Party City Holdco Inc.

and welcome to the Party City third quarter 2020 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Mr. Ian Huller, Vice President and Deputy General Counsel.

Please go ahead. Thank you, Operator. Good morning, everyone, and thanks for joining us. This morning we released our third quarter 2020 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 Brad Weston, our Chief Executive Officer, and Todd Boganson, our Chief Financial Officer. We'll start the call with some prepared remarks by Brad and Todd 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 about 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 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 Brad Weston. Thanks, Ian.

Good morning, everyone, and thank you for joining us today. As COVID-19 challenges continue and even escalate in many areas of the country and across the globe, our hearts go out to all who have been impacted. As a company, we remain focused on our number one priorities which is keeping our employees and customers safe. As a brand, we're focused on our mission and purpose, which is creating joy by making it easy for consumers to create amazing celebrations. We are very pleased with our third quarter performance. Our results were better than our expectations and underscored the ongoing strength of our core business. In a pandemic impacted environment, we stabilized our top line sales and grew adjusted EBITDA almost threefold in third quarter. There are three key themes that are reflected in this performance. First, the strides we are making to increase relevancy and elevate our customer experience across channels so we reinforce and strengthen our position of authority when it comes to celebrations. Second, the discipline and control with which we are operating our business. And third, the consumer's desire and willingness to celebrate, albeit in a unique and different way given the pandemic. I will discuss these in more detail after reviewing our financial and operational performance for the third quarter, as well as our October and Halloween season results. Todd will then elaborate on our financial results and provide some thoughts on how we're approaching the fourth quarter. As shared on our Q2 call in August, We saw positive comp performance in July, which continued through the quarter, resulting in a positive 8.3% comp increase for Q3, the largest comp we've delivered in nine years. Importantly, our core categories like balloons, birthday, and entertaining were up double digits collectively in Q3, which is a very encouraging indicator that our underlying business is strong. In fact, even in the month of October, when our businesses skewed more towards Halloween sales, we saw continued positive trends in our core category. We believe this strong performance is indicative of the underlying resiliency this business has historically demonstrated, even in recessionary environments. It illustrates how Americans are prioritizing celebrations and the marking of milestones such as birthdays, even if they are being celebrated with smaller groups of people in the privacy of homes and just with family. It also illustrates that the work that has been underway to reinvigorate our retail business, increase our relevancy, and elevate our customer experience across channels is having a demonstrable impact. e-commerce continued to perform well and digitally enabled sales increased 36% as our customers continued to take advantage of our expanded fulfillment options, including buy online pickup in store, curbside pickup, and same day delivery. Our wholesale business also demonstrated strong resiliency in the third quarter when third party sales approximately flat to last year. We still expect the wholesale business to lag the recovery at retail and and we were encouraged with the improvement in overall wholesale trends through third quarter as franchise customer volume returned to more normalized levels. We benefited from strength in our Canadian wholesale business and our Anagram metallic balloon business delivered significant growth. Anagram total sales were up 30.6% for Q3, while third-party sales were up 22.1%. Anagram's innovative design and market strength have resulted in a particularly strong recovery. Overall, Anagram EBITDA increased 7.5 million or 164% over last year. On a consolidated basis, third quarter total sales were down 1.2% or down 1.6% on a constant currency basis. With gross margin expansion of approximately 250 basis points for the quarter and very disciplined expense management, adjusted EBITDA was 49.2 million compared to 17.1 million in the prior year quarter, and adjusted earnings per share was 10 cents versus a loss of 28 cents, as Todd will discuss further shortly. Moving to our Halloween season results. For the month of October, comparable sales were down only 2.9%, which was well ahead of our expectations heading into the season, including significantly better-than-expected Halloween results, which were down 12.9% on a comp basis, and continued strength in non-Halloween sales during October, which bodes well for the remainder of 2020 and going forward. The total sales decline for the month of October reflects the strategic reduction in Party City and Halloween City stores versus the prior year period. As mentioned on our last call, we planned conservatively for Halloween this year, given the truly extraordinary environment as a result of the pandemic and election uncertainty. We positioned ourselves for a decline from an inventory, assortment, and expense standpoint, as well as from a Halloween City pop-up store perspective. Within the Halloween category, our decor business saw positive growth as we expected. And within costumes and costume accessories, the kids and licensed businesses were most negatively impacted due to the lack of kids' activities and the postponement of most licensed properties into the future. While we do leverage retail operating expenses, we anticipated the challenges of optimizing operational efficiency during our highest store traffic time period. In this COVID-19 environment, we needed to manage store occupancy and to ensure the safety of our customers and our associates. In many instances, we needed to manage the number of people in our stores and the lines that extended outside our stores. As we reported earlier, we hired a quantity of seasonal employees to both manage these atypical mid-pandemic circumstances and to improve our quality of service. And overall, I am pleased with how we operated during our busiest time of year. Needless to say, this year we dramatically improved our Halloween go-to-market strategy, including significant improvements to our assortment, in-store merchandising, pricing, marketing, and digital experience, as well as the in-store customer experience, including our new curbside pickup and delivery option. Many of these improvements were in response to our learnings from last year that we previously discussed. Our biggest learning from last year was that we needed to expand do-it-yourself options, giving customers growing preference for customizing their Halloween costumes and look, with increased personalization to make it their own. We recognize that we didn't merchandise and market do-it-yourself well enough in 2019, especially given it is what makes Party City so unique. The in-store do-it-yourself merchandise was presented more clearly and intuitively for the customer with improved visual merchandising and assortment planning. We also had Halloween marketing campaigns, such as You Boo You, to remind folks that we offer the largest breadth of assortment within do-it-yourself accessories, which resonated with customers. These changes resulted in growth in both units per transaction and the average order value. We also sought to improve our digital experience with more Halloween customers turning to online for costume-in-a-bag purchases. On PartyCity.com, we converted customers at a rate 75% higher than last year as the result of several major user experience improvements, such as Shop My Store and a product and pricing strategy that highly motivated customers to buy. In October, we drove 30% more revenue through digital sales over prior year, which included driving a higher volume of traffic into our stores as a result of our Omni services offering. We engaged in several relevant pandemic-related partnerships, both nationally and locally, to make it easy for people to celebrate Halloween safely. Next door, Halloween2020.org. Haunted Road Drive-Thru Experience in Orlando, and Hauntoween in Los Angeles, to name just a few. Lastly, on Halloween, our product sell-through increased approximately 1,000 basis points compared to 2019. This improvement, combined with our more conservative inventory approach, less carryover product compared to prior years, positioning us well for assortment freshness in 2021. During the quarter, we continued to advance the five strategic initiatives that underpin our work to stabilize our retail business. Let me now discuss the progress we made in Q3. Number one, developing a more relevant in-store experience. We continue to make progress on our next-generation store prototype as we pilot changes to provide a better shopping experience for our customers. Since June, we've opened 13 next-gen stores, including our three original pilot stores, our five Las Vegas stores, three of our Kansas City stores, and recently two new stores in North Carolina and Alaska. In the fourth quarter, we will add an additional nine next-gen stores through remodels, two new stores and one relocated store, bringing us to a total of 22 next-gen stores in 2020. We're addressing the fact that our stores can be overwhelming and time-consuming to navigate. The changes to the in-store experience we are piloting include a new shop-in-shop store layout with improved product adjacencies, edited and more curated product assortments, reduced inventory, as well as new services and experiences. A new balloon shop and customer engagement center are now the focal point of the store and add significant theater to the entire experience. The dedicated staff and placement of this new balloon shop provides more personalized service while simplifying balloon transactions and speeding up transactions for non-balloon customers. Customers are excited by the new balloon experience, which we're seeing in both their comments and the incremental balloon purchases being made. Balloon sales growth in our next-gen stores are almost double the trend in the balance of the chain. Customers are also telling us they appreciate the decluttering of the stores due to the lower sightlines and the more curated assortment. These attributes are also allowing our associates to more efficiently operate the store. I'm thrilled with the outcome of the new customer and associate experience in this next-gen store format. It successfully addresses the friction points that exist in our legacy format, and it has also enabled us to identify easy shopping experience enhancements we can make in our legacy stores while we continue to improve upon and strategize on the planned future rollout of our next-gen format beginning in 2021. Number two, winning balloons. From manufacturing and wholesale all the way through to party city retail, Balloons are a focal point of our growth strategy, and with helium shortage behind us, we began 2020 leaning into balloons as a key driver of our differentiated brand experience. I am very pleased with our go-to-market improvements and our performance in this core category. As the dominant player in the global balloon business, with an unmatched breadth of balloon assortment, we continue to bring innovation in product, do-it-yourself options, and how-to guidelines. along with new access points to balloons through new digital engagement and new additional fulfillment options through curbside pickup and delivery. Buying balloons online with the ability to pick them up in store at curbside or have them delivered the same day is increasing balloon demand. In Q3, balloons were more than 53% of our buy online pickup in store, curbside pickup, and same delivery sales. Moving forward, Winning in the balloon category will remain a top strategic priority across our enterprise growth initiatives and business disciplines. Number three, address price value perception in key categories. Customer behavior and insights have told us we were overpriced on key value indicator items across our assortment. To address this and sharpen our price value perception, since fall of 2019, we have reduced Party City retail prices on approximately 9,400 SKUs, or almost one-third of our total current active SKU count. The customer has noticed and has responded favorably with their feedback in the unit sales volume increases we intended. As projected, these reductions in price across product categories have proven to drive increased enterprise margin dollars and increased retail margin rate when coupled with the reduction of previously ineffective promotional offers. With the majority of the necessary retail price reductions now behind us, we will continue to monitor and react to price-related customer insights and price elasticity data on a regular basis. Rebuilding trust with the customer on price is critical to our broad efforts to gain relevancy with consumers, and we are extremely pleased with our progress to date. Number four, improve our customer engagement selling culture. Improving customer engagement across our marketing messages, our product and merchandising approach, as well as digital experiences with our brands is also critical to driving greater relevancy. Our dramatic shift in digital content, including new, more relevant content formats, carefully curated product assortments, and new technology has driven growth in consumer engagement as well as online conversion rates. We launched digital workshops and live video formats across our social platforms for the first time, which have garnered hundreds of thousands of views and reached millions of consumers. Headed into the Halloween season, We produce dozens of pieces of content featuring new ways to celebrate, such as boo baskets, trunk or treat options, and candy hunts, all of which drove increased engagement and our highest conversion rates, as well as earning regular news media attention. As we continue to drive digital innovation, We also tested 3D shoppable technology to help consumers not only find the right costume, but also build the perfect Halloween scene in their backyard, front porch, or any room in their home as we quickly sold through the featured items. Number five, build on our omni-channel platform. We saw 278% growth in buy-on-line pickup in-store, curbside, and same-day delivery during Q3. As key components of increasing our omni-channel capabilities, they are now core to our customer experience. We will relentlessly optimize and add to these experiences as we obsess over the customer experience with our brand and continue to find new and innovative ways to make it easy to create celebrations. In Q3, we rolled out an enhanced curbside delivery experience in all of our stores, allowing customers to now communicate their expected pickup time, arrival, and vehicle information, all via text message, which creates a more intuitive and efficient experience for our customers. We continue to optimize this program with a focus on increasing customer adoption and enabling our associates to more seamlessly deliver curbside orders. As customers seek same-day delivery options, we focused on improving the customer experience with improved speed and reliability. We invested in improved technology to enable more proficient orchestration of delivery process and expanded our last-mile delivery partner network. Shifting gears to the important topic of governance, during the quarter, reflecting our focus on continuing to strengthen and diversify the background and skill set of our board, we announced the appointment of two independent directors and a third in October. We are delighted to have added three highly qualified directors who collectively bring significant digital capital markets, financial and legal experience. We look forward to leveraging their expertise as we advance our strategy of building a leading marketplace for celebration services and products. In summary, We are very pleased with our third quarter performance, our October performance, and the ongoing progress against our strategic priorities. Our results demonstrate that we are operating from a position of authority in the category as we continue to deliver not just the industry-leading assortment for celebrations, but increasingly offer the inspiration for celebrations with increased content and engagement initiatives. The strides we are making on increasing our relevancy is evident in our business results, which bodes well for our future. Our purpose is to create joy by making it easy to create unforgettable memories. It is our reason to be, and we will relentlessly pursue this mission as we increasingly obsess over customers and their experience with Party City. With our successful capital structure reset and having successfully moved beyond Halloween 2020, we look to finish the year in a substantially stronger competitive and financial position than just nine months ago. This is a testament to our brand's position in the marketplace and the grit and resiliency of the entire Party City team to who I would like to extend my gratitude. We look forward to building on this progress as we close out the year and move into 2021. We're excited to inspire consumers in new, differentiated, and aspirational ideas and solutions to their holiday and New Year celebrations. For New Year's Eve, we will offer customers our boldest assortment of seasonal balloons to make the holiday special and have developed fun products that capture the consumer enthusiasm to leave this unique year behind. And now, I'd like to turn the call over to Todd to discuss our financial results in greater detail. Thanks, Brad, and good morning, everyone. Today, I'll focus on the key highlights for our third quarter and our October and Halloween performance, and then I'll discuss how we're approaching the last few weeks of our fiscal year. The full details regarding our third quarter and 2020 year-to-date financial results. Please refer to our earnings press release in the accompanying slides, which are available on the investor relations section of our website, As Brad discussed, our third quarter and October results demonstrate that we're delivering on our strategic priorities and that our business is resilient in this challenging macro environment. For the third quarter, consolidated revenues were down 1.2%, which includes the divestiture of 65 Canadian retail stores in October of last year and 2019 and 2020 closures related to our store optimization program. mostly offset by an increase of 8.3% in brand-comparable sales, our largest comp sales improvement in nine years. Adjusted gross margin rate was up 250 basis points in the quarter to 34.4% from adjusted gross margin rate of 31.9% in the prior year period, primarily due to lower sales promotions, occupancy leverage on the 8.3% comp, in favorable sales mix. Adjusted operating expenses were $152.4 million, a decrease of $23.6 million or 13.5% from the prior year period, driven largely by our prudent management of expenses as well as the temporary benefits from cost cutting related to the pandemic. As a result, Adjusted income from operations was $32.1 million compared to adjusted loss from operations of $2.4 million last year. Adjusted EBITDA was $49.2 million compared to $17.1 million in Q3 of 2019. And adjusted earnings per share was $0.10, up $0.38 from an adjusted loss per share of $0.28 in the prior year period. Turning to our balance sheet. Inventory was down 20% year over year at the end of the third quarter as we continued to manage our working capital prudently, realize the benefits from an optimized brick-and-mortar store base, and to improve sell-through on key categories. Looking forward, we continue to plan for improved inventory terms through more curated assortments and improved seasonal sell-throughs. As we discussed last quarter, we completed our debt refinancing in July The accounting treatment for the refinancing results in a significant amount in future interest payments being recorded to debt on the balance sheet, causing our balance sheet debt to be significantly higher than the underlying principal balances. We've included a reconciliation in our press release to bridge balance sheet debt to the principal amount outstanding. This accounting treatment also means that interest expense recorded on our income statement will differ from our actual cash interest payments. So we've got to do both income statement and cash interest in our press release. As we previously discussed, last year we generated $130 million in proceeds from the sale of our Canadian stores to Canadian Tire. The $17 million of the proceeds from this transaction that were not reinvested or committed for reinvestment by October 1, 2020, We're used to pay down our term loan, our value, under the terms of the agreement. Our balance sheet and liquidity position is significantly improved as a result of our successful exchange offer transaction, last year's sale of our Canadian stores, and our ongoing working capital management. At the end of the third quarter, we've reduced the principal balance of debt, net of cash, by $700 million. Our quarter-ending liquidity position of $349 million was comprised of $171 million of cash and $178 million of revolver availability. Year to date, during these unprecedented times, we took important steps to strengthen the business and our financial health. We have been very disciplined in managing expenses, working capital, and capital expenditures, as we pushed forward on our key strategic priorities to drive business improvement. We reduced payroll expenses, including salary reductions, as well as non-payroll expenses by working with landlords on rent relief and negotiated payment referrals. Additionally, in an effort to increase our financial strength, we successfully completed our debt exchange offer at the end of July, which accomplished the three financial goals we set out to achieve, which were One, to extend our debt maturity. Two, reduce our leverage. And three, increase our liquidity. We're reaping the benefits of these actions as well as the strides being made against our strategic initiatives as reflected in third quarter's adjusted EBITDA improvement of nearly 188%. As we get ready to close out the final quarter of the year, we've provided our outlook for the fourth quarter in today's earnings press release. We expect our consolidated sales for the fourth quarter to be approximately $675 to $695 million, with brand comparable sales flat to down low single digits. With the majority of the fourth quarter now behind us, we continue to be pleased with the performance of our core products. Also, please note that our 2020 retail calendar includes the 53rd week this year, which we estimate will drive $35 million in sales. The calendar shift does provide a small headwind to comparable sales since a large portion of our pre-New Year's Eve sales moved from week 52 to the non-comp 53rd week. For the fourth quarter, we anticipate that adjusted EBITDA will be $80 to $90 million, inclusive of the estimated $7 million impact from the 53rd week, down from $119 million last year. Given our forecast for flat to down low single-digit Q4 comps, we would anticipate some occupancy deleverage and resulting gross margin pressure in Q4. Also in October, we invested in store labor as we managed store traffic to prioritize safety of our customers and associates. As a result, SG&A is expected to be the primary driver of Q4 operating margin decline implied by our outlook. terms of capital expenditures we now expect our 2020 spend to be 45 to 50 million dollars or 10 million above our prior estimate we've pulled forward some of our spend from 2021 into the current year as part of our plans for rolling out additional next-gen stores and also technology to support our strategic priorities on the heels of these very encouraging results please refer to our press release for all other items related to our outlook In summary, we're very pleased with the performance of the business in the third quarter and the underlying momentum of our core business that continued into October. Our Halloween results were better than expectations as we planned conservatively, and our teams did an exceptional job executing during a pandemic-impacted Halloween. We are looking forward to delivering new, differentiated, and aspirational ideas and solutions for our customers' holiday and New Year's celebrations As we close out the year, our strategic growth priorities combined with our strengthened financial position and continued focus on managing expenses and working capital have us well positioned as we approach the end of our fiscal year and into 2021. With that, I will turn the call over to the operator to start the Q&A session. We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. Again, the star then 1 to ask a question. At this time, we will pause momentarily to assemble our roster. The first question comes from Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go ahead. Simeon Whitman of Morgan Stanley. Please go We have spent a lot of time actually looking at overall pricing and looking at it from both the promotional angle as well as looking at what customers are looking for from just plain pricing compared to what they would see at other retailers. And as Brad mentioned, we did make those adjustments on a number of SKUs as we went through the course of the quarter. The promotional savings, though, are well more than offsetting the price decreases that we had. And we should continue to see that tailwind really through the middle of next year. So any price decreases from a rate perspective, more than offset by promotional decreases. And as an added benefit, we really are generating exactly what we thought out of the price decreases, which is as we get more competitive pricing, we are seeing the volume improve on those units, and the volume then flows through to more units in our manufacturing wholesale business that gives us better leverage there. So it ends up being a nice, strong flow through to the bottom line. Got it. And now that you've gotten through this key period and, you know, the business is generating EBITDA again, Are you a step closer? Can you talk about where you think the normalized EBITDA power of this business is and maybe a rough timeframe to getting there? And just one more component to that is how much of it, at least in 21 of the recovery, will be more margin dependent versus top line dependent? Sure. So we are obviously early in the recovery from having stores being closed in COVID. So We're going through a lot of planning right now, particularly around 2021. It's early to provide a true framework for next year and go forward. We do continue to see opportunities across the business. And the fact that the strength we're seeing is coming through those core products, I think, bodes very well really for all areas of the P&L. But I don't want to get ahead of us, and I think we'll be providing more