-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LDOOT8ETP15cnRtLjX2vneVQchTM8CbOCwv55wpYeD8ldu4uJymDOvWAjZXGZK1Q KiZkqrkqfOmXeid0SQRdBg== 0000950123-98-003240.txt : 19980401 0000950123-98-003240.hdr.sgml : 19980401 ACCESSION NUMBER: 0000950123-98-003240 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PARTY CITY CORP CENTRAL INDEX KEY: 0001005972 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-MISCELLANEOUS SHOPPING GOODS STORES [5940] IRS NUMBER: 223033692 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-27826 FILM NUMBER: 98583757 BUSINESS ADDRESS: STREET 1: 450 COMMONS WAY CITY: ROCKAWAY STATE: NJ ZIP: 07860 BUSINESS PHONE: 2019830888 MAIL ADDRESS: STREET 2: 400 COMMONS WAY CITY: ROCKAWAY STATE: NJ ZIP: 07866 10-K 1 PARTY CITY 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------- FORM 10-K |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year end December 31, 1997 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-27826 PARTY CITY CORPORATION (Exact name of registrant as specified in its charter) Delaware 22-3033692 -------- ---------- (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 400 Commons Way, Rockaway, New Jersey 07866 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (973) 983-0888 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of Each Class on which registered ------------------- --------------------- NONE NONE Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share -------------------------------------- (Title of Class) 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 |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_| The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $310,250,848 based upon the closing price for the Company's Common Stock, $.01 par value, as reported by the National Association of Securities Dealers Automated Quotation System on March 27, 1998 of $32 per share. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Class Outstanding at March 27, 1998 ----- ----------------------------- Common Stock, $.01 par value per share 12,372,839 DOCUMENTS INCORPORATED BY REFERENCE PORTIONS OF THE REGISTRANT'S PROXY STATEMENT FOR THE 1998 ANNUAL MEETING OF SHAREHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III. SUCH PROXY STATEMENT WILL BE FILED WITHIN 120 DAYS AFTER THE END OF THE FISCAL YEAR COVERED BY THIS ANNUAL REPORT ON FORM 10-K. 2 1997 Annual Report on Form 10-K TABLE OF CONTENTS
Page ---- PART I Item 1 Business..............................................................................1 Item 2 Properties...........................................................................16 Item 3 Legal Proceedings....................................................................16 Item 4 Submission of Matters to a Vote of Security Holders..................................17 PART II Item 5 Market for the Registrant's Common Stock and Related Security Holder Matters.........17 Item 6 Selected Financial Data..............................................................18 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations...........................................................................20 Item 8 Financial Statements and Supplementary Data..........................................25 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...........................................................................25 PART III Item 10 Directors and Executive Officers of the Registrant...................................26 Item 11 Executive Compensation...............................................................26 Item 12 Security Ownership of Certain Beneficial Owners and Management.......................26 Item 13 Certain Relationships and Related Transactions.......................................26 PART IV Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K......................26
3 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain statements in this Annual Report on Form 10-K constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: changes in general economic and business conditions; loss of market share through competition; introduction of competing services by other companies; changes in industry capacity; pressure on prices from competition or from purchasers of the Company's products; difficulties in finding new site locations; availability of qualified personnel; and other factors both referenced and not referenced in this Annual Report on Form 10-K. When used in this Annual Report on Form 10-K, the words "estimate," "project," "anticipate," "expect," "intend," "believe" and similar expressions are intended to identify forward-looking statements. PART I Item 1. Business General The Company is a rapidly growing specialty retailer of party supplies through its network of discount Super Stores. At February 28, 1998, the Company owned and operated 124 Party City Super Stores in the United States and its franchisees operated an additional 157 stores in the United States, Puerto Rico, Canada, Portugal and Spain. The Company, based in Rockaway, New Jersey, believes it is one of the largest party supplies specialty superstore chains. The Company authorized the first franchise store in 1989 and opened its first Company-owned store in January 1994. System-wide sales (including net sales at Company-owned and franchised stores) for the year ended December 31, 1997 totaled approximately $399.5 million, an increase of 48.7% over the year ended December 31, 1996. During the year ended December 31, 1997, the Company significantly accelerated its Company-owned Super Store expansion program and opened 57 Company-owned Super Stores. In addition to these new Store openings, the Company purchased 24 Super Stores from franchisees or affiliates during the year ended December 31, 1997. The Company's total revenue increased from approximately $48.6 million in 1996 to approximately $141.7 million in 1997, an increase of 191.6%. During this same period, income from operations increased 119.8% from approximately $5.6 million in 1996 to approximately $12.4 million in 1997. The Company expects to open approximately 70 to 75 Company-owned Super Stores in 1998 and approximately 90 to 100 Company-owned Super Stores in 1999. The Company anticipates to continue to selectively purchase additional franchise Super Stores in 1998. The Company believes that, under its "Party City, The Discount Party Super Store" trademark, it has transformed the party supplies business by introducing increased product and marketing focus and greater mass merchandising sophistication. Pursuant to its merchandising concept, the Company operates and franchises party supplies Super Stores that generally range in size from 10,000 square feet to 12,000 square feet. These Super Stores offer a broad selection of merchandise (branded as well as private label) for a wide variety of celebratory occasions, including birthday parties, weddings, and baby showers as well as seasonal events such as Halloween, Christmas, New Year's Eve, graduation, Easter, Valentine's Day, Thanksgiving, St. Patrick's Day, the Super Bowl and the Fourth of July. Party City seeks to offer customers a "one-stop" 1 4 party store that provides a wide selection of merchandise at everyday low prices. A key element of delivering customer satisfaction is stocking inventory in sufficient quantities to satisfy customer needs for parties of virtually all sizes and types. Industry Overview The retail party supplies business has traditionally been a fragmented one, with consumers purchasing party-related products from single owner-operated party supplies stores and designated departments in drug stores, general mass merchandisers, supermarkets, and department stores of local, regional and national chains. According to Party and Paper Retailer, a retail trade publication, the market for party and special occasion merchandise, comprised of party supplies, greeting cards, gift wrap and related items had estimated retail sales of $9.4 billion in 1997. The Company believes that the increasing breadth of party supplies merchandise produced by manufacturers over the past few years has been a driving factor in the marketplace's acceptance of the party supplies superstore concept. Further, the Company believes that the significant revenues experienced by its Company-owned and franchise Super Stores in the fourth quarter can be attributed, to a large extent, to the growth in the number of persons celebrating Halloween and the increased demand for costumes and party supplies utilized in such celebrations. The Company has noted the marketplace's acceptance of other types of superstores and mega-retailers in various categories such as food, home furnishings and pet supplies, among others. The success of such superstores and mega-retailers in other industries has prompted the Company to expand its product lines to include a wider breadth of merchandise in order to make its Super Stores increasingly attractive destination shopping locations for party supplies. In addition, the Company believes that the increased breadth of related and integrated merchandise available to customers in superstores and mega-retailers influences consumers to increase the number of purchases in a given trip to a retailer. As such, the Company believes that the broad selection, and relatively low price points, of merchandise offered by its Super Stores often stimulates customers to purchase additional items on impulse. Business Strategy The Company's objective is to continue to expand its position as a leading category-dominant national chain of party supplies superstores. The Company believes that it has transformed the party supplies business by introducing increased product and marketing focus and greater mass merchandising sophistication. Key components of the Company's strategy are: Pursue Super Store Expansion. The Company believes that opportunities for substantial expansion exist by opening additional Super Stores in both new and existing markets and believes that numerous sites are available for such expansion. The Company's expansion strategy is to rapidly increase its Company-owned store base while continuing to add franchise stores on a limited basis. In addition, during 1997 the Company purchased 24 franchise stores and anticipates selectively acquiring additional franchise stores in the future. Based on its expansion plan, the Company anticipates opening approximately 70 to 75 new Company-owned stores and 12 franchise stores in 1998 and approximately 90 to 100 new Company-owned stores and 12 franchise stores in 1999, bringing the total stores in operation to approximately 187 to 192 Company-owned Super Stores and approximately 169 franchise Super Stores by the end of 1998 and 2 5 approximately 277 to 292 Company-owned Super Stores and approximately 181 franchise Super Stores by the end of 1999. Offer the Broadest Selection of Merchandise in an Exciting Shopping Environment. The Company strives to provide party-planners and party-goers with convenient one-stop shopping for party supplies and offers what it believes is one of the most extensive selections of party supplies. A typical Party City Super Store contains approximately 20,000 SKUs. Within its many product categories, Party City offers a wide variety of patterns, colors and styles. The Company has been expanding the range of items which it offers in order to create consumer loyalty and generate repeat business by striving to maintain a new and exciting product selection. Further, the Company believes that its broad selection of merchandise and relatively low price points often stimulates consumers to purchase additional party supplies on impulse. Establish Convenient Store Locations. While the Company believes that its stores typically are destination shopping locations, it seeks to maximize customer traffic and quickly build the visibility of new stores by situating its stores in high traffic areas. Site selection criteria include: population density; demographics; traffic counts; complementary retailers; storefront visibility and presence (either in a stand-alone building or in a strip or power shopping center); competition; lease rates; and accessible parking. The Company believes there is an extensive number of suitable locations available for future stores. Maintain Everyday Low Pricing. The Company, using the buying power of its 281 Company-owned and franchise Super Stores at February 28, 1998, obtains volume discounts from its vendors on most products, allowing the Super Stores to offer a broad line of high quality merchandise at competitive prices. The Company reinforces customers' expectations of savings by prominently displaying signs announcing its everyday low prices. The Company also maintains a lowest price guaranty policy, to which it suggests its franchisees adhere; this policy guarantees that Party City will meet and discount the advertised prices of a competitor's products. The Company believes that this policy has helped foster the Company's image of offering consumers exceptional value for their money. Provide Excellent Customer Service. The Company views the quality of its customers' shopping experience as critical to its continued success. The Company is committed to making shopping in its Super Stores an enjoyable experience through the employment of friendly, knowledgeable and energetic sales associates who provide customers with personalized shopping assistance. At Halloween, an important selling season for the Company, each store increases significantly the number of sales associates in the store to ensure prompt service. Sales associates assist customers in selecting or finding a certain item, which provides the sales associates with a cross-selling opportunity to suggest accessories or other complementary products. The Company believes that the compensation of its store managers and other personnel is competitive and enables the Company to attract and retain well-qualified, motivated employees who are committed to providing excellent customer service. Utilize Sophisticated Merchandising Systems. The Company believes that the daily use of its customized MIS system enables the Company to quickly analyze the performance of Company-owned and franchise stores in order to allow it to more rapidly react to changing consumer preferences. The MIS system is a critical element in management's efforts to evaluate the sales performance of individual stores and to assist in analyzing and deciding upon the proper mix of merchandise. In addition, the MIS system is essential in assisting the individual store managers in constantly replenishing their shelves, which is consistent with the Company's goal of having shelves fully stocked in order to make the stores more exciting 3 6 to consumers and to take Advantage of sales opportunities. The Company continually evaluates and updates its systems. Capitalize on Direct Marketing and Advertising. The Company believes that its advertising and marketing strategy allows it to open stores in any area of the country without the need to cluster stores. Direct mailings to potential customers are the principal form of advertising. The Company accomplishes this by soliciting zip code information from customers at the time of their purchases. This information is input into the MIS system and is used to determine the geographical area where the most likely potential customers live. With this information, in conjunction with major seasonal events, each store effects approximately 11 to 13 direct mailings per year to residents in those targeted areas, Investment in Infrastructure to Support Growth. As the Company has increased its base of Company-owned Super Stores, it has made additions to its management team. During 1997, the Company added key people and additional support in the Company's MIS, real estate, merchandising, franchise, human resources, administrative support and construction departments. The Company continues to make additions to its management team in an effort to realize its expansion plans for Company-owned stores. Expansion Plans The Company's expansion strategy is to increase its market share in existing markets and to penetrate new markets with a goal of maintaining a leading position as a category-dominant retailer of party supplies merchandise. Over the next few years, the Company intends to continue to devote greater resources to the opening of Company-owned stores and therefore believes that for the next several years its revenue growth increasingly will be derived from the opening of Company-owned, rather than franchise Super Stores. The Company is experienced in overseeing a large number of stores that are geographically disbursed. The Company believes that there is an extensive number of suitable locations available for future sites. As of February 28, 1998, the Company has opened 7 Company-owned stores in 1998. In 1997, the Company opened 57 Company-owned stores and acquired 24 franchise stores, and its franchises opened an additional 19 stores. In 1996, the Company opened 20 Company-owned stores and its franchisees opened an additional 32 stores. Based on its current planning and market information, the Company plans to open approximately 70 to 75 additional Company-owned stores in 1998, and believes that new and existing franchisees will open approximately 12 stores. As of February 28, 1998, the Company has signed leases for 36 of its planned Company-owned locations to be opened in 1998. Franchise Stores Acquired by the Company in 1997
Locations Square Footage - --------- -------------- Randolph, NJ..................................................... 8,500 Livingston, NJ................................................... 8,426 Wayne, NJ........................................................ 14,500 Woodbridge, NJ .................................................. 8,700 East Brunswick, NJ............................................... 7,700
4 7
Locations Square Footage - --------- -------------- Parsippany, NJ................................................... 11,400 Virginia Beach, VA .............................................. 7,500 Skokie, IL....................................................... 8,300 Mesquite, TX..................................................... 7,500 West Plano, TX................................................... 7,900 Torrance, CA .................................................... 8,000 Santa Ana, CA.................................................... 8,400 Richardson, TX................................................... 10,000 Carrollton, TX................................................... 9,000 Arlington, TX ................................................... 8,400 Staten Island (Hylan), NY........................................ 8,000 Chesapeake, VA................................................... 9,600 Irving, TX....................................................... 10,009 Medallion, TX.................................................... 11,250 Redbird, TX ..................................................... 11,621 Lincoln Park, IL ................................................ 10,500 Vista Ridge, TX.................................................. 8,885 White Rock, TX................................................... 11,008 Pleasant Grove, TX .............................................. 12,500
The Company anticipates that approximately 12 new franchise Super Stores will be opened in 1998. As of February 28, 1998, 5 leases for new stores had been signed by franchisees in Florida, Oregon, North Carolina and two in New Jersey. 5 8 Store Economics The Company believes that the Party City Super Store concept offers attractive unit economics and is conducive to the Company's planned expansion of its store base. The Company's 36 Company-owned stores that were in operation for all of 1997 generated average sales revenue of approximately $1,740,000 and an average store contribution of $177,000, or 10.2% of net sales. The stores included in such average are comprised of seven, nine and twenty stores opened in 1994, 1995 and 1996, respectively. The Company expects that the average cost for new Company-owned stores to be approximately $387,000 for a typical 10,000 to 12,000 square feet leased store. The Company's cost of leasehold improvements in its present stores has ranged from $0 to $250,000, with an average cost of $47,000. The average cost of the investment in equipment and fixtures in Company-owned stores has been $180,000. Pre-opening costs, which are expensed as incurred, have averaged $35,000 per Company-owned store. These pre-opening expenses primarily consist of labor, supplies, and occupancy charges. Each new store spends approximately $125,000 for inventory, net of accounts payable. Store Locations As of February 28, 1998, there were 281 Party City Discount Super Stores open in the United States, Canada, Puerto Rico, Portugal and Spain. Of these, 124 were Company-owned and 157 were operated by the Company's independent franchisees. Since the opening of its first franchise store, the Company has grown rapidly. The following table shows the growth in the Company's network of stores during the last seven years.
Year Ended December 31, ----------------------------------------------------------------- 1991 1992 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- ---- ---- Company-owned: Number of stores opened during period................ - - - 7 9 20 57 Number of stores closed during period................ - - - 0 0 0 0 Number of franchise stores acquired during the period.................................... - - - 0 0 0 24 Number of stores open at end of period............... - - - 7 16 36 117 Franchise: Number of stores opened during period................ 5 16 26 42 35 32 19 Number of stores closed during period................ 0 0 0 1 2 0 1 Number of stores purchased by the 0 0 0 0 0 0 24 Company during the period............................ Number of stores open at end of period............... 16 32 58 99 132 164 158 -- -- -- -- --- --- --- Total stores open at end of period................... 16 32 58 106 148 200 275
6 9 The Company typically seeks sites for new Super Stores that are stand-alone buildings or which are located in a strip or power shopping center near high traffic routes. The Company seeks to lease sites rather than own the real estate. Often the site may be a shopping center under construction or renovation and may be available for occupancy typically in a period ranging from three months to one year. The Company visits numerous sites throughout the year in the United States and in several foreign countries. The Company's site selection criteria include, but are not limited to: population density and/or demographics; traffic count; complementary retailers; store-front visibility and presence; competition; lease rates; and accessible parking. In addition, the Company carefully considers the presence of existing, and the potential for future, competition in the market when selecting a site. The Company believes there is an extensive number of suitable locations available for future sites. Merchandising Super Store Layout. Party City Super Stores are designed to give the shopper a feeling of excitement and create a festive atmosphere. The Company's goal is for the customer to be pleasantly surprised by his or her shopping experience. The Company's strategy to achieve this goal is to maintain an in-stock position of the widest selection of party supplies; this helps ensure that the Company will reduce the possibility of missed sale opportunities. Party City Super Stores range in size from 6,750 to 15,876 square feet with a typical store size between 10,000 and 12,000 square feet. A typical store stocks over 20,000 SKUs on its shelves. The stores are divided into various sections of different categories of party supplies, displayed to emphasize the everyday low prices and breadth of merchandise available. The floor plan is designed to impress the customer with the breadth of selection in each product category. Product Categories. The typical Party City Super Store offers a broad selection of merchandise consisting of over 20,000 SKUs divided into the following categories: Halloween. An important merchandising concept for Party City Super Stores is to provide an extensive selection of costumes for Halloween through its "Halloween Costume Warehouse" department. The stores also carry a broad array of decorations and accessories for the Halloween season. The Halloween merchandise is prominently displayed to provide an exciting and fun shopping experience for customers. The Company, because of the buying power of the Party City system, is often able to obtain supplies of some of the most sought after Halloween-related merchandise. The stores display Halloween-related merchandise throughout the year to position the Company as the customer's Halloween shopping resource. The Company believes that the importance of Halloween, among both young children and adults, is growing significantly. Seasonal. Customer purchases made for seasonal holiday events compose a significant part of Party City's business. The seasonal category includes products which are carried for the Super Bowl, Valentine's Day, St. Patrick's Day, Passover, Easter, First Communion, graduation, the Fourth of July, Christmas, Hanukkah and New Year's Eve. Some of the major items within this category are tableware, decorations, cutouts, lights and balloons tailored to the particular event. Birthdays. The birthday product category includes a wide assortment of merchandise to fulfill customer needs for celebrating birthdays, including special ones such as "first," "sweet sixteen" and other milestone birthdays such as 40th and 50th birthdays. Some of the products in this category include 7 10 invitations, thank you cards, tableware, hats, horns, banners, cascades, balloons, novelty gifts, pinatas and candies. Party Favors. The Company maintains a party favors department which includes a broad selection of packaged and bulk favors appealing to different age groups. The assortment includes different product lines varying in price points designed to offer customers a variety of purchasing options. Candy. The candy product category includes novelty and packaged candy sold to enhance children's parties or to be used as pinata fillers. Candy is sold both in individual units and in bulk packaging for customers' convenience. Balloons. The Company maintains a balloon department which carries a vast selection of basic and decorative latex balloons in many sizes, qualities, colors and package sizes. The mylar balloon department consists of numerous sizes, shapes and designs relating to birthday, seasonal, anniversary and other themes. Baby Shower. The Company maintains a baby shower department, which includes tableware, decorations, balloons, favors, centerpieces and garlands. Bridal/Wedding/Anniversary. This product category includes personalized invitations, tableware, balloons, favors, place setting cards, confetti, honeycomb bells and personalized ribbons. Personalized invitation books, which contain numerous samples of customizable event invitations, are carried from the leading invitation stationers at discounted prices. Catering Supplies. Party City stores offer a broad selection of catering supplies that consists of trays, platters, foil, bowls, warming racks and fuel. Gift Wrap. This product category includes wide assortments of gift bags, bows, tissue paper, ribbons (both solid and printed), glossy printed bags, solid gift wrap, printed gift wrap and foil gift wrap. Greeting Cards. This product category includes greeting cards from a quality national card vendor at everyday low prices. General. The Company carries a wide range of other products, including decorative tableware, solid tableware, plastic and paper table covers, cutlery, crepe paper, cups and tumblers. Party City stores carry private label items, as well as its typical branded merchandise. Product Selection, Purchasing and Suppliers. The Company's management continuously reviews new and existing product selections to provide the widest and most current assortment of party supplies. In pursuit of this goal, management attends various industry trade shows including the National Annual Halloween Trade Show in Rosemont, Illinois and the Toy Fair in New York. In an effort to keep abreast of new and popular merchandise, management views presentations given specifically for the Company by its major vendors. The Company utilizes its inventory tracking system to give the purchasing staff constant feedback on customers' preferences. Each Super Store typically purchases inventory from approximately 325 suppliers. Two of Company's suppliers accounted for 15.8% and 12.9%, respectively, of the Company inventory purchased in 1997. The loss of either one or both of these suppliers would adversely affect the Company's operations. 8 11 The Company does not have long-term purchase commitments or exclusive contracts with any particular manufacturer or supplier. The Company considers numerous factors in supplier selection, including price, credit terms, product offerings and quality. The Company negotiates pricing with suppliers on behalf of all stores in the system (both Company-owned and franchise) and believes that such buying power enables it to not only receive the most favorable pricing terms, but, as importantly, to more readily obtain high demand merchandise, especially popular Halloween costumes. As the Company continues to add new stores, the Company believes it will increase the volume of its inventory purchases and thereby may benefit further from increased discounts and more favorable trade credit terms from its suppliers. In order to maintain consistency throughout its store system, the Company has established an approved list of items that are permitted to be sold in Super Stores. Pursuant to the terms of the Company's franchise agreements, franchise stores must adhere to these guidelines. The Company establishes a standard store merchandise layout and presentation format to be followed by Company-owned and franchise Super Stores. Any layout or format changes developed by the Company are communicated to the managers of Super Stores on a periodic basis. All of the merchandise purchased by Super Stores is shipped directly from suppliers to the stores. The purchasing decisions and inventory control are facilitated by the use of sophisticated point-of-sale inventory control technology. Almost all merchandise is bar coded either by the supplier prior to delivery or at the time of receipt at the store. Consistent with the Party City Super Store concept, almost all inventory is displayed on the shelves with little or no space used for stocking. Excess merchandise is stored above the gondola fixtures on the store sales floor. Store Operations Each Super Store is typically managed by a general manager and two assistant managers who are responsible for all aspects of the store's day-to-day operations, including employee hiring and training, work scheduling, inventory control, expense control, maintenance activities and communications with central office staff. The sales and stocking staff ranges from three to eight people, except during certain holiday selling seasons when additional store employees are used. The Company seeks to pay its store managers at the top end of the competitive pay scale in order to hire and retain experienced and dedicated managers. In addition, the Company has instituted its Amended and Restated 1994 Stock Option Plan pursuant to which managers of Company-owned stores are eligible for stock option awards. Management Information Systems. The MIS system is a vital tool for increasing the efficiency of store operations. The Company believes that its management information system is an important factor in allowing the Company to support its rapid growth and enhance its competitive position in the industry. Through the MIS system, store managers are able to quickly evaluate the sales performance of their stores and of individual items in their stores, while also replenishing stock shelves in a timely fashion. Typically, merchandise is received already bar coded, enabling managers to control inventory and pricing by SKU, to manage assortment within a category, and to analyze gross margins and inventory turnover. Each Super Store uploads transaction information into the Company's corporate headquarters' MIS system on a daily basis. The headquarters' system has all of the functionality of the individual store's system and can consolidate information into multiple store groupings. All file information (i.e., vendor, item price, etc.) is maintained and downloaded nightly to each store location. The Company's MIS system allows it to monitor daily sales and gross profit across its entire store base, Training. In Company-owned stores, corporate store managers are trained for a minimum of two weeks prior to the opening of a store. During the store set-up, a manager receives additional training from 9 12 the Company's store set-up team. During the first few days after the initial opening of a store, corporate headquarters' personnel spend concentrated time in the store overseeing the operations. In franchise locations, all franchisees go through an intense training program consisting of one week in the classroom and one week in the store to learn the fundamentals of the store's operation. During the set up of their store, the franchisee receives additional training from the team leader of the set-up crew that is dispatched by the Company to assist the franchisee with the store opening. Shortly after a store opens, a representative from the Company visits the franchise and spends several days assisting with the day-to-day operations of running the store. To ensure efficient operations and that the systems, policies and processes are being followed, subsequent visits are scheduled on a regular basis to review what was covered during the initial training. Customer Service Customer service and shopping convenience are integral components of Party City's one-stop shopping concept. The Company views the quality of its customers' shopping experience as critical to its continued success. To this end, the Company employs friendly, knowledgeable and energetic sales associates who provide customers with personalized shopping assistance. For example, at Halloween, an important selling season for the Company, each store increases significantly the number of sales associates in the store. These employees will assist customers in selecting a costume, which provides the sales associates with a cross-selling opportunity to suggest various accessories and other complementary products. Also, at Halloween the associates utilize two-way radios, which the Company believes help stock personnel to quickly fill requested items, thus expediting sales and reducing lost business caused by slow service. The Company believes that the compensation of its store managers and other personnel is highly competitive and enables the Company to attract and retain well-qualified, highly motivated employees who are committed to providing excellent customer service. Marketing and Advertising For each Company-owned store, the Company budgets approximately five percent of annual sales for advertising. Under the Company's current franchise agreement, each franchisee is required to allocate a minimum of $5,500 to promote the store's grand opening and the lesser of 3.0% of net sales or $60,000 per year for local advertising and promotions. To promote the Party City Super Store concept on a larger scale and to produce professional quality advertising for system use, franchisees must also pay an additional one percent of gross sales per year to a Party City group advertising fund. Direct mailings to potential customers are the principal form of advertising. The Company believes that direct mail advertising has enabled the Company and its franchisees to successfully open stores in any location without the need to cluster stores. The overall success the Company and its franchisees have experienced with direct mailings can be attributed to targeting potential customers in the areas surrounding stores. The Company accomplishes this by soliciting zip code information from customers at the time of their purchases. This information is entered into the MIS system and used to determine the geographical area where the most likely potential customers live. With this information, in conjunction with major seasonal events, each store effects approximately ten to twelve direct mailings per year to residents in those targeted areas. 10 13 Company-Owned Stores The Company believes that an increasing amount of the growth in its operations in the future will continue to come from Company-owned Super Stores. At February 28, 1998 there were 124 Company-owned Party City Super Stores, including 57 Super Stores opened in 1997 and 24 franchised Super Stores purchased by the Company in 1997. The Company plans to open approximately 70 to 75 additional stores in 1998 and approximately 90 to 100 stores in 1999. The Company's 124 Company-owned Super Stores are located in the following States:
State Number of Stores - ----- ---------------- California ................................................... 22 Connecticut................................................... 3 Florida....................................................... 11 Illinois...................................................... 8 Indiana....................................................... 5 Maryland...................................................... 4 Michigan...................................................... 7 Minnesota..................................................... 3 Missouri...................................................... 3 Nevada........................................................ 2 New Jersey.................................................... 12 New York...................................................... 17 Ohio.......................................................... 3 Pennsylvania.................................................. 5 Texas......................................................... 15 Virginia...................................................... 3 Wisconsin..................................................... 1
Of the leases for the 124 stores listed above, one expires in 1999, four expire in 2001, five in 2002 and the balance in 2003 or thereafter. As of February 28, 1998, the Company had signed leases for an additional 36 Company-owned locations to be opened during 1998. 11 14 Franchise Operations Until opening its first Company-owned store in January 1994, the Company operated exclusively as a franchisor. As of February 28, 1998, the Company was the franchisor for 157 Super Stores throughout the United States, Puerto Rico, Canada, Portugal and Spain. A Party City Super Store run by a franchisee utilizes the Company's format, design specifications, methods, standards, operating procedures, systems and trademarks. The Company's 157 franchise stores are located in the following states and foreign countries:
State Number of Stores - ----- ---------------- Alabama...................................................... 4 Arizona...................................................... 5 Arkansas..................................................... 1 California................................................... 9 Colorado..................................................... 1 Connecticut.................................................. 4 Delaware..................................................... 1 Florida...................................................... 13 Georgia...................................................... 12 Hawaii....................................................... 1 Illinois..................................................... 5 Kansas....................................................... 2 Louisiana.................................................... 4 Maryland..................................................... 4 Mississippi.................................................. 1 Missouri..................................................... 1 New Jersey................................................... 16 New Mexico................................................... 2 New York..................................................... 11 North Carolina............................................... 10 Ohio......................................................... 3
12 15
State Number of Stores - ----- ---------------- Oregon....................................................... 2 Pennsylvania................................................. 9 South Carolina............................................... 2 Tennessee.................................................... 7 Texas........................................................ 8 Virginia..................................................... 5 Canada....................................................... 5 Puerto Rico.................................................. 4 Portugal..................................................... 1 Spain........................................................ 4
The following table summarizes the Company's franchise operations history through December 31, 1997:
Year Ended December 31, ------------------------------------------------------- 1991 1992 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- ---- ---- Number of stores open at end of period .... 16 32 58 99 132 164 158 Total sales of franchise stores ($ millions) $ 14.8 $ 28.1 $ 56.9 $ 109.0 $ 166.7 $ 230.6 $ 268.6
The Company receives revenue from its franchisees, including an initial one-time fee (currently at $35,000) and an ongoing royalty fee (currently 4.0% of net sales for new franchisees, payable monthly). In addition, each franchisee has a mandated advertising budget, which consists of a minimum of $5,500 to promote the initial store opening and thereafter the lesser of 3.0% of net sales or $60,000 per year for local advertising and promotions. Further, the franchisee must pay an additional 1.0% of net sales to a Party City group advertising fund to cover common advertising materials related to the Party City Super Store concept. The Company does not offer financing for a franchisee's initial investment. Franchise start-up expenses include the franchise fee, rent, leasehold improvements, equipment and furniture, initial inventory, opening promotion, signs, other deposits, insurance, training expenses and professional fees. Current franchise agreements provide for an assigned area or territory that typically equals a three-mile radius from the franchisee's store location and the right to use the Party City logo type and trademark "The Discount Party Super Store." In most stores, the franchisee or the majority shareholder of a corporate franchisee devotes full time to the management, operation and on-premises supervision of the franchise. Although such locations are generally obtained and secured by the franchisee, pursuant to the franchise agreement entered into with franchisees, all site locations must be approved by the Company. 13 16 As franchisor, Party City also supplies valuable and proprietary information pertaining to the operation of the Party City Super Store business, as well as advice regarding location, improvements and promotion. The Company also supplies consultation in the areas of purchasing, inventory control, pricing, marketing, merchandising, hiring, training, improvements and new developments in the franchisee's business and general business operations, as well as the provision of assistance in opening and initially promoting the store. As of February 28, 1998 the Company had 7 territory agreements with certain franchisees. These agreements permit the holder of the territory rights to open a minimum of two and in some cases three or more stores within a stated time period. If stores are not opened pursuant to the schedule, the territory agreement may be terminated. The following areas are governed by territory agreements: North Carolina; Louisiana/Alabama; Phoenix, AZ and Santa Fe/Albuquerque, NM; Atlanta, GA; Canada; Spain/Portugal; Puerto Rico. Competition The party supplies retailing business is highly competitive. Party City Super Stores compete with a variety of smaller and larger retailers, including single owner-operated party supplies stores, specialty party supplies retailers (including superstores), designated departments in drug stores, general mass merchandisers, supermarkets and department stores of local, regional and national chains. Many of these competitors have substantially greater financial resources than the Company. Management believes that Party City Super Stores maintain a leading position in the party supplies business by offering a wider breadth of merchandise, greater selection within merchandise class and discount prices offered on most items in the stores. The Company believes that the significant buying power resulting from the size of the Party City Super Store System is an integral advantage. Trademarks The Company has licensed from a wholly-owned subsidiary a number of trademarks and service marks registered with the United States Patent and Trademark Office, including the marks Party City,(R) The Discount Party Super Store(R) and Halloween Costume Warehouse.(R) Government Regulation As a franchisor, the Company must comply with regulations adopted by the Federal Trade Commission (the "FTC") and with several state laws that regulate the offer and sale of franchises. The Company also must comply with a number of state laws that regulate certain substantive aspects of the franchisor-franchisee relationship. The FTC's Trade Regulation Rule on Franchising (the "FTC Rule") requires that the Company furnish prospective franchisees with a franchise offering circular containing information prescribed by the FTC Rule. State laws that regulate the offer and sale of franchises require the Company to register before the offer and sale of a franchise can be made in that state. State laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states. Those laws regulate the franchise relationship, for example, by requiring the franchisor to deal with its franchisees in good faith, by prohibiting interference with the right of free association among franchisees and by regulating discrimination among franchisees with regard to charges, royalties or fees. 14 17 Those laws also restrict a franchisor's rights with regard to the termination of a franchise agreement (for example, by requiring "good cause" to exist as a basis for the termination) by requiring the franchisor to give advance notice to the franchisee of the termination and give the franchisee an opportunity to cure any default, and by requiring the franchisor to repurchase the franchisee's inventory or provide other compensation. To date, those laws have not precluded the Company from seeking franchisees in any given area and have not had a material adverse effect on the Company's operations. Each Party City Super Store must comply with regulations adopted by federal agencies and with licensing and other regulations enforced by state and local health, sanitation, safety, fire and other departments. Difficulties or failures in obtaining the required licenses or approvals can delay and sometimes prevent, the opening of a new store. Party City stores must comply with federal and state environmental regulations, but the cost of complying with those regulations has not been material. More stringent and varied requirements of local governmental bodies with respect to zoning, land use, and environmental factors can delay, and sometimes prevent, development of new stores in particular locations. The Company and its franchisees must comply with the Fair Labor Standards Act and various state laws governing various matters such as minimum wages, overtime and other working conditions. The Company and its franchisees also must comply with the provisions of the Americans with Disabilities Act, which require that employers provide reasonable accommodation for employees with disabilities and that stores be accessible to customers with disabilities. 15 18 Employees As of March 24, 1998, the Company employed approximately 921 full-time and 1,775 part-time employees. The Company considers its relationships with its employees to be good. None of the Company's employees is covered by a collective bargaining agreement. Item 2. Properties As of February 28, 1998, the Company leased 124 stores and had signed leases for 36 additional stores in the locations mentioned under Item 1. The Company maintains its headquarters at 400 Commons Way, Rockaway, New Jersey 07866. The Company occupies approximately 12,201 square feet of office space for its headquarters under a lease expiring in 2005. Item 3. Legal Proceedings Party City of Greenbrook, Inc., et al., v. Party City Corporation The Company has been named as the defendant in a complaint filed with the Supreme Court of the State of New York, County of New York, on January 16, 1998 (the "Complaint"), by each of Party City of Greenbrook, Inc., Party City of Watchung, Inc., Party City of 22, Inc., Party City of Ralph Avenue and Party City of Jersey City, Inc., each a franchisee of the Company. Four of the plaintiffs in the suit have existing Party City franchise stores, with the remaining plaintiff possessing a right of first refusal to develop a Party City store in Watchung, New Jersey. The Complaint states various causes of action, including unjust enrichment, unfair competition, fraud and misrepresentation, breach of contract, misappropriation of information and violations of the New Jersey Franchise Practices Act and the New York State Franchise Sales Act. The crux of the Complaint is that the Company undertook a course of conduct intentionally designed to adversely impact the value of the Plaintiffs' franchise stores in order to permit the Company to purchase such stores at a substantially reduced value. Specifically, the Complaint alleges, among other things, that the Company failed to disclose to its existing franchisees its intention to grow its business through the opening of company-owned stores rather than continuing to focus on franchise store openings. In this regard, the Complaint alleges that the Company misappropriated the zip code and inventory information collected at the point of purchase at the plaintiffs' franchise stores to determine the most desirable markets and locations to open additional company-owned stores. The Complaint further alleges that the Company purposely situated company-owned stores within established markets already served by existing franchisees to diminish the value of existing franchise stores so as to enable the Company to purchase such franchises at a significantly reduced cost. The allegations further provide that the Company's repurchase of franchise stores from Company officers in 1996 served to set a low benchmark for the value of franchise stores that it would thereafter purchase. Finally, the Complaint alleges the Company's diversion of most favorable seasonal merchandise to the company-owned stores rather than franchise stores, misuse of advertising royalties paid by franchisees and failure to account for and timely distribute vendor rebates. 16 19 The Complaint seeks monetary damages for each of the causes of action, with the amount sought ranging from $2 million to $7.5 million. The Company believes that the allegations contained in the Complaint are without basis in fact, and that it has meritorious defenses to each of the allegations. The Company has retained Kaufmann, Feiner, Yamin, Gildin & Robbins LLP as special counsel and intends to vigorously defend this action. In addition to the foregoing, the Company is from time to time involved in routine litigation incidental to the conduct of its business. As of the date of this Report, the Company is aware of no material existing or threatened litigation to which it is or may be a party. Item 4. Submission of Matters to a Vote of Security Holders Not Applicable. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The Company's Common Stock has traded on the Nasdaq National Market under the symbol "PCTY" since the Company's initial public offering. The following table sets forth the high and low closing sale prices of the Company's Common Stock as reported on the Nasdaq National Market for the periods indicated. All stock price information has been retroactively adjusted for the three-for-two common stock split, declared December 18, 1997 and paid January 16, 1998, and is rounded to the lowest 1/16.
High Low ---- --- 1996 YEAR First Quarter (beginning March 27, 1996).... 9 13/16 7 5/8 Second Quarter.............................. 12 13/16 9 Third Quarter............................... 14 13/16 10 13/16 Fourth Quarter.............................. 13 1/8 9 5/16 1997 YEAR First Quarter .............................. 11 1/8 10 Second Quarter ............................. 11 1/8 8 7/8 Third Quarter .............................. 20 1/16 10 3/4 Fourth Quarter ............................. 21 1/2 15 15/16 1998 YEAR First Quarter (through March 24, 1998) ..... 34 16 3/4
17 20 On March 27, 1998, the last sale price of the Common Stock reported on the Nasdaq National Market was $32 per share. At March 27, 1998, the approximate number of holders of record of the Common Stock was 56. Dividends Except for the S Corporation distribution of a portion of previously undistributed earnings to the Company's stockholders in 1994 upon the Company's election to be taxed as a C Corporation, the Company has never paid cash dividends on its capital stock and does not intend to pay cash dividends for the foreseeable future. The Company expects that earnings will be retained for the continued growth and development of the Company's business. Future dividends, if any, will depend upon the Company's earnings, financial condition, working capital requirements, compliance with covenants in agreements to which the Company is or may be Subject, future prospects and other factors deemed relevant by the Company's Board of Directors. See "Management's Discussion and Analysis of Financial Condition and Results of Operations --Liquidity and Capital Resources." Unregistered Securities During 1997, the Company sold 59,094 shares of Common Stock pursuant to the exercise of stock options for an aggregate purchase price of $267,071 based upon an exemption from registration under Section 4(2) of the Securities Act. Item 6. Selected Financial Data The following selected financial data for each of the years ended December 31, 1993 and 1994 are derived from financial statements of the Company not included herein. The selected Statements of Income and Balance Sheets for each of the three years in the period ended December 31, 1997 are derived from the financial statements of the Company, included elsewhere in this Annual Report on Form 10-K, which have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report appearing elsewhere herein. The financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Financial Statements, including the notes thereto appearing elsewhere in this Annual Report on Form 10-K. On December 18, 1997, the Board of Directors declared a three-for-two common stock split effective January 16, 1998. The common stock data has been retroactively adjusted for the stock split. 18 21
Year Ended December 31, --------------------------------------------------------------------- 1997 1996 1995 1994 1993 ------------ ------------- ----------- ------------ ------------ Income Statement Data: Total revenue................................... $141,714,062 $48,590,978 $23,120,342 $8,852,796 $2,408,828 ============ =========== =========== ========== =========== Company-owned stores: Net sales..................................... $131,027,688 $39,143,625 $16,118,163 $3,991,589 Cost of goods sold and occupancy costs........ 86,371,700 25,937,445 10,758,209 2,686,881 ------------ ----------- ----------- ----------- Gross profit.................................. 44,655,988 13,206,180 5,359,954 1,304,708 Store operating and selling expense........... 31,879,466 10,116,159 4,254,475 1,239,769 ------------ ----------- ----------- ----------- Company-owned stores profit contribution...... 12,776,522 3,090,021 1,105,479 64,939 ------------ ----------- ----------- ----------- Franchise stores: Royalty fees.................................. $ 10,224,374 $ 8,512,353 $ 6,074,679 $ 3,836,207 $3,836,207 Franchise fees................................ 462,000 935,000 927,500 1,025,000 615,000 ------------ ----------- ----------- ----------- ----------- Total franchise revenue....................... 10,686,374 9,447,353 7,002,179 4,861,207 2,408,828 Total franchise expense....................... 3,997,860 3,729,050 2,943,814 2,049,894 1,580,644 ------------ ----------- ----------- ----------- ----------- Franchise profit contribution................. 6,688,514 5,718,303 4,058,365 2,811,313 828,184 ------------ ----------- ----------- ----------- ----------- General and administrative expense.............. 7,049,352 3,159,404 3,023,540 1,929,850 570,075 ------------ ----------- ----------- ----------- ----------- Income before interest and income taxes......... 12,415,684 5,648,920 2,140,304 946,402 258,109 Interest income (expense), net.................. 211,611 475,805 22,861 62,121 4,128 ------------ ----------- ----------- ----------- ----------- Income before income taxes...................... 12,627,295 6,124,725 2,163,165 1,008,523 262,237 Provision for income taxes...................... 4,957,153 2,369,200 863,200 466,000 27,500 ------------ ----------- ----------- ----------- ----------- Net income...................................... $ 7,670,142 $ 3,755,525 $ 1,299,965 $ 542,523 $ 234,737 ============ =========== =========== =========== ============ Basic EPS ...................................... 0.65 $0.38 $0.16 ==== =========== =========== Diluted EPS..................................... 0.64 $0.38 $0.16 ==== ===== ===== Pro forma(1): Income before income taxes.................... $ 1,008,523 $ 262,237 Income taxes.................................. 410,089 130,019 ----------- ----------- Net income.................................... $ 598,434 $ 132,218 =========== =========== Basic and diluted EPS ........................ $ 0.08 $ 0.02 =========== =========== Weighted average shares outstanding(2) - Basic.. 11,748,610 9,802,044 7,983,500 7,512,500 6,147,500 Weighted average shares outstanding (2) - Diluted 12,038,895 9,996,303 7,983,500 7,512,500 6,147,500 Store Data: Number of Company-owned stores (end of period)............................... 117 36 16 7 Increase in Company-owned 15.5% 17.9% 26.6% same store sales(3)........................... Number of franchise stores (end of period)...... 158 164 132 99 58 Increase in franchise same store sales(3)....... 14.8% 19.5% 10.3% 13.1% 8.1% Average sales per Company-owned store(4)........ $ 1,740,000 1,662,000 1,510,000 Balance Sheet Data (at end of periods): Working capital............................... $ 13,930,084 $17,418,467 $ 1,998,988 $ 2,087,769 $ 381,759 Total assets.................................. 89,614,534 34,603,107 10,307,572 6,009,133 1,459,643 Long-term obligations......................... 7,636,032 1,665,624 996,093 489,176 276,506 Stockholders' equity.......................... 45,783,049 23,561,141 4,581,707 3,232,394 326,659
- ---------- (1) Until April 27, 1994, the Company elected to be taxed as an S Corporation under the Internal Revenue Code. As a result, the pro forma income statement data for years ended December 31, 1994 and 1993 included adjustments to the historical income statement data assuming the Company had not elected S Corporation status. 19 22 (2) In April 1994, the stockholders of the Company approved a 26,667-for-1 Common Stock split. All share information has been restated to give retroactive effect to the stock split. (3) Increases in Company-owned and franchise same store sales have been calculated for stores that were open for at least 13 months as of the end of such applicable period. (4) For stores open at least one full calendar year. Includes seven stores, 16 stores and 36 stores in 1994, 1995 and 1996, respectively. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Net income per share is computed using the weighted average common stock equivalent shares outstanding during each period. All common stock data, including earnings per store, has been retroactively adjusted for the three-for-two common stock split that occurred on January 16, 1998. Same store sales increases or decreases are calculated for stores open at least thirteen full months. Company-owned same store sales increased 17.9% in 1996 and 15.5% in 1997. The Company's 36 stores that were in operation for all of 1997 generated average net sales of approximately $1,740,000 and average store-level profit contribution of approximately $177,000, or 10.2% of average net sales. Results of Operations Year Ended December 31, 1997 Compared to Year Ended December 31, 1996 Company-owned Stores Net sales from Company-owned stores increased to $131,027,688 in the year ended December 31, 1997 up from $39,143,625 in the year ended December 31, 1996. The 1997 results include 36 stores that were open at the beginning of that year plus 57 stores opened during the year (of which 19 were opened in September, 10 in October, and three in December) and 24 stores acquired during the year. The 1996 amount represents sales from 16 stores that were open at the beginning of the year plus 20 stores opened during the year (five of which were opened in September and two in October). Of the total sales increase, 74.4% is attributable to new store openings in 1997. Same store sales increased 15.5% in 1997. Gross profit reflects the cost of goods sold and store occupancy costs including rent, common area maintenance, repair and maintenance, depreciation and utilities. Gross profit for the year ended December 31, 1997 was $44,655,988 compared to $13,206,180 for the year ended December 31,1996. The increase in 1997 was due to increased sales volume. Gross margin was 34.1% and 33.7% of sales for the years ended December 31, 1997 and December 31, 1996, respectively. Store operating and selling expenses were $31,879,466 for the year ended December 31, 1997 compared to $10,116,159 for 1996. The increase in store operating expenses is attributable to the increased number of stores operated by the Company during 1997. Store operating expenses were 24.3% and 25.8% of sales for the years ended December 31, 1997 and December 31, 1996, respectively. Company-owned store profit contribution was $12,776,522 for the years ended December 31, 1997, compared to a profit contribution of $3,090,021 for the comparable 1996 period. 20 23 Franchise Operations Franchise revenue is composed of the initial franchise fees that are recorded as revenue when the store opens, and ongoing royalty fees, generally 4.0% of the store's net sales. Franchise fees, recognized on 19 store openings during the year ended December 31, 1997 were $462,000 compared to $935,000 representing 32 store openings during 1996. The reduction in franchise fees attributed to fewer store openings was partially offset by the increase in such fees from $30,000 to $35,000 per store with respect to franchise agreements signed after January 1, 1996. Royalty fees increased 20.3% to $10,244,374 in the year ended December 31, 1997, up from $8,512,353 in the comparable 1996 period. The increase was attributable primarily to sales increases in stores opened as of December 31, 1996. Franchise same store sales increases for the years ended December 31, 1997 and December 31, 1996 were 14.8% and 13.5%, respectively. Expenses directly related to franchise revenue increased by $268,810 to $3,997,860 for the year ended December 31, 1997 from $3,729,050 for the year ended December 31, 1996. As a percentage of franchise revenue, franchise expenses were 37.4% and 39.5% for the years ended December 31, 1997 and 1996, respectively. Franchise profit contribution was $6,688,514 for the year ended December 31, 1997 compared to $5,718,303 for the year ended December 31, 1996. The 17% increase in franchise profit contribution is due to the increase in royalty fees offset by a decrease in franchise fees and increase in franchise expenses as discussed above. General and Administrative General and administrative expenses increased 123.1% to $7,049,352 in the year ended December 31, 1997 compared with $3,159,404 in the year ended December 31, 1996. The increase is primarily attributable to an increase in payroll and related benefits of approximately $1,751,000 as a consequence of establishing the necessary organizational infrastructure to allow the Company to build its Company-owned store base, professional fee increases of approximately $226,000 due primarily to increases in legal and accounting fees, travel expense increases of $730,000 which increased primarily due to the increase in the number of stores. In addition, the Company had other increases in general and administrative expenses related to insurance, investor relations expenditures and general corporate expenses. As a percentage of revenue, general and administrative expenses were 5.0% and 6.5% for the years ended December 31, 1997 and December 31, 1996, respectively. This decrease as a percentage of revenue resulted from increased leverage of general and administrative expenses over a larger sales base. Net Income Net income increased 104.2% to $7,670,142, or $0.65 per basic share and $0.64 per diluted share, in the year ended December 31, 1997 compared with $3,755,525, or $0.38 per basic and diluted share in the year ended December 31, 1996. All earnings per share data has been retroactively adjusted for the three-for-two stock split that occurred on January 16, 1998. 21 24 Year Ended December 31, 1996 Compared to Year Ended December 31, 1995 Company-owned Stores Net sales from Company-owned stores increased to $39,143,625 in the year ended December 31, 1996 from $16,118,163 in the year ended December 31, 1995. The 1996 results include 16 stores which were open at the beginning of that year plus 20 stores opened during the year, four of which were opened in the second quarter, 10 in the third quarter and six in the month of October. The 1995 amount represents sales from seven stores which were open at the beginning of the year plus nine stores opened during the year, five of which were opened in September and two in October. Of the total sales increase, 54% is attributable to new store openings in 1996. Same store sales increased 17.9% in 1996. Gross profit reflects the cost of goods sold and store occupancy costs including rent, common area maintenance, real estate taxes, repair and maintenance, depreciation and utilities. Gross profit for the year ended December 31, 1996 was $13,206,181 compared to $5,359,954 for 1995. The increase in 1996 was due to increased sales volume. Gross margin was 33.7% and 33.3% of sales for the years ended December 31, 1996 and 1995, respectively. Store operating and selling expenses were $10,116,159 for the year ended December 31, 1996 compared to $4,254,475 in 1995. The increase in store operating expenses is attributable to the increased number of stores operated by the Company during 1996. Store operating expenses were 25.8% and 26.4% of sales for December 31, 1996 and 1995, respectively. Company-owned store profit contribution was $3,090,021 for the year ended December 31, 1996, compared to a profit contribution of $1,105.479 for 1995. Franchise Operations Franchise revenue is composed of the initial franchise fees which are recorded as revenue when the store opens, and ongoing royalty fees, generally 4.0% of the store's net sales. Franchise fees, recognized on 32 store openings during the year ended December 31, 1996 were $935,000 compared to $927,500 during 1995, which represents 35 store openings. Royalty fees increased 40. 1 % to $8,512,353 in the year ended December 31, 1996 from $6,074,679 in 1995. Franchise same store sales increases for the years ended December 31, 1996 and 1995 were 13.5% and 10.3%, respectively. Expenses directly related to franchise revenue increased to $3,729,050 for the year ended December 31, 1996 from $2,943,814 for the year ended December 31, 1995. This increase is primarily attributable to additional franchise personnel required to operate this portion of the Company's business and the necessary infrastructure to support such employees. As a percentage of franchise revenue, franchise expenses were 39.5% and 42.0% for the years ended December 31, 1996 and 1995, respectively. Franchise profit contribution was $5,718,303 for the year ended December 31, 1996 compared to $4,058,365 for the year ended December 31, 1995. The 40.9% increase in franchise profit contribution is due to the increase in royalty fees and franchise fees offset in part by an increase in franchise expenses, as discussed above. General and Administrative General and administrative expenses increased 4.5% to $3,159,404 in the year ended December 31, 1996 compared to $3,023,540 in the year ended December 31, 1995. The increase is primarily attributable to an increase in payroll and related benefits, recruitment and moving of new employees and increased travel as a result of establishing the necessary organizational infrastructure to allow the Company to build the Company owned store base. General and administrative expenses for 1995 included a one time severance 22 25 expense of $275,000 and a litigation settlement expense of $200,000. As a percentage of revenue, general and administrative expenses were 6.5% and 13.1% for the years ended December 31, 1996 and 1995, respectively. This decrease as a percentage of revenue resulted from increased leverage of general and administrative expenses over a larger sales base. Net Income Net income increased 188.9% to $3,755,525, or $0.38 per basic and diluted share, in the year ended December 31, 1996 as compared to net income of $1,299,965, or $0.16 per share in the year ended December 31, 1995. All earnings per share data has been retroactively adjusted for the three-for-two stock split that occurred on January 16, 1998. Accounting and Reporting Changes The Company is required to adopt SFAS No. 130, "Reporting Comprehensive Income," during the year ending December 31, 1998. SFAS 130 establishes standards for reporting comprehensive income and its components in a full set of general-purpose financial statements. This Statement requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement, and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in-capital in the equity section of a statement of financial position. Adoption of this statement will have no effect on the Company as the Company currently has no items of comprehensive income included in the equity section of the financial statements. The Company is required to adopt SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" during the year ending December 31, 1998. The Statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. This Statement supersedes FASB Statement No. 14, Financial Reporting for Segments of a Business Enterprise, but retains the requirement to report information about major customers. It amends FASB Statement No. 94, Consolidation of All Majority-Owned Subsidiaries, to remove the special disclosure requirements for previously unconsolidated subsidiaries. The Company has not yet determined the effect of adopting this statement. Liquidity and Capital Resources The Company's cash provided by operating activities was $9,048,444, $3,557,529, and $1,600,975 in the years ended December 31, 1997, 1996 and 1995 respectively. The decrease in cash provided by operating activities in 1997 in comparison with 1996 was primarily attributable to increases merchandise inventories and prepaid expenses and other current assets offset by increases in net income, accounts payable and accrued expenses. The increase in cash provided by operating activities in 1996 compared to 1995 was primarily attributable to an increase in net income. Cash used in investing activities was $39,925,808, $4,872,000, and $2,082,158 in the years ended December 31, 1997, 1996 and 1995, respectively. The increase in cash used in investing activities in 1997 compared to 1996 was attributable to increased purchases of property and equipment necessary to support the accelerated growth in Company-owned stores and the acquisition of 24 franchise stores. Both were substantially funded by the Company's available cash as well as borrowings of $3,150,000 on the Company credit facility with its Bank and a new capital lease for computer $1,593,000. The increase in cash used in 23 26 investing activities in 1996 compared to 1995 was attributable to increased purchases of property and equipment. Cash provided by financing activities was $19,162,176, $15,151,619, $100,138 for the years ended December 31, 1997, 1996 and 1995 respectively. The cash provided by financing activities in 1997 was primarily attributable to the proceeds of the Company's Secondary Public Offering as well as to borrowings on the credit facility and the new capital lease discussed above. Cash provided by financing activities in 1996 was primarily attributable to the proceeds of the Company's initial public offering. On June 16, 1997, the Company amended its existing $5,000,000 loan facility to increase such facility to a $20,000,000 committed revolving line of credit maturing on June 30, 2000. Advances under the line bear interest, at the Company's option, at 1/2 of 1% below the bank's prime rate (8.5% as of February 28, 1998) or LIBOR plus 1.25% (which margin for the LIBOR rate option is subject to reduction to .75% or increase to 1.75% based on the Company's ratio of total liabilities to tangible net worth). The loan facility required a one-time facility fee of $50,000 and a quarterly commitment fee equal to .125% of the average unused portion of the line and is secured by substantially all of the assets of the Company. The loan facility also provides various covenants including, among others, restrictions on capital expenditures, the maintenance of a defined minimum tangible net worth, interest coverage ratio, total liabilities to tangible net worth ratio and current ratio. The Company classifies the revolving credit facility as long term, as it does not intend to repay the long term portion for at least one year. The future minimum payment of $3,150,000 is due in the year 2000. The terms of the loan facility were amended further on March 10, 1998 to temporarily increase the facility to $25,000,000 until April 30, 1998. On March 9, 1998, the Company signed a commitment letter (the "Commitment Letter") to refinance and replace its existing loan facility with a $60,000,000 committed revolving line of credit facility maturing three years after the closing date. Advances under this credit facility will bear interest, at the Company's option, at the agent bank's base rate (the higher of the bank's prime rate or the federal funds rate plus 1/2 % per annum) or LIBOR plus the applicable margin, which shall be tiered between 0.75% per annum and 1.75% per annum, based on the Company's fixed charge coverage ratio (EBITR to fixed charges) measured on a quarterly basis. The Commitment Letter requires the Company to maintain an interest rate hedge equal to a minimum of 25% of the outstanding amount of the credit facility. The Commitment Letter also requires the Company to pay at closing an underwriting fee of $450,000 (less any deposits and fees already paid prior to closing), a commitment fee which shall be between .175% and .35% of the average unused portion of the credit facility, based on the fixed charge coverage ratio, and an agent's fee of $15,000 per annum (increased by $5,000 per annum for each additional bank which becomes a lender in the bank syndicate). This credit facility will be secured by substantially all of the assets of the Company. The Commitment Letter also provides various covenants including, among others, restrictions on capital expenditures and acquisition expenditures, the maintenance of a defined minimum tangible net worth, a minimum net worth and/or maximum debt to net worth ratio, fixed charge coverage ratio, leverage ratio and liquidity ratio. The terms of the Commitment Letter are subject to the negotiation and execution of definitive loan documents. The closing and effectiveness of this credit facility is conditioned upon the satisfaction of significant conditions precedent. Over the next several years, the Company intends to devote greater resources to the opening of Company-owned stores and therefore believes that its revenue growth increasingly will be derived from the opening of Company-owned, rather than franchise, Super Stores. The Company anticipates that new and existing franchisees will open approximately 12 additional stores in 1998. Based on its current planning and marketing information, the Company plans to open approximately 70 to 75 Company-owned stores in 1998, using a combination of its existing cash and operating cash flow and funds available under the Company's proposed credit facility. In addition, the Company may seek to acquire existing stores from franchises on a selective basis. At present, the Company has no 24 27 agreement to acquire any franchise store. The Company expects that the average new store cost for Company-owned stores will to be approximately $387,000. These expenditures include $180,000 for equipment and fixtures, including point of sale equipment, $47,000 for leasehold improvements and approximately $125,000 for store inventory, net of accounts payable. Pre-opening expenses are estimated to be $35,000 per store. The Company typically leases space ranging from 10,000 to 12,000 square feet and seeks to lease sites rather than own the real estate. Out of its planned 70 to 75 Company-owned stores to be opened during 1998, as of February 28, 1998, the Company had opened 7 stores and had signed leases for 36 locations. Most of such leases are for ten-year terms, each with two five-year renewal options. The minimum lease obligation for these 43 leases is approximately $78,687,261 over the life of the leases. The Company believes that the proceeds from its cash flows from operations and its borrowing capacity under the proposed credit facility will be adequate to fund its cash requirements for at least the next 12 months. Impact of Inflation The Company believes that inflation did not have a material impact on its operations for the periods reported. Significant increases in labor, employee benefits and other operating expenses could have a material adverse effect on the Company's performance. Item 8. Financial Statements and Supplementary Data The response to this item is submitted as a separate section of this Report commencing on page F-1. Item 9. Disagreements on Accounting and Financial Disclosure Not applicable. 25 28 PART III In accordance with general instruction G (3) of Form 10-K, the information called for by Items 10, 11, 12 and 13 of Part III is incorporated by reference to the Company's definitive Proxy Statement for its 1998 Annual Meeting of Shareholders. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) List of Documents filed as part of this Annual Report on Form 10-K. 1. The following financial statements of the Company are filed as a separate section of this Report commencing on page F-1. Report of Deloitte & Touche LLP, Independent Auditors Balance Sheets - December 31, 1997 and 1996 Statements of Income for the years ended December 31, 1997, 1996 and 1995 Statements of Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995 Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 Notes to Financial Statements for the years ended December 31, 1997, 1996 and 1995 2. Financial Statement Schedules -- Not Applicable. 3. List of Exhibits. The following exhibits are included as a part of this Annual Report on Form 10-K or incorporated herein by reference. 3.1(1) -- Certificate of Incorporation of the Company. 3.2(1) -- Bylaws of the Company. 4.1(1) -- Specimen stock certificate evidencing the Common Stock. 10.1(1) -- Form of Unit Franchise Agreement entered into by the Company and franchisees. 10.2(1) -- Employment Agreement, dated January 1, 1994 and amended as of January 16, 1996, by and between the Company and Steve Mandell. 10.3(3) -- Amendment to Employment Agreement dated March 5, 1997, by and between the Company and Steven Mandell. 10.4(1) -- Employment Agreement, dated January 1, 1994 and amended as of January 16, 1996, by and between the Company and Perry Kaplan. 10.5(1) -- Employment Agreement of David Lauber, dated June 12, 1995, by and between Company and David Lauber. 10.6(1) -- Employment Agreement of Lawrence Fine, dated October 13, 1995, by and between the Company and Lawrence Fine. 10.7(2) -- Amended Stock Option Plan of the Registrant. 26 29 10.8(2) -- Amended and Restated 1994 Stock Option Plan of the Company 10.9(1) -- Loan and Security Agreement, dated February 15, 1995 and amended as of October 6, 1995, by and between Company and Midlantic Bank, N.A. 10.10(3) -- Commitment Letter between PNC Bank and Company. 10.11(4) -- Asset Purchase Agreement dated as of September 2, 1997 by and among the Registrant and Hammond Retailing of Mesquite, L.C., Hammond Retailing of West Plano, L.C., Hammond Retailing of Richardson, L.C., Hammond Retailing of Arlington, L.C., Hammond Retailing of Carrollton, L.C., Hammond Retailing of Irving, L.C., Hammond Retailing of Medallion, L.C., Hammond Retailing of Red Bird LLC, Hammond Retailing of Vista Ridge, LLC, Hammond Retailing of Pleasant Grove, LLC, Hammond Retailing of White Rock, LLC, Hammond Communications, Inc. and Mr. Geoffrey Hammond (without exhibits or schedules). 10.12(4) -- Letter Agreement by and between the Registrant and Hammond Retailing of Plano East, LLC dated July 7, 1997. 10.13(4) -- Third Amendment to Loan and Security Agreement dated as of June 16, 1997, between the Registrant and PNC Bank, National Association. 10.14 -- Fourth Amendment to the Loan and Security Agreement dated as of March 10, 1998 between the Company and PNC Bank, National Association. 10.15 -- $60,000,000 credit facility Commitment Letter dated March 9, 1998 by and between the Company and PNC Bank N.A., as agent, for a syndicate of banks. 10.16 -- Employment Agreement of David Lauber dated September 23, 1997 by and between the Company and David Lauber. 21.1 -- The wholly owned subsidiary of the Company is Party City Michigan, Inc., incorporated October 23, 1997 in the State of Delaware. This subsidiary does business under the name Party City Michigan, Inc. 23.1 -- Consent of Deloitte & Touche LLP. 24.1 -- Power of Attorney (contained on the signature page of this Report). 27.1 -- Financial Data Schedule. - ---------- Notes (1) Incorporated by reference to the Company's Registration Statement as amended on Form S-1 Number 333- 350 as filed with the Commission on January 18, 1996. (2) Incorporated by reference to the Company's Registration Statement on Form S-8 as filed with the Commission on January 9, 1997. (3) Incorporated by reference to the Company's Registration Statement on Form S-1 as filed with the Commission on March 6, 1997. (4) Incorporated by reference to the Company's Current Report on Form 8-K as filed with the Commission on September 12, 1997, as amended November 10, 1997. (b) Reports on Form 8-K. None 27 30 31 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 1998. PARTY CITY CORPORATION By: /s/ Steven Mandell ------------------------------------------- Steven Mandell, President By: /s/ David E. Lauber ------------------------------------------- David E. Lauber, Executive Vice President 28 32 POWER OF ATTORNEYS KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Steven Mandell and David Lauber, or either of them, his true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, for him and his name, place and stead, in any and all capacities, to sign any or all amendments (including post-effective amendments) to this Report on Form 10-K, and to file the same, with all Exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission granting unto said attorneys-in-fact and agents, each acting alone, full power and authority to do and perform each and every act and deed requisite and necessary to be done in connection with the above premises, and fully for all intents and purposes as he might or could do in person, hereby ratifying and conforming all that said attorney-in-fact and agents, each acting alone, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/ Steven Mandell Chairman of the Board, President, Chief March 30, 1998 - ---------------------- Executive Officer and Director (Principal Steven Mandell Executive Officer) /s/ David E. Lauber Executive Vice President, Chief Financial March 30, 1998 - ---------------------- Officer and Director (Principal Financial David E. Lauber and Accounting Officer) /s/ John J. Oberdorf Director March 30, 1998 - ---------------------- John J. Oberdorf /s/ Raymond Hemmig Director March 30, 1998 - ---------------------- Raymond Hemmig /s/ Duayne Weinger Director March 28, 1998 - ---------------------- Duayne Weinger /s/ Jack Futterman Director March 328, 1998 - ---------------------- Jack Futterman
29 33 INDEX TO FINANCIAL STATEMENTS PARTY CITY CORPORATION
Page ----- Independent Auditor's Report F-2 Balance Sheets F-3 Statements of Income F-4 Statements of Stockholders' Equity F-5 Statements of Cash Flows F-6 Notes to Financial Statements F-7
34 INDEPENDENT AUDITORS' REPORT The Stockholders of Party City Corporation Rockaway, New Jersey We have audited the accompanying balance sheets of Party City Corporation as of December 31, 1997 and 1996 and the related statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Party City Corporation as of December 31, 1997 and 1996, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP February 24, 1998 (March 10, 1998 as to Note 12) Parsippany, New Jersey F-2 35 PARTY CITY CORPORATION BALANCE SHEETS
-------------------------- December 31, December 31, 1997 1996 -------------------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 3,234,526 $ 14,949,714 Restricted assets for advertising fund 289,894 101,573 Receivables from franchisees: Royalty fees (net of allowance for doubtful accounts of $38,688 at December 31, 1997 and $32,847 at December 31, 1996) 1,069,080 1,015,161 Other 385,724 178,571 Merchandise Inventory 39,041,254 9,305,027 Due from affiliates - 35,815 Deferred income taxes - current 382,416 193,188 Prepaid expenses and other current assets 5,712,643 1,015,760 ------------------------- TOTAL CURRENT ASSETS 50,115,537 26,794,809 Propety and equipment - net 24,198,840 7,310,740 Deferred income taxes 571,802 218,224 Goodwill, net of amortization 14,129,906 - Other assets 598,449 279,334 ------------------------- TOTAL ASSETS $89,614,534 $ 34,603,107 ========================= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable - trade $24,927,362 $ 4,977,430 Accrued expenses 6,994,364 1,980,696 Advertising fund 289,894 101,573 Income taxes payable 3,080,082 1,904,562 Current portion - long-term debt 318,635 - Deferred revenue 575,116 412,081 ------------------------- TOTAL CURRENT LIABILITIES 36,185,453 9,376,342 ------------------------- LONG-TERM LIABILITIES: Long-term debt - net of current portion 4,291,775 - Deferred rent 2,985,886 1,170,624 Deferred revenue 368,371 495,000 ------------------------- TOTAL LONG TERM LIABILITIES 7,646,032 1,665,624 ------------------------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock, $.01 par value: authorized shares - 37,500,000 at December 31, 1997 and December 31, 1996; shares issued and outstanding - 12,300,095 at December 31, 1997 and 10,441,001 at December 31, 1996 123,001 104,410 Additional paid-in capital 32,246,406 17,713,231 Retained earnings 13,413,642 5,743,500 ------------------------- TOTAL STOCKHOLDERS' EQUITY 45,783,049 23,561,141 ------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $89,614,534 $ 34,603,107 =========================
See accompanying notes to financial statements F-3 36 PARTY CITY CORPORATION STATEMENTS OF INCOME
Year Ended ------------------------------------------ December 31, 1997 1996 1995 ------------------------------------------ REVENUES: Net sales $131,027,688 $ 39,143,625 $ 16,118,163 Royalty fees 10,224,374 8,512,353 6,074,679 Franchise fees 462,000 935,000 927,500 ------------------------------------------ TOTAL REVENUES 141,714,062 48,590,978 23,120,342 EXPENSES: Cost of goods sold and occupancy costs 86,371,700 25,937,445 10,758,209 Company-owned stores operating and selling expense 31,879,466 10,116,159 4,254,475 Franchise expense 3,997,860 3,729,050 2,943,814 General and administrative expense 7,049,352 3,159,404 3,023,540 ------------------------------------------ TOTAL EXPENSES 129,298,378 42,942,058 20,980,038 ------------------------------------------ INCOME BEFORE INTEREST AND INCOME TAXES 12,415,684 5,648,920 2,140,304 Interest income, net 211,611 475,805 22,861 ------------------------------------------ INCOME BEFORE INCOME TAXES 12,627,295 6,124,725 2,163,165 Provision for income taxes 4,957,153 2,369,200 863,200 ------------------------------------------ NET INCOME $ 7,670,142 $ 3,755,525 $ 1,299,965 ========================================== BASIC EPS $ 0.65 $ 0.38 $ 0.16 ========================================== Weighted average shares outstanding - basic 11,748,610 9,802,044 7,983,500 ========================================== DILUTED EPS $ 0.64 $ 0.38 $ 0.16 ========================================== Weighted average shares outstanding - diluted 12,038,895 9,996,303 7,983,500 ==========================================
See accompanying notes to financial statements F-4 37 PARTY CITY CORPORATION STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Note --------------------- Additional Retained Receivable Shares Amount Paid-In-Capital Earnings Sale of Stock Total --------------------------------------------------------------------------------- Balance-January 1, 1995 7,836,000 $ 78,360 $ 2,515,372 $ 688,010 $ (49,398) $ 3,232,394 Proceeds from note receivable 49,348 49,348 Net income 1,299,965 1,299,965 ---------------------------------------------------------------------------------- Balance-December 31, 1995 7,836,000 78,360 2,515,372 1,987,975 0 4,581,707 Sale of common shares 2,550,000 25,500 16,974,500 17,000,000 Expenses incurred on sale of common shares (1,989,661) (1,989,661) Exercise of stock options 55,001 550 174,445 174,995 Tax effect of non-qualified options 38,575 38,575 Net income 3,755,525 3,755,525 ---------------------------------------------------------------------------------- Balance-December 31,1996 10,441,001 104,410 17,713,231 5,743,500 23,561,141 Sale of common shares 1,800,000 18,000 15,582,000 15,600,000 Expenses incurred on sale of common shares (1,415,654) (1,415,654) Exercise of stock options 59,094 591 266,481 267,071 Tax effect of non-qualified options 100,349 100,349 Net income 7,670,142 7,670,142 ---------------------------------------------------------------------------------- Balance-December 31,1997 12,300,095 $ 123,001 $ 32,246,406 $ 13,413,642 $ 0 $ 45,783,049 ==================================================================================
See accompanying notes to financial statements F-5 38 PARTY CITY CORPORATION STATEMENTS OF CASH FLOWS
Years Ended -------------------------------------------- December 31, December 31, December 31, 1997 1996 1995 -------------------------------------------- Cash Flow from Operating Activities: Net income $ 7,670,142 $ 3,755,525 $ 1,299,965 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,794,333 745,889 321,936 Loss on abandonment of property and equipment 98,924 11,109 -- Deferred rent 1,812,762 705,971 325,546 Deferred tax benefit (542,806) (151,605) (160,499) Changes in assets and liabilities: Sale of marketable securities -- -- 20,558 Royalty fees receivable (53,919) (362,200) (256,118) Other receivables (207,153) (70,228) (83,750) Merchandise inventory (23,853,420) (5,464,101) (2,354,527) Due from affiliates 35,815 (30,021) 45,596 Prepaid income taxes -- -- -- Prepaid expenses and other current assets (4,696,883) (700,140) (103,333) Other assets (334,877) (5,436) (131,521) Accounts payable 19,949,932 3,016,557 1,689,554 Accrued expenses 5,013,668 755,061 347,814 Income taxes payable 1,175,520 1,390,104 397,218 Due to affiliates -- (1,779) (36,989) Deferred revenue (10,815) (37,177) 279,525 Long-term liabilities 197,221 -- -- -------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 9,048,444 3,557,529 1,600,975 -------------------------------------------- Cash Flow from Investment Activities: Purchases of property and equipment (18,272,411) (4,875,877) (2,082,158) Proceeds from sale of property and equipment -- 3,877 -- Aquisition of franchise stores (21,653,397) -- -- -------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (39,925,808) (4,872,000) (2,082,158) -------------------------------------------- Cash Flow from Financing Activities: Net proceeds from sale of stock 14,184,346 15,010,339 49,348 Proceeds from exercise of stock options 267,071 174,995 -- Tax effect of non-qualified stock options 100,349 38,575 -- Net proceeds from long-term debt 4,610,410 (72,290) 50,790 -------------------------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 19,162,176 15,151,619 100,138 -------------------------------------------- NET (DECREASE) / INCREASE IN CASH AND CASH EQUIVALENTS (11,715,188) 13,837,148 (381,045) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 14,949,714 1,112,566 1,493,611 -------------------------------------------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,234,526 $ 14,949,714 $ 1,112,566 ============================================ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Income Taxes Paid $ 4,219,437 $ 1,147,812 $ 375,850 Interest Paid $ 294,432 $ 41,009 $ 8,956
See accompanying notes to financial statements F-6 39 PARTY CITY CORPORATION NOTES TO FINANCIAL STATEMENTS Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Party City Corporation ("the Company"), which is incorporated in the State of Delaware, operates retail party goods stores within the continental United States and sells franchises on an individual store and area franchise basis throughout the United States, Puerto Rico, Spain, Portugal and Canada. On March 27, 1996, the Company completed an initial public offering (IPO) of 2,550,000 shares of common stock, $.01 par value, issued by the Company, at an initial offering price of $6.67 per share. Proceeds to the Company, net of offering expenses of $1,989,661 were $15,010,339. The Company completed its secondary public offering on May 8, 1997. The total offering was for 3,360,000 shares of common stock, of which 1,800,000 shares were offered by the Company and 1,560,000 were offered by certain selling stockholders. The offering price was $8.67 per share. Proceeds to the Company net of offering expenses were $14,184,346. On December 18, 1997, the Board of Directors declared a three-for-two common stock split effective January 16, 1998. All common stock data has been retroactively adjusted for the stock split. Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Franchising Revenue Recognition - The Company is obligated in accordance with the terms of each franchisee's respective agreement to provide the following initial services: advice on site location, store design and layout, training and pre-opening assistance. Revenue from individual franchise sales, recorded as franchise fees, is recognized by the Company upon completion of the aforementioned initial services, which normally coincide with the opening of the franchisee's store. On an ongoing basis, the Company provides assistance regarding sources of supply, pricing, advertising and promotion programs and other defined assistance. Royalty fees are recorded on a monthly basis as a percentage of the franchisee's net sales. Area franchise sales represent agreements with franchisees to open a specified number of franchises within defined geographic areas and development periods. The Company's policy is to receive in advance, a deposit for each of the potential stores, based on its standard initial franchise fee at the time the contract is signed. Upon receipt, the deposit is recorded as deferred revenue. When the Company satisfies its initial obligations to the franchisee and the store is opened, the Company recognizes the deposit as revenue. Information regarding franchise activity follows:
Year Ended December 31, ------------ 1997 1996 1995 ---- ---- ---- Number of franchises in operation at beginning of the period 164 132 99 Number of franchises opened during the period 19 32 35 Number of franchises acquired during the period (24) -- -- Number of franchises closed during the period (1) -- (2) ---- ---- ---- Number of franchises in operation at the end of the period 158 164 132 ==== ==== ====
F-7 40 PARTY CITY CORPORATION NOTES TO FINANCIAL STATEMENTS --- (Continued) Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES --- (Continued) Cash and Cash Equivalents - The Company considers all highly liquid investments with initial maturities of three months or less at the time of purchase to be cash equivalents. Cash equivalents consist of an investment in a certificate of deposit and money market funds. Fair Value of Financial Instruments - Financial instruments consist primarily of investments in cash, trade account receivables, accounts payable and debt obligations. The Company estimates the fair value of financial instruments based on interest rates available to the Company and by comparison to quoted market prices. At December 31, 1997 and 1996, the fair value of the Company's financial instruments approximated the carrying value. Allowance for Doubtful Accounts - The provision for bad debts, write-offs and recoveries for the years ended December 31, 1997, 1996 and 1995 were not material. Inventory - The Company values its inventory at the lower of average cost or market. Advertising Fund - Pursuant to its franchise agreements, the Company collects 1% of the net sales of its franchise stores, which is restricted to use for advertising on their behalf. Receipts and disbursements are not recorded as income or expense since the Company does not have complete discretion over the use of the funds. The Company also contributes 1% of net sales of its owned stores into the Advertising Fund. To cover the expenses of administering the Advertising Fund, the Company charges the fund a management fee equal to 5% of the funds contributed by franchisees. During 1997, 1996 and 1995, $210,228, $133,542 and $90,715, respectively, of Advertising Fund management fees were collected by the Company and credited to general and administrative expense. Property and Equipment - Property and equipment are carried at cost less accumulated depreciation. The Company uses the straight-line method of depreciation for property and equipment placed in service on or after January 1, 1993. Property and equipment placed in service prior to January 1, 1993 are depreciated using an accelerated method. The difference between the two methods is not material. Property and equipment are depreciated over their estimated useful lives as follows: automobiles, five years; furniture and equipment, 5-7 years. Leasehold improvements are amortized over the remaining period of the lease or the estimated useful life of the asset, whichever is less. Intangibles - Trademarks, which are included in other assets, consist primarily of capitalized legal costs and are being amortized using the straight-line method over the estimated useful lives of the assets. Goodwill recorded in connection with the acquisition of 24 franchise stores is being amortized on a straight-line basis over 15 years. Costs in excess of fair value of intangibles are assessed for recoverability on a periodic basis. In evaluating the value and future benefits of these intangible assets, their carrying value would be reduced by the excess, if any, of the intangibles over management's best estimate of undiscounted future operating income of the acquired businesses before amortization of the related intangible assets over the remaining amortization period. Income Taxes - The Company provides for the tax effects of transactions reported in the financial statements which consist of taxes currently due plus deferred taxes as a result of temporary differences. Temporary differences in the basis of assets and liabilities for financial statements and income tax reporting arise from using different methods and lives to calculate depreciation, certain costs related to the start up of store operations and the recognition of vacation pay. Earnings Per Share - The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share", for the period ended December 31, 1997, which establishes standards for computing and presenting earnings per share ("EPS") and simplifies the standards for computing EPS currently found in Accounting Principles Board F-8 41 PARTY CITY CORPORATION NOTES TO FINANCIAL STATEMENTS --- (Continued) Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES --- (Continued) ("APB") Opinion No. 15 ("Earnings Per Share"). Common stock equivalents under APB No. 15 are no longer included in the calculation of basic EPS. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS is computed similarly to primary EPS pursuant to Opinion 15. Diluted EPS reflects the potential dilution that could occur if stock option grants were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. All earning per share data has been retroactively adjusted for the three-for-two common stock split that occurred on January 16, 1998. F-9 42 PARTY CITY CORPORATION NOTES TO FINANCIAL STATEMENTS --- (Continued) Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES --- (Continued) Pre-opening Store Costs - The costs associated with opening a store are expensed as incurred. Advertising Costs - The costs associated with store advertising are expensed in the period in which the related promotion and sales occur. Advertising expense was approximately $7,034,000, $2,342,000 and $1,034,800 for the years ended December 31, 1997, 1996 and 1995, respectively. Accounting and Reporting Changes -The Company is required to adopt SFAS No. 130, "Reporting Comprehensive Income", during the year ending December 31, 1998. SFAS 130 establishes standards for reporting comprehensive income and its components in a full set of general-purpose financial statements. This Statement requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement, and (b) display the accumulated balance of other comprehensive income separately form retained earnings and additional paid-in-capital in the equity section of a statement of financial position. Adoption of this statement will have no effect on the Company as the Company currently has no items of comprehensive income included in the equity section of the financial statements. The Company is required to adopt SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" during the year ending December 31, 1998. The Statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. This Statement supersedes FASB Statement No. 14, Financial Reporting for Segments of a Business Enterprise, but retains the requirement to report information about major customers. It amends FASB Statement No. 94, Consolidation of All Majority-Owned Subsidiaries, to remove the special disclosure requirements for previously unconsolidated subsidiaries. The Company has not yet determined the effect of adopting this statement. Reclassifications - Certain reclassifications have been made to the prior period financial statements in order to conform with the current period presentation. Note 2 - ACQUISITION OF FRANCHISE STORES On February 28, 1997, the Company acquired six franchise stores. Four of the stores acquired were owned by Steven Mandell, the Company's Chairman and President. Such stores had aggregate sales of approximately $9.1 million in 1996 and were acquired for an aggregate purchase price of $5.2 million. The remaining two stores were owned by Perry Kaplan, a former executive officer and Director of the Company. Such stores had aggregate sales of approximately $3.7 million and were acquired for an aggregate purchase price of $1.3 million. On August 1, 1997, the Company acquired three franchise stores; two stores in the Southern California market and one store in Staten Island, New York. Through these transactions, the Company acquired certain development rights to the Southern California and Staten Island, New York markets. The aggregate purchase price of these transactions was approximately $3.4 million, subject to adjustments for actual inventories and trade payables. Total sales of the three franchise stores in 1996 were $6.2 million. On August 27, 1997 the Company acquired two franchise stores in the Chicago market and on September 12, 1997 the Company acquired two franchise stores in Virginia. The aggregate purchase price of these transactions was approximately $3.9 million, subject to adjustments for actual inventories and trade payables. Three of the four stores were open all of 1996 and averaged $1.8 million in sales, with the remaining store open less than a year. F-10 43 PARTY CITY CORPORATION NOTES TO FINANCIAL STATEMENTS --- (Continued) Note 2 - ACQUISITION OF FRANCHISE STORES --- (Continued) On September 2, 1997, the Company acquired 11 franchise stores in the Dallas/Fort Worth market. The purchase price of the transaction was approximately $8.3 million, subject to an adjustment for actual inventories and trade payables at the time of closing. The acquisition agreement provides that Party City has acquired the rights for any future development in the Dallas/Fort Worth market. Seven of the 11 stores were open for all of 1996 and averaged $1.8 million in sales, with the remaining four stores open less than a year. The acquisitions have been accounted for under the purchase accounting method. The results of operations of the acquired stores are included in the financial statements since the acquisition dates. Goodwill of $14,222,776 recorded in connection with the acquisitions is being amortized on a straight-line basis over 15 years. The proforma results are not necessarily indicative of the results of operations that would have occurred had the transactions been consummated as indicated nor are they intended to indicate results that may occur in the future. Assuming the stores were acquired on January 1, 1996, the proforma results would have been as follows:
Year Months Ended ----------------- December 31, December 31, 1997 1996 ---- ---- Total Revenues $159,648,615 $87,451,977 Net Income 8,000,600 5,131,600 Basic EPS 0.68 0.52 Diluted EPS 0.66 0.51
Note 3 - PROPERTY AND EQUIPMENT Property and equipment consisted of the following:
December 31, ------------ 1997 1996 ---- ---- Equipment $ 9,041,029 $ 2,974,980 Furniture 10,973,760 2,773,322 Leasehold improvements 7,550,281 2,687,462 Automobiles 117,666 94,793 ------------ ------------ 27,682,736 8,530,557 ------------ ------------ Less: Accumulated depreciation and amortization (3,483,896) (1,219,817) ------------ ------------ $ 24,198,840 $ 7,310,740 ============ ============
F-11 44 PARTY CITY CORPORATION NOTES TO FINANCIAL STATEMENTS --- (Continued) Note 4 - LONG-TERM DEBT On June 16, 1997, the Company refinanced and replaced its existing loan facility with a $20,000,000 revolving line of credit facility maturing on June 30, 2000. Advances under the line bear interest, at the Company's option, at 1/2 of 1% below the bank's prime rate (8.5% as of December 31, 1997) or LIBOR plus 1.25% (which margin for the LIBOR rate option is subject to reduction to .75% or increase to 1.75% based on the Company's ratio of total liabilities to tangible net worth). The Company paid a facility fee of $50,000 and a quarterly commitment fee equal to .125% of the average unused portion of the line, which is secured by substantially all of the assets of the Company. The credit facility provides various covenants including, among others, restrictions on capital expenditures, and maintenance of a defined minimum tangible net worth, interest coverage ratio, total liabilities to tangible net worth ratio and current ratio. At December 31, 1997, the Company was in compliance with such loan agreement covenants. The Company classifies the revolving line of credit facility as long-term as it does not intend to repay the long-term portion for at least one year. The future minimum payment of $3,150,000 is due in the year 2000. In August 1997, the Company entered into a five year capital lease with a present value of future lease obligations of $1,593,175 for computer hardware and software. The Company has the option to purchase the equipment for a nominal cost at the termination of the lease. The leased hardware and software is included in property and equipment and is recorded at $1,593,175 less accumulated amortization of $132,765.
December 31, 1997 ---- Revolving credit facility $3,150,000 Capital lease 1,460,410 Total Debt 4,610,410 Less Current Maturities 318,635 ---------- Long-term Debt $4,291,775 ==========
Future minimum lease payments for assets under the capital lease at December 31, 1997 are as follows: 1998 $ 387,650 1999 387,650 2000 387,650 2001 387,650 2002 226,129 ---------- Total minimum lease payments 1,776,729 Less amount representing Interest 316,319 ---------- Present value of net minimum lease payments 1,460,410 Less current maturities 318,635 ---------- Long-term obligation $1,141,775 ==========
Note 5 - EARNINGS PER SHARE The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations:
Income Shares Per-Share (Numerator) (Denominator) Amount ----------------------------------- Year Ended December 31, 1997 Basic EPS Net income available to common shareholders $7,670,142 11,748,422 $0.65 Effect of dilutive securities common Stock Options 290,473 ----------------------------------- Diluted EPS Net income available to common shareholders plus assumed conversions $7,670,142 12,038,895 $0.64 ========== ========== ===== Year Ended December 31, 1996 Basic EPS Net income available to common shareholders $3,755,525 9,802,044 $0.38 Effect of dilutive securities common stock options 194,259 ----------------------------------- Diluted EPS Net income available to common shareholders plus assumed conversions $3,755,525 9,996,303 $0.38 ========== ========== ===== Year Ended December 31, 1995 Basic EPS Net income available to common shareholders $1,299,965 7,983,500 $0.16 Effect of dilutive securities common stock options -- ----------------------------------- Diluted EPS Net income available to common shareholders plus assumed conversions $1,299,965 7,983,500 $0.16 ========== ========== =====
Note 6 - STOCK OPTIONS In September 1994, the Company adopted the Party City Corporation 1994 Stock Option Plan (the "Plan") pursuant to which options may be granted to employees for the purchase of common stock. The Plan permits the Company to grant incentive and non-qualified stock options to purchase an aggregate of 900,000 shares of the Company's common stock, as adjusted for the three-for-two stock split that occurred on January 16, 1998. Such options may be incentive stock options or non-qualified options. The Company has increased the amount of shares authorized under the plan to 1,800,000 subject to approval by the shareholders at the 1998 annual meeting. The term of an option is determined by the Stock Option Committee. The exercise price of the shares covered by an incentive stock option may not be less than the fair value of the shares at the time of grant. The exercise price of the shares covered by a non-qualified option need not be equal to the fair value of the stock at the date of grant, but may be granted with an exercise price as determined by the Stock Option Committee. The options granted prior to November 1997 generally vest one-third each year, over a period of three years. Options granted after November 1997 generally vest over a four year period, one-third in each the second, third and fourth years. F-12 45 PARTY CITY CORPORATION NOTES TO FINANCIAL STATEMENTS --- (Continued) Note 6 - STOCK OPTIONS --- (Continued) A summary of the Plan's status, changes during the years then ended, is presented below:
December 31, ------------ 1997 1996 1995 ---- ---- ---- Weighted-Average Weighted-Average Weighted-Average Shares Exercise Price Shares Exercise Price Shares Exercise Price ------ -------------- ------ -------------- ------ -------------- Outstanding at January 1 537,500 $ 7.46 270,000 $ 2.72 153,360 $ 1.67 Granted 602,625 $12.58 422,250 $ 9.54 119,640 $ 4.07 Exercised (90,003) $ 4.52 (54,999) $ 3.55 -- -- Canceled (67,503) $10.73 (99,752) $ 5.79 (3,000) $ 2.33 -------- ------ -------- ------ ------- ------- Outstanding December 31 991,029 $10.48 537,499 $11.14 270,000 $ 2.72 ======== ====== ======== ====== ======= ======= Options exercisable at December 31 219,627 - ======== Weighted average fair value of options granted during the year ended December 31 (per option) $3.98 $4.88 ======== ========
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in the periods ending December 31, 1997, 1996 and 1995.
December 31, ------------ 1997 1996 1995 ---- ---- ---- Expected volatility 40% 35% - Expected lives 4.33 years 6 years 6 years Risk-free interest rate 5.7% 6.50% 6.40% Expected dividend yield 0% 0% 0%
The following represents pro-forma amounts if the Company had elected to recognize compensation costs based on fair value:
December 31, ------------ 1997 1996 1995 ----------- ----------- ----------- Net Income: As reported $ 7,670,142 $ 3,755,525 $ 1,299,965 Pro-forma $ 6,943,885 $ 3,345,385 $ 1,294,791 Basic EPS: As reported 0.65 0.38 0.16 Pro-forma 0.59 0.34 0.16 Diluted EPS: As reported 0.64 0.38 0.16 Pro-forma 0.58 0.33 0.16
The pro forma effect of applying FAS 123 is not necessarily indicative of the effect on reported net income for future years. F-13 46 PARTY CITY CORPORATION NOTES TO FINANCIAL STATEMENTS --- (Continued) Note 6 - STOCK OPTIONS --- (Continued) The following table summarizes information about options outstanding under the Plan as follows:
Options Outstanding Options Exercisable ---------------------------------------------------- ------------------------ Number Weighted Number Weighted Outstanding Weighted Average Average Exercisable Average at December 31, Remaining Exercise at December 31, Exercise Range of Exercise Prices 1997 Contractual Life Price 1996 Price - ------------------------------------------------------------------------------------------------------------------------- $ 1.67 to $ 2.33 110,400 7.35 years $ 1.70 77,900 $ 1.69 $ 6.67 to $10.00 328,755 8.76 years $ 8.90 90,232 $ 8.96 $10.17 to $13.33 362,124 9.06 years $11.37 41,496 $10.83 $13.42 to $20.83 189,750 9.63 years $16.64 9,999 $14.08 ------------------------------------------------------------------------------------- $ 1.67 to $20.83 991,029 8.88 years $10.48 219,627 $ 6.97 =====================================================================================
Note 7 - PROVISION FOR TAXES The provision for taxes consisted of the following:
Year Ended December 31, ----------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Current: Federal $ 4,518,566 $ 1,962,511 $ 751,427 State 981,393 558,294 272,272 ----------- ----------- ----------- 5,499,959 2,520,805 1,023,699 ----------- ----------- ----------- Deferred: Federal (463,700) (127,311) (120,967) State (79,106) (24,294) (39,532) ----------- ----------- ----------- (542,806) (151,605) (160,499) ----------- ----------- ----------- $ 4,957,153 $ 2,369,200 $ 863,200 =========== =========== ===========
The deferred income tax provision results from temporary differences between amounts of assets and liabilities for financial reporting purposes and amounts as measured by tax laws. F-14 47 PARTY CITY CORPORATION NOTES TO FINANCIAL STATEMENTS --- (Continued) Note 7 - PROVISION FOR TAXES--- (Continued) The components of the net deferred tax assets at December 31, 1997 and 1996 are as follows:
December 31, ------------ 1997 1996 ----------- --------- Current Assets: Inventory $ 274,320 $ 123,751 Vacation pay accrual 93,614 35,104 Start-up costs 10,643 14,958 Allowance for doubtful accounts 26,622 30,085 Deferred state taxes (23,479) -- Deferred franchising 696 -- Current Liabilities: Advertising accrual -- (10,710) ----------- --------- Current Deferred Tax Asset $ 382,416 $ 193,188 =========== ========= Non-current Assets: Deferred rent $ 1,258,636 $ 471,240 Start-up costs 19,781 28,008 Deferred state taxes (73,992) -- Deferred franchising 695 -- Non-current Liabilities: Property and equipment (672,202) (281,024) Deferred state taxes 38,884 -- ----------- --------- Non-current Deferred Tax Asset $ 571,802 $ 218,224 =========== =========
The Company's effective income tax rate differs from the statutory federal rate as follows:
December 31, ------------ 1997 1996 1995 ------ ------ ------ Federal statutory rate 35.0% 34.0% 34.0% State income taxes net of federal benefit 4.7 5.6 7.1 Other (.4) (.9) (1.2) ------ ------ ------ Effective tax rate 39.3% 38.7% 39.9% ====== ====== ======
Note 8 - RELATED PARTY TRANSACTIONS The President, a major stockholder of the Company, owned all of the outstanding shares of two party supplies stores for which no royalty fees were charged. This individual was also the majority owner of two additional franchise stores and was a 50% owner of one franchise through 1995. The Company received royalty fees based on 3.0% of net sales from the majority owned stores. In addition, a former Director of the Company owned two franchises and was a 50% owner of one franchise through 1995, for which he paid royalty fees of 2.0% of net sales. On February 28, 1997, the Company acquired these six franchise stores. F-15 48 PARTY CITY CORPORATION NOTES TO FINANCIAL STATEMENTS --- (Continued) Note 8 - RELATED PARTY TRANSACTIONS --- (Continued) Furthermore, an individual who was a Senior Vice President of the Company through August 1995 owned two franchises. On August 1, 1997, the Company acquired one of these stores. The amounts included in the accompanying financial statements relating to the above are:
Year Ended December 31, ------------ 1997 1996 1995 --------- --------- ------- Royalty fees $ 23,669 $ 208,227 $260,818 Royalty fees receivable (at end of period) $ -- $ 18,551 $ 16,572
The Company shared office space with an affiliate until July 1, 1995. The affiliate charged the Company for rent and real estate taxes, utilities, insurance and telephone. The Company was charged approximately $30,400 for the year ended December 31, 1995, of which approximately $27,000 was for rent. Beginning January 1, 1996, the Company shared warehouse space with an affiliate. The Company charged the affiliate approximately $0 and $19,200 for rent for the years ended December 31, 1997 and 1996, respectively. In addition, the Company and its affiliates employ common bookkeeping personnel, for which the Company charged its affiliates approximately $14,000, $94,500 and $74,200 for the years ended December 31, 1997, 1996 and 1995, respectively. Office expenses allocated from the affiliate to the Company are based upon the square footage occupied by the Company. Personnel costs allocated to the affiliate are based upon an analysis of the percentage of time individuals devote to services for the affiliate stores. Management believes that both allocation methods are reasonable to determine the appropriate expenses to be allocated. Amounts receivable and payable from related companies represent non-interest bearing advances between affiliates with no specific repayment terms. Amounts outstanding at December 31, 1996 were paid in January 1997. In August 1992, the Company sold shares of its Common Stock for $172,000 to a former Vice President of the Company. The Company received a cash payment of $32,391 and a promissory note for 209,414 shares. This note which bore interest at 6.0%, was paid in three annual installments of $52,391, and was collateralized by the shares sold. The final payment was made in October 1995. Note 9 - COMMITMENTS Employment Agreements - The Company has entered into various employment agreements with two of its senior executives for periods of up to three years expiring no later than September 22, 2001. Under the agreements, the covered individuals are entitled to specified salaries over the contract periods; bonuses are provided contingent upon certain Company and individual performance criteria devised by the Company for each period. The commitments relating to future services from such executives under the contracts as of December 31, 1997 are approximately $1,792,975. Real Estate - The Company leases real estate in connection with the operation of corporate retail stores as well as its corporate office. The store leases are for properties ranging in size from 6,750 to 15,900 square feet. The terms range from ten years to twenty years, and expire by 2016. The leases contain escalation clauses, renewal options from five years to ten years and obligations for reimbursement of common area maintenance and real estate taxes. Certain leases contain contingent rent based upon specified sales volume. For the years ended December 31, 1997, 1996 and 1995, no such contingent rent was paid. Other - The Company leases 12 motor vehicles. The term ranges from 24 to 36 months, and expire by 2000. F-16 49 PARTY CITY CORPORATION NOTES TO FINANCIAL STATEMENTS --- (Continued) Note 9 - COMMITMENTS --- (Continued) Rent expense for all operating leases was $11,956,204, $3,779,292 and $1,554,015 for the years ended December 31, 1997, 1996 and 1995, respectively. Future minimum payments under operating leases at December 31, 1997 are as follows: 1998 $ 17,186,979 1999 17,323,290 2000 17,529,695 2001 17,620,164 2002 17,865,729 Thereafter 74,263,608 ------------ $161,789,464 ============
The Company has guaranteed a lease obligation for three of its franchises. One lease, expiring in 2001, has future minimum payments of $518,925, and the second lease, expiring in 2007, has future minimum payments of $2,438,667 and the remaining lease, expiring in 2007, has future minimum payments of $1,491,339. Note 10 - LITIGATION The Company has been named a defendant in a complaint filed with the Supreme Court of the State of New York, County of New York, on January 16, 1998 by each of Party City of Greenbrook, Inc., Party City of Watchung, Inc., Party City of 22, Inc., Party City of Ralph Avenue, Inc. and Party City of Jersey City, Inc., each a franchisee of the Company. The complaint alleges various causes of action including, among other things, misappropriation of information, diversion of favorable seasonal merchandise, misuse of advertising royalties and failure to account for, and timely distribute, vendor rebates. The Company believes that the allegations contained in the complaint are without basis in fact, and that it has meritorious defenses to each of the allegations. As this matter is in the very early stages, the Company cannot, at present, assess its potential impact on the Company's operations or financial condition. In addition to the foregoing, the Company is involved in various legal proceedings arising out of the conduct of its business. The Company believes that the eventual outcome of these proceedings will not have a material adverse effect on the Company's financial condition or results of operations. F-17 50 PARTY CITY CORPORATION SUPPLEMENTARY FINANCIAL INFORMATION NOTE 11 - SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarter Ended 1997 March 31, June 30, September 30, December 31, - ----------------------------------------------------------------------------------------------- Total revenues $ 12,628,763 $22,454,959 $ 28,016,058 $76,631,020 Cost of goods sold and occupancy costs 9,382,493 13,755,624 18,152,37 45,081,206 Net Income/(Loss) (288,282) 897,143 (244,044) 7,304,978 Basic Earnings/(Loss) per share (.03) .07 (.02) .59 Diluted Earnings/(Loss) per share (.03) .07 (.02) .57 Quarter Ended 1996 March 31, June 30, September 30, December 31, - ----------------------------------------------------------------------------------------------- Total revenues $ 5,981,012 $ 8,286,418 $ 9,907,766 $24,353,189 Cost of goods sold and occupancy costs 3,334,320 4,362,640 5,339,627 12,900,857 Net Income/(Loss) (166,506) 499,168 345,660 3,077,203 Basic Earnings/(Loss) per share (.02) .05 .03 .30 Diluted Earnings/(Loss) per share (.02) .05 .03 .29
Earnings per share data has been retroactively adjusted for the three-for-two common stock split that occurred on January 16, 1998. NOTE 12 - SUBSEQUENT EVENT (UNAUDITED) On March 9, 1998, the Company signed a Commitment Letter to refinance and replace the Company's existing loan facility with a $60,000,000 committed revolving line of credit facility maturing three years after the closing date. The terms of the Commitment Letter are subject to the negotiation and execution of definitive loan documents. F-18 51 LIST OF EXHIBITS 3.1(1) -- Certificate of Incorporation of the Company. 3.2(1) -- Bylaws of the Company. 4.1(1) -- Specimen stock certificate evidencing the Common Stock. 10.1(1) -- Form of Unit Franchise Agreement entered into by the Company and franchisees. 10.2(1) -- Employment Agreement, dated January 1, 1994 and amended as of January 16, 1996, by and between the Company and Steve Mandell. 10.3(3) -- Amendment to Employment Agreement dated March 5, 1997, by and between the Company and Steven Mandell. 10.4(1) -- Employment Agreement, dated January 1, 1994 and amended as of January 16, 1996, by and between the Company and Perry Kaplan. 10.5(1) -- Employment Agreement of David Lauber, dated June 12, 1995, by and between Company and David Lauber. 10.6(1) -- Employment Agreement of Lawrence Fine, dated October 13, 1995, by and between the Company and Lawrence Fine. 10.7(2) -- Amended Stock Option Plan of the Registrant. 10.8(1) -- Amended and Restated 1994 Stock Option Plan of the Company 10.9(1) -- Loan and Security Agreement, dated February 15, 1995 and amended as of October 6, 1995, by and between Company and Midlantic Bank, N.A. 10.10(3) -- Commitment Letter between PNC Bank and Company. 10.11(4) -- Asset Purchase Agreement dated as of September 2, 1997 by and among the Registrant and Hammond Retailing of Mesquite, L.C., Hammond Retailing of West Plano, L.C., Hammond Retailing of Richardson, L.C., Hammond Retailing of Arlington, L.C., Hammond Retailing of Carrollton, L.C., Hammond Retailing of Irving, L.C., Hammond Retailing of Medallion, L.C., Hammond Retailing of Red Bird LLC, Hammond Retailing of Vista Ridge, LLC, Hammond Retailing of Pleasant Grove, LLC, Hammond Retailing of White Rock, LLC, Hammond Communications, Inc. and Mr. Geoffrey Hammond (without exhibits or schedules). 10.12(4) -- Letter Agreement by and between the Registrant and Hammond Retailing of Plano East, LLC dated July 7, 1997. 10.13(4) -- Third Amendment to Loan and Security Agreement dated as of June 16, 1997, between the Registrant and PNC Bank, National Association. 10.14 -- Fourth Amendment to Loan and Security Agreement dated as of March 10, 1998 between the Company and PNC Bank, National Association. 10.15 -- $60,000,000 credit facility Commitment Letter dated March 9, 1998 by and between the Company and PNC Bank N.A. as agent for a syndicate of banks 10.16 -- Employment Agreement of David Lauber, dated September 23, 1997 by and between the Company and David Lauber. 21.1 The wholly owned subsidiary of the Company is Party City Michigan, Inc., incorporated October 23, 1997 in the state of Delaware. This subsidiary does business under the name Party City Michigan Inc. 23.1 -- Consent of Deloitte & Touche LLP. 24.1 -- Power of Attorney (contained on the signature page of this Report). 27.1 -- Financial Data Schedule. - ---------- Notes (1) Incorporated by reference to the Company's Registration Statement as amended on Form S-1 Number 333-350 as filed with the Commission on January 18, 1996. (2) Incorporated by reference to the Company's Registration Statement on Form S-8 as filed with the Commission on January 9, 1997. (3) Incorporated by reference to the Company's Registration Statement on Form S-1 as filed with the Commission on March 6, 1997. (4) Incorporated by reference to the Company's current Report on Form 8-K as filed with the Commission on September 12, 1997, as amended on November 10, 1994. 28 EX-10.14 2 FOURTH AMENDMENT TO LOAN AND SECURITY AGREEMENT 1 Exhibit 10.14 FOURTH AMENDMENT TO LOAN AND SECURITY AGREEMENT THIS FOURTH AMENDMENT TO LOAN AND SECURITY AGREEMENT (this "Fourth Amendment"), dated as of March 10, 1998, is entered into by and between PARTY CITY CORPORATION, a Delaware corporation (the "Borrower"), and PNC BANK, NATIONAL ASSOCIATION, successor by merger to Midlantic Bank, N.A. (the "Bank"). RECITALS: A. The Borrower and the Bank are parties to a certain Loan and Security Agreement, dated February 15, 1995, as amended by First Amendment to Loan and Security Agreement, dated as of October 6, 1995 (the "First Amendment"), by Second Amendment to Loan and Security Agreement, dated as of December 15, 1996 (the "Second Amendment"), and by Third Amendment to Loan and Security Agreement, dated as of June 16, 1997 (the "Third Amendment"; the Loan and Security Agreement, as amended by the First Amendment, Second Amendment and Third Amendment and as the same may be further amended from time to time, the "Agreement"), pursuant to which (among other things) the Bank agreed to make revolving credit loans to the Borrower, the outstanding principal of which converted to term loans at scheduled intervals; and B. The Borrower has requested that the Bank amend certain terms of the Agreement to provide for a temporary increase of the Revolving Credit Loan; and C. The Bank is willing to so amend the Agreement, upon and subject to the terms and conditions set forth herein. NOW, THEREFORE, in consideration of the premises and the mutual covenants and agreements set forth herein, and for value received by each party, the parties hereto, intending to be legally bound hereby, agree as follows: Section 1. DEFINITIONS 1.1. Existing Definitions. Unless otherwise defined herein, capitalized terms used herein shall have the meanings set forth in the Agreement. The definitions of the following defined terms used in the Agreement are amended as set forth herein and such amended definitions shall apply wherever such defined terms are used in the Loan Documents. (a) Amended Revolving Credit Note. The definition of the term "Amended Revolving Credit Note" set forth in the First Amendment is deleted and the following is substituted therefor: "'Amended Revolving Credit Note' shall mean the amended and restated promissory note of the Borrower, in substantially the form of Exhibit A annexed to this Fourth Amendment, evidencing the Revolving Credit Loan and replacing the Amended Revolving Credit 2 Note dated June 16, 1997, and any amendment, modification, restatement or renewal thereof or replacement or substitution therefor." (b) Revolving Credit Maximum. The definition of the term "Revolving Credit Maximum" set forth in the Agreement is deleted and the following is substituted therefor: "'Revolving Credit Maximum' shall mean the sum of $25,000,000 through and including April 30, 1998, and $20,000,000 thereafter." 1.2. Additional Definition. For purposes of the Agreement and the other Loan Documents, the term: "'Fourth Amendment' shall mean this Fourth Amendment to Loan and Security Agreement." Section 2. THE REVOLVING CREDIT LOAN 2.1. Amendment to the Revolving Credit Loan. Section 2.1(a) of the Agreement is deleted and the following is substituted therefor: "(a) Upon and subject to the terms and conditions hereof, the Bank agrees to make available, at any time and from time to time, until the Termination Date, for Borrower's use and upon the request of Borrower therefor, advances (each, a "Revolving Credit Advance"); provided, however, that after giving effect to each requested Revolving Credit Advance, at no time shall the sum of the aggregate amount of Revolving Credit Advances outstanding exceed the Revolving Credit Maximum then in effect. If at any time the sum of the aggregate amount of Revolving Credit Advances outstanding exceed the Revolving Credit Maximum then in effect, Borrower shall immediately, and without demand from Bank, pay to Bank the principal amount in excess of the Revolving Credit Maximum." Section 3. CONDITIONS; COVENANTS 3.1. Conditions to this Fourth Amendment. The Bank's agreement to amend the Agreement is subject to the conditions precedent that the Bank shall have received, or waived the receipt of, the following: (a) the Amended Revolving Credit Note, duly executed and delivered by Borrower to the Bank; 2 3 (b) resolutions of the board of directors of Borrower, certified by the Secretary of Borrower as of the date hereof to be duly adopted and in full force and effect on such date, authorizing the execution and delivery of this Fourth Amendment and the increased borrowing hereunder; (c) copies of (i) the certificate of incorporation of the Borrower and all amendments thereto, and (ii) the by-laws of the Borrower, certified by the Secretary of the Borrower as true and complete and in full force and effect as of the date hereof; (d) an opinion of St. John & Wayne, counsel to the Borrower, as to such matters relating to the Borrower and the Loans as the Bank may reasonably request; (e) UCC-1 financing statements deemed necessary by the Bank in order to perfect its security interest in the Collateral; (f) evidence that the insurance policies provided for in Section 7.20 of the Agreement are in full force and effect, with appropriate loss payable and additional insured clauses in favor of the Bank, certified by the insurer; (g) payment of all fees and expenses incurred by the Bank in connection with this Fourth Amendment including, but not limited to, fees and expenses of attorneys; (h) updated listing of store locations of the Borrower; and (i) such other agreements, documents, corporate resolutions and certificates, filings, recordations and instruments as the Bank may reasonably request. 3.2 Post Closing Covenants. The Borrower covenants and agrees that it shall deliver to the Bank the following, all in form and substance satisfactory to the Bank and its counsel: (a) within thirty (30) days after the date hereof, copies of the leases for each store location of the Borrower set forth in Section 3.1 (i) above; and (b) within ten (10) days after the date hereof, a guaranty by Party City Michigan, Inc., in form and substance satisfactory to the Bank and its counsel, guaranteeing all of Borrower's Obligations to the Bank; and (c) within ten (10) days after the date hereof, certificates of the appropriate Governmental Authorities, dated the most recent practicable date prior to the date hereof, showing that Borrower is organized and in good standing in the State of its organization and in each jurisdiction where it is qualified as a foreign corporation. 3 4 Section 4. SECURITY 4.1 Reaffirmation of Security Interest and Liens. The Borrower acknowledges and agrees that the security interests and other Liens granted by it to the Bank under the Agreement and the Loan Documents are and remain valid and first priority Liens on the Collateral (other than Permitted Encumbrances), and the Borrower represents and warrants that, as of the date hereof, there are no set-offs or defenses to the Bank's exercise of any rights or remedies available to it as a creditor in realizing upon the Collateral under the terms and conditions of the Loan Documents. The Borrower agrees that the Liens granted by it under the Agreement shall continue and shall secure the Obligations of the Borrower to the Bank, as amended as set forth herein. Section 5. RATIFICATION AND AMENDMENT OF REPRESENTATIONS, WARRANTIES AND COVENANTS; CONTINUATION OF REVOLVING CREDIT LOAN 5.1. Ratification. Except as set forth on Schedule A attached hereto, the Borrower hereby ratifies, confirms and restates, as if set forth herein in their entirety, all representations, warranties, covenants, acknowledgments and agreements set forth in Sections 6, 7, 8, 9 and 10 of the Agreement at and as of the date hereof (other than representations, warranties and covenants which expressly speak only as of a different date), and affirmatively states that all of the same are true and accurate as of the date hereof and shall be and remain in full force and effect, subject only to changes effected by this Fourth Amendment and/or changes previously disclosed to the Bank in writing. In addition, the Borrower represents and warrants to the Bank that: (a) Borrower has the power and authority to enter into this Fourth Amendment; (b) the execution, delivery and performance of this Fourth Amendment and the instruments and agreements executed and delivered by the Borrower in connection herewith have been duly authorized by all requisite corporate action and this Fourth Amendment and the instruments and agreements executed and delivered in connection herewith constitute the legal, valid and binding obligations of the Borrower, enforceable against it in accordance with their terms; (c) the copies of good standing certificates delivered to the Bank pursuant to Section 3.1(c) above are true and correct copies of the respective certificates received from the appropriate Governmental Authorities; (d) the audited financial statements of the Borrower as at December 31, 1996 and unaudited financial statements of the Borrower as at September 30, 1997 and December 31, 1997, which were previously furnished to the Bank, were prepared in accordance with GAAP consistently applied throughout the period involved and present fairly the financial position of the Borrower as at the date thereof and the results of operations and cash flows of the Borrower for the period then ended; 4 5 (e) no changes having a Material Adverse Effect have occurred since the date of such financial statements referred to in Section 5.1(d) above; and (f) no Default or Event of Default has occurred and is continuing or will result from the execution, delivery and performance of this Fourth Amendment and the instruments and agreements executed and delivered in connection herewith. 5.2. Continuation of Revolving Credit Loans. The Borrower and the Bank agree that as of the date hereof, the outstanding principal amount of the Revolving Credit Loan is $20,000,000, which amount shall be continued as outstanding under the Amended Revolving Credit Note, together with interest accrued thereon. Section 6. MISCELLANEOUS 6.1. Continued Effectiveness. Except as specifically amended by and/or inconsistent with this Fourth Amendment, all of the terms and conditions of the Agreement shall remain unchanged and in full force and effect and are hereby ratified, adopted and confirmed in all respects. All references to the Agreement in any Loan Document shall hereafter be deemed to refer to the Agreement as amended by this Fourth Amendment. This Fourth Amendment is a Loan Document. 6.2. Payment of Expenses. Borrower shall pay the fees and expenses (including, but not limited to, reasonable attorneys' fees and expenses, notary fees, searches and recording fees) incurred by the Bank in connection with the preparation, negotiation, execution and delivery and enforcement of this Fourth Amendment and the documents executed and delivered in connection herewith and any and all renewals, modifications, amendments and waivers hereof and hereunder. 6.3. Entire Agreement. This Fourth Amendment, together with the other Loan Documents, constitutes the entire agreement between the parties with respect to the subject matter hereof and supersedes any prior agreements, written or oral, with respect to such subject matter. 6.4. Counterparts. This Fourth Amendment may be executed in one or more counterparts, each of which shall be deemed to be an original and all of which together shall constitute one and the same agreement, and any party may execute this Fourth Amendment by signing any such counterpart. 6.5. Governing Law. This Fourth Amendment shall be interpreted, and the rights and liabilities of the parties hereto, whether arising in contract or tort and howsoever pertaining to the parties' relationship, shall be determined in accordance with the laws of the State of New Jersey. 6.6. Headings. The section titles contained in this Fourth Amendment shall be without substantive meaning or content of any kind whatsoever and are not a part of the agreement between the parties. 5 6 IN WITNESS WHEREOF, the parties have executed this Fourth Amendment the day and year first above-written. PARTY CITY CORPORATION, a Delaware corporation By: /s/ David E. Lauber ------------------------------- Name: David E. Lauber Title: Executive Vice President PNC BANK, NATIONAL ASSOCIATION By: /s/ David Krietzberg ------------------------------- Name: David Krietzberg Title: Vice President 6 7 Exhibit A AMENDED AND RESTATED REVOLVING CREDIT NOTE $25,000,000.00 March ___, 1998 FOR VALUE RECEIVED, the undersigned, PARTY CITY CORPORATION, a New Jersey corporation (the "Borrower"), having its chief executive offices located at 400 Commons Way (Building C), Rockaway, New Jersey 07866, hereby unconditionally promises to pay on the Termination Date (as defined in the Third Amendment identified below) to the order of PNC BANK, NATIONAL ASSOCIATION, f/k/a MIDLANTIC BANK, NATIONAL ASSOCIATION (the "Bank"), at its office at PNC Business Credit, Two Tower Center Boulevard, East Brunswick, New Jersey 08816, or at such other place as the holder hereof may direct, in lawful money of the United States of America and in immediately available funds, the principal amount of (a) TWENTY FIVE MILLION DOLLARS ($25,000,000), or, if less, (b) the aggregate unpaid principal amount of all Revolving Credit Advances made by the Bank to the Borrower pursuant to Section 2.1 of that certain Loan and Security Agreement, dated February 15, 1995 by and between the Borrower and the Bank, as amended by First Amendment to Loan and Security Agreement, dated as of October 6, 1995, Second Amendment to Loan and Security Agreement, dated as of December 15, 1996, Third Amendment to Loan and Security Agreement, dated as of June 16, 1997, and Fourth Amendment to Loan and Security Agreement (the "Fourth Amendment") dated as of the date hereof (as so amended and as further amended from time to time, the "Loan Agreement"). The Borrower further agrees to pay interest on the unpaid principal amount outstanding hereunder from time to time from the date hereof in like money at such office at the rates and on the dates specified in Section 4.1 of the Loan Agreement as designated in the Notice of Borrowing received from the Borrower. After the occurrence and during the continuation of an Event of Default, the interest rate shall be the Default Rate. This Note is the Amended and Restated Revolving Credit Note referred to in the Fourth Amendment, and is entitled to the benefits thereof, is secured as provided therein and is subject to optional and mandatory prepayment as set forth therein. Capitalized terms used herein, unless otherwise defined, have the meanings given to them in the Loan Agreement. Upon the occurrence of any one or more of the Events of Default specified in the Loan Agreement, all amounts then remaining unpaid on this Note shall become immediately due and payable, all as provided therein. All parties now and hereafter liable with respect to this Note, whether maker, principal. surety, guarantor, endorser or otherwise, hereby waive presentment, demand and protest and notice of presentment, dishonor, protest, default, nonpayment, maturity, release, compromise, settlement, 8 extension or renewal and any and all other notices and demands whatsoever in connection with the delivery, acceptance, performance, default or enforcement of this Note. The provisions of this Note are binding on the assigns and successors of the Borrower and shall inure to the benefit of the Bank, its successors and assigns. If this Note is placed in the hands of an attorney for collection, the undersigned shall pay all reasonable disbursements and fees of such attorney. This Note shall be governed by and construed in accordance with the laws of the United States of America and the internal laws of the State of New Jersey (without giving effect to the principles of conflicts of law). No provision of this Note may be changed or waived orally, but only by an instrument in writing signed by the party to be charged by such change or waiver. This Note amends, restates and supersedes, but is not in satisfaction or a novation of, the Amended Revolving Credit Note of Borrower, dated June 16, 1997, in the original principal sum of $20,000,000. THE BORROWER WAIVES THE RIGHT TO TRIAL BY JURY AND THE RIGHT TO INTERPOSE ANY SETOFF OR COUNTERCLAIM OF ANY NATURE EXCEPT FOR MANDATORY COUNTERCLAIMS. IN WITNESS WHEREOF, the Borrower has executed this Note as of the day and year first above-written. PARTY CITY CORPORATION, a New Jersey corporation Attest: By: - -------------------------------- -------------------------------- Name: Title: 2 9 SCHEDULE "A" 1. The Company will within fifteen (15) days after the date hereof be in compliance with the requirements of Section 6.2(c) of the Agreement and shall submit an updated Schedule 7.2 to the Bank. 2. Schedule 7.3 is updated to reflect that the Company has one subsidiary, Party City Michigan, Inc., a Delaware corporation. 3. The Borrower has regularly obtained language of waiver in its leases with the landlords of each of its store locations; however, the Borrower has not consistently obtained a separate Landlord Waiver and Consent Agreement for each location. EX-10.15 3 CREDIT FACILITY COMMITMENT LETTER 1 Exhibit 10.15 [LETTERHEAD OF PNC BANK, N.A.] March 9, 1998 PNCBANK Mr. David Lauber Party City Corporation 400 Commons Way Rockaway, NJ 07866 Dear Mr. Lauber: Party City Corporation (the "Company") has requested that PNC Bank, National Association ("PNC Bank" or the Agent") underwrite up to $60,000,000 of credit facilities (the "Financing") for general corporate purposes including the refinancing of existing PNC Bank indebtedness, providing for store expansion, and the acquisitions of franchise stores. We are pleased to inform you that PNC Bank commits to provide $60,000,000 of the Financing described in the attached Summary of Terms and Conditions (the "Summary"), subject to the terms and conditions referred to in this letter and the Summary. The Summary includes a description of the principal terms of the proposed credit facilities connected with the Financing, and is intended as a framework for the documentation and as a basis for further discussion of the Financing's terms, as appropriate. The Financing will be documented in a definitive credit agreement (the "Credit Agreement") and other agreements, instruments, certificates, and documents called for by the Credit Agreement or which PNC BANK may otherwise require (collectively, the "Credit Documents"), to be delivered at the closing of the Financing (the "Closing"). The terms of the Credit Documents shall prevail over the terms of this letter. PNC Bank's obligations are conditioned on the execution and delivery of the Credit Documents to PNC BANK in form and content satisfactory to PNC BANK. Because not all of the terms can be set forth in the Summary, a failure by the Bank or the Company to agree on the definitive terms of the Credit Documents will not constitute a breach of this commitment. This letter is also subject to acceptance by the Company as provided below and the statutory and other requirements under which PNC BANK is governed. In addition to the terms and conditions set forth in the Summary, PNC Bank's commitment to provide the proposed Financing is further subject to: (i) there being no material adverse change in the financial condition, business, operations, properties, or prospects of the Company from the information provided to PNC BANK in its due diligence process; and (ii) the non-occurrence of any material adverse change in the loan 2 Party City Corporation March 9, 1998 Page 2 syndication or capital market conditions generally, which would affect the syndication efforts by PNC BANK in its capacity as Agent in respect of any portion of the Financing. This letter is issued in reliance on the information provided to PNC BANK by the Company in connection with the Company's request for the Financing and the information in any supporting document and material. PNC Bank may terminate this commitment if there is any material misrepresentation or material inaccuracy in the information or any failure to include material information with the request. By executing this letter, the Company agrees to indemnify and hold harmless PNC Bank or any affiliate thereof and any assignees or participants thereof and their respective officers, directors, employees, affiliates and agents from and against any and all losses, claims, damages, liabilities, costs and expenses (including without limitation reasonable fees and expenses of counsel) which may be incurred by any of them in connection with any investigation, litigation or other proceeding arising in connection with the Financing, other than for their own gross negligence or willful misconduct. The Company's obligations hereunder shall be in addition to any other liability it may otherwise have. The Company agrees to pay the fees set forth in the Summary. PNC BANK shall be reimbursed from time to time by the Company upon request for all reasonable out-of-pocket expenses (including without limitation reasonable fees and expenses of counsel) which it may incur in the negotiation, preparation, due diligence, execution and delivery of this letter, the Credit Documents and other documentation and any assignment or participation of its interests herein, regardless of whether the transaction contemplated by this letter is completed or the Credit Documents are signed. The terms contained in this letter and the Summary are confidential and, except for disclosure to the Company's board of directors, officers and employees, professional advisors retained by the Company in connection with this transaction, or as may be required by law, may not be disclosed in whole or in part to any other person or entity without PNC Bank's prior written consent. This letter is solely for the benefit of the Company and no other person or entity shall obtain any rights hereunder or be entitled to rely or claim reliance upon the terms and conditions hereof. This commitment letter may not be assigned by the Company and no rights of the Company hereunder may be transferred without the prior written consent of PNC Bank. PNC BANK may elect to (a) assign a portion of its rights and obligations hereunder so that the assignee may become a party to the Credit Agreement and (b) arrange for the sale of participation interests in its commitment hereunder and/or loans made by it as contemplated hereby. In the event of any assignment referred to in (a) above, the assignor shall be released of all obligations assumed by the assignee. 3 Party City Corporation March 9, 1998 Page 3 This commitment letter shall be governed by and construed in accordance with the laws of the State of New Jersey. PNC Bank and any assignees or participants will in no event be responsible or liable for any consequential damages that may be incurred or alleged by any person as a result of this letter. No modification or waiver of any of the terms and conditions of this letter will be valid and binding unless agreed to in writing by PNC BANK. When accepted, this letter constitutes the entire agreement between PNC BANK and the Company concerning the Financing and replaces all prior understandings, statements and negotiations. This commitment letter will expire on March 20, 1998, unless on or before that date the Company signs and returns the enclosed copy of this letter along with the Commitment Fee stated below. Once accepted, PNC Bank's obligations under this letter will expire automatically and without further liability to PNC BANK on May 20, 1998 if the Financing has not closed on or before that date. Both of these expiration dates may be extended only if agreed to in writing by PNC Bank. If the foregoing accurately sets forth our understanding, please indicate your acceptance hereof by signing the enclosed copy of this letter and returning it to us with payment of our commitment fee in the amount of $100,000. This Commitment Fee along with the previously submitted deposit of $30,000 is considered non-refundable whether or not the transaction closes. These fees shall be applied to the underwriting fee due at closing. We are pleased to have this opportunity and very much look forward to working with you. Sincerely, PNC Bank, National Association David Krietzberg Vice President Agreed to and accepted: Party City Corporation By: /s/ David Lauber ---------------------- Date: 3/18/98 cc: Steven Mandell 4 Party City Corporation March 9, 1998 Page 4 Summary of Terms and Conditions $60,000,000 Revolver March 9, 1998 Borrower: Party City Corporation (the "Company"). Agent: PNC Bank, National Association ("PNC Bank or Agent") Banks: The Agent and lending institution(s) acceptable to the Company and the Agent providing a portion of the Credit Facilities described below (the "Banks"). Credit Facility: Subject to acceptable documentation, PNC BANK commits to provide up to $60,000,000 of a $60,000,000 three-year revolving credit facility (the "Credit Facility"). Purpose: Refinance existing indebtedness, provide for store expansion, acquisitions of existing Party City franchised stores, and general corporate purposes. Maturity: Three years from closing. Repayment: At maturity. Until maturity, the Company may borrow, repay and reborrow an amount not to exceed $60,000,000. Interest Rate on the Credit Facility: The Borrower will have the option of Interest Rates tied to the Base Rate or LIBOR. Interest Rates will be tiered based on the Company's Fixed Charge Coverage Ratio according to the attached Pricing Grid. The initial measurement date shall be as of 3/31/98. The Fixed Charge Coverage Ratio is defined as the ratio of EBITR to Fixed Charges. EBITR is defined as net income (before extraordinary income) plus income tax expense, interest expense, 5 Party City Corporation March 9, 1998 Page 5 and rent expense, all measured as of the end of each quarter for the previous four quarters. Fixed Charges is defined as the sum of interest expense and rent expense, both measured as of the end of each quarter for the previous four quarters. The Base Rate is the higher of PNC Bank's Prime rate as defined in the documentation or the Federal Funds rate plus One Half of One Percent (1/2%). Interest on Base Rate borrowings is calculated on an actual/365 or 366 day basis and is payable quarterly. Interest on LIBOR borrowings is calculated on an actual/360 day basis and is payable the earlier of quarterly or on the last day of each interest period. LIBOR advances will be available for periods of 1,2,3 or 6 months. LIBOR pricing will be adjusted for any statutory reserves. The Company may have no more than five borrowing tranches, including the Base Rate tranche, at any one time. Subsequent to an Event of Default which continues beyond any applicable cure period, outstandings shall bear interest at Two Percent (2.00%) over the rate of interest applicable under the Base Rate pricing option. Underwriting Fee: 75 basis points ($450,000) payable to the Agent at closing, less any deposits and commitment fees already paid by the Company to the Agent for this specific transaction. Agent's Fee: $15,000 per annum payable to the Agent, assuming three Banks as lenders. The Agent's Fee will be increased by $5,000 per annum for each additional Bank that becomes a lender. Yield Protection: The Company shall pay the Banks such additional amounts as will compensate the Banks in the event 6 Party City Corporation March 9, 1998 Page 6 applicable law, change in law, or in interpretation of law, subjects the Banks to reserve requirements, capital requirements, taxes (except for taxes on the overall net income of the Banks) or other charges which increase the cost or reduce the yield to the Banks, under customary yield protection provisions. Expenses: Reasonable out-of-pocket expenses incurred by Agent shall be for the account of the Company. These include fees and expenses of the Agent's legal counsel. Collateral: First priority perfected lien on all receivables, including franchise royalties and fees, inventory, equipment, furniture, fixtures, improvements and intangibles, as well as the right to obtain a mortgage, or such other security interest in any real property of the Borrower, as Agent in its discretion deems necessary in the future. Mandatory Commitment Reductions: Mandatory commitment reductions will be required upon any material sale of assets as defined in the documentation. Prepayments will not be required, however, if after-tax proceeds from asset sales totaling up to $500,000 are used to acquire substitute assets in the ordinary course of business and such assets are pledged to the Banks within thirty (30) days. Interest Rate Protection: Minimum Twenty Five Percent (25%) of outstandings under the Credit Facility to be hedged, as defined in the documentation, at all times, which shall be secured by the Collateral as defined herein. Representations and Warranties: The documentation shall require typical representations and warranties as to matters expected in a Credit Facility of this nature including, but not limited to: a. Organization and qualification. b. Capitalization and ownership. 7 Party City Corporation March 9, 1998 Page 7 c. Subsidiaries. d. Power and authority. e. Validity, binding effect and enforceability. f. No conflict. g. Litigation. h. Title to properties. i. Financial statements; no material adverse change. j. Margin stock. k. Full disclosure. l. Taxes. m. Consents and approvals. n. No Event of Default; compliance with contracts and instruments. o. Patents, trademarks, copyrights, licenses. p. Security interests. q. Mortgage liens. r. Status of pledged collateral. s. Insurance. t. Compliance with laws. u. Material contracts. v. Investment companies. 8 Party City Corporation March 9, 1998 Page 8 w. Plans and benefit arrangements. x. Employment matters. y. Environmental matters. z. Senior debt status. aa. Year 2000 Compliance Other Representations and Warranties as appropriate. Conditions Precedent to Closing: Receipt by Agent of the following, in form and substance satisfactory to the Agent and the Banks: a. Closing certificate as to accuracy of Representations and Warranties, compliance with covenants and absence of Event of Default or Potential Event of Default. b. Certified resolutions, incumbency certificate and corporate documents. c. Delivery of all definitive financing documents and evidence of filing of all collateral documents. d. Opinion(s) of counsel. e. Receipt of audited December 31, 1997 financial statements by independent certified public accountants satisfactory to PNC BANK. f. Receipt of management's financial projections prepared for fiscal year 1998 on a quarterly basis. g. No material adverse change. h. No material litigation. 9 Party City Corporation March 9, 1998 Page 9 i. Evidence of required insurance. j. Payment of all fees and expenses. k. A schedule detailing as to all Company locations: store name, store number, address, and square footage. A copy of all leases for all Company-owned stores. A schedule of leases that do not contain Landlord Waivers, the total number of which shall not exceed the number of leases that have been previously waived in writing by PNC BANK. l. The Company and PNC BANK shall have agreed to a modification of the standard Landlord Waiver language contained in all future Company-owned stores leases. Other Conditions Precedent to Lending as appropriate in the discretion of PNC BANK. Affirmative Covenants The Company will: o Provide within 45 days after each month end, monthly unaudited financial statements of month end, along with individual Company-owned store profit and loss reports for the year-to-date period then ending, depicting actual, budget, variance analysis, and comparisons to the same period the prior year and a Certificate of Compliance from the CEO, President or CFO. o Provide within 45 days after each of the first three fiscal quarters, quarterly unaudited financial statements and 10Q's, along with a Certificate of Compliance from the CEO, President or CFO. In the event that a subsidiary is created, then consolidated and consolidating financial reporting will be required. o Provide within 90 days after each fiscal year end, audited financial statements and 10K along with (i) a report of an independent Certified Public Accountant satisfactory to the Agent, (ii) any management letters of such accountants addressed to the Company, (iii) a Certificate of Compliance from the CEO, President or CFO and (iv) Annual Report and Shareholder Proxy Statements. In the event that a subsidiary is created, then consolidated and consolidating financial reporting will be required. 10 Party City Corporation March 9, 1998 Page 10 o Provide within fifteen (15)days from the date of possession of new Company-owned stores, a listing with detailed address information and a copy of the associated lease agreement, together with UCC-1 form or forms executed by the Borrower suitable for recording in the affected jurisdiction(s). o Provide prior to each year end, a three year projection of financial statements showing detailed income statements, balance sheets, and cash flow statements by month for the first year and by quarter for each of the subsequent two years. The first year cash flow should include a detailed schedule of cash receipts and disbursements and show the beginning and month end borrowings. In addition, the Company will supply a detailed budget showing individual store Profit And Loss Reports forecasted for the upcoming year including, but not limited to, expected store openings, and capital expenditures. o All reports prepared by outside accountants shall be accompanied by a writing evidencing the Company's knowledge that such reports are being supplied to Agent by the accountants and that Agent and the Banks are intended to rely upon such reports. Other Affirmative Covenants as deemed appropriate in the Agent's discretion. Negative Covenants: The Company will not breach the following required ratios or covenants: Liquidity Ratio - The ratio of the Company's cash, accounts receivable and inventory to outstandings under the Credit Facility shall not be less than the following:
1998-2000 --------- Jan.- Apr. 1.50:1.00 May-Aug. 1.40:1.00 Sept.-Dec. 1.50:1.00
b. Leverage - The Company's ratio of Total Indebtedness to EBITDA shall not exceed the following: 11 Party City Corporation March 9, 1998 Page 11 1st Quarter 2.50:1.00 2nd Quarter 2.50:1.00 3rd Quarter 3.25:1.00 4th Quarter 1.50:1.00
If Leverage exceeds 2.50:1 as of the end of the 3rd Quarter, the Leverage covenant shall be measured again as of 10/31/XX and shall not exceed 1.50:1. For purposes of this test only, Total Indebtedness shall be as of 11/10/XX while EBITDA shall represent the twelve months ended 10/31/XX. Total Indebtedness is defined as the Company's consolidated long and short term indebtedness for borrowed money, capital leases, guarantees and letters of credit, all measured as of the end of each quarter. EBITDA is defined as net income (before extraordinary income), plus income tax expense, interest expense, depreciation and amortization expense, all measured as of the end of each quarter for the previous four quarters. c. Fixed Charge Coverage Ratio - As of the end of each fiscal quarter, the Company's ratio of EBITR to Fixed Charges shall not be less than the following: 1st Quarter 1.35:1 2nd Quarter 1.35:1 3rd Quarter 1.20:1 4th Quarter 1.50*
* Reduced to 1.40:1 for the fourth quarter 1999 and 2000. EBITR is defined as net income (before extraordinary income) plus income tax expense, interest expense, and rent expense, all measured 12 Party City Corporation March 9, 1998 Page 12 as of the end of each quarter for the previous four quarters. Fixed Charges is defined as the sum of interest expense and rent expense, both measured as of the end of each quarter for the previous four quarters. d. Tangible Net Worth - The Company's tangible net worth shall not be less than $30,000,000 at 12/31/97 plus 50% of annual net income plus 100% of the net proceeds of any new equity issuances by the Company. This covenant shall be tested on an annual basis. e. Minimum Net Worth and/or Maximum Debt to Net Worth Such a covenant, to be tested on a quarterly basis, will be negotiated for inclusion in the definitive documentation. f. Capital Expenditures - Capital expenditures, including capitalized leases but excluding acquisition costs of intangible assets, shall not exceed the amounts shown opposite each period below.
FYE Amount --- ------ 1998 $26,000,000 1999 $26,000,000 2000 $26,000,000
g. Limitation on sale of assets. h. Restriction on loans, advances and investments. i. Limitation on additional indebtedness, liens and leases. j. Prohibition against cash distributions to shareholders. k. Prohibition on change of business. 13 Party City Corporation March 9, 1998 Page 13 l. Prohibition on change of control. m. No Mergers or acquisitions permitted, except under the following conditions: (1) the Company is the surviving entity, (2) the Company is in proforma compliance with all covenants after taking the acquisition into account, (3) the entity being acquired is an existing Party City franchisee, (4) purchase multiple and structure is consistent with the Company's stated parameters and prior acquisitions, and (5) cash consideration for acquisitions limited to $12,500,000 in the aggregate per fiscal year and limited to $30,000,000 in aggregate during the term of the Facility. n. The Company shall not execute new store leases that do not contain a Landlord Waiver in language that conforms to the new Standard Waiver language to be formalized or that is not otherwise satisfactory to PNC BANK for all Company-owned stores without PNC BANK's prior written consent. Other Negative Covenants as appropriate. Events of Default: Events of Default typical to a transaction of this nature will be required, to include, but not be limited to: a. Payment default. b. Breach of Representations or Warranties. c. Violation of covenant(s). d. Cross default to other debt. e. Bankruptcy, insolvency. Other Events of Default as deemed appropriate in the Agent's discretion. 14 Party City Corporation March 9, 1998 Page 14 Required Banks: For the purpose of making amendments or waivers to the credit agreement, approval by Banks whose commitments under the Credit Facilities aggregate at least 66.67% will be required. However, unless agreed to by all Banks, no amendment or waiver shall change the principal amount, reduce the rate of interest or fees, postpone the scheduled payment of any principal, interest or fees, release material collateral or change the definition of Required Banks. Assignments and Participations: Banks will be permitted to assign and participate their portion of the Credit Facility. Assignments will be in minimum amounts of $5,000,000 and assignees will be subject to the consent of the Company and the Agent, such consent not to be unreasonably withheld. In the event of participation, as opposed to assignments, voting rights to participants will be limited to change in principal amount, reduction of the rate of interest or fees, postponement of the scheduled payment of any principal, interest or fees or release of any collateral. Assignments will be subject to the payment by the assigning Bank of a $3,500 service fee to the Agent. Governing Law: This commitment shall be governed by and construed in accordance with the laws of the State of New Jersey. The parties will consent to New Jersey jurisdiction and will waive all rights to jury trial. 15 Party City Corporation March 9, 1998 Page 15 PRICING GRID FOR PARTY CITY CORPORATION*
=================================================================================================================================== LEVEL I LEVEL II LEVEL III LEVEL IV LEVEL V - ----------------------------------------------------------------------------------------------------------------------------------- Basis The Company's The Company's The Company's The Company's The Company's for Fixed Charge Fixed Charge Fixed Charge Fixed Charge Fixed Charge Pricing Coverage Ratio is Coverage Ratio is Coverage Ratio is Coverage Ratio is Coverage Ratio is greater than 1.90:1 is less than or equal to is less than or equal to is less than or equal to is less than or equal 1.90:1 but greater 1.70:1 but greater to 1.50:1 and to 1.35:1 and greater than 1.70:1 than 1.50:1 greater than 1.35:1 than 1.20:1 - ----------------------------------------------------------------------------------------------------------------------------------- LIBOR + 75 100 125 150 175 - ----------------------------------------------------------------------------------------------------------------------------------- Base Rate + 0 0 0 0 0 - ----------------------------------------------------------------------------------------------------------------------------------- Commitment Fee 17.5 20 25 30 35 ===================================================================================================================================
All prices are expressed in basis points. *Initial Pricing shall be at Level III. EX-10.16 4 EMPLOYMENT AGREEMENT 1 Exhibit 10.16 EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT (the "Agreement") dated as of the 23rd day of September, 1997 between Party City Corporation, a Delaware corporation (together with its successors and assigns referred to herein as the "Corporation" or the "Company"), with principal executive offices located at 400 Commons Way, Rockaway, New Jersey 07866 and David E. Lauber, with an address at 11 East 88th Street, Apartment 7B, New York, New York 10128 (the "Employee"). W I T N E S S E T H WHEREAS, the Corporation desires to employ Employee to engage in such activities and to render such services under the terms and conditions hereof and has authorized and approved the execution of this Agreement; and WHEREAS, Employee desires to be employed by the Corporation under the terms and conditions hereinafter provided; NOW, THEREFORE, in consideration of the mutual covenants and premises herein contained, the parties hereto hereby agree as follows: 1. Employment, Duties and Acceptance. 1.1 Services. The Corporation hereby employs Employee, for the Term (as hereinafter defined in Section 2 hereof), to render exclusive and full-time services to the business and affairs of the Corporation as Executive Vice President, and, in connection therewith, shall perform such duties as directed by the Board of Directors of the corporation from time to time, in its reasonable discretion, and shall perform such other duties as shall be consistent with the responsibilities of such office. Employee shall perform activities related to such office as he shall 2 reasonably be directed or requested to so perform by the Corporation's Chief Executive Officer or the Corporation's Board of Directors, to whom he shall report. Employee shall use his best efforts, skill and abilities to promote the interests of the Corporation and its subsidiaries. Notwithstanding the foregoing, Employee shall be permitted to render services in connection with various real estate entities in which Employee may, from time to time, have an interest, provided such services do not interfere with Employee's performance of his full time services to the Corporation. 1.2 Acceptance. Employee hereby accepts such employment and agrees to render the services described in Section 1.1 hereof. 2. Term of Employment. The term of Employee's employment under this Agreement (the "Term") shall commence on September __, 1997 (the "Effective Date") shall terminate on June 12, 2001, unless sooner terminated pursuant to Section 8 of this Agreement; provided, however this Agreement may be extended for additional periods of one year if, on or before 30 days prior to the then applicable termination date, both parties hereto enter into a written agreement to extend the Term of this Agreement for a period of one year. Any reference in this Agreement to time periods or matters to occur after June 12, 2001 (other than as described in Section 9 hereof) are provisional and are only applicable to the extent the Agreement is renewed in accordance with the provisions of this Section 2. Notwithstanding anything to the contrary contained herein, the provisions of this Agreement governing Protection of Confidential Information shall continue in effect as specified in Section 9 hereof. -2- 3 3. Base Salary/Bonus. 3.1 During the Term, as compensation for all services to be rendered by Employee pursuant to this Agreement, the Corporation agrees to pay Employee a minimum base salary ("Base Salary") at the annual rate of $325,000 for the year from the Effective Date to the first anniversary of the Effective Date; at an annual rate of $335,000 for the year from the first anniversary of the Effective Date to the second anniversary of the Effective Date; at an annual rate of $345,000 for the year from the second anniversary of the Effective Date to the third anniversary of the Effective Date, and at an annual rate of $355,000 for the period from the third anniversary of the Effective Date to June 12, 2001. All payments of Base Salary shall be pro rated during any partial calendar year during the Term. Such Base Salary may be adjusted upward on a merit basis by the Board of Directors in its sole discretion. The Employee will be reviewed annually by the Board of Directors to determine if Employee's compensation (including Base Salary) should be adjusted. The Board of Directors' review of the Employee's compensation shall consider both cash and non-cash (i.e., stock options) remuneration. Employee's Base Salary shall be payable during the term of this Agreement in accordance with the Corporation's customary payment practices. 3.2 In addition to Base Salary, the Employee shall be eligible to receive an annual (calendar year), performance-based cash bonus not to exceed (a) $70,000 in calendar year 1997 (b) $80,000 in calendar year 1998 (c) $90,000 in calendar year 1999 (d) $100,000 in calendar year 2000 (e) $110,000 (prorated as described below) in calendar year 2001 -3- 4 The Employee's eligibility for the bonus, subject to the maximum amount described above, shall be based upon: (i) the performance of the Company based upon performance criteria established by the Board of Directors; and (ii) the performance of the Employee in his function as Executive Vice President of the Company as determined by the Board of Directors and the President of the Company, in their sole and absolute discretion. For calendar year 2001 (in the event that the Employee's employment is not renewed and/or extended for the balance of such year) the criteria described above shall be for that portion of the year during the Term and the maximum bonus amount shall be $50,000 (in the event of Employee's continued employment for the balance of calendar year 2001, his bonus eligibility shall be a maximum amount of $110,000 subject to the above described criteria). In the event the Employee shall die during any calendar year of the Term, the Company shall remit to the Employee's estate the amount of the bonus awarded by the Board of Directors for such calendar year, prorated to the date of the Employee's death, promptly upon determination by the Board. 4. Severance. In the event that Employee's employment hereunder shall be terminated by the Corporation without Cause (as such term is defined in Section 8.2 hereof) at any time prior to September 12, 2000, Employee shall be entitled to receive from the Corporation, in addition to any Base Salary earned to the date of termination, a severance payment in an amount equal to nine months of the Employee's Base Salary applicable at the date of such termination; which amount shall be paid in biweekly increments during the nine months following such termination. -4- 5 In the event the Employee's employment hereunder shall be terminated by the Corporation without Cause (as such term is defined in Section 8.2 hereof) subsequent to September 12, 2000, then in that event Employee shall be entitled to receive from the Corporation a severance payment in an amount equal to Employee's Base Salary for the then remaining period of the Term (i.e., in the event there are four (4) months remaining in the Term, the severance payment will be a payment in an amount equal to four (4) months of Employee's then current Base Salary) which payment shall be made in bi-weekly increments during the applicable period. 5. Expenses. Upon submission to, and approval by an officer of the Corporation designated by the Board of Directors of the Corporation, of a statement of expenses, which approval shall be granted or withheld based on the Corporation's policies in effect at such time, the Corporation shall pay or reimburse Employee for all reasonable expenses actually incurred or paid by him during the Term in the performance of his services under this Agreement, including, but not limited to, expenses for entertainment, travel and similar items. Subject to such approval, the Corporation will reimburse Employee for such expenses only upon presentation of expense statements or vouchers or such other supporting information as the Corporation may require and as may be required for tax purposes. 6. Additional Benefits. (a) The Corporation shall reimburse Employee for any out of pocket expenses incurred by Employee with respect to Employee's current lease of a 1996 Jeep Grand Cherokee and related operating expenses (including gas and automobile insurance costs). Upon -5- 6 termination or expiration of the Auto Lease, the Corporation shall lease a comparable automobile for Employee's use, and shall reimburse Employee for related operating expenses incurred by Employee with respect thereto. (b) In addition to the compensation, expenses and other benefits to be paid under Sections 3, 5 and 6(a) hereof, Employee will be entitled to all rights and benefits for which he shall be eligible under any insurance, incentive, bonus, pension or other extra compensation or "fringe" benefit plan of the Corporation now existing or hereafter adopted for the benefit of the executives or employees generally of the Corporation. The provisions of this Section 6(b) are subject to the provisions of Section 7. 7. Corporation's Benefits. The provisions of this Agreement which incorporate the employee benefit package shall change as and when such employee benefit package changes. 8. Termination. 8.1 Death. If Employee dies during the Term of this Agreement, Employee's employment hereunder shall terminate upon his death and all obligations of the Corporation hereunder shall terminate on such date, except that Employee's estate or his designated beneficiary shall be entitled to payment of any unpaid accrued Base Salary through the date of his death. In addition, any accrued and unpaid Bonus (pro-rated to the date of death) shall be paid in accordance with Section 3 hereof. 8.2 Termination For Cause. The Corporation may at any time during the Term, without any prior notice, terminate this Agreement and discharge Employee for Cause, -6- 7 whereupon the Corporation's obligation to pay compensation or other amounts payable hereunder to or for the benefit of Employee shall terminate on the date of such discharge. As used herein the term "Cause" shall be deemed to mean and include: (i) a material breach by Employee of this Agreement including without limitation a breach by Employee of his obligation set forth in Section 9 hereof; (ii) excessive absenteeism, alcoholism or drug abuse; (iii) substantial neglect or inattention by Employee of or to his duties hereunder; (iv) willful violation of specific and lawful written or oral direction from the Chief Executive Officer or the Board of Directors of the Corporation; provided such direction is not inconsistent with the Executive's duties and responsibilities as an Executive Vice President of the Corporation and provided further that said direction does not require substantial and burdensome travel out of the New York metropolitan area or relocation out of the New York metropolitan area; or (v) fraud, criminal conduct or embezzlement. The obligations of the Employee under Section 9 shall continue notwithstanding termination of the Employee's employment pursuant to this Section. 8.3 Disability. Should Employee become disabled, as hereinafter defined, during the Term hereunder, this Agreement and the Employee's employment with the Corporation shall terminate upon written notice from the Corporation to the Employee, and such termination shall be deemed to be for Cause. As used herein, the term "disabled" is hereby defined as the inability of Employee, by reason of injury, physical or mental illness or other similar cause to perform a major part of his duties and responsibilities in connection with the conduct of the business and affairs of the Corporation for a continuous period of three months or more, or for an aggregate -7- 8 period of four months or more in any twelve month period, whether or not continuous. In the event of a dispute as to the existence of any such disability, Employee agrees to submit to a medical and psychiatric examination conducted by a physician mutually acceptable to the Employee and the Corporation and to be bound by any determination made by such physician. 8.4 Termination Without Cause. The Corporation may at any time during the Term, without prior notice, terminate the Agreement and discharge Employee without Cause provided, however, that the severance provisions of Section 4 shall apply. 9. Protection of Confidential Information. In view of the fact that Employee's work for the Corporation will bring him into close contact with confidential information and plans for future developments, Employee agrees to the following: 9.1 Secrecy. To keep secret and retain in the strictest confidence all confidential matters of the Corporation, including, without limitation, trade "know how" and trade secrets, customer lists, pricing policies, marketing plans, technical processes, formulae, inventions and research projects, and other business affairs of the Corporation, learned by him heretofore or hereafter, and not to disclose them to anyone inside or outside of the Corporation, except (i) in the course of performing his duties hereunder, (ii) with the express written consent of the Chief Executive Officer or Board of Directors of the Corporation, (iii) except to the extent such information is already known to the general public, or (iv) to the extent required by lawful order of a court of competent jurisdiction. -8- 9 9.2 Return Memoranda, etc. To deliver promptly to the Corporation on termination of his employment, or at any other time as the Chief Executive Officer or the Board of Directors of the Corporation may so request, all memoranda, notes, records, reports, manuals, drawings, blueprints and other documents (and all copies thereof) relating to the Corporation's business and all property associated therewith, which he may then possess or have under his control. 9.3 Non-competition. A. Employee agrees that at all times while he is employed by the Corporation and, regardless of the reason for termination of his employment or this Agreement, for a period of one (1) year thereafter, he will not, as a principal, agent, employee, employer, consultant, stockholder, investor, director or co-partner of any person, firm, corporation or business entity other than the Corporation, or in any individual representative capacity whatsoever, directly or indirectly, without the express prior written consent of the Corporation: (a) engage or participate in any business whose products or services are competitive with that of the Corporation, which business is exclusively the sale of party goods, and which conducts or solicits business, or transacts with supplier or customers located within the United States, Canada or Puerto Rico; (b) aid or counsel any other person, firm, corporation or business entity to do any of the above; -9- 10 (c) become employed by a firm, corporation, partnership or joint venture which competes with the business of the Corporation within the United States, Canada or Puerto Rico; (d) approach, solicit business from, or otherwise do business or deal with any customer of the Corporation in connection with any product or service competitive to any provided by the Corporation. B. Employee agrees that during the term of his employment hereunder, and, thereafter for a period of one (1) year, he will not, as a principal, agent, employee, employer, consultant, director or partner of any person, firm, corporation or business entity other than the Corporation, or in any individual representative capacity whatsoever, directly or indirectly, without the prior express written consent of the Corporation approach, counsel or attempt to induce any person who is then in the employ of the Corporation to leave the employ of the Corporation or employ or attempt to employ any such person or persons who at any time during the preceding six months was in the employ of the Corporation. Employee acknowledges (i) that his position with the Corporation requires the performance of services which are special, unique, and extraordinary in character and places him in a position of confidence and trust with the customers and employees of the Corporation, through which, among other things, he shall obtain knowledge of the Corporation's "technical information" and "know-how" and become acquainted with its customers, in which matters the Corporation has substantial proprietary interests, (ii) that the restrictive covenants set forth above are necessary in order to protect and maintain such proprietary interests and the other legitimate -10- 11 business interests of the Corporation, and (iii) that the Corporation would not have entered into this Agreement unless such covenants were included herein. Employee also acknowledges that the business of the Corporation presently extends throughout the United States, Puerto Rico, Canada and certain European countries, and that he will personally supervise and engage in such business on behalf of Corporation and, accordingly, it is reasonable that the restrictive covenants set forth above are not more limited as to geographic area then is set forth therein. Employee also represents to the Corporation that the enforcement of such covenants will not prevent Employee from earning a livelihood or impose an undue hardship on the Employee. If any of the provisions of this Section, or any part thereof, is hereinafter construed to be invalid or unenforceable, the same shall not affect the remainder of such provision or provisions, which shall be given full effect, without regard to the invalid portions. If any of the provisions of this Section, or any part thereof, is held to be unenforceable because of the duration of such provision, the area covered thereby or the type of conduct restricted therein, the parties agree that the court making such determination shall have the power to modify the duration, geographic area and/or other terms of such provision and, as so modified, said provision(s) shall then be enforceable. In the event that the courts of any one or more jurisdictions shall hold such provisions wholly or partially unenforceable by reason of the scope thereof or otherwise, it is the intention of the parties hereto that such determination not bar or in any way affect the Corporation's right to the relief provided for herein in the courts of any other jurisdictions as to breaches or threatened breaches of such provisions in such other jurisdictions, -11- 12 the above provisions as they relate to each jurisdiction being, for this purpose, severable into diverse and independent covenants. The provisions of this Section 9 shall be construed as an agreement on the part of the Employee independent of any other part of this Agreement or any other agreement, and the existence of any claim or cause of action of the Employee against the Corporation, whether predicated on this Agreement or otherwise, shall not constitute a defense to the enforcement by the Corporation of the provisions of this Section 9. 9.4 Injunctive Relief. Employee acknowledges and agrees that, because of the unique and extraordinary nature of his services, any breach or threatened breach of the provisions of Sections 9.1, 9.2, or 9.3 hereof will cause irreparable injury and incalculable harm to the Corporation, and the Corporation shall, accordingly, be entitled to injunctive and other equitable relief for such breach or threatened breach and that resort by the Corporation to such injunctive or other equitable relief shall not be deemed to waive or to limit in any respect any right or remedy which the Corporation may have with respect to such breach or threatened breach. Corporation and Employee agree that any such action for injunctive or equitable relief shall be heard in a state or federal court situate in New Jersey and each of the parties hereto, hereby agrees to accept service of process by registered mail and to otherwise consent to the jurisdiction of such courts. 9.5 Expenses of Enforcement of Covenants. In the event that any action, suit or proceeding at law or in equity is brought to enforce the covenants contained in Section 9.1, 9.2, or 9.3 hereof or to obtain money damages for the breach thereof, the party prevailing in any -12- 13 such action, suit or other proceeding shall be entitled upon demand to reimbursement from the other party for all expenses (including, without limitation, reasonable attorneys' fees and disbursements) incurred in connection therewith. 10. Indemnification. The Corporation will indemnify Employee, to the maximum extent permitted by Delaware law and the by-laws of the Corporation, against all costs, charges and expenses incurred or sustained by him in connection with any action, suit or other proceeding to which he may be made a party by reason of his being an officer, director or employee of the Corporation or of any subsidiary or affiliate thereof except such actions as are brought by the Corporation or in which the Corporation is an adverse party regarding Employee's obligations hereunder. 11. Termination of Prior Agreement. Each of the Corporation and the Employee hereby acknowledges and agrees that as of the Effective Date, the employment agreement between the Corporation and Employee dated as of June 12, 1995 (the "Prior Agreement") shall terminate, and all rights, duties and obligations of the parties thereunder shall be of no further legal force and effect. The Employee hereby confirms that the Corporation is in full compliance with its obligations under the Prior Agreement and that subject to the payment of the Employee's Base Salary under the Prior Agreement through the Effective Date, the Employee hereby releases the Corporation of any duty or obligation under the Prior Agreement, including, without limitation, the payment of any bonus or severance amounts. Notwithstanding the immediately preceding sentences, the provisions of Section 4 of -13- 14 the Prior Agreement governing the grant, vesting and term of certain stock options granted to the Employee shall remain in full force and effect. 12. Arbitration. Except with respect to any injunction or other equitable relief proceeding brought under Section 9.4 hereof, any controversy, claim, or dispute between the parties, directly or indirectly, concerning this Employment Agreement or the breach hereof, or the subject matter hereof, including questions concerning the scope and applicability of this arbitration clause, shall be finally settled by arbitration in Morris County, New Jersey pursuant to the rules then applying of the American Arbitration Association. The parties agree to expedite the arbitration proceeding in every way, so that the arbitration proceeding shall be commenced within thirty (30) days after request therefore is made, and shall continue thereafter, without interruption, and that the decision of the arbitrators shall be handed down within thirty (30) days after the hearings in the arbitration proceedings are closed. The arbitrators shall have the right and authority to assess the cost of the arbitration proceedings and to determine how their decision or determination as to each issue or matter in dispute may be implemented or enforced. The decision in writing of any two of the arbitrators shall be binding and conclusive on all of the parties to this Agreement. Any decision or award of the arbitrators shall be final and conclusive on the parties to this Agreement; judgment upon such decision or award may be entered in any competent Federal or state court located in the United States of America; and the application may be made to such court for confirmation of such decision or award for any order of enforcement and for any other legal remedies that may be necessary to effectuate such decision or award. The prevailing party in any such arbitration -14- 15 proceeding shall be entitled to reimbursement from the non-prevailing party for all expenses incurred in relation to such arbitration proceedings, including but not limited to, reasonable attorney's fees. 13. Notices. All notices, requests, consents and other communications required or permitted to be given hereunder, shall be in writing and shall be deemed to have been duly given if delivered personally or sent by prepaid telegram, telecopy (with confirmation of receipt) or mailed first-class, postage prepaid, by registered or certified mail (notices sent by telegram or mailed shall be deemed to have been given on the date sent), to the parties at their respective addresses hereinabove set forth or to such other address as either party shall designate by notice in writing to the other in accordance herewith. 14. General. 14.1 Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the local laws of the State of New Jersey applicable to agreements made and to be performed entirely in New Jersey. 14.2 Section Headings. The section headings contained herein are for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. 14.3 Entire Agreement. This Agreement sets forth the entire agreement and understanding of the parties relating to the subject matter hereof, and supersedes all prior agreements, arrangements and understandings, written or oral, relating to the subject matter -15- 16 hereof. No representation, promise or inducement has been made by either party that is not embodied in this Agreement, and neither party shall be bound by or liable for any alleged representation, promise or inducement not so set forth. 14.4 Assignability. This Agreement, and Employee's rights and obligations hereunder, may not be assigned by Employee. The Corporation may assign its rights, together with its obligations, hereunder in connection with any sale, transfer or other disposition of all or substantially all of its business or assets; in any event the rights and obligations of the Corporation hereunder shall be binding on its successors or assigns, whether by merger, consolidation or acquisition of all or substantially all of its business or assets. 14.5 Amendment. This Agreement may be amended, modified, superseded, cancelled, renewed or extended and the terms or covenants hereof may be waived, only by a written instrument executed by both of the parties hereto, or in the case of a waiver, by the party waiving compliance. No superseding instrument, amendment, modification, cancellation, renewal or extension hereof shall require the consent or approval of any person other than the parties hereto. The failure of either party at any time or times to require performance of any provision hereof shall in no matter affect the right at a later time to enforce the same. No waiver by either party of the breach of any term or covenant contained in this Agreement, whether by conduct or otherwise, in any one or more instances, shall be deemed to be, or construed as, a further or continuing waiver of any such breach, or a waiver of the breach of any other term or covenant contained in this Agreement. -16- 17 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. ATTEST: PARTY CITY CORPORATION By: /s/ By: /s/ Steven Mandell ---------------------------- ---------------------------- Steven Mandell, President WITNESS: EMPLOYEE /s/ /s/ David E. Lauber - ------------------------------- ------------------------------- David E. Lauber, Executive Vice President -17- EX-23.1 5 CONSENT OF DELOITTE AND TOUCHE LLP 1 Exhibit 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in the Registration Statement of Party City Corporation on Form S-8 of our report dated February 24, 1998 (March 10, 1998 as to note 12) appearing in this Annual Report on Form 10-K of Party City Corporation for the year ended December 31, 1997. DELOITTE & TOUCHE LLP Parsippany, New Jersey March 30, 1998 EX-27.1 6 FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1995 JAN-01-1995 DEC-31-1995 1,112,566 0 652,961 40,000 3,840,926 6,728,760 3,195,738 0 10,307,572 4,729,772 0 0 0 78,360 2,515,372 10,307,572 16,118,163 23,120,342 10,758,209 17,956,498 3,023,540 0 (22,861) 2,163,165 863,200 0 0 0 0 1,299,965 0.16 0.16
EX-27.2 7 FINANCIAL DATA SCHEDULE
5 3-MOS DEC-31-1997 JAN-01-1997 MAR-31-1997 5,738,349 0 863,726 43,416 13,997,610 23,357,256 9,278,535 0 37,642,876 12,381,936 0 0 0 104,610 17,749,697 37,642,876 12,628,763 14,612,025 9,382,493 13,780,894 1,432,630 0 (121,241) (479,982) (191,700) 0 0 0 0 (288,282) (0.03) (0.03)
EX-27.3 8 FINANCIAL DATA SCHEDULE
5 3-MOS DEC-31-1997 JAN-01-1997 JUN-30-1997 13,667,403 0 909,436 85,729 16,666,358 34,814,683 12,164,842 0 52,934,255 12,206,002 0 0 0 122,650 31,930,817 52,934,255 20,021,947 22,454,959 13,755,624 19,587,278 1,494,318 0 (120,280) 1,493,643 596,500 0 0 0 0 897,143 0.07 0.07
EX-27.4 9 FINANCIAL DATA SCHEDULE
5 3-MOS DEC-31-1997 JAN-01-1997 SEP-30-1997 4,113,374 0 991,767 34,181 42,492,067 53,254,875 22,477,471 0 91,156,643 39,130,813 0 0 0 122,710 38,090,902 91,156,643 25,701,615 28,016,058 18,152,377 26,993,734 1,495,017 0 (26,549) (406,144) (162,100) 0 0 0 0 (244,044) (0.02) (0.02)
EX-27.5 10 FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 3,234,526 0 1,069,080 38,688 39,041,254 50,115,537 24,198,840 0 89,614,534 36,185,453 0 0 0 123,001 32,246,406 89,614,534 131,027,688 141,714,062 86,371,700 122,249,026 7,049,352 0 (211,611) 12,627,295 4,957,153 0 0 0 0 7,670,142 0.65 0.64
EX-27.6 11 FINANCIAL DATA SCHEDULE
5 3-MOS DEC-31-1996 JAN-01-1996 MAR-31-1996 15,366,073 0 549,332 51,335 4,553,294 21,767,131 3,289,169 0 25,440,551 5,002,751 0 0 0 103,860 17,601,348 25,440,551 4,562,271 5,981,012 3,334,320 5,488,383 759,514 0 10,321 (277,206) (110,700) 0 0 0 0 (166,506) (0.02) (0.02)
EX-27.7 12 FINANCIAL DATA SCHEDULE
5 3-MOS DEC-31-1996 JAN-01-1996 JUN-30-1996 15,483,440 0 666,359 69,543 5,016,372 22,309,349 3,979,711 0 26,686,478 5,445,497 0 0 0 104,160 17,601,048 26,686,478 6,338,685 8,286,418 4,362,640 6,863,503 761,968 0 (170,021) 830,968 331,800 0 0 0 0 499,168 0.05 0.05
EX-27.8 13 FINANCIAL DATA SCHEDULE
5 3-MOS DEC-31-1996 JAN-01-1996 SEP-30-1996 12,352,771 0 784,109 82,346 12,308,082 27,285,444 6,512,075 0 34,218,625 11,790,584 0 0 0 104,160 17,601,048 34,218,625 7,507,165 9,907,766 5,339,627 8,736,690 746,246 0 (171,830) 575,660 230,000 0 0 0 0 345,660 0.03 0.03
EX-27.9 14 FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 14,949,714 0 1,015,161 32,847 9,305,027 26,794,809 7,310,740 0 34,603,107 9,376,342 0 0 0 104,410 17,713,231 34,603,107 39,143,625 48,590,978 25,937,445 39,782,654 3,159,404 0 (475,805) 6,124,725 2,369,200 0 0 0 0 3,755,525 0.38 0.38
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