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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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
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(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
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NONE NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
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(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
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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.
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1997 Annual Report on Form 10-K
TABLE OF CONTENTS
Page
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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
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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"
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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
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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
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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
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Randolph, NJ..................................................... 8,500
Livingston, NJ................................................... 8,426
Wayne, NJ........................................................ 14,500
Woodbridge, NJ .................................................. 8,700
East Brunswick, NJ............................................... 7,700
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Locations Square Footage
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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.
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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
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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
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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.
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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
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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.
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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.
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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
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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.
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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.
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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.
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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.
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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
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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.
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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.
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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.
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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.
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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
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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