasions with a differentiated shopping experience and an unrivaled assortment of innovative and exciting merchandise offered at a compelling value. We also operate multiplee-commerce sites, principally under the domain name PartyCity.com, and during the Halloween selling seasonPartyCity.com. Further, we open a network of approximately 250 - 300 temporary Halloween City stores, including approximately 50 jointly under the Halloween City banner.and Toy City banners.

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

During the first quarter of 2017, the Company and Ampology, a subsidiary of Trivergence, reached an agreement to form a new legal entity for the purpose of designing, developing and launching an online exchange platform for party-related services. The website will allow consumers to select, schedule and pay for various services (including entertainment, activities and food) all through a single portal.United States.

How We Assess the Performance of Our Company

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

Segments

Our retail operations generate revenue primarily through the sale of Amscan, Designware, Anagram, Costumes USA and other party supplies through Party City, PartyCity.com, Halloween City and PartyCity.com.Toy City. During 2016,2017, approximately 77%80% of the product that was sold by our retail operations was supplied by our wholesale operations.

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

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

Financial Measures

Revenues. RevenuesRevenue from retail store operations is recognized at the point of sale as control of the product is transferred to the customer at such time. Retaile-commerce sales are recognized at point of sale.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.E-commerce sales are recorded on a FOB destination basis and include shipping revenues. Retail sales are reported net of taxes collected. Franchise royalties are recognized based on reported franchise retail sales. Additionally, fees paid by franchisees when franchise stores are opened are recognized upon

Under the completionterms of our performance requirementsagreements with our franchisees, we provide both: 1) brand value (via significant advertising spend) and the opening2) support with respect to planograms, in exchange for a royalty fee that ranges from 4% to 6% of the franchise store.franchisees’ sales. The Company records the royalty fees at the time that the franchisees’ sales are recorded.

Revenues from our wholesale operations represent the sale of our products to third parties, less rebates, discounts and other allowances. The terms

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 FOB shipping point,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 revenue is recognized when goods are shipped. Wewe use the expected value method to estimate reductions to revenues for volume-based rebate programs and subsequent credits at the time sales are recognized. 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 retaile-commerce sales.

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

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

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

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

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

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

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

Development Stage Expenses. Representsstart-up activities related to Kazzam, LLC. See footnote 15 of the consolidated financial statements in Item 12017 Form10-K for further discussion.

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

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

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

Results of Operations

Three Months Ended SeptemberJune 30, 20172018 Compared To Three Months Ended SeptemberJune 30, 20162017

The following table sets forth the Company’s operating results and operating results as a percentage of total revenues for the three months ended SeptemberJune 30, 20172018 and 2016.2017.

 

   Three Months Ended September 30, 
   2017  2016 
   (Dollars in thousands) 

Revenues:

       

Net sales

  $557,350    99.5%  $553,382    99.4% 

Royalties and franchise fees

   2,759    0.5   3,568    0.6 
  

 

 

   

 

 

  

 

 

   

 

 

 

Total revenues

   560,109    100.0   556,950    100.0 

Expenses:

       

Cost of sales

   357,523    63.8   356,662    64.0 

Wholesale selling expenses

   16,274    2.9   14,739    2.7 

Retail operating expenses

   100,739    18.0   100,746    18.1 

Franchise expenses

   3,636    0.6   3,370    0.6 

General and administrative expenses

   37,971    6.8   38,972    7.0 

Art and development costs

   5,898    1.1   5,543    1.0 

Development stage expenses

   680    0.1   —      0.0 
  

 

 

   

 

 

  

 

 

   

 

 

 

Total expenses

   522,721    93.3   520,032    93.4 
  

 

 

   

 

 

  

 

 

   

 

 

 

Income from operations

   37,388    6.7   36,918    6.6 

Interest expense, net

   23,228    4.1   22,424    4.0 

Other expense (income), net

   593    0.1   (905)    (0.2) 
  

 

 

   

 

 

  

 

 

   

 

 

 

Income before income taxes

   13,567    2.4   15,399    2.8 

Income tax expense

   3,483    0.6   5,219    1.0 
  

 

 

   

 

 

  

 

 

   

 

 

 

Net income

  $10,084    1.8%  $10,180    1.8% 
  

 

 

   

 

 

  

 

 

   

 

 

 

Net income per common share – Basic

  $0.08    $0.09   

Net income per common share – Diluted

  $0.08    $0.08   

   Three Months Ended June 30, 
   2018  2017 
   (Dollars in thousands) 

Revenues:

       

Net sales

  $558,101    99.5%  $541,653    99.4% 

Royalties and franchise fees

   2,910    0.5   3,225    0.6 
  

 

 

   

 

 

  

 

 

   

 

 

 

Total revenues

   561,011    100.0   544,878    100.0 

Expenses:

       

Cost of sales

   329,477    58.7   321,900    59.1 

Wholesale selling expenses

   17,256    3.1   16,045    2.9 

Retail operating expenses

   92,094    16.4   90,512    16.6 

Franchise expenses

   3,980    0.7   3,713    0.7 

General and administrative expenses

   45,326    8.1   39,655    7.3 

Art and development costs

   5,732    1.0   5,942    1.1 

Development stage expenses

   1,695    0.3   6,412    1.2 
  

 

 

   

 

 

  

 

 

   

 

 

 

Total expenses

   495,560    88.3   484,179    88.9 
  

 

 

   

 

 

  

 

 

   

 

 

 

Income from operations

   65,451    11.7   60,699    11.1 

Interest expense, net

   25,501    4.5   21,294    3.9 

Other expense (income), net

   2,532    0.5   (895)    (0.2) 
  

 

 

   

 

 

  

 

 

   

 

 

 

Income before income taxes

   37,418    6.7   40,300    7.4 

Income tax expense

   9,370    1.7   15,318    2.8 
  

 

 

   

 

 

  

 

 

   

 

 

 

Net income

   28,048    5.0   24,982    4.6 

Add: Net income attributable to redeemable securities holder

   410    0.1   —    0.0 

Less: Net loss attributable to noncontrolling interests

   (29)    (0.0)   —    0.0 
  

 

 

   

 

 

  

 

 

   

 

 

 

Net income attributable to common shareholders of Party City Holdco Inc.

  $28,487    5.1%  $24,982    4.6% 
  

 

 

   

 

 

  

 

 

   

 

 

 

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

  $0.30    $0.21   

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

  $0.29    $0.21   

Revenues

Total revenues for the thirdsecond quarter of 20172018 were $560.1$561.0 million and were $3.2$16.1 million, or 0.6%3.0%, higher than the thirdsecond quarter of 2016.2017. The following table sets forth the Company’s total revenues for the three months ended SeptemberJune 30, 20172018 and 2016.2017.

 

  Three Months Ended September 30,   Three Months Ended June 30, 
  2017 2016   2018 2017 
  Dollars in
Thousands		   Percentage of
Total Revenues		 Dollars in
Thousands		   Percentage of
Total Revenues		   Dollars in
Thousands		   Percentage of
Total Revenues		 Dollars in
Thousands		   Percentage of
Total Revenues		 

Net Sales:

              

Wholesale

  $381,858    68.2%  $416,387    74.8%   $285,733    50.9%  $276,705    50.8% 

Eliminations

   (188,565)    (33.7)%  (210,562)    (37.8)%    (138,985)    (24.8)%  (134,853)    (24.8)% 
  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

 

Net wholesale

   193,293    34.5%  205,825    37.0%    146,748    26.2%  141,852    26.0% 

Retail

   364,057    65.0%  347,557    62.4%    411,353    73.3%  399,801    73.4% 
  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

 

Total net sales

   557,350    99.5%  553,382    99.4%    558,101    99.5%  541,653    99.4% 

Royalties and franchise fees

   2,759    0.5%  3,568    0.6%    2,910    0.5%  3,225    0.6% 
  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

 

Total revenues

  $560,109    100.0%  $556,950    100.0%   $561,011    100.0%  $544,878    100.0% 
  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

 

Retail

Retail net sales during the thirdsecond quarter of 20172018 were $364.1$411.4 million and increased $16.5$11.6 million, or 4.7%2.9%, compared to the thirdsecond quarter of 2016.2017. Retail net sales at our Party City stores totaled $324.8$376.2 million and were $19.2$12.4 million, or 6.3%3.4%, higher than 2016 as2017 principally due to the acquisition of franchise store acquisitions and new store growth were partially offset by negative same-store sales (see below for further detail).independent stores. During the twelve months ended SeptemberJune 30, 2017,2018, we acquired 3624 franchise and independent stores, and 1 independent store, opened 2813 new stores and closed 812 stores. Global retaile-commerce sales totaled $34.1$35.1 million during the thirdsecond quarter of 20172018 and were $1.7$0.8 million, or 4.7%2.2%, lower than during the corresponding quarter of 2016.2017. The North Americane-commerce sales that are included in our Party City brand comp decreased by 9.9%3.2% during the third quarter (see belowquarter. However, they increased by 17.0% when adjusting for further detail). Sales atthe impact of our temporary Halloween City stores were $5.2 million during the third quarter of 2017 or $1.0 million lower than the corresponding quarter of 2016 due,new “buy online,pick-up in part, to stores opening later than last year.store” program (as such sales are included in our store sales).

Same-store sales for the Party City brand (including North American retaile-commerce sales) decreasedincreased by 2.6%0.1% during the thirdsecond quarter of 2017, principally due to2018 despite headwinds from a shift in the adverse effectstiming of Hurricanes Harvey and Irma, which negatively impacted brand comp sales by approximately 140 basis points.

Easter (first quarter 2018 versus second quarter 2017). Excluding the impact ofe-commerce, same-store sales decreased by 1.8% as a 2.2% decrease in transaction count was partially offset by a 0.4% increase in average transaction dollar size. Hurricane Harvey and Hurricane Irma adversely impacted same-store sales by approximately 130 basis points.

The North American retaile-commerce sales included in our Party City brand comp decreased by 9.9% due to a 9.1% decrease in transaction count and a 0.8% decrease in average transaction dollar size. Hurricane Harvey and Hurricane Irma adversely impacted the percentage by approximately 140 basis points. The remainder of the decrease in transaction count reflects lower traffic as customer conversion levels were consistent with the corresponding quarter of the prior year. The decrease in average transaction dollar size was principally due to increased promotional activity as units per transaction increased by approximately 3% versus the third quarter of 2016.

0.4%. Same-store sales percentages were not affected by foreign currency as such percentages are calculated in local currency.

Wholesale

Wholesale net sales during the thirdsecond quarter of 20172018 totaled $193.3$146.7 million and were $12.5$4.9 million, or 6.1%3.5%, lowerhigher than the thirdsecond quarter of 2016.2017. Net sales to domestic party goods retailers and distributors (including our franchisee network) totaled $80.8$57.1 million and were $18.3$3.6 million, or 18.5%5.9%, lower than during 2016.2017. The decrease was partiallylargely due to our acquisition of 3624 franchise and independent stores during the first quarter of 2017;twelve months ended June 30, 2018; as post-acquisition sales to such stores (approximately $10$2.4 million during the thirdsecond quarter of 2016)2017) are now eliminated as intercompany sales. Additionally, sales to existing franchisees decreased versus the corresponding quarter of 2016, principally due to carryover inventory from the 2016 Halloween selling season. Further, gift product sales decreased by approximately $1 million due to the continuedde-emphasis and product-line refinement of our Grasslands Road gift business. Net sales of metallic balloons to domestic distributors and retailers (including our franchisee network) totaled $19.2$22.2 million during the thirdsecond quarter of 20172018 and were $0.7$1.6 million, or 3.8%7.8%, higher than during the corresponding quarter of 2016.2017. Our international sales

(which (which include U.S. export sales and exclude U.S. import sales from foreign subsidiaries) totaled $93.3$67.4 million and were $5.1$6.9 million, or 5.8%11.3%, higher than in 2016. Our growth2017. The increase was largely driven by the acquisition of Granmark S.A. de C.V. (“Granmark”) in Q1 of this year, as well as continued strong performance in the U.K. and German markets.markets and the impact of foreign currency translation (approximately $2 million).

Intercompany sales to our retail affiliates totaled $188.6$139.0 million during the thirdsecond quarter of 20172018 and were $22.0$4.1 million or 10.4%, lowerhigher than during the corresponding quarter of 2016.2017. Intercompany sales represented 49.4%48.6% of total wholesale sales during the thirdsecond quarter of 2017,2018, compared to 50.6%48.7% during 2016. The decrease in intercompany sales was due to carryover inventory from the 2016 Halloween selling season.second quarter of 2017. The intercompany sales of our wholesale segment are eliminated against the intercompany purchases of our retail segment in the consolidated financial statements.

Royalties and franchise fees

Royalties and franchise fees for the thirdsecond quarter of 20172018 totaled $2.8$2.9 million and were $0.8$0.3 million lower than during the thirdsecond quarter of 2016 principally2017 due to the acquisition of 36 franchise stores during the first quarter of 2017.stores.

Gross Profit

The following table sets forth the Company’s gross profit for the three months ended SeptemberJune 30, 20172018 and SeptemberJune 30, 2016.2017.

 

  Three Months Ended September 30,   Three Months Ended June 30, 
  2017 2016   2018 2017 
  Dollars in
Thousands		   Percentage of
Net Sales		 Dollars in
Thousands		   Percentage of
Net Sales		   Dollars in
Thousands		   Percentage of
Net Sales		 Dollars in
Thousands		   Percentage of
Net Sales		 

Retail

  $141,334    38.8%  $133,177    38.3%   $183,915    44.7%  $173,872    43.5% 

Wholesale

   58,493    30.3  63,543    30.9    44,709    30.5  45,881    32.3 
  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

 

Total

  $199,827    35.9%  $196,720    35.5%   $228,624    41.0%  $219,753    40.6% 
  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

 

The gross profit margin on net sales at retail during the thirdsecond quarter of 20172018 was 38.8%44.7%. Such percentage was 50120 basis points higher than during the thirdcorresponding quarter of 2016.2017. The benefitsincrease was principally due to a higher POS margin, the realization of productivity initiatives positively impacting occupancy costs, and increased manufacturing share of shelf (i.e., the percentage of our retail product cost of sales manufactured by our wholesale segment). Our manufacturing share of shelf increased from 25.8% during the second quarter of 2017 to 27.6% during the second quarter of 2018, driven by higher sales of metallic balloons and the scaling of recent acquisitions in our wholesale business. Our wholesale share of shelf at our Party City stores and our North American retail e-commerce operations (i.e., the percentage of our retail product cost of sales supplied by our wholesale operations) and reduced product costs were partially offset by increased promotional activities. Our wholesale share of shelf at our Party City stores and our North American retaile-commerce operations increased from 75.1%segment) was 78.1% during the thirdquarter and was slightly lower than during the second quarter of 20162017 due largely to 78.0% during the third quarter of 2017.product mix.

The gross profit on net sales at wholesale during the second quarters of 2018 and 2017 was 30.5% and 2016 was 30.3% and 30.9%32.3%, respectively. The decrease was principally due to sales mix (including increased international sales)inflationary pressures in both distribution andde-leveraging of our fixed distribution costs due to the lower overall sales levels. labor costs.

Operating expenses

Wholesale selling expenses were $16.3$17.3 million during the thirdsecond quarter of 20172018 and $14.7$16.0 million during the corresponding quarter of 2016.2017. The increase of $1.2 million was primarily due to approximately $1.5 million of selling costs at Granmark (acquired in March 2017).foreign currency translation, inflation and, to a lesser extent, intangible asset amortization. Wholesale selling expenses were 8.4%11.8% and 7.2%11.3% of net wholesale sales during the thirdsecond quarters of 2018 and 2017, and 2016, respectively. See above for a discussion of the decrease in net wholesale sales.

Retail operating expenses during the thirdsecond quarter of 20172018 were $100.7$92.1 million and were principally consistent with$1.6 million, or 1.7%, higher than the thirdcorresponding quarter of 2016. The impact of2017. Increased advertising spend, the higher store count (discussed above) wasand the impact of inflation were mostly offset by further realized savings associated with improved labor productivity and efficiency in our stores and slightly lower advertising costs.stores. Retail operating expenses were 27.7%22.4% and 29.0%22.6% of net retail sales during the thirdsecond quarters of 20172018 and 2016,2017, respectively.

Franchise expenses during the thirdsecond quarters of 2018 and 2017 and 2016 were $3.6$4.0 million and $3.4$3.7 million, respectively.

General and administrative expenses during the thirdsecond quarter of 20172018 totaled $38.0$45.3 million and were $1.0$5.7 million, or 2.6%14.3%, lowerhigher than in the thirdsecond quarter of 2016. Lower executive compensation2017. The increase was partially offset by inflationary cost increases.due toone-time third-party consultant costs and the impact of inflation. General and administrative expenses as a percentage of total revenues were 6.8%8.1% and 7.0%7.3% during the thirdsecond quarters of 20172018 and 2016,2017, respectively.

Art and development costs were $5.9$5.7 million and $5.5$5.9 million during the thirdsecond quarters of 2018 and 2017, and 2016, respectively.

Development stage expenses representstart-up costs related to Kazzam (see footnote 15 to the Company’s consolidated financial statements2017 Form10-K for further detail)detail and a discussion of the charges recorded during 2017).

Interest expense, net

Interest expense, net, totaled $23.2$25.5 million during the thirdsecond quarter of 2017,2018, compared to $22.4$21.3 million during the thirdsecond quarter of 2016.2017. The increasevariance principally relates to adjustments to the Company’s minority interest liabilities for Print Appeal and ACIM (see footnote 10 to the Company’s consolidated financial statements for further detail). The adjustments were partially offset by the impact of a $100 million prepayment of the Company’sincreasing LIBOR rates on our Term Loan Credit Agreement during the Company’s October 2016 refinancing;and our ABL Facility, as well as increased borrowings under our ABL Facility due to share repurchases during the impactfourth quarter of the credit spread on such debt being reduced by 25 basis points at such time.2017.

Other expense (income), net

For the thirdsecond quarter of 2017,2018, other expense, net, totaled $0.6 million.

For the third quarter of 2016, other income, net, totaled $0.9 million. Such amount$2.5 million and principally representedrelated to corporate development costs and foreign currency transaction gains.losses.

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.

The effective income tax rate for the three months ended SeptemberJune 30, 2017, 25.7%2018, 25.0%, is lowerhigher than the effectivestatutory rate for the three months ended September 30, 2016, 33.9%, principallyprimarily due to discrete items related to uncertain tax positions, stock option exercisesstate andreturn-to-provision adjustments. The impact of such items was partially offset by the effect of state tax rate changes on deferred tax liabilities. foreign taxes.

NineSix Months Ended SeptemberJune 30, 20172018 Compared To NineSix Months Ended SeptemberJune 30, 20162017

The following table sets forth the Company’s operating results and operating results as a percentage of total revenues for the ninesix months ended SeptemberJune 30, 20172018 and 2016.2017.

 

   Nine Months Ended September 30, 
   2017  2016 
   (Dollars in thousands) 

Revenues:

       

Net sales

  $1,572,966    99.4%  $1,523,094    99.3% 

Royalties and franchise fees

   9,020    0.6   11,009    0.7 
  

 

 

   

 

 

  

 

 

   

 

 

 

Total revenues

   1,581,986    100.0   1,534,103    100.0 

Expenses:

       

Cost of sales

   978,142    61.8   952,294    62.1 

Wholesale selling expenses

   47,946    3.0   45,854    2.9 

Retail operating expenses

   281,981    17.8   278,070    18.1 

Franchise expenses

   10,666    0.7   10,507    0.7 

General and administrative expenses

   125,763    7.9   115,828    7.6 

Art and development costs

   17,638    1.1   16,596    1.1 

Development stage expenses

   7,092    0.4   —      0.0 
  

 

 

   

 

 

  

 

 

   

 

 

 

Total expenses

   1,469,228    92.9   1,419,149    92.5 
  

 

 

   

 

 

  

 

 

   

 

 

 

Income from operations

   112,758    7.1   114,954    7.5 

Interest expense, net

   65,214    4.1   67,857    4.4 

Other expense (income), net

   860    0.1   (4,107)    (0.2) 
  

 

 

   

 

 

  

 

 

   

 

 

 

Income before income taxes

   46,684    3.0   51,204    3.3 

Income tax expense

   16,301    1.0   18,903    1.2 
  

 

 

   

 

 

  

 

 

   

 

 

 

Net income

  $30,383    1.9%  $32,301    2.1% 
  

 

 

   

 

 

  

 

 

   

 

 

 

Net income per common share – Basic

  $0.25    $0.27   

Net income per common share – Diluted

  $0.25    $0.27   

   Six Months Ended June 30, 
   2018  2017 
   (Dollars in thousands) 

Revenues:

       

Net sales

  $1,063,209    99.5%  $1,015,616    99.4% 

Royalties and franchise fees

   5,626    0.5   6,261    0.6 
  

 

 

   

 

 

  

 

 

   

 

 

 

Total revenues

   1,068,835    100.0   1,021,877    100.0 

Expenses:

       

Cost of sales

   646,443    60.5   620,619    60.7 

Wholesale selling expenses

   36,043    3.4   31,672    3.1 

Retail operating expenses

   181,186    17.0   181,242    17.8 

Franchise expenses

   7,762    0.7   7,030    0.7 

General and administrative expenses

   93,991    8.8   87,792    8.6 

Art and development costs

   11,705    1.1   11,740    1.1 

Development stage expenses

   3,998    0.4   6,412    0.6 
  

 

 

   

 

 

  

 

 

   

 

 

 

Total expenses

   981,128    91.8   946,507    92.6 
  

 

 

   

 

 

  

 

 

   

 

 

 

Income from operations

   87,707    8.2   75,370    7.4 

Interest expense, net

   48,776    4.6   41,986    4.1 

Other expense, net

   3,380    0.3   267    0.0 
  

 

 

   

 

 

  

 

 

   

 

 

 

Income before income taxes

   35,551    3.3   33,117    3.2 

Income tax expense

   8,666    0.8   12,818    1.2 
  

 

 

   

 

 

  

 

 

   

 

 

 

Net income

   26,885    2.5   20,299    2.0 

Add: Net income attributable to redeemable securities holder

   410    0.0   —    0.0 

Less: Net loss attributable to noncontrolling interests

   (59)    (0.0)   —    0.0 
  

 

 

   

 

 

  

 

 

��  

 

 

 

Net income attributable to common shareholders of Party City Holdco Inc.

  $27,354    2.6%  $20,299    2.0% 
  

 

 

   

 

 

  

 

 

   

 

 

 

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

  $0.28    $0.17   

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

  $0.28    $0.17   

Revenues

Total revenues for the first ninesix months of 20172018 were $1,582.0$1,068.8 million and were $47.9$47.0 million, or 3.1%4.6%, higher than the corresponding period of 2016.2017. The following table sets forth the Company’s total revenues for the ninesix months ended SeptemberJune 30, 20172018 and 2016.2017.

 

  Nine Months Ended September 30,   Six Months Ended June 30, 
  2017 2016   2018 2017 
  Dollars in
Thousands		   Percentage of
Total Revenues		 Dollars in
Thousands		   Percentage of
Total Revenues		   Dollars in
Thousands		   Percentage of
Total Revenues		 Dollars in
Thousands		   Percentage of
Total Revenues		 

Net Sales:

              

Wholesale

  $929,255    58.7%  $945,071    61.6%   $563,560    52.7%  $547,397    53.6% 

Eliminations

   (459,416)    (29.0)%  (465,189)    (30.3)%    (275,280)    (25.8)%  (270,851)    (26.5)% 
  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

 

Net wholesale

   469,839    29.7%  479,882    31.3%    288,280    27.0%  276,546    27.1% 

Retail

   1,103,127    69.7%  1,043,212    68.0%    774,929    72.5%  739,070    72.3% 
  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

 

Total net sales

   1,572,966    99.4%  1,523,094    99.3%    1,063,209    99.5%  1,015,616    99.4% 

Royalties and franchise fees

   9,020    0.6%  11,009    0.7%    5,626    0.5%  6,261    0.6% 
  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

 

Total revenues

  $1,581,986    100.0%  $1,534,103    100.0%   $1,068,835    100.0%  $1,021,877    100.0% 
  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

 

Retail

Retail net sales during the first ninesix months of 20172018 were $1,103.1$774.9 million and increased $59.9$35.9 million, or 5.7%4.9%, compared to the first nine monthscorresponding period of 2016.2017. Retail net sales at our Party City stores totaled $993.7$707.1 million and were $59.4$38.2 million, or 6.4%5.7%, higher than 2016 as2017 due to the acquisition of franchise and independent stores and increased same store acquisitions and new store growth were partially offset by negative same-store sales, (see below for further detail).in part reflecting the favorable

impact of a shift in the calendar related to the timing of certain New Year’s Eve sales, which shifted into the first quarter of fiscal 2018. During the twelve months ended SeptemberJune 30, 2017,2018, we acquired 3624 franchise and independent stores, and 1 independent store, opened 2813 new stores and closed 812 stores. Global retaile-commerce sales totaled $104.2$67.9 million during the first ninesix months of 20172018 and were $1.5$2.3 million, or 1.5%3.3%, higherlower than during the corresponding period of 2016, driven by strong international2017. The North Americane-commerce sales. Sales atsales that are included in our temporary HalloweenParty City stores were $5.2 millionbrand comp decreased by 6.5% during the period or $1.0 million lower thanperiod. However, they increased by 8.7% when adjusting for the corresponding periodimpact of 2016 partially due to the fact that we opened stores later this year than a year ago.our new “buy online,pick-up in store” program (as such sales are included in our store sales).

Same-store sales for the Party City brand (including North American retaile-commerce sales) decreasedincreased by 0.3%, largely a result1.2% during the first six months of the adverse impact of Hurricanes Harvey and Irma, which adversely impacted brand comp sales by approximately 50 basis points.

2018. Excluding the impact ofe-commerce, same-store sales decreased by 0.3% as a 0.9% decrease in transaction count was partially offset by a 0.6% increase in average transaction dollar size. Hurricane Harvey and Hurricane Irma adversely impacted same-store sales by approximately 40 basis points.

The North American retaile-commerce sales included in our Party City brand comp increased by 0.1% as a 2.9% increase in transaction count was mostly offset by a decrease in average transaction dollar size. Hurricane Harvey and Hurricane Irma adversely impacted the percentage by approximately 50 basis points. The increase ine-commerce transaction count reflects higher customer conversion levels versus the same period of last year. The decrease in average transaction dollar size principally relates to lower units, largely a reflection of lower free-freight promotional thresholds.

1.9%. Same-store sales percentages were not affected by foreign currency as such percentages are calculated in local currency.

Wholesale

Wholesale net sales during the first ninesix months of 20172018 totaled $469.8$288.3 million and were $10.0$11.7 million, or 2.1%4.2%, lowerhigher than during 2016.the first six months of 2017. Net sales to domestic party goods retailers and distributors (including our franchisee network) totaled $204.4$115.4 million and were $32.3$7.0 million, or 13.6%5.7%, lower than during the first nine months of 2016.2017. The decrease was principallylargely due to our acquisition of 3661 franchise and independent stores during the first quarter of 2017;eighteen months ended June 30, 2018; as post-acquisition sales to such stores (approximately $19$6 million during the first ninesix months of 2016)2017) are now eliminated as intercompany sales. Additionally, sales to existing franchisees decreased versus the corresponding period of 2016, principally due to carryover inventory from the 2016 Halloween selling season. Further, gift product sales decreased by approximately $3 million due to the continuedde-emphasis and product-line refinement of our Grasslands Road gift business. Net sales of metallic balloons to domestic distributors and retailers (including our franchisee network) totaled $62.4$43.5 million during the first ninesix months of 20172018 and were $3.7$0.2 million or 6.3%, higher than during the corresponding period of 2016 primarily due to stronger2017 despite a headwind from certain Valentine’s Day sales, in part due toshipments accelerating into the timingfourth quarter of certain shipments.2017 (during the 2017 Valentine’s Day season the corresponding shipments took place during the first quarter of 2017). Our international sales (which include U.S. export sales and exclude U.S. import sales from foreign subsidiaries) totaled $203.0$129.3 million and were $18.6$18.5 million, or 10.1%16.7%, higher than in 2016, despite a $4.9 million negative2017. The increase was largely driven by the impact fromof foreign currency translation during(approximately $7 million), continued strong performance in the first nine monthsU.K. and German markets and the acquisition of Granmark S.A. de C.V. (“Granmark”) in March 2017. This growth was attributable to two acquisitions and further expansion of ourstore-in-store concept with key retailers.

Intercompany sales to our retail affiliates totaled $459.4$275.3 million during the first ninesix months of 20172018 and were $5.8$4.4 million or 1.2%, lowerhigher than during the corresponding period of 2016.2017. Intercompany sales represented 49.4%48.8% of total wholesale sales during the first ninesix months of 2017,2018, compared to 49.2%49.5% during 2016. The decrease in intercompany sales was due to carryover inventory from the 2016 Halloween selling season.first six months of 2017. The intercompany sales of our wholesale segment are eliminated against the intercompany purchases of our retail segment in the consolidated financial statements.

Royalties and franchise fees

Royalties and franchise fees for the first ninesix months of 20172018 totaled $9.0$5.6 million and were $2.0$0.6 million or 18.1%, lower than during the first ninesix months of 2016 principally2017 due to the acquisition of 36 franchise stores during the first quarter of 2017.stores.

Gross Profit

The following table sets forth the Company’s gross profit for the ninesix months ended SeptemberJune 30, 20172018 and SeptemberJune 30, 2016.2017.

 

  Nine Months Ended September 30,   Six Months Ended June 30, 
  2017 2016   2018 2017 
  Dollars in
Thousands		   Percentage of
Net Sales		 Dollars in
Thousands		   Percentage of
Net Sales		   Dollars in
Thousands		   Percentage of
Net Sales		 Dollars in
Thousands		   Percentage of
Net Sales		 

Retail

  $447,787    40.6%  $419,283    40.2%   $330,750    42.7%  $306,453    41.5% 

Wholesale

   147,037    31.3  151,517    31.6    86,016    29.8%  88,544    32.0% 
  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

 

Total

  $594,824    37.8%  $570,800    37.5%   $416,766    39.2%  $394,997    38.9% 
  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

 

The gross profit margin on net sales at retail during the first ninesix months of 20172018 was 40.6%42.7%. Such percentage was 40120 basis points higher than during the corresponding period of 2016.2017. The benefitsincrease was principally due to leveraging the higher same-store sales, the realization of productivity initiatives positively impacting occupancy costs, a higher POS margin, and increased manufacturing share of shelf (i.e., the percentage of our retail product cost of sales suppliedmanufactured by our wholesale operations)segment). Our manufacturing share of shelf increased from 25.5% during the first six months of 2017 to 27.2% during the corresponding period of 2018, driven by higher sales of metallic balloons and reduced product costs were partially offset by increased promotional activities.the scaling up of recent acquisitions in our wholesale business. Our wholesale share of shelf at our Party City stores and our North American retaile-commerce operations increased from 75.9%(i.e., the percentage of our retail product cost of sales supplied by our wholesale segment) was 78.1% during the first nine months of 2016 to 78.0%period and was slightly higher than during the first nine months of 2017.

The gross profit on net sales at wholesale during the first six months of 2018 and 2017 was 29.8% and 2016 was 31.3% and 31.6%32.0%, respectively. The decrease was principally due to the strengthening of the U.S. Dollarhigher logistics and its unfavorable impact on certain of our international subsidiaries that purchase product in U.S. Dollars and sell in local currency. Benefits associated with continued improvements in our sourcing efforts were offset by the impact ofdistribution costs, sales mix (including increased international sales) and,de-leveraging of our fixed distribution costs due to the lower overall sales levels.a lesser extent, purchase accounting adjustments.

Operating expenses

Wholesale selling expenses were $47.9$36.0 million during the first ninesix months of 20172018 and $45.9$31.7 million during the corresponding period of 2016. Approximately $32017. The increase of $4.4 million, or 13.8%, was primarily due to approximately $1 million of selling costs at Granmark (acquired in March 2017) and inflationary cost increases were partially offset by favorable, the impact of foreign currency translation ($0.7(also approximately $1 million) and lower intangible asset amortization.the impact of inflation. Wholesale selling expenses were 10.2%12.5% and 9.6%11.5% of net wholesale sales during the first ninesix months of 2018 and 2017, and 2016, respectively. See above for a discussion of the decrease in net wholesale sales.

Retail operating expenses during the first ninesix months of 20172018 were $282.0$181.2 million and were $3.9 million, or 1.4%,consistent with the corresponding period of 2017. The higher than during the first nine months of 2016. The impact of the increased store count (discussed above) and inflationary cost increasesincreased advertising spend were mostlycompletely offset by lower labor costs realized savings associated with improved laboras a result of increased productivity and efficiency in our stores and lower advertising expenses.stores. Retail operating expenses were 25.6%23.4% and 26.7%24.5% of net retail sales during the first ninesix months of 2018 and 2017, respectively. The decrease was mostly due to increased sales and 2016, respectively.the improved labor productivity.

Franchise expenses during the first ninesix months of 2018 and 2017 and 2016 were $10.7$7.8 million and $10.5$7.0 million, respectively.

General and administrative expenses during the first nine monthshalf of 20172018 totaled $125.8$94.0 million and were $9.9$6.2 million, or 8.6%7.1%, higher than in the first ninesix months of 2016. In conjunction with2017. Increasedone-time third-party consultant costs, the impact of inflation and the impact of foreign currency translation were partially offset by the first quarter of 2017 including severance charges related to a Transition and Consulting Agreement disclosed in Note 14 to our consolidated financial statements, duringwhich the first nine months of 2017 we recorded a $5.7 million severance charge, $1.4 million of which related to equity-based compensation. Additionally, as part of a retail restructuring (also disclosed in Note 14), during the first nine months of 2017 we recorded $0.9 million of severance expense for employees of our retail segment. The remainder of the variance versus the first nine months of 2016 was principally due to inflationary cost increases and administrative costs at Granmark (acquired in March 2017).Company entered into with Gerald Rittenberg. General and administrative expenses as a percentage of total revenues increased from 7.6% in 2016 to 7.9% inwere 8.8% and 8.6% during the first six months of 2018 and 2017, due to the severance.respectively.

Art and development costs were $17.6 million and $16.6$11.7 million during both the first ninesix months of 20172018 and 2016, respectively. Such amounts represent 1.1%the first six months of total revenues in both periods.2017.

Development stage expenses representstart-up costs related to Kazzam (see footnote 15 to the Company’s consolidated financial statements2017 Form10-K for further detail)detail and a discussion of the charges recorded during 2017).

Interest expense, net

Interest expense, net, totaled $65.2$48.8 million during the first ninesix months of 2017,2018, compared to $67.9$42.0 million during the first ninesix months of 2016.2017. The decreasevariance principally reflects a $100 million prepaymentrelates to the impact of the Company’sincreasing LIBOR rates on our Term Loan Credit Agreement during the Company’s October 2016 refinancing;and our ABL Facility, as well as increased borrowings under our ABL Facility due to share repurchases during the impactfourth quarter of the credit spread on such debt being reduced by 25 basis points at such time.2017.

Other expense, (income), net

For the first ninesix months of 2017,2018, other expense, net, totaled $0.9 million.

During the corresponding period of 2016, other income, net, totaled $4.1$3.4 million. Such amount included $6.9 millionprincipally consisted of corporate development costs, refinancing charges and foreign currency transaction gains, primarily the impact of the change in the U.S. Dollar from December 31, 2015 to September 30, 2016 and the correspondingre-measurement of the U.S. dollar-denominated receivables and payables of our foreign operations.losses.

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.

The effective income tax rate for the ninesix months ended SeptemberJune 30, 2017, 34.9%2018, 24.4%, is lowerhigher than the effectivestatutory rate for the nine months ended September 30, 2016, 36.9%, principallyprimarily due to discrete items related to uncertain tax positions, stock option exercisesstate andreturn-to-provision adjustments. The impact of such items was partially offset by the effect of state tax rate changes on deferred tax liabilities. foreign taxes.

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

The Company presents adjusted EBITDA, adjusted net income and adjusted net income per common share—share - diluted as supplemental measures of its operating performance. The Company defines EBITDA as net income (loss) before interest expense, net, income taxes, depreciation and amortization and defines adjusted EBITDA as EBITDA, as further adjusted to eliminate the impact of certain items that the Company does not consider indicative of our core operating performance. These further adjustments are itemized below. Adjusted net income represents the Company’s net income (loss) adjusted for, among other items, intangible asset amortization,non-cash purchase accounting adjustments, amortization of deferred financing costs and original issue discounts, equity based compensation, and impairment charges. Adjusted net income per common share – diluted represents adjusted net income

divided by diluted weighted average common shares outstanding. The Company presents these measures as supplemental measures of its operating performance. You are encouraged to evaluate these adjustments and the reasons the Company considers them appropriate for supplemental analysis. In evaluating the measures, you should be aware that in the future the Company may incur expenses that are the same as, or similar to, some of the adjustments in this presentation. The Company’s presentation of adjusted EBITDA, adjusted net income and adjusted net income per common share-diluted should not be construed as an inference that the Company’s future results will be unaffected by unusual ornon-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 arenon-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and adjusted EBITDA does not reflect any cash requirements for such replacements;

 

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

 

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

 

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

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

 

   Three Months Ended
September 30, 2017		  Three Months Ended
September 30, 2016		  Nine Months Ended
September 30, 2017		  Nine Months Ended
September 30, 2016		 
(Dollars in thousands)             

Net income

  $10,084  $10,180  $30,383  $32,301 

Interest expense, net

   23,228   22,424   65,214   67,857 

Income taxes

   3,483   5,219   16,301   18,903 

Depreciation and amortization

   20,694   20,015   62,519   61,186 
  

 

 

  

 

 

  

 

 

  

 

 

 

EBITDA

   57,489   57,838   174,417   180,247 

Non-cash purchase accounting adjustments

   1,500   —     6,350   3,689 

Restructuring, retention and severance (a)

   212   92   8,839   254 

Deferred rent (b)

   2,719   7,095   5,634   12,240 

Closed store expense (c)

   1,285   971   4,164   2,927 

Foreign currency losses (gains), net

   36   (1,767)   (1,684)   (6,945) 

Employee equity based compensation (d)

   630   948   3,852   2,829 

Non-employee equity based compensation (e)

   21   —     3,286   —   

Undistributed loss (income) in unconsolidated joint ventures

   134   113   (92)   380 

Corporate development (f)

   1,634   683   6,078   1,895 

Hurricane-related costs

   385   —     385   —   

Other

   84   61   562   118 
  

 

 

  

 

 

  

 

 

  

 

 

 

Adjusted EBITDA

  $66,129  $66,034  $211,791  $197,634 
  

 

 

  

 

 

  

 

 

  

 

 

 
   Three Months
Ended
September 30,
2017		  Three Months
Ended
September 30,
2016		  Nine Months
Ended
September 30,
2017		  Nine Months
Ended
September 30,
2016		 
(Dollars in thousands, except per share amounts)             

Income before income taxes

  $13,567  $15,399  $46,684  $51,204 

Intangible asset amortization

   3,879   4,049   11,704   12,182 

Non-cash purchase accounting adjustments (g)

   2,241   (102)   8,165   4,991 

Amortization of deferred financing costs and original issuance discounts

   1,240   1,277   3,699   3,821 

Restructuring, retention and severance (a)

   (323)   —     7,491   —   

Non-employee equity based compensation (e)

   21   —     3,286   —   

Hurricane-related costs

   385   —     385   —   

Employee equity based compensation (d)

   630   948   3,852   2,829 
  

 

 

  

 

 

  

 

 

  

 

 

 

Adjusted income before income taxes

   21,640   21,571   85,266   75,027 

Adjusted income tax expense (h)

   6,467   7,568   30,713   27,918 
  

 

 

  

 

 

  

 

 

  

 

 

 

Adjusted net income

  $15,173  $14,003  $54,553  $47,109 
  

 

 

  

 

 

  

 

 

  

 

 

 

Adjusted net income per common share –diluted

  $0.13  $0.12  $0.45  $0.39 
  

 

 

  

 

 

  

 

 

  

 

 

 

Weighted-average number of common shares-diluted

   120,912,849   120,472,297   120,907,979   120,312,492 
   Three Months Ended
June 30, 2018		   Three Months Ended
June 30, 2017		   Six Months Ended
June 30, 2018		   Six Months Ended
June 30, 2017		 
(Dollars in thousands)                

Net income

  $28,048   $24,982   $26,885   $20,299 

Interest expense, net

   25,501    21,294    48,776    41,986 

Income taxes

   9,370    15,318    8,666    12,818 

Depreciation and amortization

   20,255    21,124    40,812    41,825 
  

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA

   83,174    82,718    125,139    116,928 

Non-cash purchase accounting

adjustments

   1,098    3,000    542    4,850 

Restructuring, retention and severance (a)

   (457)    813    2,154    8,627 

Deferred rent (b)

   787    2,552    1,155    2,915 

Closed store expense (c)

   793    1,512    2,605    2,879 

Foreign currency losses (gains), net

   505    (1,183)    442    (1,720) 

Stock option expense (d)

   482    824    942    3,222 

Restricted stock units expense—time-based (e)

   252    —    252    — 

Restricted stock units expense—performance-based (f)

   593    —    593    — 

Non-employee equity based compensation (g)

   104    3,265    365    3,265 

Undistributed income in unconsolidated joint ventures

   (90)    (942)    (301)    (226) 

Corporate development (h)

   2,778    3,721    5,352    4,444 

Non-recurring consulting charges (i)

   6,869    —    11,619    — 

Refinancing charges (j)

   —    —    1,146    — 

Other

   (282)    260    (251)    478 
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

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

 

 

   

 

 

   

 

 

   

 

 

 

   Three Months
Ended
June 30,
2018		   Three Months
Ended
June 30,
2017		   Six Months
Ended
June 30,
2018		   Six Months
Ended
June 30,
2017		 
(Dollars in thousands, except per share amounts)                

Income before income taxes

  $37,418   $40,300   $35,551   $33,117 

Intangible asset amortization

   3,705    4,112    7,368    7,825 

Non-cash purchase accounting adjustments

   1,668    3,920    963    5,924 

Amortization of deferred financing costs and original

issuance discounts (j)

   1,210    1,226    2,766    2,459 

Restructuring, retention and severance (a)

   —    —    —    7,814 

Non-employee equity based compensation (g)

   104    3,265    365    3,265 

Refinancing charges (j)

   —    —    800    — 

Non-recurring consulting charges (i)

   6,869    —    11,619    — 

Stock option expense (d)

   482    824    942    3,222 

Restricted stock units expense—performance-based (f)

   593    —    593    — 
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted income before income taxes

   52,049    53,647    60,967    63,626 

Adjusted income tax expense (k)

   12,813    20,318    14,849    24,246 
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net income

  $39,236   $33,329   $46,118   $39,380 
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net income per common share – diluted

  $0.40   $0.28   $0.47   $0.33 
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average number of common shares-diluted

   97,688,233    120,943,745    97,669,309    120,903,032 

(a)The “restructuring, retention and severance” amounts in the adjusted net income table relate entirely to an organizational restructuring which took place during the first quarter of

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

31, 2017, the Company recorded a $3.3 million severance charge related to the restructuring of the Company’s retailits Retail segment. See Note 14the 2017 Form10-K for further discussion. The “restructuring, retention and severance” amounts in the adjusted EBITDA table also include additional restructuring, retention and severance chargesadjustment to “Adjusted EBITDA” during 2018 principally relates to costs incurred by the Company and excluded from the definition of adjusted EBITDA in the Company’s credit facilities (see above for a discussionwhile moving one of the Company’s use of adjusted EBITDA).domestic manufacturing facilities to a new location.
(b)

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

(c)Charges

Principally charges incurred related to closing underperforming stores.

(d)The first quarter of 2017 includes a $1,362

Representsnon-cash charges related to stock option modification charge for Gerald Rittenberg. See Note 14 for further discussion.options.

(e)

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

(f)

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

(g)

Principally represents shares of Kazzam awarded to Ampology as compensation for Ampology’s services. See Note 15the 2017 Form10-K for further discussion.

(f)(h)

Primarily representsstart-up costs for Kazzam (see Note 15the 2017 Form10-K for further discussion) and third-party costs related to acquisitions (principally legal expenses).

(g)(i)On July 27, 2012, PC Merger Sub, Inc., which was our wholly-owned indirect subsidiary, merged into Party City Holdings Inc. (“PCHI”), with PCHI being

Primarilynon-recurring consulting charges related to the surviving entity (the “Transaction”). As a result of the Transaction,Company’s retail operations.

(j)

During February 2018, the Company appliedamended the acquisition methodTerm Loan Credit Agreement. In conjunction with the amendment, the Companywrote-off $0.3 million of accountingcapitalized deferred financing costs, original issue discounts and increased the value of certain property, plant and equipment.call premiums. The impact of such adjustments on depreciation expense increased the Company’s expenses. These property, plant and equipment depreciation amounts are included in“Non-cash purchase accounting adjustments” for purposes “Refinancing charges” in the adjusted EBITDA table above and in “Amortization of calculating “adjusteddeferred financing costs and original issuance discounts” in the adjusted net income” but are excluded from table above (consistent with the presentation in the Company’s condensed consolidated statement of cash flows included elsewhere in this Quarterly Report on Form“Non-cash10-Q). purchase accounting adjustments” for purposesFurther, in conjunction with the amendment, the Company expensed $0.8 million of calculating adjusted EBITDA since theyinvestment banking and legal fees. These amounts are included in depreciation expense.“Refinancing charges” in the tables above.

(h)(k)

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

Liquidity

During 2015, the Company replaced its then-existing debt withThe Company’s indebtedness consistingprincipally consists of: (i) a senior secured term loan facility (“Term Loan Credit Agreement”), (ii) a $540 million asset-based revolving credit facility (with a seasonal increase to $640 million during a certain period of each calendar year) (“ABL Facility”) and, (iii) $350 million of 6.125% senior notes.notes and (iv) $500 million of 6.625% senior notes (issued during August 2018).

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

Cash Flow

Net cash used in operating activities totaled $23.0 million during the six months ended June 30, 2018. Net cash provided by operating activities totaled $6.3 million and $23.5$52.3 million during the ninesix months ended SeptemberJune 30, 2017 and 2016, respectively.2017. Net cash flows provided by operating activities before changes in operating assets and liabilities were $113.5$75.3 million during the first nine months of 2017,2018, compared to $114.1$76.4 million during 2016.2017. Changes in operating assets and liabilities during the first nine months of2018 and 2017 and 2016 resulted in the use of cash of $107.2$98.3 million and $90.6$24.1 million, respectively. The use of cash was highergreater during 20172018 principally due to increased income tax payments duethe timing of inventory receipts, 2017 benefitting from Halloween carryover inventory from the 2016 Halloween selling season and, to the Company’s increased profitability.a lesser extent, higher interest payments.

Net cash used in investing activities totaled $120.7$65.7 million during the ninesix months ended SeptemberJune 30, 2017,2018, as compared to $89.1$101.4 million during the ninesix months ended SeptemberJune 30, 2016.2017. Investing activities during 20172018 included $72.8$21.3 million paid in connection with acquisitions, principally related to franchise stores and Granmark (see Note 13 to the consolidated financial statements for further detail). Capital expenditures during the ninesix months ended SeptemberJune 30, 2018 and 2017 and 2016 were $47.9$44.4 million and $57.3$30.9 million, respectively. Retail capital expenditures totaled $25.1$25.7 million during 20172018 and principally related to initiatives for improving store conversionsperformance, investments in new stores and information technology-related expenditures.spending on store conversions. Wholesale capital expenditures during 20172018 totaled $22.8$18.7 million and primarily related to printing plates and dies, as well as machinery and equipment at the Company’s manufacturing operations and main distribution center.

Net cash provided by financing activities was $104.6$86.7 million and $51.2 million during the ninesix months ended SeptemberJune 30, 2018 and June 30, 2017, as compared to $71.5 million during the corresponding period of 2016. Borrowingsrespectively. An increase in cash used in operating activities (see above) and increased capital expenditures (see above) were partially offset by higher during 2017 principally due to the acquisitions.acquisition activity in 2017.

At SeptemberJune 30, 2017,2018, the Company had approximately $372$111 million of availability under its ABL Facility, after considering borrowing base restrictions.

Contractual Obligations

Other than as described above under “Liquidity and Capital Resources”, there were no material changes to our future minimum contractual obligations as of December 31, 20162017 as previously disclosed in our Annual Report on Form10-K for the year ended December 31, 2016.2017.

Off Balance Sheet Arrangements

We had no off balance sheet arrangements during the threesix months ended SeptemberJune 30, 20172018 and the year ended December 31, 2016.2017.

Seasonality

Wholesale Operations

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

Retail Operations

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

Cautionary Note Regarding Forward-Looking Statements

From time to time, including in this filing and, in particular, the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we make “forward-looking statements” within the meaning of federal and state securities laws. Disclosures that use words such as the company “believes,” “anticipates,” “expects,” “estimates,” “intends,” “will,” “may” or “plans” and similar expressions are intended to identify forward-looking statements. These forward-looking statements reflect our current expectations and are based upon data available to us at the time the statements were made. An example of a forward-looking statement is our belief that our cash generated from operating activities and availability under our credit facilities will be adequate to meet our liquidity needs for at least the next 12 months. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. These risks, as well as other risks and uncertainties, are detailed in the section titled “Risk Factors” included in our Annual Report on Form10-K filed with the SEC on March 16, 2017.14, 2018 and elsewhere in this report. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. All forward-looking statements are qualified by these cautionary statements and are made only as of the date of this filing. Any such forward-looking statements, whether made in this filing or elsewhere, should be considered in context with the various disclosures made by us about our business. The following risks related to our business, among others, could cause actual results to differ materially from those described in the forward-looking statements:

 

our ability to compete effectively in a competitive industry;

 

fluctuations in commodity prices;

 

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

 

successful implementation of our store growth strategy;

decreases in our Halloween sales;

 

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

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

 

disruption to the transportation system or increases in transportation costs;

 

product recalls or product liability;

 

economic slowdown affecting consumer spending and general economic conditions;

 

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

 

disruptions at our manufacturing facilities;

 

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

 

our international operations subjecting us to additional risks;

 

potential litigation and claims;

 

lack of available additional capital;

 

our inability to retain or hire key personnel;

 

risks associated with leasing substantial amounts of space;

 

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

 

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

 

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

 

our inability to successfully identify and integrate acquisitions;

 

adequacy of our intellectual property rights;

 

risks related to our substantial indebtedness; and

 

the other factors set forth under “Risk Factors” in our Annual Report on Form10-K, filed with the SEC on March 16, 2017.14, 2018.

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

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

Item 3.Quantitative and Qualitative Disclosures about Market Risk

Item 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no material changes in our market risks since December 31, 20162017 as previously disclosed in our Annual Report on Form10-K for the year ended December 31, 2016.2017.

Item 4.Controls and Procedures

Item 4. Controls and Procedures

We have carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules13a-15(e) and15d-15(e) under the Exchange Act of 1934, as amended (the “Act”)) as of SeptemberJune 30, 2017.2018. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Act is: (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms; and (ii) accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosures.

There were no changes in our internal control over financial reporting (as defined inRules 13a-15(f) and15d-15(f) under the Act) during the quarter ended SeptemberJune 30, 20172018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PARTII-OTHER INFORMATION

Item 1.Legal Proceedings

Item 1. Legal Proceedings

Information in response to this Item is incorporated herein by reference from Note 8, Commitments and Contingencies, to our Condensed Consolidated Financial Statements in this Quarterly Report on Form10-Q.

Item 1A.Risk Factors

Item 1A. Risk Factors

There have been no material changes to the risk factors disclosed under the heading “Risk Factors” in the Company’s Annual Report on Form10-K for the year ended December 31, 2016.2017, filed with the SEC on March 14, 2018, except as noted below.

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

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

Item 6.Exhibits

Item 6. Exhibits

 

3.1  Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to Party City Holdco Inc.’s Form8-K dated April 21, 2015)
3.2  Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to Party City Holdco Inc.’s Form8-K dated April 21, 2015)
31.131.1*  Certification of Chief Executive Officer pursuant toRule 13a-14(a)/Rule  15d-14(a) of the Securities Exchange Act of 1934, as amended as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.231.2*  Certification of Chief Financial Officer pursuant toRule 13a-14(a)/Rule  15d-14(a) of the Securities Exchange Act of 1934, as amended as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.132.1*  Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.232.2*  Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101101*  Interactive Data Files pursuant to Rule 405 ofRegulation S-T: (i) Condensed Consolidated Balance Sheets at SeptemberJune 30, 20172018 and December 31, 2016;2017; (ii) Condensed Consolidated Statements of Operations and Comprehensive Income for the three month periods ended SeptemberJune 30, 20172018 and SeptemberJune 30, 2016;2017; (iii) Condensed Consolidated Statements of Operations and Comprehensive Income for the ninesix month periods ended SeptemberJune 30, 20172018 and SeptemberJune 30, 2016;2017; (iv) Condensed Consolidated Statement of Stockholders’ Equity for the ninesix month period ended SeptemberJune 30, 2017;2018; (v) Condensed Consolidated Statements of Cash Flows for the ninesix month periods ended SeptemberJune 30, 20172018 and SeptemberJune 30, 2016;2017; and (vi) Notes to the Condensed Consolidated Financial Statements.
*Filed herewith.

 

SIGNATURE

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

 

  PARTY CITY HOLDCO INC.
  By: 

/s/ Daniel J. Sullivan

   Daniel J. Sullivan
Date:November August 9, 20172018   

Chief Financial Officer

(on behalf of the Registrant and as Principal

Financial Officer)

 

35

33