News Column

PARTY CITY HOLDINGS INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

May 15, 2014

References throughout this document to "PCHI" and the "Company" include Party City Holdings Inc. and its subsidiaries. In this document the words "we," "our," "ours" and "us" refer only to the Company and its subsidiaries and not to any other person. Business Overview Our Company We are the leading party goods retailer by revenue in North America and, we believe, the largest vertically integrated supplier of decorated party goods globally, based on revenues, with multiple levers to drive future growth across channels, products and geographies. We have the only coast-to-coast network of party superstores in the U.S. and Canada that make it easy and fun to enhance special occasions with a differentiated shopping experience and an unrivaled assortment of innovative and exciting merchandise offered at a compelling value. Through a series of acquisitions between 2005 and 2010, we built a powerful retail operation that captures the full manufacturing-to-retail margin on a significant portion of the products sold in our stores. We believe we are the largest global designer, manufacturer and distributor of decorated party supplies, by revenue, with products found in over 40,000 retail outlets worldwide, including our own stores as well as independent party supply stores, mass merchants, grocery retailers, dollar stores and others. Our category-defining retail concept, multi-channel reach, widely recognized brands, broad and deep product offering, and low-cost global sourcing model are, we believe, significant competitive advantages. We believe these characteristics position us for continued organic and acquisition-led growth and margin expansion.



How We Assess the Performance of Our Company

In assessing the performance of our company, we consider a variety of performance and financial measures for our two operating segments, Retail and Wholesale. These key measures include revenues and gross profit, comparable retail same-store sales and operating expenses. We also review other metrics such as adjusted EBITDA. For a discussion of our use of these measures and a reconciliation of adjusted EBITDA to net income (loss), please see below.



Segments

Our Wholesale segment generates revenues globally through sales of Amscan, Designware, Anagram, Costumes USA and other party supplies to party goods superstores, including our company-owned and franchised stores, other party goods retailers, dollar stores, mass merchants, independent card and gift stores and other retailers and distributors throughout the world.

Our Retail segment generates revenues from the sale of merchandise to the end consumer through our chain of company-owned party goods stores, online through our e-commerce websites, including PartyCity.com, and through our chain of temporary Halloween City locations. Franchise revenues include royalties on franchise retail sales and franchise fees charged for the initial franchise award and subsequent renewals. Our retail sales of party goods are fueled by everyday events such as birthdays, various seasonal events and other special occasions occurring throughout the year. In addition, through Halloween City, our temporary Halloween business, we seek to maximize our Halloween seasonal opportunity. As a result, in 2013, our Halloween business represented approximately 25% of our total domestic retail sales, generally occurring in a five-week selling season ending on October 31. We expect to continue to generate a significant portion of our retail sales during the Halloween selling season. Intercompany sales between the Wholesale and the Retail segment are eliminated, and the profits on intercompany sales are deferred and realized at the time the merchandise is sold to the consumer. For segment reporting purposes, certain general and administrative expenses and art and development costs are allocated based on revenues. 23



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Financial Measures

Revenues. Revenues from retail operations are recognized at point of sale. We estimate future retail sales returns and record a provision in the period in which the related sales are recorded based on historical information. Retail revenues include shipping revenue related to e-commerce sales. Retail sales are reported net of taxes collected. Franchise royalties are recognized based on reported franchise retail sales. Revenues from our wholesale operations represent the sale of our products to third parties, less rebates, discounts and other allowances. The terms of our wholesale sales are generally free-on-board ("FOB") shipping point, and revenue is recognized when goods are shipped. We estimate reductions to revenues for volume-based rebate programs and subsequent credits at the time sales are recognized. Intercompany sales from our wholesale operations to our retail stores are eliminated in our consolidated total revenues. Comparable Retail Same-Store Sales. The growth in same-store sales represents the percentage change in same-store sales in the period presented compared to the prior year. Same-store sales exclude the net sales of a store for any period if the store was not open during the same period of the prior year. Comparable sales are calculated based upon stores that were open at least thirteen full months as of the end of the applicable reporting period. When a store is reconfigured or relocated within the same general territory, the store continues to be treated as the same store. If, during the period presented, a store was closed, sales from that store up to and including the closing day are included as same-store sales as long as the store was open during the same period of the prior year. Same-store sales for the Party City brand include retail e-commerce sales. Stores acquired from iParty Corp. ("iParty") in May 2013 will be included in Party City's same-store sales after the completion of thirteen full months following the acquisition. Cost of Sales. Cost of sales at wholesale reflects the production costs (i.e., raw materials, labor and overhead) of manufactured goods and the direct cost of purchased goods, inventory shrinkage, inventory adjustments, inbound freight to our manufacturing and distribution facilities, distribution costs and outbound freight to get goods to our wholesale customers. At retail, cost of sales reflects the direct cost of goods purchased from third parties and the production or purchase costs of goods acquired from our wholesale operations. Retail cost of sales also includes inventory shrinkage, inventory adjustments, inbound freight, occupancy costs related to store operations (such as rent and common area maintenance, utilities and depreciation on assets) and all logistics costs associated with our retail e-commerce business. Our cost of sales increases in higher volume periods as the direct costs of manufactured and purchased goods, inventory shrinkage and freight are generally tied to net sales. However, other costs are largely fixed or vary based on other factors and do not necessarily increase as sales volume increases. Changes in the mix of our products may also impact our overall cost of sales. The direct costs of manufactured and purchased goods are influenced by raw material costs (principally paper, petroleum-based resins and cotton), domestic and international labor costs in the countries where our goods are purchased or manufactured and logistics costs associated with transporting our goods. We monitor our inventory levels on an on-going basis in order to identify slow-moving goods. As a result of the Transaction (see note 3 of the condensed consolidated financial statements included in Item 1.), we applied the acquisition method of accounting and increased the value of our inventory by $89.8 million as of July 28, 2012. The adjustment principally reflects the previously deferred wholesale margin on inventory supplied to our retail operations at July 27, 2012. Such adjustment increased our cost of sales subsequent to July 27, 2012 as the related inventory was sold. See "Results of Operations" below for further discussion. Wholesale Selling Expenses. Wholesale selling expenses include the costs associated with our wholesale sales and marketing efforts, including merchandising and customer service. Costs include the salaries and benefits of the related work force, including sales-based bonuses and commissions. Other costs include catalogues, showroom rent, travel and other operating costs. Certain selling expenses, such as sales-based bonuses and commissions, vary in proportion to sales, while other costs vary based on other factors, such as our marketing efforts, or are largely fixed and do not necessarily increase as sales volumes increase.



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

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

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



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

Adjusted EBITDA. We define EBITDA as net income (loss) before interest expense, net, income taxes, depreciation and amortization. We define Adjusted EBITDA as EBITDA, as further adjusted to eliminate the impact of certain items that we do not consider indicative of our ongoing operating performance. We caution investors that amounts presented in accordance with our definition of Adjusted EBITDA may not be comparable to similar measures disclosed by other issuers, because not all issuers and analysts calculate Adjusted EBITDA in the same manner. We present Adjusted EBITDA because we believe it assists investors and analysts in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. In addition, we use Adjusted EBITDA: (i) as a factor in determining incentive compensation, (ii) to evaluate the effectiveness of our business strategies and (iii) because the credit facility uses Adjusted EBITDA to measure compliance with certain covenants. 25



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Results of Operations

Three Months Ended March 31, 2014 Compared To Three Months Ended March 31, 2013

The following tables set forth the Company's operating results and operating results as a percentage of total revenues for the three months ended March 31, 2014 and 2013. Three Months Ended March 31, 2014 2013 (Dollars in thousands) Revenues: Net sales $ 429,220 99.1 % $ 397,655 99.0 % Royalties and franchise fees 3,767 0.9 3,893 1.0 Total revenues 432,987 100.0 401,548 100.0 Expenses: Cost of sales 274,381 63.4 267,198 66.5 Wholesale selling expenses 18,188 4.2 17,441 4.4 Retail operating expenses 80,286 18.6 73,240 18.2 Franchise expenses 3,365 0.7 3,203 0.8 General and administrative expenses 36,093 8.4 31,611 7.9 Art and development costs 4,771 1.0 4,684 1.2 Total expenses 417,084 96.3 397,377 99.0 Income from operations 15,903 3.7 4,171 1.0 Interest expense, net 31,269 7.3 33,906 8.4 Other expense, net 6,649 1.5 12,590 3.1 Loss before income taxes (22,015 ) (5.1 ) (42,325 ) (10.5 ) Income tax benefit (7,229 ) (1.6 ) (15,225 ) (3.8 ) Net loss (14,786 ) (3.5 ) (27,100 ) (6.7 ) Less: net income attributable to noncontrolling interests 0 0.0 113 0.1 Net loss attributable to Party City Holdings Inc. $ (14,786 ) (3.5 %) $ (27,213 ) (6.8 %) Revenues Total revenues for the first quarter of 2014 were $433.0 million and were $31.4 million or 7.8% higher than the first quarter of 2013. The following table sets forth the Company's total revenues for the three months ended March 31, 2014 and 2013. Three Months Ended March 31, 2014 2013 Dollars in Percentage of Dollars in Percentage of Thousands Total Revenues Thousands Total Revenues Net Sales: Wholesale $ 232,491 53.7 % $ 213,055 53.0 % Eliminations (102,850 ) (23.8 )% (82,762 ) (20.6 )% Net wholesale 129,641 29.9 % 130,293 32.4 % Retail 299,579 69.2 % 267,362 66.6 % Total net sales 429,220 99.1 % 397,655 99.0 % Royalties and franchise fees 3,767 0.9 % 3,893 1.0 % Total revenues $ 432,987 100.0 % $ 401,548 100.0 % Retail Retail net sales during the first quarter of 2014 were $299.6 million and increased $32.2 million or 12.1% compared to the corresponding period of 2013. Retail net sales at our Party City stores (including iParty stores acquired during May 2013) totaled $271.3 million and were $25.3 million or 10.3% higher than the corresponding quarter of 2013. The May 26



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2013 acquisition and subsequent rebranding and remerchandising of iParty stores as Party City stores contributed $15.8 million to sales during the first quarter of 2014. The increase in sales at our Party City stores also reflects the operation of 19 additional stores during the first quarter of 2014 as, excluding the impact of the iParty acquisition, 25 stores were opened, six stores were acquired and 12 stores were closed during the twelve months ended March 31, 2014. Our global retail e-commerce sales totaled $28.3 million during the first quarter of 2014 and were $7.5 million or 36.1% higher than the first quarter of 2013, principally due to the March 2013 acquisition of our international e-commerce operations, Party Delights Ltd., which contributed an additional $4.9 million of sales during the first quarter of 2014. Retail net sales during the first quarter of 2014 were negatively impacted by approximately $1.5 million as a result of the timing of Easter, which shifted from March in 2013 to April in 2014. Retail sales during the first quarter of 2014 were also adversely affected by severe weather conditions in certain regions of the U.S. Same-store sales for the Party City brand (including domestic retail e-commerce sales and sales at acquired stores, to the extent that the stores were converted to the Party City format and included in our sales for the comparable period of the prior year) increased by 2.6% during 2014 as a 4.7% increase in average transaction dollar size was partially offset by a 2.1% decrease in transaction count. Excluding the impact of e-commerce, same-store sales increased by 1.7% as a 4.1% increase in average transaction dollar size was partially offset by a 2.4% decrease in transaction count. Domestic retail e-commerce sales increased by 13.2% due to a 9.9% increase in transaction count and a 3.3% increase in average transaction dollar size. The timing of Easter negatively affected same-store sales for the Party City brand by 0.6%. Retail net sales were also $0.6 million lower than the corresponding period of 2013 due to the closure of our remaining outlet stores prior to March 31, 2014. Wholesale Wholesale net sales during the first quarter of 2014 totaled $129.6 million and were $0.7 million, or 0.5%, lower than during the first quarter of 2013. During the quarter ended March 31, 2014, net sales to domestic party goods retailers and distributors, including our franchisee network, totaled $66.8 million and were $1.0 million, or 1.5%, lower than the corresponding quarter of 2013. The first quarter of 2013 included approximately $2 million of sales to iParty. As a result of the May 2013 acquisition of iParty, 2014 sales to iParty are now included in intercompany sales. Additionally, first quarter 2014 sales of summer/luau product were approximately $2 million lower than in the first quarter of 2013 as summer/luau sales shifted to the second quarter of 2014. These decreases were partially offset by an approximately $2 million increase in contract manufacturing sales of paper tableware and an approximately $1 million increase in sales of juvenile birthday product, principally driven by new licenses. Net sales of metallic balloons to domestic distributors and others totaled $20.2 million and were $0.3 million, or 1.5%, higher than in 2013. An increase in sales of metallic balloons as a result of improving helium supplies and the impact of new licenses, was substantially offset by a shift of approximately $2 million of Valentine's Day sales into December 2013 (the corresponding sales shipped in January 2013 during the prior Valentine's Day selling season). International net sales, including U.S. export sales, totaled $42.6 million and were consistent with the first quarter of 2013. Foreign currency exchange positively impacted 2014 sales by $0.6 million. Intercompany sales to our retail affiliates were $102.9 million during the first quarter of 2014 and were $20.1 million, or 24.3%, higher than the corresponding period of 2013, reflecting sales growth at our retail operations, an increase in our wholesale share of shelf at our retail operations, and our acquisition of iParty during May 2013 (which resulted in approximately $8 million of first quarter 2014 sales to iParty being included in intercompany sales). Intercompany sales represented 44.3% of total wholesale sales during the first three months of 2014, compared to 38.9% during the corresponding period of 2013. The intercompany sales of our wholesale segment are eliminated against the intercompany purchases of our retail segment in the consolidated financial statements.



Royalties and franchise fees

Royalties and franchise fees for the first quarter of 2014 were $3.8 million and were principally consistent with the corresponding quarter of 2013.

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Gross Profit

Our total gross profit on net sales during the first quarter of 2014 was 36.1%. The total gross profit on net sales during the first quarter of 2013 was 32.8%. As a result of the Transaction, we applied the acquisition method of accounting and increased the value of our inventory by $89.8 million as of July 28, 2012. Such adjustment increased our cost of sales during the first quarter of 2014 and the first quarter of 2013 by $1.4 million and $10.8 million, respectively, as the related inventory was sold. Further, during the application of the acquisition method of accounting, we increased the values of certain intangible assets and property, plant and equipment. The impact of such adjustments on depreciation and amortization expense increased our cost of sales during the first quarters of 2014 and 2013 by $4.5 million and $7.8 million, respectively. The purchase accounting adjustments to cost of sales negatively impacted our gross profit percentages during the first quarters of 2014 and 2013 by 140 basis points and 470 basis points, respectively.



The following table sets forth the Company's gross profit for the three months ended March 31, 2014 and March 31, 2013.

Three Months Ended March 31, 2014 2013 Dollars in Percentage of Dollars in



Percentage of

Thousands Net Sales Thousands Net Sales Retail $ 112,190 37.5 % $ 91,497 34.2 % Wholesale 42,649 32.9 38,960 29.9 Total $ 154,839 36.1 % $ 130,457 32.8 % The gross profit on net sales at retail during the first quarters of 2014 and 2013 was 37.5% and 34.2%, respectively. The purchase accounting adjustments to cost of sales negatively impacted retail's gross profit percentage during the first three months of 2014 and 2013 by 120 basis points and 480 basis points, respectively. Excluding the impact of purchase accounting, the gross profit percentage during the first quarter of 2014 was slightly lower than during the first quarter of 2013 due to product mix. During the first quarter of 2014, our wholesale operations' share of shelf at our domestic Party City stores (including stores acquired from iParty) and our domestic retail e-commerce operations (i.e., the percentage of total product costs included in cost of sales which relate to products supplied by our wholesale operations) was 67.7%. Our Canadian retail share of shelf was 67.9%. The gross profit on net sales at wholesale during the first quarters of 2014 and 2013 was 32.9% and 29.9%, respectively. The purchase accounting adjustments to cost of sales negatively impacted wholesale's gross profit percentage during the first three months of 2014 and 2013 by 170 basis points and 430 basis points, respectively. Excluding the impact of purchase accounting, the gross profit percentage during the first quarter of 2014 was slightly higher than during the first quarter of 2013 partially due to product mix.



Operating expenses

Wholesale selling expenses were $18.2 million during the first quarter of 2014 and $17.4 million during the first quarter of 2013. Wholesale selling expenses were $0.7 million, or 4.3%, higher than the first three months of 2013. As a result of the application of the acquisition method of accounting, we increased the values of certain intangible assets and property, plant and equipment. The impact of such adjustments on depreciation and amortization expense increased wholesale selling expenses during the first quarters of 2014 and 2013 by $1.8 million and $2.2 million, respectively. Wholesale selling expenses were 14.1% and 13.4% of net wholesale sales during the first three months of 2014 and 2013, respectively. The increase was principally due to inflationary cost increases, unfavorable foreign currency exchange and, to a lesser extent, the bringing in-house of certain international selling and marketing efforts (see above). Retail operating expenses during the first quarters of 2014 and 2013 were $80.3 million and $73.2 million, respectively. Retail operating expenses during 2014 were $7.0 million or 9.7% higher than in 2013. The increase was principally due to approximately $6 million of retail operating costs related to iParty and Party Delights, which were acquired during 2013. Retail operating expenses were 26.8% and 27.4% of net retail sales during the first quarters of 2014 and 2013, respectively.



Franchise expenses during the first three months of 2014 and 2013 were $3.4 million and $3.2 million, respectively.

General and administrative expenses during the first quarters of 2014 and 2013 were $36.1 million and $31.6 million, respectively. General and administrative expenses during 2014 were $4.5 million or 14.2% higher than in 2013. The increase reflects approximately $2 million of expenses from iParty and Party Delights, which were acquired during 2013. The remainder of the increase was principally due to higher compensation-related costs, including equity-based 28



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compensation, higher legal and professional fees and the impact of unfavorable foreign currency exchange. General and administrative expenses were 8.4% and 7.9% of total revenues during the first quarters of 2014 and 2013, respectively.



Art and development costs during the first quarters of 2014 and 2013 were $4.8 million and $4.7 million, respectively. The costs were 1.0% and 1.2% of total revenues during the first quarters of 2014 and 2013, respectively.

Interest expense, net

Interest expense, net, totaled $31.3 million during the first quarter of 2014, compared to $33.9 million during the first quarter of 2013. The decrease was principally due to the February 2013 amendment of the New Term Loan Credit Agreement, which lowered the interest rate by 150 basis points (see the December 2013 Form 10-K for further discussion).



Other expense, net

Other expense, net, was $6.6 million during the three months ended March 31, 2014, compared to $12.6 million during the same period of 2013.

During February 2014, we amended the New Term Loan Credit Agreement. In conjunction with the refinancing, we wrote-off $1.6 million of costs that had been capitalized during the issuance of the debt. Additionally, we wrote-off $0.6 million of the net original issuance discount that existed as of the time of the amendment and $0.7 million of the unamortized call premium that existed at the time of the amendment. Also in conjunction with the refinancing, we expensed $1.4 million of banker and legal fees. See Note 12 to the condensed consolidated financial statements in Item 1 for further discussion. During February 2013, we amended our New Term Loan Credit Agreement. In conjunction with the refinancing, we wrote-off $5.9 million of costs that had been capitalized during the initial issuance of the debt. Additionally, we wrote-off $2.3 million of the net original issuance discount that existed as of the time of the amendment. Also in conjunction with the refinancing, we expensed $2.5 million of a call premium and $1.6 million of banker and legal fees.



Income tax expense

The income tax benefit for the three months ended March 31, 2014 was determined based upon the Company's estimated consolidated effective income tax rate for the year ending December 31, 2014. The difference between the estimated consolidated effective income tax rate for the year ending December 31, 2014 and the U.S. federal statutory rate is primarily attributable to unrecognized foreign tax credits and state income taxes, partially offset by the foreign rate differential and available domestic manufacturing deductions. 29



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Adjusted EBITDA

We present Adjusted EBITDA as a supplemental measure of our performance. We define EBITDA as net income (loss) before interest expense, income taxes, depreciation and amortization. We define Adjusted EBITDA as EBITDA, as further adjusted to eliminate the impact of certain items that we do not consider indicative of our ongoing operating performance. These further adjustments are itemized below. You are encouraged to evaluate these adjustments and the reasons we consider them appropriate for supplemental analysis. In evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. We present Adjusted EBITDA because we believe it assists investors and analysts in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. In addition, we use Adjusted EBITDA: (i) as a factor in determining incentive compensation, (ii) to evaluate the effectiveness of our business strategies and (iii) because the credit facility agreements use Adjusted EBITDA to measure compliance with certain covenants.



Adjusted EBITDA has limitations as an analytical tool. Some of these limitations are:

Adjusted EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments;



Adjusted EBITDA does not reflect changes in, or cash requirements for, our

working capital needs; Adjusted EBITDA does not reflect the significant interest expense, or the



cash requirements necessary to service interest or principal payments, on our

indebtedness;



although depreciation and amortization are non-cash charges, the assets being

depreciated and amortized will often have to be replaced in the future, and

Adjusted EBITDA does not reflect any cash requirements for such replacements;

non-cash compensation is and will remain a key element of our overall

long-term incentive compensation package, although we exclude it as an

expense when evaluating our ongoing operating performance for a particular

period;



Adjusted EBITDA does not reflect the impact of certain cash charges resulting

from matters we consider not to be indicative of our ongoing operations; and

other companies in our industry may calculate Adjusted EBITDA differently

than we do, limiting its usefulness as a comparative measure.

Because of these limitations, Adjusted EBITDA should not be considered in isolation or as a substitute for performance measures calculated in accordance with U.S. generally accepted accounting principles ("GAAP"). We compensate for these limitations by relying primarily on our GAAP results and using Adjusted EBITDA only supplementally. The reconciliation from net loss to EBITDA and Adjusted EBITDA for the periods presented is as follows: Three Months Ended Three Months Ended March 31, 2014 March 31, 2013 (Dollars in thousands) Net loss $ (14,786 ) $ (27,100 ) Interest expense, net 31,269 33,906 Income taxes (7,229 ) (15,225 ) Depreciation and amortization 20,972 24,480 EBITDA 30,226 16,061 Equity-based compensation and other charges 396 - Non-cash purchase accounting adjustments(a) 1,447 10,828 Management fee 839 750 Restructuring, retention and severance 1,539 573 Refinancing charges (b) 4,396 12,295 Deferred rent 2,689 1,924 Closed store expense 815 75 Undistributed loss in unconsolidated joint venture 583 58 Foreign currency losses 1,179 (1,393 ) Other 726 1,498 Adjusted EBITDA $ 44,835 $ 42,669



(a) As a result of the Transaction (see Note 3 of the condensed consolidated

financial statements included in Item 1), the Company applied the acquisition

method of accounting and increased the value of its inventory by $89,754 as

of July 28, 2012. Such adjustment increased the Company's cost of sales

during the three months ended March 31, 2014 and 2013 by $1,447 and $10,828,

respectively, as the related inventory was sold.

(b) During February 2013, the Company amended the New Term Loan Credit Agreement

and recorded $12,295 of expense in its condensed consolidated financial

statements. Additionally, during February 2014, the Company amended the New

Term Loan Credit Agreement again and recorded $4,396 of expense. See Note 12

to the condensed consolidated financial statements in Item 1 for further

discussion. 30



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Liquidity

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



Cash Flow

Net cash used in operating activities totaled $77.2 million during the quarter ended March 31, 2014 and $60.1 million during the quarter ended March 31, 2013. Net cash flows provided by operating activities before changes in operating assets and liabilities were $12.7 million during the first quarter of 2014 and $5.4 million during the comparable quarter of 2013. Changes in operating assets and liabilities during the first quarters of 2014 and 2013 resulted in the use of cash of $89.9 million and $65.5 million, respectively, and principally reflected the pay down of Halloween and other fourth quarter seasonal trade accounts payable. The use of cash during the first quarter of 2014 was greater than during the first quarter of 2013 primarily due to the timing of the payment of trade payables and, to a lesser extent, the payment of Halloween and other fourth quarter trade payables related to iParty, which was acquired in May 2013. Net cash used in investing activities totaled $15.3 million during the quarter ended March 31, 2014, as compared to $21.6 million during the three months ended March 31, 2013. Investing activities during the quarter ended March 31, 2013 included $10.7 million paid in connection with the acquisition of Party Delights. Capital expenditures during the three months ended March 31, 2014 and 2013 were $13.7 million and $10.9 million, respectively. Retail capital expenditures totaled $9.7 million during the quarter ended March 31, 2014 and principally related to store conversions and new stores. Wholesale capital expenditures totaled $4.0 million and primarily related to printing plates and dies, as well as machinery and equipment at the Company's manufacturing operations. Net cash provided by financing activities was $85.0 million during the quarter ended March 31, 2014, as compared to $92.5 million during the quarter ended March 31, 2013. Borrowings during the three months ended March 31, 2014 were principally used to pay down Halloween and other fourth quarter seasonal trade accounts payable. During February 2014, the Company amended the New Term Loan Credit Agreement. As all term loans outstanding at the time of the amendment were replaced with new term loans for the same principal amount, the Company included the total principal amount, $1,111.0 million, in both the repayment of loans, notes payable and long-term obligations and the proceeds from loans, notes payable and long-term obligations. Additionally, during February 2014, PCHI made a $16.5 million distribution to PC Nextco, its indirect parent, so that PC Nextco could pay interest on outstanding notes (see Note 6 of the condensed consolidated financial statements included in Item 1 for further detail).



At March 31, 2014, we had $241.1 million of excess availability under the New ABL Facility, after considering borrowing base restrictions.

Legal Proceedings

From time to time, we are subject to various legal proceedings and claims that arise in the ordinary course of our business activities. Although the results of litigation and claims cannot be predicted with certainty, as of the date of this filing, we do not believe we are party to any claim or litigation, the outcome of which, if determined adversely to us, would individually or in the aggregate be reasonably expected to have a material adverse effect on our business. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors. 31



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Table of Contents Seasonality Wholesale Operations Despite a concentration of holidays in the fourth quarter of the year, as a result of our expansive product lines, customer base and increased promotional activities, the impact of seasonality on the quarterly results of our wholesale operations has been limited. However, due to Halloween and Christmas, the inventory balances of our wholesale operations are slightly higher during the third quarter than during the remainder of the year. Additionally, the promotional activities of our wholesale business, including special dating terms, particularly with respect to Halloween products sold to retailers and other distributors, result in slightly higher accounts receivable balances during the third quarter.



Retail Operations

Our retail operations are subject to significant seasonal variations. Historically, this segment has realized a significant portion of its revenues, cash flow and net income in the fourth quarter of the year, principally due to our Halloween sales in October and, to a lesser extent, year-end holiday sales. 32



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Cautionary Note Regarding Forward-Looking Statements

From time to time, including in this filing and, in particular, the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations," we make "forward-looking statements" within the meaning of federal and state securities laws. Disclosures that use words such as the company "believes," "anticipates," "expects," "estimates," "intends," "will," "may" or "plans" and similar expressions are intended to identify forward-looking statements. These forward-looking statements reflect our current expectations and are based upon data available to us at the time the statements were made. An example of a forward-looking statement is our belief that our cash generated from operating activities and availability under our credit facilities will be adequate to meet our liquidity needs for at least the next 12 months. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. These risks, as well as other risks and uncertainties, are detailed in the sections titled "Risk Factors" and elsewhere in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 filed with the SEC. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. All forward-looking statements are qualified by these cautionary statements and are made only as of the date of this filing. Any such forward-looking statements, whether made in this filing or elsewhere, should be considered in context with the various disclosures made by us about our business. The following risks related to our business, among others, could cause actual results to differ materially from those described in the forward-looking statements: our ability to compete effectively in a competitive industry; fluctuations in commodity prices; our ability to appropriately respond to changing merchandise trends and

consumer preferences; successful implementation of our store growth strategy; decreases in our Halloween sales;



disruption to the transportation system or increases in transportation costs;

product recalls or product liability; economic slowdown affecting consumer spending and general economic conditions;



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

material; disruptions at our manufacturing facilities;



failure by suppliers or third-party manufacturers to follow acceptable labor

practices or to comply with other applicable laws and guidelines; our international operations subjecting us to additional risks; potential litigation and claims; lack of available additional capital; our inability to retain or hire key personnel; risks associated with leasing substantial amounts of space;



failure of existing franchisees to conduct their business in accordance with

agreed upon standards;



adequacy of our information systems, order fulfillment and distribution

facilities;



our ability to adequately maintain the security of our electronic and other

confidential information; our inability to successfully identify and integrate acquisitions; adequacy of our intellectual property rights; adequacy of helium supplies; risks related to our substantial indebtedness; and the other factors set forth under "Risk Factors" in the Company's Annual

Report on Form 10-K. 33



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Table of Contents

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

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


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


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