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Edited Transcript of PRTY earnings conference call or presentation 12-Mar-20 12:00pm GMT

Q4 2019 Party City Holdco Inc Earnings Call

Elmsford Mar 17, 2020 (Thomson StreetEvents) -- Edited Transcript of Party City Holdco Inc earnings conference call or presentation Thursday, March 12, 2020 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

* Todd E. Vogensen

Party City Holdco Inc. - CFO

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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

* 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

* William Michael Reuter

BofA Merrill Lynch, Research Division - MD

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Presentation

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Operator [1]

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Good day, and welcome to the Party City Q4 2019 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Ian Heller, Vice President and Deputy General Counsel. Please go ahead.

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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 fourth quarter and full year 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; Todd Vogensen, our Chief Financial Officer; and Brad Weston, our President and the Chief Executive Officer of our Retail Group. We'll start the call with some prepared remarks by Jim, Todd and Brad before we open it up for Q&A.

Please note that in today's discussion, management may make forward-looking statements regarding their beliefs and expectations of the company's future performance, future business prospects, or 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 statements 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.

I'd like to begin today's call by welcoming and introducing Todd Vogensen, our new CFO, who joined us on February 3. Todd brings nearly 3 decades of financial management expertise to the executive team, and we are very pleased to have him on board. I also want to take this opportunity to thank our Chief Accounting Officer, Mike Correale, for all his hard work as interim CFO over the last several months and for his continued help in working with Todd to ensure a smooth transition.

As always, I will begin my remarks by providing an overview of the company's performance for the fourth quarter and fiscal 2019. Todd will then discuss our financial results in greater detail and our outlook for 2020. And finally, Brad will discuss our 2020 priorities, including the actions we are taking to improve our retail operating model and performance, which are at the core of our plans to drive profit improvement, which the company enjoyed for 22 of the previous 24 years. Then we will open up the call for your questions.

Let me begin with a quick review of the financial results of the fourth quarter and fiscal 2019.

For the quarter, sales were $731.6 million compared to $805.6 million in the prior year. And adjusted EBITDA and adjusted EPS were $119.5 million and $0.51 per share, respectively. For the year, total revenue was $2.35 billion as compared to $2.43 billion in 2018, including a comp sales decline of approximately 3%, while adjusted earnings per share was $0.46 per share and adjusted EBITDA was $269.2 million.

On the top line for the fourth quarter, as we discussed in our November call, Halloween did not meet our expectations. Additionally, our solids, Christmas and birthday businesses were not as strong as we would have liked. Our in-stock position in helium at retail was a bright spot in the fourth quarter as it drove a ramp-up in our balloon business. Our third-party consumer products business at Anagram continued to be adversely affected by the helium shortage, while the rest of our consumer products business on a revenue basis performed relatively close to plan. However, margin headwinds from promotions and increased helium costs at retail as well as unfavorable channel mix in the consumer products businesses impacted the bottom line.

As I reflect upon 2019, there's a little denying, it was a very difficult year. A confluence of events came together to create huge headwinds for the business, significantly affecting both sales and margins. Some of these were external, like the much discussed helium situation that was a significant headwind to our top and bottom line performance this past year, but others, like Halloween performance, were self-inflicted. The helium shortage negatively impacted our total revenue results by $45 million for the year and was a source of 100 basis points of our annual gross margin decline of 470 basis points. Throughout the course of the year, our procurement teams worked to find resources to alleviate the situation at retail. However, it was until late in the fourth quarter of 2019 that we were able to develop a series of creative partnerships to provide Party City with access to additional resources to stabilize and restore adequate helium supplies to our retail supply chain.

As many of you know, Party City is the go-to destination for balloons, and balloons represent a significant point of differentiation for our retail operations, clearly separating us from our competition. So far this year, our stores are experiencing a strong in-stock position for helium. In an effort to combat sales challenges caused by the helium shortages as well as excess freight and distribution expenses embedded in our inventory costs that carried over from 2018 and the soft Halloween season, we put in place significant couponing and discount promotional initiatives, which pressured margins and were not as successful as we would have expected.

2019 was also a challenging year for our consumer products businesses, as both the impact of acquired franchisees in 2018 and the effects of helium in our metallic and latex balloon businesses in the broader market put pressure on third-party sales. Having a significant global market share in the metallic balloon category is a huge asset, but as a result of the 2019 impact of the helium issues, we felt them well beyond our retail business. Although not a severe as retail impact, helium represented approximately $13 million in revenue headwinds to our third-party consumer business.

While our financial performance was disappointing, there were some bright spots and progress made against some of our key initiatives. For example, as I mentioned, we have sorted out the retail helium challenges and are seeing a pickup in our balloon categories. In 2019, we implemented a market optimization program aimed at closing 55 retail stores to help optimize our performance at a market level, focusing on the most profitable locations and improving the overall health of our store portfolio. We closed approximately 35 stores in 2019 and completed the rest in January of 2020. The sales recapture rates thus far, in excess of 35%, have exceeded our expectations, and the reserves provided for inventory liquidation remain adequate.

E-commerce was a bright spot for us in 2019, and we are pleased with the 14.8% growth we saw for the year. BOPIS has been very well received by our consumers and represented 39.3% of e-commerce orders and 24.4% of e-commerce sales in 2019. We also continue to be pleased with the performance of our Amazon storefront, which grew over 300% in 2019, and our total marketplace, which grew over 280% in 2019.

Within our consumer products business, our North American alternative markets revenue grew approximately 10%, and our global consumer products businesses delivered approximately $256 million of consolidated adjusted EBITDA in 2019. Internationally, the businesses in Mexico, Australia, Europe and U.K. performed close to plan despite the challenges presented by the strong dollar, generally weak economic conditions and uncertainty surrounding Brexit.

In terms of capital allocation, we reduced our total net indebtedness and trade payables by more than $275 million as of December 31, 2019, when compared to December 31, 2018. Part of this reduction was accomplished through the sale of our 65 Canadian Party City Stores to Canadian Tire at double-digit multiple of 4-wall EBITDA. Additionally, this agreement included a 10-year supply agreement which contemplates more than doubling our consumer product sales into Canada through the Canadian Tire family of companies.

2019 was also an important year as we significantly strengthened our leadership team throughout the organization, including the additions of Brad as President; Todd as our CFO; Sean Thompson as EVP of Merchandising; Julie Roehm as our Chief Experience Officer; and many others. Our entire management team is executing with a sense of urgency and is committed to returning PCHI to levels of success that we enjoyed for so long.

And speaking of leadership, before I turn over the call to Todd, I want to address one other announcement we made today. As many of you saw in the earnings release today, we announced that effective April 1, Brad will be assuming the role as CEO, and I will transition to the new role of Vice Chairman. In this role, I will primarily focus on ensuring a smooth transition, helping Brad and team execute corporate development opportunities as well as provide other support to both Brad and Todd. This leadership transition is the culmination of an almost 2-year succession plan which the Board and I have worked on to identify the right individual to lead our company forward and into its next chapter of growth. In conducting the search, we believe that my successor needed to possess a strong background in retail and have the bandwidth to embrace and lead the many other aspects of our business model. We believe that in Brad, we have found this unique leader. Brad has already put a stamp on the business during his 7 months at Party City. As the CEO of the Party City Retail Group, Brad has led all aspects of the company's retail operations and has developed a road map for change to improve Party City's retail experience and a long-term growth strategy to build value for shareholders. I'm extremely excited for the future of Party City and pleased to be able to support Brad and Todd in this next chapter.

And with that, I will turn the call over to Todd. Todd?

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Todd E. Vogensen, Party City Holdco Inc. - CFO [4]

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Thanks, Jim, and good morning, everyone.

First, I'd like to say that I am very excited to have joined the Party City team. It's been a busy and productive 6 weeks getting to know the business. And while the results for 2019 are disappointing, the entire team is committed to driving improved performance with a sense of urgency.

Now turning to our results. Please refer to the accompanying slides available on the Investor Relations section of our website for further details on our financial performance.

As Jim discussed, the fourth quarter did not meet our expectations as increased promotional activity was not as effective in driving sales as expected, resulting in softer sales performance. While we were successful in driving inventory decreases, the discount significantly impacted our gross margin and overall profitability.

Our consolidated total revenue for the fourth quarter was slightly below the implied outlook that we provided in our third quarter earnings call, down 9.2% on a reported basis and 9.1% in constant currency. In total, our retail segment's fourth quarter net sales decreased 12.4% on both the reported and constant currency basis, with retail comparable sales down 5.1% and net store count down 11% from last year.

As we discussed in our third quarter conference call, Halloween results were soft. In addition, our solid party supplies and Christmas categories underperformed, which more than offset improved results in the balloon category. In the Christmas category, our assortments lacked the necessary newness and innovation. And in the solids category, our pricing structure was not aligned with the market.

In a few minutes, Brad will discuss the initiatives that we're focused on to stabilize our retail business and to recapture momentum.

Turning to our third-party wholesale segment.

Net revenue increased 5%, driven by incremental wholesale volume from our Canadian Tire agreement and international growth of 13.7% on a constant currency basis. For the fourth quarter of 2019, consolidated gross profit margin was 40.3% or 500 basis points below the same quarter of last year. The gross margin decline was primarily driven by increased promotion in the fourth quarter. In addition, gross margins were negatively impacted by the company's store optimization program and the impact of increased helium costs.

Total share of shelf at our Party City stores and our North American retail e-commerce operations was 82.8% during the quarter or 210 basis points higher than Q4 of 2018 driven by an increase in internally supplied costumes, gifts and Halloween products. Compared to last year, our manufacturing share of shelf improved by 60 basis points to 17.2%, primarily due to an increase in the penetration of self-manufactured birthday products.

Operating expenses, excluding store optimization, goodwill and trade name impairment charges and sale-leaseback transactions, totaled $216.7 million or 29.6% of revenue, which was $9.2 million higher than the fourth quarter of 2018. The increase primarily reflects a $6.5 million legal settlement and increased marketing costs.

Overall, the bottom line impact of these changes is adjusted net income of $47.8 million in Q4 2019, down from $103.4 million last year. Adjusted EPS was $0.51 compared to $1.08 from the prior year. And adjusted EBITDA was $119.5 million this year compared to $188.9 million in Q4 of 2018.

Turning to our full year results.

Consolidated revenue was $2.35 billion, which represented a decline of 3.2% on a reported basis and 2.7% on a constant currency basis. Retail operations posted a decline of 3.4% on a reported basis and 3.2% in constant currency, which includes the impact of 35 store closures and the sale of 65 Canadian stores to Canadian Tire. Reported comps declined 3.0% for the year. Gross margin rate declined 470 basis points for the year, primarily due to clearance markdowns from our store optimization program, increased promotional discounts in the second half of 2019 and increased helium cost. Our total share of shelf at retail was 79.6%, up 70 basis points compared to 2018. In addition, our manufacturing share of shelf increased 60 basis points to 23.5% for the year.

Operating expenses, excluding the store optimization program, goodwill and trade name impairment and the gain on the sale-leaseback transactions, totaled $732.2 million or 31.2% of revenue and were $18.4 million higher than 2018. The increase was primarily a result of the wrap around on franchise acquisitions in late 2018.

Adjusted net income was $43.4 million versus $156.8 million in the prior year. Adjusted EPS was $0.46 per share versus $1.61 in 2018. And adjusted EBITDA was $269.2 million versus $400.1 million in the prior year.

We ended the year with net debt of $1.6 billion, down by $210 million from year-end 2018. The reduction in our debt was primarily driven by the proceeds from our sale of 65 stores to Canadian Tire and our sale-leaseback transactions. Importantly, at year-end 2019, we had $35 million in cash and cash equivalents and approximately $350 million of borrowing capacity under our ABL credit agreement.

Before discussing our 2020 outlook, I'd like to review a few items that we've factored into our full year guidance.

First, we anticipate that 2020 will be a year of stabilization for the company. We're focused on improving our financial and operating results at retail through various initiatives that Brad will talk about shortly. However, the rollout and impact of these initiatives will take time. As such, we do not expect to see the full benefits of these initiatives in our 2020 performance. We anticipate that our non-comp sales will be impacted by the sale of 65 stores to Canadian Tire in 2019 and last year's store optimization program, offset partially by modest growth in 2020, our wholesale segment. We expect gross profit margin rate to improve relative to 2019, as we return to a more normalized level of promotions and the clearance headwinds from our 2019 store optimization program end. We expect adjusted EBITDA headwind of approximately $4 million from the sale of our Canadian stores to Canadian Tire and approximately $5 million in incremental costs from our sale-leaseback transactions in 2019. We completed our 2019 store optimization plan in January 2020 with the closure of 20 stores in the month. We expect the results of our store optimization plan to benefit 2020 EBITDA by approximately $5 million. During the remainder of 2020, we plan to continue strategically rationalizing our store base, opening approximately 12 stores and closing approximately 21.

In terms of any potential impact from COVID-19, otherwise known as the coronavirus, at this point, we do not anticipate any material supply chain impacts to our financial results in the first quarter. But as you all know, the situation is very fluid, and we're closely monitoring developments. As a result, please note that our outlook excludes any potential impact from COVID-19.

Taking these factors into account, for 2020, we expect: revenue to be down in the mid single-digit percentage range; and comparable retail sales to be down in the low single-digit percentage range; net income to be in the range of $38 million to $54 million or $0.41 to $0.58 per share; and adjusted EBITDA to be in the range of $250 million to $270 million, with interest expense of $104 million to $106 million for the year. We are planning to invest approximately $65 million in capital expenditures, with approximately half invested in our retail segment and half invested in enhancing our manufacturing and distribution capabilities.

In terms of our quarterly results, during 2020, we expect our comp sales declines relative to 2019 to be roughly similar across the year.

For all other detail around our outlook, please refer to our press release.

And with that, I'd like to turn the call over to Brad.

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Bradley Morgan Weston, Party City Holdco Inc. - President [5]

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Thank you, Todd. Before I dive in, I want to say that I am incredibly excited for the opportunity to lead this fantastic organization. I'd also like to take a moment to thank Jim for his leadership of the business over the last 24 years. Under Jim's stewardship, Party City has firmly established itself as an industry leader, with a differentiated, vertically integrated wholesale business. I greatly look forward to working alongside our Board, our management team and our very talented employees as we focus on executing against our strategic priorities to drive sustainable long-term growth.

I firmly believe that we have a great platform in place. However, I'm also acutely aware that customer needs and shopping experiences are constantly evolving. So as an organization, we must make strategic changes to adapt to. In this spirit, over the last several months, I've had the opportunity to roll up my sleeves on our retail business and work closely with the team to identify the areas where we can improve. These opportunities span merchandising, marketing, store operations and e-commerce, to increase our relevance to our customers, improve our value perception, drive engagement and elevate our customer experience with the Party City brand.

While I shared some initial observations with you on our retail business last quarter, today, I'll recap the 5 key retail initiatives we are focused on and the actions we are taking to drive growth and recapture momentum.

Number one is developing a more relevant in-store experience. We believe our stores can be overwhelming and time-consuming to navigate, which provides a natural opportunity for us to simplify the shopping experience in order to better meet the needs of our customers. This begins with piloting changes to the in-store experience through curated product assortments, reduced inventory, new store layouts and product adjacencies, along with new services and experiences. These changes will help declutter the store and also provide the customer with a greater assortment of products that are presented in a more visually appealing way.

Building on the insights we learned from a successful 2-store test in December, later this month, we will launch the first 3 of what we plan to be 30 to 45 next-generation stores. These stores will be a combination of remodels, relocated stores and new stores executed in 2020. In addition to reducing SKUs, inventory reductions and product adjacency changes, we will be recalibrating these store layouts to shop-in-shop concepts focused on end use, which moves us away from the current long grocery style aisles. These shop-in-shop concepts will include kids birthday party supplies and favors, party hosting products like colored tableware and serveware, a costume shop for year-round wearable products and candy. The biggest focal point will be balloons, including a separate checkout to provide balloon customers with more personalized service, and speed up transactions for non-balloon customers in the existing queue. These stores will also have balloon delivery, party planning services and digital experiences available, taking us to the next level in terms of creating differentiated customer experiences. We plan to extend this pilot to 2 markets in Q2 2020, which will allow us to further test our experience offerings and gain deeper insights into consumer preferences to better inform our go-forward in-store strategy.

Number two is win in balloons. Balloons are a key differentiator for Party City, and we have an unparalleled foothold given our numerous licenses and unique manufacturing capabilities, providing us with a clear and achievable opportunity to better leverage our platform. We will incorporate relevant services to maximize our balloon opportunity as well as the ancillary categories we know this important purchase drives. Our goal is to significantly enhance the balloon customer experience to drive increased sales, transactions and average order value, which have begun with 2 key initiatives. First, we began piloting balloon delivery service with a delivery partner in a few markets starting in December 2019. Next, we rolled out our Balloon 365 training to all stores in January 2020 and also certified experts in every store in February. Our initial results are exceeding expectations and driving incremental sales. And we're currently planning the full chain-wide rollout in Q2.

Number three is address value perception in key categories. In reviewing our portfolio of categories, we believe there is a tremendous opportunity to drive increased sales volume and margin dollars across our product portfolio. Accordingly, we have taken a close look at our pricing to determine areas where we think we can more effectively meet the needs of our customers and drive sales. For instance, solid paper and plastic tableware is an important business for us. This is a heavily shopped category for our customer, as evidenced by the fact that tableware is almost 20% of our sales and in more than 40% of basket. Beginning last September, we began strategically lowering prices, and we're pleased with the results in increased units and gross margin dollars. We continue to see comp sales increases in the baskets that include solid tableware, which is the desired result. We've already begun to test additional categories such as kids birthday and balloons. And as we look ahead, we will continue to review and test other key value indicator items and categories, such as Halloween costumes. We expect it will take time for this effort to really start showing progress, but we're pleased with the early returns.

Number four is improve customer engagement selling culture in stores. Our customers are increasingly looking to create a complete party experience, and we need to do more than just sell party supplies. There's a clear opportunity to play more of a party planner role with customers who are shopping our stores for party supplies. If we're to successfully capitalize on this growing trend, we need to get better at engaging with our customers in store. In order to do that, we have to pivot from a store operations and maintenance culture to a customer engagement and selling culture. This pivot is driven by leading, hiring and training store management and associates with a higher level of accountability for sales and customer engagement metrics. In addition, as we reduce our SKU count and inventory levels, this frees up time for our sales associates to focus on customer engagement.

We're also in the strategic planning stages of pivoting our party planner program to a physical and digital ecosystem of on-demand, party planning professionals available via telephone, online chat or in-person appointment in a store.

Number five is building on our omni-channel platform. We will continue to add key omni-channel capabilities to keep pace with customer expectations and to create a competitive advantage. As Jim mentioned, buy online, pick up in-store performance continues to be very strong and now represents a significant portion of our total digital sales. But we see opportunity to enhance and improve multiple customer touch points throughout the process.

While we are in the early innings of the test and learn phase for many of these initiatives, we're encouraged by the preliminary results we've seen so far. As we continue to generate learnings and incorporate them, we expect to see the associated positive impact on the business become more evident in our financial results. That being said, these changes and their impact do take time.

In addition to these 5 core initiatives, we're working on a number of ways to transform our operations, including: utilizing new customer data, insights and analytics to develop new product and marketing tactics to drive acquisition and retention initiatives; accelerating CRM and loyalty initiatives to increase personalized engagement; continuing to explore store optimization opportunities to maximize market result; and identifying enterprise-wide savings to reinvest in our growth initiatives.

Party City's purpose is to create joy by making it easy to create unforgettable memories. We know we have our work cut out for us, but we also know the opportunity for improvement is substantial. I strongly believe that if we view our decisions through the lens of the customer, while exercising the full benefits of our vertical product supply chain model, which is the unique power of this brand, we will enjoy great success as a fully integrated vertical retailer, too.

With that, I'd like to now turn it back over to Jim.

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

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Thank you, Brad.

In closing, I want to thank you all for joining our call today. I would also like to thank and recognize our more than 25,000 associates who are dedicated to our growth and success.

While 2019 was an extremely challenging year, I believe that our response to these challenges only serve to make us a better, stronger company over the longer term. I'm excited about and look forward to seeing what Party City can do under Brad's leadership.

And with that, I'd now like to open the call up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from 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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Jim, wishing you all the best. And Brad, congratulations and good luck to you. I wanted to first start with just the guidance. And Brad, some of the color on the initiatives, it's really helpful. Just curious, and really it's going to take some time for some of this to play out, but guiding to low single-digit negative comps for the year, I think based on our math, you have 100, 200 basis points or so from lapping helium and all the indirect impacts from last year. So I guess what are some of the other considerations we should be thinking about that offset maybe both positive and negative?

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Bradley Morgan Weston, Party City Holdco Inc. - President [3]

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So obvious -- I appreciate that, Seth. Obviously, retail is continuing to evolve. I think many of the initiatives are not going to just be a flip of a switch. As I mentioned, relaying stores, improving the value perceptions. Those things take time. We're going to be very disciplined and physically -- fiscally responsible. We're really in a test and learn environment and test and learn mode. We won't put -- with that testing, we won't put any harm in the business long term. In fact, they're all focused on how we create stabilization that can lead to long-term growth. So we see this more as a transition period. So those are -- that's how we see it at this point.

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

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So just -- I guess it's early with some of the tweaks that you are making to the stores, there's a lot of testing and learning that's happening right now. Can you talk about the level of disruption I guess as you are making these changes and if that's one of the things that may be reflected in the guidance? And then also from a financial perspective, how do we think about sort of the level of investment to affect some of the changes that we're talking about here?

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Bradley Morgan Weston, Party City Holdco Inc. - President [5]

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So there will be very little disruption. When you can create a test and control environment and as we pilot some of these major in-store changes, as I mentioned in my remarks, we're starting with 3 stores. We'll gain a significant series of learnings. We'll try those then in a couple of markets where we can expand those learnings and then roll out additional stores based on the learnings. So we have a very organized and planned components to not just the pilot, but all 5 of the initiatives.

Relative to investment, it's very, very small. And reflected in our guidance, whether it's the capital expenditures around our pilot stores, not only are we testing the sales impact, but we're also understanding the cost implications and how to continue to control costs around those so we can do them in a very fiscally responsible way.

And when you think about price, like I said, where we're testing and learning related to price, we're not proceeding unless they have a sales -- unit sales and family margin upside. So those are all very much under control. And any of the other investments are really minimal, or if they have any relative investments, we are self-funding them.

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Seth Ian Sigman, Crédit Suisse AG, Research Division - United States Hardline Retail Equity Research Analyst [6]

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Okay. And my follow-up question, just to clarify in the guidance the COVID-19 impact. I think you said that there is no impact embedded here. Is that related to both supply and demand? And then if you can also just talk about what you are seeing from a demand perspective? I guess we're pretty deep here into the first quarter. So any more color on, I guess, the trends in the business on the back of what's happening out there.

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Todd E. Vogensen, Party City Holdco Inc. - CFO [7]

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So in terms of the guidance going forward, yes, we did look. Excluding both supply chain and demand, what I'd tell you is we're hearing positive things out of our suppliers in terms of their ability to get back up and going. We continue to monitor. I mean this is a very fluid situation. But at this point, feeling good about Q1 and continuing to monitor later in the year.

In terms of demand, I'm going to say it's just way too early. I think we've seen a big ramp-up in the amount of news just very recently. And again, we're continuing to monitor it, keeping -- obviously, safety of our customers and our associates, towards the forefront of what we're doing. And we will just have to wait until we get further into the quarter to really understand.

What you heard in the guidance? It was low single-digit comps across the year and then relatively even across the quarters, which means that reflected the run rate that we were seeing before any concerns about the coronavirus.

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Operator [8]

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Our next question comes from Simeon Gutman with Morgan Stanley.

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Simeon Ari Gutman, Morgan Stanley, Research Division - Executive Director [9]

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I wanted to ask first on your plans for debt paydown. Can you talk about what is slated for 2020 compared to 2019?

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Todd E. Vogensen, Party City Holdco Inc. - CFO [10]

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Sure. And I think going back to the comment that it's a very fluid situation out there and that I've been here, frankly, less than 6 weeks. We have a great deal of availability under our ABL. And I'd like to have more of a chance to go through and study overall cash position, overall working capital position before I get too far down the path of throwing out numbers. Mostly, we wanted to reiterate that managing our debt level was still a priority. In terms of what that means in specific numbers, I want to come back to you a little bit later in the year on that.

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Simeon Ari Gutman, Morgan Stanley, Research Division - Executive Director [11]

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Fair enough. I don't know if you can speak at this high level. But whatever the business generates in excess free cash beyond the CapEx, which we heard about and within some of the plans that Brad laid out, is that a fair assumption to assume the excess free cash is going to be used for debt paydown? Or that's too simplistic?

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Todd E. Vogensen, Party City Holdco Inc. - CFO [12]

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I think it's a little bit early in my tenure for me to get too far into that. Clearly, we are looking at debt paydown as our #1 priority. For excess cash, how much that looks like? Again, at this point, having a little bit of extra cash on the balance sheet given the environment doesn't scare me. And it's going to be more a matter of degree. And yes, we have to come back to you with more detail as I get more of a chance to study it.

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Simeon Ari Gutman, Morgan Stanley, Research Division - Executive Director [13]

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Got it. Fair enough. And then I want to ask, Brad, given the nature of the business and how it performed in 2019, I guess, look, you can always want to go faster. Do you feel that in this test and learn mode, you could go faster or you're moving at the appropriate pace just given that you're doing a lot of things at once, and you don't want to move any quicker and you're not at the stage yet to deploy even faster at this stage?

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Bradley Morgan Weston, Party City Holdco Inc. - President [14]

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So based on learnings over the last 7 months, I have a level of confidence in the 5 initiatives that we've laid out and have data and insights to say that those are -- can have a positive impact on our results. Related to rate and pace, all of those are very fluid. We're getting new learnings on a daily basis and a weekly basis. And I would say relative to how much we sort of push on the gas or the brakes relative to each of them is sort of a week-to-week, month-to-month thought process. I'm not -- I don't -- as I said to Seth, I don't think there's any risk at the rate and pace that we're anticipating. I would like nothing more than the ability to find some excellent results in those that exceed expectations and have the ability to go faster. And if there are elements of it where we can go faster, we certainly will.

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Operator [15]

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Our next question comes from Rick Nelson with Stephens.

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Nels Richard Nelson, Stephens Inc., Research Division - MD [16]

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My congrats to Jim and Brad as well. So I'm curious how you plan for Halloween at this point? A lot of uncertainties around COVID-19. Do you do anything different at this point?

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Bradley Morgan Weston, Party City Holdco Inc. - President [17]

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So at this point, we're not focused on doing anything different than the plans that we have been in works because we're not -- we obviously have a strong eye on our supply chain and keep a constant view of that. I would say the changes that we're focused on primarily around the sales opportunities that exist in Halloween, we're clearly understanding of the consumer insights that tell us that consumers want more of a do-it-yourself sort of opportunity to shop. We know we can do a better job there, the opportunities for more of a mix, match, make it your own, given those do-it-yourself trends are opportunistic for us. We have the opportunity and are focused on making our assortments more relevant. In some instances, I think we've been too reliant on licensed product. And we have the opportunity to introduce more do-it-yourself type costumes and more trend right costumes. We have an offering that is clearly different than what others could execute in the marketplace. And the learnings that we've had will be reinforced in the way that we execute in-store merchandising to reinforce that mix and match opportunity that exists in costumes and the accessories that really make them customizable. And so we have very distinct plans to make that exciting and more shoppable and more experiential for the customer.

In addition, we're focused on the marketing around Halloween as well. We can build the online experience and we can build content that, again, reinforces the strength we have in the marketplace. So relative to Halloween, we continue to plan. We continue to plan against the opportunities that we identified from last year and look forward to -- it's going to be interesting. The IP lineup for 2020 is not as positive. The presidential election timing will be interesting as Halloween is just 3 days prior to Halloween. But we also know that, traditionally, Saturday Halloween provides a tailwind. So we'll be clearly focused on this trend, newness, innovation and in looking to improve on our Halloween performance last year.

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Nels Richard Nelson, Stephens Inc., Research Division - MD [18]

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Also curious the last couple of weeks these markets have seen front and center, Seattle, San Francisco, with regard to store traffic sales. If you could provide any color around that, that'd be helpful.

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Todd E. Vogensen, Party City Holdco Inc. - CFO [19]

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Yes. This is Todd. And again, I think we are early on. It's tough to give you a day or 2 of measurements at this point because I think it can be very misleading. So we just decided to not give specifics around the demand side of the equation at this point, and that's probably the best I can tell you right now.

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Nels Richard Nelson, Stephens Inc., Research Division - MD [20]

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Okay. Fair enough. Also, if you could speak to the covenants. Where you stand with those?

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Todd E. Vogensen, Party City Holdco Inc. - CFO [21]

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In studying the -- our debt as I have before, I have to tell you, I've been really impressed how the way the company set up the debt agreements, the ABL agreement. The covenants are, I would call them, covenant very light. Really the one that's most applicable, and there is the fixed charge coverage ratio which we are very well within the bounds of right now. So covenants, not really something at this point that's a concern.

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Operator [22]

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Our next question comes from Karru Martinson with Jefferies.

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Karru Martinson, Jefferies LLC, Research Division - Analyst [23]

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Just looking at the guidance here, the $250 million to $270 million. When we last spoke, we talked about having a roughly a $45 million tailwind for the helium, for the capitalized costs. So obviously, a big swing here. Can you kind of bridge us to what has changed in your thinking from just a few months ago to today?

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Todd E. Vogensen, Party City Holdco Inc. - CFO [24]

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Having not been here a few months ago, I'm a little bit handicapped. But what I can tell you, we are seeing positive impact in balloons. What we're also seeing is the effects of the things Brad has been talking about today, that in the core underlying businesses, we have some opportunity as retail has quickly changed. And those things probably were not as evident as helium was so front and center as we went through last year. So what we've really baked in is more of what we would consider to be the core run rate of the business that then we can build off of. And so you're seeing that low single-digit negative comp rate as part of the core. And then as these initiatives start building in, you would expect to see a change in that trajectory.

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Bradley Morgan Weston, Party City Holdco Inc. - President [25]

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I would add to that, that it's been fantastic to have the last 7 months to really learn, be a student of the business, understand it and further digest sort of how we got here where we are and how we create the right path forward. I would summarize it by saying, I think we've struggled having a bit of a relevancy opportunity with consumers. And as we've said before and I'll reiterate, we have not kept pace with consumer expectations to the level that consumers expect. And I think core in the 5 strategic initiatives that I laid out are key components of how you establish relevancy, regain relevancy and create momentum.

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Karru Martinson, Jefferies LLC, Research Division - Analyst [26]

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Okay. And then when we look at the third-party balloon sales, what is the state of the helium market out for those guys?

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James M. Harrison, Party City Holdco Inc. - CEO & Director [27]

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Sure. This is Jim. When we look at the -- when we look right now at the third-party balloon business, it has definitely stabilized off of last year. The situation is improving, not just at Party City where we are back in stock on helium, but also globally, the helium situation is improving and stabilizing. And we continue to believe that by the beginning of 2021, there should be ample supplies of helium available in the broader market to satisfy the needs of the consumers.

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Karru Martinson, Jefferies LLC, Research Division - Analyst [28]

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Okay. And then when you look at your portfolio, be it manufacturing, any owned facilities or even geographies that you're looking at potentially for asset sales or ways to bolster your liquidity.

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James M. Harrison, Party City Holdco Inc. - CEO & Director [29]

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As I've mentioned before, Karru, I think understanding our portfolio, reviewing our portfolio, reviewing our portfolio in the context of what is the long-term strategy for the business, and how do we leverage up those investments and those assets to maximize the value to shareholders and to bondholders is an active process that continues. I mean last year, as you know, we -- there were 2 financial engineering transactions, one, the Canadian Tire transaction, the other being the sale and leaseback. And with Brad and with Todd, part of my role going forward is to try and work with them and provide my thoughts around the very subject you're raising. But in terms of saying is there something specific that we're doing, we're thinking about, it would be far, far too early to talk about that.

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Operator [30]

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Our next question comes from Joe 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 [31]

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And wanted to ask -- I know, obviously, the capital expenditures are stepping up. It looks like a fair amount to $925 million to $975 million is your new guidance. I mean is that what we should think about this level for the next couple of years? Or will it even step up further given as you do these tests and then start to expand and roll them out further, should we see even a step up there? And then how does that impact debt repayment if that's being jumping up a bit higher?

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Todd E. Vogensen, Party City Holdco Inc. - CFO [32]

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Sure. And just to clarify. We were looking at $65 million for our targeted capital expenditures next year. Is that what you were referring to? Just to make sure.

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Joseph Isaac Feldman, Telsey Advisory Group LLC - Senior MD, Assistant Director of Research & Senior Research Analyst [33]

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Yes, yes. Your Capex. Yes, yes.

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Todd E. Vogensen, Party City Holdco Inc. - CFO [34]

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Yes. So $65 million next year, which shouldn't be a significant step-up, it really does reflect the things we've been talking about. So about half of our investment is in storage, and you're seeing benefit or cost of new stores, where we think there is good payback as well as relocations and the types of things that we're building into the tests we're doing. So it should not be a significant step-up. And that's -- a number of things have been really impressed with here. One of which is that fiscal discipline, around making sure that we're not going out and getting ahead of ourselves on our cash investment. So you should really continue to see that.

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Joseph Isaac Feldman, Telsey Advisory Group LLC - Senior MD, Assistant Director of Research & Senior Research Analyst [35]

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So just to -- how much does it cost to do one of these remodels then? Like these full-on remodels. I'm just surprised that you're not going to have to step up the CapEx [as it were].

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Bradley Morgan Weston, Party City Holdco Inc. - President [36]

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So the remodels are fairly light relative to capital from the standpoint that there's not a lot of incremental fixtures that are being put into them. And we are -- where there are incremental fixtures, it's really around balloons and enhancing the balloon experience. Otherwise, it's more of a store relay than it is anything else and a refresh. So they are not capital-intensive. It's also fair to think about the commercial real estate market and the desire for landlords to have additional traffic in their stores and their willingness to invest in addition to us.

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Todd E. Vogensen, Party City Holdco Inc. - CFO [37]

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Then throw in one last thing is I think the team has been very disciplined about trying to take advantage of any new store opportunities that are coming up or relocations or already slated remodels so that we can piggyback on top of investments that we're already going to make and we're already a part of the plan to build in any investments that we are planning to do on next gen.

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Bradley Morgan Weston, Party City Holdco Inc. - President [38]

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I wouldn't put a single number on an individual store. They obviously vary depending on the types of agreements that you can reach and investment level others -- landlords may want to make as well. I would also say that part of testing and learning is not only with the positive customer experience in sales, lift in generation, but also the ability to manage the cost and reduce the cost based on the learnings you get as you go along. So we'll have a much -- as we roll these out over the next several months, we'll gain a greater insight as to what the long-term investment might look like.

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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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Got it. And then another kind of question. Now that -- your third quarter, you guys were pretty well baked. After Halloween, you gave some guidance. I think that the low end was going to be like $0.84 in EPS. I mean we're at ICR and spoke. Like what happened that was so different from where we and the street we're at in your guidance? Like it just seems like a lot of stuff had to happen that you probably knew about that didn't come out earlier. I guess I'm kind of confused as to what was the big change.

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Todd E. Vogensen, Party City Holdco Inc. - CFO [40]

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So I would say from everything I've looked at, gross profit margin was the big area that I moved towards the downward side more than we would have normally predicted. We went through a lot of promotional activities. We went through the course of December. After we got through Halloween, we would have expected to see a little bit more improvement in areas like the solids, like the Christmas programs. And so when we didn't and when there was incremental promotions, those really flowed through to the bottom line very, very quickly.

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Operator [41]

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We have time for one more question, and that comes from William Reuter of Bank of America Securities.

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William Michael Reuter, BofA Merrill Lynch, Research Division - MD [42]

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Just a follow-up on Karru's question. When you look at your expectations for helium this year versus last year, I assume that you'll have increased sales due to not being out of stock as much as well as, I think, some lower sourcing due to the higher spot prices that you're paying on a portion of it last year. When you think about those gross margin dollars that you're going to achieve this year, can you give us a sense of what you're expecting or what's baked into the guidance?

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Bradley Morgan Weston, Party City Holdco Inc. - President [43]

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Yes. Our balloons overall will be a plus -- should be a plus to our overall business in 2020, not a minus. Helium -- with helium shortage behind us, costs getting better sequentially. They will be higher overall in 2020, but we see them largely in line with the Q4 '19 run rate that we had. Our balloon business has been healthy, continuing to get healthier. It's a growing piece of our business. And so if we drive good sales comps in balloons, that will offset any helium cost that we see being higher. We continue to watch. As we gain insights and data around price elasticity at the balloon category and SKU level, we now have a very informed way to think about our prices, our ability to take some of our prices up, some of our prices down depending on those reads in elasticity. And so those are the things that we've thought about and put into our guidance.

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William Michael Reuter, BofA Merrill Lynch, Research Division - MD [44]

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That's helpful. I understand that given Todd's relatively new there, making assumptions on working capital and debt repayment might be a little bit challenging. I guess is it fair to say that you will allocate all of your free cash flow to debt? Or given the share price being a little depressed, would you consider that as well?

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Todd E. Vogensen, Party City Holdco Inc. - CFO [45]

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I think it is early. We're continuing to look at what that right amount of free cash flow and cash to go towards debt would be. Debt paydown is the #1 priority. For what it's worth, this is a year where we do expect to continue to improve our productivity on inventory. So as we look across the year, we don't see our working capital needs high spiking. We expect to continue to do push on inventory turns, inventory, gross margin and return on investment. And so that means we should not see massive needs out of working capital. In terms of, again, how much of that exactly goes to debt pay down, it's just a little bit early for me to commit.

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William Michael Reuter, BofA Merrill Lynch, Research Division - MD [46]

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Okay. And then just lastly, given relatively soft retail traffic, have you found any opportunity to renegotiate leases? Or do you expect that, that may be an opportunity this year to kind of reduce operating costs?

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Bradley Morgan Weston, Party City Holdco Inc. - President [47]

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So it has been an opportunity in the past, as we thought about the store optimization that we've done -- we did in 2019, we'll continue to do in 2020. Certainly negotiating lease terms and rent prices are all a part of our ongoing initiatives to reduce those expenses, and we are actively participating in those discussions on a consistent basis.

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Operator [48]

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This concludes our question-and-answer session. I would like to turn the conference back over to Brad Weston for any closing remarks.

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Bradley Morgan Weston, Party City Holdco Inc. - President [49]

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I'd like to thank each and every one of you for joining us. Todd and I are available to speak with you. I am truly excited and passionate about the opportunities that lie in front of us which are truly great. So thank you, everybody.

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Operator [50]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.