Party City Holdco Inc.
Q3 2017 Earnings Call Transcript

Published: 13 Nov 2017

[Operator:]

Good morning. My name is Leandra, and I will be your conference operator today. I would like to welcome everyone to the Party City’s Third Quarter 2017 Earnings Conference Call. [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 third quarter 2017 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; Dan Sullivan, Chief Financial Officer; Gregg Melnick, President; Ryan Vero, President of our Retail division; and Mike Correale, Chief Accounting Officer. We’ll start 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, 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. I’ll begin by providing an overview of the company’s performance for the third quarter as well as an update of the progress made against our strategic growth initiatives and Halloween. Dan will then discuss financial and operational results in further detail as well as provide an updated view on our full year guidance. Bottom line performance in the third quarter once again demonstrated the counterbalancing benefits we see from our vertical model. We experienced softer than expected retail sales, directly resulting from the effects of the hurricanes as well as an ecommerce site issue that I will address in more detail shortly. Continued gross margin expansion driven by the vertical model and disciplined cost control, coupled with modest top line growth, resulted in adjusted EPS growth of over 8%, in line with our expectations. Even more importantly for the longer term health of the business, we made good progress on our strategic growth initiatives, improving the shopability and in store experience for our customers, further positioning the consumer products businesses for accelerated growth in both the alternative markets channel as well as in key financial markets and the harvesting of synergies and integrating previously announced acquisitions around the globe, all of which provide diversified source of revenue growth, while strengthening our vertical model. Before discussing the business highlights of the quarter, I would like to take a moment to offer a special thanks to Ryan Vero and his team of incredibly loyal and dedicated associates, and in particular, Marc Ehle, our EVP of Operations, and John Voytilla, the SVP of Loss Prevention Facilities. Their hard work ensure that stores were properly prepared for the storms and that we were up and running as soon as possible after the storms. Also, we’d like to express our gratitude and thanks for the safety and well-being of all of our associates and their families in the affected areas. Turning to results. Consolidated revenue for the third quarter was positive on a constant currency basis and up 2%, excluding the impact of the hurricanes. Retail operations posted a 4.5% net sales increase in constant currency, with approximately 1% comp decline when excluding the impact of the hurricanes. The softer retail comp was largely driven by a $2 million decrease in the North American e-commerce sales on a pro forma basis. This disappointing rev result for the quarter was their product of an SCO performance issue, which we will later identify but have made significant progress in remedying. Early in the year, Google had modified their search engine algorithm. The result of this modification in the algorithm, which determines the company’s SCO ranking in user search results, led to a significant decline in our search rankings. As a result, visit to store’s e-commerce site during the third quarter declined by approximately 9%, after growing almost 3% for the first six months of the year. In response, we engaged external resources to help provide the necessary expertise in the development and execution of a mitigation plan. Traffic did stabilize later in the month of October, and rankings across the domain and in key categories began to bounce back as we made structural changes to our web platform. We have also implemented an enhanced SCO monitoring and improved linking content quality. More broadly, as you know, we’ve been focused on improving the platform functionality and responsiveness, particularly on our mobile site. This work is ongoing and will continue into early 2018. The challenges we experienced this quarter in the web business reinforced the importance of strengthening the overall platform and improving digital capabilities, which we’ll continue to do so with great urgency. Turning to the consumer products businesses, net revenue declined just over 1% after adjusting for the impact of franchise acquisitions and foreign exchange. And this was largely the result of continued softness in the franchise and independent channels, in part, due to the high levels of carryover Halloween inventory from last year. We view this primarily as a timing issue and remain excited about the multiple levers for sustained top line growth in these businesses. In the quarter, we focused against two primary growth objectives

[Dan Sullivan:]

Thanks, Jim, and good morning, everyone. I’ll provide further insight into our financial and operating performance for the quarter and for Halloween before discussing our outlook and guidance for 2017. In the quarter, we delivered on our core financial fundamentals of gross margin enhancement, focused cost control and strong cash flow generation. As you heard Jim mention, bottom line financial results for the quarter were largely in line with expectations as strong gross margin gains and continued cost discipline, particularly in store labor, helped to mitigate the impact of modest top line growth, which was due, in part, to the negative impact of the hurricanes. Free cash flow generation was almost 11% in the quarter, and adjusted diluted earnings per share was $0.13 or an increase of 8%, as approximately $0.02 of hurricane and FX headwind was partially offset by tax rate favorability. Consolidated revenue grew 60 basis points on a reported level or 30 basis points when adjusted for currency. Comparable sales, net of 140 basis points of hurricane-related headwind, were down about 1%. The hurricanes negatively impacted our top line by about $5 million during the quarter, as they affected over 180 permanent stores or roughly 23% of the fleet, as well as 27 Halloween City stores. Adjusting for this $5 million headwind, consolidated revenue increased approximately 2% to $565.2 million. Retail segment sales increased 4.7% on a reported basis or 4.5% in constant currency, largely a result of a 10% increase in retail square footage over the last 12 months, primarily from franchise acquisitions and new store growth. At quarter’s end, our store network totaled 942 stores, 794 of which were corporate stores. During the quarter, we opened six and closed one company owned store. We continue to focus on optimizing the existing fleet and completed 34 relocations in Q3. As mentioned, our brand comparable sales, adjusted for the impact of the hurricanes, declined about 1% in the quarter, driven almost entirely by our web business and the impact the SCO issue had on site visits, as Jim already discussed. Permanent store comp sales were down slightly on an adjusted basis, which is consistent with recent results. The everyday business was also flat, while cycling a 3.5% growth in Q3 of last year, and these results represented 100 basis point improvement from our Q2 trends. Summer, patriotic and graduation seasonal businesses also performed well. Fiscal October revenue grew 5.5% year-over-year through retail revenue growth of 4% and wholesale revenue growth of 20%. Comp sales for the month were minus 1.4%, which was slightly below expectations. Permanent store comp sales were slightly down and broadly in line with our expectations. The stores were well prepared, in-stock positions were solid and improved use of technology and enhanced labor in the stores ensured solid execution across the month. Everyday comp sales were up 2.5% in October, while cycling a 4% comp growth performance last October, driven by improved merchandising and more effective promotional spend. Although traffic level stabilized over the course of the month of October, our web business continued to struggle with traffic as a result of the search engine issues discussed earlier, although we did see improvement as the month went on. We’ll provide further insight on our Halloween performance during our Q4 earnings call. The performance across our permanent stores is a strong reminder of the importance of the effort we’re taking to improve store productivity and overall shopability, and our pilot results remain encouraging. In support of improving store productivity, we have piloted over 20 in store operational initiatives designed to change the work, simplify store operations, improve labor scheduling and help our associates run better stores. As Jim indicated, we’re pleased with the results and look to complete the full roll-out of these initiatives across our store base over the next 60 days. Improved store operations and labor productivity will then become the catalyst to redeploy and fund labor in support of improving the overall in-store experience and driving sustainable basket growth through consultative selling activities. The initial five store pilot has provided encouraging results with improved comp trends, stronger basket performance and positive feedback from both customers and associates. We are now expanding the pilot to over 50 additional stores and expect to continue deploying on an accelerated cadence throughout 2018. Turning to the non-vertical consumer products businesses. After adjusting for foreign currency and the elimination of $9.8 million in sales due to the acquisition of 36 franchise stores since October of last year, total revenues decreased 1.6%, largely a result of the sluggish environment in both the franchise and independent channels, in part, due to the high levels of carryover inventory at stores from last year’s Halloween. International sales increased 5.2% on a constant currency basis, which was in line with our expectations and was driven by a combination of solid organic growth across our key markets as well as the recently announced Granmark acquisition in Mexico. We were again pleased with the solid growth delivered in the UK and broader European markets, and this was partially offset by the impact of cycling last year’s initial launch of the Halloween program with BIG W in Australia. In these core markets, we’ve seen the expansion of our store-in-store concept and broader acceptance of the category by consumers. The breadth of our product offering and category management leadership role continues to serve us well, and we still anticipate double-digit constant currency growth for the full year 2017 and beyond. Consolidated gross profit margin was 35.9% or 40 basis points above the same quarter last year, driven by continued leveraging of the vertical model. Gross margin expansion is a core component of our business model and a clear point of differentiation, and the Q3 results are a reminder of the meaningful margin growth opportunities that remain in this business. The catalyst for margin growth are twofold

[Jim Harrison:]

Thank you, Dan. Overall, I’m pleased with the progress we’re making against all of these various strategic growth initiatives. As you heard Dan say, guidance for 2017 remains strong, with about 4% top line growth, 5% EBITDA growth and approximately 7% EPS growth. It is with this as a backdrop, I am pleased to announce that our Board of Directors has approved a $100 million share repurchase program in support of the strong business outlook. The business generated substantial consistent free cash flow. This affords us the opportunity to reinvest in the business, actively pursue accretive acquisitions, pay down debt and return cash to shareholders. This authorization gives us the flexibility to make opportunistic share repurchases and take advantage of what we feel is a depressed share price. We will continue to allocate capital in a balanced and disciplined manner to drive shareholder returns. Going forward, our efforts have positioned us well to continue to harvest multiple levers of revenue growth opportunities, deliver meaningful gross margin gains, generate healthy free cash flow and continue to grow EBITDA and EPS. These are all core features of our business model. While we will discuss 2018 in more detail in our Q4 earnings call, we remain confident in this business’ ability to generate positive comp sales growth and more importantly, mid-single digit EBITDA growth and high single-digit EPS growth well into 2018 and beyond. And with that, I’d like to turn the call over back to the operator for questions.

[Operator:]

[Operator Instructions] And our first question comes from the line of Simeon Gutman with Morgan Stanley. Your line is open.

[Simeon Gutman:]

My first question is related to the fourth quarter. The guide is a little bit, I guess, weaker than initially. And I guess I wanted to understand the direct source, is it some of the website issues around Halloween? Just why is the -- why was the shortfall relative to expectations?

[Dan Sullivan:]

So I think the Halloween performance, obviously, is the first thing which we’ve talked about and that was, in large part, due to the web issues Jim explained. When we look at the quarter holistically, I think you’ve got to look at it more on a run-rate basis because you have the New Year’s Eve impact factoring into the quarter, which we’ve talked about on a few occasions. And so we still think November and December will be positive months for us in terms of comp performance. And the overall quarter, again, on an adjusted basis, stripping out the New Year’s Eve effect, will be flat to slightly positive.

[Simeon Gutman:]

And then stepping back, right, there was a lot of noise in the beginning of this quarter, I think it was Amazon running aggressive custom promotions, just thinking about how Halloween is progressing in general, are you pleased with the performance? Is it becoming an increasingly competitive period? And you think the businesses is as equipped as it’s ever been to deal with these threats?

[Jim Harrison:]

So there are similar question there. So let’s start with the competitive nature of Halloween. We definitely saw more competition in Halloween this year. Bearing in mind, we’ve moved from a Monday to a Tuesday, so we saw the midweek effect. So the pie itself gets smaller. As I’ve said many times before, the part of our business that is most susceptible to online competition from Amazon and others is costumes in a bag, and we saw a price competition with costumes in a bag, which we responded to. We’re also looking at our assortment and making sure that we have proper pricing for opening price points, so that we can make a very competitive and compelling offer when we face that type of competition. With respect to the brick-and-mortar stores, our biggest competitor there, as you know, is a pop-up, Spirit. And Spirit opened approximately three or more stores this year, I believe. And more importantly, they had a number of stores closer to our stores this year. And I’m really pleased with the performance of our brick-and-mortar stores, really, based upon the Tuesday and as well as the competition.

[Operator:]

Your next question comes from the line of Seth Sigman with Credit Suisse.

[Seth Sigman:]

I wanted to follow up on the website issues in the quarter. Can you just help us better understand when those issues actually started? And then where are you today in addressing it? And then in general as you think about allocating capital to online and omnichannel investments, does it change your view on that at all?

[Jim Harrison:]

I’ll answer the second part of the question first, then I’ll turn it over to Ryan to give you more color on the actual issues. We have -- we’ve planned on investing heavily in our platform, both upgrading our mobile site as well as our desktop site. We feel that -- we continue to feel that e-commerce is an important part of our future. I do would -- I would like to frame it a little bit. When we talked about our e-commerce issues, I’d like to just mention that one -- the decline in e-commerce for the third quarter in terms of absolute dollars was roughly $2 million. And the effect on Halloween was about $1.2 million. So these are not really big numbers. We just think that it’s important to mention it since we’ve had such great growth in our e-commerce site, we wanted to explain what happened this quarter. With that, I’ll turn it over to Ryan to explain the issues.

[Ryan Vero:]

Yes. So the issues really began from some changes that were made to the search algorithms, primarily on Google, earlier in the spring of the year. Those changes didn’t -- we didn’t really start seeing the traffic impact associated with those changes until later in the summer. Without getting into too much detail, just based on timing of some of the words that were changing our rankings on, we really took two actions in the short run. One was to put in some new monitoring reporting tools that allow us to see these changes to our rankings before they start impacting our sales. Those were tools we just didn’t have in place at the time. The second thing is we made a number of technical changes to our web pages to improve rankings. This is an ongoing moving target with the way the search engines rank sites. And you have to really stay on top of that in terms of how you’re structuring pages, the quality of your content and links and so forth. So we made a number of technical design changes, some content changes on the site to really impact how those algorithms are now ranking sites. And as Jim mentioned, we have been working on, for most of the year, the replatforming of our desktop site, which is also going to allow us to go to a responsive platform, which means essentially our mobile and desktop sites share the same core site functionality and design, which is also a big step forward for us. And we anticipate that being completed in the medium term, in the next 90 or so days.

[Seth Sigman:]

Okay, and then Dan, from a CapEx perspective, as you think about next year, is there any reason to believe that spending should change just between these online investments and some of the retail initiatives you guys have talked about?

[Dan Sullivan:]

No. I think -- so the overall CapEx view we have, call it, 3%, 3.5% of revenue is still the proper guide. Obviously, that shifts a bit between store spend, warehouse, maintenance cap and IT. So the initiatives Ryan has been discussing were already in our operational plans for ‘17 and in our long-term plans beyond, so it’s no issue there.

[Operator:]

Your next question comes from the line of Rick Nelson with Stephens.

[Rick Nelson:]

I’d like to ask you about your commentary on the comps, you were tracking negative through the third quarter as well as October. Your commentary suggests that November, December would turn positive. I’m curious what you see as the drivers there?

[Jim Harrison:]

I think what we’re seeing Rick is that our stores are continuing to perform quite well. It’s interesting during the Halloween season, there were a number of surveys conducted asking consumers where they were going to go shop for their Halloween goods. And 60% to 65% to 75% indicated that they intended to shop at brick-and-mortar in-stores. They also indicated that they would use the web primarily for inspiration, 38%, while only 22% indicated that they intended to shop for their Halloween goods on the web. So I think we still see a very active and robust consumer, who likes the experience of shopping for their party goods and their Halloween goods in brick-and-mortar stores, and I think that speaks very well for our business. When we look at our business in the fourth quarter, we’re looking at roughly -- our everyday business being quite strong. It was down 1% in Q2 and we’re up 2.5% in Q3, and we’re also up over 2% everyday business in the month of Halloween. So it’s really our everyday business that’s really driving the comp, which is really our bread-and-butter in our core. So I think there’s a lot of good news in our stores and a lot of good things going on, fundamentally, in the party category.

[Rick Nelson:]

And so I’d assume that the web challenges [Indiscernible] would push into these final two months or is it well over in that time horizon?

[Jim Harrison:]

Yes, Rick, it does. I mean, fundamentally, we remediated the bulk of the problems, and what we’re doing now is really looking to the next chapter of the development of our ecommerce strategy and our capabilities at both the desktop and our mobile.

[Rick Nelson:]

And if I could ask you about the manufacturing shelf, you mentioned that 24% this quarter, up 300 basis points year-over-year. That, I think, last quarter you mentioned that was 25% of your share of shelf. I’m curious about the sequential decline?

[Dan Sullivan:]

Yes, Rick, it’s difficult to look at share of shelf on a trend basis because seasonality plays a big role and product mix plays a big role. So you really have to look at it at discrete moments in time year-over-year. What we were really excited about in Q3 is not only did we grow overall share of shelf, but we grew manufactured share of shelf 300 basis points. And you saw that come through in three really important areas

[Rick Nelson:]

Great. Any targets for next year at this time?

[Dan Sullivan:]

No. It’s too early for us to give specific targets for next year, but we’ll certainly do that in our Q4 call.

[Operator:]

Your next question comes from the line of Matt McClintock with Barclays. Your line is open.

[Matt McClintock:]

A couple of questions. The first one just on alternative markets and international. It sounds like the sales team is optimized and in place. When can we start to see a real acceleration in those businesses? Is that something that would happen in the next couple of quarters or over the course of next year? How do we think about those businesses?

[Jim Harrison:]

I’ll talk about marketing, Gregg can talk about international. With respect to the alternative markets, as you’ve highlighted, we’ve made some very important structural changes in our selling organization and added some additional selling resources. I like to describe our alternative markets business as really having three pieces to it, right? The ability to manufacture, the ability to source, the ability to distribute, the ability to design and then, finally, the ability to sell. And the last part of that still, the selling organization, is really the part that has been underdeveloped for us because our focus has been the party specialty store. So as we’ve now developed those resources, we would expect to see some meaningful improvements and growth, not that we’ve had any growth, but more accelerated growth in alternative markets over the next 12 to 18 months. And I’ll turn it now to Gregg to talk about international.

[Gregg Melnick:]

Great. Matt, I think from an international perspective, we’ve been experiencing low to mid-double-digit growth within the various markets around the world organically. And now adding on acquisitive growth with Granmark, it really provides us continued foundation for us to grow those businesses. What’s going on in the international markets is kind of a twofold strategy. One, we’re bringing in additional products for existing customers to be able to grow their footprint on party as the category begins to really take foot. But we also still have a lot of runway for new accounts, and so you’re getting a real leveraging of the growth opportunity, both from new accounts, acquisitions as well as, as base grows, category grows. And so we would expect that to continue really in the coming years.

[Matt McClintock:]

Okay. And then just the initiative to improve store experience. I think, if I recall correctly, you said that you’re rolling the pilot out to 50 additional stores. I guess that’s in the near term. When could we potentially see those initiatives rolled out to the entire chain?

[Ryan Vero:]

So we began this pilot in roughly five stores prior to the Halloween season. We began recruiting additional selling resources to really launch post-Halloween in 50 stores. We’re in a real test and learn mode right now on this program, we want to make sure that we have the right tools, the right folks doing the selling, the right engagement model with our consumers. And as we see that success be able to be consistently executed in our stores, we’ll continue to roll it out through the course of next year.

[Operator:]

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

[Tami Zakaria:]

So my first question is, we’ve seen some spike in resin prices this year, especially after the hurricanes. How do you expect that to impact your margin or pricing, if at all?

[Jim Harrison:]

Historically, we’ve been able -- where there has been a dramatic change in a commodity cost, we’ve been able to pass that along through our pricing, both at the wholesale as well as retail level because everyone is affected by that. To date, we’ve not seen a dramatic impact on our cost as a result of changes in resin. Part of that is due to the levels of inventory as well as contracts we have in place. Resin, paper, those commodity costs that we’re familiar with dealing with and historically, we’ve been able to manage them quite well.

[Tami Zakaria:]

And my second question is, could you remind us how much of your business is costumes or about costumes?

[Dan Sullivan:]

So costumes, you have to be careful a bit because you get into definitions of costumes, juvenile costumes, adults, it gets hard. But I think if you use the proxy of roughly 40% of our Halloween business is costume, that’s a fair estimate.

[Operator:]

Your next question comes from the line of Adam Sindler with Deutsche Bank. Your line is open.

[Mike Baker:]

It’s actually Mike Baker. So I think if these numbers are right, did you say that the e-commerce issue hurt October by $2 million? And if that’s the case, that’s about 40 basis points, I think. Yet, October is down closer to 140. So what’s the rest of the weakness? I guess I’m just trying to figure out how much of your comp declines are because of this e-commerce issue and how much is other, whether it be more competition or just general weakness?

[Dan Sullivan:]

So Mike, I think, important, the numbers Jim quoted was essentially getting e-commerce back to a flat year-over-year performance. He was just quantifying the impact of the decline in the web. Obviously, we’ve seen growth in the web coming into Q3 into Halloween. So that’s one piece, just to clear up the math. Our store base was slightly down year-over-year, and that’s a combination of U.S. and Canadian stores, which is an improvement in performance from what we saw in Q2, but that will be the remainder of the gap.

[Mike Baker:]

And is that in your opinion due to consumer spending? Or you have insight into some of your competitors because of your wholesale business, do you feel like your share is being impacted by others?

[Jim Harrison:]

So I’ll frame what 1% on our stores mean. 1% in our stores means $3 million. So it’s a $3 million effect in terms of quantifying it. In terms of competition, we have obviously tremendous visibility to the franchisee network. We also have good visibility in terms of independents. And I would say across the board, Party City outperformed all those segments. In terms of the mass market and Spirit and Amazon, we don’t have a lot of visibility on that, but we do believe, based upon surveys and the intercepts that have been done, we have not lost any meaningful market share whatsoever.

[Mike Baker:]

You’ve not. Okay, understood. If I could ask one more question again, maybe my math -- hopefully, my math is right here. But I think your implied fourth quarter guidance has, at the midpoint, sales up maybe 6%, and I think you adjust -- you addressed why I think that will accelerate. But EBITDA, up closer to 2%, which would imply margins down about 100 basis points. Even in the third quarter, which was a little tough, your EBITDA margins were essentially flat. Why should the EBITDA margins be down so much in the fourth quarter? If my math is right.

[Dan Sullivan:]

Yes, you’re close. Your point on the revenue is right. We would say that the Q4 is going to be somewhere in the 5% range year-over-year. We will see gross margin expansion in Q4 and OpEx performance in Q4 similar to what we’ve seen year-to-date September. We expect to see operating income margins broadly in line with last year Q4. I think we have to keep in mind, last year, we did quite a number of new store and relo activity, post-Halloween, and we had some significant add-backs for deferred rent that were in the fourth quarter. We’ve done a much better job this year of prioritizing our capital spend ahead of Halloween.

[Mike Baker:]

So you had add-backs in the fourth quarter of last year, which helped your EBITDA, which you -- which won’t repeat this year?

[Dan Sullivan:]

That’s right.

[Mike Baker:]

And that’s why the margins might be down. Okay. Understood.

[Operator:]

Your next question comes from the line of Curtis Nagle with Bank of America.

[Curtis Nagle:]

So just one on capital allocation. So you guys announced a $100 million buyback. I guess, why prioritize the buyback relative to debt pay down? I understand that your shares aren’t exactly expensive, but on a rent adjusted basis, you guys are running at a leverage level that is a good bit above peers and at a level where typically we don’t see other retailers engaging in buybacks. So any color on that would be very helpful.

[Jim Harrison:]

Sure, I would just start by saying that I don’t think there are any peers per se for us. There are retailers, there are consumer product companies, we are a hybrid of both. Our cash flow characteristics are substantially different than most other "retailers," and I think having that access to the free cash flow in excess of $250 million on an annualized basis gives us the ability to look at capital and try and deploy it in the very best way we can think of for our shareholders, whether it’s acquisitions, as I said earlier, or whether it’s investing in stores or whether it’s building out our manufacturing competencies or whether it’s returning capital to shareholders and paying down debt. We look at all of those as options, and it’s a matter of how we think best to deploy our capital to get the best returns for our shareholders. We believe that $100 million authorization of a share buyback is less than 0.25x of debt in terms of leverage. And I think if we look at that and look at it in that context, it provides us the wherewithal to provide a support feature for all those shareholders who understand our business and understand our model.

[Operator:]

Your next question comes from the line of Joseph Feldman with Telsey Group.

[Joseph Feldman:]

The first one, just to -- sort of a nitpicky one. But with the tax rate that you guys had in the quarter, I understand the issues, why it was lower and you’re going to move back to the 37%. But is there anything else around the corner on the tax line that we need to be thinking about? Because it did have a little positive impact on the quarter if you exclude it.

[Dan Sullivan:]

Yes. No, it did have a -- I assume you mean positive impact on EPS. It did. Yes. There was also, just to highlight, there was headwind in the quarter on EPS as well related to the hurricane and related to FX. But no, I mean on the tax rate, to answer the question, we saw a number of things in the quarter from a state tax matter that was resolved in our favor to the exercise of options and we had, as I mentioned in my upfront, some return to provision adjustments that were small true-ups. So the answer is, no, we don’t see anything in Q4 beyond that would have the effect that we saw in Q3.

[Jim Harrison:]

And if you’re extending that question to include the proposed tax reforms, obviously, we are a U.S.-based company with most of our income coming from our U.S. operations, so a change in the effective rate would have a very positive effect, obviously, on our EPS.

[Joseph Feldman:]

Good point. And then another question. This may be a little harder to sift through some of the noise given the issues with the ecommerce site this quarter. But since launching BOPIS and inventory check, like, have you seen any change in the trend or the way people are using or like what percentage of people are picking up at store at this point? I know it’s only been 1.5 or 2 months really, but anything to comment there on the BOPIS?

[Dan Sullivan:]

Yes, I’ll take the numbers end of it, and I’ll ask Ryan to fill in the execution of it. So yes, we do see an impact, and we do see, obviously, your traditional web business that moves to the store and so -- and that’s roughly a couple hundred basis points of impact to the web business. We’ve actually built out over $2 million of BOPIS-related revenue in the period that it has been open now, which is really September and a good bit of October. So yes, we do see the impact. Obviously, it doesn’t affect our total comp, but we do look at stores with and without BOPIS and online with and without BOPIS. And maybe, Ryan, you want to talk to the program.

[Ryan Vero:]

Yes, and as you mentioned, we’re fairly early on in our deployment of buy online, pick up in store in all of our stores. And I think we’re really, really bullish about the longer-term potential once we fully build it out, even onto our mobile platform. Today, it’s only capable on the desktop platform, which is only about a third of the total web traffic. And so we have a tremendous upside as we move this thing onto the mobile platform to deliver for more customers using BOPIS and drive some categories that have historically not been strong web categories, like balloons, which are obviously much, much greater opportunity for us to pick up in the retail store for our customers while they order them online. So really, really excited by the potential with that.

[Operator:]

Your next question comes from the line of William Reuter with Bank of America Merrill Lynch.

[William Reuter:]

You’ve made some comments about an increase in competition around the holiday period. I’m wondering whether you’re seeing increased competition in every day, either from other brick-and-mortar players or mostly from e-commerce competitors.

[Jim Harrison:]

With respect to the competition in the everyday category, the competition really is pretty much what it has always been in terms of the mass market of the party stores, our own party stores. We have great visibility there since we basically hold all the IP associated and with the wholesaler to almost everybody in the business. When we look at the primary ecommerce players, we don’t see a lot of everyday competition coming from them. For lots of reasons, it clearly is a very difficult category to manage them on the web or anywhere. We don’t sell items, we sell coordinated party ensembles and managing maybe 50 to 100 SKUs of coordinated ensemble and being in-stock on core components is a pretty tricky thing to do, and I think that’s where the party specialty business really differentiates itself from the general merchandiser and also the general merchandiser on the web.

[William Reuter:]

Okay. And then based upon the increased competitive activity around the holiday, do you think it will change the number of pop-up shops that you guys will do next year? And I guess, do you believe that there are a substantial number of those that may not have been profitable this year?

[Jim Harrison:]

We have not finished our total diagnostic on Halloween and, particularly, on Halloween City. And in terms of formulating our plans for next year and how we approach the pop-ups; that simply is still yet to be determined as we do our postmortems on Halloween on the effects of the various components of the business for Halloween.

[William Reuter:]

Okay. And then just lastly from me. Do you have a leverage target for the end of next year? We’ve seen your target for the end of this year. But have you started to think about where you hope to end leverage next year?

[Jim Harrison:]

Somewhere in the range of 3 times.

[Operator:]

Your next question comes from the line of Karru Martinson with Jefferies. Your line is open.

[Karru Martinson:]

So I just wanted to follow up on the pilot stores. You’ve had the five now, deploying 50 more. What are the CapEx expenditures for that? And in kind of do you see that being applicable to your entire store fleet?

[Dan Sullivan:]

Yes, the CapEx is actually de minimis. There really isn’t much. What we’ll see happening here is the work we’re doing in-store to improve store productivity will help take labor out of the store and allow us to pivot that labor into the types of skills and also resources we need to create a better selling environment. But on a CapEx line, there’s no impact.

[Jim Harrison:]

It’s really people, Karru.

[Dan Sullivan:]

It’s people.

[Karru Martinson:]

And is that something that you feel that you can roll out to the entire footprint, if it continues to have the success that it has had?

[Jim Harrison:]

Absolutely. It’s a matter of building the right resources in terms of people, building the right training programs and putting in place the proper disciplines to make sure it’s executed on a consistent basis across the entire fleet.

[Karru Martinson:]

Okay. And just lastly, when we think about the net leverage target for the year-end, 3.5 times, I mean, does that include kind of potential share buybacks ahead of that? I would assume that cash would leave the box here. Or how should we think about that working capital swing for you?

[Jim Harrison:]

None of our guidance, including leverage, incorporates any thought process as to how much money we spend on the buyback, how many shares we buy back.

[Operator:]

Your next question comes from the line of Grant Jordan with Wells Fargo. Your line is open.

[Grant Jordan:]

Just a couple of quick ones. You talked a little bit about there was some weakness because there was some carryover Halloween inventory from last year. How did this year finish up in terms of inventory in stores?

[Jim Harrison:]

We would anticipate that the carryover of inventory at independents and at franchisees as well as we see on our own stores, the carryover inventory is down substantially year-over-year. So we would expect -- that’s why in my remarks, I mentioned that as being a timing issue, we see that bouncing back.

[Grant Jordan:]

Okay. And then you talked a little bit about there was some weakness out of the franchisee stores. Are you seeing, I mean, out of some of the independents, are you seeing closures there? Or is it more just weak trends for those guys?

[Jim Harrison:]

I think the independents and also the franchisees, to some extent, because of the high-level of carryover inventories, really had a lot of pressure on their open to buys through the course of this entire year, not just at Halloween. And I think now that they’ve worked their way through that carryover of inventory to a large degree, I would anticipate that they would get themselves back into a better in-stock position, which ultimately translates into more sales for them.

[Grant Jordan:]

And then there’s roughly like 160 or so franchisee stores left. Do you have any sort of anticipated pipeline of acquisitions out of those stores?

[Jim Harrison:]

The acquisition franchisees is part of our strategy. We look at the acquisition franchisees as being a good use of capital as much as we believe it can be accretive to shareholders, and it gives us the ability to open up additional territories, potentially for more stores where there’s white space available and further reinforce the strength of our brand and get continuity on brand. I think as we think about developing our customer-facing strategy, a better store engagement with associates, with our customers, getting all of our stores to perform to that model is important for long-term success of that endeavor.

[Grant Jordan:]

And then last one, just -- I think you may have already said this, but overall Halloween, do you think you gained share or held share?

[Jim Harrison:]

I think we pretty much held share.

[Operator:]

This concludes the Q&A session. I will now turn the call back over to management for closing remarks.

[Jim Harrison:]

Very good. Once again, everybody, thank you for joining us today. We appreciate your continued support and interest in the business. As always, Dan, myself and the rest of the team, stand willing, able and ready to answer any additional questions you may have at a subsequent time. Feel free to reach out to us. We are quite happy to be able to have this call and provide the information for the quarter. Thank you very much.

[Operator:]

This concludes today’s conference call. You may now disconnect.