Party City Holdco Inc.
Q2 2021 Earnings Call Transcript

Published: 7 Aug 2021

[Operator:]

Good morning, and welcome to the Party City Q2 2021 Earnings Conference Call. . Please note that this event is being recorded. I would now like to turn the conference over to Eric Warren, VP, Treasurer and Investor Relations. Please go ahead.

[Eric Warren:]

Thank you, operator. Good morning, everyone, and thanks for joining us. This morning, we released our second quarter 2021 financial results. You can find a copy of the 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 Vogensen, our Chief Financial Officer. We'll start the call with 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 and plans. These statements are subject to risks and uncertainties that could cause actual results to differ materially from these statements. Although we believe 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 Brad Weston.

[Bradley Weston:]

Thank you, Eric. Good morning, everyone, and thank you for joining us today. I'll begin our call with a review of the highlights of our second quarter performance. Then I'll discuss the operational progress we're making against the strategic priorities that support our purpose to inspire joy and make it easy to create unforgettable memories. Todd will provide more detail on our financial performance as well as some outlook commentary before we open up the call to your questions. Our second quarter was better than expected with consolidated total sales up 110% to $536 million. Retail sales were $444 million, with brand comparable sales increasing 118% or up 19% relative to 2019 and our wholesale business was up 30% year-over-year for the quarter. During the quarter, we anniversaried the bulk of the pandemic store closures in April and May, with April being the most impacted in Q2 2020. The momentum we saw in March continued into Q2 as the economy opened up and restrictions subsided, driving an improvement in ability to celebrate. Overall, relative to Q1, we're very pleased with the acceleration we saw in the business, the consistency we saw each month of the quarter in Q2 and the continued strength in our core categories. Compared to 2019, which we view as the most recent normalized year given the pandemic impact on 2020, trends across the business were very consistent and this trend continued into July with results for the month very solid compared to both 2019 and 2020. A few very encouraging highlights of the quarter to mention are performance was broad-based. We again saw strong performance from our core everyday categories, which continues to bode well for us given consumers rely on Party City most for our everyday core celebratory product. Our seasonal business performed better than during the pandemic and continues to improve as people return to celebrating seasonal holidays they didn't celebrate last year. In Q2, we were particularly pleased with the performance of graduation. Our teams consistently executed, providing the consumer with assortments, both in-store and online, in a way that continues to better meet their shopping needs. We continue to see strong momentum within our digital business. Digital continues to be a bright spot with digitally enabled sales up strong double digits versus 2019, primarily reflective of digital strength in our core categories. Our wholesale business has begun to rebound, albeit not as strong of a rebound as retail. Canada has continued to lag given the more restrictive environment in pandemic related measures. However, the recent easing of restrictions serves well with a gradual recovery in that market. Anagram continues to perform extremely well and we're increasing production capacity to keep pace. From a profitability perspective, we are pleased with the EBITDA increases year-on-year and versus 2019 as we leverage gross margin and operating expenses on our sales increase. And finally, we ended the quarter with net debt down approximately $500 million versus last year as we continue to remain committed to reducing debt over time. I'll now discuss the progress we made in Q2 on advancing the fundamental building blocks of our transformation strategy, which are product innovation and quality, in-store experience, being celebration occasion obsessed and focus on our North American vertical model. Starting with product innovation. As we focus on bringing product freshness and innovation to market, we continue to leverage consumer insights and data to drive our decision. In 2021, we've reset 5 categories

[Todd Vogensen:]

Thanks, Brad, and good morning, everyone. Today I'll focus on the key highlights of our second quarter performance and then I'll discuss how we're approaching the rest of fiscal 2021. For full details regarding our financial results, please refer to our earnings press release and the accompanying slides, which are available on the Investor Relations section of our website. As Brad discussed, we are very pleased with the acceleration we saw in the business and the broad-based strength in the second quarter. Consolidated revenues were up approximately 110% versus the prior year period. Brand comparable sales increased approximately 118%, driven primarily by strong performance in our core categories. Versus 2019, brand comparable sales increased 19%, including a 28% increase in our core categories. Additionally e-commerce delivered strong growth in the second quarter and the percent of our sales that originated online represented approximately 13.6% of our mix, an increase of 310 basis points versus 2019. Wholesale revenue for the second quarter increased 33% versus 2020, primarily due to the COVID-19 pandemic impact in the prior year period. This increase was partially offset by the divestiture of a significant portion of our international operations in the first quarter of 2021. Excluding the impact of the divestiture, wholesale revenues increased 97% versus the prior year period or 1% versus 2019. Importantly, we were pleased by the improving sales trends we delivered to our franchise and independent customers in the second quarter as COVID-related restrictions continue to subside. Although it's still early in the recovery, we have strategies in place that are focused on driving growth in our wholesale business overall and we're encouraged by the resulting revenue growth. Adjusted gross margin rate for the second quarter expanded 2,100 basis points from the prior year period and 270 basis points versus 2019, driven primarily by sales leverage on fixed costs and favorable product mix, partially offset by increased cost of delivery services. Adjusted operating expenses were approximately $151 million, an increase of $35 million from the prior year period and a 1,700 basis point improvement, primarily driven by more normalized sales and expense levels. As a result, adjusted income from operations was $69 million compared to an adjusted loss from operations of $65 million last year and adjusted income from operations of $59 million in Q2 2019. Adjusted EBITDA was $86 million in the second quarter compared to a loss of $43 million in 2020 and adjusted EBITDA of $81 million in 2019. And second quarter adjusted earnings per share was $0.29 compared to an adjusted loss per share of $0.66 in the prior year period and adjusted earnings per share of $0.23 in 2019. Turning to our balance sheet and cash flow. Inventory was down 33% year-over-year, driven primarily by 2 strategic items that we've previously discussed, namely the disposal of seasonal inventory in the fourth quarter of 2020 in order to drive higher in-season sell-through and less annual inventory carryover as well as the international inventory that was sold as part of the international business divestiture. Together, these items accounted for approximately $154 million of reduced inventory, resulting in a year-over-year decline of approximately 9%, excluding these 2 items. We continue to prudently manage our working capital and we expect ongoing opportunities to improve inventory levels. Year-to-date, through second quarter, our operating cash flow improved approximately $63 million versus the prior year period, primarily by higher net sales and improved operating income. We were also pleased with liquidity, which ended the quarter at approximately $269 million, comprised of $84 million in cash and $185 million of revolver availability. In addition, our principal balance of debt, net of cash, was approximately $500 million lower than the prior year period at $1.26 billion. Now let me turn my comments to our outlook. We remain optimistic about the trends throughout our business and the prospects for continued economic growth. We also recognize that the macro environment still has a high level of uncertainty, given current inflation and COVID-19 trends. Therefore, we're not providing a specific annual sales and earnings guidance. However, in today's earnings release, we did provide our sales and earnings outlook for the third quarter. In the third quarter, we expect our consolidated sales to be approximately $490 million to $515 million with the brand comp sales increase in the high-single digit percent range versus the comparable 13-week period in 2020 or a mid-teens percent increase versus the comparable period in 2019. Lastly, we expect Q3 adjusted EBITDA to be in the range of $35 million to $45 million. There are a few elements to note relative to our expectations for the third quarter. First, as a reminder, with the sale of our international operations in January of 2021, there is an impact on our revenue and other financial metrics. As we shared previously, in 2019 the international business generated approximately $250 million in revenue with an immaterial amount of profit. However, for the third quarter modeling purposes, it is important to note that the divested international business generated approximately $80 million in revenue and $6 million of EBITDA during the third quarter of 2019. Second, like many in the industry, we are experiencing heightened inflationary impacts on our business, including freight and labor cost headwinds. With the continued challenges facing all global supply chains, our logistics team is taking prudent actions to ensure high end stock rates for our Halloween season. We feel confident that we are well positioned to fully support our holiday strategies, but we also expect to incur higher freight costs over the nearer term. We are taking additional pricing actions, as mentioned earlier by Brad as well as other cost mitigation actions to limit the overall impact on our profitability. It is also important to note that we expect our pricing actions to offset some third quarter headwinds, but to have a more significant benefit to fourth quarter results while the nature of inflation is still quite dynamic. Based on our current plans, our guidance includes the estimated third quarter impact of overall inflation net of our mitigation efforts to be $7 million to $12 million. Taken together, the inflation headwinds and divestiture of our international business is expected to impact our Q3 EBITDA by $13 million to $18 million. In terms of CapEx for the full year 2021, we now expect CapEx spend in the range of $80 million to $90 million, up from the previous expectations of $70 million to $80 million, with the increase primarily related to capacity investments in support of Anagram's growth. So in summary, we are really pleased with our second quarter financial and operational performance and remain encouraged by the underlying momentum of the business. Our team's disciplined execution of our key growth priorities has positioned us to capitalize on the opportunities received for the business in the back half of the year. And with that, I'll turn the call over to the operator to start the Q&A session.

[Operator:]

. The first question comes from Rick Nelson from Stephens.

[Nels Nelson:]

So I'd like to follow-up on the commentary about July sales, how they're tracking versus the high single-digit compared to a year ago, mid-teens compared to pre-pandemic 2019.

[Bradley Weston:]

Yes. And if you'll remember the last -- in 2020 our July and Q3 -- or our Q3 comps, I should say, we're in the high single digits and our trend in Q2 was in the 19% versus 2019. As I said in my remarks, July continues to be very strong, both on top of 2019 as our trend continues as well as on top of our strong 2020. And we really attribute that to the underpinnings of the transformation strategy that we've put into place in addition to the strong overall consumer demand that we've seen broadly at retail and that's really across all 3 segments of our business, retail, digital and now seeing our wholesale business coming back as we would have -- as we said, we anticipated as wholesale sales intuitively follow strong retail sales.

[Nels Nelson:]

You also discussed some of the financials around the next-gen stores. It sounds like they're performing well. The plan for rollout, now I think you had mentioned an acceleration in rollout next year. I guess what is keeping you from accelerating that rollout? And you could discuss the plan for the remainder of this year and what you're thinking about for next.

[Bradley Weston:]

Yes. And we've been building momentum as we continue to see the positive results, whether it's a remodel store, a relocated store or a new store opening. And so we've been building -- we built our -- after our piloting in 2020, we built some momentum going into 2021. We'll continue to build momentum on our ability to execute every refinement that we make in the prototype because those are ongoing. We continue to find ways to make it even better for both our consumer as well as our associates from an operating capacity and continue to tweak the assortments in the categories to ensure that we're maximizing those. So we're extremely bullish. We haven't pegged an exact number for 2022. Obviously, we're looking at all of the remodel opportunities as well as new store opportunities as we look ahead to 2022 and beyond. Our continued desire is to upgrade the majority of the chain over the next several years. So we'll be as aggressive as we can.

[Nels Nelson:]

Finally if I could ask you, the outlook for Halloween, how you're planning for that. Can you give any insights through the wholesale operation as to what your customers are thinking about Halloween?

[Bradley Weston:]

Yes. We're not going to talk directly to how we're thinking about Halloween as it falls in -- into the fourth quarter. There's a lot of factors obviously that influence Halloween. We have a lot more learnings and customer insights and data relative to prior years. We have a new merchandising and store teams that had built over the last 18 months that are ready to -- that are executing well, leading up to Halloween and excited to get going with this really fun and important season. We continue to improve our product assortment, our merchandising techniques in the store, our marketing and our digital content, all of which I believe have made real progress over our past go-to-market strategies and our investment improving on all fronts will certainly increase our relevancy in the Halloween. We're ready for any level of demand as we are sort of in a -- still in a volatile and dynamic time. Our wholesale outlook relative to Halloween is stable, consistent and it looks like everybody is sort of feeling the same as we'll have to see what consumer participation is in Halloween, but we are ready.

[Operator:]

The next question comes from William Reuter from Bank of America.

[William Reuter:]

The first question was on the $7 million to $12 million, the third quarter inflation impact. Did that include the impact of higher freight costs? Or was that just on product itself?

[Todd Vogensen:]

I'll go. Yes. That was just -- that did include all the freight costs as well as any inflation pressures on raw materials or base product and the biggest impact for us really is that supply chain pressure that we're seeing, really everybody's seeing.

[William Reuter:]

Yes. And then given lead times, I would imagine you guys have pretty good perspective on what that number might look like for the fourth quarter. Can you share what that number might look like? And I guess are you contracted with regard to your freight at this point for the second half of the year? Or are you generally purchasing the spot market?

[Todd Vogensen:]

So at this point, we're not giving Q4 guidance, but I think it's fair to say the pressures that we're seeing on the supply chain front have been building during the year. So we would expect to continue to see that through the rest of the year. And the way everything works, we match up our costs with our inventory flow. So given the timing of Halloween, you are going to see a little bit more flow-through from those costs in Q4. We also said we should have better opportunity to mitigate some of those costs with pricing action in Q4. So both of those 2 things kind of coming together to net out as we get into the fourth quarter. In terms of managing versus contracts, the shortage is really acute from a container perspective, from a ship perspective. So what we're hearing from most retailers is that whether you have a contract or not, you're going to be facing the same pressures and that's fairly well what we are seeing. We have contracts in place, but we are still in a position where we need to look for alternative ways to bring goods in and fortunately for us, we have a strong supply chain team that's been able to get ahead of that and put us in a really good position for Halloween where even though there's cost structure, we feel good about our in-stocks and feel good that we're positioned well from a product perspective for the season.

[William Reuter:]

Okay. And then just lastly for me. Given strong demand during the second quarter, I guess you mentioned that July continues to go well. Would -- is there an impact on third quarter sales from out of stocks currently? Meaning would your revenue guidance be higher by X percent if you had as much inventory as you would like right now?

[Bradley Weston:]

Listen, our -- there are certainly supply chain constraints and volatility across categories. It's interesting because we've experienced those even in Q1 and Q2 relative to supply constraints and shortages that have been in the market as we came out of the height of the pandemic, and our business has sustained itself very well through those. They're spotty. And one category recovers well and another one may be challenged a little bit, but we do not see any negative impact relative to that in our July results or in Q3.

[Operator:]

The next question comes from Joe Feldman from Telsey Advisory Group.

[Joseph Feldman:]

I wanted to ask about product innovation and there are other things you can share with us there like you mentioned that 20-pack tableware, which makes a lot of sense, and you managed to get the price down to $20, like $1 a person basically. But can you -- are there other areas where there's some big opportunities like that that you are targeting right now?

[Bradley Weston:]

So these -- the introductions that we made that I talked about were primarily in girl's and boy's birthday favors and candy. We eliminated some nonproductive SKUs, curated some new items that really allowed us to gain relevancy with our consumers and we replaced, like I said, old product with new product in many instances. Those were really gleaned from just consumer feedback, focus groups, putting product in front of consumers and really understanding the sales data as well as the consumer insights and what they're looking for, where some of the friction points may be in the product thereby or some of the gaps in the assortments that we have. As we look at every single category, I can tell you that we are finding opportunities for new innovation, we're finding opportunities to improve our quality. And the good news is when we improve our quality, it's either doing it without impacting cost or if we do have any cost adjustments and therefore price adjustments, these are margin neutral or margin enhancements, and they're in places that we know based on our price elasticity data and modeling that the consumer is willing to accept a higher price to pay for the value they're getting and the innovation and the quality. So they've been extraordinarily well received. We have some in the pipeline and this is just a mindset in how we operate our assortments, and how our merchants and product development teams really think about their opportunities to build relevancy.

[Joseph Feldman:]

That's helpful. And then I wanted to ask, can you share a little more color on the pricing actions you mentioned that you're planning to take in the third quarter. Was that meant to say that you're taking prices up or down? Or I guess I was a little confused by that statement and what areas you're planning to do in?

[Bradley Weston:]

So let me start that answer by stating as I often do that we've instilled practices to be extremely price aware. And our data and analytics around price elasticity and basket analysis at the category level and down to the SKU level allows us to make really smart decisions. When we talked in 2020 about our initiatives to stabilize our retail performance, we outlined poor pricing perception as a barrier to being relevant with consumers. That work included lowering our prices to be more competitive in most cases. But it did also include taking price increases where the analytics really showed it was appropriate. So based on that, as we address changing prices related to cost headwinds just like we do constantly, we'll use a test-and-learn approach to adjust prices to mitigate those headwinds in a way that makes sense to our customer and our long-term growth goals. And as I said in our remarks, we have a broad view of the market. So we have the ability to really understand price elasticity throughout the supply chain. And as the category-defining brand, we have pricing power that will allow us to find the right pricing equilibrium.

[Joseph Feldman:]

Got it. Okay. So continue to just optimize on that front. That makes sense. And then with regard to those supply chain pressures that others have asked about, are there any particular categories that you're seeing then the pressures on or where you can maybe -- and what the alternatives are in those areas?

[Bradley Weston:]

I would -- the best way to think about them is they're very supply and demand base. And where our demand has shifted, we've shifted our ability to get product through our own manufacturing capacity or our sourcing capacity to meet those needs. So we're ramping up capacity where we have high demand and so pressure is really coming through demand changes. So you can tell in the categories that we're talking about, having the highest level of performance, therefore driven by the highest level of the demand are the places where we're really working on capacity to continue to maintain that demand.

[Operator:]

Next question comes from Jenna Giannelli from Goldman Sachs.

[Jenna Giannelli:]

The first one is just a follow-up on the inflation headwind for the third quarter. I'm assuming that includes helium. But if we could just talk about helium specifically, how much of a headwind that is for the balance of the year, remind us on hedging and any early outlook, how we should think about that for '22?

[Todd Vogensen:]

Sure. So if you look at our helium, just our helium cost per cubic foot in Q1 and Q2 versus 2019, we were wrapping around on some headwinds there. But as we move into Q3, we're on a much more level playing field. We've got contracted rates for helium. Any increases that are in there for helium put us right back in line with 2019. So we're not really seeing any inflationary pressures there and really would not expect to see any as we go into 2022 either. So we have gone out and put long-term contracts in place. We actually have even partnered with a couple of wells directly. And based on that, we're feeling secure with the amount of supply we have and the price that we have it at.

[Jenna Giannelli:]

Okay. Great. And then I just want to ask about balloons in the store just because it's such an important traffic driver. If we can talk about that for a minute. Specifically, how you're working through that experience in the store, whether customer service, merchandising, location, checkout, et cetera. And I'm curious how just the retail balloon sales and customer trends that you're seeing compare now as we compare back relative to maybe 2019. Basically there still might be some upside and opportunity here in this category in-store.

[Todd Vogensen:]

Our balloon demand continues to be very strong. And as we've talked about, it is a driver of our sales this year as well as our highlights of Q3 in 2020 -- we had strong balloon sales throughout 2020 and now into 2021, and like to see and love seeing the ongoing demand. Relative to your question around the experience in the stores. We continue to focus on the key items and the assortment that is driving those sales and ensuring that we have adequate capacity and adequate quantities to drive those sales is a focus. The experience in the store has changed to some degree with the onset of buy online pickup in-store and balloon delivery, which are about both now available to consumers in the stores that we have adjusted for to make that experience seamless as consumers both preorder balloons for their parties to come in and pick them up as well as come in and build bouquet of balloons with our sales associates to personalize them for their own parties. Many -- a lot of the innovations that we brought into market around larger standup balloons, larger letters and numbers as well as very topical and seasonal items are doing well. Also our premade bouquet which we make ahead of time for the consumers, for the walk-in consumer, relative to things that are happening in the marketplace at the time, whether that's graduation, 4th of July, those types of occasions. We're ready for the consumer and have product waiting for them.

[Operator:]

The next question comes from Hale Holden from Barclays.

[Hale Holden:]

I just had two questions. Can you remind us that 80 to 100 Halloween stores that you're planning, how that compares to 2019, Halloween City…

[Bradley Weston:]

In 2019, we had approximately 250. And in 2020, we had 25.

[Hale Holden:]

And then I was wondering if you had seen any changes since you talked about July regionally through the U.S. where perhaps there might be more COVID outbreaks or if there are -- it was pretty even performance across the country.

[Todd Vogensen:]

Yes. As cases have increased and restrictions have been put in place in certain areas, we've not seen an impact to our overall business in geographies that are being watched closely like Florida, areas of California, the Deep South. We've seen a bit of slowdown to the increase in these areas, but the increase in sales over 2019 in those areas are still very strong.

[Operator:]

. The next question comes from Karru Martinson from Jefferies.

[Karru Martinson:]

I just wanted to circle back on the Halloween inventories. So just so we're clear that you are fully in-stock and you feel that you have the goods either in transit or in your warehouses or in your stores so that you're ready for the Halloween season, correct?

[Todd Vogensen:]

Yes. So we have a view of every place we have products in the supply chain. We have products in our stores. We have products in our DCs, and we have product on the water. And so as we look at our in-stocks relative to prior years, we can look at 2019, 2020, we're in a solid position.

[Karru Martinson:]

Okay. And then in terms of the wholesale portion that you produce for all, I mean how long do your customers' needs to order in terms of advanced times? Like when do you get a good read on that traffic?

[Todd Vogensen:]

So the majority of our wholesale orders for Halloween come in anywhere from November to approximately January and February of the prior year.

[Karru Martinson:]

Okay. So that is already done. And so you have a good read on that, correct?

[Todd Vogensen:]

Absolutely.

[Karru Martinson:]

Okay. And then when we look at the full year, in our calculation you should be positive free cash flow this year. Can you talk to kind of the uses? You mentioned adding some capacity in Anagram, paying down debt. Where are you prioritizing uses of cash here?

[Todd Vogensen:]

Absolutely focused on making sure that we can be paying down debt. First and foremost, has to come funding internal operational growth initiatives. So of course we're doing that and making sure that we have the right levels of working capital for the business, but from a pure capital allocation perspective, debt pay down is top of the list and should continue to be.

[Operator:]

The next question comes from Michael Coppola from JPMorgan.

[Michael Coppola:]

Just one question regarding any sort of deferred rents during COVID. Has that all been repaid? Or if not, is there any update done on how much is remaining?

[Todd Vogensen:]

Absolutely. So we still haven't announced out there. We were really scheduled -- most of that is to be paid off over the course of 2021. So we paid another $15 million in Q2. And we have another $70 million left that will be really mostly over the course of the second half.

[Michael Coppola:]

Great. Understood. And just as a second question. Have you guys seen any sort of changes as to the size of parties that are happening? Or anything that kind of gives color to that?

[Bradley Weston:]

Yes. We have places in our basket analysis that we can see that and certainly, we are seeing in some of the quantities being purchased that there is a return to larger quantities of sizes of parties, which obviously bodes well for the breadth of product and the average order value in a basket, which we're pleased with.

[Operator:]

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

[Bradley Weston:]

In closing, we're pleased with the ongoing momentum in our business. As we update and improve our product assortments and inventory position, our relevancy with celebration consumers continues to expand. Our relentless focus on consumer insights as well as both forward-looking and performance-based data are informing our decision-making and improving our ability to inspire joy and make it easy for our customers to create unforgettable memories. As we move into the back half of the year, we will continue to make progress on our strategic initiatives to further drive our performance. I want to thank you for joining us this morning, and let you know we will be participating in the Goldman Sachs retail conference in September and look forward to seeing some of you there. Have an excellent day.

[Operator:]

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