The Container Store Group, Inc.
Q3 2020 Earnings Call Transcript

Published: 2 Feb 2021

[Operator:]

Greetings, and welcome to The Container Store's Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I would now like to turn the conference over to your host, Caitlin Churchill, Investor Relations. Thank you. You may begin.

[Caitlin Churchill:]

Good afternoon, everyone, and thanks for joining us today for The Container Store's Third Quarter Fiscal Year 2020 Earnings Results Conference Call. Speaking today are Melissa Reiff, Chairwoman; Satish Malhotra, Chief Executive Officer; and Jeff Miller, Chief Financial Officer. After Melissa, Satish and Jeff have made their formal remarks, we will open the call to questions.

[Melissa Reiff:]

Thanks, Caitlin, and hello, everyone. Welcome to our fiscal 2020 Q3 earnings call. We appreciate you joining us today. We issued a press release late last month announcing my retirement March 1 of this year and the appointment of my replacement, Satish Malhotra. We also shared in our release that we were tracking well above our expectations for our Q3 sales results. But before we share those results, I do want to tell you that I am delighted with the transition plan that Satish and I have in place. It is going smoothly, and he officially assumed the roles of CEO and President just yesterday. So today is his second day on the job. And Satish is joining Jeff and me on this call. I will ask him to say a few words in just a moment and share some of his thoughts as he begins the journey of leading our great company into the future. And while we only announced my planned retirement last month, the Board and I spent months preparing for this and searching for the perfect candidate for our very special and cultural leading company. We were thrilled to have found exactly what we were looking for in Satish. He has had a very successful 21-year career with Sephora, most recently as Chief Retail and Operating Officer; and has had leadership responsibilities for stores, services, supply chain, technology, real estate and partnerships, among others. Also very important is that his values align perfectly with ours, which makes him a wonderful fit.

[Satish Malhotra:]

Thank you, Melissa, for the kind introduction and for your unyielding support as I begin my new role. I'm very excited to be here today sitting in our headquarters in Coppell, Texas, as the newest member of The Container Team Store and have the opportunity to lead this incredible company. As this is only my second day at The Container Store, I'll keep my comments brief. I wanted to first congratulate Melissa and the team on delivering outstanding results in Q3 and for providing such a strong foundation for me to build upon. I’ve long admired The Container Store brand and the great success the team has had in creating, innovating and leading the storage and organization industry, including Custom Closets, which continues to have such strong momentum. Equally important, though, is the very unique culture that has been cultivated throughout the Company's history that was particularly attractive to me. Organizational culture is critically important to building a successful business. And my 21-year tenure at Sephora served to strengthen my belief in its importance. I'm looking forward to spending my initial weeks meeting with our teams. It will be virtually for the moment and spending time in our stores and our distribution centers. I'm also looking forward to getting to know you, our analysts and investors. Once again, I want to thank Melissa for her warm welcome and her partnership during this transition. And with that, I will hand it back over to her.

[Melissa Reiff:]

Thanks much, Satish. I'll begin by discussing the highlights of our fiscal Q3 performance and then share the progress we are making against our strategic initiatives. Jeff will follow and share our financial results in more detail.

[Jeff Miller:]

Thank you, Melissa, and good afternoon, everyone. Before I get into more detail regarding our results, I just want to express my deepest thanks to Melissa for everything she's done to build our company into what it is today and establish the special culture we are so proud of. While we will miss her, we know she's only a phone call away. And as we start this new chapter, I'm excited to welcome Satish and look forward to his leadership and partnership as we continue to build on the strong success we have seen to date. As Melissa shared, we are very proud of our third quarter performance. Our sales and earnings results significantly outperformed our expectations that factored in our conservative plans for holiday categories as well as the ongoing uncertain macro environment with COVID-19.

[Operator:]

At this time, we will be conducting a question-and-answer session. Our first question comes from the line of Steven Forbes with Guggenheim Securities. Please proceed with the question.

[Steven Forbes:]

I wanted to focus on, I guess, I wanted to start with the segment level gross margin performance, right. You talked about the puts and takes, right, within the release and mentioned them again, but I was hoping you could help us quantify them the various drivers you mentioned? And then within Elfa, you have four consecutive quarters here at or above 40% on the gross margin line. Is that the right level to think about going forward? Or do you foresee incremental opportunities looking out to '21 and beyond?

[Jeff Miller:]

Okay. Yes, Steve, this is Jeff. And looking at gross margin at the segment level, as we discussed, Container Store, we certainly saw headwinds related to the higher mix of online sales, incurring a lot more in shipping costs than we originally expected. And the third-party surcharges we are experiencing on freight, we're much more impactful than we originally thought. And Elfa, of course, when you look at the gross margin, they have benefited through a lot of their cost saving activity over the last four quarters, as you mentioned, but I wouldn't expect it necessarily to continue. We're in the early stages of planning fiscal 2021 right now. And we can't really speak to what fiscal '21 is going to look like, but I will say there is looking at commodity price increases, both at Container Store and Elfa there is pressure on that front. And while there was no impact to Q3, we could see some of that come through in Q4 and certainly into fiscal '21. And as a reminder, we have historically, at Container Store, have been able to manage commodity price increases through either vendor negotiations or through price increases.

[Steven Forbes:]

And maybe just a quick follow-up on that. If you don't want to specifically quantify the drivers. Can you provide some color on what the segment level gross margin performance or what level is implied in the guide as we think of the models here? Because I would imagine some of those pressures, right, are going to weigh on the fourth quarter performance?

[Jeff Miller:]

Correct. Yes, Steve, the way we're looking at Q4, we're certainly seeing our online business -- strengthen the online business, and we'll continue to experience those increased freight cost, freight and shipping costs, not only due to the higher mix, but also due to the surcharges that we continue to incur. So, we're thinking about Q4 right now, we see it at slightly down to flat.

[Steven Forbes:]

Perfect. And then if I can, one additional follow up, Melissa or Satish, if you don't mind answering, as you think about the brand awareness sort of ramping right behind this year's strength. I think, you pushed out Richmond right to spring of this year. So, I would love to just get your initial thoughts on any sort of time line, right behind the return to unit growth for the brand, right, especially just given the strength you're seeing in the top line here and taking advantage right of all the growth that you're experiencing?

[Melissa Reiff:]

Right. Steve, it's Melissa. Yes, you're right. We're going to open Richmond at the end of this fiscal year. And then we have one more store planned for 2021. And then I feel confident in already my conversations with Satish, that he and the team will be evaluating our new store growth. As you can imagine, this is a second day, Steve so, but Satish, you might want to add some color to that, but he will be, I know, evaluating all that and determining the investments that we're going to make in our new store growth because there is so much white space.

[Satish Malhotra:]

Yes. Thanks, Melissa. And hi, Steve, listen, I would just say it's way too early to me to be talking specifics about our approach. But rest assured, as I get into the business and really spend time with the organization, it will definitely help formulate my thinking and the plan for 2021. So just stay tuned for that.

[Operator:]

Our next question comes from the line of Kate McShane with Goldman Sachs. Please proceed with your question.

[Kate McShane:]

I just to start, I was interested in one of the comments you made, Melissa, with regards to the amount of DIY you're seeing. Obviously, that's been the trend across retail as people have been home and have prevented the pros from coming inside the home because of the pandemic. But I just wondered if you had seen a meaningful change in the cadence with regards to DIY installation at this point in time?

[Melissa Reiff:]

Specific to installation, Kate?

[Kate McShane:]

Yes.

[Melissa Reiff:]

Yes. We have seen, as I said in the remarks, installation is down year-over-year because of the pandemic. But what I'm so proud of is that we pivoted immediately with the virtual in home design and that has helped tremendously. Also, Elfa, we've been selling Elfa for 42 years, and it's a 70-plus year old company. And not only is it a great closet solution or pantry solution, but really, the Elfa prepacks and our -- what we call our Grab-&-Go, have really, really picked up, Kate. And again, our customers are -- because they are at home. They are a really the gratification or of doing it themselves. I don't know if that's going to continue, we don't know. But we will continue to do it for them as well, and that will include delivery and installation. And once the pandemic we get past this, we are anticipating that installation will increase for sure, and we're prepared for that.

[Kate McShane:]

Okay. But there's been no real change, I assume then from what you saw maybe more in the middle of the pandemic in the summer versus now with regards to installation, it's still kind of the same?

[Melissa Reiff:]

No, no. No significant change at all. It's just the same. Actually, I think in some ways, Kate, it's getting better. Customers are getting a little bit more comfortable with having the installers in their home practicing protocol because we are so big on safety and so making sure that that is the priority. And so, I think some of our customers are getting much more comfortable.

[Kate McShane:]

Okay. Great. And then I know there's been a lot of disruption within the supply chain, which you applied also during your prepared comments. Is there a way to quantify the impact to comp from any of the disruption that you've said you’ve seen? And could you maybe walk through how you're feeling about inventory by certain categories currently? Are there places where maybe you feel a little bit less -- there's less inventory available than other categories?

[Melissa Reiff:]

Yes. I'll let Jeff take this, but just one comment. I don't know how to quantify the impact from the supply chain. I don't know how to do that. But I can tell you that we are in great shape in terms of inventory for our Elfa sale, which began in the middle of December 18 and goes through February 23. And we're in very good shape there. And all the other product categories, like every other retailer, we've been chasing this inventory across the board, but you can look at the results, and our team has done an excellent job with that. So I mean, Jeff, I don't know if you can quantify it, but I don't know how to do that.

[Jeff Miller:]

I think it's really difficult to quantify, just simply because there's a lot of different factors at play in how we address it. I mean in areas -- I'm sorry, I hope --

[Melissa Reiff:]

That's okay.

[Jeff Miller:]

Whether it'd be disruption in the freight lines or in the manufacturers, I mean, we are dealing with vendors negotiate -- we're negotiating with our different vendors. We're also seeing situations where customers may come in, they may not have the product they want because of the disruption, but they're picking and choosing something else. From a business standpoint, it's really hard to --

[Melissa Reiff:]

To quantify. I think that's a really great point. Because, Kate, the strength of our assortment, if a customer comes in looking for one specific solution or even a specific item, we have other opportunities and other options for them, and they're taking advantage of it. And our supply chain team has done a great job in really adding lead times to try and build more safety stock. So even though inventory has been on my mind constantly, and I worry about it, I feel very confident that we are -- and for the most part, a very good shape. I mean, we're going to continue due to some things we can't control to chasing some inventory. But overall, I think we've done a really good job. And again, I think the results speak for that.

[Kate McShane:]

Okay. If I could just maybe sneak in one last question. Just going back to the question. I know with the CEO transition, that there's going to be a lot of decisions being made going forward. So when we think about your investment spend for 2021, just in the context of what you just experienced as a company throughout this pandemic. Is there any kind of shift or reprioritization of how you're thinking about your CapEx, your investment spend this year?

[Melissa Reiff:]

Kate, and I don't think Satish can address this either being number two day on the job. We just don't know yet. We're right in the midst of planning 2021, and I've shared all my thoughts with Satish. Now he and the team are going to take it from here. And it's a lovely position we're in. I would personally -- my personal opinion, I would assume that our CapEx is going to increase because we're going to look at more investment, whether it's new stores or whether Satish and the team decided focused on digital or technology or whatever, because we have so much opportunity ahead but I can't comment. Satish, I don't think you can either right?

[Satish Malhotra:]

No, no. It's just too early. And I actually look to spend a lot of my next coming weeks early into the months really just listening and learning as much as possible to make that very decision.

[Jeff Miller:]

Right. Yes. I'd just like to add to that. As always, we're always going to be looking to invest our money where we get us return, whether it's paying down debt or expanding our business and making striking a good balance between the two. And of course, fiscal '20, when you look at it, we have a very low amount of CapEx just because of COVID, And I would expect CapEx levels will return to normalized levels for '21.

[Melissa Reiff:]

Jeff, you're choking, take another drink. I hope that answered, Kate. Did that answer your question?

[Kate McShane:]

Yes.

[Operator:]

Our final question comes from the line of Tami Zakaria with JP Morgan. Please proceed with your question.

[Tami Zakaria:]

Hi, thank you so much for taking my question and congrats on excellent results. So my first question is around Custom Closets. I think you mentioned it grew about 20% in the quarter. So I was wondering how much of that is driven by volume versus ticket? Meaning, was it any price increase driven? Or it was just pure volume driving that impressive growth?

[Melissa Reiff:]

Tami, there were not any price increases. We're very, very pleased by Custom Closets and the growth. It has been driven mostly from Elfa because, of course, we can install it for the customer or the customer can install Elfa. Now Avera and Laren, we have to install, as you'll recall, Tami. So, yes, we're very pleased with it. And as I said, we've begun the Elfa sale and so far so good with the Elfa sale. So, we've got a lot of momentum and expecting things to continue.

[Tami Zakaria:]

Got it. That's super helpful. And then if I could switch to the Leg income store, so any detail around the revenue impact from closing that? And how much do you expect to recapture through the Chelsea location. And on the rent side, how much do you expect to say when the lease expires?

[Melissa Reiff:]

Yes. The lease expires at the end of this month, as I said in my remarks. And I hesitate to give a percentage of what we think transferred to Sixth Avenue. But we're encouraged. And I have to say that the closing of that store, which was our Tami, as you'll recall, I was -- I think we all were just incredibly proud of the team and the way that we close that store and sold down the merchandise the way we communicate with our customers. We had a lot of customers coming -- still continue to come in, and so they'll be shopping at Sixth Avenue in Chelsea. So I'm encouraged by that. As I said, the store was unprofitable because the occupancy was so high. So, there just wasn't another decision. And it was sad for all of us because that's kind of the jewel box, we call it, they're at Lexington 58, but it's the right decision for the Company. It's the right decision for the short, mid and long term.

[Tami Zakaria:]

Got it. So no quantification around how much rent you might say after closing it?

[Melissa Reiff:]

No.

[Tami Zakaria:]

Got it. Got it. And then one last one from me. So, the freight pressures, is that primarily the last mile? Or is it coming from the import of goods from overseas, like where is the freight pressure mostly happening?

[Jeff Miller:]

It's Tami, it's all over the place. It's the first being the shipping costs that we pay for our direct-to-consumer business, the higher mix of online sales, we're incurring much more because of the volume plus the third-party carriers are charging us surcharges on top of that. And then, of course, in the freight lanes over the water, there's all kinds of disruption in that freight category. And we're incurring much more cost on that front as well. So, we're seeing it both in shipping costs and the cost to get our goods to us.

[Melissa Reiff:]

Yes.

[Jeff Miller:]

And really, I think one of the reasons for that driver is, we do have contracted rates, but even those rates have gone up and because of the volumes that we're doing, much higher than expected, we're having to go into the spot market, and of course, that's much higher than our contracted grades.

[Tami Zakaria:]

Got it. Sorry, one last one. So, the shipping charges that are -- is it fair to say the past quarter was probably the peak of the surcharge headwind. And now that the holiday volume has sort of died down that all charge driven pressure is probably saw the peak in the past quarter and should wane as we look ahead. Is that fair to say?

[Jeff Miller:]

Tami, we have not seen any reduction in the surcharges since the holidays. The third-party carriers are still charging them.

[Melissa Reiff:]

We haven't seen that abate yet, Tami, and just don't know.

[Operator:]

And with that, we reached the end of our question-and-answer session. And I would like to turn the floor back over to management for any closing remarks.

[Melissa Reiff:]

Well, I just want to say thank you so much for joining us today. And again, I appreciate all your support of The Container Store over the years. And again, congrats Satish and just take it from here and just let this company soar because the opportunities are just incredible. So good luck to everybody.

[Caitlin Churchill:]

Thank you.

[Operator:]

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.