Party City Holdco (PRTY) Q2 2020 Earnings Call Transcript

Party City Holdco (PRTY -60.00%)
Q2 2020 Earnings Call
Aug 06, 2020, 8:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Party City Q2 2020 earnings call. [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.

Ian Heller -- Vice President and Deputy General Counsel

Thank you, operator. Good morning, everyone, and thanks for joining us. This morning, we released our second-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 discussions, 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 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.

Brad Weston -- Chief Executive Officer

Thanks, Ian. Good morning, everyone, and thanks for joining us today. COVID-19 continues to impact the lives and livelihoods of so many across the globe, and our hearts go out to all of them. We look forward to the day when this pandemic no longer poses a threat.

In addition, our country continues to wrestle with social injustice issues. On this front, here at Party City, we've been working to understand how we, as a company, can make a difference for our associates and customers. We've established an internal diversity and inclusion action board and appointed a dedicated leader who is now evaluating our current state and will lead the creation and implementation of a formal diversity and inclusion strategy in the coming months. Against this difficult backdrop, our teams continue to demonstrate their resilience as they adapted quickly to changing operating conditions and worked to advance our strategic priorities and strengthen our financial position.

I am very pleased with the progress we made and our ability to deliver improving performance through Q2 and into July. In addition, the successful completion of our debt exchange post quarter end was a landmark development for our company as it significantly improved our financial flexibility. I will discuss this in more detail along with our financial and operational performance in the second quarter. Todd will then review our second-quarter financial results in more detail and provide thoughts on how we are approaching the remainder of 2020.

On our last call in mid-June, I shared that we have begun the process of reopening stores while prioritizing associate and customer health and safety. With our brick-and-mortar stores closed in April and for most of May, retail sales declined 56% in Q2. Total brand comp for Q2 declined 52.4%. E-commerce performance was a clear standout with growth, including buy online, pickup in store, curbside pickup and delivery of 83.2% for Q2 as we quickly pivoted to focus on our online business and launch new fulfillment options for our customers.

As you might expect, early April was the most difficult period of the quarter. And then, as we quickly launched an expanded fulfillment options, including curbside pickup and same-day delivery, we saw sequential improvement as we moved through Q2, which accelerated as stores began reopening. As a result, for the month of June, our brand comp sales were down 6.5%. If we look at the cohort of stores that were open for the entire month of June, comps for these stores, including buy online, pick up in store, curbside pickup and same-day delivery, were up 6.3%.

This performance was driven by a very successful graduation season, including personalized products, as well as kid's birthday, and strength in balloons. The improving trends carried into July as consumers continued to celebrate in new and unique ways using balloons and other decorative items for cars and front yards in drive by celebrations, as well as in-home decorating for small, more private celebrations. our wholesale business declined 50% in Q2, as franchise and independent retail customers contended with the same pandemic headwinds to demand and store operations during the quarter. A bright spot to the quarter was the resilience of our Anagram balloon business, which generated moderating sales declines throughout April and May, followed by a double-digit increase in revenues in June.

On a consolidated basis, second-quarter total sales were down 54.8%. Fixed cost deleverage was a significant gross margin headwind. And while we moved swiftly to curtail expenses, the significant sales decline resulted in operating and net losses for the quarter. On the bottom line, loss per share was $0.66, and adjusted EBITDA was a loss of $42.8 million.

Tom will discuss our Q2 financial results in more detail in a moment. Let me now discuss the progress we made in Q2 against our key initiatives. No. 1, developing a more relevant in-store experience.

Due to store closures, we delayed the opening of our first three next-gen prototype stores to June. During July, we also remodeled our five Las Vegas stores and three of our Kansas City stores in this prototype, and the current plan remains to open 20 to 25 total next-gen stores in 2020, primarily remodels. We're addressing the fact that our stores can be overwhelming and time-consuming to navigate. The changes to the in-store experience we're 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.

While these initial stores have only been open a handful of weeks, the feedback from our customers and our store associates has been enormously positive. By decluttering the stores, bringing down the sight line and providing a more edited assortment, customers are telling us they believe we've expanded the store and are carrying more merchandise. The reality is we've reduced the number of SKUs in the inventory by more than 20%. Customer comments regarding the ability to locate product, put the party components together and overall ease of shopability have been resoundingly positive.

Our store associates are also extremely pleased that the improvements are making it easier to operate the store, thereby creating more time to engage customers. A separate balloon shop-in-shop with dedicated checkout that provides more personalized service while speeding up transactions for nonballoon customers in the existing queue has also been extraordinarily positive. On my visits to these stores, I'm especially pleased to see the additional energy and theater of balloons being filled and bouquets being created to the delight of everyone in the store. It's a true epicenter of joyful emotion in the store, which is exactly what we were seeking to create.

While it's too early to celebrate success, we're extremely pleased with the initial results and the insights we're gaining from the customer feedback, the operator feedback and the performance metrics across categories. No. 2, win with balloons. This is a critical initiative for us given our market leadership position as a manufacturer, wholesaler and retailer of this dynamic category.

Clearly, the next-gen store prototype is delivering on our goal to make balloons an even stronger key differentiator for our brand. Our unparalleled balloon assortment and innovation, coupled with an improved in-store experience and further strengthened by an elevated and expanded digital experience and delivery capabilities, will enable us to better leverage the inherent strengths of our vertical balloon business and expand our balloon upside across our Anagram, wholesale and retail businesses. Innovation is a critical component of our balloon growth. We're producing and supplying differentiated and inspiring products that are resonating with consumers.

New products introduced in the past several months are driving over 20% of the sales growth in the category. Additionally, our marketing and merchandising teams are elevating the balloon shopping experience and inspiring customers with improved product presentations, both in stores and online. New innovation in the digital space is also driving engagement. In Q2, we launched a new online digital balloon bouquet builder experience, including premium balloon bouquet offerings.

Buying balloons online with the ability to pick them up in store at curbside or have them delivered the same-day is also increasing balloon demand. In Q2, we made progress expanding each of these options. Balloons were more than 50% of our buy online, pickup in store, curb side pickup and same-day delivery sales. As consumers continue to seek unique, outward ways to express themselves, balloons remain an integral part of everyday celebrations, as well as key life events.

We continue to build relevance by providing consumers everyday reasons to celebrate with balloons. No. 3, address price value perception in key categories. Based on success from price reductions we executed last fall in our solid-colored tableware products, in late June, we lowered prices on approximately 3,000 SKUs across a broad selection of tableware, birthday-related products and seasonal items.

As we experienced in the initial fall 2019 price reductions, the customer is noticing and responding favorably with unit volume increasing in large enough quantities to create accretive gross profit dollars to the vertical supply chain. We're monitoring the performance daily, and initial results are surpassing our expectations. Based on the continued favorable consumer response, we're accelerating efforts to test additional product categories for future price reductions, which will address categories and SKUs that are key value indicators, have strong price elasticity and are highly competitive, including Halloween. We continue to expect that any potential negative impact to retail margin rate due to price reductions will be mitigated by a sharp reduction in previously ineffective promotions.

Notably, as an occasion-based retailer, we know we need to drive trust with consumers through the right price value every day rather than attempting to drive transactions through short-duration promotions that are only relevant to select customers. No. 4, improve our customer engagement selling culture. During Q2, in a largely closed-store environment, we focused on initiatives and actions to improve customer engagement through our marketing messages, our merchandising approach, as well as our digital initiatives, including expansion of fulfillment options for customer orders.

I am extremely pleased with our team's customer-centric shifts, which have resulted in significant progress in our ability to be a valuable partner in bringing joy and creating memorable moments for our customers. Each has been well-received and highly utilized. And collectively, they've made it significantly more relevant to consumers even as stores reopen, and they're enhancing our results today. From a digital perspective, we've made dramatic shifts in content, which are designed to make the experience inspirational, aspirational and more engaging to make it easier to create unforgettable memories.

First is the use of enhanced visual merchandising on our website using inspirational content with tagged and shoppable vignettes, which customers have immediately gravitated toward. Other new features include how-to videos and how-to programs, supported by product-infused content and influencer sharing, including summer camp at home, backyard olympics and graduation and birthday party redos, as well as podcasts and relevant ungated consumer content, including recipes, virtual parties and activity agendas. We leaned into consumers' expanded appetite for public expressions of joy, such as parades, front yard and porch displays. As we pivoted back to an open-store environment, we're continuing our efforts to engage customers as partners and providing solutions for their party needs with increased associate training along with scorecard metrics and incentive rewards focused on customer service.

No. 5, build on our omnichannel platform. As our stores reopened, customers' desire for buy online, pickup in store, curbside pickup and delivery remained strong. Curbside pickup is available in all of our stores, and all but a handful of our stores now offer same-day delivery.

We saw 324% growth in buy online, pickup in store, including curbside pickup during Q2 and 436% growth in June. Our expanded delivery program, including more convenient customer delivery windows, is helping drive our balloon business and uniquely positions us to attract new customers. We expect customers to continue to seek both contactless and more convenient ways to purchase products and consolidate their shopping trips. We will relentlessly optimize these experiences to drive customer loyalty and continued sales growth.

To that end, we introduced enhanced customer communication options for these new services and are piloting additional procedures to expedite the curbside pickup process to make this option seamless and even more convenient for customers. In summary, we made a lot of headway against our five key initiatives in a very short and challenging period of time, and we'll continue to keep you updated on our progress. On the wholesale side of the business, we're also seeing performance recover, both domestically and internationally. However, the pace and rate of improvement have not yet accelerated to the level of our retail performance.

Similar to our retail business, we saw North American wholesale trends improve throughout Q2, preserving approximately 70% of prior-period sales for the month of June and tracking ahead of that rate for the month of July. Our international business performance slightly exceeded this North American performance. Within wholesale in North America, Anagram was a meaningful outperformer with performance returning to positive territory in June,with the month posting strong double-digit increases. From a domestic channel perspective, mass and grocery were our strongest channels.

We remain confident that wholesale will continue to rebound to more normalized levels over time as our retail partners reopen stores and resume full operations. As we sit here today, we currently have 100% of our stores reopened, and much like we indicated on our last call, we saw performance building through the reopen period with a lot of waves of openings outperforming the earlier waves. This is reflected in our improved June comp performance of negative 6.5% and the building of that performance that we've seen thus far in Q3. While we were encouraged by this improvement and the early progress we're making against our strategic priorities, our enthusiasm is tempered by the environment of continued uncertainty.

This includes uncertainty around, first, potential future waves in spread of the virus; second, consumer confidence in spending once the initial stimulus impact is behind us; and third, consumer behavior and appetite for celebrations, including Halloween, as we enter the seasonally important second half of the year. And finally, our debt exchange offering. As you are aware, in June, we commenced the exchange offering that we first announced in late May in order to improve our financial health and flexibility. Todd will speak to the specific details, but I am extremely pleased that we successfully completed this exchange and accomplished the three financial goals we set out to achieve through the transaction, which were: one, extend our debt maturities; two, reduce our leverage; and three, increase our liquidity.

Notably, the completed transactions have the combined effect of reducing our total debt by $463 million, as well as providing $100 million in new capital to support our operations and transformation initiatives. In summary, while Q2 was a challenging quarter, we responded swiftly, taking the necessary action from an operational, as well as an expense and liquidity standpoint. We simultaneously worked diligently to execute against our strategic priorities and strengthen our financial position through the debt exchange process that is now complete. We're pleased to have all of our stores now open and be in position to meet customers' celebratory needs across channel.

Encouraged as we are with recent business trends, given the environment, we remain extremely disciplined, maintaining a conservative posture from an expense, cost, capex and working capital standpoint as we plan the second half, including a Halloween season that we currently expect to be down year over year. We're controlling what we can and staying nimble and ready for a range of scenarios. While demand is unknown, we're bullish on the changes we have made to 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, which will include our new curbside pickup and delivery options. All of these initiatives are laser-focused on the customer and will dramatically improve their experience with Party City during the fun and exciting Halloween time.

And now, I'd like to turn the call over to Todd to discuss the second-quarter results in greater detail.

Todd Vogensen -- Chief Financial Officer

Thanks, Brad, and good morning, everyone. Today, I'll focus on the key highlights of our second quarter and recent performance, and then I'll provide an update on our financial position. For full details regarding our second 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. The impact of COVID-19 on our second-quarter results was significant given the loss of store operating days for all of April and most of May.

In addition to its impact on retail store sales, the pandemic-related disruption also resulted in a significant pullback in franchise and independent orders for our wholesale segment. Consolidated revenues for the quarter were down 54.8% or 54.6% on a constant-currency basis, and brand comparable sales for the quarter were down 52.4%. The retail segment's second-quarter net sales declined 56.3%, both on a reported and constant-currency basis. E-commerce continued to deliver strong performance with growth of 83%, which includes store-fulfilled digital sales from curbside pickup, buy online, pickup in store and same-day delivery.

Our wholesale segment, which includes international, was also negatively impacted in the second quarter as many of our third-party retail customers temporarily closed their stores. Overall, net wholesale revenue decreased 50.3% in the second quarter or 49.5% on a constant-currency basis. Trends in our wholesale business also continued to improve throughout Q2, albeit at a somewhat slower pace than retail, driving revenues to approximately 70% of prior-year sales for the month of June with July tracking ahead of that rate. Moving down to P&L.

Adjusted gross margin rate declined by 1,860 basis points, mainly due to deleverage from lower sales caused by the temporary closure of stores. We expect sales dynamics will continue to be the primary driver of margin rate change for the remainder of the year. Adjusted operating expenses declined by $41 million or 26% from last year, driven largely by the temporary store closures during the quarter and the resulting cost reductions implemented in response to the COVID-19 pandemic. Our quick transition to curbside pickup enabled us to deliver sales improvements that were better than our expectations, and while there was an associated investment in store labor, the net impact on profitability was positive.

Even as we prudently add back costs with the reopening of stores and ramping of sales, we will continue to manage both expenses and capital with great discipline as we navigate the second half of the year. From a profit perspective, adjusted EBITDA was a loss of $42.8 million, compared to income of $81 million in Q2 of 2019. Adjusted net loss for the quarter was $61.3 million in Q2 of 2020, compared to adjusted net income of $20.2 million last year. And adjusted loss per share was $0.66, compared to adjusted EPS of $0.22 in the prior year.

Turning to our balance sheet. Inventory was down 19% and year over year at the end of Q2 due to both our proactive steps to manage the timing of orders to be more aligned with Halloween product sales and due to fewer stores from the Canadian retail divestiture and the 2019 store optimization program. Importantly, the composition of inventory is largely long-lived in nature with most of the seasonal items relevant beyond the current year. As a result, we do not expect significant inventory exposure related to the COVID-19 disruption.

At the end of the second quarter, we had $326 million outstanding under our revolving credit facility, and total ending net debt was $1.74 billion. We had $154 million in cash and cash equivalents, which, when combined with $136 million of revolver availability, resulted in total liquidity at quarter end of $290 million. Our ending liquidity represents an increase of $25 million compared to the end of the first quarter. Throughout the quarter, preservation of our financial health and flexibility remained our top priority, and accordingly, we continued to aggressively manage expenses, inventory and capital expenditures.

As I outlined on our last call, we took actions to cut back on both payroll and nonpayroll expenses, including working with landlords to effectively manage occupancy expenses. In addition and by far the most significant development on this front was the successful completion of our debt exchange offering, which I'll discuss in a moment. In terms of capital expenditures, we continue to plan for a significantly reduced 2020 capex budget, which is expected to be $35 million to $40 million, down from $62 million last year. We will continue to prioritize spend related to select next-gen stores, as well as important investments in equipment and technology.

Also, and as we previously disclosed, last year, we generated $130 million in proceeds from the sale of our Canadian stores to Canadian Tire. We've reinvested a significant portion of these proceeds and assets for our business, and we expect to deploy the remaining balance of those proceeds in the near future. Any proceeds from this transaction that have not been invested or committed for investment by October 1 would need to be used for pay down of our term loan at par value under the terms of that agreement. Regarding the previously announced debt exchange offer, the offering expired on July 27 with approximately 84.7% of existing notes validly tendered and accepted for exchange by the company.

Importantly, this includes more than 93% of the 2023 notes, meaning that a significant amount of our 2023 notes now mature in 2025 and '26, which provides a strong pathway to refinancing our term loan that is due in 2022. Through the exchange offer, participating holders of our 2023 and 2026 notes received a combination of 15.9 million shares of common stock, $84.7 million of second lien notes due in 2026 and issued by Anagram and $161.7 million of senior secured first lien notes due 2025, issued by Party City Holdings. In addition, the company generated $100 million in new liquidity through $110 million in first lien notes due in 2025 and issued by Anagram as well. As a result of this successful transaction, we materially reduced our total net debt from $1.74 billion to $1.28 billion and extended our maturities out to five years or more from the transaction closing.

Accompanying slide deck includes the table that details our debt and cash pro forma for the completion of this exchange offer. As Brad mentioned, the exchange offering has the combined effect of deleveraging our balance sheet by approximately $463 million and raising approximately $100 million in new capital to increase our financial strength and support our global operations and ongoing transformation initiatives. Also as a result, 2020 interest expense, assuming current interest rates, is expected to be approximately $80 million. This is about $25 million below our original expectation of $104 million to $106 million for the year.

The reduction is due to $5 million in partial-year impact of the exchange offers, as well as $20 million in the onetime elimination of the August 2020 semiannual interest payments for the senior notes that participated in the exchange offer. On a pro forma annualized basis, we expect interest expense to decrease by $10 million. In addition, shares outstanding will increase by 15.9 million. Given the continued uncertainty around the duration and trajectory of COVID-19-related disruption, we are not providing additional 2020 outlook at this time.

So in summary, the second quarter was a challenging one given the peak COVID-related impact and disruption across the business. Despite this, we're proud of how quickly and nimbly our teams pivoted to the changing operating conditions, positioning us to capitalize on a successful graduation season and strong kids birthday demand, including balloon sales. As Brad discussed, we're encouraged by the sequential improvement we saw as the quarter progressed and into July, as we made the necessary adjustments to our business. However, we head into the seasonally important Q3 with appropriate conservatism given the still pervasive nature of the pandemic in our country and the resulting impact on the safety and desirability of group celebrations, including Halloween.

While we are reimagining the holiday, as consumers undoubtedly are too, we are planning the season to be down year on year and stand ready to chase, should demand exceed our expectations. We will continue to manage liquidity and expenses with great discipline even as we push forward on our key strategic priorities to drive the stabilization of our business and long-term growth. With that, I'll turn the call over to the operator to start the Q&A session.

Questions & Answers:

Operator

Thank you. We will now begin the question and answer session. [Operator instructions] Your first question comes from Seth Sigman with Credit Suisse. Please go ahead.

Seth Sigman -- Credit Suisse -- Analyst

Hey, guys, good morning. Thanks for taking the question. I wanted to talk about e-commerce. I think that was one of the bright spots in the period, and you made a lot of changes there.

A lot of the e-commerce growth seems to be centered around the store, right, delivery and pickup and curbside. Two questions. One, what are you learning about how the customer likes to shop in your category? And why they would rather pick it up in the store versus getting it shipped, and I'm thinking beyond even just balloons? And then, second, more about the capacity of that model. How can you handle peak periods of volume with this model? What are you learning about it? And how are you planning? Thanks.

Brad Weston -- Chief Executive Officer

Thanks, Seth. It's certainly been interesting to see the customer's immediate appetite for buy online, pickup in store and curbside pickup. We have adjusted our label models such that we can handle some of the additional strain that puts on store associates. But because we had time before the stores were really open to ramp up this capability, it went pretty seamlessly, and we've learned to really operate that.

Certainly, the driver of that activity is [Inaudible] especially. Also, beyond that, I think the consumers just continues to look to consolidate their trips. We see in our purchase basket and our average order value that we're continuing to become more of a one-stop destination. And I think those two activities are really driving the consumer's mindset that Party City is that destination.

They can get everything they need. They can get it conveniently. So we're pleased with the consumers' response, and we're pleased with our operating capabilities to create an increasingly better experience at curbside. We're continuing actually to invest in that experience for the consumer.

We see that as something that is going to be around for a while. And we see opportunities to continue to add technology, add capabilities that will continue to make that an even better experience beyond what's probably partially just a contact-free environment today.

Seth Sigman -- Credit Suisse -- Analyst

OK, all right. That's helpful. And then, my follow-up question was just around the gross margin and the performance in the quarter. I think you talked about some of the factors, but can you just help us understand, as sales improved in June and into July, did you also start to see an improvement in the gross margin trend? And then, the second part of it is just stepping back.

A lot of factors here. Last year, you had helium. This year, fixed cost deleverage and a bunch of other things. Do you have a sense as to what your normalized gross margin could look like, and when you could potentially get there?

Todd Vogensen -- Chief Financial Officer

Sure. So this is Todd. I'd say as we look back across Q2 and even for the rest of the year, the No. 1 impact on leverage is going to be net sales, sales volume.

We have a lot of puts and takes between helium costs in Q2 that were higher. We started wrapping around them on the helium cost increases in Q3, so that starts to abate a little bit. We do have some mix benefit from balloons where we have the benefit of just plain higher-margin rates within the product categories and a host of other things. But the sales leverage is going to be the No.

1 factor. And I would think that all of our other variable margin elements should tend to wait out to be relatively flattish to maybe slightly better when we look at the impact of less promotions and the unit volume increase from price reductions in the store. So we're not giving exact guidance going forward, but I can tell you, if we can get back to a point of normalized sales, you should be looking at a margin rate that is improving over time.

Seth Sigman -- Credit Suisse -- Analyst

OK, OK. Thank you. Good luck.

Brad Weston -- Chief Executive Officer

Thank you.

Operator

Next question comes from Simeon Gutman with Morgan Stanley. Please go ahead.

Simeon Gutman -- Morgan Stanley -- Analyst

Good morning, everyone. My first question is on June, which seems to be the restart for you officially. Can you talk about how it compared to your expectations? And I'm more curious around the predictability of the business as opposed to how good you are at forecasting at this point? And then, can you clarify July? It sounds like it's still positive. Can you say if it's accelerated or decelerated versus the June run rate?

Brad Weston -- Chief Executive Officer

Yeah. So we're still in the process of closing July, and I really can't share more details on that performance at this time. The July brands comparable sales were positive, but sales trends remain fluid. And obviously, we're looking at Q3 and just not going to go into that level of detail.

Certainly, our customers are celebrating in different ways with parades, driveway parties, virtual celebrations. And the stores that have reopened, we're seeing the categories really improving sequentially in broad-based level of success, which, like I said, has accelerated into July. As we moved through the month of June, we saw a continued upswing in sales by week early in the month. That was driven by sales reopening.

And as all stores reopened in the back half of the month, we saw continued improvement. We also saw the mix of the sales adjust from early in the month being much more driven by online and by curbside. And then, as we sequentially move through the month and as we sequentially move through July, we saw that find a more predictable rate and pace and penetration of sales and saw how it balanced with the stores. So what we're seeing is something very consistent, consistently improving and consistently stabilization in our mix of sales.

Simeon Gutman -- Morgan Stanley -- Analyst

OK. And then, my follow-up is can you remind us what percentage of the Party retail sales are balloons? How is that looking like at present? Because I assume the mix of the business is changing. As you mentioned, Brad, it's fluid. And then, what are we lapping? I think we can figure out from the prior year, but what are you lapping in terms of the balloon category in terms of growth or decline from the prior year? And if you can distinguish between Q3 and Q4, that would be helpful.

Brad Weston -- Chief Executive Officer

Let me answer the first part. Not quite sure I understood the second, but let's do the first part and then we can come back. We said in the past that balloons is 20% of our retail sales on an annualized basis. I'm not going to quantify percent of sales for June that were balloons.

But as we've discussed, balloons is a key differentiator for us across wholesale and across retail. So we're focused on the growth of the category broadly. The penetration of Balloon sales within our retail business fluctuates really by quarter, depending on the number of factors, as you would speculate. In Q2, balloons was higher than its typical Q2 penetration based on the types of celebrations that are happening, as well as our improved execution, which, quite frankly, really creates further runway.

As we discussed back in March, we saw early success in our same-day balloon delivery initiative prepandemic. And now with an increase in curbside pickup, same-day delivery as part of our expanded omni capabilities. The balloon category is definitely benefiting from the ability for customers to more easily procure them. And what was the second part of your question, Simeon?

Simeon Gutman -- Morgan Stanley -- Analyst

I guess, the simple way is what were balloon comps or revenues down in last year's third quarter and last year's fourth quarter?

Brad Weston -- Chief Executive Officer

Yeah. So balloon comps is, we were challenged with helium back in the third quarter and fourth quarter of last year if you recall, we were really seeing the rebound of helium in Q3. But at that time, our business really pivots to Halloween, and the balloon business, as you can imagine, really drops in penetration. As we went into fourth quarter, we really saw the balloon business start to pick back up.

It was never particularly negative, it was just not as significantly positive in our business prior to our helium shortage challenges.

Simeon Gutman -- Morgan Stanley -- Analyst

Thanks.

Operator

Our next question comes from Rick Nelson with Stephens. Please go ahead.

Rick Nelson -- Stephens Inc. -- Analyst

Thanks. Good morning, guys. So just to get more color around how you're prepping for Halloween. I know you're saying it's going to be down.

Any feel for magnitude and how you see consumers celebrating Halloween?

Brad Weston -- Chief Executive Officer

Yeah. So we're not really providing forward-looking guidance, so not going to get too specific with the numbers. For financial P&L expense management, we are being protected. So even though we see it down, we're planning Halloween, we're really just trying to avoid overspending against potentially decreased demand.

But I would say the situation is really fluid, and we have to be fluid. We're approaching Halloween really building in flexibility to meet all variables in potential demand. We bought conservatively and have appropriate carryover from 2019 to 2020. We plan to go into the Halloween season conservatively, knowing we have the ability to really refill in-demand product if demand proves to be stronger than expected.

We certainly believe Halloween is going to happen in some form and it's likely to be different regionally across the country based on what local communities mandate and how people in different communities really feel about the safety of Halloween activities. We believe the kid's costume business will continue even if celebrations occur at home. And if the way consumers are decorating today, we anticipate that Halloween decorating will be robust. The more unknown piece is what the environment will be for adult parties.

We'll continue to expand our omnichannel offer and be prepared to meet the customer where the customer wants to engage, obviously, whether that's in store, online to pick up at the store or through delivery. Rick, I'd tell you that we're certainly bullish on the approach that we've taken to completely revamp our Halloween assortments, really, to capitalize on our breadth of costumes and the digital experience, which is going to be full of inspirational ideas, how-to videos really related to the latest dress up ideas, as well as our in-store merchandising, our marketing, our new lower pricing and the new buy online, pickup in store, buy online, pick up at curbside and delivery options that will all be major improvements over last year. So I can tell you that if demand is there, we will definitely capitalize on it.

Rick Nelson -- Stephens Inc. -- Analyst

Great. To follow up, as the consumer shifts online and toward curbside pickup, is there opportunities to reduce the cost structure, you don't need so many people in the store? Or if you could speak to the expense side of things with online.

Brad Weston -- Chief Executive Officer

Yeah. So first and foremost, let me just remind everybody that we want to serve customers the way that they want to shop and purchase from us. Therefore, we're absolutely channel agnostic. Curbside pickup of an online order is margin favorable as it eliminates the shipping and packaging expense.

So if the high penetration continues, the profitability of our e-commerce business should improve as well. We did sacrifice some efficiency and profitability for the sake of speed of the launch and expansion of some of these fulfillment capabilities recently, and it was the right thing to do and the customer response was good. But our focus is to be increasingly efficient from a cost standpoint. So we're going to continue to assess the margin mix and work to reduce the cost of fulfillment in every channel, and that includes the store.

I think Seth asked a similar question about our pivot to that and our efficiency around the pivot to that. We're learning as we go, and we have a lot of learnings. We're starting to understand as we take pressure off some of the operations in our stores with our assortment improvements. Our reduction in inventory, we know that does free up hours, and that can free up hours for customer engagement, whether that is assisting a customer in the aisle or assisting them at curbside or preparing delivery or buy online, pickup in store orders.

So work in progress, but we firmly have our arms around it and continue to find efficiencies every day.

Rick Nelson -- Stephens Inc. -- Analyst

Great. Thanks a lot. Good luck.

Brad Weston -- Chief Executive Officer

Thanks, Rick.

Operator

Your next question comes from Tami Zakaria with JP Morgan. Please go ahead.

Tami Zakaria -- J.P. Morgan -- Analyst

Hi, thanks for taking my question. So on the same-day delivery from stores, could you comment on how you're fulfilling those orders, meaning whether you're partnering with any third-party to do the actual delivery? And how does that impact the margin profile of the business?

Brad Weston -- Chief Executive Officer

Yeah. So our partner today is both Shipt and Hertz. We primarily rely on Hertz for van for large balloon orders, but more than 90% of our delivery is through Shipt. And the delivery fee for that is $9.99, free for orders over $35.

The average cost to us is around $12. And so the economics of it are proving to be very good. The driver of that is -- our AOV is our highest AOV deliveries. And because a lot of that is balloons, it drives a high AOV, and it drives a high margin.

Tami Zakaria -- J.P. Morgan -- Analyst

Got it. That's super helpful. And then, just quickly, is historically back-to-school an important season for you? And what are you seeing in terms of back-to-school shopping?

Brad Weston -- Chief Executive Officer

Yeah. Back-to-school actually is not a particularly big season for us outside of our regular everyday business during that time period. Really, we get some business and teachers preparing with decorations for classrooms. Obviously, that will be a little bit different this year.

But a lot of teachers, we anticipate, as happens with virtual parties online, if there's virtual learning, there's still a decoration element that happens with that, especially in smaller, younger classroom environments. But relative to the dollar volume that we see from back-to-school, it's low.

Tami Zakaria -- J.P. Morgan -- Analyst

Got it. Thank you so much, and best of luck.

Brad Weston -- Chief Executive Officer

Thanks, Tami.

Operator

Your next question comes from Joe Feldman with Telsey Advisory Group. Please go ahead.

Joe Feldman -- Telsey Advisory Group -- Analyst

Hey, good morning, guys. I wanted to ask a little more about pricing. And I guess, where are you in the effort? Like, are you at a point where you want to be? And how are you guys getting there, meaning like who are you benchmarking against? Are you trying to be like a certain percentage within a range of Walmart or Dollar Stores or The Grocers? I guess, how should we think about where you are in this kind of evolution?

Brad Weston -- Chief Executive Officer

Yeah. So like I said, we've lowered prices on approximately 3,000 SKUS, really focused on our kids birthday assortments, tableware, solid tableware, seasonal tableware and decorated tableware, as well as costumes and accessories. And we are looking to expand the penetration of those changes. We're planning additional reductions on another large number of SKUs prior to the Halloween selling season.

We remain acutely in tune with price elasticity, both historically and in the current environment, and have really not seen any significant changes that would erode our confidence in our analysis or the outcomes we're seeing. I would say that the next group of changes is going to be significant, and more than the last. Again, we're looking at key value indicators, like elasticity, and what really are the trip drivers and the basket builders and how do they perform. We now have data that allows us to see elasticity at the SKU level and the category level.

We see the opportunity to touch as many as one-thirds of our total SKUs and touch two-thirds of our categories. In terms of benchmarking, our real competition is Walmart, Target and Dollar Stores for everyday party products. We don't benchmark against any one of them singularly, and we're not targeting a specific range. We're really driven by our own performance.

The elasticity that we see really guides us because that's what determine -- helps us determine where the sales and the margin can end up. We want to be competitive, but we also know that we don't have to be exactly at the prices of competition, like Walmart or Dollar Stores, because we offer -- as a specialty retailer, we offer a broader level of choice, we're more assortative, incredible in the category. And we're a one-stop shop destination. So we don't have to be at those competitors' prices, we just need to find the space where consumers -- really the elasticity level where consumers trust us and we're driving unit increases and gross profit dollar increases.

Joe Feldman -- Telsey Advisory Group -- Analyst

Got it. That's really helpful. And then, another question with regard to the stores, the next-gen stores. I know it's very early, but it sounds like it's really off to a very good start.

I know, at the moment, I think you said you're only targeting like 20, 25 stores for next year. I guess, is that up for acceleration if you're really liking what you see in the back half of this year? Like, is there an opportunity to accelerate that? And I was also curious what the cost is to kind of upgrade the store to this next-gen model that you like?

Brad Weston -- Chief Executive Officer

So we originally had hoped to do 35 to 45, which was going to be kind of maxing out our capacity of getting all of the learnings that we sought to achieve, both from how does the store perform with customer feedback? How does the store perform from a sales perspective across categories? How do we learn what the right capital expenditure for the stores is since they're predominantly remodeled, and we are focused on making them as impactful as possible and as capital-light a possible manner? We had to truncate that activity because of the pandemic, and so where we initially thought we might not hit 20 to 25 then. But with the acceleration in our business, great early performance and our desire to get as many learnings as possible this year to inform 2021 and beyond, we have pushed that number up to about all we can accomplish. Obviously, we're moving into early fall, Halloween prep season then Halloween and then to holiday, and so we're pushing as many into the pre-Halloween period as possible. We think that will give us as many learnings as we can, again, both on the sales uplift side, the operating side, as well as the cost side, all things yet to be learned and determined.

Our desire, clearly, is to accelerate these as fast as possible when we find the right mix of all the things that we are working on. As you said, the initial performance, while early, is still really positive, both on the sales side and the customer feedback side. But I can tell you, having just gotten the first three open at the end of June and then more in July in an environment that we're in, we're learning. We're learning a ton, and we're right in the midst of an important learning time period.

Joe Feldman -- Telsey Advisory Group -- Analyst

Got it. That's helpful. Thanks. Good luck with this quarter then.

Brad Weston -- Chief Executive Officer

Thanks, Joe.

Operator

Our next question comes from Carla Casella with JP Morgan. Please go ahead.

Carla Casella -- J.P. Morgan -- Analyst

I'm wondering if you can give us a sense for your bad debt expense related to retailers. And then, on that same note, how many of your customer doors remain closed, and if you expect any to close permanently on the wholesale side?

Brad Weston -- Chief Executive Officer

I'm sorry. I might not have caught the first part of your question.

Carla Casella -- J.P. Morgan -- Analyst

The bad debt expense related to your wholesale customers.

Brad Weston -- Chief Executive Officer

Yeah, yeah. At this point, it's been minimal. We've had a couple of customers that were in trouble, one franchisee that had to close stores. And so we've taken a cautious approach, but it just has not been material at this point.

In terms of overall retail, we are continuing to see that there's demand out there. So while our independent stores and franchise stores are ramping up at a slower pace than our retail yet, we have a lot of initiatives under way there are gaining traction. We have a lot of capabilities that others might not, and we're taking advantage of that. But net-net, we feel like we're positioned well from a wholesale perspective.

Carla Casella -- J.P. Morgan -- Analyst

Do you have a sense for how many of your wholesale customers' door are still closed? Or most of them are open now, just like yours?

Brad Weston -- Chief Executive Officer

Oh, yeah, most of them are open now at this point.

Carla Casella -- J.P. Morgan -- Analyst

OK. And then, just one other one on cash flow. CARES Act, I'm wondering if you got any easy-to-quantify benefit? And then, if you expect any working capital benefits for the remainder of this year or in '21 related to tax, changes with tax related to the CARES Act.

Brad Weston -- Chief Executive Officer

CARES Act, we're at a size where we haven't seen a lot of the impacts flow through to our own benefits. So there are some impacts in terms of sales tax. We were able to delay our tax payment from April and into Q2, though it was relatively small. But I wouldn't say there's anything material that you would not to worry about from a modeling perspective.

Carla Casella -- J.P. Morgan -- Analyst

OK, great. Thank you.

Brad Weston -- Chief Executive Officer

Thank you.

Operator

That is all the time we have for questions today. I would like to turn the conference back over to Mr. Brad Weston for any closing remarks.

Brad Weston -- Chief Executive Officer

Thank you, everybody, for joining us today. In conclusion, our second quarter and the weeks following have been pivotal for our company. We achieved a number of critical accomplishments that position us for success, both the near -- in the near term and the long term. Driving an unparalleled experience in the Party City brand underpins our entire strategy to stabilize and revitalize our retail business, and I am proud of the enormous progress we've made on this front against each of our five strategic priorities.

The resilience and agility of our teams have been on full display with rapid launch and expansion of additional customer fulfillment options and merchandising and marketing strategies that are resonating in this current environment. We expanded our omnichannel capabilities, dramatically enhanced our digital experience, made meaningful strides to address our customer value perception opportunity and launched important new store format prototypes, all in an extremely difficult environment. Our customers' response to these actions have not only been positive but have exceeded our expectations. In addition, the debt exchange, which significantly reduces our overall debt, extends our bond maturities and adds liquidity, has meaningfully improved our financial flexibility.

It really enables us to continue to invest in and make progress against the opportunity we see for our brand as we seek to establish Party City as the undisputed go-to destination for customers to create joy and make unforgettable memories. That said, I'd like to reiterate that the environment remains uncertain with an end of this pandemic not yet in sight. So we remain very disciplined in our approach to managing expenses and capital as preserving our financial health and liquidity remains our top priority. At the same time, we're staying flexible so we can adapt quickly to changing operating conditions.

With focused execution of our strategic priorities, we are moving forward with our plan to stabilize the business and reposition Party City for enduring success. And thanks again, everybody, for joining us.

Operator

[Operator signoff]

Duration: 27 minutes

Call participants:

Ian Heller -- Vice President and Deputy General Counsel

Brad Weston -- Chief Executive Officer

Todd Vogensen -- Chief Financial Officer

Seth Sigman -- Credit Suisse -- Analyst

Simeon Gutman -- Morgan Stanley -- Analyst

Rick Nelson -- Stephens Inc. -- Analyst

Tami Zakaria -- J.P. Morgan -- Analyst

Joe Feldman -- Telsey Advisory Group -- Analyst

Carla Casella -- J.P. Morgan -- Analyst

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