Item 1B.
Unresolved Staff Comments
Not applicable.
The Company maintains its corporate headquarters in Elmsford, New York and conducts its principal design, manufacturing and distribution operations at the following facilities:
In addition to the facilities listed above, we maintain smaller distribution facilities in Australia, Canada and Mexico. We also maintain sales offices in Australia, Canada, Hong Kong and Japan and showrooms in New York, California, Georgia, Texas, Canada and Hong Kong.
As of December 31, 2009, there were 386 company-owned Party City and Party America superstores, 161 company-owned FCPO stores and 54 Paper Factory Outlet stores open in the United States. We lease the property for all of our company-owned stores. Our Party City, Party America and FCPO stores range in size from 6,800 to 19,800 square feet, with a typical store size between 8,000 and 12,000 square feet. Our Paper Factory Outlet stores range in size from 3,000 to 5,000 square feet. We do not believe that any individual store property is material to our financial condition or results of operations. Of the leases for the company-owned stores, 106 expire in 2010, 77 expire in 2011, 96 expire in 2012, 108 expire in 2013, 97 expire in 2014 and the balance expire in 2015 or thereafter. We have options to extend most of these leases for a minimum of five years.
The following table shows the change in our retail network of stores for each of the years in the three-year period ended December 31, 2009.
As of December 31, 2009, Company and franchise-owned retail stores were located in the following states and Puerto Rico:
In 2009, the Company operated 247 temporary Halloween stores principally under the Halloween USA name. Under this program, we operate temporary stores under short-term leases with terms of approximately four months, to cover the early September through early November Halloween season.
We believe that our properties have been adequately maintained, are in generally good condition and are suitable for our business as presently conducted. We believe our existing manufacturing facilities provide sufficient production capacity for our present needs and for our anticipated needs in the foreseeable future. To the extent such capacity is not needed for the manufacture of our products, we generally use such capacity for the manufacture of products for others pursuant to terminable agreements. All manufacturing and distribution facilities generally are used on a basis of two shifts
per day. We also believe that, upon the expiration of our current leases, we will be able either to secure renewal terms or to enter into leases for alternative locations at market terms.
We are a party to certain claims and litigation in the ordinary course of business. We do not believe these proceedings will have, individually or in the aggregate, a material adverse effect on our financial condition or future results of operations.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities
There is no public trading market for the Company’s common stock.
As of the close of business on March 31, 2010, there were 120 holders of record of the Company’s common stock.
Dividends
The Company has not paid any dividends on its Common Stock and has no current plans to pay cash dividends in the foreseeable future. The Company currently intends to retain its earnings for working capital, repayment of indebtedness, capital expenditures and general corporate purposes. In addition, the Company’s current credit facility and the indenture governing its notes contain restrictive covenants which have the effect of limiting the Company’s ability to pay cash dividends or distributions to its stockholders.
Issuer Purchases of Equity Securities
Under the terms of our stockholders’ agreement, we have an option to purchase all of the shares of common stock held by former management stockholders, as defined, and, under certain circumstances, former management stockholders can require us to purchase all of the shares held by them. The purchase price as prescribed in the stockholders’ agreements is to be determined through a market valuation of the minority-held shares or, under certain circumstances, based on cost, as defined therein.
Equity Compensation Plan Information
The following table sets forth certain information as of December 31, 2009, concerning our equity compensation plans (1);
(1)
See Note 15 to our consolidated financial statements included herein for a description of our equity incentive plan.
Item 6.
Item 6.
Selected Consolidated Financial Data
The selected consolidated financial data presented below as of and for the years ended December 31, 2009, 2008, 2007, 2006 and 2005, are derived from the consolidated financial statements of the Company. The consolidated financial statements as of and for the years ended December 31, 2009, 2008 and 2007, are included in this report under Item 8, “Financial Statements and Supplementary Data.” The selected consolidated financial data should be read in conjunction with the consolidated financial statements and the related notes thereto and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
(1)
FCPO and PCFG are included in the balance sheet data as of December 31, 2007, and the statement of operations and other financial data from Party City Franchise Group Transaction Date (November 2, 2007) and the Factory Card & Party Outlet Acquisition Date (November 16, 2007), respectively.
(2)
Party America is included in the balance sheet data beginning with December 31, 2006, and the statement of operations and other financial data from the Party America Acquisition Date (September 29, 2006).
(3)
Party City is included in the balance sheet data beginning with December 31, 2005 and the statement of operations and other financial data from the Party City Acquisition Date (December 23, 2005).
(4)
During the fourth quarter of 2008, the Company instituted a program to convert its company-owned and franchised Party America stores to Party City stores and recorded a $17.4 million charge for the impairment of the Party America trade name
(5)
In connection with the refinancing of debt in May 2007, the Company recorded non-recurring expenses of $16.2 million, including $6.2 million of debt retirement costs, $6.3 million write off of deferred finance costs, and a $3.7 million write-off of original issue discount associated with the repayment of debt.
(6)
In connection with the Party City Acquisition in December 2005, the Company recorded non-recurring expenses for the write-off of $4.0 million of deferred financing costs associated with the repayment of the then outstanding debt.
(7)
For purposes of determining the ratio of earnings to fixed charges, earnings are defined as earnings before income taxes and minority interests plus fixed charges. Fixed charges consist of interest expense on all obligations, amortization of deferred financing costs and an estimate of the rental expense on operating leases representing that portion of rental expense deemed by the Company to be attributable to interest.
(8)
Common stock issued to consummate the Party America Acquisition totaled $29.7 million. Cash also paid to consummate the acquisition included $1.1 million for transaction costs, and $12.6 million to repay Party America senior debt.
(9)
Cash paid to consummate the Party City Acquisition totaled $567.0 million. Financing for the acquisition, including the repayment of borrowings under the Company’s 2004 Senior Secured Credit Facility, was provided by: (i) the $166.4 million Equity Investment in the Company’s parent, AAH, (ii) the $325 million First Term Loan (net of an original issue discount of $3.25 million), (iii) the $60 million Second Term Loan (net of an original issue discount of $1.5 million) and (iv) cash on-hand of $20.4 million.
(10)
Short-term obligations consist primarily of borrowings under bank lines of credit and the current portion of long-term debt. At December 31, 2008, the current portion of long-term debt includes $27.5 million of PCFG term debt that has been classified as current due to the PCFG’s noncompliance with the loan agreement’s financial covenants. See “Liquidity and Capital Resources”.
(11)
Under the terms of the AAH stockholders’ agreement dated April 30, 2004, we have an option to purchase all of the shares of common stock held by former management stockholders, as defined, and, under certain circumstances, including death and disability, former management stockholders can require us to purchase all of the shares held by the former associates. The purchase price as prescribed in the stockholders’ agreements is to be determined through a market valuation of the minority-held shares or, under certain circumstances, based on cost, as defined therein. The aggregate amount that may be payable by us to all management stockholders, based on fully paid and vested shares, is classified as redeemable common securities.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
Our wholesale revenues are generated from the sales of approximately 35,000 SKU’s consisting of party goods for all occasions, including paper and plastic tableware, accessories and novelties, metallic balloons, stationery and gift items. Tableware (e.g., plates, cups, cutlery, napkins and tablecovers) is our core product category, with coordinating accessories (e.g., balloons, banners, gifts and stationery) and novelties (e.g., party favors) being offered to complement these tableware products. Our products are sold at wholesale to party goods superstores, including our company-owned retail stores, other party goods retailers, independent card and gift stores, and other retailers and distributors throughout the world. As a metallic balloon manufacturer, we have a strong presence in grocery, gift and floral distribution channels. With our retail segment, we operate 601 retail party and social expressions supply stores within the continental United States, and franchise individual store and franchise areas throughout the United States and Puerto Rico. At December 31, 2009, our network included 248 franchise stores. Our retail operations generate revenue primarily through the sale of more than 20,000 Amscan and other branded SKU’s through our company-owned stores, and through the imposition of an initial one-time franchise fee and ongoing franchise royalty payments based on retail sales from our franchised stores.
Results of Operations
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Percentage of Total Revenues
Total Revenues
The following table sets forth the Company’s total revenues for the years ended December 31, 2009 and 2008, respectively.
Wholesale
Net sales for 2009 of $411.4 million were $27.1 million or 6.2% lower than net sales for 2008, principally as a result of the downturn in the U.S. economy. Net sales to franchised and domestic independent party stores totaled $161.3 million and were $14.5 million or 8.3% lower than 2008 sales. Net sales to non-affiliated domestic retail channels totaled $84.6 million and were $1.9 million or 2.2% lower than in 2008, as the negative impact of the economy was partially offset by a seasonal direct import and contract manufacturing program for a supplier to the mass market and other channels. Net sales of metallic balloons were $84.5 million or 8.9% lower than in 2008, as wholesale distributors and retailers rationalized stock inventory levels in light of the economic downturn. International sales totaled $81.0 million and were $2.5 million or 3.0% lower than in 2008. Fluctuations in foreign currency account for an $11.0 million decrease in international sales, more than offsetting volume related growth in local currency sales, principally at European national accounts.
Intercompany sales to our retail affiliates of $221.6 million were $6.7 million or 3.1% higher than in 2008. The increase in intercompany sales principally reflects growth in our share of shelf at our company-owned retail stores, particularly the FCPO stores acquired in November of 2007. The intercompany sales of our wholesale segment are eliminated against the intercompany purchases of our retail segment in the consolidated financial statements
Retail
Net retail sales at our company-owned stores for 2009 of $1,056 million were $43.2 million or 3.9% lower than net retail sales for 2008, reflecting the downturn in the U.S. economy and the operation of fewer Factory Card & Party Outlet and Paper Factory Outlet stores during 2009 and the inclusion of a 53rd week in our 2008 retail calendar. Net retail sales of our company-owned Big Box party goods stores (i.e., stores generally greater than 8,000 square feet) totaled $790.9 million and were $42.2 million or 5.1% lower than in 2008. Same store sales during 2009 decreased 3.4% compared to 2008 as the result of a decrease in transaction count, as the average dollar per transaction remained consistent between 2009 and 2008. Net retail sales at our FCPO stores of $197.0 million decreased $29.5 million or 13.0%, reflecting a 3.0% decrease in store count by year end and a decrease of 5.0% in same store sales. The decrease in same store sales reflects a 5.3% decrease in transaction count partially offset by a 0.3% increase in average dollar per transaction. Net retail sales at our TPF outlet stores totaled $22.6 million and were $14.4 million or 38.9% lower than in 2008, principally due to the operation of 50% fewer outlet stores by year end, and a 15.9% decrease in same store sales. Net sales at our temporary Halloween stores totaled $68.0 million and were $28.6 million or 72.3% higher than in 2008 due to a 7.5% increase in average sales per store and a 65.7% increase in store count compared to 2008.
Royalties and franchise fees
Franchise related revenue for the year ended December 31, 2009, consisting of royalties and franchise fees, totaled $19.5 million or 11.5% lower than in 2008, as our franchise store count decreased by 23 stores or 8.4% and the stores experienced a same-store net sales decrease of 2.3% compared to 2008.
Gross Profit
The following table sets forth the Company’s consolidated gross profit on net sales for the years ended December 31, 2009 and 2008, respectively.
The gross profit margin on net sales at wholesale for 2009 was 36.1% or 360 basis points higher than in 2008. The increase in wholesale gross profit margin principally reflects reductions in distribution costs and changes in product mix, including fewer full case sales in 2009, which generally have lower profit margins.
Retail gross profit margin for 2009 was 39.8% or 80 basis points higher than in 2008, primarily the result of favorable variances in inventory shrink and damage reserves as compared to 2008.
Operating expenses
Selling expenses totaled $39.8 million and were $2.1 million or 5.0% lower than in 2008, reflecting a decrease in variable selling expenses, consistent with the decrease in wholesale sales, and a reduction in the size of our sales force and changes in foreign currency exchange rates, partially offset by inflationary increases principally in base compensation and employee benefits. Selling expenses were 2.7% of total revenue in both 2009 and 2008.
Retail operating expenses of $261.7 million for 2009 were $11.9 million or 4.3% lower than 2008, principally reflecting a reduction in store count. Retail operating expenses were 24.8% of retail sales in 2009 and comparable to 2008. Franchise expenses for 2009 of $12.0 million were $1.7 million or 12.3% lower than in 2008, also reflecting a reduction in store count. Franchise expenses were 61.5% of franchise related revenue in 2009 compared to 62.2% in 2008.
General and administrative expenses for 2009 totaled $119.2 million and were $1.1 million or 0.9% lower than in 2008. The decrease in general and administrative expenses reflects the benefit of a management-directed cost reduction program, which included reductions in work force, travel and other expenses, the reduction of a prior year purchase accounting reserve, and the impact of changes in foreign currency exchange rates. These decreases were partially offset by inflationary increases, particularly in base compensation and employee benefits, increased support for our expanding temporary Halloween operations, an increase in consulting expense and additional provision for bad debts due to the bankruptcy of a national account in Europe. As a percentage of total revenues, general and administrative expenses were 8.0% for 2009 compared to 7.7% for 2008.
Art and development costs of $13.2 million for 2009 were comparable to 2008 expenses. As a percentage of total revenues, art and development costs were 0.9% and 0.8% of total revenues for 2009 and 2008, respectively.
Interest expense, net
Interest expense of $41.5 million for 2009 was $9.4 million lower than for 2008, reflecting the impact of lower average debt and Libor rates.
Other income, net
Other income, net, in 2009 primarily includes our share of income from an unconsolidated balloon distribution joint venture located in Mexico partially offset by foreign currency transaction losses and other expenses.
Income tax expense
Income tax expense for 2009 and 2008 were based upon the estimated consolidated effective income tax rates of 37.5% and 37.9% for the years ended December 31, 2009 and December 31, 2008, respectively. The decrease in the 2009 effective income tax rate is primarily attributable to a lower average state income tax rate and the expiration of state statutes of limitations for certain states that resulted in the recognition of previous unrecognized tax benefits and the favorable settlement of the audits of our 2006 and 2005 federal tax returns. These tax rate reductions were partially offset by a lower domestic manufacturing deduction, as a percentage of pre-tax income.
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Percentage of Total Revenues
Total Revenues
The following table sets forth the Company’s total revenues for the years ended December 31, 2008 and 2007, respectively.
Wholesale
Net sales for 2008 of $438.5 million were $14.8 million or 3.3% lower than net sales for 2007. Net sales for 2008 reflect the elimination of intercompany sales to PCFG and FCPO for the entire year. Net sales for 2007 reflect the elimination of intercompany sales to PCFG and FCPO from the Party City Franchise Transaction Date and the Factory Card & Party Outlet Acquisition Date, respectively. Had the PCFG transactions and FCPO acquisition occurred January 1, 2007, the Company would have eliminated an additional $31.0 million of intercompany sales during 2007 and net sales for 2008 would have been $16.2 million or 3.8% higher than adjusted sales for 2007.
Net sales to party goods superstores (including our franchisees) and independent party stores totaled $151.5 million and were $5.2 million or 3.6% higher than adjusted 2007 sales, reflecting synergy-driven increases in sales to franchisees. Net sales of metallic balloons were $92.7 million or 4.5% higher than in 2007, principally the result of increased sales to international balloon distributors and the domestic mass market. Net sales to other retail channels (including card and gift stores, mass merchant, drug, craft and contract manufacturing) were $110.8 million or 3.2% higher than 2007, principally due to higher contract manufacturing sales early in 2008. International sales totaled $83.5 million and were $3.5 million or 4.4% higher than in 2007, as strong demand for new party programs at several European national accounts was partially offset by the impact of foreign currency fluctuations.
Retail
Net retail sales for company-owned stores for 2008 of $1,099 million were $331.0 million or 43.1% higher than net retail sales for 2007, reflecting the inclusion of FCPO and PCFG sales for the entire year 2008, which were $319.8 million higher than those sales included in 2007.
Net retail sales of Party City and Party America company-owned stores totaled $685.6 million and were essentially flat compared to 2007, as a 3.6% decrease in average store count and a 13.0% decrease in same stores sales at our outlet stores offset a 1.2% increase in same store sales at our Big Box party stores (i.e., generally greater than 8,000 square feet) and the inclusion of a 53rd week in our 2008 retail calendar. Net sales at our temporary Halloween stores totaled $39.5 million or 38.0% higher than in 2007 due to an increase in store count.
Royalties and franchise fees
Franchise related revenue for the year ended December 31, 2008, consisting of royalties and franchise fees, totaled $22.0 million or 14.9% lower than in 2007 principally as a result of the elimination in 2008 of royalties from the 55 former franchise stores acquired by PCFG in November 2007. During 2008, 23 stores were either opened or acquired by franchisees and 14 franchise stores were closed or sold, as compared to 29 stores opened or acquired by franchisees and 15 franchise stores were closed or sold during 2007. Franchise stores reported same-store net sales of $468.4 million or an increase of 0.7% for the year ended December 31, 2008 compared to the year ended December 31, 2007.
Gross Profit
The following table sets forth the Company’s consolidated gross profit on net sales for the years ended December 31, 2008 and 2007, respectively.
The gross profit margin on net sales at wholesale for 2008 was 32.5% or 350 basis points higher than in 2007. The increase in gross profit margin principally reflects the elimination of certain low margin full case sales, other changes in product mix and lower distribution costs.
Retail gross profit margin for 2008 was 39.0% or 160 basis points lower than in 2007, primarily due to increased promotional product pricing and inventory shrink and damage reserves and higher occupancy costs, as a percent of sales, principally as a result of the acquisition of FCPO.
Operating expenses
Selling expenses totaled $41.9 million for both 2008 and 2007 as a decrease in variable expenses, attributable to a decrease in sales at wholesale, was offset by increases principally in base compensation and employee benefits. Selling expenses decreased to 2.7% of total revenue in 2008 from 3.4% in 2007, as a result of the increase in retail sales.
Retail operating expenses of $273.6 million for 2008 were $82.2 million higher than 2007, reflecting the full year expenses of PCFG and FCPO. Retail operating expenses were 24.9% of retail sales in both 2008 and 2007. Franchise expenses for 2008 of $13.7 million increased to 62.1% of franchise related revenue in 2008 compared to 49.8% in 2007, principally as a result of the elimination of royalties from PCFG’s former franchise stores.
General and administrative expenses for 2008 were $120.3 million, increasing by $14.6 million over 2007. After adjusting general and administrative expenses for the full year impact of PCFG and FCPO, comparable expenses decreased by $10.3 million. The decrease in general and administrative expenses principally reflects lower retail expenses resulting from the completion of the Party America integration, partially offset by higher base compensation and employee benefits. As a percentage of total revenues, general and administrative expenses were 7.7% for 2008 compared to 8.5% for 2007.
Art and development costs of $12.5 million for 2008 were comparable to the costs for 2007. As a percentage of total revenues, art and development costs were 0.8% and 1.0% of total revenues for 2008 and 2007, respectively.
During the fourth quarter of 2008, the Company instituted a program to convert its company-owned and franchised Party America stores to Party City stores and recorded a $17.4 million charge for the impairment of the Party America trade name.
Interest expense, net
Interest expense of $50.9 million for 2008 was $3.8 million lower than for 2007, reflecting the impact of lower Libor as well as lower margin rates following our May 2007 debt refinancing, on higher average debt, following the PCFG transaction and the FCPO acquisition.
Other (income) expense, net
Other income, net, totaled $0.8 million in 2008, as a net gain on the disposal of assets and our share of income from an unconsolidated balloon distribution joint venture located in Mexico were partially offset by the cost to amend a licensing agreement. In 2007, other expense, net of $18.2 million principally consists of debt retirement costs related to the refinancing of our term and revolving credit facilities during the second quarter of 2007, and a reserve recorded against an investment in a foreign subsidiary. It also includes derivative gains and losses, a net loss on the disposal of assets and our share of income from the unconsolidated joint venture. The undistributed income from the unconsolidated joint venture includes the elimination of intercompany profit in the joint venture’s inventory at December 31, 2008 and 2007.
Income tax expense
Income tax expense for 2008 and 2007 were based upon the estimated consolidated effective income tax rates of 37.9% and 40.2% for the years ended December 31, 2008 and December 31, 2007, respectively. The decrease in the 2008 effective income tax rate is primarily attributable to a lower average state income tax rate.
Liquidity and Capital Resources
Capital Structure
On May 25, 2007, the Company and its parent company, AAH, entered into (i) a $375 million Term Loan Credit Agreement (the “Term Loan Credit Agreement”), and (ii) an ABL Credit Agreement (the “ABL Credit Agreement”) with a committed revolving credit facility in an aggregate principal amount of up to $250 million (as amended). The Company used the proceeds from these facilities to terminate a previously existing $410 million first lien credit and guaranty agreement and (ii) the $60 million second lien credit and guaranty agreement.
Term Loan Credit Agreement
The Term Loan Credit Agreement provides for two pricing options: (i) an alternate base rate (“ABR”) equal to the greater of (a) Credit Suisse’s prime rate in effect on such day and (b) the federal funds effective rate in effect on such day plus 1/2 of 1% or (ii) a LIBOR rate determined by reference to the cost of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, in each case plus an applicable margin. The applicable margin is 1.25% with respect to ABR borrowings and 2.25% with respect to LIBOR borrowings.
The Term Loan Credit Agreement provides that the term loans may be prepaid any time prior to their maturity. The term loans are subject to mandatory prepayment out of (i) 100% of net proceeds arising from asset sales, insurance and condemnation proceeds, subject to reinvestment provisions, (ii) 50% of net proceeds arising from certain equity issuances by the Company or its subsidiaries (which percentage will be reduced to 25% or 0% if the Company’s total leverage ratio is less than specified ratios), (iii) net proceeds arising from any debt issued by the Company or its subsidiaries and (iv) 50% (which percentage will be reduced to 25% or 0% if the Company’s total leverage ratio is less than specified ratios) of the Company’s Excess Cash Flow, as defined, if any.
The Company is required to repay installments on the term loans in quarterly principal amounts of 0.25% of their funded total principal amount through March 31, 2013, with the remaining amount payable on the maturity date of May 25, 2013.
The obligations of the Company under the Term Loan Credit Agreement are jointly and severally guaranteed by AAH and each wholly-owned domestic subsidiary of the Company. Each guarantor has secured its obligations under the guaranty by a first priority lien on substantially all of its assets, with the exception of accounts receivable and inventories, which are under a second priority lien.
The Company may, by written notice to the Administrative Agent from time to time, request additional incremental term loans, in an aggregate amount not to exceed $100 million from one or more lenders (which may include any existing Lender) willing to provide such additional incremental term loans in their own discretion.
The Term Loan Credit Agreement contains a number of covenants that, among other things, restrict, subject to certain exceptions, the ability of the Company and its Subsidiaries to incur additional indebtedness; create, incur or suffer to exist liens on any of their property or assets; make investments or enter into joint venture arrangements; pay dividends and distributions or repurchase capital stock of the Company; engage in mergers, consolidations and sales of all or substantially all their assets; sell assets; make capital expenditures; enter into agreements restricting dividends and advances by the Company’s subsidiaries; and engage in transactions with affiliates.
The Term Loan Credit Agreement also contains certain customary affirmative covenants and events of default.
At December 31, 2009, the balance of the Term Loan was $364.7 million.
ABL Credit Agreement
The Company has a committed revolving credit facility in an aggregate principal amount of up to $250 million for working capital, general corporate purposes and the issuance of letters of credit. The ABL Credit Agreement provides for (a) extension of credit in the form of Revolving Loans at any time and from time to time during the period ended May 25, 2012 (the “Availability Period”), in an aggregate principal amount at any time outstanding not in excess of $250 million, subject to a borrowing base described below, (b) commitments to obtain credit, at any time and from time to time during the Availability Period, in the form of Swingline Loans, in an aggregate principal amount at any time outstanding not in excess of $10 million and (c) ability to utilize Letters of Credit, in an aggregate face amount at any time outstanding not in excess of $25 million, to support payment obligations incurred in the ordinary course of business by the Company and its subsidiaries.
The borrowing base at any time equals (a) 85% of eligible trade receivables, plus (b) the lesser of (i) 75% of eligible inventory and eligible in-transit inventory, valued at the lower of cost or market value, and (ii) 85% of net orderly liquidation value of eligible inventory and eligible in transit inventory (subject in the case of eligible in-transit inventory to a cap of $10 million) , plus (c) 85% of eligible credit card receivables, less (d) certain reserves.
The ABL Credit Agreement provides for two pricing options: (i) an alternate base rate (“ABR”) equal to the greater of (a) Credit Suisse’s prime rate in effect on such day and (b) the federal funds effective rate in effect on such day plus 1/2 of 1% or (ii) a LIBOR rate determined by reference to the cost of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, in each case plus an applicable margin. The applicable margin is up to 0.50% with respect to ABR borrowings and from 1.00% to 1.50% with respect to LIBOR borrowings. The applicable margin at December 31, 2009 was 0.0% with respect to ABR borrowings and 1.00% with respect to LIBOR borrowings.
In addition to paying interest on outstanding principal under the ABL Credit Agreement, the Company is required to pay a commitment fee of between 0.30% and 0.25% per annum in respect of the unutilized commitments thereunder. The Company must also pay customary letter of credit fees and agency fees.
Upon prior notice, the Company may prepay any borrowing under the ABL Credit Agreement, in whole or in part, without premium or penalty other than customary “breakage” costs with respect to LIBOR loans.
There is no scheduled amortization under the ABL Credit Agreement. The principal amount outstanding of the loans under the ABL Credit Agreement is due and payable in full on the fifth anniversary of the closing date.
The obligations of the Company under the ABL Credit Agreement are jointly and severally guaranteed by AAH and each wholly-owned domestic subsidiary of the Company. Each guarantor has secured its obligations under the guaranty by a first priority lien on its accounts receivable and inventories and a second priority lien on substantially all of its other assets.
The ABL Credit Agreement contains negative covenants that are substantially similar to the Term Loan Credit Agreement. The ABL Credit Agreement requires the Company to comply with certain financial covenants if it has less than $25 million of excess availability. The ABL Credit Agreement also limits the amount of consolidated capital expenditures in any fiscal year
The ABL Credit Agreement also contains certain customary affirmative covenants and events of default.
Borrowings under the ABL Credit Agreement were $77.0 million and outstanding standby letters of credit totaled $11.6 million at December 31, 2009.
Unrestricted Subsidiary Credit Agreement
On November 2, 2007, PCFG entered into a Credit Agreement (the “PCFG Credit Agreement”), among PCFG, CIT Group/Business Credit, Inc., as Administrative Agent and Collateral Agent, Newstar Financial, Inc., as Syndication Agent, CIT Capital Securities LLC, as Sole Arranger, and the Lenders party thereto.
Pursuant to the PCFG Credit Agreement, PCFG borrowed $30.0 million in term loans (“PCFG Term Loan”) and obtained a committed revolving credit facility in an aggregate principal amount of up to $10.0 million, as amended, for working capital and general corporate purposes and the issuance of letters of credit (of up to $5.0 million at any time outstanding) (“PCFG Revolver”). At December 31, 2009, the balance of the term loan was $23.0 million, borrowings under the PCFG Revolver were $0.6 million and there were no outstanding letters of credit. The Company is in compliance with the terms the PCFG Credit Agreement at December 31, 2009.
PCFG and PCFG Holdings, the sole member of PCFG, have been designated by the Board of Directors of the Company as “Unrestricted Subsidiaries” pursuant to the Company’s existing ABL Credit Agreement, and the indenture governing its 8.75% Senior Subordinated Notes and neither PCFG nor PCFG Holdings is a guarantor of any of the Company’s other credit
facilities or indenture. In addition, PCFG’s credit facility is a stand-alone facility for PCFG and is not guaranteed by the Company or its other subsidiaries.
At December 31, 2008, PCFG had not been in compliance with the financial covenants contained in the PCFG Credit Agreement. Effective September 30, 2009, PCFG and its lenders entered into a Waiver and Amendment Agreement which provided that, among other things, (1) interest would be accrued prospectively at either (i) for ABR borrowings, the Alternate Base Rate plus 6.00%, with a floor of 4.00% for the Alternate Base Rate or (ii) the Adjusted LIBO Rate plus 7.00% with a floor of 3.00% for the Adjusted LIBO Rate, (2) PCFG would pay an additional $1.5 million in principal on the Term Loans at the effective date of the waiver and amendment , and thereafter the quarterly amortization payment for the Term Loans would be $1.0 million each quarter until the Maturity Date, (3) the PCFG Revolver would be limited to a maximum of $10.0 million, and (4) financials covenants related to leverage ratio, fixed charge coverage ratio, minimum EBITDA, and maximum capital expenditures, were revised. As PCFG is an unrestricted subsidiary, the acceleration of our obligation under the PCFG Term Loan would not constitute an event of default under our other debt instruments.
Other Credit Agreements
At December 31, 2009, we have a $0.4 million Canadian dollar denominated revolving credit facility that bears interest at the Canadian prime rate plus 1.1% and expires in April 2010, and a 1.4 million British Pound Sterling denominated revolving credit facility that bears interest at the UK base rate plus 1.75% on the first 1.0 million British Pound Sterling and 4.75% over the UK base rate on the remaining $0.4 million British Pound Sterling. The British Pound Sterling revolving credit facility expires on June 30, 2010. At December 31, 2009 the borrowings outstanding under the British Pound Sterling revolving credit facility was 0.4 million British Pound Sterling. We expect to renew these revolving credit facilities upon expiration.
Long-term borrowings at December 31, 2009 include a mortgage note with the New York State Job Development Authority of $5.6 million. The mortgage note was amended on December 18, 2009, extending the fixed monthly payments of principal and interest for a period of 60 months up to and including December 31, 2014. The note bears interest at the rate of 2.45%, and is subject to review and adjustment semi-annually based on the New York State Job Development Authority’s confidential internal protocols. The mortgage note is collateralized by a distribution facility located in Chester, New York.
In connection with its acquisition by AAH in April 2004, the Company issued $175.0 million of 8.75% senior subordinated notes due 2014 to their initial purchasers, which were subsequently resold to qualified institutional buyers and non-U.S. persons in reliance upon Rule 144A and Regulation S under the Securities Act of 1933 (the “Note Offering”). In August 2004, the Company filed with the Securities and Exchange Commission a Registration Statement on Form S-4, offering to exchange registered notes for the notes issued in connection with the Note Offering. The terms of the notes and the exchange notes were substantially identical. The exchange was completed in October 2004. Interest is payable semi-annually on May 1 and November 1 of each year.
We have entered into various capital leases for machinery and equipment and automobiles with implicit interest rates ranging from 4.39% to 11.65% which extend to 2013. The Company has numerous non-cancelable operating leases for its retail store sites as well as several leases for offices, distribution and manufacturing facilities, showrooms and equipment. These leases expire on various dates through 2020 and generally contain renewal options and require the Company to pay real estate taxes, utilities and related insurance costs.
Rent expense for the years ended December 31, 2009 and 2008 totaled $136.8 million and $142.5 million, respectively. Minimum lease payments currently required under non-cancelable operating leases for the year ending December 31, 2010, approximate $108.7 million.
Restructuring costs associated with the Factory Card & Party Outlet Acquisition of $9.1 million were accrued for as part of net assets acquired. Through December 31, 2009, the Company incurred $6.7 million in restructuring costs, including $3.8 million incurred in 2009. The Company expects to incur the balance in 2010.
During October of 2009, the Company communicated its plan to close the FCPO corporate office in Naperville, Illinois and to consolidate its retail corporate office operations with those of Party City, in Rockaway, New Jersey. In connection with the closing, the Company recorded additional planned severances costs of $1.8 million during 2009 and expects to incur additional retention costs of $1.5 million through April 2010. The Company will continue to utilize the Naperville facility as a distribution center for greeting cards and other products.
The Company has a management agreement with Berkshire Partners LLC and Weston Presidio. Pursuant to the management agreement, the Company pays annual management fees of $1.2 million. Although the indenture governing the 8.75% senior subordinated notes will permit the payments under the management agreement, such payments will be restricted during an event of default under the notes and will be subordinated in right of payment to all obligations due with respect to the notes in the event of a bankruptcy or similar proceeding of Amscan.
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 twelve 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 our senior secured credit facilities in an amount sufficient to enable us to repay our indebtedness, including the notes, or to fund our other liquidity needs.
Cash Flow Data - Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Net cash provided by operating activities during the year ended December 31, 2009 totaled $123.9 million, as compared to $79.9 million for the year ended December 31, 2008. Net cash flow provided by operating activities before changes in operating assets and liabilities for the years ended December 31, 2009 and 2008, was $124.2 million and $102.6 million, respectively. Changes in operating assets and liabilities for the year ended December 31, 2009 and 2008 resulted in the use of cash of $0.2 million and $22.7 million, respectively. The increase in cash provided by operating activities during 2009 principally reflects an increase in income from operations and decreases in interest expense and inventory levels, partially offset by an increase in other assets.
During the years ended December 31, 2009 and 2008, net cash used in investing activities totaled $54.4 million and $51.2 million, respectively. Investing activities for 2009 included $24.9 million paid in escrow in connection with the Asset Purchase Agreement with American Greetings. Retail capital expenditures, principally for store renovations and updated information systems, totaled $16.3 million in 2009, while wholesale capital expenditures totaled $9.9 million.
During the years ended December 31, 2009 and 2008, net cash used in financing activities was $70.2 million and $23.0 million respectively. During 2009, the majority of cash used in financing activities was used to reduce borrowings under our revolving line of credit. Additionally, cash used in financing activities included scheduled payments on our long-term obligations that totaled $11.0 million compared to $8.9 million during the year ended December 31, 2008. Scheduled payments during the year ended December 31, 2009 included an additional $2.5 million for payments on the PCFG term loan in connection with the amended credit agreement.
Cash Flow Data - Year Ended December 31, 2008 Compared to Year Ended December 31,
Net cash provided by operating activities during the year ended December 31, 2008 totaled $79.9 million, as compared to $9.6 million for the year ended December 31, 2007. Net cash flow provided by operating activities before changes in operating assets and liabilities for the years ended December 31, 2008 and 2007, were $102.6 million and $70.8 million, respectively. Changes in operating assets and liabilities for the years ended December 31, 2008 and 2007 resulted in the use of cash of $22.7 million and $61.2 million, respectively. The increase in cash provided by operating activities during 2008 principally reflects cash generated by the retail operations acquired in the fourth quarter of 2007, partially offset by higher levels of inventory.
During the years ended December 31, 2008 and 2007, net cash used in investing activities totaled $51.2 million and $133.4 million, respectively. Investing activities for 2008 include $1.6 million of costs associated with our prior year acquisition of FCPO and our investment in PCFG. Retail capital expenditures, principally for store renovations and updated information systems, totaled $42.7 million in 2008, while wholesale capital expenditures totaled $10.3 million. Investing activities for 2007 include our $73.6 million acquisition of FCPO, our $32.4 million, net, investments in PCFG, Halloween USA and other franchise store transactions, retail capital expenditures of $13.5 million and wholesale capital expenditures of $13.9 million.
During the years ended December 31, 2008, net cash used in financing activities was $23.0 million. During 2008, cash used to reduce borrowings under our revolving line of credit and for scheduled payments on our long-term obligations totaled $26.8 million. In addition, in 2008, the Company used $0.5 million to purchase redeemable common stock. Sources of cash included $2.5 million generated by the sale of an additional minority interest in PCFG and $1.8 million in tax benefits related to the exercise of common stock options held by employees. During the year ended December 31, 2007, net cash provided by financing activities was $134.6 million. Sources included (i) net borrowings under our revolving credit agreements of $152.7 million, principally used to acquire FCPO, PCFG, and Halloween USA, and (ii) capital contributions of $4.7 million. These sources were partially offset by a $10 million reduction of our term loan resulting from the refinancing, a $11.8 million cost to refinance current debt and retire prior debt, and scheduled payments on capital leases and other long-term obligations.
Tabular Disclosure of Contractual Obligations
Our contractual obligations at December 31, 2009 are summarized by the year in which the payments are due in the following table (dollars in thousands):
(a)
See Note 8 to our Consolidated Financial Statements which are included in this report beginning on page.
(b)
We are also an assignor with continuing lease liability for seven stores sold to franchisees that expire through 2014. The assigned lease obligations continue until the applicable leases expire. The maximum amount of the assigned lease obligations may vary, but is limited to the sum of the total amount due under the lease. At December 31, 2009, the maximum amount of the assigned lease obligations was approximately $4.2 million and is not included in the table above.
The operating lease obligations included above do not include contingent rent based upon sales volume (which represented less than 1% of minimum lease obligations in 2009), or other variable costs such as maintenance, insurance and taxes. See Note 17 to our Consolidated Financial Statements which are included in this report beginning on page.
(c)
The Company has certain purchase commitments with vendors requiring minimum purchase commitments through 2012.
At December 31, 2009 there were no non-cancelable purchase orders related to capital expenditures.
At December 31, 2009, there were $77.0 million of borrowings under our ABL Credit Agreement, and standby letters of credit totaling $11.6 million. Under our PCFG Revolver there were $0.6 million borrowings and no standby letters of credit. See Note 8 to our Consolidated Financial Statements which are included in this report beginning on page.
Not included in the above table are $1.0 million of net potential cash obligations associated with unrecognized tax benefits due to the high degree of uncertainty regarding the timing of future cash outflows associated with such obligations. Please refer to Note 16, “Income Taxes,” in the Notes to Consolidated Financial Statements for further information related to unrecognized tax benefits.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K under the Securities Exchange Act of 1934, as amended.
Effects of Inflation
Although we expect that our operating results will be influenced by general economic conditions, we do not believe that inflation has had a material effect on our results of operations during the periods presented. However, there can be no assurance that our business will not be affected by inflation in the future.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the appropriate application of certain accounting policies, many of which require estimates and assumptions about future events and their impact on amounts reported in the financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the consolidated financial statements included herein.
We believe our application of accounting policies, and the estimates inherently required by these policies, are reasonable. These accounting policies and estimates are constantly re-evaluated and adjustments are made when facts and circumstances dictate a change. Historically, we have found the application of accounting policies to be reasonable, and actual results generally do not differ materially from those determined using necessary estimates.
Revenue Recognition
Our terms of sale to retailers and other distributors are principally F.O.B. shipping point and, accordingly, title and the risks and rewards of ownership are transferred to the customer, and revenue is recognized, when goods are shipped. We estimate reductions to revenues for volume-based rebate programs at the time sales are recognized. Should customers earn rebates higher than estimated by us, additional reductions to revenues may be required.
Revenue from retail operations is recognized at the point of sale. We estimate future retail sales returns and, when material, record a provision in the period that the related sales are recorded based on historical information. Should actual returns differ from our estimates, we would be required to revise estimated sales returns. Retail sales are reported net of taxes collected.
Store Closure Costs
We record estimated store closure costs, estimated lease commitment costs net of estimated sublease income and other miscellaneous store closing costs when the liability is incurred. Such estimates, including sublease income, may be subject to change.
Product Royalty Agreements
The Company enters into product royalty agreements that allow the Company to use licensed designs on certain of its products. These contracts require the Company to pay royalties, generally based on the sales of such product, and may require guaranteed minimum royalties, a portion of which may be paid in advance. The Company matches royalty expense with revenue by recording royalties at the time of sale, at the greater of the contractual rate or an effective rate calculated based on the guaranteed minimum royalty and the Company’s estimate of sales during the contract period. If a portion of the guaranteed minimum royalty is determined to be unrecoverable, the unrecoverable portion is charged to expense at that time.
Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers and franchisees to make required payments. A considerable amount of judgment is required in assessing the ultimate realization of these receivables, including consideration of our history of receivable write-offs, the level of past due accounts and the economic status of our customers. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances would be required.
Inventories
Our policy requires that we state our inventories at the lower of cost or market. In assessing the ultimate realization of inventories, we are required to make judgments regarding, among other things, future demand and market conditions, current inventory levels and the impact of the possible discontinuation of product designs. If actual conditions are less favorable than those projected by us, additional inventory write-downs to market value may be required.
We estimate retail inventory shortage, for the period from the last inventory date to the end of the reporting period, on a store-by-store basis. Our inventory shortage estimate can be affected by changes in merchandise mix and changes in actual shortage trends. The shrinkage rate from the most recent physical inventory, in combination with historical experience, is the basis for estimating shrinkage.
Long-Lived and Intangible Assets
We review the recoverability of our long-lived assets, including definite-lived intangible assets other than goodwill, whenever facts and circumstances indicate that the carrying amount may not be fully recoverable. For purposes of recognizing and measuring impairment, we evaluate long-lived assets other than goodwill based upon the lowest level of independent cash flows ascertainable to evaluate impairment. If the sum of the undiscounted future cash flows expected over the remaining asset life is less than the carrying value of the assets, we may recognize an impairment loss. The impairment related to long-lived assets is measured as the amount by which the carrying amount of the assets exceeds the fair value of the asset. When fair values are not readily available, we estimate fair values using expected discounted future cash flows.
In the evaluation of the fair value and future benefits of finite long-lived assets attached to retail stores, we perform our cash flow analysis on a store-by-store basis. Various factors including future sales growth and profit margins are included in this analysis. To the extent these future projections or strategies change, the conclusion regarding impairment may differ from the current estimates.
Goodwill is reviewed for potential impairment, on an annual basis or more frequently if circumstances indicate a possible impairment, by comparing the fair value of a reporting unit with its carrying amount, including goodwill. We estimate the fair value of each reporting unit using expected discounted cash flows. If the carrying amount of a reporting unit exceeds its fair value, the excess, if any, of the fair value of the reporting unit over amounts allocable to the unit’s other assets and liabilities is the implied fair value of goodwill. If the carrying amount of a reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss will be recognized in an amount equal to that excess. The fair value of a reporting unit refers to the amount at which the unit as a whole could be sold in a current transaction between willing parties.
Insurance accruals
Our consolidated balance sheet includes significant liabilities with respect to self-insured workers’ compensation, medical and general liability claims. We estimated the required liability for such claims based upon various assumptions, which include, but are not limited to, our historical loss experience, projected loss development factors, actual payroll and other data. The required liability is also subject to adjustment in the future based upon changes in claims experience, including changes in the number of incidents (frequency) and changes in the ultimate cost per incident (severity). Adjustments to earnings resulting from changes in historical loss trends have been insignificant. Further, we do not anticipate any significant change in loss trends, settlements or other costs that would cause a significant change in our earnings.
Income Taxes
Temporary differences arising from differing treatment of income and expense items for tax and financial reporting purposes result in deferred tax assets and liabilities that are recorded on the balance sheet. These balances, as well as income tax expense, are determined through management’s estimations, interpretation of tax law for multiple jurisdictions and tax planning. If our actual results differ from estimated results due to changes in tax laws or tax planning, our effective tax rate and tax balances could be affected. As such these estimates may require adjustment in the future as additional facts become known or as circumstances change.
The Company’s income tax returns are periodically audited by the Internal Revenue Service and by various state and local jurisdictions. The Company reserves for uncertain tax positions according to the guidance of FIN No. 48. See further discussion in Note 16 of the Notes to the Consolidated Financial Statements.
Stock-Based Compensation
On January 1, 2006, the Company adopted Statement of Financial Accounting Standards, Accounting Standards Codification or “ASC” Subtopic 718 (“SFAS“No. 123(R)) “Share-Based Payment,” which is a revision of SFAS No. 123 “Accounting for Stock-Based Compensation” as amended. ASC Subtopic 718 (SFAS No. 123(R)) establishes standards for the accounting for transactions where an entity exchanges its equity for goods or services and transactions that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. ASC Subtopic 718 (SFAS No. 123(R)) focuses primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions. Generally, the fair value approach in ASC Subtopic 718 (SFAS No. 123(R)) is similar to the fair value approach described in SFAS No. 123.
The Company adopted ASC Subtopic 718 (SFAS No. 123(R)) using the prospective method. Since the Company’s common stock is not publicly traded, the options granted in 2005 under SFAS No. 123 continue to be expensed under the provisions of SFAS No. 123 using a minimum value method. Options issued subsequent to January 1, 2006 are expensed under the provisions of ASC Subtopic 718 (SFAS No. 123(R)) (see Note 15).
Legal Proceedings
We are a party to certain claims and litigation in the ordinary course of business. We do not believe any of these proceedings will result, individually or in the aggregate, in a material adverse effect upon our financial condition or future results of operations.
Recently Issued Accounting Standards
Implemented:
Effective in the third quarter 2009, the Company adopted ASC 105 Generally Accepted Accounting Standards which became the single source for all authoritative generally accepted accounting principles, or GAAP, recognized by the FASB. ASC 105 does not change GAAP and did not impact the Company’s results of operations, cash flows or financial position. Subsequent revisions to GAAP will be incorporated into the ASC through issuance of Accounting Standards Updates (“ASU”).
Effective January 1, 2009, the Company adopted an amendment to ASC 810 Consolidation which changes presentation of the financial statements. This standard governs the accounting for, and reporting of, noncontrolling interests in partially owned consolidated subsidiaries and the loss of control of subsidiaries. The standard requires that: (i) noncontrolling interest, previously referred to as minority interest, be reported as part of equity in the consolidated financial statements; (ii) losses be allocated to a noncontrolling interest even when such allocation might result in a deficit balance, reducing the losses attributed to the controlling interest; (iii) changes in ownership interests be treated as equity transactions if control is maintained; (iv) changes in ownership interests resulting in gain or loss be recognized in earnings if control is gained or lost; and (v) in a business combination the noncontrolling interest’s share of net assets acquired be recorded at the fair value, plus its share of goodwill. The Company’s consolidated balance sheet as of December 31, 2009 and 2008 and consolidated statements of income, stockholders’ equity and cash flow for each of the three years in the period ended December 31, 2009, have been retrospectively adjusted upon application of the standard.
During the second quarter of 2009, the Company adopted ASC 855 Subsequent Events which (i) incorporates the principles and accounting guidance for recognizing and disclosing subsequent events that originated as auditing standards into the body of authoritative literature issued by the FASB and also (ii) prescribes disclosure regarding the date through which subsequent events have been evaluated. In February 2010, the FASB amended this new standard to eliminate the disclosure requirement regarding the date through which subsequent events have been evaluated. As the new standard was not intended to significantly change the current practice of reporting subsequent events, it did not have an impact on our results of operations, cash flows or financial positions. Refer to Note 23.
Effective January 1, 2009, the Company adopted ASC 815 Derivatives and Hedging which enhanced disclosures about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for and (iii) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. The adoption of ASC 815 did not have a financial impact on the Company’s financial statements.
Effective January 1, 2009, the Company adopted an amendment to ASC 805 Business Combinations which significantly changes the accounting for business acquisitions both during the period of the acquisition and in subsequent periods. These amendments will be considered for all business combinations completed subsequent to the adoption date (none in 2009). Among the more significant changes:
•
Acquired in-process research and development, which was previously expensed at acquisition, is now accounted for as an asset, with the cost recognized as the research and development is realized or abandoned.
•
Contingent consideration, which was previously accounted for as a subsequent adjustment to purchase price, is now recorded at fair value as an element of purchase price with subsequent adjustments recognized in operations.
•
Subsequent decreases in valuation allowances on acquired deferred tax assets are recognized in operations after the measurement period. Such changes were previously considered to be subsequent changes in consideration and were recorded as decreases in goodwill.
•
Transaction costs, which were previously treated as costs of the acquisition, are now expensed.
•
Upon gaining control of an entity in which the equity method or cost basis investment was held, the carrying value of that investment is adjusted to fair value with the related gain or loss recorded in earnings. Previously, this fair value adjustment would not have been made.
•
Effective January 1, 2009, the Company retrospectively adopted an amendment to ASC 805 released in April 2009. The amendment requires pre-acquisition contingencies to be recognized at fair value, if fair value can be determined or reasonably estimated during the measurement period. If fair value cannot be determined or reasonably estimated, the standard requires measurement based on the recognition and measurement criteria of ASC 450 Contingencies.
The Company adopted ASC 820 Fair Value Measurement and Disclosure in two steps: Effective January 1, 2008, the Company adopted it for all financial instruments and non-financial instruments accounted for at fair value on a recurring basis. Effective January 1, 2009, the Company adopted it for all non-financial instruments accounted for at fair value on a non-recurring basis. This standard also establishes a new framework for measuring fair value and expands related disclosures. Refer to Note 20.
Not Yet Implemented:
The Company is currently evaluating all applicable outstanding ASU’s and does not believe any will have a material impact on the consolidated financial statements.
During the second quarter of 2009, we adopted a newly issued accounting standard for subsequent events. The new standard incorporates the principles and accounting guidance for recognizing and disclosing subsequent events that originated as auditing standards into the body of authoritative literature issued by the FASB and also prescribes disclosure regarding the date through which subsequent events have been evaluated. We are required to evaluate subsequent events through the date our financial statements are issued. In February 2010, the FASB amended this new standard to eliminate the disclosure requirement regarding the date through which subsequent events have been evaluated. As the new standard was not intended to significantly change the current practice of reporting subsequent events, it did not have an impact on our results of operations, cash flows or financial positions.
“Safe Harbor” Statement under Private Securities Litigation Reform Act of 1995
This report includes “forward-looking statements” within the meaning of various provisions of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, included in this report that address activities, events or developments that we expect or anticipate will or may occur in the future, future capital expenditures (including the amount and nature thereof), business strategy and measures to implement strategy, including any changes to operations, goals, expansion and growth of our business and operations, plans, references to future success and other such matters are forward-looking statements. These statements are based on certain assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions and expected future developments as well as other factors we believe are appropriate in the circumstances. Actual results may differ materially from those discussed. Whether actual results and developments will conform with our expectations and predictions is subject to a number of risks and uncertainties, including, but not limited to (1) the concentration of sales by us to party goods superstores where the reduction of purchases by a small number of customers could materially reduce our sales and profitability, (2) the failure by us to anticipate changes in tastes and preferences of party goods retailers and consumers, (3) the introduction by us of new product lines, (4) the introduction of new products by our competitors, (5) the inability to increase prices to recover fully future increases in raw material prices, especially increases in prices of paper and petroleum-based resin, (6) the loss of key employees, (7) changes in general business conditions, (8) other factors which might be described from time to time in our filings with the Commission, and (9) other factors which are beyond our control. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and the actual results or developments anticipated by us may not be realized or, even if substantially realized, may not have the expected consequences to or effects on our business or operations. Although we believe that we have the product offerings and resources needed for growth in revenues and margins, future revenue and margin trends cannot be reliably predicted. Changes in such trends may cause us to adjust our operations in the future. Because of the foregoing and other factors, recent trends should not be considered reliable indicators of future financial results. In addition, our highly leveraged nature may impair our ability to finance our future operations and capital needs and our flexibility to respond to changing business and economic conditions and business opportunities.
Quarterly Results (Unaudited)
Despite a concentration of holidays in the fourth quarter of the year, as a result of our expansive product lines and wholesale customer base and increased promotional activities, the impact of seasonality on the quarterly results of our wholesale operations in recent years has been limited. Promotional activities, including special dating terms, particularly with respect to Halloween and Christmas products sold to retailers and other distributors in the third quarter, and the introduction of our new everyday products and designs during the fourth quarter generally result in higher accounts receivables and inventory balances. Our retail operations are subject to substantial seasonal variations. Historically, our retail stores have realized a significant portion of their net sales, net income and cash flow in the fourth quarter of the year, principally due to the sales in October for the Halloween season and, to a lesser extent, due to sales for end of year holidays.
The following table sets forth our historical revenues, gross profit, income (loss) from operations and net income (loss), by quarter, for 2009 and 2008.
(a)
During the fourth quarter of 2008, the Company instituted a program to convert its company-owned and franchised Party America stores to Party City stores and recorded a $17.4 million charge for the impairment of the Party America trade name.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Our earnings are affected by changes in interest rates as a result of our variable rate indebtedness. However, we utilize interest rate swap agreements to manage the market risk associated with fluctuations in interest rates. If market interest rates for our variable rate indebtedness averaged 2% more than the interest rate actually paid for the years ended December 31, 2009, 2008 and 2007, our interest expense, after considering the effects of our interest rate swap agreements, would have increased, and income before income taxes would have decreased, by $6.7 million, $7.3 million, and $7.9 million, respectively. These amounts are determined by considering the impact of the hypothetical interest rates on our borrowings and interest rate swap agreements. This analysis does not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to further mitigate our exposure to the change. However, due to the uncertainty of the specific actions that we would take and their possible effects, the sensitivity analysis assumes no changes in our financial structure.
Our earnings are also affected by fluctuations in the value of the U.S. dollar as compared to foreign currencies, predominately in European countries, as a result of the sales of our products in foreign markets. Although we periodically enter into foreign currency forward contracts to hedge against the earnings effects of such fluctuations, we (1) may not be able to achieve hedge effectiveness to qualify for hedge-accounting treatment and, therefore, would record any gain or loss on the fair value of the derivative in other income (expense) and (2) may not be able to hedge such risks completely or permanently. A uniform 10% strengthening in the value of the dollar relative to the currencies in which our foreign sales are denominated would have resulted in a decrease in gross profit of $5.5 million, $5.6 million, and $5.4 million for the years ended December 31, 2009, 2008 and 2007, respectively. These calculations assume that each exchange rate would change in the same direction relative to the U.S. dollar. In addition to the direct effects of changes in exchange rates, which could change the U.S. dollar value of the resulting sales, changes in exchange rates may also affect the volume of sales or the foreign currency sales price as competitors’ products become more or less attractive. Our sensitivity analysis of the effects of changes in foreign currency exchange rates does not factor in a potential change in sales levels or local currency prices.
Item 8.
Item 8. Financial Statements and Supplementary Data
See the consolidated financial statements and supplementary data listed in the accompanying Index to Consolidated Financial Statements and Financial Statement Schedule on page herein.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
We maintain disclosure control procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), designed to provide reasonable assurance that information required to be disclosed in reports filed under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms; and (ii) accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosures.
As of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer evaluated, with the participation of our management, the effectiveness of our disclosure controls and procedures. Based on the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of December 31, 2009.
(b) Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fourth quarter of 2009 identified in connection with our Chief Executive Officer’s and Chief Financial Officer’s evaluation that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
(c) Management’s Annual Report on Internal Control Over Financial Reporting
The management of Amscan is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d - 15(f) promulgated under the Exchange Act, as amended, as a process designed by, or under the supervision of, Amscan’s Chief Executive Officer and Chief Financial officer, or persons performing similar functions, and effected by Amscan’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
•
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of Amscan;
•
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of Amscan are being made only in accordance with authorizations of management and directors of Amscan; and
•
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Amscan’s assets that could have a material effect on the consolidated financial statements.
Our internal control system was designed to provide reasonable assurance to our management and Board of Directors regarding the preparation and fair presentation of published financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the Company’s internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on the evaluation performed, management concluded that its internal control over financial reporting, based on the COSO criteria, was effective, at the reasonable assurance level, as of December 31, 2009.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Item 9 (A) (T)
The information required by Item 9 (A) (T) of Regulation S-K is included herein in Item 9A(b).
Item 9B.
Item 9B. Other Information
Not applicable.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Set forth below are the names, ages and positions with the Company of the persons who are serving as directors and executive officers of the Company at March 31, 2010.
Gerald C. Rittenberg became our Chief Executive Officer in December 1997. From May 1997 until December 1997, Mr. Rittenberg served as acting Chairman of the Board. Prior to that time, Mr. Rittenberg served as the President of Amscan Inc. from April 1996 to October 1996, and as our President from the time of our formation in October 1996.
James M. Harrison became our President in December 1997 and our Chief Operating Officer in March 2002. From February 1997 to March 2002, Mr. Harrison also served as our Chief Financial Officer and Treasurer. From February 1997 to December 1997, Mr. Harrison served as our Secretary. Prior to that time, Mr. Harrison served as the Chief Financial Officer of Amscan Inc., from August 1996 to February 1997.
Michael D. Heller became our Executive Vice President - Retail Operations in December 2008. From December 2007 to December 2008, Mr. Heller served as the Executive Vice President of PCFG following our Party City Franchise Group transaction. Prior to that time, Mr. Heller was a significant franchisee of Party City.
Michael A. Correale became our Chief Financial Officer in March 2002. Prior to that time, Mr. Correale served as our Vice President - Finance, from May 1997 to March 2002.
Robert J. Small became one of our directors upon the consummation of the 2004 Transactions. Mr. Small, a Managing Director of Berkshire Partners LLC, which he joined in 1992, currently serves on the board of directors of TransDigm Group Incorporated. Mr. Small has also served on the board of directors of Hexcel Corporation and several privately held companies.
Steven J. Collins has been a member of our Board since August 2008. Mr. Collins, a Managing Director of Advent International, which he joined in 1995, is currently a member of the board of directors of Kirkland’s, Inc. and previously served on the board of directors of lululemon athletica inc. and several privately held businesses. Mr. Collins received a B.S. from the Wharton School of the University of Pennsylvania and an M.B.A. from the Harvard Business School.
Michael F. Cronin became one of our directors upon the consummation of the 2004 Transactions. From 1991 to the present, Mr. Cronin has served as Managing Partner of Weston Presidio. Mr. Cronin also serves as a director of several privately held companies and has served on the board of directors of Tweeter Home Entertainment Group and Tekni-Plex Inc.
Kevin M. Hayes became one of our directors upon the consummation of the 2004 Transactions. Mr. Hayes is a General Partner of Weston Presidio and has served in that position since 2000. Mr. Hayes is also a director of Associated Materials Incorporated.
Jordan A. Kahn became a director in January 2005. Mr. Kahn was the founder and Chairman of the Board of Directors of The Holmes Group and served as President and Chief Executive Officer of the Holmes organization from 1982 through 2005. Since 1968, Mr. Kahn has also been Managing Director of Jordan Kahn Co., Inc., a manufacturer’s representative representing small electric personal appliance manufacturers to retailers across the Northeast.
Richard K. Lubin became one of our directors upon the consummation of the 2004 Transactions. Mr. Lubin, a Managing Director of Berkshire Partners LLC, which he co-founded in 1986, currently serves on the board of directors of Electro-Motive Diesel. Mr. Lubin has also served on the board of directors of Holmes Products Corporation and U.S. Can Corporation.
Carol M. Meyrowitz became a director in August 2006. Ms. Meyrowitz is currently a Director and President and CEO of The TJX Companies, Inc., where she has had extensive management experience since 1983. Ms. Meyrowitz also serves as a director of Staples, Inc. and is a member of the Board of Overseers for the Joslin Diabetes Center. Ms. Meyrowitz also served on the board of directors of the Yankee Candle Company from 2004 through 2007.
David M. Mussafer has been a member of our Board since August 2008. Mr. Mussafer, a Managing Partner of Advent International, which he joined in 1990, is currently a member of the board of directors of lululemon athletica inc. and several privately held businesses. Mr. Mussafer received a B.S.M. from Tulane University and an M.B.A. from the Wharton School of the University of Pennsylvania.
Board of Directors
The Board of Directors is led by Robert J. Small, a Non-Executive Chairman of the Board, and is comprised of seven additional non-employee directors and two employee directors. The Board of Directors has determined that Jordan A. Kahn and Carol M. Meyrowitz are independent directors, as used in Item 7(d)(iv) of Schedule 14A under the Exchange Act.
The Board of Directors holds regularly scheduled meetings each quarter. In addition to the quarterly meetings, there are typically other scheduled and special meetings annually. At each quarterly meeting, time is set aside for the non-management directors to meet without management present.
Board Leadership Structure
The Company separates the roles of Chief Executive Officer and Chairman of the Board of Directors in recognition of the differences between the two roles. The Chief Executive Officer is responsible for setting the strategic direction for the Company and the day to day leadership and performance of the Company, while the Chairman of the Board of Directors provides guidance to the Chief Executive Officer and sets the agenda for board meetings and presides over meetings of the full Board of Directors. We also believe that separation of the positions creates an environment that is more conducive to objective evaluation and oversight of management’s performance, increasing management accountability and improving the ability of the Board of Directors to monitor whether management’s actions are in the best interests of the Company and its stockholders. Mr. Small, our Chairman of the Board of Directors, presides at all executive sessions of the Board of Directors.
Risk Oversight
The Board of Director’s role in the Company’s risk oversight process includes receiving reports from members of senior management on areas of material risk to the Company, including operational, financial, legal and regulatory, and strategic risks. The full Board of Directors receives these reports to enable it to understand our risk identification, risk management and risk mitigation strategies. While the Audit and Compensation Committees are responsible for evaluating certain risks and overseeing the management of such risks, the entire Board of Directors is informed of such risks at the Board of Directors meeting following a given committee meeting. This enables the Board of Directors and its committees to coordinate the risk oversight role, particularly with respect to risk interrelationships.
Audit Committee
The Audit Committee of the Board of Directors consists of Michael F. Cronin, Chairman, Robert J. Small, Steven J. Collins and James M. Harrison. The Audit Committee is responsible for evaluating and recommending independent auditors, reviewing with the independent auditors the scope and results of the audit engagement and establishing and monitoring the Company’s financial policies and control procedures. The audit committee is governed by a written charter approved by the Board of Directors. There are two regularly scheduled meetings of the Audit Committee and typically other special meetings each year.
As required by SEC rules, the Audit Committee has established procedures for the receipt, retention and treatment of complaints received by the Company regarding accounting, internal accounting controls or auditing matters, as well as the confidential and anonymous submission of information, written or oral, by Company employees regarding questionable accounting or auditing matters. Both our independent auditors and internal financial personnel meet privately with our Audit Committee and have unrestricted access to the Committee.
The Board of Directors has determined that Mr. Harrison has the requisite financial knowledge and experience and qualifies as an “audit committee financial expert” within the meaning of SEC regulations. Because of his role as an executive officer of the Company, Mr. Harrison is not “independent” within the meaning of SEC regulations.
Compensation Committee
The Compensation Committee of the Board of Directors consists of Richard K. Lubin, Chairman, Kevin M. Hayes, Jordan A. Kahn and David M. Mussafer. The Compensation Committee is responsible for setting and administering the Company’s policies that govern executive compensation and for establishing the compensation of the Company’s executive officers. The Compensation Committee is also responsible for the administration of, and grants under, the Company’s equity incentive plan.
Code of Ethics
The Company has adopted a Code of Business Conduct, a copy of which is filed with the Securities and Exchange Commission as an exhibit to this report. The Company’s Code of Business Conduct is a “code of ethics,” as defined in Item 406(b) of Regulation S-K of the Securities and Exchange Commission.
Section 16(a) Beneficial Ownership Reporting Compliance
Because the Company’s common stock is not registered under the Exchange Act, none of the Company’s directors, officers or stockholders is obligated to file reports of beneficial ownership of Company common stock pursuant to Section 16 of the Exchange Act.
Item 11.
Item 11. Executive Compensation
Compensation Discussion and Analysis
This compensation discussion and analysis section is intended to provide information about our compensation objectives and policies for our Chief Executive Officer, our Chief Operating Officer, our Executive Vice President - Retail Operations and our Chief Financial Officer (we refer to these officers as our “named executive officers”) that will place in context the information contained in the tables that follow this discussion.
Compensation Committee
The Compensation Committee of the Board of Directors consists of Richard K. Lubin, Chairman, Kevin M. Hayes, Jordan A. Kahn and David M. Mussafer. The Compensation Committee is responsible for setting and administering the Company’s policies that govern executive compensation and for establishing the compensation of the Company’s executive officers. The Compensation Committee is also responsible for the administration of, and grants under, the Company’s Equity Incentive Plan (as defined hereafter). The Compensation Committee met periodically in 2009, and all members of the Compensation Committee attended each meeting. Our Board of Directors determined that each of these directors is a non-employee director within the meaning of Section 16 of the Securities Exchange Act.
The Compensation Committee has the authority to retain outside independent executive compensation consultants to assist in the evaluation of executive officer compensation and in order to ensure the objectivity and appropriateness of the actions of the Compensation Committee. The Compensation Committee has the sole authority to retain, at our expense, and terminate any such consultant, including sole authority to approve such consultant’s fees and other retention terms. However, all decisions regarding compensation of executive officers are made solely by the Compensation Committee. No independent executive compensation consultants were retained by the Compensation Committee during 2009.
Compensation Philosophy
The executive compensation program of the Company has been designed to motivate, reward, attract, and retain the management deemed essential to ensure the success of the Company. The program seeks to align executive compensation with Company objectives, business strategy, and financial performance. Our Company’s goal is to create a sustainable competitive advantage by achieving higher productivity and lower costs than our competitors. Our compensation objectives at all compensation levels are designed to support this goal by:
•
linking pay to performance to create incentives to perform;
•
ensuring compensation levels and components are actively managed; and
•
using equity compensation to align employees’ long-term interests with those of the stockholders.
Compensation
The Chief Executive Officer evaluates the performance of all executive and senior officers against their established goals and objectives. Annually, the Chief Executive Officer uses the results of these evaluations to determine compensation packages for executive and senior officers to be recommended for approval by the Compensation Committee. The Compensation Committee meets annually, usually in January, to evaluate the performance of the executive and senior officers, and to establish their base salaries, annual cash bonus and share-based incentive compensation to be effective in the first quarter of the current year. The Chief Executive Officer may request a meeting of the Compensation Committee at an interim date to review the compensation package of a named executive or other officer, as the result of unforeseen organizational or responsibility changes, including new hires that occur during the year.
In determining compensation components and levels, the Chief Executive Officer and the Compensation Committee consider the size and responsibility of the officer’s position, the Company’s overall performance, the officer’s overall performance and future potential, the compensation paid by competitors to employees in comparable positions, and the officer’s income potential resulting from common stock acquired and stock options received in prior years.
Our Chief Executive Officer and Chief Operating Officer set salaries and bonus opportunities for employees below the levels of executive and senior officers and make recommendations with respect to equity incentive awards to employees at these levels.
Components of Compensation
The Company’s named executive and other officer compensation includes both short-term and long-term components. Short-term compensation consists of an officer’s annual base salary and annual incentive cash bonus. Long-term compensation may include grants of stock options, restricted stock or other share-based incentives established by the Company, as determined by the Compensation Committee.
Compensation is comprised of the following components:
Base Salary
The base salaries for our officers were determined based on the scope of their responsibilities, taking into account competitive market compensation paid by other companies for similar positions. Generally, we believe that executive base salaries should be targeted near the median of the range of salaries for executives in similar positions and with similar responsibilities. Base salaries will be reviewed annually, and adjusted from time to time to reflect individual responsibilities, performance and experience, as well as market compensation levels.
Annual Cash Bonus Plan
Officers are eligible to receive cash bonuses based on the Company’s actual performance compared to budgeted amounts approved by the Board of Directors on an annual basis. The bonus program focuses on Adjusted EBITDA, as well as the accomplishment of individual goals. Adjusted EBITDA is a non-GAAP measure used internally and is measured by taking net income (loss) from operations and adding back interest charges, income taxes, depreciation and amortization and adjustments for other non-cash or non-recurring transaction. Bonus targets are approved by the Compensation Committee on an annual basis and range between 10% and 100% of the employee’s base salary, based on the employee’s position with the Company, before any adjustments based on actual Adjusted EBITDA achieved or individual performance.
Stock-based Incentive Program
The Company has adopted the AAH Holdings Corporation 2004 Equity Incentive Plan (the “Equity Incentive Plan”) under which the Company may grant incentive awards in the form of options to purchase shares of Company common stock and shares of restricted or unrestricted Company common stock to certain directors, officers, employees and consultants (“Participants”) of the Company and its affiliates. The Compensation Committee is authorized to make grants and various other decisions under the Equity Incentive Plan. Unless otherwise determined by the Compensation Committee, any Participant granted an award under the Equity Incentive Plan must become a party to, and agree to be bound by, the Company’s Stockholders’ Agreement.
The Compensation Committee uses the Equity Incentive Plan as an important component of our overall compensation program due to its effect on retaining key employees, aligning key employees’ financial interests with the interests of shareholders, and rewarding the achievement of the Company’s long-term strategic goals. Common stock options provide our employees with the opportunity to purchase and maintain an equity interest in the Company and to share in the appreciation of the value of our stock.
At December 31, 2009, there are 2,981.07 shares of Company common stock reserved for issuance under the Equity Incentive Plan, which may include restricted and unrestricted common stock awards and basic and performance incentive and nonqualified stock options. The Company’s common stock and stock options are nontransferable (except under certain limited circumstances). Common stock options issued under the plan are issued at the current fair market value on the date of grant. The grant dates for these stock options are the dates the Compensation Committee approves such awards. Common stock options generally vest 20% each year over a five-year period and, unless otherwise determined by the Compensation Committee, have a term of ten years. Upon a Participant’s death or when the Participant’s employment with the Company or the applicable affiliate of the Company is terminated for any reason, such Participant’s previously unvested stock options are forfeited and the Participant or his or her legal representative may, within 60 days (if termination of employment is for any reason other than death) or 90 days (in the case of the Participant’s death), exercise any previously vested Company stock options and in the case of performance options, within 30 days following the date value is determined as specified by the Board in the agreement evidencing the grant of such options.
Unless otherwise provided in the related award agreement or, if applicable, the Stockholders’ Agreement, immediately prior to certain change of control transactions described in the Equity Incentive Plan, all outstanding Company stock options will, subject to certain limitations, become fully exercisable and vested and any restrictions and deferral limitations applicable to any restricted stock awards will lapse.
The Equity Incentive Plan will terminate ten years after its effective date; however, awards outstanding as of such date will not be affected or impaired by such termination. The Company’s Board of Directors and the Compensation Committee has authority to amend the Equity Incentive Plan and awards granted thereunder, subject to the terms of the Equity Incentive Plan.
Other Compensation
Each named executive is eligible to participate in the Company’s benefit plans, such as medical, dental, group life, disability and accidental death and dismemberment insurance. Under our profit sharing plan, our named executive officers and generally all full-time domestic exempt and non-exempt employees who meet certain length-of-service and age requirements, as defined, may contribute a portion of their compensation to the plan on a pre-tax basis and receive a matching contribution ranging from 25% to 100% of the employee contributions, not to exceed a range of 4% to 6% of the employee’s annual salary. In addition our profit-sharing plans provide for annual discretionary contributions to be credited to participants’ accounts. Named executive officers participate in the benefit plans on the same basis as most other Company employees.
The Chief Executive Officer and the Chief Operating Officer drive automobiles owned by the Company. The Chief Financial Officer receives an allowance to cover the cost of his automobile. The annual value of the automobile usage and the allowance are reported as taxable income to the executive. All employees, including the named executives are reimbursed for the cost of business related travel.
Executive officers did not receive any other perquisites or personal benefits or property in 2009.
Accounting and Tax Treatment
Accounting Treatment
The Company accounts for share-based payment awards in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 123(R) or Accounting Standards Codification Subtopic 718, “Share-based Payment Awards,” which requires that all forms of share-based payments to employees, including but not limited to stock options, be treated as compensation expense and recognized in the Company’s consolidated statements of income over the vesting period.
Cash compensation or non-share based compensation, including base salary and incentive compensation, is recorded as an expense in the Company’s consolidated financial statements as it is earned.
Tax Treatment
As the Company’s common stock is not publicly traded, executive compensation is not subject to the provisions of Section 162(m) of the Internal Revenue Code which limit the deductibility of compensation paid to certain individuals to $1,000,000, excluding qualifying incentive-based compensation. However, as part of its role, the Compensation Committee reviews and considers the current and future deductibility of executive compensation. Accordingly, the Company believes that compensation paid to its named executive officers is and will remain fully deductible for federal income tax purposes. However, in certain situations, the Compensation Committee may approve compensation that will not meet these requirements in order to ensure competitive levels of total compensation for its named executive and senior officers. In addition, should executive compensation become non-deductible for income tax purposes, the Compensation Committee may consider revisions to its policies and programs in response to this provision of law.
The following is a general description of the federal income tax consequences to the Participant and the Company with regard to the types of share-based payment awards granted under the Equity Incentive Plan:
Incentive stock-options. There typically will be no federal income tax consequences to the optionee or to the Company upon the grant of an incentive stock option. As discussed subsequently in this paragraph, the exercise of an incentive stock option may result in alternative minimum tax consequences to the optionee. If the optionee holds the option shares for the required holding period of at least two years after the date the option was granted and one year after exercise, the difference between the exercise price and the amount realized upon sale or disposition of the option shares will be long-term capital gain or loss, and the Company will not be entitled to a federal income tax deduction. If the optionee disposes of the option shares in a sale, exchange, or other disqualifying disposition before the required holding period ends, he or she will recognize taxable ordinary income in an amount equal to the excess of the fair market value of the option shares at the time of exercise over the exercise price, and the Company will be allowed a federal income tax deduction equal to such amount. While the exercise of an incentive stock option does not result in current taxable income, the excess of the fair market value of the option shares at the time of exercise over the exercise price will be an item of adjustment for purposes of determining the optionee’s alternative minimum taxable income. Thus, exercise of an incentive stock option may trigger alternative minimum tax.
Non-qualified stock-options. There typically will be no federal income tax consequences to the optionee or to the Company upon the grant of a nonqualified stock option under the Plan. When the optionee exercises a nonqualified option, however, he or she will recognize ordinary income in an amount equal to the excess of the fair market value of the common stock received at the time of exercise over the exercise price, and the Company will be allowed a corresponding deduction, subject to any applicable limitations under the Internal Revenue Code Section 162(m). Any gain that the optionee recognizes when he or she later sells or disposes of the option shares will be short-term or long-term capital gain, depending on how long the shares were held.
Restricted Stock. Unless a participant makes an election to accelerate recognition of the income to the date of grant (as described below), the participant will not recognize income, and the Company will not be allowed a tax deduction, at the time a restricted stock award is granted. When the restrictions lapse, the participant will recognize ordinary income equal to the fair market value of the common stock as of that date (less any amount paid for the stock), and the Company will be allowed a corresponding federal income tax deduction at that time, subject to any applicable limitations under Section 162(m) of the Internal Revenue Code. If the participant files an election under Section 83(b) of the Internal Revenue Code within 30 days of the date of grant of the restricted stock, he or she will recognize ordinary income as of the date of grant equal to the fair market value of the stock as of that date (less any amount paid for the stock), and the Company will be allowed a corresponding federal income tax deduction at that time, subject to any applicable limitations under Section 162(m). Any future appreciation in the stock will be taxable to the participant at capital gains rates. However, if the stock is later forfeited, the participant will not be able to recover the tax previously paid pursuant to a Section 83(b) election.
Report of Compensation Committee on Executive Compensation
The Compensation Committee has reviewed and discussed the “Compensation Discussion and Analysis” required by Item 402(b) of Regulation S-K with management. Based on such review and discussions, the Compensation Committee recommended to the Board of Directors that the “Compensation Discussion and Analysis” be included in this Form 10-K.
Respectfully submitted,
Richard K. Lubin, Chairman
Kevin M. Hayes
Jordan A. Kahn
David M. Mussafer
This Report shall not be deemed to be incorporated by reference by any general statement incorporating this report on Form 10-K into any filing under the Securities Act of 1933, as amended, and shall not otherwise be deemed filed under such statute.
Summary of Compensation Table
(a)
Amounts include executive’s contribution to profit sharing plans
(b)
Represents annual bonuses earned with respect to the years indicated, whether paid or accrued, and, in 2009 and 2008, annual deferred compensation for Messrs. Rittenberg and Harrison of $350,000 and $250,000, respectively.
(c)
The dollar values shown reflect the aggregate grant date fair value of equity awards granted within the year in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification Topic 718 for stock-based compensation (formerly SFAS No. 123(R)). These amounts reflect the total grant date expense for these awards and do not correspond to the actual cash value that will be recognized by each individual when received.
(d)
Represents contributions by the Company under a profit sharing and savings plan, insurance premiums paid by the Company with respect to term life insurance for the benefit of the named executive officer and automobile-related compensation.
Grants of Plan Based Awards
There were no time or performance-based stock option awards granted to the named officers during the year ended December 31, 2009.
Potential Payments upon Change in Control
The employment contracts of Mr. Rittenberg and Mr. Harrison and a severance agreement with Mr. Correale provide for severance benefits upon the involuntary termination of their employment in the event of change of control to help keep them focused on their work responsibilities during the uncertainty that accompanies a change in control, to provide benefits for a period of time after a change in control transaction and to help us attract and retain key talent. Under these agreements, Mr. Rittenberg and Mr. Harrison would receive a minimum of 12 months of compensation and up to 36 months compensation should Mr. Rittenberg or Mr. Harrison be terminated following a change in control or should the Company extend the term of their Restriction Period (as defined hereafter, see “Employment Arrangements”) and Mr. Correale would receive 12 months of compensation.
Options Exercised
There were no time or performance based options exercised by our named executives during the year ended December 31, 2009.
Outstanding Equity Awards
The following table sets forth certain information with respect to outstanding equity awards at December 31, 2009 with respect to the named executive officers.
Director Compensation
Annual Compensation
We have agreed to pay our independent directors an annual retainer fee of $20,000 and fees of $1,500 and $2,500 for regular and special meetings of the Board. We also reimburse our independent directors for customary expenses for attending board and committee meetings. In addition, independent directors were granted 2.5 basic stock options and 2.5 performance stock options during the year they joined the board of directors.
The following table further summarizes the compensation paid to the independent directors for the year ended December 31, 2009.
There were no time or performance based stock option awards granted to our independent directors in during the year ended December 31, 2009.
Directors who are also our employees receive no additional compensation for serving as a director.
Compensation Committee Interlocks and Insider Participation
No interlocking relationship exists between our board of directors or Compensation Committee and the Board of Directors or Compensation Committee of any other company, nor has any interlocking relationship existed in the past.
Employment Arrangements
Employment Agreement with Gerald C. Rittenberg. Gerald C. Rittenberg entered into an employment agreement with us, dated January 1, 2008, which is referred to as the Rittenberg Employment Agreement, pursuant to which Mr. Rittenberg will serve as our Chief Executive Officer through December 31, 2012. During 2009, Mr. Rittenberg received an annual base salary of $1.1 million, which will increase per the terms of the Rittenberg Employment Agreement. Mr. Rittenberg will be eligible for an annual bonus for each calendar year if certain operational and financial targets are attained as determined by both our compensation committee and board of directors in consultation with Mr. Rittenberg. In addition to the annual bonus, Mr. Rittenberg shall be entitled to receive a deferred bonus accruing at a rate of $0.4 million per year, payable on the earlier of the expiration of the Employment Agreement or termination of employment by the Company other than for cause or by Mr. Rittenberg for good reason, as defined in the Rittenberg Employment Agreement. The Rittenberg Employment Agreement also provides for other customary benefits including incentive, savings and retirement plans, paid vacation, health care and life insurance plans and expense reimbursement.
Under the Rittenberg Employment Agreement, if we terminate Mr. Rittenberg’s employment other than for cause, death or disability or Mr. Rittenberg terminates his employment for good reason, we would be obligated to pay Mr. Rittenberg a lump sum cash payment in an amount equal to the sum of (1) accrued unpaid salary, earned but unpaid annual bonus for any prior year and accrued but unpaid vacation pay, collectively referred to as Accrued Obligations, (2) severance pay equal to his annual base salary, provided, however, that in connection with a termination following a change in control, the severance payment shall equal three years salary and, in connection with a termination by us other than for cause or due to his death or disability, such severance pay will be equal to Mr. Rittenberg’s annual base salary multiplied by the number of years we elect as the Restriction Period (as defined hereafter) and (3) an amount equal to the annual bonus which Mr. Rittenberg would otherwise have been entitled to receive for the year in which Mr. Rittenberg is terminated. Upon termination of Mr. Rittenberg’s employment by us for cause, death or disability or if he terminates his employment for other than good reason, Mr. Rittenberg will be entitled to his unpaid Accrued Obligations.
The Rittenberg Employment Agreement also provides that during the term of the agreement and during the three-year period following any termination of his employment, referred to as the Restriction Period, Mr. Rittenberg will not participate in or permit his name to be used or become associated with any person or entity that is or intends to be engaged in any business that is in competition with our business, or any of our subsidiaries or controlled affiliates, in any country in which we or any of our subsidiaries or controlled affiliates operate, compete or are engaged in such business or at such time intend to so operate, compete or become engaged in such business. However, if we terminate Mr. Rittenberg’s employment other than for cause or due to his death or disability, the Restriction Period will be instead a one, two or three-year period at our election. If all, or substantially all, of our stock or assets is sold or otherwise disposed of to a third party not affiliated with us and Mr. Rittenberg is not offered employment on substantially similar terms by us or by one of our continuing affiliates immediately thereafter, then for all purposes of the Rittenberg Employment Agreement, Mr. Rittenberg’s employment shall be deemed to have been terminated by us other than for cause effective as of the date of such sale or disposition, provided, however, that we shall have no obligations to Mr. Rittenberg if he is hired or offered employment on substantially similar terms by the purchaser of our stock or assets. The Rittenberg Employment Agreement also provides for certain other restrictions during the Restriction Period in connection with (a) the solicitation of persons or entities with whom we have business relationships and (b) inducing any of our employees to terminate their employment or offering employment to such persons, in each case subject to certain conditions.
Employment Agreement with James M. Harrison. James M. Harrison entered into an employment agreement with us, dated January 1, 2008, which is referred to as the Harrison Employment Agreement, pursuant to which Mr. Harrison would serve as our President through December 31, 2012. During 2009, Mr. Harrison received an annual base salary of $0.9 million, which will increase per the terms of the Harrison Employment Agreement. The Harrison Employment Agreement contains provisions for deferred bonus payments (accruing at an annual rate of $0.3 million) annual bonus payments, severance, other benefits and provisions for non-competition and non-solicitation similar to those in the Rittenberg Employment Agreement.
Employment Agreement with Michael D. Heller. Michael D. Heller entered into an employment agreement with us, dated December 2, 2008, which is referred to as the Heller Employment Agreement, pursuant to which Mr. Heller would serve as our Executive Vice President - Retail Operation, through November 2, 2010. During 2009, Mr. Heller received
an annual base salary of $0.5 million, which will increase per the terms of the Heller Employment Agreement. The Heller Employment Agreement contains provisions for annual bonus payments, severance, other benefits and provisions for non-competition and non-solicitation similar to those in the Rittenberg Employment Agreement. However, provisions for severance, non-competition and non-solicitation are limited to a one year period
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
As of December 31, 2009, the issued and outstanding capital stock of AAH consisted of 30,819.36 shares of common stock, par value $.01 per share. The number of shares of AAH common stock outstanding used in calculating the percentage for each listed person includes the shares of AAH common stock underlying the options beneficially owned by that person that are exercisable within 60 days following December 31, 2009. The stockholders agreement of AAH governs the stockholders’ exercise of their voting rights with respect to the election of directors and other material events. See “Certain Relationships and Related Transactions.”
The following table sets forth information with respect to the beneficial ownership of AAH common stock as of March 31, 2010 (i) by each person known by us to own beneficially more than 5% of such class of securities, (ii) by each director and named executive officer and (iii) by all directors and executive officers as a group. Unless otherwise noted, to our knowledge, each of such stockholders has sole voting and investment power as to the shares shown.
Stockholders Agreement
The Company maintains a stockholders’ agreement with the Principal Investors, other investors and certain employees of the Company listed as parties thereto (the “Stockholders’ Agreement”). The following discussion summarizes the terms of the Stockholders’ Agreement, as amended, which the Company believes are material to an investor in the debt or equity securities of the Company. The Stockholders’ Agreement provides, among other things, for (i) the right of the non-principal investors to participate in, and the right of the Principal Investors to require the non-principal investors to participate in, certain sales of the Company’s common stock by the Principal Investors, (ii) prior to an initial public offering of the stock of the Company (as defined in the Stockholders’ Agreement), certain rights of the Company to purchase, and certain rights of the non-principal investors to require the Company to purchase (except in the case of termination of employment by such non-principal investors) all, but not less than all, of the shares of the Company’s common stock owned by a non-principal investor upon the termination of employment or death of such non-principal investor, at prices determined in accordance with the Stockholders’ Agreement and (iii) certain additional restrictions on the rights of the non-principal investors to transfer shares of the Company’s common stock. The Stockholders’ Agreement also contains certain provisions granting the Principal Investors and the non-principal investors certain rights in connection with the private sale or public registrations of the Company’s common stock and provides for indemnification and certain other rights, restrictions and obligations in connection with such registrations.
For information concerning our equity compensation plan, see “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”
Item 13.
Item 13. Certain Relationships and Related Transactions
The Company executed a management agreement with Berkshire Partners LLC and Weston Presidio, pursuant to which Berkshire Partners LLC and Weston Presidio will be paid annual management fees of $0.8 million and $0.4 million, respectively. At December 31, 2009, accrued management fees payable to Berkshire Partners LLC and Weston Presidio totaled $0.1 million and $0.1 million, respectively. Although the indenture governing the 8.75% senior subordinated notes
will permit the payments under the management agreement, such payments will be restricted during an event of default under the notes and will be subordinated in right of payment to all obligations due with respect to the notes in the event of a bankruptcy or similar proceeding of the Company.
Item 14.
Item 14. Principal Accountant Fees and Services
Audit Fees
Fees for audit services totaled $1.7 million and $1.8 million for the years ended December 31, 2009 and 2008, respectively. These fees included the audit of the consolidated financial statements; reviews of financial statements included in the Company’s Quarterly Reports on Form 10-Q; assistance with SEC filings, including comfort letters, consents and comment letters; and accounting consultations on matters addressed during the audit or interim reviews.
Audit-Related Fees
Fees for audit-related services totaled $0.1 million and $0.1 million for the years ended December 31, 2009 and 2008, respectively. Such fees related to the audits of the Company’s employee benefit plans; due diligence services; statutory audits incremental to the audit of the consolidated financial statements.
Tax Fees
Fees for tax services, including tax compliance, tax advice and tax planning, totaled $0.5 million for each of the years ended December 31, 2009 and 2008.
All Other Fees
The Company paid minimal subscription fees for access to the Ernst & Young Global Accounting and Auditing Information Tool.
The Company’s Audit Committee appoints the independent registered public accounting firm and pre-approves the fee arrangements with respect to the above accounting fees and services.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) Documents filed as part of this report:
1. and 2. Financial Statements and Schedule.
See Index to Consolidated Financial Statements and Financial Statement Schedule which appears on page herein.
3. Exhibits
Supplemental Information to be Furnished with Reports Filed Pursuant to
Section 15(d) of the Act by Registrants Which Have Not Registered Securities Pursuant to Section 12 of the Act.
The Company will not send to its security holders an annual report for the year ended December 31, 2009.
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.
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 in the capacities and on the dates indicated.
AMSCAN HOLDINGS, INC.
FORM 10-K
Item 8, Item 15(a) 1 and 2
AMSCAN HOLDINGS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2009 and 2008
Consolidated Statements of Income for the Years Ended December 31, 2009, 2008 and 2007
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2009, 2008 and 2007
Consolidated Statements of Cash Flows for the Years Ended December 31, 2009, 2008 and 2007
Notes to Consolidated Financial Statements
Financial Statement Schedule for the Years Ended December 31, 2009, 2008 and 2007:
Schedule II - Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission (“SEC”) are not required under the related instructions or are inapplicable and therefore have been omitted.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Amscan Holdings, Inc.
We have audited the accompanying consolidated balance sheets of Amscan Holdings, Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Amscan Holdings, Inc. and subsidiaries at December 31, 2009 and 2008, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
New York, New York
March 31, 2010
AMSCAN HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
AMSCAN HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Thousands)
See accompanying notes to consolidated financial statements.
AMSCAN HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2007, 2008 and 2009
(Dollars in Thousands)
See accompanying notes to consolidated financial statements.
AMSCAN HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Supplemental information on non-cash activities:
Capital lease obligations of $59, $700, and $9,203 were incurred during the years ended December 31, 2009, 2008 and 2007, respectively.
See accompanying notes to consolidated financial statements.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share)
Note 1 - Organization and Description of Business
Amscan Holdings, Inc. (“Amscan” or the “Company”) designs, manufactures, contracts for manufacture and distributes party goods, including paper and plastic tableware, metallic balloons, accessories, novelties, gifts and stationery throughout the world. In addition, the Company operates specialty retail party goods and social expressions supply stores in the United States under the names Party City, Party America, The Paper Factory, Halloween USA and Factory Card & Party Outlet and franchises both individual stores and franchise areas throughout the United States and Puerto Rico principally under the names Party City and Party America. The Company is a wholly-owned subsidiary of AAH Holdings Corporation. (“AAH”).
Note 2 - Summary of Significant Accounting Policies
Consolidated Financial Statements
The consolidated financial statements of the Company include the accounts of Amscan and all majority-owned subsidiaries and controlled entities. All significant intercompany balances and transactions have been eliminated.
Retail operations define a fiscal year (“Fiscal Year”) as the 52-week period or 53-week period ended on the Saturday nearest December 31st of each year, and define their fiscal quarters (“Fiscal Quarter”) as the four interim 13-week periods following the end of the previous Fiscal Year, except in the case of a 53-week Fiscal Year when the fourth Fiscal Quarter is extended to 14 weeks.
The Company has determined the difference between the retail operation’s Fiscal Year and Fiscal Quarters and the calendar year and quarters to be insignificant, and will be reconciled in the financial consolidation process.
Use of Estimates
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Management periodically evaluates estimates used in the preparation of the consolidated financial statements for continued reasonableness. Appropriate adjustments, if any, to the estimates used are made prospectively based on such periodic evaluations.
Cash Equivalents
Highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents.
Inventories
Inventories are valued at the lower of cost or market. The Company determines the cost of inventory at its retail stores using the weighted average method. All other inventory cost is determined using the first-in, first-out method.
The Company estimates retail inventory shortage for the period between physical inventory dates on a store-by-store basis. Inventory shrinkage estimates are affected by changes in merchandise mix and changes in actual shortage trends. The shrinkage rate from the most recent physical inventory, in combination with historical experience, is the basis for estimating shrinkage.
Allowance for Doubtful Accounts
The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of the Company’s customers to make required payments. A considerable amount of judgment is required in assessing the ultimate realization of these receivables including consideration of the Company’s history of receivable write-offs, the level of past due accounts and the economic status of our customers. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
Long-Lived and Intangible Assets
Property, plant and equipment are stated at cost. Depreciation is calculated principally on the straight-line method over the estimated useful lives of the assets. Equipment under capital leases are stated at the present value of the minimum lease payments at the inception of the lease. Equipment under capital leases and leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or the estimated useful life of the asset.
Goodwill represents the excess of the purchase price of acquired companies over the estimated fair value of the net assets acquired. Goodwill and other intangibles with indefinite lives are not amortized but are reviewed for impairment annually or more frequently if certain indicators arise. The Company evaluates the goodwill associated with its acquisitions and other intangibles with indefinite lives as of the first day of its fourth quarter based on current and projected performance. The Company estimates fair value of each reporting unit using expected discounted cash flows. The Company completed its review and determined that goodwill and other intangible assets with indefinite lives were not impaired.
The Company evaluates finite-lived assets in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets” (“SFAS No. 144”). Finite-lived assets are evaluated for recoverability whenever events or changes in circumstances indicate that an asset may have been impaired. In evaluating an asset for recoverability, the Company estimates the future cash flows expected to result from the use of the asset and eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss, equal to the excess of the carrying amount over the fair market value of the asset, is recognized.
Deferred Financing Costs
Deferred financing costs are amortized to interest expense using the effective interest method over the lives of the related debt.
Investments
In December 2003, the Company exchanged 50.1% of the common stock of a wholly-owned subsidiary for the balloon assets of a competitor. Following the exchange, the entity, Convergram Mexico, operates as a joint venture distributing metallic balloons principally in Mexico and Latin America. The Company accounts for its investment in the joint venture using the equity method. The Company’s investment in the joint venture is included in other assets on the consolidated balance sheet and the results of the joint venture’s operations are included in other (income) expense on the statement of income (also separately disclosed in Note 13).
Insurance Accruals
The Company maintains certain self-insured workers’ compensation and general liability insurance plans. The Company estimates the required liability for claims under such plans based upon various assumptions, which include, but are not limited to, our historical loss experience, projected loss development factors, actual payroll and other data. The required liability is also subject to adjustment in the future based upon the changes in claims experience, including changes in the number of incidents (frequency) and changes in the ultimate cost per incident (severity).
Revenue Recognition
The Company’s terms of sale to retailers and other distributors are generally F.O.B. shipping point and, accordingly, title and the risks and rewards of ownership are generally transferred to the customer, and revenue is recognized, when goods are shipped. The Company estimates reductions to revenues for volume-based rebate programs at the time sales are recognized.
Revenue from retail operations is recognized at the point of sale. The Company estimates future retail sales returns and records a provision in the period that the related sales are recorded based on historical information. Retail sales are reported net of taxes collected.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
Shipping and Handling
Outbound shipping costs billed to customers are included in net sales. The costs of shipping and handling incurred by the Company are included in cost of sales.
Store Closure Costs
The Company records estimated store closure costs, estimated lease commitment costs, net of estimated sublease income, and other miscellaneous store closing costs when the liability is incurred. A liability is incurred when it becomes probable that the Company is legally obligated for these closure costs.
Product Royalty Agreements
The Company enters into product royalty agreements that allow the Company to use licensed designs on certain of its products. These contracts require the Company to pay royalties, generally based on the sales of such product, and may require guaranteed minimum royalties, a portion of which may be paid in advance. The Company matches royalty expense with revenue by recording royalties at the time of sale, at the greater of the contractual rate or an effective rate calculated based on the guaranteed minimum royalty and the Company’s estimate of sales during the contract period. If a portion of the guaranteed minimum royalty is determined to be unrecoverable, the unrecoverable portion is charged to expense at that time. Guaranteed minimum royalties paid in advance are recorded in the consolidated balance sheets as other assets.
Catalogue Costs
The Company expenses costs associated with the production of catalogues when incurred.
Art and Development Costs
Art and development costs are primarily internal costs that are not easily associated with specific designs, some of which may not reach commercial production. Accordingly, the Company expenses these costs as incurred.
Derivative Financial Instruments
The Company accounts for derivative financial instruments pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 133 or Accounting Standards Codification Subtopic 815, “Accounting for Derivative Instruments and Hedging Activities.” Accounting Standards Codification or ASC Subtopic 815 (SFAS No. 133), as amended and interpreted, requires that all derivative financial instruments be recognized on the balance sheet at fair value and establishes criteria for both the designation and effectiveness of hedging activities. The Company uses derivatives in the management of interest rate and foreign currency exposure. ASC Subtopic 815 (SFAS No. 133) requires the Company to formally document the assets, liabilities or other transactions the Company designates as hedged items, the risk being hedged and the relationship between the hedged items and the hedging instruments. The Company must measure the effectiveness of the hedging relationship at the inception of the hedge and on an on-going basis.
If derivative financial instruments qualify as fair value hedges, the gain or loss on the instrument and the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings during the period of the change in fair values. For derivative financial instruments that qualify as cash flow hedges (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The ineffective portion of a cash flow hedge, if any, is determined based on the dollar-offset method (i.e., the gain or loss on the derivative financial instrument in excess of the cumulative change in the present value of future cash flows of the hedged item) and is recognized in current earnings during the period of change. As long as hedge effectiveness is maintained, interest rate swap arrangements and foreign currency exchange agreements qualify for hedge accounting as cash flow hedges (see Note 21.)
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
Income Taxes
The Company accounts for income taxes in accordance with the provisions of Accounting Standards Codification Subtopic 740 (SFAS No. 109), “Accounting for Income Taxes.” Under the asset and liability method of ASC Subtopic 740, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities and operating loss and tax credit carryforwards applying enacted statutory tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance when, in the judgment of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Stock-Based Compensation
On January 1, 2006, the Company adopted Accounting Standard Codification or ASC Subtopic 718 (SFAS No. 123(R)) “Share-Based Payment,” which is a revision of SFAS No. 123 “Accounting for Stock-Based Compensation” as amended. ASC Subtopic 718 (SFAS No. 123(R)) establishes standards for the accounting for transactions where an entity exchanges its equity for goods or services and transactions that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. ASC Subtopic 718 (SFAS No. 123(R)) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. Generally, the fair value approach in ASC Subtopic 718 (SFAS No. 123(R)) is similar to the fair value approach described in SFAS No. 123.
The Company adopted ASC Subtopic 718 (SFAS No. 123(R)) using the prospective method. Since the Company’s common stock is not publicly traded, the options granted prior to January 1, 2006 continue to be expensed under the provisions of SFAS No. 123 using a minimum value method. Options issued subsequent to January 1, 2006 are expensed under the provisions of ASC Subtopic 718 (SFAS No. 123(R)) (see Note 15).
Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) at December 31, 2009 and 2008 consisted of the Company’s foreign currency translation adjustment and the fair value of interest rate swap and foreign exchange contracts, net of income taxes, that qualify as hedges (see Notes 20 and 21).
Foreign Currency Transactions and Translation
The functional currencies of the Company’s foreign operations are the local currencies in which they operate. Realized foreign currency exchange gains or losses resulting from the settlement of receivables or payables in currencies other than the functional currencies are credited or charged to operations. Unrealized gains or losses on foreign currency transactions are insignificant. The balance sheets of foreign subsidiaries are translated into U.S. dollars at the exchange rates in effect on the balance sheet date. The results of operations of foreign subsidiaries are translated into U.S. dollars at the average exchange rates effective for the periods presented. The differences from historical exchange rates are recorded as comprehensive income (loss) and are included as a component of accumulated other comprehensive income (loss).
Recently Issued Accounting Standards
Implemented:
Effective in the third quarter 2009, the Company adopted ASC 105 Generally Accepted Accounting Standards which became the single source for all authoritative generally accepted accounting principles, or GAAP, recognized by the FASB. ASC 105 does not change GAAP and did not impact the Company’s results of operations, cash flows or financial position. Subsequent revisions to GAAP will be incorporated into the ASC through issuance of Accounting Standards Updates (“ASU”).
Effective January 1, 2009, the Company adopted an amendment to ASC 810 Consolidation which changes presentation of the financial statements. This standard governs the accounting for, and reporting of, noncontrolling interests in partially owned consolidated subsidiaries and the loss of control of subsidiaries. The standard requires that: (i) noncontrolling interest, previously referred to as minority interest, be reported as part of equity in the consolidated financial statements; (ii) losses be allocated to a noncontrolling interest even when such allocation might result in a deficit balance, reducing the losses attributed to the controlling interest; (iii) changes in ownership interests be treated as equity transactions if control is maintained; (iv) changes in ownership interests resulting in gain or loss be recognized in earnings if control is gained or lost; and (v) in a business combination the noncontrolling interest’s share of net assets acquired be recorded at the fair value, plus its share of goodwill. The Company’s consolidated balance sheet as of December 31, 2009 and 2008 and consolidated statements of income, stockholders’ equity and cash flow for each of the three years in the period ended December 31, 2009, have been retrospectively adjusted upon application of the standard.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
During the second quarter of 2009, the Company adopted ASC 855 Subsequent Events which (i) incorporates the principles and accounting guidance for recognizing and disclosing subsequent events that originated as auditing standards into the body of authoritative literature issued by the FASB and also (ii) prescribes disclosure regarding the date through which subsequent events have been evaluated. In February 2010, the FASB amended this new standard to eliminate the disclosure requirement regarding the date through which subsequent events have been evaluated. As the new standard was not intended to significantly change the current practice of reporting subsequent events, it did not have an impact on our results of operations, cash flows or financial positions. Refer to Note 23.
Effective January 1, 2009, the Company adopted ASC 815 Derivatives and Hedging which enhanced disclosures about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for and (iii) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. The adoption of ASC 815 did not have a financial impact on the Company’s financial statements.
Effective January 1, 2009, the Company adopted an amendment to ASC 805 Business Combinations which significantly changes the accounting for business acquisitions both during the period of the acquisition and in subsequent periods. These amendments will be considered for all business combinations completed subsequent to the adoption date (none in 2009). Among the more significant changes:
•
Acquired in-process research and development, which was previously expensed at acquisition, is now accounted for as an asset, with the cost recognized as the research and development is realized or abandoned.
•
Contingent consideration, which was previously accounted for as a subsequent adjustment to purchase price, is now recorded at fair value as an element of purchase price with subsequent adjustments recognized in operations.
•
Subsequent decreases in valuation allowances on acquired deferred tax assets are recognized in operations after the measurement period. Such changes were previously considered to be subsequent changes in consideration and were recorded as decreases in goodwill.
•
Transaction costs, which were previously treated as costs of the acquisition, are now expensed.
•
Upon gaining control of an entity in which the equity method or cost basis investment was held, the carrying value of that investment is adjusted to fair value with the related gain or loss recorded in earnings. Previously, this fair value adjustment would not have been made.
•
Effective January 1, 2009, the Company retrospectively adopted an amendment to ASC 805 released in April 2009. The amendment requires pre-acquisition contingencies to be recognized at fair value, if fair value can be determined or reasonably estimated during the measurement period. If fair value cannot be determined or reasonably estimated, the standard requires measurement based on the recognition and measurement criteria of ASC 450 Contingencies.
The Company adopted ASC 820 Fair Value Measurement and Disclosure in two steps: Effective January 1, 2008, the Company adopted it for all financial instruments and non-financial instruments accounted for at fair value on a recurring basis. Effective January 1, 2009, the Company adopted it for all non-financial instruments accounted for at fair value on a non-recurring basis. This standard also establishes a new framework for measuring fair value and expands related disclosures. Refer to Note 20.
Not Yet Implemented:
The Company is currently evaluating all applicable outstanding ASU’s and does not believe any will have a material impact on the consolidated financial statements.
Note 3 - Inventories
Inventories consisted of the following:
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
Note 4 - Property, Plant and Equipment, Net
Property, plant and equipment, net consisted of the following:
Depreciation and amortization expense related to property, plant and equipment was $37,823, $38,696, and $31,530 for the years ended December 31, 2009, 2008 and 2007, respectively.
The Company is obligated under various capital leases for certain machinery and equipment which expire on various dates through 2013 (see Note 8). The amount of machinery and equipment and related accumulated amortization recorded under capital leases and included within property, plant and equipment, net consisted of the following:
Amortization of assets held under capitalized leases is included in depreciation and amortization expense.
Note 5 - Retail Acquisitions and Transactions
The Factory Card & Party Outlet Acquisition
On the Factory Card & Party Outlet Acquisition Date, the Company completed its acquisition of FCPO, in accordance with the terms of the Agreement and Plan of Merger, dated as of September 17, 2007 (the “Factory Card & Party Outlet Merger Agreement”). FCPO common stock was suspended from trading on the Nasdaq Global Market as of the close of trading on November 16, 2007. The merger followed tender offer for all of the outstanding shares of FCPO common stock by the Company. As a result of the merger, FCPO is a wholly-owned subsidiary of the Company, and each remaining outstanding share of FCPO common stock was converted into the right to receive $16.50 per share, net to the seller in cash.
The excess of the FCPO purchase price over the tangible net assets acquired has been allocated to intangible assets consisting of trade names ($27,400) and goodwill ($14,100), which are not being amortized, and net deferred tax liabilities ($12,900). In addition, assets acquired totaled $70,100, including an allocation to recognize below-market leases ($1,400) and to adjust property, plant and equipment to market value ($7,100). Liabilities assumed totaled $41,800.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
Party City Franchise Group Transaction
Party City Corporation (“Party City”), a wholly-owned subsidiary of the Company, completed the acquisition of new stores from franchisees in a series of transactions involving Party City, Party City Franchise Group Holdings, LLC (“PCFG Holdings”), a majority owned subsidiary of Party City, and Party City Franchise Group, LLC (“PCFG”), a wholly-owned subsidiary of PCFG Holdings on November 2, 2007 (“Party City Franchise Group Transaction Date”). Party City contributed cash and 11 of its corporate retail stores located in Florida to PCFG Holdings. In addition, PCFG Holdings and PCFG acquired 55 retail stores located in Florida and Georgia from franchisees. PCFG operates the acquired 66 stores in the Florida and Georgia regions.
The franchisee sellers received approximately $43,000 in cash and, in certain instances, equity interests in PCFG Holdings in exchange for the retail stores. The acquisitions were financed through the combination of cash contributed by Party City, borrowings under the Company’s existing credit facility and a new credit facility entered into by PCFG (see Note 7) and equity issued in exchange for certain stores. PCFG and PCFG Holdings are unrestricted subsidiaries under the Company’s existing debt facilities and the new PCFG credit facility is a stand-alone facility which is not guaranteed by the Company or its other subsidiaries.
The excess of the PCFG purchase price over the tangible net assets acquired has been allocated to intangible assets consisting of goodwill ($30,300), which is not being amortized and franchise rights ($28,400), which are amortized over 20 years. In addition, assets acquired totaled $37,700 and liabilities assumed were $24,800.
On December 30, 2008, the Company acquired the PCFG Holdings equity held by the two former franchisees, in exchange for total consideration of $15,444 which included cash of $500 and warrants to purchase 544.75 shares of AAH common stock at $0.01 per share. The Company has allocated the purchase price to the fair value of net assets, which resulted in an additional $558 charge to goodwill. As the AAH stock underlying the warrants and the PCFG equity previously held by the two former franchisees could be put back to the Company in certain instances, per the terms of the Company and PCFG shareholders agreements, the warrants and PCFG equity are classified as redeemable common securities in the Company’s consolidated balance sheets at December 31, 2009 and 2008, respectively.
Note 6 - Other Intangible Assets, net
The Company had the following balances of other identifiable intangible assets as a result of various acquisitions:
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
The amortization expense for finite-lived intangible assets for the years ended December 31, 2009, 2008, and 2007 was $6,559, $8,582, and $6,563, respectively. Estimated amortization expense for each of the next five years will be approximately $6,722, $6,715, $6,590, $6,518, and $6,186, respectively.
During the fourth quarter of 2008, the Company instituted a program to convert its company-owned and franchised Party America stores to Party City stores and recorded a $17,376 charge for the impairment of the Party America trade name.
Note 7 - Loans and Notes Payable
On May 25, 2007, the Company and AAH entered into (i) a Term Loan Credit Agreement (the “Term Loan Credit Agreement”) to borrow $375,000 and (ii) an ABL Credit Agreement (the “ABL Credit Agreement”) to borrow up to $250,000, as amended, for working capital and general corporate purposes.
On November 2, 2007, PCFG entered into a Credit Agreement (the “PCFG Credit Agreement”) to borrow $30,000 in term loans (“PCFG Term Loan Agreement”) and up to $10,000, as amended, for working capital and general corporate purposes (“PCFG Revolver”).
Below is a discussion of the Company’s ABL Credit Agreement and the PCFG Credit Agreement. See Note 8 for discussion of the Company’s Term Loan Credit Agreement.
ABL Credit Agreement -
The Company has a committed revolving credit facility in an aggregate principal amount of up to $250,000 for working capital, general corporate purposes and the issuance of letters of credit. The ABL Credit Agreement provides for (a) extension of credit in the form of Revolving Loans at any time and from time to time during the period ending May 25, 2012 (the “Availability Period”), in an aggregate principal amount at any time outstanding not in excess of $250,000, subject to the borrowing base described below, (b) commitments to obtain credit, at any time and from time to time during the Availability Period, in the form of Swing Line Loans, in an aggregate principal amount at any time outstanding not in excess of $10,000 and (c) ability to utilize Letters of Credit, in an aggregate face amount at any time outstanding not in excess of $25,000 to support payment obligations incurred in the ordinary course of business by the Company and its subsidiaries.
The borrowing base at any time equals (a) 85% of eligible trade receivables, plus (b) the lesser of (i) 75% of eligible inventory and eligible in-transit inventory, valued at the lower of cost or market value, and (ii) 85% of net orderly liquidation value of eligible inventory and eligible in transit inventory (subject, in the case of eligible in-transit inventory, to a cap of $10,000) , plus (c) 85% of eligible credit card receivables, less (d) certain reserves.
The ABL Credit Agreement provides for two pricing options: (i) an alternate base rate (“ABR”) equal to the greater of (a) Credit Suisse’s prime rate in effect on such day and (b) the federal funds effective rate in effect on such day plus 1/2 of 1% or (ii) a LIBOR rate determined by reference to the cost of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, in each case plus an applicable margin. The applicable margin is up to 0.50% with respect to ABR borrowings and from 1.00% to 1.50% with respect to LIBOR borrowings.
In addition to paying interest on outstanding principal under the ABL Credit Agreement, the Company is required to pay a commitment fee of between 0.30% and 0.25% per annum in respect of the unutilized commitments thereunder. The Company must also pay customary letter of credit fees and agency fees.
Upon prior notice, the Company may prepay any borrowing under the ABL Credit Agreement, in whole or in part, without premium or penalty other than customary “breakage” costs with respect to LIBOR loans.
There is no scheduled amortization under the ABL Credit Agreement. The principal amount outstanding of the loans under the ABL Credit Agreement is due and payable in full on the fifth anniversary of the closing date.
The obligations of the Company under the ABL Credit Agreement are jointly and severally guaranteed by AAH and each wholly-owned domestic subsidiary of the Company. Each guarantor has secured its obligations under the guaranty by a first priority lien on its accounts receivable and inventories and a second priority lien on substantially all of its other assets.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
On November 2, 2007, the Company entered into an amendment to its ABL credit facility with the lenders party thereto. The Amendment increased the aggregate commitments of the lenders under the ABL Credit Agreement by $50,000 to $250,000. Borrowings under the ABL Credit Agreement continue to be subject to the borrowing base and affirmative and negative covenants and events of default that are substantially similar to the Term Loan Credit Agreement. In addition, the Amendment modifies the ABL Credit Agreement by providing that the Company must maintain a Fixed Charge Coverage Ratio, as defined, of not less than 1.0 to 1.0 if it has less than $25,000 of excess availability under the ABL Credit Agreement.
At December 31, 2009, borrowings under the ABL Credit Agreement were $76,990, and outstanding standby letters of credit totaled $11,587.
PCFG Credit Agreement
On November 2, 2007, PCFG entered into a Credit Agreement (the “PCFG Credit Agreement”), among PCFG, CIT Group/Business Credit, Inc., as Administrative Agent and Collateral Agent, Newstar Financial, Inc., as Syndication Agent, CIT Capital Securities LLC, as Sole Arranger, and the Lenders party thereto. PCFG and Party City Franchise Group Holdings, LLC (“PCFG Holdings”), the sole member of PCFG have been designated by the Board of Directors of the Company as “Unrestricted Subsidiaries” pursuant to the Company’s existing ABL Credit Agreement, and the indenture governing its 8.75% Senior Subordinated Notes and neither PCFG nor PCFG Holdings guaranty any of the Company’s other credit facilities or indenture. In addition, PCFG’s credit facility is a stand-alone facility for PCFG and is not guaranteed by the Company or its other subsidiaries.
Pursuant to the PCFG Credit Agreement, PCFG borrowed $30,000 in term loans (“PCFG Term Loan”) and obtained a committed revolving credit facility in an aggregate principal amount of up to $10,000 for working capital and general corporate purposes and the issuance of letters of credit (of up to $5,000 at any time outstanding) (“PCFG Revolver”). At December 31, 2009, the balance of the term loan was $23,000 and borrowings under the PCFG Revolver were $645. There were no outstanding letters of credit at December 31, 2009.
At December 31, 2008, PCFG had not been in compliance with the financial covenants contained in the PCFG Credit Agreement. Effective September 30, 2009, PCFG and its lenders entered into a Waiver and Amendment Agreement which provided that, among other things, (1) interest would be accrued prospectively at either (i) for ABR borrowings, the Alternate Base Rate plus 6.00%, with a floor of 4.00% for the Alternate Base Rate or (ii) the Adjusted LIBO Rate plus 7.00% with a floor of 3.00% for the Adjusted LIBO Rate, (2) PCFG would pay an additional $1,500 in principal on the Term Loans at the effective date of the waiver and amendment , and thereafter the quarterly amortization payment for the Term Loans would be $1,000 each quarter until Maturity Date, (3) the PCFG Revolver would be limited to a maximum of $10,000, and (4) financials covenants related to leverage ratio, fixed charge coverage ratio, minimum EBITDA, and maximum capital expenditures, were revised.
Under the terms of our other indebtedness, PCFG is an unrestricted subsidiary and the acceleration of our obligation under the PCFG Term Loan would not constitute an event of default under our other debt instruments.
Other Credit Agreements
In addition to the Term Loan Credit Agreement, the ABL Credit Agreement and the PCFG Credit Agreement, at December 31, 2009, we have a 400 Canadian dollar denominated revolving credit facility which bears interest at the Canadian prime rate plus 1.1% and expires in April 2010, and a 1,400 British Pound Sterling denominated revolving credit facility which bears interest at the UK base rate plus 1.75% on the first 1,000 British Pound Sterling and 4.75% over the UK base rate on the remaining 400 British Pound Sterling. The UK credit facility expires on June 30, 2010. We expect to renew these revolving credit facilities upon expiration.
Borrowings under the British Pound Sterling revolving credit facility at December 31, 2009 totaled 357 British Pound Sterling. There were no borrowings under the British Pound Sterling revolving credit facility at December 31, 2008 nor under the Canadian dollar denominated revolving credit facility at December 31, 2009 and 2008.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
Note 8 - Long-Term Obligations
Long-term obligations consisted of the following:
(a) On May 25, 2007, the Company, a wholly owned subsidiary of AAH , and AAH, entered into (i) a $375,000 Term Loan Credit Agreement, and (ii) an ABL Credit Agreement (see Note 7), and used the proceeds to refinance certain existing indebtedness and to pay transactions costs.
The Term Loan Credit Agreement provides for two pricing options: (i) an ABR equal to the greater of (a) Credit Suisse’s prime rate in effect on such day and (b) the federal funds effective rate in effect on such day plus 1/2 of 1% or (ii) a LIBOR rate determined by reference to the cost of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, in each case plus an applicable margin. The applicable margin is 1.25% with respect to ABR borrowings and 2.25% with respect to LIBOR borrowings.
The term loans may be prepaid at any time and are subject to mandatory prepayment out of (i) 100% of net proceeds arising from asset sales, insurance and condemnation proceeds, subject to reinvestment provisions, (ii) 50% of net proceeds arising from certain equity issuances by the Company or its subsidiaries (which percentage will be reduced to 25% or 0% if the Company’s total leverage ratio is less than specified ratios), (iii) net proceeds arising from any debt issued by the Company or its subsidiaries and (iv) 50% (which percentage will be reduced to 25% or 0% if the Company’s total leverage ratio is less than specified ratios) of the Company’s Excess Cash Flow, as defined.
The Company is required to repay installments on the term loans in quarterly principal amounts of 0.25% of their funded total principal amount, beginning September 30, 2007 and ending March 31, 2013, with the remaining amount payable on the maturity date of May 25, 2013.
The obligations of the Company under the Term Loan Credit Agreement are jointly and severally guaranteed by AAH and each wholly-owned domestic subsidiary of the Company. Each guarantor has secured its obligations under the guaranty by a first priority lien on substantially all of the Company’s assets, with the exception of accounts receivable and inventories, which are under a second priority lien.
The Company may, by written notice to the Administrative Agent from time to time, request additional incremental term loans, in an aggregate amount not to exceed $100,000 from one or more lenders (which may include any existing Lender) willing to provide such additional incremental term loans in their own discretion.
The Term Loan Credit Agreement contains a number of covenants that, among other things, restrict, subject to certain exceptions, the ability of the Company and its Subsidiaries to incur additional indebtedness; create, incur or suffer to exist liens on any of their property or assets; make investments or enter into joint venture arrangements; pay dividends and distributions or repurchase capital stock of the Company; engage in mergers, consolidations and sales of all or substantially all their assets; sell assets; make capital expenditures; enter into agreements restricting dividends and advances by the Company’s subsidiaries; and engage in transactions with affiliates.
The Term Loan Credit Agreement also contains certain customary affirmative covenants and events of default.
At December 31, 2009 and 2008, the balance of the Term Loans was $364,688 and $368,437, respectively.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
(b) At December 31, 2009 and 2008, the balance of the PCFG Term Loans was $23,000 and $27,500, respectively. There were $645 of borrowings outstanding under the PCFG Revolver and no outstanding letters of credit at December 31, 2009. (See Note 7.)
(c) In conjunction with the construction of a new distribution facility, the Company borrowed $10,000 from the New York State Job Development Authority on December 21, 2001, pursuant to the terms of a second lien mortgage note. On December 18, 2009 the mortgage note was amended, extending the fixed monthly payments of principal and interest for a period of 60 months up to and including December 31, 2014. The interest rate under the amended mortgage note remained variable and subject to review and adjustment semi-annually based on the New York State Job Development Authority’s confidential internal protocols. At December 31, 2009, the amended mortgage note bears at an interest rate of 2.45%. At December 31, 2008, the mortgage note bore interest at a rate of 4.89%. The principal amounts outstanding under the mortgage note as of December 31, 2009 and 2008, were $5,600 and $6,285, respectively. At December 31, 2009, the distribution facility had a carrying value of $40,798.
(d) The Company has entered into various capital leases for machinery and equipment and automobiles with implicit interest rates ranging from 4.39% to 11.65% which extend to 2013.
(e) The $175,000 senior subordinated notes due 2014 bear interest at a rate of 8.75% per annum. Interest is payable semi-annually on May 1 and November 1 of each year. The senior subordinated notes are redeemable at the option of the Company, in whole or in part, at any time on or after May 1, 2009, at redemption prices ranging from 104.375% to 100%, plus accrued and unpaid interest to the date of redemption. If a Change of Control, as defined in the note indenture, were to occur, the Company will be obligated to make an offer to purchase the senior subordinated notes, in whole or in part, at a price equal to 101% of the aggregate principal amount of the senior subordinated notes, plus accrued and unpaid interest, if any, to the date of purchase.
If a Change of Control were to occur, the Company may not have the financial resources to repay all of its obligations under the Term Loan Credit Agreement, the note indenture and the other indebtedness that would become payable upon the occurrence of such Change of Control.
At December 31, 2009, maturities of long-term obligations consisted of the following:
Note 9 - Capital Stock
At December 31, 2009 and 2008, the Company’s authorized capital stock consisted of 10,000.00 shares of preferred stock, $0.01 par value, of which no shares were issued or outstanding and 40,000.00 shares of common stock, $0.01 par value, of which 30,819.35 and 30,811.65 shares were issued and outstanding, respectively. Of these shares 592.85 and 585.15 shares were redeemable at December 31, 2009 and 2008, respectively, and classified as “redeemable common securities” on the balance sheet, as described below.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
During the year ended December 31, 2008, in connection with the sale of approximately 38% of the Company’s outstanding common stock to a new investor, management shareholders sold 308.64 shares of common stock previously classified as redeemable.
Under the terms of the AAH stockholders’ agreement dated April 30, 2004, the Company has an option to purchase all of the shares of common stock held by these employees and, upon their death or disability, these employee stockholders can require the Company to purchase all of their shares. The purchase price as prescribed in the stockholders’ agreements is to be determined through a market valuation of the minority-held shares or, under certain circumstances, based on cost, as defined therein. The aggregate amount that may be payable by the Company to all employee stockholders, based on the estimated fair value of fully paid and vested common securities, totaled $16,807 and $16,589 at December 31, 2009 and 2008, respectively, and is classified as redeemable common securities on the consolidated balance sheet, with a corresponding adjustment to stockholders’ equity. As there is no active market for the Company’s common stock, the Company estimates the fair value of its common stock based on a valuation model confirmed periodically by its recent acquisitions.
As explained in Note 15, in 2004, the CEO and the President exchanged vested Amscan stock options for vested AAH stock options (“Rollover Options”) to purchase 98.182 shares. In 2008, 60.87 Rollover Options were exercised. The remaining Rollover Options are valued at $1,582 at December 31, 2009 and 2008, respectively, and are classified as redeemable common securities on the consolidated balance sheet.
Total redeemable common securities on the balance sheet were as follows:
At December 31, 2007, two officers of PCFG owned 8,443.72 and 5,000.00 shares of PCFG common stock, respectively. Under the terms of the PCFG stockholders’ agreement dated November 2, 2007, under certain circumstances the employee stockholders were entitled to receive at least the original cost of their shares, if purchased by the Company. Including an additional 2008 investment of $2,500, the employee shareholders held 15,943.72 shares of PCFG common stock. On December 30, 2008, the Company exchanged 544.75 warrants to purchase AAH common stock at $.01 per share, valued at $28,350 per share, plus $500 in cash, to acquire the 15,943.72 shares of PCFG common stock. As a result of this transaction, the Company charged $558 to goodwill. The warrants, which have a term of 10 years, are exercisable into AAH common stock under certain conditions, with the right to require the Company to purchase the shares upon the death or disability of the employees and are classified on the balance sheet as a current liability under the provisions of FASB Staff Position No. 150-5 “Issuer’s Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares that are Redeemable.”
The Company has not paid any dividends on the Common Stock and has no current plans to pay cash dividends in the foreseeable future. The Company currently intends to retain its earnings for working capital, repayment of indebtedness, capital expenditures and general corporate purposes. In addition, the Company’s current credit facility and the indenture governing its notes contain restrictive covenants which have the effect of limiting the Company’s ability to pay dividends or distributions to its stockholders.
Note 10 - Provision for Doubtful Accounts
The provision for doubtful accounts is included in general and administrative expenses. For the years ended December 31, 2009, 2008 and 2007, the provision for doubtful accounts was $3,982, $1,092, and $1,290, respectively.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
Note 11 - Non-recurring Expenses and Write-off of Deferred Financing Costs
In connection with the refinancing of the Company’s debt obligations in May 2007, the Company incurred $3,781 of expenses associated with original issue discount and wrote off $6,333 of deferred financing costs associated with the repayment of debt.
Note 12 - Restructuring Charges
Restructuring costs associated with the Party City Acquisition of $3,680 were accrued for as part of the net assets acquired. All related costs have been incurred, with the last $480 incurred during 2008.
In connection with the Party America Acquisition, $4,100 was accrued related to plans to restructure Party America’s administrative operations and involuntarily terminate a limited number of Party America personnel. All related costs have been incurred, with the last $2,100 incurred during 2008. The Company also incurred $1,700 in employee retention expense in 2007.
In connection with the Factory Card and Party Outlet Acquisition, $9,101 has been accrued related to plans to restructure FCPO’s merchandising assortment and administrative operations and involuntarily terminate a limited number of FCPO personnel. Through December 31, 2009, the Company incurred $6,703 in restructuring costs including $3,834 incurred in 2009. The Company expects to incur the balance in 2010.
During October of 2009, the Company communicated its plan to close the FCPO corporate office in Naperville, Illinois and to consolidate its retail corporate office operations with those of Party City, in Rockaway, New Jersey. In connection with the closing, the Company recorded additional planned severances costs of $1,800 during 2009 and expects to incur additional retention costs of $1,500 through April 2010. The Company will continue to utilize the Naperville facility as a distribution center for greeting cards and other products.
Restructuring costs associated with the Party City Franchise Group Transaction of $1,000 were accrued related to plans to restructure PCFG’s merchandising assortment and administrative operations and involuntarily terminate a limited number of PCFG personnel. PCFG incurred $100 and $900 in restructuring costs in 2009 and 2008, respectively.
Note 13 - Other (Income) Expense
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
Note 14 - Employee Benefit Plans
Certain subsidiaries of the Company maintain profit sharing plans for eligible employees providing for annual discretionary contributions to a trust. Eligible employees are full time domestic employees who have completed a certain length of service, as defined, and attained a certain age, as defined. In addition, the plans require the subsidiaries to match from 25% to 100% of voluntary employee contributions to the plans, not to exceed a maximum amount of the employee’s annual salary, ranging from 4% to 6%. Profit sharing expense for the years ended December 31, 2009, 2008, and 2007 totaled $4,201, $3,518, and $4,736, respectively.
Note 15 - Equity Incentive Plan
On May 1, 2004, the Company adopted the 2004 Equity Incentive Plan (the “Plan”)under which the Company may grant incentive awards in the form of restricted and unrestricted common stock options to purchase shares of the Company’s common stock (“Company Stock Options”) to certain directors, officers, employees and consultants of the Company and its affiliates. A committee of the Company’s board of directors (the “Committee”), or the board itself in the absence of a Committee, is authorized to make grants and various other decisions under the 2004 Equity Incentive Plan. Unless otherwise determined by the Committee, any participant granted an award under the 2004 Equity Incentive Plan must become a party to, and agree to be bound by, the Company’s stockholders’ agreement. Company Stock Options reserved under the 2004 Equity Incentive Plan total 3,474.6898 and may include incentive and nonqualified stock options. Company Stock Options are nontransferable (except under certain limited circumstances) and, unless otherwise determined by the Committee, vest over five years and have a term of ten years from the date of grant.
The Company has three types of options - rollover options, time-based options, and performance-based options, each of which is described below.
Rollover Options
In 2004, the Company’s CEO and its President exchanged vested options in the predecessor company for 98.18 vested options to purchase common shares at $2,500 per share (the “Rollover Options”). These options had intrinsic value of $737 and fair value of $880. Under Paragraph 84 of FIN 44, vested options granted by the acquiring company in exchange for outstanding options of the target company should be considered part of the purchase transaction and accounted for under FAS 141. The fair value is accounted for as part of the purchase price of the target company.
Since these options were vested immediately and can be exercised upon death or disability of the executives and put back to the Company, they are reflected as redeemable common securities on the Company’s consolidated balance sheet.
However, these options have an additional condition, whereby they may be put back to the Company at fair market value upon retirement. Because the terms of the Rollover Options could extend beyond the retirement dates of these two executives, it is possible that they could exercise these options within six months of the specified retirement date and then put the immature shares back to the Company at retirement less than six months later. FIN 44, Paragraphs 68 requires variable accounting for awards with puts that can be exercised within six months of the issuance of the shares.
Therefore, regardless of the probability of this occurrence, changes in market value of the shares should be expensed as additional stock compensation because the put, even if not probable, is within the control of the employee.
The Company did not consider this condition, because it considered that a change in control was probable before 2014 and, as a result, the put of immature shares was not ever probable. Since probability is not relevant under the guidance of FIN 44, Paragraph 68 requires that future changes in market value after issue must follow variable accounting and be marked to market.
Therefore, the Company should have charged pretax income for $638 in 2007, $221 in 2005, and $736 in 2004. Since the Company had been marking to market these securities through a debit to equity and a corresponding increase to the redeemable securities, the balance sheet was properly stated.
During 2008, the reduction in liability caused by the exercise of 37 of these options, net of the increase in valuation of the remaining 61.18 options, resulted in a net credit to pretax income of $210. There was no charge to earnings for these options in 2009 because the valuation did not change from 2008.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
Time-based options
In April 2005, the Company granted 722 time-based options (“TBO’s”) to key employees and its outside directors, exercisable at a strike price of $10,000. The Company used a minimum value method under SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” to determine the fair value of the Company Stock Options granted in April 2005, together with the following assumptions: dividend yield of 0%, risk-free interest rate of 3.1%, forfeitures, expected cancellation of 3%, and an expected life of four years. The estimated fair value of the options granted in 2005 is amortized on a straight line basis to compensation expense, net of taxes, over the vesting period of four years. The Company recorded compensation expense of approximately $140, $201, and $201 in general and administrative expenses during each of the years ended December 31, 2009, 2008 and 2007, respectively. There is no remaining stock compensation in future years related to these options.
On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R) “Share-Based Payment,” which is a revision of SFAS No. 123 “Accounting for Stock-Based Compensation” as amended. SFAS No. 123(R) establishes standards for the accounting for transactions where an entity exchanges its equity for goods or services and transactions that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. Generally, the fair value approach in SFAS No. 123(R) is similar to the fair value approach described in SFAS No. 123.
The Company adopted SFAS No. 123(R) using the prospective method. Since the Company’s common stock is not publicly traded, the options granted in 2005 under SFAS No. 123 continue to be expensed under the provisions of SFAS No. 123 using a minimum value method. Options issued subsequent to January 1, 2006 are expensed under the provisions of SFAS No. 123(R).
Since January 1, 2006, the Company granted an additional 489.50 TBO’s, exercisable at a strike price of $12,000 per share, 187 TBO’s exercisable at a strike price of $14,250 per share, 20 TBO’s exercisable at a strike price of $17,500 per share, and 76.5 TBO’s exercisable at a strike price of $20,750 , 5 TBO’s exercisable at a strike price of $22,340, and 55.28 TBO’s exercisable at a strike price of $28,350 to key eligible employees and outside directors. In addition, in connection with the acquisition of Party America, certain Party America employees elected to roll their options to purchase Party America common stock into fully vested TBO’s. As a result, the Company issued 19.023 fully vested TBO’s exercisable at strike prices of $6,267 and $10,321 per share and with a fair market value of $170. The fair value of these options was recorded as part of the Party America purchase price.
The Company recorded compensation expense of $736, $677, and $538 during the years ended December 31, 2009, 2008, and 2007 related to the options granted since 2006 under SFAS No. 123(R), in general and administrative expenses. The fair value of each grant is estimated on the grant date using a Black-Scholes option valuation model based on the assumptions in the following table.
The weighted average expected lives (estimated period of time outstanding) was estimated using the Company’s best estimate for determining the expected term. Expected volatility was based on implied historical volatility of an applicable Dow Jones Industrial Average sector index for a period equal to the stock option’s expected life. The remaining stock compensation expense to be recorded in future years for these options is $1,339.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
Performance-based options
In April 2005, the Company granted 760 performance based options (“PBO’s”) to key employees and its outside directors, exercisable at a strike price of $10,000. Under the PBO feature, the ability to exercise vested option awards is contingent upon the occurrence of an initial public offering of the Company’s common stock or a change in control of the Company and the achievement of specified investment returns to the Company’s shareholders.
Since January 1, 2006, the Company granted an additional 890.50 PBO’s exercisable at a strike price of $12,000 per share, 314 PBO’s exercisable at a strike price of $14,250 per share, 30 PBO’s exercisable at a strike price of $17,500 per share, 76.5 PBO’s exercisable at a strike price of $20,750, 185 PBO’s exercisable at a strike price of $22,340, and 100.62 PBO’s exercisable at a strike price of $28,350 to key eligible employees and outside directors.
Prior to 2008, the Company had accounted for PBO’s on the same basis as described above for TBO’s. Paragraph 44 of SFAS 123( R ) requires that if a performance condition is not probable of achievement, no compensation expense is recorded. The Company believed that a change in control was probable, and therefore that the options should be accounted for under the same provisions of SFAS 123 and 123(R). However, that accounting was incorrect.
While a change in control condition is not specifically discussed in SFAS 123 or SFAS 123(R), EITF 96-5, “Recognition of Liabilities for Contractual Termination Benefits or Changing Benefit Plan Assumptions in Anticipation of a Business Combination” requires that compensation cost should not be recognized until a business combination is consummated. This approach should be applied to other types of liquidity events, including initial public offerings and change in control events.
Since a change in control condition cannot be assessed as probable before it occurs, no compensation expense should have been recorded for these options in prior periods.
The stock compensation amounts that had been recognized in prior years for performance-based options were $1,140 in 2007, $709 in 2006, and $153 in 2005.
During the third quarter of 2008, a new investor acquired 38% of the outstanding stock held by existing shareholders as well as 37 rollover options, 258 time-based options, and 333 performance-based options held by optionholders, at a price of $28,350 per share.
Although this transaction did not result in a change in control, the Company’s majority shareholders decided to waive the requirements of change in control, and permitted the time-vested portion of the performance-based options to be exercisable. Additionally, for both performance-based and time-based options, employees were permitted to have their net shares exercised settled for cash.
This waiver did not change the terms of the option plans for any remaining options still outstanding, or obligate the Company to permit any future waiver of the change in control requirement.
For the performance-based options that were exercised as a result of the transaction noted above, the waiver of the change in control requirement resulted in a vesting of these options. Therefore, the performance condition for those exercised options was met immediately upon exercise. Therefore, the effect of the vesting and settlement was accounted for as stock compensation. The fair value of the performance-based options at exercise required to be charged to income is $5,639. (As noted above, $2,002 of this amount was charged to income in prior years.)
Summary
As a result of the Company’s errors noted above regarding rollover options and performance-based options, reported pretax income was understated by $502 in 2007 and $488 in 2006 and was overstated by $43 in 2005 and $736 in 2004. The Company determined that the net errors in previously reported pretax income were not material to any prior year presented. Therefore, prior years were not restated.
SFAS No. 123(R) also requires that excess tax benefits related to stock option exercises be reflected as financing cash inflows instead of operating cash inflows. The tax benefit for the 295 exercised time-based options exceeded the net deferred tax assets recognized in the stock compensation charge by $1,823. That excess benefit has been reflected as a financing cash inflow, and has been reflected on the balance sheet as additional paid-in capital.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
The following table summarizes the changes in outstanding options under the Equity Incentive Plan for the years ended December 31, 2007, 2008 and 2009:
Note 16 - Income Taxes
A summary of domestic and foreign income before income taxes and minority interest follows:
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
The income tax expense consisted of the following:
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred income tax assets and liabilities from domestic jurisdictions consisted of the following:
At December 31, 2009, the Company had a net operating loss carryforward remaining from FCPO of approximately $4,457. In addition, the Company had alternative minimum tax credit carryforwards of $576.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
The difference between the Company’s effective income tax rate and the federal statutory income tax rate is reconciled below:
The non-deductible reserve of the investment in our subsidiary is not expected to be deductible on the Company’s foreign tax return.
Other differences between the effective income tax rate and the federal statutory income tax rate are composed of favorable permanent differences related to inventory contributions and favorable foreign rate differences, offset by the non-deductible portion of meals and entertainment expenses.
At December 31, 2009 and 2008, the Company’s share of the cumulative undistributed earnings of foreign subsidiaries was approximately $36,882 and $31,767, respectively. No provision has been made for U.S. or additional foreign taxes on the undistributed earnings of foreign subsidiaries because such earnings are expected to be reinvested indefinitely in the subsidiaries’ operations. It is not practical to estimate the amount of additional tax that might be payable on these foreign earnings in the event of distribution or sale; however, under existing law, foreign tax credits would be available to substantially reduce incremental U.S. taxes payable on amounts repatriated.
The Company and its subsidiaries file a U.S. federal income tax return, and over 100 state, city, and foreign tax returns. Effective January 1, 2007, the Company adopted Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 48: “Accounting for Uncertainty in Income Taxes.” In accordance with FIN 48, the Company recognized a cumulative-effect adjustment of $635, decreasing its income tax liability for previously reserved tax items, interest, and penalties by that amount, decreasing goodwill by $666, and decreasing the January 1, 2007 balance of retained earnings by $31.
The following table summarizes the activity related to our gross unrecognized tax benefits (in thousands):
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
(Dollars in thousands, except per share)
Our total net unrecognized tax benefits that, if recognized, would impact our effective tax rate were $1,032, $1,787 and $1,242 as of December 31, 2009, 2008 and 2007, respectively.
Liabilities for unrecognized tax benefits are reflected in other long-term liabilities in the consolidated balance sheet. Included in the balance of unrecognized tax benefits at December 31, 2009, is $768 related to tax positions for which it is possible that the total amounts could significantly change during the next twelve months.
The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company has accrued $146 and $265 for the potential payment of interest and penalties at December 31, 2009 and 2008, respectively. The Company credited $119 in interest to income tax expense in 2009 and $54 in 2008.
For federal income tax purposes, the years 2007 through 2009 are open to examination at December 31, 2009. For non-U.S. income tax purposes, tax years from 2005 through 2009 remain open. Lastly, the Company is open to state and local income tax examinations for the tax years 2005 through 2009.
Note 17 - Commitments, Contingencies and Related Party Transactions
Lease Agreements
The Company has non-cancelable operating leases for its numerous retail store sites as well as for its corporate offices, certain distribution and manufacturing facilities, showrooms, and warehouse equipment that expire on various dates through 2017. These leases generally contain renewal options and require the Company to pay real estate taxes, utilities and related insurance.
At December 31, 2009, future minimum lease payments under all operating leases consisted of the following:
We are also an assignor with contingent lease liability for seven stores sold to franchisees. The potential contingent lease obligations continue until the applicable leases expire in 2014. The maximum amount of the contingent lease obligations may vary, but is limited to the sum of the total amount due under the lease. At December 31, 2009, the maximum amount of the contingent lease obligations was approximately $4,200 and is not included in the table above as such amount are contingent upon certain events occurring which management has not assessed as probable or estimable at this time.
The operating leases included in the above table also do not include contingent rent based upon sales volume or other variable costs such as maintenance, insurance and taxes.
Rent expenses for the years ended December 31, 2009, 2008 and 2007, were $136,785, $142,471, and $109,685, respectively, and include immaterial amounts of rent expense related to contingent rent.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
(Dollars in thousands, except per share)
Product Royalty Agreements
The Company has entered into product royalty agreements with various licensors of copyrighted and trademarked characters and designs that are used on the Company’s products which require royalty payments based on sales of the Company’s products, and, in some cases, include annual minimum royalties.
At December 31, 2009, the Company’s commitment to pay future minimum product royalties was as follows:
Product royalty expense for the years ended December 31, 2009, 2008 and 2007, was $8,615, $8,455, and $8,337, respectively.
The Company has entered into product purchase commitments with certain vendors. At December 31, 2009, the Company’s future product commitments were as follows:
Legal Proceedings
The Company is a party to certain claims and litigation in the ordinary course of business. The Company does not believe any of these proceedings will result, individually or in the aggregate, in a material adverse effect upon its financial condition or future results of operations.
Related Party Transactions
Pursuant to the terms of a management agreement, Berkshire Partners LLC and Weston Presidio were paid annual management fees of $833 and $417, respectively, for each of the years ended December 31, 2009, 2008 and 2007. Management fees payable to Berkshire Partners LLC and Weston Presidio totaled $139 and $69, respectively, at December 31, 2009 and 2008 and are included in accrued expenses on the consolidated balance sheet. Although the indenture governing the 8.75% senior subordinated notes will permit the annual payments under the management agreement, such payments will be restricted during an event of default under the notes and will be subordinated in right of payment to all obligations due with respect to the notes in the event of a bankruptcy or similar proceeding of Amscan.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
(Dollars in thousands, except per share)
Note 18 - Segment Information
Industry Segments
The Company has two identifiable business segments. The Wholesale segment includes the design, manufacture, contract for manufacture and distribution of party goods, including paper and plastic tableware, metallic balloons, accessories, novelties, gifts and stationery, at wholesale. The Retail segment includes the operation of company-owned specialty retail party goods and social expressions supply stores in the United States and the sale of franchises on an individual store and franchise area basis throughout the United States and Puerto Rico.
The Company’s industry segment data for the years ended December 31, 2009, 2008 and 2007 is as follows:
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
(Dollars in thousands, except per share)
Geographic Segments
The Company’s export sales, other than those intercompany sales reported below as sales between geographic areas, are not material. Intercompany sales between geographic areas consist of sales of finished goods for distribution in foreign markets. No single foreign operation is significant to the Company’s consolidated operations. Intercompany sales between geographic areas are made at cost plus a share of operating profit.
The Company’s geographic area data are as follows:
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
(Dollars in thousands, except per share)
Note 19 - Quarterly Results (Unaudited)
Despite a concentration of holidays in the fourth quarter of the year, as a result of our expansive product lines and wholesale customer base and increased promotional activities, the impact of seasonality on the quarterly results of our wholesale operations in recent years has been limited. Promotional activities, including special dating terms, particularly with respect to Halloween and Christmas products sold at wholesale during the third quarter, and the introduction of our new everyday products and designs during the fourth quarter generally result in higher accounts receivables and inventory balances. Our retail operations are subject to substantial seasonal variations. Historically, our retail operations have realized a significant portion of their net sales, net income and cash flow in the fourth quarter of the year, principally due to the sales in October for the Halloween season and, to a lesser extent, due to sales for end of year holidays.
The following table sets forth our historical revenues, gross profit, income from operations and net income, by quarter, for the years ended December 31, 2009, 2008, and 2007. The results of FCPO’s and PCFG’s operations are included in the Company’s consolidated results of operations for the year ended December 31, 2007, from the Factory Card & Party Outlet Acquisition Date of November 16, 2007 and the Party City Franchise Group Transaction Date of November 2, 2007, respectively.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
(Dollars in thousands, except per share)
Note 20 - Fair Value Measurements
The provisions of Accounting Standards Codification or ASC, Subtopic 820 (SFAS No. 157) defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. ASC 820 established a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
The following table shows assets and liabilities as of December 31, 2009 that are measured at fair value on a recurring basis:
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
(Dollars in thousands, except per share)
The following table shows assets and liabilities as of December 31, 2008 that are measured at fair value on a recurring basis:
In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company is required to record other assets and liabilities at fair value on a nonrecurring basis, generally as a result of impairment charges.
The carrying amounts for cash and cash equivalents, accounts receivables, prepaid expenses and other current assets, accounts payable, accrued expenses and other current liabilities approximate fair value at December 31, 2009 and December 31, 2008 because of the short-term maturity of those instruments or their variable rates of interest.
The carrying amount and fair value (based on market prices) of the Company’s Term Loan and $175,000 Senior Subordinated Notes are as follows:
The carrying amounts for other long-term debt approximate fair value at December 31, 2009 and 2008, based on the discounted future cash flow of each instrument at rates currently offered for similar debt instruments of comparable maturity.
Note 21 - Derivative Financial Instruments
Interest Rate Risk Management
As part of the Company’s risk management strategy, the Company periodically uses interest rate swap agreements to hedge the variability of cash flows on floating rate debt obligations (see Notes 7 and 8). Accordingly, interest rate swap agreements are reflected in the consolidated balance sheets at fair value and the related gains and losses on these contracts are deferred in stockholders’ equity and recognized in interest expense over the same period in which the related interest payments being hedged are recognized in income. The fair value of an interest rate swap agreement is the estimated amount that the counterparty would receive or pay to terminate the swap agreement at the reporting date, taking into account current interest rates and the current creditworthiness of the swap counterparty.
To effectively fix the interest rate on a portion of its Term Loans (see Note 8), the Company entered into an interest rate swap agreement with a financial institution in 2006, for an aggregate notional amount of $57,000, which expired in February 2009.
In 2008, the Company entered into a second interest rate swap agreement with a financial institution for an initial aggregate notional amount of $118,505, which increases to a maximum of $163,441 during its term and expires in March 2011.
The swap agreements had unrealized net losses of $3,977 and $5,294 at December 31, 2009 and 2008, respectively, which were included in accumulated other comprehensive loss (see Note 22). No components of these agreements are excluded in the measurement of hedge effectiveness. As these hedges are 100% effective, there is no current impact on earnings due to hedge ineffectiveness. The fair value of interest rate contracts at December 31, 2009 and 2008 of $(6,313) and $(8,403) are reported in current liabilities in the consolidated balance sheet.
In addition to the agreements above, during the year ended December 31, 2007, the Company purchased a $73,000 interest rate cap at 6.00%, for $12, which was charged to expense during the year.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
(Dollars in thousands, except per share)
Foreign Exchange Risk Management
A portion of the Company’s cash flows is derived from transactions denominated in foreign currencies. The United States dollar value of transactions denominated in foreign currencies fluctuates as the United States dollar strengthens or weakens relative to these foreign currencies. In order to reduce the uncertainty of foreign exchange rate movements on transactions denominated in foreign currencies, including the British Pound Sterling and the Euro, the Company enters into foreign exchange contracts with major international financial institutions. These forward contracts, which typically mature within one year, are designed to hedge anticipated foreign currency transactions, primarily inter-company inventory purchases and trade receivables. No components of the contracts are excluded in the measurement of hedge effectiveness. The critical terms of the foreign exchange contracts are the same as the underlying forecasted transactions; therefore, changes in the fair value of foreign exchange contracts should be highly effective in offsetting changes in the expected cash flows from the forecasted transactions.
At December 31, 2009 and 2008, the Company had foreign currency exchange contracts with notional amounts of $19,200, and $18,560, respectively. The foreign currency exchange contracts are reflected in the consolidated balance sheets at fair value. The fair value of the foreign currency exchange contracts is the estimated amount that the counter-parties would receive or pay to terminate the foreign currency exchange contracts at the reporting date, taking into account current foreign exchange spot rates. The fair value adjustment at December 31, 2009 and 2008 resulted in an unrealized net (loss) gain of $(169), and $1,698, respectively, which are included in accumulated other comprehensive loss (see Note 22). No components of these agreements are excluded in the measurement of hedge effectiveness. As these hedges are 100% effective, there is no current impact on earnings due to hedge ineffectiveness. The Company anticipates that substantially all gains and losses in accumulated other comprehensive loss related to these foreign exchange contracts will be reclassified into earnings by December 2010. The fair value of foreign exchange contracts for the years ended December 31, 2009 and 2008 of ($269) and $2,695 are reported in accrued expenses and other current assets in the consolidated balance sheets, respectively.
(a)
PP = Prepaid expenses and other current assets
(b)
AE = Accrued expenses
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
(Dollars in thousands, except per share)
Note 22 - Comprehensive Income
Comprehensive income consisted of the following:
Accumulated other comprehensive loss consisted of the following:
Note 23 - Subsequent Events
On December 21, 2009, the Company entered into an Asset Purchase Agreement with American Greetings Corporation (“American Greetings”) under which it acquired certain assets, equipment and processes used in the manufacture and distribution of party goods effective on March 1, 2010. In connection with the Asset Purchase Agreement, the companies also entered into a Supply and Distribution Agreement and a Licensing Agreement (collectively, the “Agreements”). Under the terms of the Agreements, effective on or about March 1, 2010, the Company will have exclusive rights to manufacture and distribute products into various channels including the party store channel. American Greetings will continue to distribute party goods to various channels including to their mass, drug, grocery and specialty retail customers. American Greetings will purchase substantially all of their party goods requirements from the Company and the Company will license from American Greetings the “Designware” brand and other character licenses.
In connection with the Agreements, American Greetings received total consideration of $45,880, including cash of $24,881, which was held in escrow at December 31, 2009 and reported in other assets in the consolidated balance sheet, and a warrant to purchase approximately 2% of the Common Stock of AAH.
Note 24 - Condensed Consolidating Financial Information
On May 25, 2007, the Company, a wholly owned subsidiary of AAH, along with AAH entered into (i) a $375,000 Term Loan Credit Agreement, and (ii) a $200,000 ABL Credit Agreement (see Note 7).
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
(Dollars in thousands, except per share)
Borrowings under the Term Loan Credit Agreement, the ABL Credit Agreement and the Company’s $175,000 8.75% senior subordinated notes are guaranteed jointly and severally, fully and unconditionally, by the following wholly-owned domestic subsidiaries of the Company (the “Guarantors”):
Non-guarantor subsidiaries (“Non-guarantors”) include the following:
•
Amscan Distributors (Canada) Ltd.
•
Amscan Holdings Limited
•
Amscan (Asia-Pacific) Pty. Ltd.
•
Amscan de Mexico, S.A. de C.V.
•
Anagram International (Japan) Co., Ltd.
•
JCS Hong Kong Ltd.
•
Party City Franchise Group, LLC
The following consolidating information presents consolidating balance sheets as of December 31, 2009 and 2008, and the related consolidating statements of operations and cash flows for the years ended December 31, 2009, 2008 and 2007, for the combined Guarantors and the combined Non-guarantors, and elimination entries necessary to consolidate the entities comprising the combined companies.
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
CONSOLIDATING BALANCE SHEET
December 31, 2009
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
CONSOLIDATING BALANCE SHEET
December 31, 2008
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
CONSOLIDATING STATEMENT OF OPERATIONS
For The Year Ended December 31, 2009
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
CONSOLIDATING STATEMENT OF OPERATIONS
For Year Ended December 31, 2008
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
CONSOLIDATING STATEMENT OF OPERATIONS
For Year Ended December 31, 2007
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
CONSOLIDATING STATEMENT OF CASH FLOWS
For The Year Ended December 31, 2009
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
CONSOLIDATING STATEMENT OF CASH FLOWS
For Year Ended December 31, 2008
AMSCAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in thousands, except per share)
CONSOLIDATING STATEMENT OF CASH FLOWS
For Year Ended December 31, 2007
SCHEDULE II
AMSCAN HOLDINGS, INC.
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 2009, 2008 and 2007