Party City Holdco, Inc. (NYSE:PRTY) Q3 2020 Results Conference Call November 9, 2020 8:00 AM ET
Ian Heller – VP & Associate General Counsel
Brad Weston – Chief Executive Officer
Todd Vogensen – Chief Financial Officer
Conference Call Participants
Simeon Gutman – Morgan Stanley
Rick Nelson – Stephens
Tami Zakaria – JP Morgan Chase
Joe Feldman – Telsey Advisory
Karru Martinson – Jefferies
William Reuter – Bank of America Merrill Lynch
Carla Casella – JP Morgan
Good day, and welcome to the Party City Third Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Mr. Ian Heller, Vice President and Deputy General Counsel. Please go ahead.
Thank you, operator. Good morning, everyone, and thanks for joining us. This morning, we released our third-quarter 2020 financial results. You can find a copy of our press release on our website at investor.partycity.com.
Now, I’d like to introduce our executive team who are here on today’s call. We have Brad Weston, our chief executive officer; and Todd Vogensen, our chief financial officer. We’ll start the call with some prepared remarks by Brad and Todd before we open it up for Q&A. Please note that in today’s discussion, management may make forward-looking statements 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 you no assurance that such expectations will be realized. We expressly disclaim any duty to provide updates to our forward-looking statements, whether as a result of new information, future events or otherwise. We urge everyone to review the safe harbor statements provided in our earnings release as well as the risk factors contained in our SEC filings.
During today’s call, we will refer to both GAAP and non-GAAP financial measures of the Company’s operating and financial results. For more information regarding our non-GAAP financial measures and reconciliations to the most directly comparable GAAP measures, please refer to the earnings release. And with that, I’ll turn the call over to Brad Weston.
Thanks, Ian. Good morning, everyone, and thank you for joining us today. As COVID-19 challenges continue and even escalate in many areas of the country and across the globe, our hearts go out to all who have been impacted. As a company, we remain focused on our number one priority, which is keeping our employees and customers safe. As a brand, we are focused on our mission and purpose which is creating joy by making it easy for consumers to create amazing celebration.
We are very pleased with our third-quarter performance. Our results were better than our expectations and underscore the ongoing strength of our core businesses. In a pandemic-impacted environment, we stabilized our top-line sales and grew adjusted EBITDA almost threefold in the third quarter. There are three key themes that are reflected in this performance.
First, the strides we are making to increase relevancy and elevate our customer experience across channels so we reinforce and strengthen our position of authority when it comes to celebrations; second, the discipline and control with which we are operating our business; and third, the consumers’ desire and willingness to celebrate, albeit in a unique and different way given the pandemic.
I will discuss these in more detail after reviewing our financial and operational performance for the third quarter as well as our October and Halloween season results. Todd will then elaborate on our financial results and provide some thoughts on how we’re approaching the fourth quarter. As shared on our Q2 call in August, we saw positive comp performance in July which continued through the quarter resulting in a positive 8.3% comp increase for Q3, the largest comp we’ve delivered in nine years.
Importantly, our core categories like balloons, birthday and entertaining were up double digits collectively in Q3 which is a very encouraging indicator that our underlying business is strong. In fact, even in the month of October, when our business is skewed more toward Halloween sales, we saw continued positive trends in our core category.
We believe this strong performance is indicative of the underlying resiliency this business has historically demonstrated even in recessionary environments. It illustrates how Americans are prioritizing celebrations and the marking of milestones such as birthdays even if they are being celebrated with smaller groups of people in the privacy of homes and just with family.
It also illustrates that the work that has been under way to reinvigorate our retail business increased our relevancy and elevate our customer experience across channels is having a demonstrable impact. E-commerce continued to perform well, and digitally enabled sales increased 36% as our customers continued to take advantage of our expanded fulfillment options including buy online, pick-up in store, curbside pickup and same-day delivery.
Our wholesale business also demonstrated strong resiliency in the third quarter, with third-party sales approximately flat to last year. We still expect the wholesale business to lag the recovery at retail, and we were encouraged with the improvement in overall wholesale trends through third quarter as franchise customer volumes returned to more normalized levels.
We benefited from strength in our Canadian wholesale business, and our Anagram metallic balloon business delivered significant growth. Anagram total sales were up 30.6% for Q3, while third-party sales were up 22.1%. Anagram’s innovative designs and market strength have resulted in a particularly strong recovery. Overall, Anagram EBITDA increased $7.5 million or 164% over last year.
On a consolidated basis, third-quarter total sales were down 1.2% or down 1.6% on a constant-currency basis. With gross margin expansion of approximately 250 basis points for the quarter and very disciplined expense management, adjusted EBITDA was $49.2 million compared to $17.1 million in the prior-year quarter, and adjusted earnings per share was $0.10 versus a loss of $0.28, as Todd will discuss further shortly.
Moving to our Halloween season results. For the month of October, comparable sales were down only 2.9% which was well ahead of our expectations heading into the season including significantly better-than-expected Halloween results which were down 12.9% on a comp basis and continued strength in non-Halloween sales during October which bodes well for the remainder of 2020 and going forward.
The total sales decline for the month of October reflects the strategic reduction in Party City and Halloween City stores versus the prior-year period. As mentioned on our last call, we planned conservatively for Halloween this year, given the truly extraordinary environment as a result of the pandemic and election uncertainty. We positioned ourselves for a decline from an inventory assortment and expense standpoint as well as from a Halloween City pop-up store perspective. Within the Halloween category, our decor business saw positive growth, as we expected.
And within costumes and costume accessories, the kids and licensed businesses were most negatively impacted due to the lack of kids activities and the postponement of most licensed properties into the future. While we deleverage retail operating expenses, we anticipated the challenges of optimizing operational efficiency during our highest store traffic time period. In this COVID-19 environment, we needed to manage store occupancy and to ensure the safety of our customers and our associates.
In many instances, we needed to manage the number of people in our stores and the lines have extended outside our stores. As we reported earlier, we hired a quantity of seasonal employees to both manage these atypical mid-pandemic circumstances and to improve our quality of service. And overall, I am pleased with how we operated during our busiest time of the year.
Needless to say, this year, we dramatically improved our Halloween go-to-market strategy including significant improvements to our assortment, in-store merchandising, pricing, marketing and digital experience as well as the in-store customer experience including our new curbside pickup and delivery options. Many of these improvements were in response to our learnings from last year that we previously discussed.
Our biggest learning from last year was that we needed to expand do-it-yourself options, given customers’ growing preference for customizing their Halloween costumes and look with increased personalization to make it their own. We recognize that we didn’t merchandise and market do-it-yourself well enough in 2019, especially given it is what makes Party City so unique. This year, the in-store do-it-yourself merchandise was presented more clearly and intuitively for the customer with improved visual merchandising and assortment planning.
We also had Halloween marketing campaigns such as You Boo You to remind folks that we offer the largest breadth of assortment within do-it-yourself accessories which resonated with customers. These changes resulted in growth in both units per transaction and the average order value. We also sought to improve our digital experience with more Halloween customers turning to online for costume in a bag purchases.
On partycity.com, we converted customers at a rate 75% higher than last year as the results of several major user experience improvements, such as shop my store and a product and pricing strategy that highly motivated customers to buy. In October, we drove 30% more revenue through digital sales over prior year which included driving a higher volume of traffic into our stores as a result of our omni services offering.
We engaged in several relevant pandemic-related partnerships, both nationally and locally to make it easy for people to celebrate Halloween safely. Next store, Halloween2020.org, haunted road drive-thru experience in Orlando and HAUNTOWEEN in Los Angeles to name just a few. Lastly, on Halloween. Our product sell-through increased approximately 1,000 basis points compared to 2019.
This improvement, combined with our more conservative inventory approach going into the season, resulted in significantly less carryover product compared to prior years, positioning us well for assortment freshness in 2021. During the quarter, we continued to advance the five strategic initiatives that underpin our work to stabilize our retail business. Let me now discuss the progress we made in Q3.
Number one, developing a more relevant in-store experience. We continue to make progress on our next-generation store prototype as we pilot changes to provide a better shopping experience for our customers. Since June, we’ve opened 13 next-gen stores including our three original pilot stores, our five Las Vegas stores, three of our Kansas City stores and recently two new stores in North Carolina and Alaska.
In the fourth quarter, we will add an additional nine next-gen stores through remodels, two new stores and one relocated store, bringing us to a total of 22 next-gen stores in 2020. We’re addressing the fact that our stores can be overwhelming and time-consuming to navigate. The changes to the in-store experience we are piloting include a new shop-in-shop store layout with improved product adjacencies, edited and more curated product assortments, reduced inventory as well as new services and experiences.
A new balloon shop and customer engagement center are now the focal point of the store and add significant theater to the entire experience. The dedicated staff and placement of this new balloon shop provides more personalized service while simplifying balloon transactions and speeding up transactions for non-balloon customers. Customers are excited by the new balloon experience, which we’re seeing in both their comments and the incremental balloon purchases being made.
Balloon sales growth in our next-gen stores are almost double the trend in the balance of the chain. Customers are also telling us they appreciate the decluttering of the stores due to the lower sightlines and the more curated assortment. These attributes are also allowing our associates to more efficiently operate the store.
I’m thrilled with the outcome of the new customer and associate experience in this next-gen store format. It successfully addresses the friction points that exist in our legacy format, and it has also enabled us to identify easy shopping experience enhancements we can make in our legacy stores while we continue to improve upon and strategize on the planned future rollout of our next-gen format beginning in 2021.
Number two, win in balloons. From manufacturing and wholesale all the way through to Party City retail, balloons are a focal point of our growth strategy. And with helium shortage behind us, we began 2020 leaning into balloons as a key driver of our differentiated brand experience. I am very pleased with our go-to-market improvements and our performance in this core category.
As the dominant player in the global balloon business with an unmatched breadth of balloon assortment, we continue to bring innovation in product, do-it-yourself options and how to guidelines, along with new access points to balloons through new digital engagement and new additional fulfillment options through curbside pickup and delivery.
Buying balloons online with the ability to pick them up in store, at curbside or have them delivered the same day is increasing balloon demand. In Q3, balloons were more than 53% of our buy online, pick up in-store, curbside pickup and same delivery sales. Moving forward, winning in the balloon category will remain a top strategic priority across our enterprise growth initiatives and business discipline.
Number three, address price value perception in key categories. Customer behavior and insights have told us we were overpriced on key value indicator items across our assortment. To address this and sharpen our price value perception, since fall of 2019, we have produced Party City retail prices on approximately 9,400 SKUs or almost one-third of our total current active SKU count.
The customer has noticed and has responded favorably with their feedback and the unit sales volume increases we intended. As projected, these reductions in price across product categories have proven to drive increased enterprise margin dollars and increased retail margin rate when coupled with the reduction of previously ineffective promotional offer.
With the majority of the necessary retail price reductions now behind us, we will continue to monitor and react to price-related customer insights and price elasticity data on a regular basis. Rebuilding trust with the customer on price is critical to our broad efforts to gain relevancy with consumers, and we are extremely pleased with our progress to-date.
Number four. Improve our customer engagement selling culture. Improving customer engagement across our marketing messages, our product and merchandising approach as well as digital experiences with our brands is also critical to driving greater relevancy.
Our dramatic shift in digital content including new more relevant content formats, carefully curated product assortments and new technology has driven growth in consumer engagement as well as online conversion rates. We launched digital workshops and live video formats across our social platforms for the first time which have garnered hundreds of thousands of views and reached millions of consumers.
Headed into the Halloween season, we produced dozens of pieces of content featuring new ways to celebrate such as boo baskets, trunk-or-treat options and candy hubs, all of which drove increased engagement and our highest conversion rates as well as earning regular news media attention.
As we continue to drive digital innovation, we also tested 3D shoppable technology to help consumers not only find the right costume, but also build the perfect Halloween theme in their backyard, front porch or any room in their home as we quickly sold through the featured items.
Number five, build on our omni-channel platform. We saw 278% growth in buy online, pick up in-store, curbside and same-day deliveries during Q3. As key components of increasing our omni-channel capabilities, they are now core to our customer experience. We will relentlessly optimize and add to these experiences as we obsess over the customer experience with our brand and continue to find new and innovative ways to make it easy to create celebrations.
In Q3, we rolled out an enhanced curbside delivery experience in all of our stores, allowing customers to now communicate their expected pickup time, arrival and vehicle information, all via text message which creates a more intuitive and efficient experience for our customers. We continue to optimize this program with a focus on increasing customer adoption and enabling our associates to more seamlessly deliver curbside orders.
As customers seek same-day delivery options, we focused on improving the customer experience with improved speed and reliability. We invested in improved technology to enable more proficient orchestration of delivery process and expanded our last-mile delivery partner networks.
Shifting gears to the important topic of governance. During the quarter reflecting our focus on continuing to strengthen and diversify the background and skillset of our Board, we announced the appointment of two independent directors and a third in October. We are delighted to have added three highly qualified directors who collectively bring significant digital, capital markets, financial and legal experience. We look forward to leveraging their expertise as we advance our strategy of building a leading marketplace for celebration services and products.
In summary, we are very pleased with our third-quarter performance, our October performance and the ongoing progress against our strategic priorities. Our results demonstrate that we are operating from a position of authority in the category as we continue to deliver not just the industry-leading assortment for celebrations but increasingly off of the inspiration for celebrations with increased content and engagement initiatives.
The strides we are making on increasing our relevancy is evident in our business results which bodes well for our future. Our purpose is to create joy by making it easy to create unforgettable memories. It is our reason to be, and we will relentlessly pursue this mission as we increasingly obsess with our customers and their experience with Party City.
With our successful capital structure reset and having successfully moved beyond Halloween 2020, we look to finish the year in a substantially stronger competitive and financial position than just nine months ago. This is a testament to our brand’s position in the marketplace and the grit and resiliency of the entire Party City team to who I would like to extend my gratitude. We look forward to building on this progress as we close out the year and move into 2021.
We’re excited to inspire consumers in new differentiated and aspirational ideas and solutions to their holiday and New Year celebrations. For New Year’s Eve, we will offer customers our boldest assortment of seasonal balloons to make the holiday special and have developed fun products that capture the consumer enthusiasm to leave this unique year behind.
And now, I’d like to turn the call over to Todd to discuss our financial results in greater detail.
Thanks, Brad, and good morning, everyone. Today, I’ll focus on the key highlights for our third quarter and our October and Halloween performance, and then I’ll discuss how we’re approaching the last few weeks of our fiscal year. For full details regarding our third quarter and 2020 year-to-date financial results, please refer to our earnings press release and the accompanying slides which are available on the investor relations section of our website.
As Brad discussed, our third-quarter and October results demonstrate that we’re delivering on our strategic priorities and that our business is resilient in this challenging macro environment. For the third quarter, consolidated revenues were down 1.2% which includes the divestiture of 65 Canadian retail stores in October of last year and 2019 and 2020 closures related to our store optimization program, mostly offset by an increase of 8.3% in brand comparable sales, our largest comp sales improvement in nine years.
Adjusted gross margin rate was up 250 basis points in the quarter to 34.4% from adjusted gross margin rate of 31.9% in the prior-year period primarily due to lower sales promotions, occupancy leverage on the 8.3% comp and favorable sales mix.
Adjusted operating expenses were $152.4 million, a decrease of $23.6 million or 13.5% from the prior-year period driven largely by our prudent management of expenses as well as the temporary benefits from cost cutting related to the pandemic.
As a result, adjusted income from operations was $32.1 million compared to adjusted loss from operations of $2.4 million last year. Adjusted EBITDA was $49.2 million compared to $17.1 million in Q3 of 2019 and adjusted earnings per share was $0.10, up $0.38 from an adjusted loss per share of $0.28 in the prior-year period.
Turning to our balance sheet. Inventory was down 20% year over year at the end of the third quarter, as we continued to manage our working capital prudently realized the benefits from an optimized brick-and-mortar store base and to improve sell-through on key categories.
Looking forward, we continue to plan from improved inventory turns through more curative assortments and improved seasonal sell-throughs. As we discussed last quarter, we completed our debt refinancing in July. The accounting treatment for the refinancing results in a significant amount in future interest payments being recorded to debt on the balance sheet causing our balance sheet debt to be significantly higher than the underlying principal balances.
We’ve included a reconciliation in our press release to bridge balance sheet debt to the principal amount outstanding. This accounting treatment also means that interest expense recorded on our income statement will differ from our actual cash interest payments. So we’ve guided to both income statement and cash interests in our press release.
As we previously discussed, last year, we generated $130 million in proceeds from the sale of our Canadian stores to Canadian Tire. The $17 million of the proceeds from this transaction that were not reinvested or committed for reinvestment by October 1, 2020, were used to pay down our term loan or value under the terms of the agreement.
Our balance sheet and liquidity position has significantly improved as a result of our successful exchange offer transaction, last year’s sale of our Canadian stores and our ongoing working capital management. At the end of the third quarter, we’ve reduced the principal balance of debt net of cash by $700 million. The quarter ending liquidity position of $349 million was comprised of $171 million of cash and $178 million of revolver availability.
Year to date, during these unprecedented times, we took important steps to strengthen the business and our financial health. We have been very disciplined in managing expenses, working capital and capital expenditures as we push forward on our key strategic priorities to drive business improvement. We reduced payroll expenses including salary reductions as well as non-payroll expenses by working with landlords on rent relief and negotiated payment deferrals.
Additionally, in an effort to increase our financial strength, we successfully completed our debt exchange offer at the end of July which accomplished the three financial goals we set out to achieve which were: One, to extend our debt maturity; two, reduce our leverage; and three, increase our liquidity.
We’re reaping the benefits of these actions as well as the strides being made against our strategic initiatives as reflected in third-quarter’s adjusted EBITDA improvement of nearly 188%. As we get ready to close out the final quarter of the year, we’ve provided our outlook for the fourth quarter in today’s earnings press release.
We expect our consolidated sales for the fourth quarter to be approximately $675 million to $695 million, with brand comparable sales flat to down low single digits. With the majority of the fourth quarter now behind us, we continue to be pleased with the performance of our core products. Also, please note that our 2020 retail calendar includes a 53 week this year which we estimate will drive $35 million in sales.
The calendar shift does provide a small headwind to comparable sales since a large portion of our pre New Year’s Eve sales moved from week 52 to the non-comp 53 week. For the fourth quarter, we anticipate that adjusted EBITDA will be $80 million to $90 million, inclusive of the estimated $7 million impact from the 53 week, down from $119 million last year.
Given our forecast for flat to down low single-digit Q4 comps, we would anticipate some occupancy deleverage and resulting gross margin pressure in Q4. Also in October, we invested in store labor as we managed store traffic to prioritize safety of our customers and associates. As a result, SG&A is expected to be the primary driver of Q4 operating margin decline implied by our outlook.
In terms of capital expenditures, we now expect our 2020 spend to be $45 million to $50 million or $10 million above our prior estimate. We pulled forward some of our spend from 2021 into the current year as part of our plans for rolling out additional next-gen stores and also technology to support our strategic priorities on the heels of these very encouraging results. Please refer to our press release for all other items related to our outlook.
In summary, we’re very pleased with the performance of the business in the third quarter and the underlying momentum of our core business that continued into October. Our Halloween results were better than expectations as we planned conservatively, and our teams did an exceptional job executing during a pandemic-impacted Halloween.
We are looking forward to delivering new, differentiated and aspirational ideas and solutions for our customers’ holiday and New Year celebrations as we close out the year. Our strategic growth priorities, combined with our strengthened financial position and continued focus on managing expenses and working capital, have us well positioned as we approach the end of our fiscal year and into 2021.
With that, I will turn the call over to the operator to start the Q&A session.
We will now begin a question-and-answer session. [Operator Instructions] The first question comes from Simeon Gutman of Morgan Stanley. Please go ahead.
My first question, short term one on gross margin. Can you talk about how much you’re saving from lower promotion versus how much it’s getting dragged by price investments?
Sure thing. This is Todd. So we have spent a lot of time actually looking at overall pricing and looking at it from both the promotional angle as well as looking at what customers are looking for from just playing pricing compared to what they would see at other retailers. And as Brad mentioned, we did make those adjustments on a number of SKUs as we went through the course of the quarter. The promotional savings though are well more than offsetting the price decreases that we had, and we should continue to see that tailwind really through the middle of next year.
So, the — any price decreases from a rate perspective more than offset by promotional decreases. And as an added benefit, we really are generating exactly what we thought out of the price decreases, which is as we get more competitive pricing, we are seeing the volume improve on those units and the volume then flows through to more units in our manufacturing and wholesale business that gives us better leverage there. So it ends up being a nice strong flow-through to the bottom line.
And now that you’ve gotten through this key period and the business is generating EBITDA again, are you a step closer? Can you talk about where you think the normalized EBITDA power of this business is and maybe a rough time frame to getting there? And just one more component to that is how much of it, at least in ’21 or the recovery will be more margin dependent versus top-line dependent?
Sure. So we are obviously early in the recovery from having stores being closed in COVID. And so we’re going through a lot of planning right now, particularly around 2021. It’s early to provide a true framework for next year and go forward.
We do continue to see opportunities across the business. And the fact that the strength we’re seeing is coming through those core products I think bodes very well really for all areas of the P&L. But I don’t want to get ahead of us, and I think we’ll be providing more of a framework as we get into next quarter’s call.
The next question comes from Rick Nelson of Stephens. Please go ahead.
Thanks a lot. Good morning. So I’d like to follow up on the next-gen stores, how you’re thinking about those, the time line to evaluate what sort of lift you’re getting with early ones and the costs around the remodel of these stores.
Yes. As I said, we’re very pleased with the results of our next-gen pilots. Of course, we would have liked to have opened the 35 to 45 that we stated we would open at the beginning of the year, but we’ve continually modified the elements of the prototype with each new learning, and we’re excited by their performance. We’re really working through our 2021 strategy and our continued plan to test and learn while we remodel more of these stores.
We’re thrilled with the outcome thus far and look forward to the continued evolution. We are seeing a lift. The lift is — varies by category. So we continue to learn from that. From a CapEx perspective, we also continue to improve the cost of these as we get increased learnings. I think we’ll see as we move into 2021 and think about the development of these, we’re keeping them as capital light as possible.
We’re engaging landlords based on increased traffic to have conversations about their level of support for them. With our prototypes, we didn’t have a level of support. And so we’re looking forward to making them having a good payback, and we won’t venture ahead unless they have the proper return on investment.
Okay, thanks for that. Core categories is also you referenced strong growth there. Can you talk about what those categories represent of total sales? What sort of growth you’re seeing I guess in balloon category? It sounds like it may have led the charge, but the future of these core categories.
Yes. Those core categories are really the bulk of our business. We have seasonal businesses that are — I think we’ve talked about in the past that Halloween has represented as high as 20% of our total business, and we have seasonal businesses that are not as large as you might think. So really, the vast majority of our business is those core everyday businesses. And so as we think about what the consumer considers as the destination for, it really is balloons and birthdays and entertaining in those milestone occasions.
And we’re very pleased with our third-quarter results in those. And then as we move into October, we saw continued strength in those despite the fewer transactions in our Halloween business. And even in the baskets of Halloween, we continue to see more of the core elements, core categories in the Halloween baskets. And those — that core business continued to be strong throughout October.
Thanks for that. Finally, if I could ask you about the store base, how you’re thinking about that? Should we expect growth or more store closings or no changes that are potential?
Yes. So I want to be super consistent with this over time. We’re constantly examining our store fleet from a sales and profitability optimization perspective. We’re regularly engaged, as you would anticipate, in rigorous analysis, both at store level and at market level. As we look at population changes and shifts, co-tenancy, viability of the center or repositioning of stores obviously those are a little bit of moving targets right now with the state of retail and the challenges around COVID. So our rigor just increases.
So we look thoroughly at what opportunities we have to recapture share if we close stores and gain share where we can. It is this process that has really resulted in store openings, store relocations and store closures in the past as it will — and that will continue. The good news is stores are required for curbside pickup. They facilitate delivery, and they’re extraordinarily convenient for balloons With regard to fiscal 2020, I would say that that is to be determined. It’s something that we’re in the process of as we speak. And we continue to look at areas of white space and analyze it on a market-by-market basis.
The next question comes from Tami Zakaria of JP Morgan Chase. Please go ahead.
Hi, thank you for taking my questions and congrats on very strong results. So just continuing on the last question, do you expect to acquire the remaining franchise stores in the coming years or what’s your plan with those?
Sure. So we have had, in the past, reduced the number of franchise stores by acquiring stores. I think in this environment, it is all about making sure that we’re being financially disciplined. So if there are franchise locations where there’s a particular opportunity where it’s a geography that we would want to be and for a variety of reasons we can have good economics on our side, then we’re certainly not close to it, but also understanding the environment, we’re being very cautious on cash. So I wouldn’t look for a wholesale broad plan either way at this point. We’re just approaching it very cautiously.
Got it. That’s super helpful. And then with the price reductions that you have taken, are those now more or less complete or do you see more opportunity for price reduction? And a quick follow-up on that, after the price reductions, are you now more price competitive versus the mass players or versus specialty? Basically, I’m trying to understand your position in the price letter in terms of the competition out there.
Yes. So I would say that our — we’ve taken on and impacted the SKUs that our data showed us initially had price elasticity opportunities and whereas we really examine the price value of the product, we had opportunities to either reduce price or opportunities to increase quality. We are not focused on price in any one competitor. None of them are really specialty retailers who offer one-stop shop opportunities that we do. We make it easiest and most convenient because we have all the categories of the party, our competition does not.
And at a SKU level, we’re highly aware of how competition is priced, and we really balance that with our more comprehensive levels of assortment, our knowledge and service as we consider our overall value proposition, and we do this with a constant eye on customer feedback and insights balanced by data and analysis of price elasticity. We have the heavy lifting in terms of the reductions behind us. And as we cycle through the balance of this year and transition into next year, we’ll continue to evaluate, but we’ve gotten through the majority of it.
The next question comes from Joe Feldman of Telsey Advisory. Please go ahead.
With balloons, can you talk a little bit about the attachment rate of other categories? Are you seeing it improve lately or is it similar or even worse potentially? But I would think it would be better. It just seems like there’s a lot of strength in the category. How’s that driving things?
Yes. So balloons is obviously a very strong category. In the past, we have talked about the fact that it does have a strong attachment rate. It is also really a key driver of trips, and balloons are core to our long-term growth strategy. Obviously, it was one of our five strategic initiatives to stabilize retail in 2020, and it will be — it will continue to be a constant focus across our enterprises. We look to drive innovation in products and services in balloons to continue to drive relevancy.
And then I know it kind of wanted to ask about. With COVID-19, have you seen a change in trends with the surge recently? I know it would probably be in — literally in the past week or two that you might notice it in your business. But have you seen any difference in behavior like that maybe we saw early in the pandemic when things were initially surging and then in the summer when they surged again?
We have not seen dramatic sensitivity to COVID-related issues. We — that said I would say geographically, if there has been spikes in certain geographies, we’ve seen some ebb and flow in those, but have not seen them really at a macro level as the environment has evolved.
Got it. That’s helpful. Thank you.
And probably an important point, we first got when COVID first popped up, there was a lot of folks delayed some of their celebrations. And so we did see that big pop down. I think we’re at a point where behavior — underlying behavior has changed, and there’s still a great desire to celebrate, and that has very definitely played into the trends for those core categories. So it’s a little bit of a different time in terms of consumer reaction to COVID.
The next question comes from Karru Martinson of Jefferies. Please go ahead.
Good morning. When you look at the net guidance — net debt guidance for the year and it’s kind of flat to the third quarter. How should we think about the working capital as you guys worked down your Halloween inventory and not so much back away and cash flow generation here as we close out the year?
Sure. So, two elements really both sides of the equation for working capital. On inventory, you’re right, sell-through on Halloween was much, much better than last year. So we are ending with less Halloween inventory specifically. And I think more broadly, we are looking to be — to have higher inventory turns going through the store to buy more prudently and manage that inventory tighter really over time. And so you should continue to see that inventory have a seasonal swing down, maybe a little bit even more than normal.
And the flip side of that is going to be, we have managed accounts payable very tightly as we’ve gone through the year. And our conversations with our vendors have been we want to match up the timing on payables with the timing of cash inflows for sales from Halloween. So versus prior years, we probably do have more of a buildup in accounts payable that will also pay itself down as we go across the rest of Q4. And those two things should roughly offset and then the real driver being the EBITDA that we drive in the fourth quarter.
Okay. And then when we look at the pilot stores and the rollout of that, what are the thoughts on the balloon shop being the focal point here? Is that something that can independently be expanded out to your store base or is that something that is part of the pilot remodel, if you will?
Today, it’s part of the pilot and remodel as we try to continue to learn about the power of that. And as I’ve mentioned, we’re very pleased with that. One of the things that the next-gen pilots have shown us is, they’ve highlighted some of the friction points in our current legacy stores. And so we are getting balloon learnings. We are not, at this point, planning on taking the full shop to the legacy stores. They are the center point of the next-gen remodels. And so, we’ll continue to think about them that way. However, we get a lot of balloon — a lot of learnings around balloons from those and we are instilling many of those learnings.
Okay. And then just lastly, you’ve done a great job in terms of managing your capital structure. The piece that remains is the term loan with the maturity coming up. How are you looking at the structure today?
Sure. So you’re right, the next maturity up in our overall capital structure is that term loan, a little bit less than $700 million now and coming due in August of ’22. So a little bit less than two years from now.
We continue to look at it I think as we show results like we did today, it just continues to build confidence in the long term — in the long-term trajectory of the business and confidence behind the recovery in our financials and ability to drive cash flow which just inherently makes it easier as we look to either extend or refinance that debt.
And we’ll be looking at which options are the better options for us as we get into next year, but not feeling like we have a gun to our heads today. And we’re looking to just manage it prudently based on what options the market presents.
The next question comes from William Reuter of Bank of America. Please go ahead.
Good morning, guys. The first is, I’m wondering if you have any data on the industry in terms of Halloween and how I think that your share may have fared over this period.
Yes. Well, we knew going in that NRF was forecasting Halloween to be down approximately 10% down to $8 billion from an expected — or from $8.8 billion in 2019. We anecdotally know that Spirit opened 1,400 stores this year, but do not have data — hard data around their results. And so our strategy was really to increase our relevancy by growing our core categories and satisfy more of the total party occasion during the month. We did so, and our Halloween performance came in as we expected, and we’re looking to learn more as we get more results out of the marketplace.
Okay. And then on a related note, given the commentary about NRF estimates, etc., how do you feel that the competitive environment was this year I guess in terms of either mass or commerce, pure-play competitors? Do you think that they changed their strategy in terms of the amount of time, inventory, advertising that they devoted to the event?
I think going into the season, it was clear that decor would likely be the strongest part of the Halloween season. As we observed the trend of how consumers are celebrating, we anticipated that. It looked like those who are particularly strong in the quarter, like a Home Depot or a Lowe’s appeared to be bullish on the category in decor. It appears as we anticipated with uncertainty around activities, uncertainty around trick or treating and especially kids activities with regard to trick or treating or school activities and then really with a lack of licenses this year with most licensed properties being pushed out until next year, it appears that people were more conservative in the costume and the costume accessory categories.
The next question comes from Carla Casella of JP Morgan. Please go ahead.
Hi. I’m wondering if you could give us some more color on the gross margin improvement you saw. How much of it may have been driven by less clearance versus mix shift? And if there is any helium impact to gross margin this year?
Sure. So within gross margin, it really had the biggest two factors being the reduced promotions which is significant with a partial offset from the initial price reductions, and then occupancy leverage was significant as well. So I think those two played hand-in-hand and were the biggest by far. We did see — so from a helium perspective cost, year over year, it was up very slightly, not enough to really even make a difference in total.
We’ve reached that point of stabilization, at least in the near term on pricing. Balloons inherently are a slightly higher product margin. So when you look at helium costs at least at this point, it still nets out to a healthy margin for us. So that dynamic actually has been a net positive for us.
So really, it does come down to a combination of occupancy and promotional mix being roughly even in there. As we go into Q4 and look at the comps being down a bit. And that’s why we’d say we see a little bit of pressure coming on gross margin, it’s just the occupancy deleverage going the other direction. But good balanced progress really across the board on gross margin.
That’s great. And then just one question on wholesale, have all of your wholesale customers fully reopened? And do you see any permanent closures coming out of COVID? And I’m just wondering if any of your balance sheet items for receivables or any of the other accrues are related to kind of weakness or pressure at the wholesale customer level?
So from a customer perspective, there are isolated cases within — especially independents and franchisees, the smaller chains, where it clearly had pressure on their economics. And I think a lot of those folks didn’t have some of the benefit that we have coming out of COVID of that national recognition, the programs we have around omni-channel and balloons and so forth. So there are a few isolated incidents there that are playing out. I wouldn’t say that’s significant in total.
So from a wholesale perspective, we continue to see our customers building back. We have had a couple of reserves we’ve taken on accounts receivable. I wouldn’t say that’s anything that’s going to move the dial significantly on our net receivables or overall expenses. But we have made sure that we’re covered from the perspective of anyone that has told us there’s challenges. So net-net, we continue to see wholesale recovering, and I headed back to a level that we feel is the more sustainable level going forward.
This concludes our question-and-answer session. I would like to turn the conference back over to Brad Weston, chief executive officer, for any closing remarks.
I want to thank everybody for joining us today.
In conclusion, our third quarter and October results have been encouraging despite this challenging backdrop. We’re particularly pleased with the performance of our core non-seasonal business during the quarter and into October, which demonstrates the strength and resiliency of our underlying business and our team’s ability to execute against our strategic priorities which have strong traction and are delivering very positive results.
We’re also operating the business with greater discipline and control which combines with our strengthened financial position as a result of the recent debt exchange offer and continued progress on our strategic priorities, helps reinforce our position of authority in the category for both the near and long term. We continue to improve our relevancy and to position ourselves as the destination for all things celebratory.
And thanks again, everybody, for joining us this morning.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.