Party City Holdco's (PRTY) CEO Jim Harrison on Q4 2017 Results - Earnings Call Transcript

Party City Holdco, Inc. (PRTY) Q4 2017 Results Earnings Conference Call March 8, 2018 8:00 AM ET

Executives

Ian Heller - Associate General Counsel

Daniel Sullivan - CFO

James Harrison - CEO

Analysts

Seth Sigman - Credit Suisse

Rick Nelson - Stephens

Mike Baker - Deutsche Bank

Joe Feldman - the Telsey Group

Curtis Nagle - Bank of America Merrill Lynch

William Reuter - Bank of America Merrill Lynch

Christopher Prykull - Goldman Sachs

Operator

Good morning. My name is Jack, and I'll be your conference operator today. I would like to welcome everyone to the Party City Fourth Quarter 2017 Earnings Conference Call. At this time all participant are in a listen-only mode. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the call over to Mr. Ian Heller, Associate General Counsel of Party City. Thank you. Mr. Heller, you may begin.

Ian Heller

Thank you, operator. Good morning, everyone, and thanks for joining us. This morning, we released our fourth quarter and full year 2017 financial results. You can find a copy of our press release on our website at investor.partycity.com.

Now I'd like to introduce our executive team who are here on today's call. We have Jim Harrison, our Chief Executive Officer; and Dan Sullivan, our Chief Financial Officer. We'll start the call with some prepared remarks by Dan and Jim, before we open it up for Q&A.

Please note that in today's discussion, management may make forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995 regarding their beliefs and expectations about the company's future performance, future business prospects or business events or plans. These statements are subject to risks and uncertainties that could cause actual results to differ materially from these statements. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we can give no assurance that such expectations will be realized. We expressly disclaim any duty to provide updates to our forward-looking statements whether as a result of new information, future events or otherwise.

We encourage everybody to review the safe harbor statement provided in our earnings release as well as the risk factors contained in our SEC filings.

During today's call, we will refer to both GAAP and non-GAAP financial measures of the company's operating and financial results. For information regarding our non-GAAP financial measures and reconciliations to the most directly comparable GAAP measures, please refer to the earnings release.

And with that, I'll turn the call over to Jim Harrison.

James Harrison

Thank you, Ian, and good morning, everyone, and thank you for joining us today. As you saw from our earnings press release, our fourth quarter results were in line with expectations and within the outlook ranges we've provided. With top line growth of 4%, adjusted EBITDA growth of 5% and adjusted EPS growth of 8% for the full year 2017, we largely achieved our business and financial objectives.

More importantly, we have accelerated strategic and operational efforts to ensure sustainable future growth across both the retail and consumer products businesses. As we enter 2018, we are well-positioned to deliver solid financial performance, as we continue to take the right steps to position the business for even greater success.

Allow me to begin by providing an overview of the company's performance for the year and then discuss the progress we are making across critical strategic initiatives. Dan will then discuss our financial and operational results in greater detail as well as the outlook for 2018. After which, we will open up the call for your questions.

Consistent and sustainable growth is a trademark of this business, and 2017 was yet another reminder as it represented the eighth consecutive year of constant currency top line growth and 17th year of consecutive EBITDA growth. A closer look at underlying performance for the year once again demonstrates the inherent strength of our business model.

Despite essentially flat comp sales after taking into account the effects of the hurricanes and New Year's Eve calendar shift, we grew the top line by 4%. This was done by activating a number of top line growth levers, which, in large part, are unique to our business, including expanding channels of trade across the consumer products businesses and strong growth internationally.

We significantly expanded the reach of our vertical model, largely with accelerated manufacturing Share of Shelf gains driving 40 bps of gross margin improvement.

We continue our focus on strong cost control and efficiency, with year-over-year productivity increases in both retail stores and manufacturing businesses. Furthermore, we realized meaningful benefits from our global sourcing operations.

2017 was also another year of generating strong cash flow from operations, with double-digit free cash flow growth allow us to fund further acquisitions, and most significantly, a highly accretive share buyback program.

2017 was a year where we made significant advances in the execution of many of our strategic initiatives. Firstly, we made good progress in improving our retail execution, offering consumers a more tailored assortment and an improved in-store shopping experience.

Our consumer research has shown that the party goods category is best shopped in-store where the complete assortment of over 22,000 highly coordinated SKUs can be fully experienced by our customers. This is why our fleet of over 800 company-owned stores remains a great asset, a true competitive advantage and a good place for continued capital investment.

In support of running an even better store, we deployed over 20 separate retail store operating initiatives aimed at standardizing and simplifying store operating procedures, improving store labor efficiency and freeing up the resources necessary to be redeployed into customer-facing activities.

We also scaled up a new proactive selling pilot in over 50 stores, where we've had the labor and technology and a broader selling-focused program designed to enhance the customer engagement in stores. Initial results are encouraging, and Dan will discuss this in more detail later.

As the lines between brick-and-mortar and e-commerce further blur, our omnichannel strategy positions us well to enhance and simplify the consumers shopping experience online. And in 2017, we took a number of important steps in this regard.

Over the course of the year, we successfully introduced several enhanced technology applications aimed at simplifying the shopping experience for our customers, including online inventory availability checks and buy online, pickup in store. Both [ph] been extremely well received by our customers, with Q4 sales of over $3 million. Additionally, we are encouraged by initial positive impact we are seeing on growing the basket.

During the fourth quarter, we also completed the first phase of replatforming our e-commerce site, making the necessary improvements to the technology, core functionality, as well as responsiveness of the website.

This first phase of work serves as a foundation for a broader site replatforming, which will be occurring late in the first half of 2018, which, in addition to enhanced product creative and site content, we'll also support better usability, check outflow and a browsing experience for our consumers, particularly on their mobile platform.

The consumer products business has performed well in 2017, and we remain excited about all of the underlying growth opportunities that we see, both in the U.S. and across international markets.

The U.S. business continues to effectively navigate the declining franchise and independent businesses by capturing increased share of the largely untapped alternative markets.

The consumer's desire for experiential celebrations, in part out of home, provides the opportunity for us to bring a broader product offering to entertainment and non-traditional retail channels. Late last year, we executed a sales force reorganization that provides the necessary focus and experience for the organization to capture these opportunities.

While still focusing on the core business of selling decorative party goods in major discount, party and merchant retailers, we will also capitalize on the far broader opportunities our product portfolio and manufacturing capabilities provide, including costume kits and accessories on cruise ships; branded popcorn tops for movie theaters; direct-to-consumer fulfillment for key retailers, such as Staples and Disney; and licensed souvenir products of sports stadiums.

By leveraging our vast licensed product portfolio, unique manufacturing and sourcing capabilities and newly defined sales organization, we are convinced that the double-digit growth rates realized in 2017 are a good indicator of a long-term potential for these channels.

Internationally, our consumer products business grew 15% in 2017 in constant currency. This strong growth was delivered by the deepened partnerships with key retailers across multiple geographies. We also broadened our Mexican market position with the acquisition of Granmark and expanded our properties across many markets.

Whether you are Mars in the U.K., the [indiscernible] in Germany or a Big W in Australia, you will see an increasingly developed category and broader assortment of party goods, largely anchored by the Amscan brand. With a 2-year constant currency growth rate of about 12%, we are making great progress, but much more to do and achieve.

Acquisitions were an important part of our success in 2017 also. Through the lens of the manufacturing businesses, the Granmark acquisition provided a new capability on printing on paper, while serving as a stronghold in the highly attractive Latin American market.

In 2017, Granmark began manufacturing and shipping to our U.S. distribution centers with products such as banners, candles, stickers and other decorative items, all of which had previously been sourced from Asia. This activity will accelerate in 2018 and beyond. Similarly, the acquisition of Print Appeal has given us entry into the growing and highly profitable market of personalized products.

Scaling up previous acquisitions and adding these new capabilities in 2017 helped deliver over 200 basis points of gains in manufacturer's Share of Shelf, and Dan will discuss the associated gross margin benefit shortly.

From the standpoint of retail acquisitions, we added almost 9% of retail square footage in 2017, with over 60% of the increase coming via acquisition. By acquiring 36 franchisees and 8 independent stores, we've strengthened the Party City brand and solidified our presence in key markets, all at very attractive economics.

2017 also marked an important year in the effort to reinforce the Party City brand, while strengthening our digital assets. In conjunction with Halloween, we deployed a new brand creative using omni [ph] as traditional media, social network activation, key [indiscernible] and influences. The Party City brand maintains a very strong level of brand awareness and consideration with consumers. And we were pleased with the initial results of our new creative campaign, which launched ahead of Halloween.

Our overall brand communication resonated well with consumers and was activated across all forms of media. In the fourth quarter, we focused on SEM [ph] efficiency to drive traffic and doubled our year-over-year digital spend to support our shipment strategy to support programmatic platforms and paid social.

Speaking of residual assets. In 2017, we initiated the development of an electronic marketplace that enable consumers to plan their celebrations by connecting them directly with related party service vendors. Having now live in the Dallas, Fort Worth market in the latter part of Q4, we are encouraged by the early results and key learning’s.

In 2017, we invested approximately $0.03 per share in the development of this platform called Kazzam, and it will remain at the forefront of our long-term digital strategy. We are currently finalizing plans for a broader expansion in 2018.

Finally, as you all saw, we executed a highly accretive share buyback program in the fourth quarter. Be assure that we remain committed to disciplined capital allocation that balances growth objectives with the continued deleverage of our balance sheet and the maximizing of returns to our shareholders.

In summary, 2017 was another successful year, with financial results largely in line with our expectations. With top line growth of 4%, EBITDA growth of 5% and an EPS growth of 8%, we once again demonstrated the ability to deliver strong and consistent growth.

As we look to 2018, we anticipate solid top line growth through a healthy combination of both retail and consumer product growth, and we are off to a fast start.

Since late December, we've finalized the acquisition of 18 stores, representing a combination of independent and franchise operations, and have also finalized a deal to acquire 8 more stores over the course of 2018. This will support our growth objectives for 2018, while offering us the opportunity to strengthen our brand and broaden our access to key markets for the future.

In 2018, further expansion of our vertical model and continued cost (inaudible) will enable strong income from operations performance and mid-single-digit EBITDA growth, while we reinvest in our strategic growth initiatives and manage the headwinds associated with the tightened labor market and expected commodity cost pressures.

And now I'd like to turn the call over to Dan to discuss the results as well as our 2018 outlook in more detail.

Daniel Sullivan

Thanks, Jim, and good morning, everyone. I'll provide further insight on our financial and operating performance for the quarter and for the full year before discussing our outlook for 2018, and then we'll open up the call for questions.

As you heard Jim mentioned, 2017 was another solid year for us, both operationally and financially. We continued to execute well against our strategic priorities, driving further EBITDA and EPS growth, despite choppy comps, largely attributed to some transitory issues.

For the full year, net sales increased 4% on a constant currency basis, gross margin rate expanded 40 basis points, adjusted EBITDA increased 5%, and adjusted EPS increased 8%. And we generated free cash flow of $342 million, up 11% from last year.

Our fourth quarter results were overall in line with our expectations, with solid top line growth of nearly 5% on a constant currency basis. Strong wholesale revenues and retail store growth more than offset a slightly softer retail brand comp.

And when combined with gross margin expansion of 50 basis points and disciplined cost control, drove adjusted EBITDA growth of nearly 3% and adjusted EPS growth of 7%. These results once again illustrate the power of our unique vertical model as we continue to leverage all of our assets and drive additional Share of Shelf gains.

Looking more closely at our fourth quarter results. Consolidated revenue grew 5.4% on a reported basis or 4.7% when adjusted for currency. In our retail segment, sales increased just over 4% in constant currency, largely a result of an increase in retail square footage over the last 12 months.

At quarter's end, our store network totaled 951 stores, 803 of which were corporate stores. Our brand comparable sales, which include our U.S. and Canadian permanent stores and North American e-commerce business, declined 1.4%, and were essentially flat for the quarter when adjusting for the New Year's Eve calendar shift.

We were pleased with the performance of our Everyday category, which grew about 3% in the quarter, driven by a strong growth in juvenile birthday and reflective of our focus on improved merchandising efforts in-store, better in-stock position on key license properties and the development of impactful new generic trend patterns, which were well received by customers.

Additionally, our mylar balloon category continued to accelerate its growth. We're also encouraged that our web comp rebounded post Halloween, as we took steps to address the SCO [ph] performance issues that we discussed last quarter. Our Q4 North American e-commerce comp was up 0.5% when adjusted for (inaudible) as enhanced SCO monitoring and more effective promotions helped drive traffic to the site.

Turning to the non-vertical consumer products businesses. Net revenue increased 12% in Q4 after adjusting for the impact of franchise acquisitions and foreign exchange. As expected, this represented a significant acceleration from Q3 results, with strong performance from both our domestic and international businesses.

In the U.S., we grew over 8% when adjusting for the impact of acquired franchise stores, led by double-digit growth in our alternative markets business and the Print Appeal acquisition in July of last year.

International consumer products delivered 20.2% constant currency revenue growth in Q4, benefiting both from the addition of Granmark in Mexico and accelerated organic growth across key markets in the U.K., Europe and Australia.

These results reflect the innovative merchandising and full breadth of our product assortment as well as the benefits associated with our category management leadership role with key retail partners.

Our consolidated gross profit margin was 46.9% or 50 basis points above the same quarter last year. The expansion of our vertical and commensurate Share of Shelf gains and the realization of sourcing efforts initiated earlier in the year helped to mitigate slightly higher promotional levels in our retail business and increasing inflationary pressure on distribution costs.

As we leveraged up recent acquisitions, including Festival, ACIM and Granmark, and accelerated our mylar balloon growth with our Anagram business, our manufacturing Share of Shelf increased 230 basis points to 18.2% and helped drive overall Share of Shelf up 440 basis points to just over 82%.

Operating expenses as a percent of revenue increased 40 basis points year-over-year, principally due to the investment in Kazzam, our online exchange platform for party-related services.

Retail operating expenses increased $2.7 million, but the rate leveraged by 50 basis points versus Q4 of last year as the added costs associated with both inflation and increased advertising were more than offset by improved labor productivity and better overall expense management.

These results reinforce our continued focus on strong cost discipline, and in part, demonstrates the significant progress we've made to simplify store operations and improve the productivity of our stores.

In Q4, we completed the rollout of our new store operating processes across the fleet, which included training all of our associates and deploying a more effective labor scheduling tool to ensure that the stores have the right complement of hours to service the customers.

As Jim mentioned, we also expanded our selling pilot to 50 stores, with the addition of our Party Planner roll-in store, as we test both internal and outsourced resource models. Initial results remain encouraging, with comp sales growth, driven largely by basket growth, well above pre-pilot trend.

And our customers have noticed the impact of a well-trained in-store ambassador in creating a better shopping experience. We will continue to evaluate results and gather critical learning’s over the coming months as we also prepare for a broader rollout.

While representing an important vehicle for sustained comp sales growth, we don't anticipate material benefit to 2018 comps given the timing of the expanded pilot, and I'll touch on this in more detail when I discuss our 2018 outlook.

In the quarter, our reported effective tax rate reflects approximately $90 million of nonrecurring income tax benefits from revaluing our deferred tax liabilities in connection with the new tax legislation. Adjusting for the tax reform impact, our adjusted tax rate for the quarter was [37.24%].

Adjusted net income of $94.1 million represents an increase of 3.2% compared to last year's fourth quarter. Adjusted EPS increased $0.05 to $0.81 per share, inclusive of a $0.03 tailwind from the reduction in our share count due to our share buyback activity, which was mostly offset by $0.01 of foreign exchange headwind and $0.01 of investment in Kazzam. Adjusted EBITDA increased 3% versus the fourth quarter last year to $197.4 million.

Turning to our full year results. Consolidated revenue was $2.37 billion, which represented growth of about 4% on both a reported and constant currency basis. Retail operations posted a 5.3% increase on both a reported and in constant currency basis, driven by increased store count.

During the year, we acquired 36 franchise stores and eight independent stores and opened 9 net new stores. Comps declined 0.7%, and were essentially flat when excluding the negative impact of hurricanes Harvey and Irma and the New Year's Eve shift, which I discussed earlier.

Our Everyday business rebounded well after a sluggish first half, led by a continued strength in mylar balloons and improved performance in juvenile birthday.

Our e-commerce comp sales for the year decreased 2.2%, but were up 1.2% when adjusted for the effects of [indiscernible] and the hurricanes.

Our non-vertical wholesale revenue increased 5% after adjusting for the impact of franchise acquisitions and foreign exchange. Our domestic wholesale business was down 2.8% versus the prior year, after adjusting for franchise store acquisitions, largely reflective of lower Halloween sales to franchisees and independents due to carryover inventory from the 2016 Halloween selling season.

The alternative markets business grew 11% for the year. Our international consumer-products business grew 15% for the year on a constant currency basis, driven by the acquisition of Granmark and strong growth in core markets in Germany and the U.K.

Gross margin rate improved 40 basis points for the year, primarily due to higher share of shelf and reduced product costs, partially offset by increased promotional activities. We increased manufacturing Share of Shelf 200 basis points to 22.6% and overall Share of Shelf 300 basis points to 79.6% in 2017. It is this unique vertical model that enables these gains and has driven our gross margin expansion with a meaningful opportunity remaining.

Operating expenses were $696.2 million, which were higher by about $37 million or 50 basis points. Our investment in Kazzam and restructuring charges each resulted in OpEx deleverage of about 40 basis points or 80 basis points in total.

Excluding these amounts, the rate improved by approximately 30 basis points, primarily due to improved labor productivity and better expense management. Interest expense was $87.4 million or $2 million lower than last year.

Our reported effective tax rate reflects approximately $90 million of nonrecurring income tax benefits in the fourth quarter from revaluing our deferred tax liabilities in conjunction with the new tax legislation. Our adjusted tax rate for the year was 36.9%.

Adjusted net income was $148.6 million or 7.5% better than last year, resulting in adjusted EPS growth of 8% to $1.24 per share. Adjusted EBITDA rose 5% to $409.2 million.

Finally, for the year, we delivered free cash flow, defined as adjusted EBITDA less CapEx, of $342.2 million, an increase of $34.1 million or 11% versus 2016. Cash flow from operations was a source of $267.9 million, including a working capital source of $49 million, which was largely a reflection of strong inventory management. CapEx totaled $67 million, while we allocated $287 million towards stock repurchases and $75 million towards acquisitions.

We ended the year with net debt of about $1.8 billion, resulting in a debt leverage ratio of 4.3 times, with 0.7 turns, a result of our share buyback program. And at the end of the quarter, we had approximately $172 million available in our existing asset base revolver.

Before I discuss our 2018 guidance, I wanted to note a few items impacting our outlook.

There are clear calendar shifts throughout the year that will impact the quarterly cadence of our roughly 1% full year expected comp growth. Specifically, our first quarter comps will reflect about 250 basis points of combined benefit associated with the calendar shifts related to New Year's Eve and Easter, which we will -- which we expect will more than offset the negative impact of holiday compression in the quarter.

Conversely, we expect Q4 comps to face headwinds from a loss of December 30, a key New Year's Eve selling day, which moves out into fiscal 2019. This roughly 100-basis-point negative shift, combined with a slightly negative Halloween comp, driven largely by a Wednesday Halloween, will result in an approximately minus 1% comp in Q4.

We will see a significant benefit in 2018 from tax reform, as our effective tax rate will drop to about 26%. We plan to utilize about a third of this benefit to partially fund the reinvestments we are making in support of in-store selling pilots, further activating our brands and focusing on improving our shopping experience online.

And it will also provide the flexibility to help fund increased capital investment. Additionally, Kazzam will remain an important component of our overall digital platform, and we anticipate investment levels broadly consistent with 2017.

We expect additional cost headwinds, primarily related to labor pressure, increased distribution expenses and rising commodity costs. Despite these cost headwinds and business reinvestment, we expect to deliver about 30 basis points of operating margin increase year-over-year against our 11.8% reported operating margin in 2017, largely driven by our productivity initiatives. The cadence of our operating income margin growth will reflect both the expected comp cadence and the fact that much of our reinvestment begins to kick in, in the second quarter of the year.

Lastly, in February, we announced the repricing of our term loan. We decreased the applicable margin by 25 to 50 basis points. The exact benefit will depend on our future net leverage metrics. For 2018, we expect the interest expense to be in the range of $95 million to $98 million.

With that said, for fiscal '18, we expect revenue to be in the range of $2.44 billion to $2.49 billion, and comp sales to be approximately 1%. We project full year adjusted net income to be in the range of $172 million to $183 million or $1.76 to $1.87 per share. We expected adjusted EBITDA to be in the range of $415 million to $430 million.

In terms of capital allocation priorities, we expect to spend about 3.5% of net revenue on CapEx and anticipate ending the year with a net debt leverage ratio of 3.8 times. For all other detail around our outlook, please refer to our press release.

And with that, I'd like to turn the call back over to the operator to open it up for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Your first question comes from the line of Seth Sigman with Credit Suisse. Your line is open.

Seth Sigman

Hey, guys. Good morning.

Daniel Sullivan

Good morning.

Seth Sigman

I wanted to do a follow-up on the cadence of the fourth quarter. So comps were down 1.4%, I think, for the October period. They were relatively flat for the full quarter adjusted for the New Year shift. So I think that implies up maybe 3% in the back half of the quarter. I just want to make sure that math is right.

And I think the comparison was actually a little bit more difficult in the back half of the quarter, so if you can maybe just talk through like what drove that improvement, some of the drivers behind that, it would be helpful.

Daniel Sullivan

Absolutely, Seth. You're right. I mean, I would characterize November and December as about a plus 2.5% comp and cycling more challenging comps from last year. We had a very strong November and December as well, largely led by continued growth in Everyday.

We continued to see juvenile birthday strengthen as we brought new patterns, new trend patterns to market, improved our juvenile birthday assortment, got better merchandising in-store. So it's largely, by far, our strongest Everyday category, and that led the improved performance post Halloween.

Seth Sigman

Okay, great. And then just as you're thinking about the guidance for 2018, can you maybe talk about the building blocks behind that 1% comp? You gave us some color on the quarterly shifts. The New Year's Eve impact, is that -- I just want to confirm, is that neutral for the full year? And what are the other drivers, I guess, to get you to that 1%?

Daniel Sullivan

Yes. So on your last question, yes, New Year's Eve is essentially neutral for the year, as we -- as Q1 gains Sunday the 31 and Q4 loses Sunday the 30. So I would think about New Year's Eve as awash. Obviously, a piece of the comp outlook is based on cycling of hurricanes, for example, and so there's a bit of tailwind there.

But I think what we look to in our underlying comp performance is continued strong Everyday growth, largely through the metallic balloon business and some of the items I mentioned earlier. We also expect to continue to improve our operational effectiveness in-store and continue to grow traffic on the web. Those will be sort of the underlying drivers on comps.

Seth Sigman

Okay, great. Thank you. Very much.

Daniel Sullivan

And Seth, just to also be clear, a bit of headwind as we move to a Wednesday Halloween, which as I said in my remarks, we would expect to be slightly negative.

Seth Sigman

Thank you.

Operator

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

Rick Nelson

Thanks. Just to follow up on that point, Dan, the Halloween shift from Tuesday to Wednesday, when comparing relatively benign and [indiscernible] why you think the comp will be down?

James Harrison

Sure, Rick. This is Jim. I think we find that as we move away from the weekend, the impact on the adult part of the business obviously grows. So Monday is worse than Sunday, Tuesday is worse than Monday, and Wednesday is a little bit worse than Tuesday.

And then as we move back to next year, once we get to Thursday, that starts to pick up again because you get the momentum from the adult celebrations on the weekend. So on a Wednesday, there's really no natural weekend for folks -- for adults to have a Halloween event.

Rick Nelson

It makes sense. Store growth, you talked about the 18 franchise stores plus another 8, so 26 stores, is that what's built into the model?

James Harrison

In the model, it's roughly 10% square footage growth in total, which is a combination of new stores, some remodels and bigger footprints as well as acquisitions.

Rick Nelson

Okay, got you. And the new pilot that new labor model, it's in 50 stores. It sounds like results have been encouraging. What is the time line to roll that out?

James Harrison

Yes. So the pilot -- there's 2 pilots, right? Obviously, the first, which I think you were referencing, on the operational improvements, changing the work, taking costs out of the stores, that work matured last year. And right before the New Year's, that work is now across all of our fleet.

So we are now operating on new operational processes, better labor scheduling and improved productivity of the store. And we get the run rate benefit of those actions probably right about now for the rest of the year. On the selling initiatives, we are in about 50 stores right now.

We've been in those 50 stores for just over a month. And our approach there will be to continue to learn, measure, tweak and ultimately look to roll it out to a broader set of stores likely over the back half of the year, which is why we don't see it providing material tailwinds to comps this year.

Daniel Sullivan

Yes. I would anticipate, Rick, that if all goes well, we'd probably be somewhere near the 200 stores on the program by the end of the year.

Rick Nelson

Got you. Thanks a lot and good luck.

Daniel Sullivan

Thank you.

Operator

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

Mike Baker

Hi. Thanks, guys. A couple of questions. One, the tax reform, you said you're spending 1/3 of that in SG&A. And I think you said and then some CapEx reinvestment. Is that CapEx above and beyond that third of the SG&A spend?

Daniel Sullivan

Yes. What I was trying to indicate, Mike, is we're going to reinvest on the P&L roughly 1/3 of the benefit. And obviously, from a cash perspective, the tax reform has provided us a bit of flexibility to lean in on CapEx, which we expect to be at about 3.5% of revenue for the year, which is slightly higher than where we've been over the last 2 to 3 years.

Mike Baker

And is that difference...

James Harrison

I'm sorry, just quickly, Mike. It's essentially, if you look at our total CapEx spend year-over-year, it's about a 33% increase on our CapEx spend between 2017 and 2018. Obviously, we'll continue to do as we've always done, which is be very cautious on our CapEx spend and making sure that we have a fairly quick and meaningful IRR and payback term on the reinvestments.

But there are -- and on manufacturing operations, we've not spent a lot of money over the years, and we'll probably spend a little bit more this year, taking advantage of the cash flow from the tax refund.

Mike Baker

Understood, okay. And then, I guess, following up on that. There probably still should be some excess cash, just in general. Your use of the excess cash obviously paid down -- or sorry, bought back a lot of stock this year. What should we expect going forward in terms of paying down debt versus buying back more stock?

James Harrison

Sure. I think Dan may have mentioned in his remarks, we anticipate having our leverage ratio at about 3.8 at the end of the year, paying down 70 basis points from where we are today, 3.8.

Mike Baker

That makes sense. One more, if I could ask, just on the P&L. Gross margins, pretty impressive there. And I think this is the third year in a row of increases. As you continue to increase your Share of Shelf, I assume that you continue to see some room there?

James Harrison

Yes, it's not just Share of Shelf, Mike. It's really the leveraging up of our manufacturing. As you know, the last several years, we said we have a stated goal of increasing our manufactured Share of Shelf up towards the 50%, and we're continuing to march towards that goal. And I clearly see this line of sight to that happening over the next several years.

Daniel Sullivan

Yes. And so, Mike, just on the -- I think what I've said in the past is 20 to 30 basis points of margin growth year-over-year is what this business is capable of. And we probably aim towards the lower end of that range in '18, given some of the cost headwinds I mentioned around commodity costs and some labor wage challenges.

James Harrison

And distributions.

Mike Baker

Great, understood. And I'll let someone else ask about the impact of commodity in freight costs. Thanks.

James Harrison

All right, great.

Operator

Your next question comes from the line of Joe Feldman with the Telsey Group. Your line is open.

Joe Feldman

Hey, guys. I'll ask about freight costs. What -- how are you guys thinking about freight costs this year and the pressure with driver shortages and diesel costs getting up and how that's factoring into all this? I know you called it out as one of the headwinds, but how much of a headwind do you think it will be?

Daniel Sullivan

Yes. I'm not going to go into the specifics, Joe, of breaking out the pieces. Certainly, we've seen -- we expect to see over the road capacity continue to be challenged, which is factored into our outlook.

And we've negotiated all of our rates for 2018, so we have a pretty clear line of sight. But as I mentioned, it does represent a bit of an increase over where we've been for the reasons mentioned.

We're also seeing wage pressure largely in our distribution centers, given, obviously, what we're all seeing in terms of unemployment levels and overall wage pressures. So we've taken up both our daytime and our evening associates in our DCs.

And then to a lesser degree, commodity costs have moved a bit, but of the three items, that's by far the least impactful. So we've got freight challenges baked in our outlook. We've got the impact on wages, and then, of course, to a smaller degree, commodities.

Joe Feldman

Got it. And then if I can follow up with a different topic. How is the [indiscernible] doing? And can you share any thoughts on that?

Daniel Sullivan

Yes, it's performing quite well for us. We launched it, obviously, late last year. We then turned it off for the Halloween pressure, and then -- and now we've turned it back on. It was about a $3.9 million sales impact for us, which, of course, weighs down the web sales, which is why we quantify the number.

Operationally, we're seeing terrific response from the customers. We're seeing our store associates manage the process quite well. And we're seeing a slightly higher basket than what you would see in-store as you see a greater shop up of customer and you see a greater balloon penetration. So, so far, we're very encouraged by the program.

Joe Feldman

That’s great. Thanks. Good luck with this quarter. Thanks.

Joe Feldman

Thank you.

Operator

[Operator Instructions] Your next question comes from the line of Curtis Nagle with Bank of America Merrill Lynch. Your line is open.

Curtis Nagle

Thanks very much. Perhaps I'll just follow up on Mike's question on the gross margin. So retail has been a terrific story in terms of getting the rate up. But -- so your wholesale channel has been a little bit more mixed. Just kind of curious what you guys are expecting for this year in terms of where the rate goes.

James Harrison

I'll let Dan talk to rate. But in terms of -- as we look up for it on our wholesale business, we're growing out the alternative markets, and the alternative markets tend to have a lower margin profile.

A lot of that is FOB out of plant, a lot of it is one-off major production distribution of large items, and as a result, it has a different margin profile than decorative party goods on the wholesale side of the business.

The thing to remember is that this is an incremental business, and so it represents more cash. And while it might have a dampening effect on a percentage basis, it certainly has a very, very positive effect on overall EBITDA as well as cash flow. I'll let Dan to talk about the second part of the question.

Daniel Sullivan

Yes. So I think margin, as I mentioned earlier, I think the broader guide that we look at is 20 to 30 basis points for year -- per year. We think '18 will fall well within that range, as I said probably to the lower end, given some of the headwinds in costs.

And we just have to keep in mind the lines for our margin growth. We also have an incredibly effective sourcing organization that continues to implement programs around product reengineering and optimizing geographic locations.

And as Jim mentioned, we've invested a bit in the past and more heavily now going forward in our manufacturing operations, which will lead to productivity gains as well. So there are multiple elements of margin accretion that we expect to continue over the longer term despite what will be a slightly choppy margin around alternative markets.

Curtis Nagle

Okay. And then just a quick follow-up on the sales and comp guidance. Just curious why so early in the year give such a, I guess, a fairly narrow range. Why not give yourself a little more flexibility in that?

Daniel Sullivan

Yes. I mean, the way we thought about it, maybe I'll answer it slightly differently. In the past, particularly in '17 where we had a broader range, that was largely a result of some unknowns coming up -- coming over from the previous year's Halloween and the inventory levels that were in the trade around Halloween that there were some unknowns about what we would look like as we cycle that. We obviously don't have that issue in '18. We have a pretty clearly line of sight to both our comp and our non-comp growth, and we felt comfortable at a tighter range.

Curtis Nagle

Okay. Fair enough. Thanks very much.

Daniel Sullivan

Thank you.

Operator

[Operator Instructions] Your next question comes from the line of William Reuter with Bank of America Merrill Lynch. Your line is open.

William Reuter

Good morning, guys. First question is just on your e-commerce business. For the quarter and the year, you guys were relatively flat. I was curious on how you think that the industry may have done and, I guess, in the e-commerce world, whether you lost or gained share.

James Harrison

Okay. Firstly, I think, for e-commerce, as you may recall from our last quarterly call, took a bit of a hit when -- as a result of Google changing their algorithm, particularly as it affected Halloween. And as a result, we saw a diminution in our web sales around Halloween, principally, we believe associated with the impact of the algorithm change.

In terms of the party side of the business, since we are the broad supplier to the entire market, including folks who are on the market place with Amazon or have their own website. We have a very good visibility into their businesses, and we don't believe we lost any really meaningful, if any at all, market share on the party side. Other folks, if anything, we believe we maintained and grew our party presence.

On the Halloween side, the costume and the bag, we did see quite a bit of a pressure around the costume in the bag business during Halloween at Amazon and others. And we've taken steps -- we took steps in-season to address that increased competition, and we have plans in place to look at our presence in the web in this upcoming Halloween season where there will be, certainly, more competition again, we believe, and we're prepared to address it with -- as we look at our good, better, best philosophy in costumes in the bag.

William Reuter

That's helpful. And then in terms of the relatively large share repurchase during the quarter, it's obviously delayed the deleveraging. And you guys gave us some guidance for what you expect. I guess, can you talk a little bit about that decision? And you obviously have given us a target leverage for next year, but how you guys are thinking about leverage over the next handful of years in terms of the target?

James Harrison

Sure. So I mean, our target is to delever roughly half a turn every year. We just had an unusually up -- unusual purchase opportunity in the Q4. One of our major sponsors, for their own reasons, we're seeking liquidity, and we felt that was an excellent opportunity and excellent use of our cash strength and the strength of our balance sheet to take advantage of that and to reduce the share count by almost 20 million -- over 20 million shares, and we think that, that is -- was a very -- at a accretive purchase to shareholders.

If we look at the price paid in the context of our multiple, in the context of our cash flow, in the context of our earnings per share, irrespective of where our team may or may not trade today.

We thought it was an extraordinarily opportunistic purchase and something that we felt was in the best interest of all shareholders, not just the short-term basis, but on a long-term basis.

William Reuter

Great. Thank you.

Operator

Your next question comes from the line of Christopher Prykull with Goldman Sachs. Your line is open.

Christopher Prykull

Good morning, guys. Thanks for taking my question. I just had a follow-up on the 1/3 of tax reinvestment. Just wondering, how did you arrive at sort of 1/3? Any more specifics on where that money is going?

And how were you thinking about the ROI on that reinvestment? Is there something where you expect to see incremental EBITDA growth or a sales uplift longer term or is it just keeping pace with what other retailers are doing?

Daniel Sullivan

Yes. I think it's important to point out perhaps the obvious. We didn't start writing our plans for '18 the minute tax reform became law, right? We had plans in place for '17 and plans in place for '18. And those plans reflect a reinvestment, mostly behind our commercial initiatives, our web re-platforming, the work we're doing in stores with our selling initiatives and our selling pilots, and also, our efforts to continue to expand our CRM capabilities.

So those plans have been in place and are being activated in '18. We then obviously looked at the impact of tax reform and made some decisions around what we thought was the optimal mix of reinvestment, also acknowledging some of the cost headwinds I mentioned versus returning value to the shareholders.

So that was sort of our overall thinking. And we feel, obviously, the steps we're taking, particularly on the commercial reimbursement, are important, not only in '18, but moving forward for the business.

James Harrison

As a general rule of thumb, any investments we make on the capital side of the business as it relates to the consumer products business, we tend to focus on the payback of 3 years or less.

Christopher Prykull

Great. That's helpful. And then just a question on Kazzam. Can you provide an update on what investments are being made? Any initial customer reaction update on the rollout schedule? And then how are you thinking about advertising for any type of rollout?

James Harrison

I'll let Dan go first.

Daniel Sullivan

Yes. So as I said in my remarks, we're thinking about a level of investment in Kazzam in '18 that is largely the same as '17. We haven't yet finalized our rollout plans, so we're not going to comment on that. At this moment, we're still in beta phase in one market.

We're extremely excited about how we've developed in that market, both from the lens of vendor acquisition, and of course, building the site and the web platform and beginning to introduce it to the customers in Dallas.

We're learning a tremendous amount around customer and customer acquisition. And we have to continue to do that as we develop a deployment plan for the rest of 2018.

Christopher Prykull

Great. And then if I could just sneak one housekeeping question. And it looked like the wholesale gross margin was a bit softer year-over-year in the fourth quarter. Is that just attributable to mix, as Jim was referring to earlier?

Daniel Sullivan

Yes.

Christopher Prykull

Thank you.

Operator

This concludes the Q&A portion of our call. I would now like to turn the call back over to management for closing remarks.

James Harrison

Thank you, operator, and thank you, everybody, for joining us for today's call. We continue to be extremely enthused about our business and our prospects for 2018. And we're excited about the next 12 months as well as the next 20 years. So with that, I'd like to welcome everybody who'd like to contact Dan and myself at any point in time. We remain available for any questions or concerns or interest you may have. And have a great day, thank you so much.

Operator

This concludes the Party City Fourth Quarter 2017 Earnings Conference Call. We thank you for your participation. You may now disconnect.