This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk08: Good morning and welcome to the Party City fourth quarter 2021 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then 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 Eric Warren, Treasurer and Head of Investor Relations at PartyCity. Please go ahead.
spk05: Thank you, Operator. Good morning, everyone, and thanks for joining us. This morning we released our fourth quarter and full year 2021 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 Vogeson, 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 four looking statements regarding their beliefs and expectation about the company's future performance, future business prospects, future events and plans these statements are subject to risks and uncertainties it could call actual results to differ materially from these statements although we believe that the expectations reflected in these four 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 our risk factors contained in our SEC filings. During today's call, we'll 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. With that, I'll turn the call over to Brad West.
spk08: Thank you, Eric. Good morning, everyone, and thank you for joining us today. I'll begin our call with a review of our financial and operational results for the fourth quarter in 2021, and then discuss our go-forward plan on our strategic initiatives that support our purpose to inspire joy and make it easy to create unforgettable memories. Todd will then elaborate on our financial results, and provide some thoughts on how we're approaching 2022 before we open the call to your questions. Our transformation process began in 2020 as we focused on executing strategies to stabilize our business and determine our path to market expansion. 2021 was an important year in our transformation process. Despite the continued challenging and volatile backdrop, the business performed extremely well as the consumer returned to social gatherings, celebrations, and parties while we continued to implement significant operational and capital structure improvements. We delivered a strong year of financial and operational results. Total sales increased 17%. Retail sales increased 28%. Adjusted EBITDA increased over 178% to $266 million, and adjusted earnings per share increased to 68 cents per share compared to a loss last year. Key among our operational accomplishments were we delivered strong results in our core categories at retail, demonstrating traction of our overall strategy, enhanced the in-store experience for our customers, with an increased focus on product quality and innovation, including five major category resets while strengthening our pricing power. We accelerated the rollout of next-gen stores by opening or remodeling 73 stores in 2021 with encouraging store economics and returns, ending the year with a total of 95 next-gen stores. Go continued improvement and increased traction in our omnichannel capabilities, including buy online, pick up at store, pick up at curbside and delivery, making it easier for our customers to fulfill their celebration needs and resulting in an increase in digital sales. Finalize the sale of our international wholesale operations, providing us opportunity to increase our focus on our North American vertical model. We completed an inventory write-down at year-end in support of our initiatives to right-size and optimize inventory, with this effort now fully behind us. Operated with strong execution by the entire PCHI team securing merchandise, managing through the significant supply chain disruptions impacting the industry, and staffing the stores to meet the demand. we strengthened our financial position in liquidity by refinancing our term loan at the beginning of the year. Now, let me discuss the key highlights of our fourth quarter performance. We are pleased with our fourth quarter performance with results that met our expectations. For the quarter, consolidated sales were up 7.7% to $698.3 million with brand comparable sales of 17.8%. As you recall, we reported a brand comp of 16% for the month of October. As mentioned in our Q3 call, we experienced a really solid Halloween with October results that were better than expected. Subsequent to Halloween, In November and most of December, we saw continued strength in our core business as we continue to build momentum in this area. In the latter part of December, though, we saw a softening in demand based on the reduction in social gatherings due to Omicron, with these trends continuing into January, most profoundly in the Northeast. However, as we have experienced with past surges and subsequent updating of cases, We've already seen a pickup in demand over the past few weeks. E-commerce continued to perform well in the quarter as customers continue to use our expanded fulfillment capabilities. Visually enabled sales increased to 14.5% of our sales in Q4 of 270 basis points versus Q4 2019. In terms of our wholesale performance, our domestic wholesale consumer products business continues to regain strength. Anagram, again, performed very well in the fourth quarter, and we're continuing to increase production capacity to keep pace with the increased demand. Adjusted EBITDA was $105.2 million, which was also in line with our expectations, as Todd will discuss further in a moment. turning to our strategic initiatives. In 2021, we made good progress advancing the fundamental building blocks of our transformation strategy across product innovation, in-store experience, being celebration occasion obsessed, and focusing on our North American vertical model. Those investments have yielded important benefits. And in 2022, we will build on this progress in two areas, including one, ongoing enhancements in customer engagement, as well as two, digital platforms, information technology, and supply chain. First, customer engagement. We will continue to enhance the way in which we engage with our customers as we remain focused on increasing relevancy and our mission of being customer and celebration obsessed. ensuring we deliver on our purpose to inspire joy and make it easy to create unforgettable memories. We will support this initiative at retail through various strategies, including continued rollout of our NextGen stores. We are extremely pleased with customer response with our NextGen stores as we enhance and refine the prototypes. Remodeled stores are continuing to average a mid-single-digit sales increase with improved gross profit compared to control stores with a run rate that delivers a payback period on each store of less than 24 months on average. As a result of this strong performance, we remain committed to an aggressive rollout plan in 2022 and beyond with approximately 100 to 125 next-gen remodels or reopenings targeted for 2022. which would result in about a third of the fleet being converted by the end of 2022. As we've gained insights from the first generations of our NextGen prototype, we will be introducing several enhancements to the format to increase the level of inspiration in the store experience. These will be introduced beginning in March, and we'll quickly study the results and roll out enhancements as they meet our required financial thresholds. As we demonstrated in 2021, quality improvements and innovation brought life through category resets that drove significant improvements in our retail business, contributing to our comp sales performance of up 34.2% compared to 2020. We will continue to aggressively lead in both product innovation and quality improvements to solidify our position as an authority in the celebration space. In 2022, we plan to improve quality of over 500 items, introduce 250 innovative items, introduce new platforms to customers. Two examples occurring in Q1 include a new yard sign program and the introduction of both traditional snacking items and better for you options in our candy department. Leverage brands to clearly segment quality and occasions consumers improving the overall shopping experience. Our first brand launch will be in our tableware category in Q2. We look forward to telling you more in the coming quarters. This year, we're enhancing our customer engagement on our website by transforming the experience from just selling party supplies to providing the full party solution. The site will pivot from shopping SKU by SKU to to also providing an inspirational and empowering celebration building experience. Instead of having to search and find products for your celebration on the site, the user will now be able to browse and customize curated party assortments, build a customizable balloon arrangement, send balloons like you would flowers, build a complete customized celebration, and get assistance from a certified party planner. The new flexible website platform and the development of specialized patent-pending digital tools, such as the Balloon Builder, are designed to drive more quality traffic, increase conversion, and grow average order value. It will now allow us to offer shoppable video content, seamless social commerce experience, cross-category shopping, improved omnichannel shopping journey, and enriched search results. after the launch of the new site later this spring, we'll continue to add even more enhancements. In the meantime, we already piloted the customizable balloon arrangement builder for New Year's Eve and Valentine's Day. Both seasonal tests experienced higher conversion rates and larger average order values than site averages and provided customer insights that give us the confidence to expand the digital tools capabilities. Within our wholesale business, we bolster our capabilities to provide actionable consumer insights to our partners, which is beginning to manifest in share expansion within existing accounts and securing new customer opportunities. We expect strong growth from the consumer products division in the year ahead. In our Anagram Balloon business unit, we significantly increased capacity throughout 2021 to meet customer needs. further solidifying Anagram as the leader in this category. This transmitted into record Valentine's Day performance with strong double-digit growth. In 2022, we'll continue to expand our leadership in the category with an aggressive innovation plan that both supports traditional balloon usage and expands usage occasions by introducing products in rapidly growing subsegments, such as do-it-yourself options. We've invested in a service team dedicated to our largest customer, Canadian Tire, which owns the Party City brand in Canada. This investment is critical to partnering with them to continue to drive growth in Canada. Business with our independent party store customers and other third-party customers grew in Q4 versus both 2019 and 2020. Second, digital platforms information technology, and supply chain. Our vertical model is the powerhouse of our brand, and we reap many benefits from the integration of our retail and wholesale business, including unparalleled category expertise, operating synergy, and elevated margins. Going forward, we will continue to fortify these advantages and take incremental actions to further mitigate supply chain challenges. These enhancements include investing in our supply chain to enhance and continuously improve in stocks and service levels across selling channels. Supply chain investments include further integrating supply functions to drive operational synergy, adding sourcing talent and capabilities in the U.S. and Asia, leveraging transportation and logistics opportunities namely chartering vessels and leasing our own containers, utilizing East Coast ports with wider traffic to deliver to DCs predominantly on the East Coast, and enhancing processes to shorten lead times. Investing in Enneagram manufacturing capacity and innovation, adding printing and fabrication machinery to further enhance our supply and market differentiation and extend our lead in the balloon business. Investing in digital technology and IT infrastructure, including new talent and resources, creating foundational capabilities that allow us to drive operational synergies, as well as the customer engagement enhancements I framed a moment ago. Significant upgrades in our digital capabilities and the technology that drives it further advance our ability to inspire joy and make it easy for customers to create their unique celebrations. and create another key market differentiator. New data architecture, inventory management technology investments, and increased space timing capabilities improve our knowledge, analytical capabilities, and productivity, benefiting our business as well as our partnerships across our wholesale channels. Now turning to our outlook for 2022. As anticipated, the environment remains somewhat volatile and supply chain headwinds persist for the industry, which will be most evident in our Q1 results, as Todd will outline. Against this backdrop, we continue to be committed to delivering an improved customer experience as well as exercising our pricing power in the celebrations market by expanding our already strong understanding of where the consumer is receptive to increased prices. The consumer's acceptance of our price actions thus far bodes well for us as we continue to manage inflationary pressures through both price as well as cost mitigation actions. We are excited to be beyond the latest Omicron surge and see customer demand in line with full-year guidance. We look forward to advancing our transformation and building on our success in 2022. And this is reflected in our outlook for adjusted EBITDA to increase in the high single digit range at the midpoint of our guidance range. So in summary, we are pleased with our 2021 performance and progress made as we continue to transform the business, pivoting to a more customer-oriented, celebratory-obsessed company. one of the things we are most proud of is the work we've initiated on the ESG front. In 2021, we made significant progress with our diversity and inclusion work, focused on listening to the organization with empathy, and evolved our strategy around three core components, raising awareness, creating a learning culture, and developing our infrastructure to embed diversity, equity, inclusion, and belongings into our people practices and everyday behaviors. As we shifted into 2022, we established an ESG committee and are ready to issue our first ESG report later this year. And now I'd like to turn the call over to Todd to discuss the fourth quarter and four-year results and the 2022 outlook in greater detail. Thanks, Brad, and good morning, everyone. Today, I'll focus on the key highlights of our fourth quarter results and full year performance, and then I'll discuss how we're approaching fiscal 2022. For full details regarding our financial results, the accompanying slides, which are available on the investor relations section of our website.
spk06: We're pleased with our fourth quarter results, which met our expectations. We're approaching fiscal 2022.
spk08: For full details regarding our financial results, please visit our website while making meaningful operational progress, as Brad discussed. More importantly, we achieved this growth in the face of a volatile operating backdrop. Now, turning to a review of our results. For the fourth quarter, consolidated revenues increased 7.7% versus the prior year period. The strong retail sales growth was partially offset by the divestiture of a significant portion of our international operations in the first quarter of 2021. Retail net sales increased 12.6% versus last year and 3.4% versus the fourth quarter of 2019, driven by a strong brand comparable sales increase in our core everyday categories and Halloween sales. Brand comparable sales increased 17.8% year-over-year, as strength in core categories in Halloween was partially offset by Omicron-related softness in kids' birthday as well as New Year's Eve categories in the last few weeks of the quarter. Versus 2019, fourth quarter brand comparable sales increased 10.8%, including a 22.8% increase in our core categories. This strong core category of performance has been a recurring theme in our results throughout the year and is a direct result of the work that we've been doing to increase our relevancy and improve the ease of purchase. In terms of e-commerce, the percent of our retail sales that originated online, including Bocas, was approximately 14.5% of our retail sales mix, an increase of 270 basis points versus 2019. Wholesale revenue for the fourth quarter decreased 13.7% versus 2020, primarily due to the divestiture of our international operations in the first quarter of 2021. Excluding the impact of the divestiture, net third-party wholesale revenues increased 30.3% versus the prior year period, driven by strong performance at our anagram balloon division. We continued to be pleased by the improving sales trends we delivered with our franchise and independent customers in the fourth quarter. Our Canadian sales have also shown meaningful improvement, starting to reverse previous trends associated with lingering COVID-related restrictions. Wholesale remains an important and strategic part of our business, and we're pleased with the fourth quarter performance and are focused on driving continued growth into 2022. Adjusted gross margin rate for the fourth quarter expanded approximately 120 basis points from the prior year period, driven primarily by the divestiture of our lower margin international operations and leverage on retail occupancy costs, partially offset by higher freight and raw material input costs. Adjusted operating expenses were approximately $197.5 million, or 28.3% of net sales, a 260 basis point rate decrease versus prior year, primarily driven by leverage on higher sales levels and partially offset by increased retail wage rates. As a result, adjusted income from operations was $89.8 million compared to $58.6 million last year. Adjusted EBITDA was $105.2 million in the fourth quarter compared to $77.3 million last year, And fourth quarter adjusted earnings per share was $0.40 compared to earnings per share of $0.25 in the prior year period. For the full year, consolidated revenues increased 17.3%, which includes a retail sales increase of 28% and brand comparable sales increase of 34.2%, reflecting strength in our core categories and highlighting the traction our strategy is gaining. And... a wholesale revenue decline of 14.4%, driven primarily by the sale of our international business in the first quarter of 2021. Excluding the impact of the investiture, wholesale revenues increased 25.3% versus the prior year. Adjusted gross margin rate increased approximately 450 basis points to 38.9%. primarily due to higher retail sales mix and the divestiture of lower-margin international operations, partially offset by approximately 120 basis points of headwinds from freight and input cost inflation, and adjusted operating expenses for $644.6 million, or 29.7% of sales, a decrease of 360 basis points versus the prior year, driven by leverage on higher sales, and partially offset by approximately 50 basis points of headwinds from wage inflation. For the full year, these measures resulted in adjusted income from operations of $201 million compared to $20.6 million last year, adjusted EBITDA of $266.3 million compared to $95.5 million in 2020, And adjusted earnings per share of $0.68 compared to an adjusted loss per share of $0.49 in the prior year period. Now turning to our year-end balance sheet and cash flow. Inventory was up approximately 7.5% year-over-year, driven in part by proactive delivery of 2022 seasonal merchandise, increased unit costs driven by higher input and freight expenses, as well as increases in transit times. all of which were partially offset by the previously announced inventory write-down in Q4 of 2021. During the year, net cash provided by operating activities decreased to $51.9 million from $77.2 million in the prior year period, driven by an increase in seasonal inventory and the related freight, as well as the repayment of rents that were deferred from 2020. We ended the year with $255 million in liquidity, comprised of $48 million in cash and $207 million of revolver availability. Turning now to our capital structure, we ended the year with a principal balance of debt, net of cash, $1.1 million. In 2021, we took steps to strengthen our financial health and flexibility. As a reminder, in February, we completed the refinancing of our term loan that matured in 2022 through the offering of senior secured notes. Concurrently, we extended the maturity of our revolving ABL to 2026, and we maintained considerable flexibility to further optimize our capital structure, having no material debt maturities until the third quarter of 2025. Now let me turn my comments to the outlook for 2022. As Brad mentioned, January was off to a slow start as Omicron weighed on sales, particularly in the Northeast. As the surge has slowly waned, we've seen a recovery in line with our full-year guidance, and we remain optimistic about the year as a whole. Acknowledging that there still remains uncertainty around various macro factors, particularly supply chain and input cost headwinds, we believe that we have enough flexibility at this point to provide annual guidance. Please note that our guidance does not contemplate impact from potential future COVID variants or other macro disruptions. We are assuming that the existing macro inflationary environment remains somewhat constant throughout 2022, and our outlook includes the mitigation measures that we put into place. With that in mind, we're providing the following expectations for 2022. Net sales of $2.275 billion to $2.35 billion, or an increase of 5% to 8% versus 2021. Brand comp growth of approximately 2% to 4%. 100 to 125 new next-generation stores with a combination of new openings and remodels. Gap net income of approximately $64 to $83 million, assuming a full-year tax rate of 27%. adjusted EBITDA of approximately $275 million to $300 million, which at the midpoint assumes percentage growth in the high single-digit range, and relatively flat adjusted EBITDA margin rate versus 2021, despite the significant inflationary pressures that we're facing in 2022. Please also note that included in our EBITDA estimate is approximately 40 basis points of impact from software expenses, which historically had been capitalized but will now be accounted for as an operating expense due to our continued migration to the cloud, and cash interests of approximately $95 to $105 million. In terms of capital expenditures, we expect our 2022 spend to be in the $120 to $130 million range, with balanced spend across our next-gen store rollout, web and e-commerce enhancements, store facilities capital, and ongoing investments in our manufacturing and supply chain assets, as well as our new headquarter building with our HQ capital spend, partially offset by significant tenant improvement allowances and state tax incentives in the short term and largely offset by these same factors in the long term. In addition to this annual outlook, we also wanted to provide some color around the first quarter to help you build your models. First, Due to the temporary disruption from the Omicron variant earlier in the quarter, combined with input cost headwinds for which additional offsets ramp up later in the year, we expect Q1 adjusted EBITDA to be down materially versus the prior year. As a reminder, the divested international business generated approximately $18 million in revenue in the first quarter of 2021. Since we sold the business in the first quarter of 2021, this is the last quarter where we need to mention this year-over-year impact. As highlighted earlier, we will also incur approximately $2 million of incremental software expense in the first quarter. In line with our plans coming into 2022 and given recently improving demand trends, we expect to continue investing in the business to reinforce the foundation for long-term growth. especially in the areas of digital platforms, information technology, and supply chain. In the first quarter, we expect these strategic initiatives to impact EBITDA by approximately $2 to $3 million. The continued evidence of demand strength and traction in our initiatives outside periods of virus surges gives us confidence in our strategy and our full-year expectations. Importantly, We expect adjusted EBITDA trends to improve in the second half of the year as our mitigation and additional planned pricing actions take hold and as we anniversary some of the most significant increases from the prior year period. While the pricing mitigation is expected to be well short of our input cost inflation in Q1, based on the current expected levels of input cost inflation and planned pricing actions that we have strong line of sight to, We expect to deliver a full year of adjusted EBITDA growth, despite substantial inflationary pressures facing our industry. So in summary, we are very proud of our team's execution in 2021, and we're very pleased with the results for the year. We're entering 2022 in a strong financial and operational position and are confident in our ability to continue to execute against our transformation strategy. We look forward to building on our progress in 2022 and beyond. And with that, I'll turn the call back 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 two. At this time, we will pause momentarily to assemble our roster. The first question comes from Rick Nelson with Stevens. Please go ahead.
spk03: Thanks a lot, Jim. I'd like to dig into the first quarter, chance a bit if we could. I think you mentioned January got off to a slow start, but things have picked up. Some more color around that. And maybe since the war began in Ukraine, have you seen any change in sales trends?
spk08: Yeah, Rick, good morning. So, you know, as we mentioned, sales, you know, Omicron really started to pick up and get traction beginning in the northeast, really in the middle of December, right before Christmas. And so that's when we started to see a little bit of pressure and demand. As we've seen in the past, when there are restrictions that are localized or even broader, or there are you know, pressure put on social gatherings. It certainly does impact our demand, and we saw that at the very end of the last half of December. As we all know, that continued into January and really lasted the full month of January. It was across the country, but as we said, mostly or most profoundly in the Northeast. That's where we saw the greatest impact sort of right in line with how cases really played out. And then since it's coming out of January and coming into February, we really saw demand pick up. And in fact, we had an excellent Super Bowl and Valentine's Day period, as we noted. We did not see a tail off really in demand since the Ukraine-Russia situation elevated last week. And so our eyes have really been on the pandemic related to demand.
spk03: Great. Thanks for that, Brad. I'd also like to dig into the product cost, inflation, and also on the labor side, you know, how significant Are these inflationary pressures and your ability to pass those higher costs?
spk08: Absolutely. So we've talked about the net impact in Q4 being $5 to $10 million, and it was. So it ended up being an impact to gross margin of about 120 basis points and 50 basis points to SG&A. What we're seeing thus far from all the testing we've been doing is that we do have a lot of pricing power. So we do have the ability to increase price and in certain areas of the stores we're testing into it, seeing that there's not a lot of resistance. So that gives us a lot of confidence that As we roll out those price changes and we get further into the year, we would expect the pricing to be offsetting inflation by the time we get into the second half. For the first half, we're just at the point where all those costs are really rolling through the P&L now. They had gone into our inventory, and now in Q1 we'll get the full brunt of those costs. That's happening at the same time that Omicron was weighing on our sales in January. So that creates a headwind in Q1. We're looking at $8 million to $12 million of inflation headwind in Q1. And so that's the short-term. Long-term, obviously, a much better story as we do get into the back half and we're able to roll out the pricing changes more fully. Yeah, and I would just add to that that, you know, we've become, as we've talked about in the past, extraordinarily price aware. We have a good understanding of our pricing data and price elasticity at both the category level as well as the SKU level. And so our pricing actions are really ongoing, and we continue to test price, continue to maintain an understanding, and as Todd said, We're demonstrating that we do have pricing power, and the customer has been responsive, and all that bodes well as we continue to navigate this dynamic environment.
spk03: Thanks very much, Brad and Todd. Good luck as we push forward. Thanks, Rick.
spk08: The next question comes from Joe Feldman with Tulsi Advisory. Please go ahead.
spk07: Hey, good morning, guys. Thanks for taking the question. I wanted to ask about the next-gen stores, and thanks for the updated color on what you're seeing and the progress there. What are some of the enhancements that you are planning to make this spring? You talked about trying a few new things, and I was just kind of curious if you could share any little preview of that with us.
spk08: Sure. As I mentioned, we're extraordinarily pleased with the next-gen stores that that we've opened thus far. And I think one of the things we've talked about is that we will relentlessly learn and we will relentlessly improve and that that should be something that is always ongoing. As we've accumulated a lot of customer feedback, a lot of data around the performance and a lot of insights from our customer, you know, we're perpetually, as I said, assessing how we continue to improve.
spk06: You know, we see the
spk08: And one of the things that the customer gets excited about in their feedback is their ability to visualize the art of the possible. You know, I think in the past we've maybe been less inspirational online and in our stores. And, you know, when they're able to see something that they can create that they maybe did not think was possible on their own, they love to take that as inspiration in. They love the aspirational elements of what they can do. And so we're going to continue to create additional digital and merchandising elements in the store that help them to do that. We've talked a lot about our success with balloons in that store and have an opportunity to continue to expand our balloon assortments and continue to add to the do-it-yourself elements that the customers really responded to. We also see an opportunity to enhance the seasonal presentations at the front of the store featuring newness and innovation and key items that are working really well for us. And then the last thing I would add is continuing to add ease for the shopping experience in this case, particularly around the checkout process and building on the separate balloon checkout is that has been a win for us as well.
spk07: Okay, that's really helpful. Thank you. And then, you know, with regard to the the year and we thank you for the guidance that you gave, I guess, maybe Todd, within the guidance, you know, how should we think about the complexion of it, maybe gross margin versus SG&A? You know, is it? I guess it sounds like maybe more pressure on the gross margin in the first half versus the second half, given the pricing that you talked about, or I'll let you answer. But you know, just I guess the complexion of those two line items would be helpful.
spk08: Absolutely. So when we step back and look on a full year basis, we actually expect improved gross margins resulting both from fixed cost leverage on a sales increase, as well as the benefit of the pricing and other inflation mitigation factors. So gross margin, you're right, a little bit of pressure in the very short term. But as we go across the year, a lot of good news stories there. Operating expense, you know, since the midpoint of the guide was about flattish margin rate, I would say operating expense, you would see a little bit of pressure as we go across the year. But the two big drivers really are, and we talked about it, there's 40 basis points of headwind from the SaaS move where we have software that used to be capital that now will be expense as we move to the cloud. as well as investments that are meant to support our strategy growth initiatives that Brad discussed, along with wage inflation. So when you add up those three, operating expense is probably going to see a little bit more pressure than gross margin, roughly offsetting each other as we go across the year.
spk07: Got it. That's really helpful. Thanks. And then I guess just one final quick one. With regard to the CapEx, you did call out that the new headquarters is a decent chunk. I was just wondering how much of a chunk of the CapEx that is. Is it $20 million, $30 million, or can you share that with us?
spk08: You know, I think the best way to think about capital is once you take out – there's two ways to think about it. One, pour that headquarters out. it's going to be partially offset by tenant improvement allowances and state tax incentives in the short term. In the long term, actually, all but less than $5 million of it is going to be offset by that funding. So the net cash out actually ends up being a very small piece. You know, to take a step back, up until now, we really – I've had a pretty difficult challenge of operating in four office buildings in three states, really opposite sides of the country. So what we're looking to do is bring the teams together from Rockaway in New Jersey, Elmsford in New York, Pleasanton in California, into one location. And so a lot of unrealized synergies that come out of that, opportunities for collaboration and innovation along the way. So it's really that big driver towards creating a one PCHI, one party city holdings culture. And so it'll be one of those things that is very foundational for us as a corporation, and it does end up being less than $5 million over the long term from a capital perspective.
spk07: That's great. Thank you so much, and good luck with this quarter.
spk08: The next question comes from William Breuder with Bank of America. Please go ahead.
spk02: Hi. The first is, In the prepared remarks when you discussed the inventory write-downs, there was some sort of kind of conclusionary statement that seemed to indicate that given where we are with evolving strategies, we shouldn't expect to see these write-downs next year or the year after. Did I understand that correctly?
spk08: Yeah. If we back up to the work that we did in 20 and 21, you know, 20 we really addressed our our seasonal inventory challenges and learn to run our seasonal business much differently by bringing in the amount of receipts we needed to drive and optimize our sell-throughs and really optimize productivity and Jim Roy. And as we went into 2021, we were extraordinarily focused on our everyday categories We talked during the year about resets in major categories that turned out to be very positive to our overall business, very positive from both a revenue side as well as an inventory turn and from a Jim Roy perspective. And so after those two significant pieces of work, we've now right-sized our inventory to the operating level that we believe will drive the right level of efficiency. And so it's fantastic to have those behind us.
spk02: Okay, that's helpful. And then, Todd, I appreciate your discussion around first half, second half, gross margins, as well as operating expenses. I guess I'm curious what level of sequential improvement we're going to see from the first to the second. And really on the margins here, I'm sure that the first quarter Omicron impact on sales is going to be greater. But based on the timing, will we see a substantial improvement from one to two? Or is it really the third quarter where we start to see big improvements?
spk08: Yeah, I think Omicron in Q1 clearly was a significant improvement. temporal anomaly for us. So that was going to have a much bigger impact than anything else in our guidance. And yeah, so you would expect to see improvement in that year-over-year trend as we go into Q2. Second half is where it really all starts to come together, where you really do see the pricing upsetting the inflationary costs, and we see all those mitigation actions really starting to take hold. But you should see incremental improvement as we do go into Q2.
spk02: Okay. And just to be clear, the incremental improvement is not just in sales. Incremental improvement is also in gross margins?
spk08: That is correct.
spk02: Yeah.
spk08: Okay. Cool. All right. Thank you. Thank you. The next question comes from Jenna Smith. Gianelli with Goldman Sachs. Please go ahead.
spk01: Hi there. Good morning. Thanks for taking my question. On the 2% to 4% comp guide, I guess I just want to better understand, I mean, is that mostly pricing? Is that the best way to think about it? Or should we, I guess, wanting to better understand the underlying volume demand expectations for the year and how to balance pricing benefits, wholesale recovery, next-gen success with kind of underlying volume demand in the business and how you're thinking about it.
spk08: Absolutely. So there is an element of pricing built into the comp for sure. You know, we would expect from a comp perspective to be looking at, let's call it 100 to 150 basis points of benefit for comp sales. A little bit larger than that on total sales as we get the benefit from wholesale and everything else. But from a comp sales perspective, call it 100 to 150 basis points of benefit off of pricing. There is a little bit of benefit baked in from our next-gen stores. We're continuing to see that mid-single-digit growth in those stores and looking at doing conversions mostly of 100 to 125 stores this year. So that does help, but then above and beyond that, the guidance does assume that demand is continuing to increase. So when you look at that midpoint of the 2% to 4%, it does still include, especially as we get past Omicron, seeing underlying unit demand continue to increase across the company.
spk01: Okay. Beautiful. I know that's helpful. I appreciate that detail. And, you know, one other one that I have on just kind of thinking about the full year, given some of the puts and takes in 21, one factoring in the write-down of inventory, working capital, I guess when we think about the normalization of some of these items, how are you thinking about your propensity to generate free cash flow this year and the positive potential uses for that free cash flow? And that's it for me.
spk08: You bet. Okay. So, yes, we would look at generating positive free cash flow this year. Our capital spend, like I mentioned before, we do have a significant amount of it that is offset by tenant improvement allowances. And with the $275 to $300 million of EBITDA that should put us – In good stead, we would look for our working capital to be about flattish with the end of this year. So that puts us in positive territory, and we would number one uses of cash after our internal capital is always going to be debt paydown. So I think we're continuing to look at how we can continue to improve our our debt position and leverage ratio.
spk01: Excellent. Thank you. Appreciate it.
spk07: Thank you. The next question comes from Caru Martinson with Jefferies. Please go ahead.
spk08: Good morning. Just on that free cash flow, do we get the tax refund here in the fourth quarter, or is that something that's going to drop in the first quarter? I the, um, test refund we filed for in Q three. We're expecting to receive shortly, actually. So there's something that likely should flow into Q one. And for everyone's, uh, um, memory, we do have a receivable from the IRS of $55 million. So yeah, expecting to see that shortly. Okay, good. And then when you said you pulled forward some seasonal inventory, how is the landscape out there? I think a big question is, you know, how far in advance do you guys have to plan for Halloween and other big seasonal events, and how should that cadence go through the course of the year for working capital? Yeah, so for working capital, we are, you saw it at the end of – Q4, our inventory was up, and it was up really driven by three big factors. Part of it is buying ahead on seasons, and so we have gotten ahead of it. We've got a much more proactive calendar this year than we've had in the past. And so that'll allow us an extra, call it 30 days or so, maybe longer on some seasons where we can be buying ahead and making sure that inventory comes in on time. And then then From an overall inventory value perspective, there's, of course, input costs that are now built into that inventory base. They were there at the end of Q4, so we'll just be wrapping around on it as we get to Q4 this coming year. So all that leads us back to the flat-edge working capital. Okay. And in terms of getting products, you mentioned the 30 days. When we look out to Halloween and the all-important seasonal period at year end, when do we need to kind of place those orders, get that product on ships in order to make it for this year? Well, when you think about Halloween, those orders have all been placed. They're actually placed You know, sort of during and pretty closely following the Halloween time period as soon as we've analyzed and digested, fully digested our results. So they're well in production as we speak. And then the timing of the shipping varies. Obviously, we've put a little bit more slack in the rope. this year on all of the timelines of orders all the way through production that gives us a little bit of cushion, like I said. And then, obviously, we have learned and continue to learn all of the elements of logistics that learnings from last year and past years that are firmly put into place now to ensure we have product. Thank you very much, guys. Appreciate it.
spk07: Thank you. The next question comes from Oliver Brotman with JPMorgan. Please go ahead.
spk04: Hey, good morning. This is Oliver Brotman for Carla Casella. Thanks for the question. So my first question, currently you're capitalized through Enneagram and PartyCity. Do you see benefit of keeping those structures separate or benefit to consolidating them in 2025-2026 when the bonds mature?
spk08: Yeah, I think we're continuing to look at what the overall structure is that's right for us. The structure we have with the anagram notes was exactly what we needed at the time, which was really at the peak of the pandemic when stores were closed and We were looking to reduce the amount of debt outstanding, so it was a really positive move for us. Whether we need that long-term, I think we would love to move to a more traditional debt structure, but we're going to have to just evaluate what the opportunities are that are available for us and make sure we're making the right long-term move for the company.
spk04: great thanks for that and then um sorry my second question is on uh marketing and promotional cadence in 2022 um just will it change given the strength you're seeing the balloons and changes you made to halloween assortment uh we've learned quite a bit about promotional activity over the last couple years of what it uh what it does for uh traffic and for
spk08: And, you know, one of the guiding principles in our business that's most important to understand related to promotions is we're very occasion-based. And when you have a need for our product and services, then you're not driven by promotional activity. And if you don't have sort of an occasion need, then promotions aren't necessarily going to get you off the couch to stop Party City. And so we've been able to really ramp down our promotional activity. We do do some small promotions online, but, you know, our focus is mostly to be priced right for the customer every day and be there when they need us.
spk04: Thanks so much. That's all for me.
spk08: this concludes our question and answer session, I would like to turn the conference back over to Brad Weston for any closing remarks. Thank you, Operator. In closing, I'd like to again thank our entire team for their dedication to our mission and strategy and their extraordinary execution in a challenging operating environment. We are so proud of all they've accomplished and uh in 2021 across our manufacturing operations our stores e-commerce and supply chain while continuing to better leverage our unique north american vertical model and navigating an uncertain and dynamic environment as we transition into 2022 we feel great about what has been put in place over the course of the last two years during the pandemic which has increased our relevancy, improved our brand, and reinforced our ability to positively impact our customers' lives with new capabilities. So thank you for your time, for your questions, and have a joyful day. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
Disclaimer