-----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, UsXA0xA7DCuK1nLf0SLkXDSf/yjXmwZWzm0B6md4/EWA4v7+uHk4xNcqWzuR1/MY vYc79TuTvCzYcFyBosbGLg== 0000950123-99-010311.txt : 19991117 0000950123-99-010311.hdr.sgml : 19991117 ACCESSION NUMBER: 0000950123-99-010311 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19991002 FILED AS OF DATE: 19991116 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: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-27826 FILM NUMBER: 99759048 BUSINESS ADDRESS: STREET 1: 450 COMMONS WAY CITY: ROCKAWAY STATE: NJ ZIP: 07860 BUSINESS PHONE: 9739830888 MAIL ADDRESS: STREET 1: 400 COMMONS WAY STREET 2: 400 COMMONS WAY CITY: ROCKAWAY STATE: NJ ZIP: 07866 10-Q 1 PARTY CITY CORPORATION 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ----------------- FOR THE QUARTERLY PERIOD ENDED COMMISSION FILE NUMBER OCTOBER 2, 1999 0-27826 ----------------- PARTY CITY CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 22--3033692 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 400 COMMONS WAY 07866 ROCKAWAY, NEW JERSEY (Zip Code) (Address of Principal Executive Offices) 973-983-0888 (Registrant's telephone number, including area code) ----------------- Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes / / No: /X/ Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: As of November 12, 1999, there were outstanding 12,455,538 shares of Common Stock, $.01 par value. 1 2 PARTY CITY CORPORATION INDEX
Part I. Financial Information Page No. -------- Item 1. Consolidated financial statements Consolidated balance sheets - October 2, 1999 (Unaudited) and July 3, 1999 3 Consolidated statements of operations (Unaudited) - For the quarters ended October 2, 1999 and September 30, 1998 4 Consolidated statements of cash flows (Unaudited) - For the quarters ended October 2, 1999 and September 30, 1998 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Part II. Other Information Item 2. Changes in Securities 14 Item 3. Defaults Under Senior Securities 14 Item 6. Exhibits and Reports on Form 8-K 15 Exhibit Index 15
2 3 PART 1. FINANCIAL INFORMATION Item 1. Financial Statements PARTY CITY CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
OCTOBER 2, 1999 JULY 3, 1999 ---------------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents $ 4,824 $ 11,470 Merchandise inventory 69,444 47,016 Refundable income taxes 1,919 6,848 Advance merchandise payments 6,794 9,439 Other current assets 17,741 13,327 ------ ------ Total current assets 100,722 88,101 Property and equipment, net 46,619 50,557 Goodwill, net 15,754 18,483 Other assets 1,393 906 -------- -------- Total assets $164,488 $158,047 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable - trade $48,460 $45,114 Accrued expenses 13,544 10,145 Borrowings under Credit Agreement 39,922 58,550 Senior Notes 28,078 - Other current liabilities 1,566 986 -------- -------- Total current liabilities 131,570 114,795 Long-term liabilities: Deferred rent 6,571 6,527 Other long-term liabilities 707 791 Commitments and contingencies Stockholders' equity: Common stock 125 125 Additional paid-in capital 35,989 34,024 Retained earnings (10,474) 1,785 -------- -------- Total stockholders' equity 25,640 35,934 -------- -------- Total liabilities and stockholders' equity $164,488 $158,047 ======== ========
See accompanying notes to consolidated financial statements. 3 4 PARTY CITY CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTER ENDED ------------------------------- OCTOBER 2, SEPTEMBER 30, 1999 1998 ---- ---- (Unaudited) Revenues: Net sales $67,813 $56,006 Royalty fees 2,316 2,008 Franchise fees 322 360 ------- ------- Total revenues 70,451 58,374 Expenses: Cost of goods sold and occupancy costs 50,717 39,513 Company-owned stores operating and selling expense 20,059 17,034 Franchise expense 1,124 1,060 General and administrative expense 8,376 3,195 ------- ------- Total expenses 80,276 60,802 ------- ------- Loss before interest and income taxes (9,825) (2,427) Interest expense 2,434 1,147 ------- ------- Loss before income taxes (12,259) (3,575) Income tax benefit - (1,414) ------- ------- Net loss $(12,259) $(2,161) ========= ======== Basic loss per share $(0.98) $(0.17) ======= ======= Weighted average shares outstanding - basic 12,456 12,441 ====== ====== Diluted loss per share $(0.98) $(0.17) ======= ======= Weighted average shares outstanding - diluted 12,456 12,441 ====== ======
See accompanying notes to consolidated financial statements. 4 5 PARTY CITY CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
QUARTER ENDED ------------------------ OCTOBER 2, SEPTEMBER 30, 1999 1998 ---- ---- (Unaudited) Cash flow from operating activities: Net loss $(12,259) $(2,161) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 2,694 1,907 Non-cash interest 195 - Deferred rent 44 854 Loss on sale of stores to franchisees 1,042 - Changes in assets and liabilities: Merchandise inventory (26,962) (33,786) Refundable income taxes 4,929 (1,875) Advance merchandise payments 2,645 - Other current assets (4,787) 356 Other assets (98) (72) Accounts payable - trade 3,346 31,494 Accrued expenses 3,399 5,171 Income taxes payable - 270 Other current liabilities (520) (205) Other long term liabilities (84) (36) -------- ------- Net cash provided by (used in) operating activities (26,416) 1,917 Cash flow from investment activities: Purchases of property and equipment (807) (16,632) Proceeds from sale of stores to franchisees 9,877 - Stores acquired from franchisees - (4,951) -------- ------- Net cash provided by (used in) investment activities 9,070 (21,583) Cash flow provided by financing activities: Proceeds from exercise of stock options - 120 Proceeds from Senior Notes 30,000 - Payment of Senior Note issuance costs (673) - Net proceeds from (payments on) Credit Agreement (18,628) 15,020 ------ ------ Net cash provided from financing activities 10,699 15,140 ------ ------ Net increase (decrease) in cash and cash equivalents (6,646) 4,526 Cash and cash equivalents, beginning of period 11,470 5,089 ------ ----- Cash and cash equivalents, end of period $4,824 $ 563 ====== ====== Supplemental disclosure of cash flow information: Income taxes paid (refunded) ($5,030) $ 193 Interest paid $1,038 $993
See accompanying notes to consolidated financial statements. 5 6 PARTY CITY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The consolidated financial statements, except for the July 3, 1999 consolidated balance sheet, are unaudited. In the opinion of management, the accompanying consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial position of the Company as of October 2, 1999 and September 30, 1998 and the results of operations and cash flows for the respective quarter then ended. Because of the seasonality of the party goods industry, operating results of the Company on a quarterly basis may not be indicative of operating results for the full year. These consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements for the eighteen-month period ended July 3, 1999, included in the Company's Annual Report of Form 10-K filed with the Securities and Exchange Commission. All significant intercompany accounts and transactions have been eliminated. The July 3, 1999 consolidated balance sheet amounts have been derived from the Company's audited consolidated balance sheet amounts. Effective July 3, 1999, the Company changed its fiscal year end for financial reporting from December 31 to the Saturday nearest to June 30. The Company continues to use December 31 as its tax year end. The change to a 52-53 week calendar was made to facilitate comparable store sales computations. The term "Fiscal Year" refers to the 52-53 weeks ending the Saturday nearest June 30, unless otherwise noted. 2. FINANCING ACTIVITIES On April 24, 1998, the Company refinanced and replaced its then existing $20 million loan facility with a $60 million secured revolving line of credit agreement with a group of banks maturing April 24, 2001 (as amended, the "Credit Agreement"). Advances under the Credit Agreement originally bore 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 an applicable margin. The Company's previous failure to issue its consolidated financial statements on a timely basis was a default under the Credit Agreement. In addition to this default, the Company did not meet certain of its financial covenants, including those relating to minimum levels of profitability, net worth, liquidity, fixed charge coverage and others. Consequently, the Company's debt under the Credit Agreement was subject to acceleration and is classified as a current liability in the consolidated balance sheets at October 2, 1999 and July 3, 1999. The Credit Agreement is secured by all the assets of the Company. Additionally, the Credit Agreement restricts the payment of dividends. On August 16, 1999 the Company entered into the following agreements with its existing bank lenders under the Credit Agreement (the "Banks"), a new group of investors (the "Investors") and its trade vendors. The bank lenders and the Company entered into a Standstill and Forbearance Agreement (the "Bank Forbearance Agreement"). Under the Bank Forbearance Agreement, the Banks agreed not to exercise rights and remedies based upon any existing defaults until June 30, 2000 unless a further event of default occurs. The Company agreed to reduce its outstanding bank borrowings from the $58.6 million outstanding at July 3, 1999, to $15 million at October 30, 1999, to increase the interest rate on its bank debt to 2% over the bank's prime interest rate and to pay a forbearance fee of $580,000. The Company has reduced its outstanding bank borrowings to $15 million at October 30, 1999. Company management intends to refinance its outstanding indebtedness to the Banks with an asset-based lending arrangement. There is no assurance such a lending arrangement can be obtained. The $15 million outstanding at October 30, 1999 is due June 30, 2000 unless the Bank Forbearance Agreement is extended or amended. On August 17, 1999, the Company received $30 million in financing from the Investors. The Investors purchased senior secured notes and warrants pursuant to separate securities purchase agreements (the "Securities Purchase Agreements") each dated as of August 16, 1999. Under these Securities Purchase Agreements, the Company issued (i) $10 million of its 12.5% Secured Notes due 2003 (the "A Notes"); (ii) 6 7 $5 million of its 13.0% Secured Notes due 2003 (the "B Notes"); (iii) $5 million of its 13.0% Secured Notes due 2002 (the "C Notes"); (iv) $10 million of its 14.0% Secured Notes due 2004 (the "D Notes", and together with the A Notes, the B Notes and the C Notes, the "Notes"); and (v) warrants (the "Warrants") to purchase 6,880,000 shares of the Company's common stock at an initial exercise price of $3.00 per share. Up to $15 million of the Notes is secured by a first lien that is pari pasu with the liens under the Credit Agreement. The Notes are also secured by a second lien on all of the Company's assets. The Company issued the Warrants in connection with the sale of the C Notes and the D Notes. The Warrants may be exercised before the close of business on August 16, 2006. The shares of Common Stock reserved for issuance under the Warrants represent approximately 35% of the shares of Common Stock outstanding assuming the exercise of the Warrants. The warrants were valued at $1,965,000 based on management's estimate using certain fair value methodologies and represent an original issue discount to the C and D notes. This discount is being amortized using the effective interest method. The effective yield is 18.3% and 18.9% on the C Notes and D Notes, respectively. The Company also entered into an Investor Rights Agreement (the "Investor Rights Agreement") with the Investors and the chief executive officer of the Company. In this agreement, the Company granted registration rights with respect to shares of common stock. The Company has agreed to nominate two individuals designated by the Investors to its Board of Directors. Under the Investor Rights Agreement, the Investors agree that they will not, without the prior written consent of the Board of Directors, (i) acquire or agree to acquire, publicly offer or make any public proposal with respect to the possible acquisition of (a) beneficial ownership of any securities of the Company, (b) any substantial part of the Company's assets, or (c) any rights or options to acquire any of the foregoing from any person; (ii) make or in any way participate in any "solicitation" of "proxies" (as such terms are defined in the rules of the Securities Exchange Act of 1934, as amended) to vote, or seek to advise or influence any person with respect to the voting of any voting securities of the Company; or (iii) make any public announcement with respect to any transaction between the Company or any of its securities holders and the Investors, including without limitation, any tender or exchange offer, merger or other business combination of a material portion of the assets of the Company. These standstill provisions terminate if the Company's consolidated earnings before interest, taxes, depreciation and amortization and exclusive of special charges, as defined in the Investor Rights Agreement, do not meet specified targets. Party City's trade vendors representing approximately $36.4 million of trade debt have also entered into an agreement with the Company. Pursuant to a Vendor Standstill and Forbearance Agreement ("Vendor Forbearance Agreement"), these trade vendors agreed to forbear from taking any action against Party City until January 15, 2000, unless an event of default occurs. The trade vendors have received promissory notes from Party City representing one-third of their unpaid balances as of May 1, 1999 (the "Trade Notes"). The Trade Notes bear interest at a rate of 10% per year and mature on November 15, 1999. Interest on the Trade Notes is due on January 15, 2000, unless the bank debt is refinanced before then. On or about January 15, 2000, the Company management believes it will reach agreement to resume normal credit terms with substantially all its vendors. Upon such event, management believes the remaining two-thirds of the unpaid claims that were due as of May 1, 1999, will be satisfied through individual arrangements with its vendors. However, there can be no assurance that the Company will successfully negotiate normal credit terms or conclude these arrangements. Separately, certain seasonal trade vendors have agreed to extend credit to Party City for 30% of purchases for the Halloween, Thanksgiving and end of year holiday seasons. Vendors that have agreed to extend credit will receive a shared lien that is pari passu with the liens of the Credit Agreement on the Company's inventory for the amount of the credit extended. See Note 4 for further discussion. Also, in connection with these transactions, one outside director of the Company resigned and two representatives of the Investors joined the Board of Directors. 7 8 The proceeds from the $30 million in new financing have been used as follows (in thousands):
Purchase of seasonal inventory $20,000 Payment of amounts under the Credit Agreement 4,000 Transactions fees 673 Working capital 5,327 ----- Total proceeds $30,000 =======
In order to meet the cash flow requirements of the Halloween seasonal purchase of inventory and to meet the requirements of the Bank Forbearance Agreement, the Company began a program to identify stores for sale to existing franchisees to generate working capital. Eighteen stores with a net book value of approximately $9,150,000 were sold to franchisees, of which seventeen stores with a net book value of approximately $8,750,000 were sold subsequent to July 3, 1999. In connection with the sales, normal franchise fees were waived for negotiated periods up to five years. The total proceeds from the sales of these stores are approximately $9,883,000, of which $9,683,000 was received subsequent to July 3, 1999. The net proceeds from the sale of stores is required under the Bank Forbearance Agreement to be used to pay down the outstanding borrowings under the Credit Agreement. 3. SECURITIES LITIGATION The Company has been named as a defendant in the following twelve class action complaints: (1) Weber v. Party City Corp., Steven Mandell, and David Lauber, Civ. Action No. 99-CV-1252; (2) Opus GT Partners LP v. Party City Corp. and Steven Mandell, Civ. Action No. 99-CV-1327; (3) Klein and Shiffrin v. Party City Corp., Steven Mandell and David Lauber, Civ. Action No. 99-CV-1325; (4) Flynn v. Party City Corp., David Lauber and Steven Mandell, Civ. Action No. 99-CV-1328; (5) Catanzarite v. Party City Corp., Steven Mandell and David Lauber, Civ. Action No. 99-CV-1317; (6) Tabbert v. Party City Corp. and Steven Mandell, Civ. Action No. 99-CV-1353; (7) Maietta v. Steven Mandell and Party City Corp., Civ. Action No. 99-CV-1386; (8) Barry v. Party City Corp., Steven Mandell and David Lauber, Civ. Action No. 99-CV-1453; (9) Kurzweil v. Party City Corp., Steven Mandell and David Lauber, Civ. Action No. 99-CV-1396; (10) Hormel v. Party City Corp., Steven Mandell and David Lauber, Civ. Action No. 99-CV-1689; (11) Sacher v. Party City Corp., Steven Mandell and David Lauber, Civ. Action No. 99-CV-2238: and (12) Gross v. Party City Corp., Steven Mandell and David Lauber, Civ. Action No. 99-CV-2355. The Company's former Chief Executive Officer and former Chief Financial Officer and Executive Vice President of Operations have also been named as defendants. The complaints have all been filed in the United States District Court for the District of New Jersey. The complaints were filed as class actions on behalf of persons who purchased or acquired Party City common stock during various time periods between February 1998 and March 19, 1999. The complaints allege, among other things, violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and seek unspecified damages. The plaintiffs allege that defendants issued a series of false and misleading statements and failed to disclose material facts concerning, among other things, the Company's financial condition, adequacy of internal controls and compliance with certain loan covenants. The plaintiffs further allege that because of the issuance of a series of false and misleading statements and/or failure to disclose material facts, the price of Party City common stock was artificially inflated. On September 13, 1999, the Court signed an Order appointing lead plaintiffs and lead counsel to represent the classes alleged in the complaints. The Order directed plaintiffs to file a consolidated and amended complaint in October 1999, which the plaintiffs did and which was served on the Company on or about October 18, 1999. Other The Company was named as a 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 8 9 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 stated 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 was 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. The Company settled the lawsuit on June 30, 1999, at no cost to the Company. In connection with the settlement, the Company agreed to sell the plaintiff one store at its fair value. On April 23, 1999, plaintiff Emil Asch, Inc. filed a Complaint in the United States District Court for the Eastern District of New York against the Company and co-defendants Amscan, Inc., Hallmark, Inc., and Rubie's Costume. The Complaint alleges five violations of the Robinson-Patman Act, which pertains to price discrimination, unfair competition tortious interference with contractual relations, and false and deceptive advertising. Plaintiff seeks damages of $2 million, as well as treble and punitive damages for certain counts. The Company has answered the Complaint, and discovery should proceed shortly. Although the Company's management is unable to express a view on the likely outcome of these litigations because they are in their early stages, they could have a material adverse effect on the Company's business and results of operations. In addition to the foregoing, the Company is from time to time involved in routine litigation incidental to the conduct of its business. The Company is aware of no other material existing or threatened litigation to which it is or may be a party. 4. SUBSEQUENT EVENTS The Company entered into an agreement with a crisis management firm in April 1999 to assist the Company in restructuring its operations as well as with negotiations with its vendors and banks. Based on the attainment of certain goals in the first quarter of Fiscal 2000, the crisis management firm earned a success fee, which at the option of the crisis management firm is to be paid either in cash or a combination of cash and stock. The Company recorded a liability for the success fee in the first quarter of Fiscal 2000. Subsequent to October 2, 1999, the crisis management firm agreed to accept 80% of its success fee in stock and as such the Company expects to issue approximately 266,667 shares of common stock in the second quarter of Fiscal 2000. Pursuant to agreements reached with various vendors in August, 1999, the Company is obligated to make certain payments to its vendors on November 15, 1999. The Company will not satisfy these obligations in full by November 15. The failure to satisfy these obligations constitutes a default under the Bank Forebearance Agreement, Securities Purchase Agreement, Investor Rights Agreement and Vendor Forebearance Agreements to which the Company is a party. The Company is engaged in discussions with its vendors and its lenders in connection with these defaults. There is no assurance that the Company will be able to reach agreement with the vendors and its lenders. As of October 30, 1999, the Company met its requirements to reduce its outstanding bank borrowings under the Credit Agreement to $15 million. 9 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS
SELECTED FINANCIAL DATA (in thousands, except per share and store data) QUARTER ENDED OCTOBER 2, SEPTEMBER 30, 1999 1998 ---- ---- (UNAUDITED) STATEMENT OF OPERATIONS DATA Total revenue $ 70,451 $ 58,374 ======== -------- Company-owned stores Net sales $ 67,813 $ 56,006 Cost of goods sold and occupancy costs 50,717 39,513 -------- -------- Gross profit 17,096 16,493 Store operating and selling expense 20,059 17,034 -------- -------- Company-owned stores profit contribution (loss) (2,963) (541) Franchise stores: Royalty fees 2,316 2,008 Franchise fees 322 360 -------- -------- Total franchise revenues 2,638 2,368 Total franchise expense 1,124 1,060 -------- -------- Franchise profit contribution 1,514 1,308 General and administrative expense: Special charges (a) 4,868 - Other general and administrative expenses 3,508 3,195 -------- -------- 8,376 3,195 -------- -------- Loss before interest and income tax benefit (9,825) (2,428) Interest expense, net 2,434 1,147 -------- -------- Loss before income tax benefit (12,259) (3,575) Income tax benefit - (1,414) -------- -------- Net loss $(12,259) $ (2,161) ======== ======== Basic earnings per share $ (0.98) $ (0.17) ======== ======== Diluted earnings per share $ (0.98) $ (0.17) ======== ======== Weighted average shares outstanding -- Basic 12,456 12,441 Weighted average shares outstanding -- Diluted 12,456 12,441 EBITDA (b) $ (2,263) $ (520) Depreciation and amortization $ 2,694 $ 1,907
10 11
QUARTER ENDED ------------- OCTOBER 2, SEPTEMBER 30, 1999 1998 ---- ---- (Unaudited) STORE DATA: COMPANY-OWNED: Stores open at beginning of period 215 148 Stores opened 1 40 Stores closed - - Stores acquired from franchisees - 5 Stores sold to franchisees (17) - ----- ----- Stores open at end of period 199 193 FRANCHISE: Stores open at beginning of period 178 161 Stores opened 12 12 Stores closed - 1 Stores acquired from franchisees - 5 Stores acquired from Company 17 - ----- ----- Stores open at end of period 207 167 === === Increase (decrease) in company-owned same store sales (4.5%) 9.2% Increase (decrease) in franchise same store sales 6.9% 1.8% Average sales per Company-owned store 332 334 BALANCE SHEET DATA: Working capital (deficiency) $(10,848) $36,104 Total assets 164,488 169,427 Bank borrowings and other debt 68,000 54,299 Capital lease obligation 635 903 Stockholders' equity $25,640 $11,023
(a) Special charges in 1999 relate to consulting services, accounting fees, bank fees, legal fees and other expenses related to the Company's default on its Credit Agreement and related financial transactions. The Company engaged the services of a crisis management consulting firm and numerous other professionals to advise management during the complex negotiations with the bank, vendors and potential investors. (b) Earnings before interest, taxes, depreciation and amortization, and exclusive of special charges, as defined above. Quarter Ended October 2, 1999 ("First Quarter") Compared to Quarter Ended September 30, 1998 ("1998 Quarter") Retail. Net sales from Company-owned stores increased 21.1% to $67.8 million for First Quarter, from $56.0 million for the comparable 1998 Quarter. The First Quarter results include 14 stores which opened during the last calendar quarter of 1998 plus ten stores which opened during the first three calendar quarters of 1999. The 1998 Quarter represents sales from 193 stores, including 40 stores which opened during the third calendar quarter of 1998 and five stores acquired from franchisees during the quarter. Same store sales decreased 4.5% in the First Quarter. 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 First Quarter increased 3.6% to $17.1 million from $16.5 million for the comparable 1998 Quarter. The increase in the First Quarter was primarily due to increased sales volume. Gross margin was 25.2% for the First Quarter compared with 29.4% for the comparable 1998 Quarter. The decrease in gross margin is related primarily to a decrease of discounts and rebates in the First Quarter. Store operating and selling expenses increased 17.8% to $20.1 million for the First Quarter from $17.0 million in the comparable 1998 Quarter. The increase in store operating expenses is attributable to the 11 12 increased number of stores operated by the Company during the First Quarter. Store operating and selling expenses were 29.6% and 30.4% of sales for the First Quarter and 1998 Quarter, respectively. Pre-opening expenses in the First Quarter were $97,000 relating to one Company-owned store opened in the quarter compared to pre-opening expenses of $1.4 million incurred in the 1998 Quarter. Company-owned stores recorded a loss of $3.0 million for the First Quarter, compared to a loss of $ .5 million for the 1998 Quarter. The increased loss was primarily the result of reduced gross margin offset by the decrease in pre-opening expenses and the increased profitability of older stores. Franchising. 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 12 store openings were $322,000 for the First Quarter compared to $360,000 for the comparable 1998 Quarter, which also represents 12 store openings. Royalty fees increased 15.3% to $2.3 million in the First Quarter from $2.0 million in the comparable 1998 Quarter due primarily to an increase in the number of stores. Expenses directly related to franchise revenue increased 6.0% to $1.1 million for the First Quarter from $1.06 million for the comparable 1998 quarter. As a percentage of franchise revenue, franchise expenses were 42.6% and 44.8% for the First Quarter and 1998 Quarter, respectively. Franchise profit contribution increased 15.7% to $1.5 million for the First Quarter from $1.3 million for the comparable 1998 Quarter. The increase in franchise profit contribution is due to higher revenues from the increased number of franchise stores. General and Administrative. General and administrative expenses increased 163% to $8.4 million in the First Quarter from $ 3.2 million in the comparable 1998 Quarter. This increase is attributable in part to $4.9 million in special charges relating to consulting accounting, banking and other expense resulting from the Company's refinancing arrangements. In addition, during the First Quarter there was an increase in corporate expenses primarily attributable to an increase in payroll and related benefits and increased travel and occupancy costs as a result of establishing the necessary organizational infrastructure to allow the Company to maintain the Company-owned store base. Exclusive of the $4.9 million in special charges discussed above, general and administrative expenses were 5.0% and 5.5% of revenue for the First Quarter and 1998 Quarter, respectively. Interest Expense. Interest expense increased 112% to $2.4 million for the First Quarter from $1.1 million in the comparable 1998 Quarter. The increased expense is primarily attributable to increased interest rates, new borrowings and average borrowings outstanding. Income Tax Benefit. There was no income tax benefit for the First Quarter as compared to the $1.4 million benefit reported in the 1998 Quarter. This decrease is the result of the Company recording a valuation allowance on its deferred tax assets related to part-year federal and state net operating losses. The valuation allowance was due to the Company's determination that it was more likely than not such tax assets would not be realized. Net Loss. As a result of the above factors, net loss for the First Quarter was $12.3 million, or $(0.98) per basic and diluted share, in the First Quarter, as compared to a net loss of $2.2 million, or $(0.17) per basic and diluted share in the 1998 Quarter. LIQUIDITY AND CAPITAL RESOURCES For the First Quarter, cash used in operating activities was $26.4 million, compared to cash provided by operating activities of $1.9 million for the comparable 1998 Quarter. The increase in cash used in operating activities was primarily attributable to increases in merchandise inventory of $27.0 million, other current assets and other assets of $4.9 million, net loss of $12.3 million, partially offset by depreciation and amortization of $2.7 million, an increase in refundable income taxes of $4.9 million, increases in accounts payable of $3.3 million, compared to an increase in accounts payable of $31.5 million in the 12 13 1998 Quarter, and accrued expenses of $3.4 million as well as other net changes in operating assets and liabilities. Cash provided by (used in) investing activities for the First Quarter was $9.1 million compared to $21.6 million used in investing in the comparable 1998 Quarter. The change in cash used in investing activities was primarily attributable to sales of stores to franchisees, fewer new store additions and a decrease in acquisitions. Cash provided by financing activities was $10.7 million for the First Quarter compared to $15.1 million in the comparable 1998 Quarter. This amount is primarily attributable to the repayment of borrowings of $18.6 million under the Credit Agreement and net proceeds of $29.3 million from the issuance of Senior Notes. Pursuant to agreements reached with various vendors in August, 1999, the Company is obligated to make certain payments to its vendors on November 15, 1999. The Company will not satisfy these obligations in full by November 15. The failure to satisfy these obligations constitutes a default under various loan and other agreements to which the Company is a party. The Company is engaged in discussions with its vendors and its lenders in connection with this default. There is no assurance that the Company will be able to reach agreement with the vendors and its lenders. As of October 30, 1999, the Company met its requirements to reduce its outstanding bank borrowings under the Credit Agreement to $15 million. IMPACT OF YEAR 2000 ON THE COMPANY'S COMPUTER OPERATIONS The Company is preparing for the impact of the arrival of the Year 2000 on its business. The "Year 2000 Problem" is a term used to describe the problems created by systems that are unable to accurately interpret dates after December 31, 1999. These problems are derived predominately from the fact that certain computer hardware and many software programs historically recorded a date's "year" in a two digit format (i.e., 98 for 1998) and therefore may recognize "00" as 1900 instead of the year 2000. The Year 2000 Problem creates potential risks for the Company, including the inability to recognize and properly treat dates occurring on or after January 1, 2000, which may result in computer system failures or miscalculations of critical financial or operations information. In addition to its internal systems, the Company relies heavily on third parties in operating its business. Such third parties include vendors and utilities that provide electricity, water, natural gas, transportation, telephone and banking. The Company began formulating a plan in 1998 to address the Year 2000 Problem and to ensure that all relevant systems had been subject to a full Year 2000 review and, if necessary, implement remediation, replacement or upgrades. Under the plan, the Company has focused on (i) internal financial and operational computer systems and (ii) the Year 2000 compliance of all material suppliers and vendors doing business with the Company. The Company has contacted all outside suppliers and vendors with which the Company has material relationships and engaged in discussions which will continue throughout 1999 in furtherance of the Company's stated goal of minimizing any adverse impact relating to the Year 2000 Problem. The Company has completed its assessment of all material financial and operating systems. In connection with this review, the Company upgraded its financial accounting systems to Year 2000 compliant systems in the first calendar quarter of 1999. This system is currently being tested to verify Year 2000 compliance, and such testing should be completed by November 30, 1999. As of November 30, 1999 all computer operating systems in use will be upgraded and upon 2000 compliant. In addition, the Company has assessed all computer hardware, including servers, microcomputers, POS registers, and peripheral equipment at the store and corporate levels. Only minor remediation and/or upgrade of these systems has been required; each will be tested and compliant by November 30, 1999. The Retail POS software at the store level has been tested and is compliant. 13 14 The Company estimates that the total costs and expenses associated with completing the outlined Year 2000 compliance plan will range from $ 1,500,000 to $ 1,700,000, of which all but approximately $300,000 has been incurred and expensed. Company management presently believes that it will substantially complete its internal Year 2000 compliance program prior to January 1, 2000, and that there should be no material adverse impact at such time related to Year 2000 Problems associated with the Company's systems or software. Based on communications with its vendors and suppliers, the Company also believes that each third party with whom the Company has a material relationship is currently Year 2000 compliant or scheduled to be Year 2000 compliant by January 1, 2000. Despite the Company's best efforts, there can be no assurance that (i) the Company's assessments regarding the Year 2000 Problem are correct; (ii) the Company will be able to successfully complete its Year 2000 review and implement such upgrades and/or remediation as is necessary or (iii) third parties or suppliers with whom the Company does business will avoid Year 2000 Problems which might adversely affect the Company's business or operations. While the Company is developing contingency plans to address such failures or unexpected problems (such plans include identification of alternative suppliers), there can be no assurance that such contingency plans will be adequate to resolve these problems. The Company's contingency plan is expected to be completed by November 30, 1999. The Year 2000 Problems involves substantial risk to the Company. The Company believes today that the likely worst case scenario regarding the Year 2000 Problem will involve temporary disruptions in the receipt of merchandise inventory and temporary disruption in the payment of bills. These events may also cause lost revenue. The foregoing assessment is based on information currently available to the Company. The Company can provide no assurances that applications and equipment believed to be Year 2000 compliant will not experience difficulties, or the Company will not experience difficulties obtaining resources needed to make modifications to, or replacement of, the Company's affected systems and equipment. Failure by the Company or third parties, on which it relies to resolve Year 2000 issues, could have a material effect on the Company's results of operations. FORWARD-LOOKING STATEMENTS This Form 10-Q (including the information incorporated herein by reference) contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. The statements are made a number of times throughout the document and may be identified by forward-looking terminology as "estimate," "project," "expect," "believe," "may," "will," "intend" or similar statements or variations of such terms. Such forward-looking statements involve certain risks and uncertainties, and include among others, the following: levels of sales, store traffic, acceptance of product offerings, competitive pressures from other party supplies retailers, availability of qualified personnel, availability of suitable future store locations, schedules of store expansion plans and year 2000 readiness issues relating to the Company's internal systems and those of third parties, the ability of the Company to refinance its existing debt on terms acceptable to it and other factors. As a result of the foregoing risks and uncertainties, actual results and performance may differ materially from that projected or suggested herein. Additional information concerning certain risks and uncertainties that could cause actual results to differ materially from that projected or suggested may be identified from time to time in the Company's Securities and Exchange Commission filings and the Company's public announcements. PART II OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES In connection with the Securities Purchase Agreements, the Company issued to the holders of the C Notes and D Notes warrants to purchase an aggregate of 6,880,000 shares of Common Stock at an initial exercise price of $3.00 per share. The Warrants may be exercised at any time before the close of business on August 16, 2006. The shares of Common Stock reserved for issuance under the Warrants represent approximately 35% of the shares of Common Stock outstanding assuming the exercise of the Warrants. 14 15 ITEM 3. DEFAULTS UNDER SENIOR SECURITIES See Note 2 to the Notes to the Consolidated Financial Statements. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The exhibits required to be filed as part of this report on Form 10-Q are listed in the attached Exhibit Index. (b) The Company filed the following Current Reports on Form 8-K during the quarter for which this report has been filed. Form 8-K, dated August 25, 1999 (Item 5). Form 8-K, dated September 17, 1999 (Item 6). Form 8-K, dated September 29, 1999 (Item 8). 15 16 SIGNATURES Pursuant to the requirements 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. PARTY CITY CORPORATION By /s/ Jack Futterman --------------------- (Jack Futterman) Chief Executive Officer By /s/ Thomas E. Larson ----------------------- (Thomas E. Larson) Chief Financial Officer By /s/ Linda M. Siluk --------------------- (Linda M. Siluk) Chief Accounting Officer Date: November 12, 1999 16 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS JUL-01-2000 JUL-04-1999 OCT-02-1999 4,824 0 2,490 (430) 69,444 100,722 46,619 (15,249) 164,488 103,492 0 0 0 125 25,515 164,488 67,813 70,451 50,717 80,276 0 51 2,434 (12,259) 0 (12,259) 0 0 0 (12,259) (.98) (.98)
-----END PRIVACY-ENHANCED MESSAGE-----