Party City Holdco Inc.
Q4 2018 Earnings Call Transcript

Published: 28 Feb 2019

[Operator:]

Good morning. My name is Jacqueline, and I'll be your conference operator today. I'd like to welcome everyone to the Party City's Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Mr. Ian Heller, Associate General Counsel of Party City. Thank you. Mr. Heller, you may now begin.

[Ian Heller:]

Thank you, operator. Good morning, everyone, and thanks for joining us. This morning, we released our fourth quarter and full year 2018 financial results. You can find a copy of our press release on our website at investor.partycity.com. Now I'd like to introduce our executive team who are here on today's call. We have Jim Harrison, our Chief Executive Officer; and Dan Sullivan, our Chief Financial Officer. We'll open the call with some prepared remarks by Jim and Dan, before we open it up for Q&A. Please note that in today's discussion, management may make forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995 regarding their beliefs and expectations about the company's future performance, future business prospects for 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 encourage everybody 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 information regarding our non-GAAP financial measures and reconciliations to the most directly comparable GAAP measures, please refer to the earnings release. And with that, I'll turn the call over to Jim Harrison.

[James Harrison:]

Thank you, Ian. Good morning, everyone, and thank you for joining us today. I will begin by providing an overview of the company's performance for the fourth quarter and fiscal 2018. We will then discuss the progress made across various businesses. Dan will then discuss the financial operation results in greater detail as well as our outlook for 2019, after which we will open up the call for your questions. As you saw from this morning's earnings press release, top line results for the fourth quarter was slightly below expectations, in large part due to continued helium supply pressures that unexpectedly persisted from November and to a lesser degree into December. Gross margins were in line with expectations and EBITDA and EPS were at the low end of our expected ranges as we exercise discipline cost control. The full year consolidated revenues grew 2.4%, gross margins declined 20 bps with EBITDA and EPS tolling $400 million and $1.61 respectively. We generate strong cash flow of $315 billion for the year, which allowed us to complete significant franchisee acquisitions, while also investing in the businesses, and opportunistically repurchasing shares. Looking back at 2018, it was an important foundational year for the business in which we made meaningful progress against several growth strategies that will strengthen the businesses in 2019 and beyond. Starting with the retail business. Sales grew 4.3% for the year, reflecting the further execution of our omnichannel strategy. We continued focusing on improve consumer shopping experiences across both brick and mortar, as well as online. This focus included competing phase one of retail productivity initiatives within the Party City stores, thereby improving the operational performance of stores, simplifying store operating procedures, improving the flow of product and optimizing labor. The same is associated with these initiatives, have served as a catalyst for reinvestment into the party planner program, as store level enhancing our level of customer service and customer experience. At the end of the year, the party planner program was in 150 stores and the positive results clearly demonstrate the opportunity for us to grow the basket to create a customer engagement and higher quality of service. In 2018, we also strengthen our seasonal product offerings with a wide variety of refresh assortments. At Halloween City, we supported a better curated course store, I mean for the temporary store consumer with a larger offering of animatronics, thereby creating greater in-store theater. Additionally, we expanded the assortment in certain stores to include a selected toy offering. These changes help drive meaningful comp sales in our temporary stores. Touching for a moment on the toy pilot, the results were mixed. The performance of the 50 Toy City temporary stores did not meet our early on expectations. However, we are very encouraged by the results seen in permanent stores where we piloted a number of tests for the toy category, including expanded in-out presence and front end in and out programs. While we are still evaluating the full opportunity for this category, there is little doubt that toys can play a role in strengthening our overall offering. We also made meaningful improvements to our e-commerce business in the fiscal 2018. We completed and launched the broadest site re-platforming that included improve product creative and site content. This re-platforming has resulted in better usability, easier checkout flow and a more facile browsing experience for consumers, especially when using their mobile devices. We also leverage this technology to support the consumers' desire to seamlessly shop the category through the expansion of our “buy online pickup in store” program, as well as improved product availability checks online. In October, we announced the expansion of our digital initiatives with the creation of a Party City brand new storefront on Amazon Marketplace. This move has allowed us to further expand the reach of our brands and unique product offerings, while complementing the PartyCity.com website. Within the Amazon storefront, we initially focused on a curated offering for Halloween, and then broadly store that include Christmas and New Year's products. And recently we have brought new offering to include a selected everyday product offering as well. Largely, this offering is in the form of coordinated kits as we leverage our position as a leading manufacturer, supplier and retailer of consumer party goods. These e-commerce improvements have been well received by consumers, reflected by improve traffic to our sites, increase conversion rates, and accelerated growth rates. When including the impact of bogus e-commerce comps for the fourth quarter and full year with 33% and 18% respectively. Turning for a moment to consumer products businesses. While the helium shortages, supply chain disruptions in the second half of 2018 affected our consolidated top line performance, the total consumer products business on a pro forma basis increased about 1%. The North American consumer products business gained significant new customers in both the grocery and mass channels, which help partially offset continue sluggish franchise and independent party specially retailer performance. The North American consumer products business was also successful and continuing to increase distribution into non-traditional party channels, or alternate channels, including movie theaters, zoos, sporting and entertainment venues. The results we've seen from increased focused on leveraging of our personalized products capabilities, as well as newer channels has been very encouraging. Internationally, the consumer products businesses have deepen the relationship with key retailers in Australia, Europe, The U.K. and Mexico. Education and curation of SKU assortments are creating inroads in many new markets. We continue to see an opportunity for us to increase our overall global presence. The Kazzam marketplace pilot remains as part of our broader future digital strategy. In the fourth quarter, we achieved the goal of going live in about 50 markets at the end of the year. I am pleased that the broad proof of concept has been met and we are aggressively moving to the second stage of this pilot focused on customer acquisition. Plans for 2019 include utilizing the full suite of Party City assets to build awareness, drive traffic and exploit intersects of our marketplace in retail businesses. We are now deploying in about 15% of our stores, a combination of in store initiatives, as well as digital efforts and limited above the line marketing to drive consumer awareness and help scale the business. Based upon the results, we anticipate further marker roll out later this year, and I look forward to sharing the results as Kazzam comes to life and becomes a reality. In addition to Kazzam, in 2018, we invested heavily to improve and expand our CRM capabilities. These efforts have and will continue to allow us to gain a deeper understanding of our consumer and create more targeted marketing campaigns delivering more personalized experience for our consumers. We ended 2018 with a customer database of over 25 million identifiable customers, representing four years of purchase data. It is this growing database that we will leverage to create more personalized experiences for our customers. We continue to optimize the effectiveness and the mix of our marketing spend. Working dollars increased 3% year-over-year, despite spending remaining essentially flat. These efforts include the diversifying way from traditional media venues and increasing our digital spend and promotional advertising, which increased 25% year-over-year in 2018. With unaided brand awareness over 70%, the marketing dollars we deploy must be done so in conjunction with our enhanced CRM targeting capabilities, and really focused on driving uniqueness for the customer. Like all retailers, we have been faced with heightened inflationary pressures in 2018. However, our bottom line results for your demonstrate the clear benefits of our differentiated vertical model. The self-manufacturer Share of Shelf expanded by 30 points in 2018 and productivity improvement initiatives help partially mitigate the inflationary pressures limiting gross margin decline to 20 bps for the year. Dan will discuss this in more detail shortly. The vertical model also provided the business and opportunity to mitigate the potential impact of the tariff policy on the business. If the 25% tariff were to go into effect at some future point in time, we have largely addressed and essentially mitigated the potential $12 million annual run rate headwind. This has been accomplished in large part to a combination of product reengineering, accelerated resourcing efforts and increasing the self-manufactured share generally in our factories in North America. I'm extremely proud of our consumer products' teams have moved quickly and effectively to leverage our best-in-class capabilities to meet this significant operational challenge. Timely and highly accretive retail acquisitions were a core component of our growth strategy in 2018. And we completed the acquisition of 58 franchise and independent stores across Maryland, Pennsylvania, Minnesota, North Dakota, and Texas in 2018. As we said before, these acquisitions further expand our corporate footprint at very attractive cash-on-cash multiples. And 2018 provided a unique moment for us to accelerate these acquisition efforts. Going forward, we expect the pace of retail store acquisitions to significantly decrease and will prioritize debt pay down as we focused on our leverage ratio goal of between 3 and 3.5 times by the end of 2020. So in summary, 2018 top line results were slightly below expectations, due in part to the temporary headwinds. But through control costs and deleveraging the vertical, we delivered bottom line results at the low end of our guided range. We made meaningful progress on strategic initiatives to strengthen the business and we're well positioned in 2019 as account that turns favorable with Halloween moving to a Thursday and with what we believe to be a very strong licensed portfolio in the year ahead. The 2019 strategic objectives for the businesses are clear. One, drive meaningful organic growth. Two, expand the vertical as we have produced source and should be more efficiently and improve the overall operation performance of the business. And finally, most importantly, strengthen the balance sheet for long term success of the business. Critical investments in support of our top line objectives have been made and businesses poised for sustainable comp sales growth. Process adjustments have been instituted to improve operational efficiencies and the capital investments in manufacturing distribution made in 2018 are set to yield the anticipated benefits. But once again, less assured we remain firmly committed to accelerating our pay down debt, all of which supports our focus on creating long lasting shareholder value. Before I close, I like to acknowledge the announcement we today the Dan Sullivan has decided to pursue another opportunity elsewhere. He will be leaving the company on March 22. I want to thank Dan for his commitment and dedication to PCHI over the past two and a half years. He has built a strong and capable finance organization and help drive our retail productivity initiatives. We wish Dan all the best in his future endeavors. As a result of Dan departure, we have also announced that Michael Correale, our Chief Accounting Officer, who served as our CFO for 14 years from 2000 to 2016 has accepted the position of Interim CFO, allowing for a seamless transition until the permanent replacements for Dan is identified. Mike's knowledge of the business and experience will provide a steady set of hands. And now, I'd like to turn the call over to Dan to discuss the fourth quarter and full-year results and the 2019 outlook in greater detail.

[Daniel Sullivan:]

Thanks, Jim. It's been a wonderful two and a half years at Party City, a privilege to serve the company and our shareholders. I'm extremely proud of the tremendously talented finance organization that has been built and I'm confident that the organization is well positioned for continued success. Now, turning to the results. As you heard Jim mentioned, 2018 was an important foundational year as we made critical investments across the business to enhance our positioning as a world class vertically integrated retailer. There were a few unexpected transitory issues which we've discussed and which I'll elaborate on in a moment that transpired in the back half of the year that negatively impacted the top line and pressured gross margins at both retail and wholesale. That said, even with these operational headwinds, we still reported EPS and EBITDA within our updated guided range for the year. For fiscal 2018, revenues increased 2.2% on a constant currency basis, gross Margin rate declined 20 basis points as expected, adjusted EBITDA decline 2% and adjusted EPS increased to $1.61 from $1.24 inclusive of share repurchases and the benefit from Tax Reform, as well as the headwind associated with higher interest expense. And we once again generated strong free cash flow of $315 million. Our fourth quarter top line results were impacted by persisting helium pressures that at times were a significant headwind for both our balloon business and juvenile birthday business, negatively impacting both our retail comps as well as our consumer product sales. Despite sluggish revenues in the quarter, in part also impacted by the New Year's Eve shift, the year-over-year decline in gross margin was in line with expectations and EPS came in towards the middle of the range driven by solid cost control. Looking more closely at fourth quarter results. Consolidated revenue grew 2% on a reported basis or 2.5% when adjusted for currency. In our retail segment, sales increased 4.5% in constant currency, largely a result of the acquisition of franchise and independent stores over the last 12 months, as we added about 8% in retail square footage in 2018, almost entirely through acquisitions. At quarter end, our store network total 962 stores, 866 of which were corporate stores. Our brand comparable sales, which include our U.S. and Canadian permanent stores and North American e-commerce business declined 2.9%. This reflects an approximate 150 basis point impact from the helium shortage that persisted from Q3. In addition, as we expected, the headwind of the New Year's Eve shift was about 110 basis points, implying an underlying comp for the quarter, absent of these two factors of down slightly. Underlying comp sales performance strengthened as the quarter progressed and seasonal comps in December were positive despite the New Year's Eve shift. With the Christmas season up over 20%, as customers responded well to our new Christmas and Hanukkah designs and updated assortments. Our web business remained a bright spot in the quarter increasing 12% in Q4 or 33% when adjusted for bogus. Turning to the non-vertical consumer products businesses, net revenue increased 30 basis points in Q4 after adjusting for the impact of franchise and independent acquisitions and foreign exchange, as we cycled last year's 4Q constant currency organic growth of 12%. International consumer products declined approximately 1.8% in constant currency, despite mid-single digit growth in our core commercial markets. This decline was partially due to continued sluggish results in our direct from plant FOB business. Combined with the tough comparison the prior year period when we saw 20% international growth. Importantly, we continue to strengthen relationships with key retail partners in our core international markets and have leveraged our strong positioning in the foil balloon category which drove continued growth in Australia, Europe and Mexico. On a two year basis, we have seen quarterly growth of about 18% The domestic consumer products business continues to be challenged, due to soft franchise and independent performance and declined 1.1% adjusted for acquisitions, as we cycled 10% growth from last year in Q4. The declines were largely result of American Greetings' decision to exit the category of sluggish Wednesday Halloween and declines in the gift business. Importantly, the alternative markets channel increased about 5% on a run rate basis in the quarter, and reflects key wins in mass and grocery, most notably with Target, Michaels and Kroger's. As expected, our consolidated gross profit margin was 45.3% or 160 basis points below the same quarter last year and in line with our expectations. Almost 100 basis points of the decline was attributable to the operational headwinds that we previously discussed on our Q3 call. This was related to supply chain disruptions associated with the surge in demand for moving product out of China ahead of tariff implementation, resulting in incremental freight, distribution and labor costs that were largely realized in Q4. Additionally, we continue to experience increased inflationary pressures associated with freight and distribution costs and saw some negative impact as a result of higher helium costs in terms of both sourcing and negative product mix. Finally, as we previewed in our 3Q call, we shifted promotional spend from the third quarter to the fourth quarter in support of our holiday execution. All of these headwinds were partially mitigated by the continued execution of our retail productivity initiatives. Overall, Share of Shelf decreased 160 basis points, primarily due to the negative impact on Halloween from Q3's operational issues getting product out of China. Manufacturing Share of Shelf also decreased to 160 basis points to 16.6%, also driven largely by the negative helium shortage impact on balloon sales. Normalizing for the helium issue, the operational challenges already discussed and the New Year's Eve shift, manufacturing Share of Shelf was just over 18% and flat to last year's Q4. Operating expenses as a percent of revenue leveraged 20 basis points year-over-year, largely reflecting the continued labor productivity efforts at retail and a reduction in management incentive costs. In our retail business, we saw labor rates improved by 40 basis points fueled by 70 basis points of benefit from the scaling of our productivity initiatives. And we've already begun piloting the next phase of our work for 2019. We are redeploying the savings from our productivity initiatives into the party planner program, which we now have in about 150 stores, with about 70 stores having been launched late in 3Q. Overall, we're continuing to see about a 1% to 2% comp lift versus the rest of chain with stronger results in the more mature stores. We continue to improve this program by strengthening the labor model, enhancing our training program, reducing associate turnover and continuing to modify the underlying incentive schemes to drive performance. We are seeing the benefits of these improvements in our customer satisfaction and net promoter scores which continue to strengthen. With the holidays now behind, we'll further evaluate and scale the program over the course of 2019. Reported income from operations was $158.8 million or 19.7% of net revenue, compared to $167.4 million or 21.2% of net revenue in the prior year period, with a decrease due to lower gross margins. Interest expense for the fourth quarter was $29.2 million or $7 million above the same quarter last year. With the increase equally attributable to increased borrowings under ABL Facility, the impact of increasing LIBOR rates on both our term loan and ABL Facility and the high yield offering that was successfully executed in August. In the quarter, our reported effective tax rate was impacted by non-recurring adjustment related to Tax Reform. Our adjusted effective tax rate was 25.4%. Adjusted net income of $103.4 million increased 9.9% compared to last year's fourth quarter and adjusted EPS increased to $1.08 per share from $.081 per share. The 2018 results are inclusive of tailwinds from Tax Reform and a reduction in our share count through our share buyback activity, partially offset by a higher interest expense year-over-year. Adjusted EBITDA decreased about 4% versus the fourth quarter of last year to $188.9 million. Turning to our full year results, consolidated revenue was $2.43 billion, which represented growth of over 2% on both the reported and constant currency basis. Retail operations posted a 4.3% increase on both of reported basis and in constant currency, driven largely by increased store count. During the year, we acquired 58 franchise and independent stores and opened five net new stores. Reported comps declined client 70 basis points for the year, while on an adjusted basis, excluding the unique headwinds of helium shortages, the operational issues getting product out of China, as well as the tailwinds of lapping hurricanes and the SEO issues of a year ago, underlying comps were essentially flat. Our e-commerce calm sales increased 18%, when including both the sales. Our non-vertical consumer products revenue increased 0.3% after adjusting for the impact of franchise acquisitions, and foreign exchange, largely reflective of American Greetings' decision to exit the category and the continued deterioration of the independent and franchise business, in part a reflection of a Wednesday Halloween. The alternative markets business grew 9% on a run rate basis for the year and we are encouraged by the growth seen not only in mass and grocery, but also in the promotional and experiential channels, which will continue to focus on in 2019. Our international consumer products business grew 1.7% for the year on a constant currency basis, driven by almost 9% constant currency growth in our core markets of Australia, Europe, the U.K., Canada and Mexico. We continue to exploit our full product assortment, with growth being driven by innovative merchandising, product development and category management with key retailers. Gross margin rates declined 20 basis points for the year, despite continued productivity gains at retail. The margin declines were primarily due to increased rate and logistics costs and higher costs from the Q3 operational issues related to getting product out of China. The negative product mix, and commodity and labor inflationary pressures are additional the less meaningful headwinds. We increased manufacturer Share of Shelf 30 basis points to 22.9% and estimate this increased to be 100 basis points year-over-year when adjusting for the negative effects of the items discussed earlier. Operating expenses were $713.9 million which were higher by about $17.7 million or flat as a percentage of revenue versus 2017, primarily due to the improved labor productivity management, better expense management and lower incentive costs. At retail, we realized a 60 basis point improvement in direct labor rates, largely as a result of the maturation of our first phase of labor productivity initiatives. Interest expense was $105.7 million compared to $87.4 million last year. With the increase attributable to the increase borrowings under the ABL, the impact of increasing LIBOR rates on both our term and ABL and to a lesser degree the recent high yield offering that was successfully executed in August. Our reported effective tax rate reflects a non-recurring adjustment related to tax reform. And for the full year, this rate was 25%. Adjusted net income was $156.8 million or 5.5% above last year, resulting in adjusted EPS growth to $1.61 per share versus $1.24 per share in the prior period. The 2018 results are inclusive of tailwinds from Tax Reform, our reduction in our share count, do our buyback activity and partially offset by higher interest expense and Kazzam investments year-over-year. Adjusted EBITDA for the year was $400.1 million versus $409.2 million in the prior year. Finally for the year, we delivered free cash flow defined as adjusted EBITDA less CapEx of $314 million, a decrease of $28 million, or 8% versus 2017, primarily due to increase CapEx of $19 million in support of our web re-platforming and productivity efforts at retail and in our main distribution center. Cash flows from operations was a source of $102 million, including a working capital use of $125 million, which was largely reflection of increased inventory levels, in part due to the softer than expected Halloween sales. CapEx totaled $86 million, while the allocated $40 million towards stock repurchases and $65 million towards acquisitions. We ended the year with net debt of about $1.9 billion, resulting in a debt leverage ratio of 4.7 times with about a 10th of a turn as a result of our share repurchase program. At the end of the quarter, we had approximately $210 million available in our existing asset base revolver. Before I discuss our 2019 guidance, I wanted to note a few items impacting our outlook. As Jim said, there were a few tailwinds in 2019, including the shift to a Thursday Halloween and a more favorable licensed property calendar, which is most relevant for a juvenile party and costume businesses. Our comps guidance for the year contemplates further helium supply constraints, anticipated to be at current levels, and which are likely to disproportionately impact half one, due to business seasonality and the fact that we will cycle 2018 supply issues which began in August of last year. Further, our quarterly comp outlook reflects calendar favorability in Q1 due to the New Year's Eve shift and it's partially offset by the negative impact of Easter shifting into Q2. Overall, we expect half one comps to be flat to slightly negative. We expect to benefit from supply chain investments we made ahead of and following the disruptions that impacted the business in 2018. While inflationary pressures are expected to persist, most notably related to freight and helium, we anticipate GAAP operating income margin to be slightly positive when compared to 2018 rates, largely reflective of slightly positive gross margin rates. We expect interest expense to be in the range of $115 million to $120 million dollars for the year. With that said, for fiscal 2019, we expect revenue to be in the range of $2.488 billion to $2.538 billion and comp sales to be up about 1%. We project full year adjusted net income to be in the range of $152 million to a $162 million or a $1.61 to $1, 72 per share. We expect adjusted EBITDA to be in the range of $405 million to $418 million. In terms of capital allocation priorities, we expect to spend about 2.8% of net revenue on CapEx, which is down from approximately 3.5% in 2018. And we anticipate ending the year with a net debt leverage ratio of 4.1 times. For all other detail around our outlook, please refer to our press release. And with that, I'd like to turn the call back over to the operator to open up the call for questions.

[Operator:]

[Operator Instructions] Your first question comes from Matt McClintock with Barclays. Your line is open.

[Matthew McClintock:]

Hi, yes, good morning, everyone and best of luck Dan.

[Daniel Sullivan:]

Thanks, Matt.

[Matthew McClintock:]

Two questions. The first one is just helium. Can you just give us your broader perspective on the helium shortage? There's been a lot of news over the course of the last month that the helium shortage is getting, is intensifying. And can you just talk about how your sources of helium are I guess locked in or provide you with some type of you that you will be able to get that product? Thanks.

[James Harrison:]

And Sure Matt. So I think as you recall, in our third quarter call, we called out helium, and it was our expectation and it was the expectation of those who are quote unquote experts that the situation would stabilize and begin to resolve itself. Obviously, it continues to persist. And as Dan mentioned, in our comps, we've projected a continuance of the helium situation at its current levels as we look at the full year. From a percentage standpoint, currently we're operating at about a 60% to 70% of our average allocation for helium, and that bounces around quite a bit based upon the time of the month and general availabilities. We've done a number of things to source helium from additional resources outside of our standard contract relationship. And as a result of that, we've been able to bring the average up to about 70%. As we look at typically what we need to really satisfy our demand vis-à-vis our allocation of our contract, we need about 80% to 85%. So there's about a 14 give or take true headwind and the availability to us of helium on a day in and day out basis. But like I said, over the course of a month or a week, it can it can vary from anywhere from 50 stores having helium issues over 200 stores having helium emissions. As we look for the longer term, as you know, and probably we talked about healing in the past, there's plenty of helium in terms of known reserves. The constraint really today is really supply chain and refining capacity. It's really well documented in number of articles where that refining capacity is being built in the causes for the shortage of the refining capacity being primarily the input influence of the government's decision to continue with the ceiling mounted the BLM years ago in quantities that inhibited investment in refining capacity. So as we look at the full year, we expect helium to continue to be a headwind. We believe our comp guidance incorporates in it enough of a quantification of that headwind that we're still conservatively believe that we can be in the range of flat to slight 1% comp. Hopefully that's helpful.

[Matthew McClintock:]

Great. It's extremely helpful, Jim. Thank you very much. And just I guess as a clarification question on the comp guidance of one, for the full year, I believe that's similar to your comp guidance as you entered last year or 2018. So I guess my question is, does the helium headwind offset the benefit of more optimal timing of Halloween and that's why you have similar comp as you began last year? Thanks.

[James Harrison:]

I think fundamentally, it's probably a very down and dirty quick analysis of the situation. Obviously, there's a great number of puts and takes within our guidance and within our project where we comp for the year. Obviously the operational issues that we highlighted in our third quarter call, we've taken tremendous strides and steps to make sure that we're ahead of that curve. We don't extend to speed that sort of drag on comps in 2019. And there are - like I said, there are a number of puts and takes. But the easiest way of thinking about is, yes, we move to a strong calendar on Halloween. We move to strong properties. And helium mitigates the full impact of what that normalization normally would have provided us.

[Matthew McClintock:]

Thank you very much for the color.

[Operator:]

Your next question comes from Simeon Gutman from Morgan Stanley. Your line is open.

[Simeon Gutman:]

Hey, good morning, guys. My question is on EBITDA guidance for the growth that's embedded in the guidance year-over-year. So we know you're lapping investment from 2018, you mentioned some non-recurring consultant cause, I don't know if you quantified, some operational headwinds and now - and we know helium, even though it sounds like it will linger a little bit in the first half. And then Jimmy just mentioned, better licensed product. And I would guess Halloween should be no worse than a push relative to this year. So it looks like the EBITDA growth that's implied, if you're muted for conservatism or there's just a lot of costs that still you know, holding on in a business?

[Daniel Sullivan:]

Hey Simeon, it's Dan. I would maybe highlight two things. One is our outlook on gross margin and we should not ignore the helium impact on gross margin. What we've said is, we expect gross margins to be flat to slightly positive versus a year ago. Helium will represent about a 30 basis point headwind to margins in the year equally sort of balanced between higher cost to secure helium and the negative effect on mix that selling less balloons have. So you have to start with our gross margin outlook. I think the other piece that I would call out is the TI impact year-over-year. We continue to have less and less TI add backs to our EBITDA, which you know we're cycling about $5 million less in add backs in 2019 then we were in 2018, which makes the flow through of EBITDA look a little bit skewed, but doesn't actually change sort of how we think about the year.

[Simeon Gutman:]

Okay. And then just related to balloons and helium, can you tell us when you make money on a balloon, are you making money marking up the balloon and the helium or is it just one side of it and have you considered raising prices on balloons?

[James Harrison:]

There's that question - the answer to the question is, not only have we considered it, we've actually done it. To mitigate some of the headwind on the helium, we don't really mark up the helium per se, helium is part, it's similar to the labor to fill the balloon and make the - put the ribbon on the balloon. That's all incorporated within the cost of executing the sale of inflated balloon. But we have looked at pricing on our balloons to adjust for the increased cost of the helium. But with increased prices, obviously there's a put and take that occurs at retail in terms of consumers' perception as to how many balloons are going to buy. And just following up on your earlier question a little bit about the calendar shift and the impact of strong licensing. It's interesting to note that as we mentioned in the third quarter, the portion of our business that we saw really most affected by this most recent Halloween, was not necessarily the adult business, which you would generally expect to be substantially affected by the mid-week Halloween, but actually the girls business, due to the absence of strong properties. So as we think about the shift to Thursday, and the impact of that, really that coupled with the girl's shift is really what's going to drive the Halloween business as opposed to one of the dominant we expected to be a larger portion of the assortment being purchased by the adult category. So there's - while there is two benefits there, they basically merged into one.

[Simeon Gutman:]

Got it. Okay. Thanks, Jim. Dan, good luck.

[Daniel Sullivan:]

Thanks. I appreciate it.

[Operator:]

Your next question comes from Mike Baker from Deutsche Bank. Your line is open.

[Mike Baker:]

Hi. Thanks. Just to touch on these issues again. And I guess throughout the year, you've given us enough data with some data we could probably try to back into it. But I'll just ask your view on, can you order all the issues that happened in 2018? Which impacted you the most in terms of Halloween, the helium, poor licensing, the tariff China issues, even freight cost when they were like five or six things, what was the most impactful in your mind?

[Daniel Sullivan:]

Mike, so it's Dan. I think you have to separate it between, are you talking top line impact or gross margin impact, right. Certainly from a top line standpoint comps in particular, we would obviously say the issue is getting product out of China and therefore affecting our Halloween business would be first and foremost on the list. And then secondarily, helium while it had an impact in Q4, which we've estimated to be 150 basis points of comp headwind on a full-year basis obviously far less than that. And if you talk about gross margins and full-year rate, the freight and distribution costs would be first on the list because that's a structural issue that has been with us for the entire year and drove about 35 to 40 basis points of headwind against margins. Again, from a timing point of view, the issues getting product out of China was limited to the fourth quarter. It had a meaningful impact on the quarter. We've said about 100 basis points year-over-year, but far less on a full-year. So hopefully that answers your question.

[Mike Baker:]

Yeah, it doesn't. And then following-up, the freight and distribution costs of 35 to 40, is that including the China issue or is that separate just higher freight rates in the like?

[Daniel Sullivan:]

You know, it's separate.

[Mike Baker:]

Understood. Do we expect that to dissipate it all and in 2019, some spot rate and contact rates have already come down a little bit or you planning for that same type of tailwind into the - or headwind I should say in 2019?

[James Harrison:]

We were anticipating being continuing headwind to the magnitude that was this past year. We're not expecting any real loosing on freight anytime soon. The number of bankruptcies are freight carriers recently in this quarter even. So to speak, freight loosening up substantially.

[Mike Baker:]

Okay. Understood. If I could ask one more maybe more of a positive question. Do the party planner initiative, seems like it's going pretty well, it's in 150 stores. You've sort of been reluctant to talk about the pace of the rollout, but any color on how many more stores we expect to see that in 2019, eventually can this be in off-stores and is there enough efficiencies to offset those costs still to go?

[James Harrison:]

Sure. I'll start and I'll ask Ryan Vero our President to join in. Essentially, in terms of rolling it out to all stores, that would not make sense. What we're doing is, we're looking at ways of utilizing technology at various levels, extra level and also broadening the training of our associates, so that we don't have a bifurcated group who simply focus on customer engagement. Really, our goal and Ryan can certainly enhance this conversation, is to really create a service orientation throughout our retail organization. So that we were less dependent upon a single party planner to be the face of the customer engagement initiative, but rather broaden the customer engagement initiative across the full spectrum of associates. Ryan?

[Ryan Vero:]

Yeah, sure. Mike. A couple comments I guess. We've been testing this program now for nearly a year and we've expanded to the 150 stores. We're continuing to refine that model. We are seeing some very positive elements of it, particularly the customer feedback and the results of average transactions when we're engaging with these customers. But it is a continued refinement, finding the right model, the right operating hours or the right hours for those associates to be in the stores and on the right days. And as we get those things honed in, we'll be expanding it to a broader basis stores. And also developing, as Jim mentioned, into an element of our selling culture that we're trying to essentially inculcate into the entire organization. So we're seeing some positive results there as well.

[Mike Baker:]

Thanks for the comments.

[Operator:]

Your next question comes from Tami Zakaria from JP Morgan. Your line is open.

[Tami Zakaria:]

Hi, thanks for taking my question. I have a question regarding your inventory position which has been growing for two quarters in a row now and your day's inventory outstanding has jumped quite a bit in 2018 versus 2017. So do you expect that to come down as we look into 2019?

[James Harrison:]

The answer to that question, Tami, is yes. The growth inhibitor is really been driven - on a consolidated basis, it's been driven by a number of things, right. As Dan mentioned, we acquired approximately 50 franchisee and independent stores. That by itself is an addition of more than $25 million of inventory for those acquisitions. We also had a heavier carry over on Halloween then we had in 2017 going to 2018. The irony there is the strong sell through and lower by in 2017 actually put us in a position where when we ran into those operational issues in 2018, we didn't have the carry overstock to really make up significant statement for Halloween in advance of the normal selling season. And so obviously there's a good news, bad news with a larger carry over Halloween this year that will be able to make a strongest statement earlier in the season at the beginning of September. But fundamentally as an organization, as I said in my earlier comments, we're committed to driving our leverage down. That means doing a lot of things, including sharpening our pencils, and taking a tougher look and a harder look at our working capital utilization, not just that retail but throughout our entire business. We've got 28 operating businesses, three of which are retail and 25 of which are on the consumer product side. And each one of those businesses has a general manager, it needs a steward of assets and his job as a steward of assets as to sweat and maximize return on those assets, not just the working capital but also fixed assets. And that's really a huge focus for us this year. And as Dan said, our guidance to take the leverage down to just above four times and that's barring any other potential activities, which could generate onetime cash flow.

[Tami Zakaria:]

Got it. Thank you. And I do have a very quick follow-up question, which is, have you been seeing any impacts from the main tax refunds? Is that - did that impact your performance in January or February so far?

[Daniel Sullivan:]

No.

[Tami Zakaria:]

Got it. Thank you.

[Daniel Sullivan:]

Thank you.

[Operator:]

Your next question comes from Joe Feldman from Telsey Advisory Group. Your line is open.

[Joe Feldman:]

Yeah. Hey, guys. Good morning. One question, kind of about the outlook for 2019. How should we think about interest expense going forward, because it did come out a little bit above I think what some of us were thinking for the fourth quarter and I know obviously, the impacts you described with floating rates and things like that. How should we look at it for next year?

[Daniel Sullivan:]

Joe, we've guided at $115 million to $120 million. Recall for 2018, we guided at $105 million. We came in actually just under that just over that about $106 million. So we feel like we've been pretty transparent with the figures. Obviously the high yield offering of August and the slightly higher debt levels coming into 2019 will both increase that drive increased interest expense for us. And our guide reflects, if you essentially use the guide, we put forward on EPS. There's about a $0.07 to $0.10 headwind in EPS associated with the higher interest expense.

[James Harrison:]

And remember, Joe, we chose to swap some term out for the high yield at a much higher rate. We felt create some certainty around interest expense and particular our rate of interest going forward was a prudent decision as opposed to being subject to perhaps the volatilities that might occur with the floating rate that that was in our term debt. But once again, as we continue to pay debt down, we'll see that interest expense number come down. And the fact that we now have fixed rate debt will make it a lot easier and much more transparent for everybody here as well as those on the call to be able to gain a perspective and an outlook with respect to where interest is where it's at it.

[Joe Feldman:]

That's helpful. Thanks. And then when we go back to - I know you guys did a lot of operating improvement within the store the past year to just enhance the overall experience and new operating procedures and all that those things you talked about early in the call. What and you referred to it as phase one, what - how should we think about phase two like, what is kind of phase two and is that a 2019 event or is it longer term? Thanks.

[Daniel Sullivan:]

Yeah. So I would think a couple of things, Joe, for how we think about phase two. One is, this is not a retail only mindset or approach, productivity improvements and efficiency improvements are core to the DNA of the business. So we have programs in place here in the headquarters. We have programs in place in our manufacturing facilities. I think retail was just out ahead of it, and did a very good job developing the program for 2018, which also provides some carryover benefit in 2019. So I would start by saying that it is a way of how we think about running the business and really driving productivity across the enterprise. In terms of 2019 sort of specific efforts, maybe Ryan, I'll ask you to just touch on some of the things that the team is working on at retail.

[Ryan Vero:]

Yeah. So as Dan mentioned, we do have some carryover from the prior year. But as with any new payroll model that you implemented in store, new operating procedures, there's continued enhancements that go on. And so we have realigned our payroll model throughout last year, and actually going into 2019 as well to better align with front facing consumer demand, allocating more hours to that activity to help on the selling culture side that I referred to prior. As well as continued refinement of the operating back office procedures receiving and put away Anagram transitions, et cetera that are sort of the boring parts of operating retail stores too many but very, very important in terms of our operating excellence in the stores.

[James Harrison:]

And then Joe, this Jim. I'll just add that on a consumer product side of the business, we've made a number of investments in 2018, which both Dan and I referred to in our comments, we will harvest some of the benefits of that this year as we continue to work through those investments and finalize the implementation of investments. Most notably in our distribution center, we recently put in a new another pick module, which is referred to as the order stock retrieval system, which enhances the efficiency of our picking in our warehouse on slow moving items or lower turning items and smaller items by a factor of what was three fold, which is in response to obviously higher labor rates, as well as the continued growth of our business.

[Joe Feldman:]

Got it. That's great. Thanks, guys. And good luck with the first quarter.

[James Harrison:]

Thank you.

[Operator:]

Your next question comes from Curtis Nagle from Bank of America Merrill Lynch. Your line is open.

[Curtis Nagle:]

Good morning. Thanks very much. So yeah, I guess to start, the first question would be, what are you guys targeting for manufacturing Share of Shelf this year and do you think you're still on track to double over the next four or five years or so?

[Daniel Sullivan:]

Yeah. We don't actually guide at that level, but I will say we do expect to continue to see meaningful growth in manufacture Share of Shelf. We didn't see it in the fourth quarter, I think I commented in my opening remarks about that, essentially there was the headwinds of the product issues getting product out of China and the helium issues. But if you normalize for all of that we saw share it manufactured Share of Shelf essentially flat in the fourth quarter and up about 30 basis points for the year. We think that the growth in 2019 and beyond will be meaningfully more than that as we continue to scale up our recent Granmark acquisition and increase the capacity of product coming out of that facility, as well as continue to see growth in our balloon category.

[Curtis Nagle:]

Got it. And yeah, just I guess going back to helium issue, I mean what gives you a confidence you think this will dissipate I guess by the middle of the year and how much certainty you have that capacity constraints will be resolved?

[Daniel Sullivan:]

Yeah, I think it's important, as we contemplated the guide, we don't think this dissipates at the middle of the year. So I want to be clear about how we thought about the guide. We do think that there are structural constraints within supply that will last for the year. But having said that, the impact will be felt for us more in the first half of the year for a couple of reasons. One is just the seasonality of the business New Year's Eve to Valentine's Day to graduation. And secondarily, we will begin to cycle the supply constraints that we saw in 2018 in August. So our guide contemplates a full-year of continued challenge within helium much the way Jim described it, but it will be felt disproportionately in the first half of the year.

[Curtis Nagle:]

All right. Thanks very much.

[Operator:]

Your next question is from William Reuter from Banks of America. Your line is open.

[Unidentified Analyst:]

Hi guys. This is Mike on for Bill. So my first question is, can you talk about the impact if any that you guys are expecting from the second film of Disney's Frozen and what it will have on the fiscal year or Halloween as you saw weak girls?

[James Harrison:]

Sure. The Frozen is a fourth quarter event. We're not allowed to sell products associated with the new movie Frozen 2 until October 4. So somewhere around the end of September, our stores the back rooms of our stores will be packed with lots of Frozen products and party product to costumes and the core. We anticipate it being a good strong property. We don't anticipate that it will be quite the phenomena that it was back in 2014, 2015. But we do expect it will be a strong property. I believe the first snippet of a trailer had, Ryan was it…?

[Ryan Vero:]

116 million in a day.

[James Harrison:]

116 million views in one day, so that kind of tells you that the markets ready for it. But in terms of being a meaningful event for us in Q4, as I said earlier, when we looked last year at Halloween, the costume side of the business, it was really the juvenile girl side of business that was really the weakest. And so to the extent that Frozen will be a strong property. We see it potentially filling that void, which fundamentally really has a customer that we're accustomed to having making an alternative products likes them with respect to the Frozen images. I look at Frozen really as having a bit of a tailwind in Q4 and hopefully a better tailwind as we go into 2020, as it continues to gain momentum. And then they go to DVD and all the other forms of streaming media that helps support a property for a longer period of time.

[Ryan Vero:]

And there's just one other thing worth noting is the movies official release date is in November. And so will be obviously marketing off the hype of the movie and the build up to the launch of the movie. There is some limit to the product that that you can sell prior to the actual movie launch as well. So we'll obviously have all of that product in the stores ready to go in early October for Halloween, but it will be in advance of the movie's release.

[James Harrison:]

But on the subject of IP, there's a lot of good IP this year outside of Frozen. This a new descendants, which should be very strong for the team and young adult female. There's a movie called Ugly Dolls which will do very well for juveniles. And then on the Marvel's side, there is new Avengers and then there is Toy Story 4 and Aladdin and then there's Lion King. So there is pretty robust pipeline from the major studios of IP. And then when you couple that with what's going on in the gaming world, as well as some of the more terrestrial licenses that have a bit of a pop potentially this year. We look at IP really being a nice driver, particularly in Q4. But at the end of the day, from a standpoint of Frozen, it's probably going to be a much more significant 2019 event.

[Ryan Vero:]

2020.

[James Harrison:]

2020. I apologize. Thank you.

[Unidentified Analyst:]

Thanks. And then just lastly. Should we expect any franchise repurchases in the next fiscal year?

[James Harrison:]

As I said in my remarks this year is the year we're going to focus on the pay down of debt. And as a result, unless there's an extraordinarily opportunistic opportunity out there, we would not anticipate doing any franchisee acquisitions.

[Unidentified Analyst:]

Great. Thanks so much.

[Operator:]

Thank you. There are no further questions at this time. This concludes our Q&A session. I will now turn the call back over to our management for closing remarks.

[James Harrison:]

Thank you very much, operator. Once again, everybody, thank you for joining us today. And once again on behalf of the entire organization, I want to thank Dan for his many contributions over the years and over the past 25 years and wish him well as he embarks upon a new set of challenges. As always, should you have any questions or wish to reach out to us at any time, please do not hesitate to do so. We are happy to answer any questions you might have until I talk about the business. Thank you very much, everybody.

[Operator:]

This concludes today's conference call. You have a great day. Thank you for participating.