Party City Holdco Inc.
Q2 2019 Earnings Call Transcript
Published:
- Operator:
- Ladies and gentlemen, I do apologize for this morning's technical difficulties. I would now like to begin the conference. Good morning. My name is Angel, and I will be your conference operator. I would like to welcome everyone to the Party City Q2 2019 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]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 begin.
- Ian Heller:
- Thank you, Operator. Good morning everyone and thanks for joining us. This morning we released our second quarter 2019 financial results. You can find a copy of our press release on our website at investor.partycity.com. Now I'd like to introduce you to our executive team who are here on today's call. We have Jim Harrison, our Chief Executive Officer; Brad Weston, our President and Chief Executive Officer of our Retail Group; Mike Harrison, Senior Vice President and General Manager of our North American Consumer Products Business; and Michael Correale, our Interim Chief Financial Officer.We'll start the call this morning with some prepared remarks by Jim and Mike Correale, 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, or future events or plans.These statements are subject to risks and uncertainties that could cause actual results to differ materially from these statements. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we can give no assurance that such expectations will be realized. We expressly disclaim any duty to provide updates to our forward-looking statements whether as a result of new information, future events, or otherwise.We urge everyone to review the Safe Harbor statements provided in our earnings release as well as the risk factors contained in our SEC filings. During today's call, we will refer to both GAAP and non-GAAP financial measures of the company's operating and financial results. For more information regarding our non-GAAP financial measures and reconciliations to the most directly comparable GAAP measures, please refer to the earnings release.And with that, I'll turn the call over to Jim Harrison.
- Jim Harrison:
- Thank you, Ian. Good morning, everyone, and thank you for joining us today. Once again, we apologize for the delay. As most of you probably know, we normally tape our prepared remarks a day in advance. For some reason the servers had trouble uploading it in this morning. We do apologize. I will begin with a brief overview of our financial performance for the second quarter, and then focus on the key strategic initiatives and accomplishments during the quarter, which will improve our overall performance, strengthen our balance sheet, and address many of the headwinds that we have faced.I will then discuss those factors which has given rise to our adjusted full-year guidance. Mike will then discuss the financial results in detail and provide some additional color around our adjusted full-year revenue and adjusted earning guidance. Following which, we will open up the call for your questions. Overall our second quarter revenue and earnings results were below expectations.We continued to experience the impacts of the helium shortages in many of our markets beyond what we had anticipated. On a consolidated constant currency basis, revenue in the quarter and for the six months increased 1.2% and 1.6% respectively. These results for the quarter and six months include negative comparable store sales result of -2.1% and 1.7%.The helium challenges with respect to the balloon category alone generally represented a 200 basis points headwind to comp over the entire first half of the year. As both the latex and metallic balloon categories were negative impacted. In addition to the impact associated with the sales of balloons, we also continue to see related softness in other categories, especially in juvenile birthday which we believe can be attributed to our inability to offer the full breath of assortment that consumers have come to rely upon on Party City for.We estimate this related effect on non-balloon product sales to be a negative headwind of between 100 and 200 basis points year-to-date. On a positive note, we saw a continued momentum in our digital businesses including sales on the Amazon marketplace. Total digital sales including buy online, pickup, and store comped up 14.7% and 16.6% for the quarter and six months respectively.Total consumer product sales in constant currency after adjusting for the impact of franchise acquisitions, declined 70 bps for the quarter and were flat for the six months. These results too were adversely affected by the helium headwind as wholesale revenues from foil and latex balloon sales by our consumer products businesses slowed as well. Excluding the impact of metallic balloons, our North American consumer products wholesale revenues increased 6.7%.After adjusting for the impact of acquired stores in Q2 were 5.6% for the six months. Internationally, the businesses in Mexico, Australia, Europe, and U.K. continue to perform on plan despite the challenges presented by the strong dollar and generally weak economic conditions. For the quarter, gross margins of 37.1% were declined a 390 basis points due primarily to the flow through of previously capitalized freight cost associated with last year's supply chain issues, higher net helium cost, cost arising from the store optimization initiative, and unfavorable product mix and foreign exchange.Adjusted EBITDA for the quarter was $81 million. Year-to-date EBITDA totaled $133 million slightly below our expectations. Despite the softer sales and margin pressures, we generated $101 million of free cash flow over the first half of the year which is historically weaker than the second half of the year. As I mentioned during our first quarter call, debt reduction during 2019 is the significant capital priority for us this year.We recently announced two specific transactions which align with this priority. The outcome of these transactions when coupled with other initiatives underway this year will enable us to substantially reduce our leverage levels by yearend while improving the long-term strength of the business. Firstly, on June 28, the company filed a periodic report on Form-8K disclosing that we have entered into sale-leaseback transaction with Spirit Realty.Under terms of this transaction, we reported that we have successfully sold the real estate assets associated with our distribution center in Chester, New York; the Anagram foil balloon factory in Eden Prairie, Minnesota; and the injection moulding facility in Albuquerque, New Mexico for an aggregate purchase price consideration of $128 million. Concurrently, we entered into lease arrangements for all three facilities with initial terms of 20 years.We were able to complete this transaction at the multiple of 15 times EBITDA and an effective cap rate or 6.4%. Monetizing these real-estate assets, the proceeds of which were used to pay down debt will only further reduce our leverage levels at year-end beyond our original guidance.Earlier today, we announced that we have entered into an agreement with Canadian Tire Corporation, one of Canada's largest and most respected retailers, whereby they acquired the retail assets and business of our Party City Canadian subsidiary. The transaction, which is subject to customary closed conditions, including government approval is expected to close by October 1.In addition to the transfer of the Canadian retail assets, this transaction also establishes an ongoing relationship between the American consumer products business and Canadian Tire to a supplied agreement with an initial term of 10 years. The agreement contemplates that on average, the North American consumer products will nearly double the sales into the Canadian Party City locations and Canadian Tire over the term of the agreement.Canadian Tire will look to leverage this acquisition through their network of over 500 theaters, while expanding Party City's brand throughout Canada. With locations within a 15-minute drive of 90% of the Canadian population, Canadian Tire is truly uniquely positioned to grow the brand and the category. This transaction similar to our massive franchise relationships in Mexico, and our European and Australian store partnerships, aligns with our overall international strategy of identifying and partnering with strong domestic retailers to grow the party market, positioning ourselves as the primary resource for product and innovation. The proceeds of this transaction were approximately $174 million Canadian. Like those are the aforementioned sale leaseback transactions will serve to reduce our leverage levels.Finally, we believe this partnership with Canadian Tire is a huge endorsement of the Party City retail concept and the party supply category overall. Having one of Canada's premier retailers make this investment in the business and partnering with us in a long-term vendor relationship is an affirmation of our faith and belief in the long-term growth and viability of our position in the category.For full-year guidance has been adjusted to reflect the effects of both of these capital transactions with respect to revenues and earnings. As I stated during our last call, in addition to the strong cash flow generated by our business model, we are targeting a reduction of between $75 million and $100 million in networking capital year-over-year by 12/31/2019. We expect to see the majority of this reduction manifest as a fourth quarter. As we significantly reduce our fall seasonal inventory carry over.While the progress achieved in date to reduce all leverages quite significant. We can seem to be focused on exploring other long-term strategic opportunities, which will free up capital throughout the business and pay down debt. Currently, we are targeting to reduce our consolidated debt by approximately $400 million on a year-over-year basis, and hope to exceed that target. We continue to make progress regarding our ability to procure adequate quantities of helium to satisfy our consumers demand for this brand defining category.As I mentioned earlier, the expected shortages persisted, creating a second quarter headwind. More importantly, however, these headwinds are rapidly abating. During the second quarter, we entered into an agreement with a source to provide us with approximately 2 million cubic feet a month of helium over the next four years. This represents approximately 35% of our average monthly demand, and will provide a significant tailwind to our business in the second-half of the year. As we speak, helium from these wells is beginning to be distributed into our stores. This helium along with our existing allocations from our primary suppliers, and other third-party providers, are expected to put us north of 90% of our needs.Additionally, we have reached a tentative agreement with another provider, which is expected to come online in early October and would put us at over 100% of our requirements.As pleased as we are to be able to share this news, we are truly mindful that we must reach the face and trust of our consumers. The Party City is in stock on helium. And once again, the primary go to for all of these celebratory needs. I want to take this opportunity to thank and commend the members of our retail procurement management team who've done a terrific job of attacking the cyclical supply challenge.It is also important to recognize that the average cost of helium which is a commodity has continued to increase, while we have successfully put in place selective price increases which serve to partially mitigate these higher costs, we have and will continue to see an adverse effect upon our margins.During the second quarter, these higher helium costs represented a 50 basis point gross margin headwind and we reflected this in our full-year guide. As mentioned during the first quarter call, we conducted a comprehensive review of our store portfolio aimed at improving the overall productivity of the fleet our approach was to evaluate the opportunity to drive market level profitability improvement. This resulted in our decision to close approximately 45 stores over the course of 2019 where we believe there was an opportunity to recapture a substantial portion of the closed door sales as they transferred to other parts stores in those markets.As of July 31, we have fully closed and liquidated 34 stores. Another 10 are currently in liquidation mode and will be closed by the end of November. I'm pleased to report that initial results are indicating that the sales recapture rates are being achieved and the impact on stores during liquidation is less than anticipated. In addition, we have now decided to accelerate the closure of 10 stores originally slated for closure in 2020 into the fourth quarter of this year, so as to have a clean slate of new stores as a focus for our teams in 2019.During the quarter, we opened three new smaller format concept stores in several markets. These 7000 to 10,000 square foot test stores are designed to fill what we see as a void in smaller markets or markets with distinct characteristics such as college towns where we can offer unique curated and tailored assortments. These stores require approximately 30% less inventory and we are looking to achieve sales performance of 90 plus percent of what the largest store would provide. If successful this format will augment the whitespace opportunity while providing better inventory turns, greater sales per square foot, improved ROIC and most importantly free-up associates that have work time available to interact with our customers.During the quarter, we also continued to pilot several pricing initiatives using differing media strategies aimed at driving customer traffic. The results have been extremely encouraging and as we enter the Halloween selling season, you will see these strategies in our approach to media advertising around the season. We have spoken about the various tailwinds that we see in the second half of the year which we expect will help improve our comp store sales performance, perhaps not as more significant than our year-over-year in stock position heading into the Halloween season.As of July 31, 95% of our Halloween inventory requirements are either in stores in a warehouse or in transit. This is an overwhelming improvement not only from last year when we faced a tariff driven supply chain challenges but also when compared to any previous Halloween season. As a result, our full Halloween assortment will be in store and on the web by September 1st and we will be ready to capture the early sales in the season. Additionally, our store associates will be better able to serve our customers and not be overwhelmed by largely deliveries.This will be the case not only for our 943 stores but also for Halloween city pop-up stores. We are currently planning on opening 235 Halloween city stores towards for the season. This is an increase of 10% over last year. We are excited about our pop-up stores this year as we have made major changes to the store environment making it an even greater Halloween experience with expanded animatronics and other exciting additions to the in-store experience.In addition to improve the supply in our Halloween inventory availability, there are several other tailwinds as well for the back half of the year, starting with Halloween moving to Thursday. Historically as the holiday moves closer to the weekend, we have seen an increase in adult celebrations. We expect that to be the case this time around as well. From a juvenile practice, the intellectual property available this year is by far one of the strongest lineups we have seen. Beginning with frozen for which product first becomes available on October 4th. There was an amazing portfolio of licensed properties, Lion King, Cat the Marvel, Avengers, Spider Man, Toy Story 4, Aladdin, Descendants and many more. And that's just the movie properties.This year we'll also be offering a broad range of gaming inspired costumes and wearables from Ubisoft to Microsoft including Assassin's Creed, Years of War and Dragon Ball Super, Party City and Halloween City will be in stock and have something for everyone whether they choose to shop in our Party City Stores, Halloween City stores, partycity.com or in any of the marketplaces where you can find a party city store front including Amazon.During the second quarter, net third-party revenues on the North American products business excluding anagram and adjusted for the acquisition of stores grew 6.7%. For the six months adjusted revenues grew 5.6%. In addition to the growth of third-party revenues to this growth, the growth in third-party revenues grew and remain share of shelf also grew 10 bps to 27.3%. As most of you are aware growing our manufacturing share of shelf is important for several reasons. First obviously as we grow the manufacturing Share of shelf, we harvest the manufacturing margins along with wholesale profit and improved the consistent quality of our products.Equally important in these times of global trade tensions controlling our manufacturing allows us to continue to diversify our sourcing base into multiple geographies away from China. As a case in point, we have just concluded the final shipment of costumes from a new joint venture with one of our premier suppliers of costumes from our Cambodian factory.Reducing our dependence on China supply and diversification continues to be a core element of our strategy. On the subject of tariffs, our total annual purchases from China subject to the new 10% duties are approximately $150 million. As with the earlier tariffs, we will look to mitigate these tariffs through resourcing, self-manufacturing, better vendor prices and when necessary look to pass these increases on in the form of higher prices.For the second half of the year absent any mitigation efforts, we believe that the potential impact from these tariffs to be less than $2 million. The final but certainly not least important developments in the quarter was the addition of Brad Weston into our executive team as President of Party City Holdings and CEO of the Party City Retail Group. I'm extremely excited and pleased to have Brad join Party City Holdings in this significant leadership position.Brad's deep experience and knowledge especially retail, from his many years in key exact roles at both Petco and Dick's Sporting Goods uniquely positions him to lead our business. It's the next chapter of growth and success, Brad's initial focus will be primarily on the retail side of the business where he will develop and put into motion the processes and strategies which will drive sales growth and comp store performance. During this time, he will also begin to develop a broader understanding and knowledge of our consumer product operations and business to help shape those future strategies as well.I look forward to all of you getting to know Brad better as the next few quarters evolve. In summary, the second quarter was softer than we had anticipated both in terms of revenues as well as margins with much of the shortfalls being attributed to Helium. These factors have been incorporated in our adjusted full-year guidance. Looking forward to the second half of the year from a retail perspective, the helium headwinds are abating and this month helium availability should start to become a tailwind.We are closely reviewing our promotional accounting and strategies given the Halloween tailwinds which I mentioned earlier. We have made progress in many operational fronts and remain encouraged by the growth opportunities that we believe will present themselves later this year including greater availability of helium and extremely strong IP calendar, Thursday Halloween and benefits from supply chain investments that we made following the disruptions that impacted the business to 2018.And with that I'll turn the call over to Mike Correale who will provide further details around our financial results and our expectations for the balance of the year.
- Mike Correale:
- Thanks, Jim, and good morning everyone. I'll provide further insight into our financial and operating performance for the quarter, discuss our outlook and guidance for 2019 and then open-up the call for questions. As Jim said, our second quarter top and bottom line financial results were negatively impacted by the ongoing helium shortage and its direct and indirect effect on balloons and other products including our juvenile birthday product.Looking more closely at our second quarter results, consolidated total revenue grew 1.2% in constant currency. Retail segment net sales increased 2.9% on a reported basis or 3.2% in constant currency, principally driven by the additional square footage provided by 16 new store openings and 44 franchise and independent stores acquired over the last 12 months partially offset by nine store closures completed during the same period.Brands comparable sales which include our U.S. and Canadian permanent stores and North American e-commerce business decrease 1.2% in the quarter given by approximately 200 basis points of direct headwind from helium shortage. The tailwind from Easter shifting into the second quarter was more than offset, principally by the indirect effects of helium on juvenile product categories and declines a commodity product and candy sales.Looking at our sales by category during the quarter everyday product sales comp 4.1% lower than in 2018, and consistent with Jim's comment that the indirect impact of the helium shortage is felt in the categories usually shocked along with balloon purchases. Again, the declines occurred in juvenile non-solid commodity product in candy. It should also be noted that the 2018 results included approximately $3 million of revenues from the clearance event, which has been delayed this year until the third quarter.Seasonal product sales increased 9.1% versus comparable sales in 2018, driven by strong Easter and spring seasonal sales in early costume business. Our North American webcam sales including focus were up 14.7%. Turning to the non-vertical consumer products business, net revenues decrease 70 basis points after adjusting for the impact of franchise acquisition and foreign currency.As Jim mentioned, this decline was attributable to the impact of helium on our latex and metallic balloon businesses. In particular, our anagram metallic balloon business. Sales and metallic balloons at wholesale, which had enjoyed single-digit growth prior to the helium shortage were down approximately 17% as a result of the shortage. The adjusted net revenue of the North American party business excluding sales metallic balloons increased 6.7%. This increase in non-vertical consumer products occurred in multiple areas, including increase in accelerated orders from certain mass and grocery retailers, modest sales gains at franchisee and independent stores, and increase sales of personalized product for [indiscernible] operations.Our non-party store business continues to be a bright spot with double-digit growth achieved through strength in the mass and grocery channels. Despite the loss of sales arising from American Greetings, decided to exit the party category. We continue to leverage the breath of assortment and manufacturing capabilities to meet third-party independent customer's requirements in a cost-effective manner.International consumer product sales decreased 1.6% in constant currency, in line with our expectations. For the second quarter of 2019, retail and wholesale margins were 40.7% and 26.4%, respectively. Our consolidated gross profit margin was 37.1% or 390 basis points below the same quarter of last year. Consolidated margin was negatively impacted by approximately 200% -- 200 basis points of higher logistics costs associated with product imported during the second-half of 2018 blowing through both wholesale and retail costs of sales.As you recall, the higher costs were related to the supply disruption associated with China tariffs. In addition, 150 basis points of the decrease was due to retail markdowns and provisions against inventory, recorded in conjunction with our previously discussed store optimization programs, as well as a change in our personalization product offerings to improve our relevancy to the consumer.Lastly, margins -- the margin decline reflects a two-pronged impact from the temporary Halloween shortage, which results in both higher helium costs and a decrease in higher margin balloon sales at both wholesale and retail. Operating expenses excluding the gain on sale leaseback and store and impairment and restructuring charges totaled $166.5 million or 29.5% of revenue consistent with the second quarter of 2018.In terms of the sale leaseback as Jim described, during June, we completed the sale of three operating facilities and recorded a gain of $58 million in the quarter, which is backed out of our adjusted results. We use the net proceeds of the sale of $125 million to repay amounts of standing under our ABL at June 30.In July, half the proceeds withdrawn from the ABL to repay approximately $63 million of our term loan, the lease commitments from the sale leaseback requires annual rent payments of $8.3 million for the first year, increasing by 2% annually. As the lease associated with the Los Lunas, New Mexico property qualifies as a finance lease. The present value of the related lease payments of $13 million is classified as debt, resulting in a net reduction to our reported debt of $112 million.Income from operations totaled $97 million, excluding the $58 million benefit from the leaseback transaction, and $9 million of charges associated with store closures. Income from operations was approximately $48 million, compared to $65 million in the prior year period.Interest expense in the second quarter was $30.2 million or $4.7 million above the same quarter last year, with approximately half the increase attributable to higher labor rates on our ABL and term loan credit facilities and half as a result of the company's August 2018 high yield refinancing. In the quarter, our reported effective tax rate was 25%. And once adjusted increase to 26%.Reported net income total $48 million or $20 million greater than in the quarter second quarter of last year and reported diluted EPS increased to $0.51 per share from $0.29 cents per share. On an adjusted basis net increase, net income decreased to $20.2 million from $39.2 million in the quarter two 2018. Adjusted EPS decreased to $0.22 per share from $0.40 per share with $0.15 of this decline related to the revenue and margin factors previously discussed and the remainder of the change principally related to a higher interest rate.Adjusted EBITDA of $81 million, compared to adjusted EBITDA of $96.6 million in the second quarter of last year. During the quarter, we delivered free cash flow defined as adjusted EBITDA with CapEx of $62 million, which is approximately $8 million below second quarter of 2018. We ended the quarter with net debt of about $1.9 billion. It should be noted that the trade payables and the accrued expenses at 630 were $58 million below year-end 2018 and $29 million below the same period of last year. Despite much earlier receipt of our Halloween goods. We have approximately $296 million of borrowing capacity under our ABL credit agreement.Before reviewing our outlook, I'd like to go over a few recent developments that will impact the fiscal 2019 guidance. As discussed earlier, in June, we completed the sale leaseback transaction and use the net proceeds to pay down debt. While the impact on pre-tax income will be a headwind of approximately $3 million, as rent expense recognized on a straight-line basis exceeds the reduction in interest and depreciation and amortization. The full-year impact on adjusted EBITDA will be a negative $9 million or the full rent expense on the now lease facilities.As you also saw in a press release, in addition to the previously announced planned closure of approximately 45 Party City locations, we now plan to close 10 additional stores during the fourth quarter for a total of 55 store closures occurring throughout the year. And as Jim mentioned, we announced today that Canadian Tire transaction, which aligns with our international retail strategy, and will be a key driver of long-term wholesale growth in Canada. We expect to use approximately $120 million U.S. in proceeds to pay down debt in line with capital allocation priorities we have outlined.As a result of this transaction, we will see approximately $105 million reduction in retail sales on an annualized basis which will partially be offset in the form of third-party wholesale sales and profits. The net impact of this transaction is expected to reduce 2019 retail sales and adjusted EBITDA by approximately $39 million and $8 million, respectively.Turning to our full-year guidance, based on our performance to date, the sale leaseback transaction, the additional store closings, the Canadian Tire transaction, and an updated view of the direct and indirect impact of helium availability and costs on both our retail and Anagram business, we’ re revising our previously provided fiscal 2019 outlook. We are now expecting to be in the revenue range of $2.4 billion to $2.45 billion, and comp sales to be flat to down 1% versus last year. Excluding the impairment and restructuring charges related to store closures and sale leaseback transaction, we anticipate adjusted operating margin to be down approximately 100 basis points when compared to 2018 levels.We now expect full-year adjusted net income to be in the range of $118 million to $128 million, or $1.26 to $1.36 per share. We expect adjusted EBITDA to be in the range of $355 million to $370 million, and interest expense to be $115 million to $117 million for the year. In terms of capital allocation priorities, we continue to plan to spend about 2.8% of net revenues on CapEx, and anticipate ending the year with net debt at approximately four times adjusted EBITDA. For all other detail around our outlook, please refer to our press release.With that, I'd like to turn the call over to the operator and open it up for questions.
- Operator:
- [Operator Instructions] And your first question comes from the line of Seth Sigman with Credit Suisse. Please go ahead.
- Seth Sigman:
- Hey, guys, good morning. Thanks for taking the question. I wanted to just follow-up on the guidance here. So you lowered the full-year comp guidance from up 1% previously to flat to down 1% now I think. So implied back-half comps effectively down slightly to up 1%, which seems to be lower than you initially thought as well, yet you highlighted a number of tailwinds for the second-half of the year. So just wondering what changed for the second-half of the year relative to your expectations?
- Jim Harrison:
- Sure, Seth. So, the helium availability is a great story. It's happening a little slower than we had anticipated. And couple that with the extended impact on other categories, the juvenile, as I mentioned in my comments. We think that that impact other categories outside of balloons because of failure of that helium is about 100 to 200 basis points. And we're taking a conservative view with respect to our ability to get the consumer back in the mindset of thinking Party City first because of balloons. There's going to have to be an education process. We have plans in place to spread the word through media as we see various markets get back in stock 100% on helium, so -- but we've taken a bit of a conservative views as to the speed with which that can happen. So it's really the impact of helium. If you think about it in terms of the tail of the impact of helium on the business as we get back in stock, and get the consumer back in the mindset of Party City first because of our breath of assortment, including balloons.
- Seth Sigman:
- Okay, got it. And then just a follow-up question on the gross margin, I just want to better understand the impact from the higher freight costs related to the operational disruptions from last year. It sounds like, is it right that these costs were capitalized into inventory; they're now flowing through cogs as the inventory turns, and that's why you're seeing the impact? And if so, I'm just curious, what's incremental versus your expectations. And then how should we be thinking about that 200 basis point impact over the next few quarters?
- Jim Harrison:
- Okay. So the cost of freight actually gets capitalized in inventory. It also gets capitalized in the deferral between sales from wholesale to retail, so that concept is correct, it's capitalized. It is flowing through. We still have a little bit to go, but by the end of this quarter it should all flow through. I think it's important to note, Seth, that our original guide had that margin impact in it. We don't guide on margin. Margin was developed through the consensus. And we had attempted to communicate that, obviously, unsuccessfully. We knew this was going to happen. So if you look at the reconciliation of our EBITDA the 200 basis points from the flow through is not a reconciling item to the EBITDA guide, it's merely within the margin percent. We had anticipated it was in our EBITDA.
- Operator:
- And your next question comes from the line of Rick Nelson with Stephens. Please go ahead.
- Rick Nelson:
- Thanks. Good morning. Jim, can you update us on the helium supply agreement and when it began? And is there an opportunity here to capture the share when others are short of helium?
- Jim Harrison:
- Yes. So, I'm going to say this past week, give or take a couple of days, the most recent agreement we entered into began flowing tanks of liquid helium to transfer station primarily in the Florida, Georgia, and Houston markets. And so that's flowing as we speak. We are seeing substantial improvement in the in-stock position of helium in those markets. And we would anticipate that by the middle of August, give or take, somewhere between the 15th and the 20th, we should be in a position to actually broadcast to the broader markets -- within those markets broadcast widely that Party City is the place to come for balloons with helium. And you are absolutely correct, Rick, that this should represent an opportunity for us to have an advantage over the competition. Obviously, through the Anagram results, we see that helium is not unique to Party City. And being in the position as we expect to be by the middle of October of being close to 100% stock on helium should be a tailwind for us. But like I said to Seth earlier, it's a matter of, one, getting that message out, and then reestablishing our relationship with the consumer as being the place to go for everything for parties.
- Rick Nelson:
- Okay, got you. Thanks for that color. Also, like to ask you about the tariffs. You talked about the impact in 2019. Does that incorporate the list for tariff exposure, and how you might see that impacting 2020 as that flows through inventory and the cog?
- Jim Harrison:
- Okay, so with respect to that -- yes, there's two parts to that. So with respect to the absolute impact on earnings for 2019, as I mentioned earlier, we modeled out to be under $2 million. Your point is well taken that there will be some tariff impact that ends up being deferred in 2019, and to flow through in 2020. That number would be probably somewhere in the neighborhood of $3 million give or take. We have every expectation that we will aggressively address the impact of this 10% tariff, similar to what we did earlier with the 10%, and then subsequently 25%, where we've substantially mitigated it. It's going to be more challenging. I think it would be foolish to think that we could address it as effectively and as quickly as we did in 2018 and 2019 in terms of the first couple of tranches.But we have been actively looking to resource out of many geographies and will continue to do so. There are opportunities, we believe, for us to resource. There's opportunities now when some of our core manufacturing categories which had not been affected by the duties earlier on, things such as napkins and plates, where we now have the opportunity, we believe, to have a distinct advantage in the U.S. marketplace with folks who have been historically sourcing those products from China. Also, to the extent that we have China competition in metallic balloons, we see that as an opportunity. And from are resourcing or probably from a vendor negotiating standpoint, clearly although the Chinese have stabilized their currency there are certain elements of our vendors' course that is denominated in RMB, labor, overheads.While they source most of their materials in U.S. dollars, there is still an element of their cost that is denominated in RMB, and we expect to receive price adjustments from our vendors with respect to the movements in the currency. And I mentioned, our last resort is looking at pricing. I mean we do have a huge advantage in that we have an AUR of $2, so our price points are nominal. And to whatever extent we are affected by tariffs, so too are our competitors both on the wholesale as well as on the retail side. So we believe that we've got the leverage within our business and the leverage within the market place for us to successfully address this headwind and manage down the exposure
- Operator:
- And your next question comes from the line of Marc Regenbaum with Neuberger Berman. Please go ahead.
- Marc Regenbaum:
- Hey, Jim; hey, Mike. My question relates to the Canadian tire announcement. The strategic rationale sounds compelling and the value unlock seems pretty straight forward. That said, my question is, can you provide us with the dollar amount of wholesale sales the Company does to Canadian party city stores are approximately?
- Mike Correale:
- Sure, currently on an annualized basis it's a little bit above -- in Canadian dollars, a little bit about $50 million a year.
- Marc Regenbaum:
- Got it. So it's fair to say, if my math is correct, that you have a goal that you said in the press release to double those sales over a period of 10-years, we're talking about a potentially $1 billion CAD wholesale revenue deal for the full time frame in addition to the cash proceeds, am I understanding that correctly?
- Mike Correale:
- You're in the ballpark, absolutely. And we would expect that that incremental revenue would substantially replace - provide us the opportunity to substantially replace a good portion of the EBITDA which we sold in this transaction.
- Marc Regenbaum:
- Great. And I guess - that sounds great. And as a follow-up, Jim, are there other markets where you think you can pursue a similar sort of asset light approach?
- Jim Harrison:
- Yes. That's a -- thank you for that question, as I've said, when we look at the retail market place outside the U.S., I think having us focus on the U.S. market is important for our long-term strategy - important part of our long-term strategy and important for our overall success. Clearly, the U.S. market is the most developed market for this category by far for lots of reasons, some of which are cultural, some of which of course the real estate, some of which is just the availability of a product itself. And I think having us focus our efforts in terms of our retail, pure retail business here in the U.S. and then partly with people in geographies like we've done in Australia with Big W, what we've done with Morrisons in the U.K. or our master franchisee in New Mexico, I think gives us the ability to leverage up our retail knowledge through that partnership while allowing the local retailer to build the brand with their expertise in the marketplace, allow us to keep our capital dry powder, invest in a consumer products businesses and other associated parts of the business.And while they build out the brick and mortar or the infrastructures for those markets, I think as we think about it, we think Latin America over the long-term is clearly an ideal market for us to develop these sorts of relationships. And I think to the extent that we can do that. It should bode well. I think e-commerce - we view e-commerce a little differently. We, as you know, we have an e-commerce business in Europe and in the U.K. With e-commerce on a B2C basis has a lot of merit, but in terms of brick and mortar and physical presence and heavy investment in stores and heavy investment in the geography, it's better served by a good premium partner that we can partner with and supply products through.
- Operator:
- And your next question comes from the line of Karru Martinson with Jefferies. Please go ahead.
- Karru Martinson:
- Good morning. So to get to the 4x leverage target that you have for the end of the year, it's another turn off here. Can you kind of breakdown the combination of asset sales and free cash flow that's going to get you there?
- Mike Correale:
- Sure. So there's some moving parts crew in terms of the ultimate disposition of taxes and the ultimate open resolution of what the tax exposures are. So it was around a little bit, but there are -- there is the free cash flow from operations, which is somewhere in the neighborhood of $150 million, which money will pay down the debt. Then there is about $100 million from the - $75 million of working capital. And then from the sale leaseback in the Canadian tire transactions, probably both is somewhere in the neighborhood of probably $58 million on sale leaseback, that's a gain. The $100 million of sale leaseback and then about $100 million on the Canadian tire transaction, however, the taxes on that will be a bit higher because we have to write off goodwill in the transaction, which will give us the cash but it increases the amount of -- it's not tax deductible. So the gain on that will actually be taxable but higher rate. Those are the big elements. And then the other side of it is our accounts payable will be substantially lower at year end. So I think if we look at our total indebtedness, I mentioned in my comments, we think we'll generate roughly $400 million of cash to pay down debt.
- Karru Martinson:
- Okay. And when we look at the guidance, you can look at the $50 million kind of reduction here at the low point here. We know that it's coming from the rent increase and in the step up from the - sorry, the disposition of the Canadian business. Is the right way to think about it is that the rest of that really is coming from those freight costs that are capitalized gross margin challenges in the helium?
- Jim Harrison:
- No, I'm sorry. Our original guidance the freight cost in it. It's in the consensus on the margin that we tried to communicate to get adjusted that didn't get adjusted, to be public handed. The movements on EBITDA are essentially -- there's essentially four big components, the Canadian tire transactions in this in U.S. dollars, it's about $8 million against our previous guide, the movement in comp is about $16 million from our original guide, the impact of helium and anagram which was not on our list guide, because we really hadn't begun to see the impact on the anagram business. Of course, most of the problems had been isolated to the U.S, but it's been more contingent to Europe as well as other parts of the U.S. market. So the impact on the anagram business is about $13 million. And then the sale leaseback is $5 million. Those are the large components of the movement. That is up to like $43 million of the $50 million I think.
- Karru Martinson:
- Okay. And then just lastly on e-commerce, it's been an area that folks have talked about saying that as you close stores you continue to grow that channel. What are you seeing there on the competitive front for you guys?
- Jim Harrison:
- Well, we -- as I believe, you know, most of the players in e-commerce space are customers of ours. We hold license rights on party goods as well as obviously -- our balloon category and [indiscernible] generally. We've seen that business remain relatively stable growing in low single digits. The challenge for us is as we talk about our e-commerce business from a GAAP standpoint, both this is considered a brick and mortar sale. From a logical standpoint, both this is really a digital sale. So when we give our e-commerce results, we include both in there with digital standpoint, because the sale initiates on the web. And I think that's one of the huge advantages that we have over other e-commerce players, because in our category, we believe that our shoppers are going to call "Mom" right now. Mom likes to have the certitude around having her party goods in her hands and make sure she has everything she needs day or two in advance of the party. So she enjoys the convenience of shopping online, having the ability to physically garner the product and have it in her possession and make sure she has everything she needs in advance of the party. There's a huge advantage of party, city has over I believe anybody else in the category on e-commerce. And as you know, we're on the marketplace. We're on Amazon marketplace, the world's number 1 marketplace. So we have visibility to performance of our category there as well.
- Operator:
- Your next question comes from the line of Simeon Gutman with Morgan Stanley. Please go ahead.
- Simeon Gutman:
- Thanks, good morning. A quick question on tariffs, the first round of tariffs, Jim, were there any price increases that you had to make at the -- to the end user, and then are you seeing any price increases across the category, from any competitors?
- Jim Harrison:
- So with respect to tariffs, as it affected our wholesale business, we did have some price increases, I believe the total amount of price increases, we've seen at retail are probably somewhere in the neighborhood of $3 million to $4 million in total for the whole year. So we've been able to mitigate most of that. On our American business that we increased our pricing in the mid to low single digits, primarily associated with tariffs and some other increased cost. So in terms of our business both from the vertical as well as retail, as it relates to the vertical, most of the impact has been mooted from other third parties, suppliers, to Party City, then the impact has not been that great either. Most folks were able to either pass along, get concessions from vendors resource or redesign.
- Simeon Gutman:
- Got it. Yes, I'm trying to assess in the next round, if you have to raise prices. If your hypothesis is right that, you know, the low AUR should be -- should help consumers absorb it a little bit better because the end result shouldn't be that terrible, didn't know if you have any evidence of that thus far.
- Jim Harrison:
- No, we have -- we have not raised prices for this next round rates on our products, right, so the next round of products. There's it is -- it's more difficult, as I said earlier with Rick, it's more difficult to do because it's generally a product that has a lot more hand labor in it, and therefore more difficult to just resource automatically outside of China, coupled with labor availability and supply. That being said, that then ties back to my earlier comments that those are costs that are associated with and denominator RMB. So we would expect to get some significant relief on the price increases at vendor level. And I think it's important to remember, if we're talking about something that we buy for $0.50 cents, which ultimately becomes close to a $2 retail, I guess we just Keystone things. 10% tariff increases $0.5 on that item. And if we get $0.2 or $0.3 relief on that item, we pretty much mooted the entire product problem.
- Simeon Gutman:
- Right. Can I ask you about Q3 comps, I guess I don't care about the comp to date, as much as the traffic trends? We just heard from a couple of companies that their July business looked a little different from their June business, trying to put our finger on why and any thoughts if you can talk about what you've seen so far?
- Jim Harrison:
- We don't -- as you know, we don't give guide for -- we don't give guide by quarter on top. We don't guide quarters. July was a bit more challenging than it had been seen in June. Not to the point where it's dramatic, but it has been more challenging. Whether that's the timing of the holiday, or just the consumer in general, it's hard to say right now. But July also, but you should bear in mind July is a very, very soft month for us. And when I say soft, I mean in terms of our aggregate sales for the whole year. It's a pretty light month; our business starts to crank up the second-half this month and into September and October, November, December. That's what my businesses is most significant. And as I said, we've got some fairly meaningful and sizable tailwind. I believe we have time for one more question operator?
- Operator:
- And your final question comes from the line of Joseph Feldman with Telsey Advisory Group. Please go ahead.
- Joseph Feldman:
- Hi, guys. Thanks for taking my question. I apologize for my voice. Excuse me. Can you talk about on the leverage ratio with about $400 million of debt pay down? Why wouldn't you guys be a little below four times the end of the year?
- Jim Harrison:
- Yes, based upon the current guide, you're exactly right Joe.
- Joseph Feldman:
- Okay, thanks. And then the other thing I was curious about, can you kind of provide the same type of bridge you did for EBITDA, but do it for sales? I just wanted to get a little bit of clarity on like, how much sales is getting removed?
- Jim Harrison:
- Sure. Sure. I'll give Mike that.
- Mike Correale:
- Yes, that so. So the primary components when it comes to sales, is the Canadian Tire transaction. As I said earlier, it's $39 million. Actually in the reconciliation is net to $32 million, because there are a lot of wholesale sales previously into companies and now become third-party. So you got $32 million for the Canadian Tire transaction, you've got the 1% comp becoming flat to down 1%. That's a $32 million movement. And then you've got anagram and anagram although sales is -- sales ultimately have been forecasted from our previous guidance down $15 million. Those are the three major components.
- Joseph Feldman:
- Got it? Thank you. And then just one final one, can you talk about where we are with the party planner and the kind of lift, you're seeing from that? And I may have missed it, if you said it earlier, but like how many you have now, I think it was 150 as of last quarter?
- Jim Harrison:
- Right. It's roughly still the same. The party planner has been a successful experiment from the standpoint that we know, when we interact with our customer. And we know when we provide customer service, we can and we will build the basket. I'm going to introduce Mr. Brad Weston, because he is -- Brad is a terrific experience as a merchant. And terrific has great track record of building comp sales and building and building traffic. I'm going to ask him to talk a little bit about the party planner program, from a little bit different perspective, thinking about it more globally in terms of our full organization being sales conscious and customer centric.
- Brad Weston:
- Thanks, Jim. As I've looked at our business, prior to joining in now in the 80s [ph] that I've been with the company, clearly our biggest opportunity is to drive customer-centric mindset. Throughout our business, obviously, it starts with how we curate assortments includes how we merchandise our stores, and then most importantly, how we engage the customer in our store. And I can tell you, I'm already focused on how we raise the average order value in our stores and online as we serve as party co-host for consumers who need solutions in party components that we provide. As I look at the party planner, strategy, I think it's right on, it's 150 stores today, I think we can continue, as I gain additional understanding and apply some additional strategy work to that party planner program, we will continue to roll it out and build it as a strength of our in-store experience.
- Operator:
- And I would now like to turn it back over to management for closing remarks.
- Jim Harrison:
- Thank you, Operator. Once again, everybody, we apologize for the technical difficulties that led to the delay. But as always, thank you for your interest and support in the business and we look forward to speaking with you later on one-on-one or whenever you want. As you know, my phone is always open and you should feel free to reach out to me if you have any questions to Mike, and have a great day. Thank you all very much.
- Operator:
- Ladies and gentlemen, thank you for participating in today's Party City Q2 2019 earning call. This does conclude today's conference call. You may now disconnect.
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