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Edited Transcript of PRTY earnings conference call or presentation 8-Aug-19 12:00pm GMT

Q2 2019 Party City Holdco Inc Earnings Call

Elmsford Aug 13, 2019 (Thomson StreetEvents) -- Edited Transcript of Party City Holdco Inc earnings conference call or presentation Thursday, August 8, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bradley Morgan Weston

Party City Holdco Inc. - President

* Ian Heller

Party City Holdco Inc. - VP & Associate General Counsel

* James M. Harrison

Party City Holdco Inc. - CEO & Director

* Michael A. Correale

Party City Holdco Inc. - Interim CFO & CAO

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Conference Call Participants

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* Joseph Isaac Feldman

Telsey Advisory Group LLC - Senior MD, Assistant Director of Research & Senior Research Analyst

* Karru Martinson

Jefferies LLC, Research Division - Analyst

* Marc Regenbaum

Neuberger Berman Investment Advisers LLC - MD & Portfolio Manager

* Nels Richard Nelson

Stephens Inc., Research Division - MD

* Seth Ian Sigman

Crédit Suisse AG, Research Division - United States Hardline Retail Equity Research Analyst

* Simeon Ari Gutman

Morgan Stanley, Research Division - Executive Director

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Presentation

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Operator [1]

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Good morning. My name is Angel, and I'll be your conference operator. I would like to welcome everyone to the Party City Q2 2019 Earnings Conference Call. (Operator Instructions)

I would now like to turn the call over to Mr. Ian Heller, Associate General Counsel of Party City. Thank you, Mr. Heller. You may begin.

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Ian Heller, Party City Holdco Inc. - VP & Associate General Counsel [2]

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Thank you, operator. Good morning, everyone, and thanks for joining us.

This morning, we released our second quarter 2019 financial results. You can find a copy of our press release on our website at investor.partycity.com.

Now I'd like to introduce our executive team who are here on today's call. We have Jim Harrison, our Chief Executive Officer; Brad Weston, our President and Chief Executive Officer of our Retail Group; Mike Harrison, Senior Vice President and General Manager of our North American Consumer Products business; and Michael Correale, our Interim Chief Financial Officer. We will start the call this morning with some prepared remarks by Jim and Mike Correale before we open it up for Q&A.

Please note that in today's discussion, management may make forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995 regarding the beliefs and expectations about the company's future performance, future business prospects, future events or plans. These statements are subject to risks and uncertainties that could cause actual results to differ materially from these statements. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we can give no assurance that such expectations will be realized. We expressly disclaim any duty to provide updates to our forward-looking statements whether as a result of new information, future events or otherwise. We urge everyone to review the Safe Harbor statement provided in our earnings release as well as the risk factors contained in our SEC filings.

During today's call, we will refer to both GAAP and non-GAAP financial measures of the company's operating and financial results. For more information regarding our non-GAAP financial measures and reconciliations to the most directly comparable GAAP measures, please refer to the earnings release.

And with that, I'll turn the call over to Jim Harrison.

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James M. Harrison, Party City Holdco Inc. - CEO & Director [3]

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Thank you, Ian. Good morning, everyone, and thank you for joining us today.

Once again, we apologize for the delay. As most of you probably know, we normally tape our prepared remarks a day in advance. For some reason, the service had trouble uploading on this morning. We do apologize.

I'll begin with a brief overview of our financial performance for the second quarter and then focus on the key strategic initiatives and accomplishments during the quarter, which will improve our overall performance, strengthen our balance sheet and address many of the headwinds that we have faced. I will then discuss those factors which have given rise to our adjusted full year guidance. Mike will then discuss the financial results in detail and provide some additional color around our adjusted full year revenue and adjusted earnings guidance, following which we will open up the call for your questions.

Overall, our second quarter revenue and earnings results were below expectations. We continued to experience the impacts of the helium shortages in many of our markets beyond what we had anticipated. On a consolidated constant currency basis, revenue in the quarter and for the 6 months increased 1.2% and 1.6% respectively. These results for the quarter and 6 months include negative comparable store sales results of minus 2.1% and 1.7%.

The helium challenges with respect to the balloon category alone generally represented a 200 basis point headwind to comp over the entire first half of the year, as both the latex and metallic balloon categories were negatively impacted. In addition to the impact associated with the sales of balloons, we also continued to see related softness in other categories, especially in juvenile birthday, which we believe can be attributed to our inability to offer the full breadth of assortment that consumers have come to rely upon Party City for. We estimate this related effect on non-balloon product sales to be a negative headwind of between 100 and 200 basis points year-to-date.

On a positive note, we saw a continued momentum in our digital businesses, including sales on the Amazon Marketplace. Total digital sales including Buy Online, Pickup In Store comped up 14.7% and 16.6% for the quarter and 6 months respectively.

Total consumer product sales in constant currency after adjusting for the impact of franchise acquisitions declined 70 bps for the quarter and were flat for the 6 months. These results too were adversely affected by the helium headwind as wholesale revenues from foil and latex balloon sales by our consumer products businesses slowed as well. Excluding the impact of metallic balloons, our North American consumer products wholesale revenues increased 6.7% after adjusting for the impact of acquired stores in Q2, or 5.6% for the 6 months.

Internationally, the businesses in Mexico, Australia, Europe and UK continue to perform on plan despite the challenges presented by the strong dollar and generally weak economic conditions.

For the quarter, gross margins of 37.1% were a decline of 390 basis points due primarily to the flow-through of previously capitalized freight costs associated with last year's supply chain issues, higher net helium costs, costs arising from the store optimization initiative and unfavorable product mix and foreign exchange.

Adjusted EBITDA for the quarter was $81 million. Year-to-date EBITDA totaled $133 million, slightly below our expectations. Despite the softer sales and margin pressures, we generated $101 million of free cash flow over the first half of the year, which is historically weaker than the second half of the year.

As I mentioned during our first quarter call, debt reduction during 2019 is the significant capital priority for us this year. We recently announced 2 specific transactions which align with this priority. The outcome of these transactions, when coupled with other initiatives underway this year, will enable us to substantially reduce our leverage levels by year-end, while improving the long-term strength of the business.

Firstly, on June 28 the company filed a periodic report on Form 8-K, disclosing that we had entered into a sale and leaseback transaction with Spirit Realty. Under the terms of this transaction, we reported that we had successfully sold the real estate assets associated with our distribution center in Chester, New York, the Anagram foil balloons factory in Eden Prairie, Minnesota, and the injection molding facility in Albuquerque, New Mexico, for an aggregate purchase price consideration of $128 million.

Concurrently, we entered into lease arrangements for all 3 facilities with initial terms of 20 years. We were able to complete this transaction at a multiple of 15x EBITDA and an effective cap rate of 6.4%. Monetizing these real estate assets, the proceeds of which were used to pay down debt, will only further reduce our leverage levels at year-end beyond our original guidance.

Earlier today, we announced that we have entered into an agreement with Canadian Tire Corporation, one of Canada's largest and most respected retailers, whereby they acquired the retail assets and business of our Party City Canadian subsidiary. The transaction, which is subject to customary closing conditions, including government approval, is expected to close by October 1.

In addition to the transfer of the Canadian retail assets, this transaction also establishes an ongoing relationship between the Amscan Consumer Products business and Canadian Tire through a supply agreement with an initial term of 10 years. The agreement contemplates that on average the North American consumer products will nearly double the sales into the Canadian Party City locations and Canadian Tire over the term of the agreement.

Canadian Tire will (inaudible) acquisition through their network of over 500 dealers, while expanding Party City's brand throughout Canada. With locations within a 15-minute drive of 90% of the Canadian population, Canadian Tire is truly uniquely positioned to grow the brand and the category. This transaction, similar to our master franchise relationships in Mexico and our European and Australian store in store partnerships, aligns with our overall international strategy of identifying and partnering with strong domestic retailers to grow the party market, positioning ourselves as the primary resource for product and innovation.

The proceeds of this transaction of approximately CAD174 million Canadian, like those of the aforementioned sale-leaseback transaction, will serve to reduce our leverage levels.

Finally, we believe this partnership with Canadian Tire is a huge endorsement of the Party City retail concept and the party supply category overall. Having one of Canada's premier retailers make this investment in the business and partnering with us in a long-term vendor relationship is an affirmation of our faith and believe in the long-term growth and viability of our position in the category.

Our full year guidance has been adjusted to reflect the effects of both of these capital transactions with respect to revenues and earnings.

As I stated during our last call, in addition to the strong cash flow generated by our business model, we are targeting a reduction of between $75 million and $100 million in net working capital year-over-year by 12/31/2019. We expect to see the majority of this reduction manifested in the fourth quarter as we significantly reduce our full seasonal inventory carryover.

While the progress achieved to date to reduce our leverage is quite significant, we continue to be focused on exploring other long-term strategic opportunities which will free up capital throughout the business and pay down debt. Currently, we are targeting to reduce our consolidated debt by approximately $400 million on a year-over-year basis and hope to exceed that target.

We continue to make progress regarding our ability to procure adequate quantities of helium to satisfy our consumers' demands for this brand-defining category. As I mentioned earlier, the expected shortages persisted, creating a second quarter headwind. More importantly, however, these headwinds are rapidly abating.

During the second quarter, we entered into an agreement with a source to provide us with approximately 2 million cubic feet a month of helium over the next 4 years. This represents approximately 35% of our average monthly demand and will provide a significant tailwind to our business in the second half of the year. As we speak, helium from these wells is beginning to be distributed into our stores. This helium, along with our existing allocations from our primary suppliers and other third-party providers, are expected to put us north of 90% of our needs. Additionally, we have reached a tentative agreement with another provider, which is expected to come online in early October and would put us at over 100% of our requirement.

As pleased as we are to be able to share this news, we are truly mindful that we must repay the faith and trust of our consumers that Party City is stock on helium and, once again, the primary go-to for all of their celebratory needs. I want to take this opportunity to thank and commend the members of our retail procurement management team who have done a terrific job of attacking the cyclical supply challenge.

It is also important to recognize that the average cost of helium, which is a commodity, has continued to increase. While we have successfully put in place selective price increases, which serve to partially mitigate these higher costs, we have and will continue to see an adverse effect upon our margins. During the second quarter, higher helium costs represented a 50 basis point gross margin headwind and we have reflected this in our full year guide.

As mentioned during the first quarter call, we conducted a comprehensive review of our store portfolio aimed at improving the overall productivity of the fleet. Our approach was to evaluate the opportunity to drive market level profitability improvement. This resulted in our decision to close approximately 45 stores over the course of 2019, where we believe there was an opportunity to recapture a substantial portion of the closed store sales as they transfer to other Party City stores in those markets. As of July 31, we have fully closed and liquidated 34 stores. Another 10 are currently in liquidation mode and will be closed by the end of November.

I am pleased to report that the initial results are indicating that the sales recapture rates are being achieved and the impact on sister stores during liquidation is less than anticipated. In addition, we have now decided to accelerate the closure of 10 stores originally slated for closure in 2020 into the fourth quarter of this year so as to have a clean slate of new stores as a focus for our teams in 2019.

During the quarter, we opened 3 new smaller format concept stores in several markets. These 7,000 to 10,000 square foot test stores are designed to fill what we see as a void in smaller markets or markets with distinct characteristics such as college towns where we can offer unique, curated and tailored assortments. These doors require approximately 30% less inventory, and we are looking to achieve sales performance of 90-plus percent of what a larger store would provide. If successful, this format will augment the white space opportunity, while providing better inventory turns, greater sales per square foot, improved ROIC and, most importantly, free up associates to have more time available to interact with our customers.

During the quarter, we also continued to pilot several pricing initiatives using different media strategies aimed at driving customer traffic. The results have been extremely encouraging, and as we enter the Halloween selling season, you will see these strategies in our approach to media advertising around the season.

We have spoken about the various tailwinds that we see in the second half of the year, which we expect will help improve our comp store sales performance, perhaps none as more significant than our year-over-year in-stock position heading into the Halloween season. As of July 31, 95% of our Halloween inventory requirements are either in stores, in a warehouse or in transit. This is an overwhelming improvement, not only from last year when we faced a tariff driven supply chain challenges, but also when compared to any previous Halloween season. As a result, our full Halloween assortment will be in store and on the web by September 1, and we will be ready to capture the early sales of the season.

Additionally, our store associates will be better able to serve our customers and not be overwhelmed by largely deliveries. This will be the case not only for our 900 Party City stores but also for our Halloween city pop-up stores. We are currently planning on opening [255] Halloween City stores for the season. This is an increase of 10% over last year. We are excited about our pop-up stores this year as we have made major changes to the store environment, making it an even greater Halloween experience with expanded animatronics and other exciting additions to the in-store experience.

In addition to improved helium supply and our Halloween inventory availability, there are several other tailwinds as well for the back half of the year, starting with Halloween moving to a Thursday. Historically, as the holiday moves closer to the weekend, we have seen an increase in adult celebrations. We would expect that to be the case this time around as well.

From a juvenile perspective, the intellectual property available this year is by far one of the strongest lineups we have seen. Beginning with Frozen, for which product first becomes available on October 4, there was an amazing portfolio of licensed properties. Lion King, Captain Marvel, Avengers, Spider-Man, Toy Story 4, Aladdin, Descendants, It and many more. And that's just the movie properties. This year, we will also be offering a broad range of gaming inspired costumes and wearables from Ubisoft to Microsoft, including Assassin's Creed, Years of War and Dragon Ball Super.

Party City and Halloween City will be in stock and have something for everyone, whether they choose to shop in our Party City stores, Halloween City stores, PartyCity.com or in any of the marketplaces where you can find a Party City storefront, including Amazon.

During the second quarter, net third-party revenues of the North American consumer products business, excluding Anagram and adjusted for the acquisition of stores, grew 6.7%. For the 6 months, adjusted revenues grew 5.6%. In addition to the growth of third-party revenues -- in addition to growth, third-party revenues grew, and our manufacturing share of shelf also grew 10 bps to 27.3%.

As most of you are aware, growing our manufacturing share of shelf is important for several reasons. First, obviously as we grow the manufacturing share of shelf, we harvest the manufacturing margins, along with the wholesale profit and improve the consistent quality of our products. Equally important in these times of global trade tensions, controlling our manufacturing allows us to continue to diversify our sourcing base into multiple geographies away from China. As a case in point, we have just concluded the final shipment of costumes from a new joint venture with one of our premier suppliers of costumes from our Cambodian factory. Reducing our dependence on China supply and diversification continues to be a core element of our strategy.

On the subject of tariffs, our total annual purchases from China, subject to the new 10% duties, are approximately $150 million. As with the earlier tariffs, we will look to mitigate these tariffs through resourcing, self-manufacturing, better vendor prices and, when necessary, look to pass these increases on in the form of higher prices. For the second half of the year, absent any mitigation efforts, we believe that the potential impact from these tariffs to be less than $2 million.

The final but certainly not the least important development during the quarter was the addition of Brad Weston to our Executive Team as President of Party City Holdings and CEO of the Party City Retail Group. I'm extremely excited and pleased to have Brad join Party City Holdings in this significant leadership position. Brad's deep experience and knowledge, especially in retail from his many years in key executive roles at both Petco and Dick's Sporting Goods, uniquely positions him to lead our business into the next chapter of growth and success.

Brad's initial focus will be primarily on the retail side of the business where he will develop and put into motion the processes and strategies which will drive sales growth and comp store performance. During this time, he will also begin to develop a broader understanding and knowledge of our consumer product operations and business to help shape those future strategies as well. I look forward to all of you getting to know Brad better as the next few quarters evolve.

In summary, the second quarter was softer than we had anticipated, both in terms of revenues as well as margins, with much of the shortfalls being attributed to helium. These factors have been incorporated in our adjusted full year guidance. Looking forward to the second half of the year from a retail perspective, the helium headwinds are abating and this month helium availability should start to become a tailwind. We are closely reviewing our promotional calendar and strategies, given the Halloween tailwinds which I mentioned earlier.

We have made progress in many operational fronts and remain encouraged by the growth opportunities that we believe will present themselves later this year, including greater availability of helium, an extremely strong IP calendar, a Thursday Halloween and benefits from supply chain investments that we made following the disruptions that impacted the business in 2018.

And with that, I will turn the call over to Mike Correale who will provide further details around our financial results and our expectations for the balance of the year.

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Michael A. Correale, Party City Holdco Inc. - Interim CFO & CAO [4]

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Thanks, Jim, and good morning, everyone.

I'll provide further insight into our financial and operating performance for the quarter, discuss our outlook and guidance for 2019 and then open up the call for questions.

As Jim said, our second quarter top and bottom line financial results were negatively impacted by the ongoing helium shortage and its direct and indirect effects on balloons and other products, including our juvenile birthday products.

Looking more closely at our second quarter results. Consolidated total revenue grew 1.2% in constant currency. Retail segment net sales increased 2.9% on a reported basis or 3.2% in constant currency, principally driven by the additional square footage provided by 16 new store openings and 44 franchise and independent stores acquired over the last 12 months partially offset by 9 store closures completed during the same period.

Brand comparable sales, which include our U.S. and Canadian permanent stores and our North American e-commerce business, decreased 1.2% in the quarter driven by approximately 200 basis points of direct headwind from helium shortage. The tailwind from Easter shifting into the second quarter was more than offset principally by the indirect effects of helium on juvenile product categories and declines in commodity product and candy sales.

Looking at our sales by category. During the quarter, everyday product sales comped 4.1% lower than in 2018 and, consistent with Jim's comment, that the indirect impact of the helium shortages felt in the categories usually shopped along with balloon purchases. Again, the declines occurred in juvenile solid commodity product and candy. It should also be noted that the 2018 results included approximately $3 million of revenue from the clearance event, which has been delayed this year until the third quarter. Seasonal product sales increased 9.1% versus comparable sales in 2018 driven by strong Easter and spring seasonal sales and early costume business. Our North American web comp sales, including BOPIS, were up 14.7%.

Turning to the non-vertical consumer products business. Net revenues decreased 70 basis points after adjusting for the impact of franchise acquisitions and foreign currency. As Jim mentioned, this decline was attributable to the impact of helium on our latex and metallic balloon businesses, in particular, our Anagram metallic balloon business. Sales of metallic balloons at wholesale, which had enjoyed single-digit growth prior to the helium shortage, were down approximately 17% as a result of the shortage. The adjusted net revenue of our North American party business, excluding sales of metallic balloons, increased 6.7%. This increase in non-vertical consumer products occurred in multiple areas, including increase in accelerated orders from certain mass and grocery retailers, modest sales gains at franchisee and independent stores and increased sales of personalized product from our Print Appeal operations.

Our non-party store business continues to be a bright spot, with double-digit growth achieved through strength in the mass and grocery channels despite the loss of sales arising from American Greeting's deciding to exit the party category. We continue to leverage the breadth of assortment and manufacturing capabilities to meet third-party independent customers' requirements in a cost effective manner.

International consumer product sales decreased 1.6% in constant currency, in line with our expectations.

For the second quarter of 2019, retail and wholesale margins were 40.7% and 26.4% respectively. Our consolidated gross profit margin was 37.1% or 390 basis points below the same quarter of last year. Consolidated margin was negatively impacted by approximately 200 basis points of higher logistics costs associated with product imported during the second half of 2018 flowing through both wholesale and retail cost of sales.

As you recall, the higher costs were related to the supply disruption associated with China tariffs. In addition, 150 basis points of the decrease was due to retail markdowns and provisions against inventory recorded in conjunction with our previously discussed store optimization program as well as a change in our personalization product offerings to improve our relevancy to the consumer. Lastly, the margin decline reflects a two-pronged impact from the temporary Halloween shortage, which results in both higher helium costs and a decrease in higher-margin balloon sales at both wholesale and retail.

Operating expenses, excluding the gain on sale-leaseback and store impairment and restructuring charges totaled $166.5 million or 29.5% of revenue, consistent with the second quarter of 2018.

In terms of the sale-leaseback Jim described, during June we completed the sale of 3 operating facilities and recorded a gain of $58 million in the quarter, which is backed out of our adjusted results. We used the net proceeds of the sale of $125 million to repay amounts outstanding under our ABL at June 30. In July, half the proceeds were drawn from the ABL to repay approximately $63 million of our term loan. The lease commitment from the sale-leaseback requires annual rent payments of $8.3 million for the first year, increasing by 2% annually. As the lease associated with the Los Lunas, New Mexico, property qualifies as a finance lease, the present value of the related lease payments of $13 million is classified as debt, resulting in a net reduction to our reported debt of $112 million.

Income from operations totaled $97 million. Excluding the $58 million benefit from the leaseback transaction and $9 million of charges associated with store closures, income from operations was approximately $48 million compared to $65 million in the prior year period.

Interest expense for the second quarter was $30.2 million or $4.7 million above the same quarter last year, with approximately half the increase attributable to higher LIBOR rates on our ABL and term loan credit facilities and half as a result of the company's August 2018 high yield refinancing.

In the quarter, our reported effective tax rate was 25%, and once adjusted, increased to 26%.

Reported net income totaled $48 million or $20 million greater than in the second quarter of last year, and reported diluted EPS increased to $0.51 per share from $0.29 per share. On an adjusted basis, net income decreased to $20.2 million from $39.2 million in the quarter 2 2018. Adjusted EPS decreased to $0.22 per share from $0.40 per share, with $0.15 of this decline related to the revenue and margin factors previously discussed and the remainder of the change principally related to the higher interest rates.

Adjusted EBITDA of $81 million compared to adjusted EBITDA of $96.6 million in the second quarter of last year.

During the quarter, we delivered free cash flow, defined as adjusted EBITDA less CapEx, of $62 million, which is approximately $8 million below second quarter of 2018.

We ended the quarter with net debt of about $1.9 billion. It should be noted that the trade payables and accrued expenses at 6/30 were $58 million below year-end 2018 and $29 million below the same period of last year despite much earlier receipt of our Halloween goods. We have approximately $296 million of borrowing capacity under our ABL credit agreement.

Before reviewing our outlook, I'd like to go over a few recent developments that will impact of fiscal 2019 guidance.

As discussed earlier, in June we completed the sale-leaseback transaction and used the net proceeds to pay down debt. While the impact on pretax income will be a headwind of approximately $3 million as rent expense recognized on a straight-line basis exceeds the reduction in interest and depreciation and amortization, the full year impact on adjusted EBITDA will be a negative $9 million or the full rent expense on the now leased facilities.

As you also saw in our press release, in addition to the previously announced planned closure of approximately 45 Party City locations, we now plan to close 10 additional stores during the fourth quarter for a total of 55 store closures occurring throughout the year.

And, as Jim mentioned, we announced today the Canadian Tire transaction, which aligns with our international retail strategy and will be a key driver of long-term wholesale growth in Canada. We expect to use approximately $120 million in proceeds to pay down debt, in line with capital allocation priorities we have outlined. As a result of this transaction, we will see approximately $105 million reduction in retail sales on an annualized basis, which will partially be offset in the form of third-party wholesale sales and profits. The net impact of this transaction is expected to reduce 2019 retail sales and adjusted EBITDA by approximately $39 million and $8 million respectively.

Turning to our full year guidance. Based on our performance to date, the sale-leaseback transaction, the additional store closings, the Canadian Tire transaction and an updated view of the direct and indirect impact of helium availability and costs on both our retail and Anagram business, we are revising our previously provided fiscal 2019 outlook. We are now expecting to be in the revenue range of $2.4 billion to $2.45 billion and comp sales to be flat to down 1% versus last year.

Excluding the impairment and restructuring charges related to store closures and sale-leaseback transaction, we anticipate adjusted operating margin to be down approximately 100 basis points when compared to 2018 levels. We now expect full year adjusted net income to be in the range of $118 million to $128 million or $1.26 to $1.36 per share. We expect adjusted EBITDA to be in the range of $355 million to $370 million and interest expense to be $115 million to $117 million for the year.

In terms of capital allocation priorities, we continue to plan to spend about 2.8% of net revenues on CapEx and anticipate ending the year with net debt at approximately 4x adjusted EBITDA. For all other detail around our outlook, please refer to our press release.

With that, I'd like to turn the call over to the operator and open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from the line of Seth Sigman with Credit Suisse.

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Seth Ian Sigman, Crédit Suisse AG, Research Division - United States Hardline Retail Equity Research Analyst [2]

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I wanted to just follow up on the guidance here. So you lowered the full year comp guidance from up 1% previously to flat to down 1% now, I think. So implied back half comp is effectively down slightly to up 1%, which seems to be lower than you initially thought as well. You highlighted a number of tailwinds for the second half of the year. So just wondering what changed for the second half of the year relative to your expectations.

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James M. Harrison, Party City Holdco Inc. - CEO & Director [3]

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Sure, Seth. So the helium availability is a great story. It's happening a little slower than we had anticipated. And couple that with the extended impact on other categories -- juvenile, as I mentioned in my comments, we think that that impact other categories outside of balloons because of the (inaudible) about 100 to 200 basis points. And we're taking a conservative view with respect to our ability to get the consumer back in the mindset of thinking Party City because of balloons. There is going to have to be an education process. We have plans to -- in place to spread the word through media as we see various markets get back in stock 100% on helium. But we've taken a bit of a conservative view as to the speed with which that can happen. So it's really the impact of helium. If you think about in terms of the tail of the impact of helium on the business as we get back in stock and get the consumer back in the mindset of Party City first because of our breadth of assortment including balloons.

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Seth Ian Sigman, Crédit Suisse AG, Research Division - United States Hardline Retail Equity Research Analyst [4]

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Okay, got it. And then just a follow-up question on the gross margin. I just want to better understand the impact from the higher freight costs related to the operational disruptions from last year. It sounds like -- is it right that these costs were capitalized into inventory, they are now flowing through COGS as the inventory turns, and that's why you're seeing the impact? And if so, I'm just curious, what's incremental versus your expectations and then how should we be thinking about that 200 basis point impact over the next few quarters?

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Michael A. Correale, Party City Holdco Inc. - Interim CFO & CAO [5]

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Okay. So the cost of freight actually gets capitalized in inventory. It also gets capitalized in the deferral between sales from wholesale to retail. So that concept is correct. It's capitalized, it is flowing through. We still have a little bit to go. But by the end of this quarter, it should all flow through.

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James M. Harrison, Party City Holdco Inc. - CEO & Director [6]

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I think it's important to note, Seth, that our original guide had that margin impact in it. We don't guide on margin. Margin was developed through the consensus, and we had attempted to communicate that obviously unsuccessfully. We knew this was going to happen. So if you look at the reconciliation of our EBITDA, the 200 basis points from the flow-through is not a reconciling item to the EBITDA guidance. It's merely within the margin percent. We had anticipated it was in our EBITDA.

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Operator [7]

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And our next question comes from the line of Rick Nelson with Stephens.

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Nels Richard Nelson, Stephens Inc., Research Division - MD [8]

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Tim, can you update us on the helium supply agreement? When it began? And is there an opportunity here to capture share when others are short of helium?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [9]

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Yep. So I'm going to say this past week, give or take a couple of days, the most recent agreement we entered into begin flowing tanks of liquid helium to transfer stations, primarily in the Florida, Georgia and Houston markets. And so that's flowing as we speak. We are seeing substantial improvements in the in-stock position of helium in those markets. And we would anticipate that by the middle of August, give or take, somewhere between the 15th and the 20th, we should be in a position to actually broadcast to the broader market -- within those markets broadcast widely that Party City is the place to come for balloons with helium. And you are absolutely correct, Rick, that this should represent an opportunity for us to have an advantage over the competition. Obviously, through the Anagram results, we see that helium is not unique to Party City, and being in a position as we expect to be by the middle of October of being close to 100% stock on helium should be a tailwind for us. But like I said to Seth earlier, it's a matter of, one, getting that message out and then re-establishing our relationship with the consumer as being the place to go for everything for parties.

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Nels Richard Nelson, Stephens Inc., Research Division - MD [10]

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Thanks for that color. Also, I'd like to ask you about the tariffs. You talked about the impact in 2019. Does that incorporate the List 4 tariff exposure and how you might say that impacting 2020 as that flows through inventory and COGS?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [11]

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Okay. So with respect to the -- yes, there is 2 parts to that. So with respect to the absolute impact on earnings for 2019, as I mentioned earlier, we've modeled it out to be under $2 million. Your point is well taken that there will be some tariff impact that ends up being deferred in 2019 and to flow through in 2020. That number would be probably somewhere in the neighborhood of $3 million, give or take. We have every expectation that we will aggressively address the impact of this 10% tariff similar to what we did earlier with the 10% and subsequently 25% where we've substantially mitigated it. It's going to be more challenging. I think it would be foolish to think that we could address as effectively and as quickly as we did in 2018 and 2019 in terms of the first couple of tranches. But we have been actively looking to resource out of many geographies and we'll continue to do so. There are opportunities we believe for us to resource. We believe there is opportunities now when some of our core manufactured categories which had not been affected by the duties earlier on, things such as napkins and plates where we now have the opportunity, we believe, to have a distinct advantage in the U.S. marketplace with folks who have been historically sourcing those products from China. Also, to the extent that we have China competition in metallic balloons, we see that as an opportunity. And from a resourcing or probably from a vendor negotiating standpoint, clearly, although the Chinese have stabilized their currency, there are certain elements of our vendors' cost that is denominated in RMB, labor overheads. While they source most of their materials in U.S. dollars, there is still an element of their cost that is denominated in RMB, and we expect to receive price adjustments from our vendors with respect to the movements in the currency. And as I mentioned, our last resort is looking at pricing. I mean we do have a huge advantage in that we have an AUR of $2 and so our price points are nominal. And to whatever extent we are affected by tariffs, so too are our competitors, both on the wholesale as well as on the retail side. So we believe that we've got the leverage within our business and the leverage within the marketplace for us to successfully address this headwind and manage down the exposure.

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Operator [12]

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And your next question comes from the line of Marc Regenbaum with Neuberger Berman.

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Marc Regenbaum, Neuberger Berman Investment Advisers LLC - MD & Portfolio Manager [13]

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My question relates to the Canadian Tire announcement. The strategic rationale sounds compelling and the value unlock seems pretty straightforward. And so my question is, can you provide us with the dollar amount of wholesale sales the company does to Canadian Party City stores? Or approximately?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [14]

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Sure. Currently, on an annualized basis, it's a little bit above -- in Canadian dollars, a little bit above CAD50 million a year.

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Marc Regenbaum, Neuberger Berman Investment Advisers LLC - MD & Portfolio Manager [15]

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Got it. So it's fair to say, if my math is correct, if you have a goal, as you said in the press release, to double those sales over a period of 10 years, we are talking about a potentially CAD1 billion wholesale revenue deal for the full time frame in addition to the cash proceeds. Am I understanding that correctly?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [16]

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You are in the ballpark, absolutely, absolutely. And we would expect that that incremental revenue would substantially replace -- provide us the opportunity to substantially replace a good portion of EBITDA which we sold in this transaction.

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Marc Regenbaum, Neuberger Berman Investment Advisers LLC - MD & Portfolio Manager [17]

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Great. That sounds great. And as a follow-up, Jim, are there other markets where you think you can pursue a similar sort of asset-light approach such as this?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [18]

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Yes. Thank you for that question. As I've said, when we look at the retail marketplace outside the U.S., I think having us focus on the U.S. market is important for our long term -- important part of our long-term strategy and important for our overall success. Clearly, the U.S. market is the most developed market for this category by far for lots of reasons, some of which are cultural, some of which are the cost of real estate, some which is just the availability of the product itself. And I think having us focus our efforts in terms of our retail -- pure retail business here in the U.S. and then partner with people in geographies like we've done in Australia with BIG W or what we've done with Morrisons in the UK or our master franchisee in the Mexico, I think gives us the ability to leverage up our retail knowledge through that partnership, while allowing the local retailer to build the brand with their expertise in the marketplace, it allow us to keep our capital dry powder to invest in our consumer products businesses and other associated parts of the business and while they build out the brick and mortar or the infrastructures for those markets. I think as we think about it, we think Latin America over the long term is clearly an ideal market for us to develop these sorts of relationships. And I think to the extent that we can do that, it should bode well. I think e-commerce -- we view e-commerce a little differently. As you know, we have an e-commerce business in Europe and in the UK. We think e-commerce on a B2C basis has a lot of merit, but in terms of brick and mortar and physical presence and heavy investment in stores and heavy investment in the geography is better served by a good premier partner that we can partner with and supply product through.

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Operator [19]

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And your next question comes from the line of Karru Martinson with Jefferies.

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Karru Martinson, Jefferies LLC, Research Division - Analyst [20]

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So to get to the 4x leverage target that you have for the end of the year -- it's another turn-off here. Can you kind of break down the combination of asset sales and free cash flow that's going to get you there?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [21]

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Sure. So there are some moving parts, Karru, in terms of the ultimate disposition of taxes and the ultimate resolution of what the tax exposures are, so it moves around a little bit. But there are -- there is the free cash flow from operations, which is somewhere in the neighborhood of $150 million which -- money available to pay down debt. Then there is about $100 million from the -- or $75 million from working capital. And then from the sale-leaseback and the Canadian Tire transactions, probably both somewhere in the neighborhood of $100 million -- probably $58 million, sorry, on the sale-leaseback and then -- and that's a gain. --$100 million (sic - see Press Release) of sale-leaseback, and then about $100 million on the Canadian Tire transaction. However, the taxes on that will be a bit higher because we have to write off goodwill in the transaction, which will give us the cash, but it's increasing the amount of -- it's not tax deductible, so the gain on that will actually be taxable at a little bit higher rate. Those are the big elements. And then the other side of it is our accounts payable will be substantially lower at year-end. So I think if we look at our total indebtedness, I had mentioned in my comments we think will generate roughly $400 million of cash to pay down debt.

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Karru Martinson, Jefferies LLC, Research Division - Analyst [22]

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Okay. And when we look at the guidance, we can look at the $50 million kind of reduction here at the low point here. We know that it's coming from the rent increase and this step-up from the -- sorry, the disposition of the Canadian business. Is it the right way to think about it that the rest of that really is coming from those freight costs that are capitalized [and] gross margin challenges in the helium?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [23]

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No. I'm sorry, no. Our original guidance had additional freight costs in it. It's in the consensus on the margin that we tried to communicate to get adjusted, that didn't get adjusted, to be perfectly candid. The movements on EBITDA are essentially -- there is essentially 4 big components. The Canadian Tire transaction is about -- and this in U.S. dollars -- of about $8 million against our previous guide; the movement in comp is about $16 million from our original guide; the impact of helium on Anagram which was not in our last guide because we really hadn't begun to see the impact on the Anagram business because most of the problems have been isolated to the U.S., but there's been more contagion to Europe as well as other parts of the U.S. market. So the impact on the Anagram business is about $13 million. And then the sale and leaseback is $5 million. And those are the largest components of the movement. That is up to like [$43 million] of the [$50 million], I think.

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Karru Martinson, Jefferies LLC, Research Division - Analyst [24]

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Okay. And then just lastly on e-commerce. It's been an area that folks have talked about saying that as you closed stores, you've continued to grow that channel. What are you seeing there on the competitive front for you guys?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [25]

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Well, as I believe you know, most of the players in e-commerce space are customers of ours. We hold license rights on party goods as well as obviously our balloon category and our [birthday] line generally. We've seen that business remain relatively stable, growing in low single digits. The challenge for us is, as we talked about our e-commerce business, from a GAAP standpoint, BOPIS is considered a brick and mortar sale. From a logical standpoint, BOPIS is really a digital sale. So when we give our e-commerce results we include BOPIS in there from a digital standpoint because the sale initiates on the web. And I think that's one of the huge advantages we have over other e-commerce players because in our category, we believe that our shopper -- and I'll call her mom right now -- mom likes to have the certitude around having her party goods in her hands and make sure she has everything she needs a day or 2 in advance of the party. So she enjoys the convenience of shopping online. Having the ability to physically going to the product and have it in her possession and make sure she has everything she needs in advance of the party is a huge advantage that Party City has over, I believe, anybody else in the category. That's on e-commerce. And as you know, we're on the marketplaces. We're on Amazon Marketplace as well as a number of other marketplaces. So we have visibility to the performance of our category there as well.

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Operator [26]

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Your next question comes from the line of Simeon Gutman with Morgan Stanley.

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Simeon Ari Gutman, Morgan Stanley, Research Division - Executive Director [27]

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Quick question on tariffs. The first round of tariffs, Jim, were there any price increases that you had to make to the end user? And then, are you seeing any price increases across the category for many competitors?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [28]

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So with respect to tariffs, as it affected our wholesale business, we did have some price increases. I believe the total amount of price increases we've seen at retail are probably somewhere in the neighborhood of $3 million to $4 million in total for the whole year. So we've been able to mitigate most of that. On our Amscan business, we increased our pricing in the mid to low single digits, primarily associated with tariffs and some other increased costs. So in terms of our business, both from the vertical as well as the retail as it relates to the vertical, most of the impact has been mooted. From other third-party suppliers to Party City, the impact has not been that great either. Most folks were able to either pass along, get concessions from vendors, resource or redesign.

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Simeon Ari Gutman, Morgan Stanley, Research Division - Executive Director [29]

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Got it. Yes. I'm trying to assess in the next round, if you have to raise prices, if your hypothesis is right that the low AUR should help consumers absorb it a little bit better because the end result shouldn't be that terrible, didn't know if you have any evidence of that thus far.

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James M. Harrison, Party City Holdco Inc. - CEO & Director [30]

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No, we have not raised prices for this next round -- rates around the products. So the next round of products -- it's more difficult, as I said earlier with Rick, it's more difficult to do because it's generally product that has a lot more hand labor in it and therefore were difficult to just resource automatically outside of China, coupled with labor availability and supply chain. That being said, that then ties back to my earlier comment that those are costs that are associated with -- and denominated in RMB. So we would expect to get some significant relief on the price increases at vendor level. And I think it's important to remember, if we are talking about something that we buy for $0.50, which ultimately becomes close to a $2 retail I guess with just [keystone] things, 10% tariff increase is $0.05 on that item. And if we can get $0.02 or $0.03 relief on that item, we've pretty much mooted the entire problem.

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Simeon Ari Gutman, Morgan Stanley, Research Division - Executive Director [31]

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Right. Can I ask you about Q3 comps? I guess I don't care about the comps to date as much as the traffic trends. We just heard from a couple of companies that their July business looked a little different from their June business. Trying to put our finger on why, and any thoughts if you can talk about what you've seen so far.

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James M. Harrison, Party City Holdco Inc. - CEO & Director [32]

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We don't -- as you know, Simeon, we don't give guide for -- we don't give guide by quarter on comp. We don't guide quarters. July was a bit more challenging than had been seen in June, not to the point where it's dramatic, but it has been more challenging. Whether that's the timing of the holiday or just the consumer in general, it's hard to say right now. But July -- also, you should bear in mind, July is a very, very soft month for us. And when I say soft, I mean, in terms of our aggregate sales for the whole year, it's a pretty light month. Our business starts to crank up the second half of this month and into September and October -- October, November and December. That's when our business is most significant. And as I said, we've got some fairly, fairly meaningful and sizable tailwinds. I believe we have time for one more question, operator.

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Operator [33]

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And your final question comes from the line of Joseph Feldman with Telsey Advisory Group.

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Joseph Isaac Feldman, Telsey Advisory Group LLC - Senior MD, Assistant Director of Research & Senior Research Analyst [34]

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I apologize for my voice. Excuse me. Can you talk about on the leverage ratio? With about $400 million of debt paydown, why wouldn't you guys be a little below 4x by the end of the year?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [35]

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Yes. Based upon the current guide, you're exactly right, Joe.

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Joseph Isaac Feldman, Telsey Advisory Group LLC - Senior MD, Assistant Director of Research & Senior Research Analyst [36]

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And then the other thing I was curious about, can you kind of provide the same type of bridge you did for EBITDA, but do it for sales? I just wanted to get a little bit of clarity on like how much sales was getting removed?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [37]

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Sure, sure. I'll give Mike that.

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Michael A. Correale, Party City Holdco Inc. - Interim CFO & CAO [38]

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Yes. So the primary components when it comes to sales is the Canadian Tire transaction -- as I said earlier, it's $39 million. Actually, in the reconciliation, it nets to $32 million because there are wholesale sales previously inter-company and now become third party. So you got $32 million for the Canadian Tire transaction. You've got the 1% comp becoming flat to down 1%. That's a $32 million movement. And then you've got Anagram. And Anagram, although sales ultimately are being forecasted from our previous guidance down $15 million. Those are the 3 major components.

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Joseph Isaac Feldman, Telsey Advisory Group LLC - Senior MD, Assistant Director of Research & Senior Research Analyst [39]

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And then just one final one. Can you talk about where we are with the Party Planner and the kind of lift you're seeing from that? And I may have missed it if you said it earlier, but like how many you have now? I think it was 150 as of last quarter?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [40]

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Right. It's roughly still the same. The Party Planner has been a successful experiment from the standpoint that we know when we interact with our customer and we know when we provide customer service. We can -- we will build the basket. I'm going to introduce Mr. Brad Weston because he is -- Brad has terrific experience as a merchant and has terrific -- has a great track record of building comp sales and building traffic. I'm going to ask him to talk a little bit about the Party Planner program from a little bit different perspective, thinking about it more globally in terms of our full organization being sales conscious and customer-centric.

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Bradley Morgan Weston, Party City Holdco Inc. - President [41]

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Thanks, Jim. As I've looked at our business prior to joining and now in the [8] days that I've been with the company, clearly our biggest opportunity is to drive customer-centric mindset throughout our business. Obviously, it starts with how we curate assortments, includes how we merchandise our stores, and then most importantly, how we engage the customer in our store. And I can tell you I'm already focused on how we raise the average order value in our stores and online as we serve as party co-hosts for consumers who need solutions and party components that we provide. As I look at the Party Planner strategy, I think it's right on. It's 150 stores today. I think we can continue as I gain additional understanding and apply some additional strategy work to that Party Planner program, we will continue to roll it out and build it as a strength of our in-store experience.

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James M. Harrison, Party City Holdco Inc. - CEO & Director [42]

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Thank you, Brad.

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Operator [43]

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And I would now like to turn it back over to management for closing remarks.

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James M. Harrison, Party City Holdco Inc. - CEO & Director [44]

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Thank you, operator. Once again, everybody, we apologize for the technical difficulties that led to the delay. But as always, thank you for your interest and support in the business, and we look forward to speaking with you later on one on one or whenever you want. As you know, my phone is always open and should feel free to reach out to me if you have any questions or to Mike. And have a great day. Thank you all very much.

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Operator [45]

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And ladies and gentlemen, thank you for participating in today's Party City Q2 2019 Earning Call. This does conclude today's conference call. You may now disconnect.