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.
We are the leading decorated party goods omni-channel retailer, by revenue, in North America and, we believe, the largest vertically integrated supplier of decorated party goods globally by revenue. With approximately 900 locations (inclusive of franchised stores), we have the only
coast-to-coast
network of party superstores in the U.S. and, through September 30, 2019, Canada, and such stores make it easy and fun to enhance special occasions with a differentiated shopping experience and an unrivaled assortment of innovative and exciting merchandise offered at a compelling value. We also operate multiple
e-commerce
sites, principally under the domain name PartyCity.com. Further, we open a network of approximately 250 - 300 temporary Halloween City stores.
In addition to our retail operations, we are also one of the largest global designers, manufacturers and distributors of decorated consumer party products, with items found in over 40,000 retail outlets worldwide, including independent party supply stores, mass merchants, grocery retailers,
e-commerce
merchandisers and dollar stores. Our products are available in over 100 countries with the United Kingdom, Canada, Germany, Mexico and Australia among the largest end markets for our products outside of the United States.
How We Assess the Performance of Our Company
In assessing the performance of our company, we consider a variety of performance and financial measures for our two operating segments, Retail and Wholesale. These key measures include revenues and gross profit, comparable retail same-store sales and operating expenses. We also review other metrics such as adjusted net income (loss), adjusted net income (loss) per common share – diluted and adjusted EBITDA. For a discussion of our use of these measures and a reconciliation of adjusted net income (loss) and adjusted EBITDA to net income (loss), please refer to “Financial Measures - Adjusted EBITDA,” “Financial Measures - Adjusted Net Income (Loss)” and “Financial Measures - Adjusted Net Income (Loss) Per Common Share – Diluted” below.
Our retail segment generates revenue primarily through the sale of our party supplies, which are sold under the Amscan, Designware, Anagram and Costumes USA brand names through Party City, Halloween City and PartyCity.com. During 2018, 79% of the product that was sold by our retail segment was supplied by our wholesale segment and 23% of the product that was sold by our retail segment was self-manufactured.
Our wholesale revenues are generated from the sale of decorated party goods for all occasions, including paper and plastic tableware, accessories and novelties, costumes, metallic and latex balloons and stationery. Our products are sold at wholesale to party goods superstores (including our franchise stores), other party goods retailers, mass merchants, independent card and gift stores, dollar stores and
e-commerce
merchandisers.
Intercompany sales between the Wholesale and the Retail segment are eliminated, and the wholesale profits on intercompany sales are deferred and realized at the time the merchandise is sold to the retail consumer. For segment reporting purposes, certain general and administrative expenses and art and development costs are allocated based on total revenues.
Revenue from retail store operations is recognized at the point of sale as control of the product is transferred to the customer at such time. Retail
e-commerce
sales are recognized when the consumer receives the product as control transfers upon delivery. We estimate future retail sales returns and record a provision in the period in which the related sales are recorded based on historical information. Retail sales are reported net of taxes collected.
Under the terms of our agreements with our franchisees, we provide both: 1) brand value (via significant advertising spend) and 2) support with respect to planograms, in exchange for a royalty fee that ranges from 4% to 6% of the franchisees’ sales. The Company records the royalty fees at the time that the franchisees’ sales are recorded.
For most of our wholesale sales, control transfers upon the shipment of the product as: 1) legal title transfers on such date and 2) we have a present right to payment at such time. Wholesale sales returns are not significant as we generally only accept the return of goods that were shipped to the customer in error or that were damaged when received by the customer. Additionally, due to our extensive history operating as a leading party goods wholesaler, we have sufficient history with which to estimate future sales returns and we use the expected value method to estimate such activity.
Intercompany sales from our wholesale operations to our retail stores are eliminated in our consolidated total revenues.
Comparable Retail Same-Store Sales.
The growth in same-store sales represents the percentage change in same-store sales in the period presented compared to the prior year. Same-store sales exclude the net sales of a store for any period if the store was not open during the same period of the prior year. Acquired stores are excluded from same-store sales until they are converted to the Party City format and included in our sales for the comparable period of the prior year. Comparable sales are calculated based upon stores that were open at least thirteen full months as of the end of the applicable reporting period. When a store is reconfigured or relocated within the same general territory, the store continues to be treated as the same store. If, during the period presented, a store was closed, sales from that store up to and including the closing day are included as same-store sales as long as the store was open during the same period of the prior year. Same-store sales for the Party City brand include North American retail
e-commerce
sales.
Cost of sales at wholesale reflects the production costs (i.e., raw materials, labor and overhead) of manufactured goods and the direct cost of purchased goods, inventory shrinkage, inventory adjustments, inbound freight to our manufacturing and distribution facilities, distribution costs, including rent at distribution facilities, and outbound freight to get goods to our wholesale customers. At retail, cost of sales reflects the direct cost of goods purchased from third parties and the production or purchase costs of goods acquired from our wholesale segment. Retail cost of sales also includes inventory shrinkage, inventory adjustments, inbound freight, occupancy costs related to store operations (such as rent and common area maintenance, utilities and depreciation on assets) and all logistics costs associated with our retail
e-commerce
business.
Our cost of sales increases in higher volume periods as the direct costs of manufactured and purchased goods, inventory shrinkage and freight are generally tied to net sales. However, other costs are largely fixed or vary based on other factors and do not necessarily increase as sales volume increases. Changes in the mix of our products may also impact our overall cost of sales. The direct costs of manufactured and purchased goods are influenced by raw material costs (principally paper, petroleum-based resins and cotton), domestic and international labor costs in the countries where our goods are purchased or manufactured and logistics costs associated with transporting our goods. We monitor our inventory levels on an
on-going
basis in order to identify slow-moving goods.
Cost of sales related to sales from our wholesale segment to our retail segment are eliminated in our consolidated financial statements.
Wholesale Selling Expenses.
Wholesale selling expenses include the costs associated with our wholesale sales and marketing efforts, including merchandising and customer service. Costs include the salaries and benefits of the related work force, including sales-based bonuses and commissions. Other costs include catalogues, showroom expenses, 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 include the costs associated with operating our franchise network, including salaries and benefits of the administrative work force and other administrative costs. These expenses generally do not vary proportionally with royalties and franchise fees.
General and Administrative Expenses.
General and administrative expenses include all operating costs not included elsewhere in the statement of operations and comprehensive (loss) income. These expenses include payroll and other expenses related to operations at our corporate offices, including occupancy costs, related depreciation and amortization, legal and professional fees and data-processing costs. These expenses generally do not vary proportionally with net sales.
Art and Development Costs.
Art and development costs include the costs associated with art production, creative development and product management. Costs include the salaries and benefits of the related work force. These expenses generally do not vary proportionally with net sales.
Development Stage Expenses.
Development stage expenses represent
start-up
activities related to Kazzam, LLC (“Kazzam”).
We define EBITDA as net income (loss) before interest expense, net, income taxes, depreciation and amortization. We define Adjusted EBITDA as EBITDA, as further adjusted to eliminate the impact of certain items that we do not consider indicative of our core operating performance. We caution investors that amounts presented in accordance with our definition of Adjusted EBITDA may not be comparable to similar measures disclosed by other issuers, because not all issuers calculate Adjusted EBITDA in the same manner. We believe that Adjusted EBITDA is an appropriate measure of operating performance in addition to EBITDA because we believe it assists investors in comparing our performance across reporting periods on a consistent basis by eliminating the impact of items that we do not believe are indicative of our core operating performance. In addition, we use Adjusted EBITDA: (i) as a factor in determining incentive compensation, (ii) to evaluate the effectiveness of our business strategies, and (iii) because the credit facilities use Adjusted EBITDA to measure compliance with certain covenants.
Adjusted Net Income (Loss).
Adjusted net income (loss) represents our net income (loss), adjusted for, among other items, intangible asset amortization,
non-cash
purchase accounting adjustments, amortization of deferred financing costs and original issue discounts, equity-based compensation and impairment charges. We present adjusted net income because we believe it assists investors in comparing our performance across reporting periods on a consistent basis by eliminating the impact of items that we do not believe are indicative of our core operating performance.
Adjusted Net Income (Loss) Per Common Share – Diluted.
Adjusted net income (loss) per common share – diluted represents adjusted net income (loss) divided by the Company’s diluted weighted average common shares outstanding. We present the metric because we believe it assists investors in comparing our per share performance across reporting periods on a consistent basis by eliminating the impact of items that we do not believe are indicative of our core operating performance.
Total revenues for the third quarter of 2019 were $540.2 million and were $12.8 million, or 2.3%, lower than the third quarter of 2018. The following table sets forth the Company’s total revenues for the three months ended September 30, 2019 and 2018.
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Three Months Ended September 30,
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Royalties and franchise fees
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Retail net sales during the third quarter of 2019 were $369.5 million and were $6.2 million, or 1.7%, lower than during the third quarter of 2018. Retail net sales at our North American Party City stores totaled $326.8 million and were $9.5 million, or 2.8%, lower than in the third quarter of 2018 principally due to the continued impact of the ongoing helium shortage and the closure of 34 stores in conjunction with our 2019 store optimization program. These negative factors affecting sales were partially offset by the acquisition of six franchise and independent stores and the opening of nine new stores during the twelve months ended September 30, 2019, as well as the acquisition of 37 franchise stores throughout the third quarter of 2018. Global retail
e-commerce
sales totaled $36.8 million during the third quarter of 2019 and were $2.6 million, or 7.6%, higher than during the corresponding quarter of 2018. Sales at our temporary Halloween City stores totaled $4.8 million and were $0.3 million or 5.7% lower than in the third quarter of 2018. Sales at other store formats totaled $1.0 million during the third quarter of 2019.
Same-store sales for the Party City brand (including North American retail
e-commerce
sales) decreased by 2.6% during the third quarter of 2019, principally due to the impact of the ongoing helium shortage on balloon sales.
Our North American retail
e-commerce
sales, which include our Amazon marketplace sales, increased by 11.6% compared to the third quarter of 2018 and, when adjusting for the impact of our “buy online,
pick-up
in store” program (such sales are included in our store sales), increased by 14.8%.
Excluding the impact of
e-commerce,
same-store sales decreased by 3.9%.
Same-store sales percentages were not affected by foreign currency as such percentages are calculated in local currency.
Wholesale net sales during the third quarter of 2019 totaled $168.9 million and were $6.3 million, or 3.6%, lower than the third quarter of 2018. Net sales to domestic party goods retailers and distributors (including our franchisee network) totaled $65.9 million and were $4.5 million, or 6.4%, lower than during 2018. The acquisition of six franchise and independent stores during the twelve months ended September 30, 2019, together with the acquisition of 37 franchise stores late in the third quarter of 2018, negatively impacted sales as post-acquisition sales to such stores (approximately $2.5 million during the third quarter of 2018) are now eliminated as intercompany sales. Adjusted for the acquisitions, sales to domestic party goods retailers and distributors decreased by approximately $2.0 million, or 2.9%, versus the third quarter of 2018. Net sales of metallic balloons to domestic distributors and retailers (including our franchisee network) totaled $16.8 million during the third quarter of 2019 and were $1.1 million, or 6.2%, lower than during the corresponding quarter of 2018 principally due to the ongoing helium shortage. Our international sales (which include U.S. export sales and exclude U.S. import sales from foreign subsidiaries) totaled $86.2 million and were $0.7 million, or 0.8%, lower than in 2018. Foreign currency translation negatively impacted sales by approximately $4.1 million and more than offset $3.4 million of sales growth on a constant currency basis.
Intercompany sales to our retail affiliates totaled $214.5 million during the third quarter of 2019 and were $34.9 million lower than during the corresponding quarter of 2018. Intercompany sales represented 56.0% of total wholesale sales during the third quarter of 2019 and were 2.7% lower than during the third quarter of 2018, principally reflecting the impact of our store optimization program, strong seasonal
in-stock
positions at our retail stores from the prior year and a reduction in sales of metallic balloons to our retail operations. The intercompany sales of our wholesale segment are eliminated against the intercompany purchases of our retail segment in the consolidated financial statements.
Development stage expenses represent
start-up
costs related to Kazzam (see the 2018 Form
10-K
for further detail).
During the nine months ended September 30, 2019, the Company performed a comprehensive review of its store locations aimed at improving the overall productivity of such locations (“store optimization program”). Each year, the Company typically closes approximately 10 Party City stores as part of its typical network rationalization process and in response to ongoing consumer, market and economic changes that naturally arise in the business. During the first nine months of 2019, after careful consideration and evaluation of store locations, the Company made the decision to accelerate the optimization of its store portfolio with the closure of approximately 55 stores which are primarily located in close proximity to other Party City stores. These closings should provide the Company with capital flexibility to expand into underserved markets. In conjunction with the store optimization program, during the third quarter of 2019, the Company recorded $2.6 million of labor and other costs related to closing the stores.
Goodwill impairment charges for the three months ended September 30, 2019 were $259.1 million. The
non-cash
pre-tax
goodwill impairment charges were the result of a sustained decline in the Company’s market capitalization. There were no goodwill impairment charges for the three months ended September 30, 2018. See Note 4 to the condensed consolidated financial statements for further discussion.
Interest expense, net, totaled $29.4 million during the third quarter of 2019, compared to $27.7 million during the third quarter of 2018. The variance principally relates to the impact of the Company’s August 2018 refinancing (see the Company’s 2018 Form
10-K
for discussion of such refinancing) and higher average borrowings and rates under our Term Loan and ABL credit facilities.
For the third quarters of 2019 and 2018, other expense, net, totaled $2.0 million and $5.7 million, respectively. During the third quarter of 2018, other expense included costs associated with the August 2018 refinancing of our debt portfolio.
Income tax (benefit) expense
The effective income tax rate for the three months ended September 30, 2019, 8.8%, is lower than the statutory rate primarily due the non-deductible portions of the goodwill impairment charges noted above.
Retail net sales during the first nine months of 2019 were $1,170.8 million and increased $20.2 million or 1.8% compared to the first nine months of 2018. Retail net sales at our North American Party City stores totaled $1,060.3 million and were $16.9 million, or 1.6%, higher than 2018, principally due to the acquisition of six franchise and independent stores and the opening of nine new stores during the twelve months ended September 30, 2019, as well as the acquisition of 37 franchise stores late in the third quarter of 2018. These positive factors were partially offset by the closure of 34 stores in the second and third quarters, in conjunction with our 2019 store optimization program and the continued impact of the ongoing helium shortage. Global retail
e-commerce
sales totaled $104.0 million during the first nine months of 2019 and were $1.9 million, or 1.9%, higher than during the corresponding period of 2018. Sales at our temporary Halloween City stores totaled $4.8 million and were $0.3 million or 5.7% lower than during the first nine months of 2018. Sales at other store formats totaled $1.7 million during the first nine months of 2019.
Same-store sales for the Party City brand (including North American retail
e-commerce
sales) decreased by 2.0% during the first nine months of 2019, principally due to impact of the ongoing helium shortage on balloon sales.
Our North American retail
e-commerce
sales, which include our Amazon marketplace sales, increased by $2.7 million or 3.2% compared to the first nine months of 2018 and, when adjusting for the impact of our “buy online,
pick-up
in store” program (such sales are included in our store sales), increased by 16.0%.
Excluding the impact of
e-commerce,
same-store sales decreased by 2.4%.
Same-store sales percentages were not affected by foreign currency as such percentages are calculated in local currency.
Wholesale net sales during the first nine months of 2019 totaled $440.4 million and were $23.1 million, or 5.0% lower than during the first nine months of 2018. Net sales to domestic party goods retailers and distributors (including our franchisee network) totaled $176.5 million and were $9.3 million, or 5.0% lower than during 2018. The decrease was partially due to our acquisition of six franchise and independent stores during the twelve months ended September 30, 2019, together with the acquisition of 37 franchise stores throughout the third quarter of 2018; as post-acquisition sales to such stores (approximately $13.7 million during the first nine months of 2018) are now eliminated as intercompany sales. Adjusted for the acquisitions, sales to domestic party goods retailers and distributors increased by approximately $4.4 million or 2.3%. Net sales of metallic balloons to domestic distributors and retailers (including our franchisee network) totaled $54.7 million during the first nine months of 2019 and were $6.7 million, or 10.9%, lower than during the corresponding period of 2018 principally due to the ongoing helium shortage. Our international sales (which include U.S. export sales and exclude U.S. import sales from foreign subsidiaries) totaled $209.1 million and were $7.1 million, or 3.3%, lower than in 2018. Foreign currency translation negatively impacted sales by approximately $10.0 million and more than offset $2.9 million in sales growth on a constant currency basis.
Intercompany sales to our retail affiliates totaled $522.4 million during the nine months ended September 30, 2019 and were $2.3 million lower than during the corresponding period of 2018. Intercompany sales represented 55.6% of total wholesale sales during the first nine months of 2019, compared to 53.1% during the comparable period of 2018. The increase in percentage was principally due to the impact of franchise/independent store acquisitions, partially offset by the impact of strong season
in-stock
positions from the prior year and a reduction in sales of metallic balloons to our retail operations. 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 nine months ended September 30, 2019 totaled $6.1 million and were $1.7 million lower than during the comparable period of 2018 principally due to the acquisition of franchise stores.
The following table sets forth the Company’s gross profit for the nine months ended September 30, 2019 and September 30, 2018.
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Nine Months Ended September 30,
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The gross profit margin on net sales at retail during the first nine months of 2019 was 37.3%. Such percentage was 460 basis points lower than during the corresponding period of 2018. The decrease was principally due to markdowns in conjunction with the Company’s “store optimization program” and provisions against inventory recorded in conjunction with such program (see “operating expenses” below for further discussion) and the impact of an aggressive coupon program during the third quarter of 2019. Additionally, the decrease was partially due to a flow through of higher freight and distribution costs for product acquired from the Company’s wholesale operations during the second half of 2018 as the China tariffs caused
non-recurring
logistical challenges. Our manufacturing share of shelf (i.e., the percentage of our retail product cost of sales manufactured by our wholesale segment) was 26.7% during the period, or 10 basis points higher than during the during the first nine months of 2018. Our wholesale share of shelf at our Party City stores and our North American retail
e-commerce
operations (i.e., the percentage of our retail product cost of sales supplied by our wholesale segment) was 78.0% during the period, or 20 basis points higher than the nine months ended September 30, 2018.
The gross profit on net sales at wholesale during the first nine months of 2019 and 2018 was 24.7% and 29.2%, respectively. The decrease was principally due to the decrease in high-margin sales of metallic balloons and lower sales to franchisees (due to the store acquisitions discussed above).
Wholesale selling expenses were $50.9 million during the first nine months of 2019 and were $2.7 million or 4.9% lower than during the corresponding period of 2018, due partially to the impact of foreign currency translation. Wholesale selling expenses were 11.6% of net wholesale sales during each of the first nine months of 2019 and 2018.
Retail operating expenses during the first nine months of 2019 were $302.8 million and were $17.7 million, or 6.2%, higher than the corresponding period of 2018. The increase was principally due to higher average store count during the first nine months of 2019 as well as an increase in advertising, e-commerce and information technology related expenses compared to the corresponding period in 2018. Retail operating expenses were 25.9% and 24.8% of retail sales during the first nine months of 2019 and 2018, respectively.
Franchise expenses during the first nine months of 2019 and 2018 were $9.8 million and $8.6 million, respectively. Franchise expenses for 2018 reflect a third quarter
non-recurring
adjustment that lowered franchise intangible asset amortization expense.
General and administrative expenses during the first nine months of 2019 totaled $126.5 million and were $9.7 million, or 7.1%, lower than in the first nine months of 2018. The decrease for the first nine months of 2019 was principally due to
non-recurring
consulting costs and
non-recurring
executive severance charges incurred during 2018. General and administrative expenses as a percentage of total revenues were 7.8% and 8.4% during the first nine months of 2019 and 2018, respectively.
Art and development costs were $17.6 million and $17.3 million during the first nine months of 2019 and 2018, respectively.
Development stage expenses represent
start-up
costs related to Kazzam (see the 2018 Form
10-K
for further detail).
During September 2019, the Company reported a $58.4 million gain from the sale and leaseback of its main distribution center in Chester, New York and its metallic balloons manufacturing facility in Eden Prairie, Minnesota. The aggregate sale price for the three properties was $128.0 million. Simultaneous with the sale, the Company entered into twenty-year leases for each of the facilities.
During the nine months ended September 30, 2019, the Company performed a comprehensive review of its store locations aimed at improving the overall productivity of such locations (“store optimization program”). Each year, the Company typically closes approximately 10 Party City stores as part of its typical network rationalization process and in response to ongoing consumer, market and economic changes that naturally arise in the business. During the first nine months of, 2019, after careful consideration and evaluation of the store locations, the Company made the decision to accelerate the optimization of its store portfolio with the closure of approximately 55 stores which are primarily located in close proximity to other Party City stores. These closings should provide the Company with capital flexibility to expand into underserved markets. In conjunction with the store optimization program, during the first nine months of 2019, the Company recorded a $14.1 million impairment charge for its operating lease asset, a $4.7 million impairment charge for property, plant and equipment, $6.3 million of labor and other costs related to closing the stores and $0.7 million of severance.
Goodwill impairment charges for the nine months ended September 30, 2019 were $259.1 million. The
non-cash
pre-tax
goodwill impairment charges were the result of a sustained decline in the Company’s market capitalization. There was no goodwill impairment for the nine months ended September 30, 2018. See Note 4 to the condensed consolidated financial statements for further discussion.
Interest expense, net, totaled $88.9 million during the first nine months of 2019, compared to $76.5 million during the comparable period of 2018. The variance principally relates to the impact of the Company’s August 2018 refinancing (see the Company’s 2018 Form
10-K
for discussion of such refinancing) and the impact of borrowings and average rates under our Term Loan and ABL credit facilities.
For the first nine months of 2019 and 2018, other expense, net, totaled $6.6 million and $9.1 million, respectively. During the first nine months of 2018, other expense included costs associated with the August 2018 refinancing of our debt portfolio.
The effective income tax rate for the nine months ended September 30, 2019, 7.6%, is lower than the statutory rate primarily due to the non-deductible portions of the goodwill impairment charges noted above.
Adjusted EBITDA, Adjusted Net Income and Adjusted Net Income per Common Share – Diluted
The Company presents adjusted EBITDA, adjusted net income and adjusted net income per common share - diluted as supplemental measures of its operating performance. The Company defines EBITDA as net income (loss) before interest expense, net, income taxes, depreciation and amortization and defines adjusted EBITDA as EBITDA, as further adjusted to eliminate the impact of certain items that the Company does not consider indicative of our core operating performance. These further adjustments are itemized below. Adjusted net income represents the Company’s net income (loss) adjusted for, among other items, intangible asset amortization,
non-cash
purchase accounting adjustments, amortization of deferred financing costs and original issue discounts, equity-based compensation, and impairment charges. Adjusted net income per common share – diluted represents adjusted net income divided by diluted weighted average common shares outstanding. The Company presents these measures as supplemental measures of its operating performance. You are encouraged to evaluate these adjustments and the reasons the Company considers them appropriate for supplemental analysis. In evaluating the measures, you should be aware that in the future the Company may incur expenses that are the same as, or similar to, some of the adjustments in this presentation. The Company’s presentation of adjusted EBITDA, adjusted net income and adjusted net income per common share-diluted should not be construed as an inference that the Company’s future results will be unaffected by unusual or
non-recurring
items. The Company presents the measures because the Company believes they assist investors in comparing the Company’s performance across reporting periods on a consistent basis by eliminating items that the Company does not believe are indicative of its core operating performance. In addition, the Company uses adjusted EBITDA: (i) as a factor in determining incentive compensation, (ii) to evaluate the effectiveness of its business strategies and (iii) because its credit facilities use adjusted EBITDA to measure compliance with certain covenants. The Company also believes that adjusted net income and adjusted net income per common share - diluted are helpful benchmarks to evaluate its operating performance.
Adjusted EBITDA, adjusted net income, and adjusted net income per common share - diluted have limitations as analytical tools. Some of these limitations are:
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they do not reflect the Company’s cash expenditures or future requirements for capital expenditures or contractual commitments;
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(k)
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Non-cash
charges for restricted stock units that vest based on service conditions.
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Non-cash
charges for restricted stock units that vest based on performance conditions.
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During June 2019, the Company reported a $58,381 gain from the sale and leaseback of its main distribution center in Chester, New York and its metallic balloons manufacturing facility in Eden Prairie, Minnesota. The aggregate sale price for the three properties was $128,000. Simultaneous with the sale, the Company entered into twenty-year leases for each of the facilities.
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(n)
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Represents income tax expense/benefit after excluding the specific tax impacts for each of the
pre-tax
adjustments. The tax impacts for each of the adjustments were determined by applying to the
pre-tax
adjustments the effective income tax rates for the specific legal entities in which the adjustments were recorded.
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The Company’s indebtedness principally consists of: (i) a senior secured term loan facility (“Term Loan Credit Agreement”), (ii) $350 million of 6.125% senior notes and (iii) $500 million of 6.625% senior notes. Additionally, the Company has a $640 million asset-based revolving credit facility (“ABL Facility”) that it draws down on as necessary (see the consolidated statement of cash flows in Item 1).
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 twelve months. We cannot provide assurance, 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.
Net cash used in operating activities totaled $182.3 million and $86.2 million during the nine months ended September 30, 2019 and 2018, respectively. The variance principally reflects the net loss from operations for the nine months ended September 30, 2019 compared to the net income for the nine month ended September 30, 2018. Net cash flows used in operating activities before changes in operating assets and liabilities were $23.2 million during the first nine months of 2019, compared to positive cash flows of $101.2 million during the corresponding period of 2018. Changes in operating assets and liabilities during the first nine months of 2019 and 2018 resulted in the use of cash of $159.1 million and $187.4 million, respectively.
Net cash provided by investing activities totaled $58.6 million during the nine months ended September 30, 2019, as compared to $129.3 million used during the nine months ended September 30, 2018. During September 2019, the Company sold and leased back its main distribution center in Chester, New York and its metallic balloons manufacturing facility in Eden Prairie, Minnesota. The net sale price for the properties is included in “Proceeds from disposal of property and equipment” in the Company’s condensed consolidated statement of cash flows. See Note 5 to the Company’s consolidated financial statements for further detail. Capital expenditures during the nine months ended September 30, 2019 and 2018 were $45.8 million and $65.5 million, respectively. Retail capital expenditures totaled $25.8 million during 2019. Wholesale capital expenditures during 2019 totaled $20.0 million.
Net cash provided by financing activities was $97.8 million during the nine months ended September 30, 2019 and $210.1 million during the first nine months of 2018. The variance was principally due to less of a need to borrow funds during 2019 due to proceeds from the sale of certain properties (see above).
As of September 30, 2019, the Company had approximately $152 million of availability under the ABL Facility, after considering borrowing base restrictions.
Critical Accounting Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the appropriate application of certain accounting policies, many of which require estimates and assumptions about future events and their impact on amounts reported in the financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the consolidated financial statements included herein.
We believe our application of accounting policies, and the estimates inherently required by these policies, are reasonable. These accounting policies and estimates are constantly
re-evaluated
and adjustments are made when facts and circumstances dictate a change. Historically, we have found the application of accounting policies to be reasonable, and actual results generally do not differ materially from those determined using necessary estimates.
Goodwill is reviewed for potential impairment on an annual basis or more frequently if circumstances indicate a possible impairment. For purposes of testing goodwill for impairment, reporting units are determined by identifying individual components within our organization which constitute a business for which discrete financial information is available and is reviewed by management. Components within a segment are aggregated to the extent that they have similar economic characteristics. Based on this evaluation, we have determined that our operating segments, wholesale and retail, represent our reporting units for the purposes of our goodwill impairment test.
If it is concluded that it is more likely than not that the fair value of a reporting unit is less than its carrying value, we estimate the fair value of the reporting unit using a combination of a market approach and an income approach. If such carrying value exceeds the fair value, an impairment loss will be recognized in an amount equal to such excess. The fair value of a reporting unit refers to the amount at which the unit as a whole could be sold in a current transaction between willing parties. The determination of such fair value is subjective, and actual fair value could differ due to changes in the expectations of cash flows or other assumptions, including discount rates.
During the third quarter of 2019, the Company identified an impairment indicator associated with its market capitalization and performed an interim impairment test on the goodwill at its retail and wholesale reporting units. As a result, the Company recorded a $259.1 million goodwill impairment charge. See footnote 4 to the condensed consolidated financial statements for further discussion. Should actual results differ from certain key assumptions used in the interim impairment test, including revenue and EBITDA growth, which are both impacted by economic conditions, or should other key assumptions change, including discount rates and market multiples, in subsequent periods the Company could record additional impairment charges for the goodwill of such reporting units.
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, 2018 as previously disclosed in our Annual Report on Form
10-K
for the year ended December 31, 2018.
Off Balance Sheet Arrangements
We had no
off-balance
sheet arrangements during the nine months ended September 30, 2019 and the year ended December 31, 2018.
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.
Our retail operations are subject to significant seasonal variations. Historically, this segment has realized a significant portion of its revenues, cash flow and net income in the fourth quarter of the year, principally due to our Halloween sales in October and, to a lesser extent,
year-end
holiday sales.
Cautionary Note Regarding Forward-Looking Statements
From time to time, including in this filing and, in particular, the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we make “forward-looking statements” within the meaning of federal and state securities laws. Disclosures that use words such as the company “believes,” “anticipates,” “expects,” “estimates,” “intends,” “will,” “may” or “plans” and similar expressions are intended to identify forward-looking statements. These forward-looking statements reflect our current expectations and are based upon data available to us at the time the statements were made. An example of a forward-looking statement is our belief that our cash generated from operating activities and availability under our credit facilities will be adequate to meet our liquidity needs for at least the next 12 months. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. These risks, as well as other risks and uncertainties, are detailed in the section titled “Risk Factors” included in our Annual Report on Form
10-K
filed with the SEC on February 28, 2019. 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:
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our ability to compete effectively in a competitive industry;
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fluctuations in commodity prices;
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our ability to appropriately respond to changing merchandise trends and consumer preferences;
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successful implementation of our store growth strategy;
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decreases in our Halloween sales;
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unexpected or unfavorable consumer responses to our promotional or merchandising programs;
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failure to comply with existing or future laws relating to our marketing programs,
e-commerce
initiatives and the use of consumer information;
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disruption to the transportation system or increases in transportation costs;
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product recalls or product liability;
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economic slowdown affecting consumer spending and general economic conditions;
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loss or actions of third-party vendors and loss of the right to use licensed material;
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disruptions at our manufacturing facilities;
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failure by suppliers or third-party manufacturers to follow acceptable labor practices or to comply with other applicable laws and guidelines;
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our international operations subjecting us to additional risks;
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potential litigation and claims;
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lack of available additional capital;
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our inability to retain or hire key personnel;
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risks associated with leasing substantial amounts of space;
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failure of existing franchisees to conduct their business in accordance with agreed upon standards;
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adequacy of our information systems, order fulfillment and distribution facilities;
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our ability to adequately maintain the security of our electronic and other confidential information;
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our inability to successfully identify and integrate acquisitions;
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adequacy of our intellectual property rights;
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risks related to our substantial indebtedness; and
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the other factors set forth under “Risk Factors” in our Annual Report on Form
10-K,
filed with the SEC on February 28, 2019.
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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.