The Container Store Group, Inc.
Q1 2018 Earnings Call Transcript

Published: 1 Aug 2018

[Operator:]

Greetings, and welcome to The Container Store First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would like to turn the conference over to your host, Shannon Devine. Thank you, you may begin.

[Shannon Devine:]

Thank you, operator. Good afternoon, everyone and thanks for joining us today for The Container Store's first quarter fiscal year 2018 earnings results conference call. Speaking today are Melissa Reiff, Chief Executive Officer; and Jodi Taylor, Chief Financial and Administrative Officer. After Melissa and Jodi have made their formal remarks, we will open the call to questions. Before we begin, I need to remind you that certain comments made during this call regarding our plans, strategies and goals and our anticipated financial performance may constitute forward-looking statements and are made pursuant to and within the meaning of the Safe Harbor Provision of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements. Those important factors are referred to in The Container Store's press release issued today and in our Annual Report on Form 10-K filed with the SEC on May 31, 2018. The forward-looking statements made today are as of the date of this call and The Container Store does not undertake any obligations to update their forward-looking statements. Finally, the speakers may refer to certain adjusted or non-GAAP financial measures on this call. A reconciliation schedule of the non-GAAP financial measures to the most directly comparable GAAP measures is also available in The Container Store's press release issued today. A copy of today's press release may be obtained by visiting the Investor Relations page of the website at www.containerstore.com. I will now turn the call over to Melissa. Melissa?

[Melissa Meyer Reiff:]

Thank you, Shannon, and thank you all for joining our call today. I will first share the highlights of our fiscal Q1 performance and then review the progress we are making against our strategic initiatives. Jodi will then review our financial results in more detail and discuss our fiscal 2018 outlook. We had a strong start to fiscal 2018 with our fourth quarter momentum continuing into fiscal Q1. Total sales for the first quarter were $195.8 million, up 6.9% compared to the prior year period. Comp store sales were up 4.7% led by our Custom Closets business, which contributed significantly to our Q1 comp. Approximately 1.9 percentage points of this comp performance was driven by the recognition of Q4 deferred sales, resulting from Custom Closets orders that were taken in Q4, but delivered and installed in Q1. Our other product categories also positively contributed to Q1 comps and our online business was up 26.2%. Elfa third-party sales were down 3.1% in local currency and down 1.9% in U.S. dollars due to really lowered sales in Nordic and other markets. Our strong top-line performance was accompanied by 200 basis points of Optimization Plan driven gross margin expansion. We also achieved 80 basis points of SG&A leverage, excluding final Optimization Plan expenses. This led to a $0.03 improvement in adjusted loss per share to $0.08 from $0.11 in Q1 last year and that is despite a $0.05 per share headwind from incremental interest expense in this quarter's result. Much like Q4, improved top-line trends during the quarter were driven by our many sales revitalization and optimization initiatives. A great example is our marketing efforts. The reallocation of our marketing spend from traditional to digital channels continues to drive our improving results, and our fresh and reinvigorated marketing campaigns were well received by our customers. Beginning in April and into May, we had a very strong closet sale, as we've moved from a blanket category promotion last year to a more deliberate and targeted approach this year, and customer response to our free Elfa installation promotion in May and June was also positively received. In this fiscal 2018 year, we plan to open two new stores and complete two relocations. The first of our new stores opened on April 7th in Bridgewater, New Jersey and we've been very pleased with its sales so far. Our second new store will be located in Oklahoma City and is scheduled to open in September. As a reminder, our Oklahoma City store as well as our Cherry Creek, Denver and Tysons Corner, Virginia relocations will be under 20,000 square feet. We intend to build upon the success we have experienced on our smaller format Albuquerque store and we see the opportunity for future stores in smaller size formats. Both of our relocations are scheduled to occur in the second half of this year. And of course our much anticipated Dallas flagship store redesign was completed and launched just last month. Customer feedback to the redesigned store look and feel with new technology and fixtures, as well as visual merchandising improvements has really been positive. Our research has shown us that our customer's biggest hurdle in beginning a project is feeling overwhelmed. Therefore, the focus of our technology tools, in-store merchandising, and overall layoff in our redesign Dallas flagship store is to make it easier and more convenient for our customers to accomplish their projects. We look forward to leveraging the learnings from this store to inform our decisions regarding existing and new stores. Now, let me turn just for a brief update on our Optimization Plan, we have made good progress with our cost of goods project and the associated savings are flowing through as expected. We've also completed the initial work on our pricing initiative, which I will discuss in more detail in just a minute. And as we have shared before, the SG&A portion of our Optimization Plan savings were largely realized in fiscal 2017. So we don't anticipate incremental SG&A benefits for the remainder of fiscal 2018. Turning to our refined strategic plan which is providing our company clarity on our priorities. As previously shared, our vision is to be a beloved brand and the first choice for customized organization solutions and services. Our purpose is to help our customers accomplish projects, maximize their space and make the most of their home. To achieve this, we have six current prioritized strategic initiatives being fully executed by a cross-functional team with each being led by one of our executives. Each strategic initiatives has an executive sponsor, a lead and a working team. Progress was made in many areas during our first quarter, and so I would like to discuss a few of those in just a little more detail. Number one, to own Custom Closets, as is evidenced by the significant comp store sales contribution from Custom Closets in Q1, we're making good progress. More targeted campaigns and marketing messages along with new product introductions and visual merchandising improvements continue to contribute positively. We're very focused on new products across our Custom Closets business and have an exciting road map for future innovations. Number two, to deliver on accomplishing projects across all customer touch points, that is how we speak to our customers about who we are and how we can help them accomplish their projects is key. We just launched an exciting new brand marketing campaign across a variety of channels based on two important objectives, acquiring new customers and refreshing our brand messaging. As we determined our brand messaging, the place to begin was with our brands purpose, again to help customers accomplish their projects, maximize their space and make the most of their home. And so we began our creative journey to help our customers discover the power of space. We knew it was critical that we show our customers that The Container Store understands their challenges with space and we are committed to helping them accomplish all of their storage and organization projects. And we took this opportunity to sharpen our focus to become more approachable and to improve our price perception. Our new brand campaign and tagline The Container Store

[Jodi Lynn Taylor:]

Sure, and thank you, Melissa, and good afternoon, everyone. For the first quarter ended June 30, 2018, our consolidated net sales were $195.8 million, up 6.9% compared to the prior year period. Sales for The Container Store retail business were up 7.8% to $180.1 million driven by a 4.7% comp store sales increase as well as new store sales. As you saw in our earnings release, this comp performance included an estimated 190-basis point benefit from recognition of deferred sales resulting from fiscal fourth quarter 2017 Custom Closets orders that were delivered and installed in the first quarter of fiscal 2018. Custom Closets contributed significantly to our first quarter comp store sales and we once again saw a positive contribution from our other product categories as Melissa shared. We ended the first quarter with 91 stores and approximately 2.3 million gross square footage as compared to 87 stores and approximately 2.2 million of gross square footage at the end of the first quarter of fiscal 2017. Now turning to Elfa International AB. Elfa's third-party net sales were $15.7 million, down 1.9% compared to the first quarter of fiscal 2017, primarily due to lower sales in the Nordic and other markets, partially offset by the positive impact of foreign currency translation during the quarter, which increased third-party net sales by 1.2%. Moving on to profitability, in the first quarter, consolidated gross profit dollars increased 10.8% to $114.8 million and consolidated gross margin increased to 200 basis points compared to the prior year period. Gross margin at The Container Store retail business was up 140 basis points, driven primarily by lower cost of goods associated with our Optimization Plan. Elfa's gross margin decreased 170 basis points from the prior year period, primarily due to impact of higher direct material costs, which will partially offset by production efficiencies. The consolidated gross margin increase of 200 basis points was primarily due to increased sales of higher margin Elfa products during the first quarter of fiscal 2018. Moving on to SG&A, as expected, SG&A increased 160 basis points during the first quarter due to approximately $4.9 million of final consulting Optimization Plan expenses, which added 240 basis points to – which contributed 240 basis points of deleverage. This increase was partially offset by an SG&A improvement of 80 basis points, primarily due to ongoing savings and efficiency efforts. New store preopening expenses decreased this quarter to approximately $346,000 from $1.4 million in the first quarter last year. We opened one store in Bridgewater, New Jersey in the current year period compared to one store opening in the prior year period. The decrease year-over-year is primarily attributable to a shift in the timing of new store openings, as the company incurred preopening costs in the first quarter fiscal 2017, first store that opened early in the second quarter of fiscal 2017. Our net interest expense in the first quarter of fiscal 2018 was $7.9 million, up from $4.2 million in the prior year period due to the August 2017 amendment to the senior secured term loan, which increased the applicable interest rate margin. We continue to actively monitor the debt capital markets for opportunities to re-price our term loan facility and reduce our interest expense. The effective tax rate for the quarter was 34% compared to 37.4% in the first quarter of last year. The decrease in our effective tax rate is primarily due to lower statutory rates as a result of the Tax Cuts and Jobs Act enacted in fiscal 2017, partially offset by a benefit for the re-measurement of deferred tax balances recorded in the first quarter of fiscal 2018, as a result of a reduction to the Swedish tax rate. On an adjusted basis, our effective tax rate for Q1 was 25.4% compared to 37.3% in the first quarter of last year. Our net loss for the quarter was $6.8 million or $0.14 per share as compared to net loss of $7.7 million or $0.16 per share in the first quarter of last year. On an adjusted basis, excluding the costs associated with the Optimization Plan, our adjusted net loss was $4 million or $0.08 per share as compared to a net loss of $5.5 million or $0.11 per share in the first quarter of last year. Adjusted EBITDA nearly doubled moving to $12.4 million in the first quarter this year compared to $6.4 million in Q1 last year. Turning to the balance sheet, we ended the quarter with $14.1 million in cash, $299.7 million in outstanding borrowings and combined availability on revolving credit facilities and cash on hand of approximately $84.7 million. Our net debt position was down approximately $31.7 million from last year. We ended the quarter with inventory down 0.9% compared to the end of the first quarter of fiscal 2017, despite the increase in stores opened from 87 at the end of the first quarter last year to 91 at the end of the first quarter fiscal 2018. On a per store basis, inventory levels at TCS were down 5.8% with the decline largely due to improved inventory management combined with lower product costs as a result of the Optimization Plan. Given our stronger than expected fiscal first quarter results, we are raising our outlook for fiscal 2018. We now expect consolidated sales to be in the range of $890 million to $900 million based on a comp store sales range of up 1.5% to up 2.5%. We expect GAAP EPS to be between $0.30 and $0.40 and adjusted EPS to be between $0.38 and $0.48 on a weighted average of 49 million diluted shares outstanding. This raised outlook reflects the tailwinds that we discussed as well as some headwinds that we are now facing, namely foreign exchange and fuel. It also reflects a higher level of digital marketing spend, given we have been pleased with the results of our digital marketing efforts thus far. We expect our tax rate for the full fiscal 2018 to be approximately 30% and our annual interest expense using forward LIBOR rates, but not assuming a refinancing between now and year-end to be approximately $30 million. In fiscal 2018, we still expect to spend approximately $38 million in capital expenditures for our planned two store openings and two relocations, $11 million to $12 million of our fiscal 2018 CapEx will be invested in our second distribution center expected to open in the Northeast in late fiscal 2019, as well as technology projects, maintenance spend on our existing stores and our Elfa business, and we would expect to incur similar $11 million to $12 million of CapEx spend for this DC in fiscal 2019 as we complete the project and bring the new facility online in late fiscal 2019. We still plan to generate positive free cash flow once again in fiscal 2018, which we continue to expect to utilize for further debt reduction. Now, with respect to the second quarter specifically, here is the few call-outs. One, we expect our comparable store sales increase for Q2 to be towards the low-end of our full year comp store sales outlook range. Q1 was stronger than the full year outlook range, given the significant Custom Closets benefit to comp store sales in Q1, both in the recognition of Q4 deferred sales, as well as the closet-related campaigns that were more heavily weighted to Q1. In addition, we are making some changes in our B2B business to improve our go-to-market position to capitalize on the mid to longer term opportunities that we see. We expect these changes to benefit our B2B business, but they will create some near-term disruption which we factored into our outlook. And lastly, there is a small Q2 impact resulting from the timing of our sale campaigns, which are shifting as we test and learn. In some cases, we're modifying the scope of our campaigns and in other cases the timing of our campaigns, all with the goal of increasing effectiveness and driving improvement in full-year sales and EPS. Number two, Q2 EPS will be burdened by incremental marketing expense spend of approximately 100 basis points due to the launch of our new brand marketing campaign. So from an earnings perspective, we would expect the year-over-year improvement in adjusted EPS to be at or below the levels seen in Q1. And then number three, we expect incremental interest expense of Q2 – in Q2 of approximately $1.6 million or $0.02 per share, since the refinancing of our senior secured term loans didn't occur until mid-August last year. Four, and finally as a result in – or as a reminder, in Q2 of last year, we incurred $6.7 million of consulting expenses that were recorded to SG&A that we do not anticipate this year. It's therefore important to share to look at our results and performance on a full-year basis given these shifts. In summary, we're very pleased with the strength of our first quarter top and bottom line financial performance, both of which exceeded our expectations. We are encouraged by the progress we're making and remain focused on continued discipline execution of our key strategic initiatives. We look forward to updating you on our second quarter fiscal 2018 earnings call. Thank you. Now, I'd like to turn the call back over to the operator, so that we can open up the lines for your questions. Matt?

[Operator:]

Great. Thank you. At this time, we will be conducting a question-and-answer session. Our first question is from Steve Forbes from Guggenheim Securities. Please go ahead.

[Steven Forbes:]

Good morning. Good afternoon.

[Melissa Meyer Reiff:]

Hi Steve.

[Steven Forbes:]

I guess it feels like morning.

[Melissa Meyer Reiff:]

Okay.

[Steven Forbes:]

The – I guess to start with the flagship store, right, the Dallas there. Obviously, looking at some of the pictures and so forth, I haven't had a chance to visit yet, but if you think about some of the merchandising changes, maybe some of the smaller ones like the Elfa Door & Wall Rack touchscreen display or some of the other ones within the box. I mean how long do you need before you can start rolling out some of these initiatives to the chain? Do you envision doing it piecemeal or do you – do you want to sit back this year and digest the remodels as a whole and come up with a more methodical approach? Like how do you – how are you thinking about approaching kind of the initiative in general?

[Melissa Meyer Reiff:]

Yeah, Steve, it's Melissa, and I'm so glad that you've seen some of the pictures. Obviously, it's still so early, we just launched it last month, and we do want to take a methodical and a very strategic approach to analyzing what's working, what's not, listening to employees, listening to our customers with all of our customer intercepts to know what is the right thing to do to roll out to existing and new stores. So, we've got our metrics in place, we've got the economics in place, we're going to continue to be evaluating it, we're very excited about you mentioned the Door & Wall Rack, we've also – I've mentioned in my remarks about our new organization studio, we're just very excited to test and learn, and this is The Container Store of the future. And as I said to that so far Steve the feedback has really been positive, but there is things that we've already learned, that we've made mistakes on, that we're correcting, and then there was many things that we're really digging, but it's going to take some more time for us to really decide how we're going to roll it out and when to other stores.

[Steven Forbes:]

And then a two-part follow-up. So, on that first question there, can you remind us the new store at Oklahoma and the relocations in Colorado, Virginia, are those going to be in next-generation formats? And then the second part, you mentioned the goal of reducing interest expense or the rates right on the term loan, can you help us kind of understand what you think right is the potential timing of the initiative in the magnitude of the savings, I mean, is it a 2018 kind of goal to get that lower?

[Melissa Meyer Reiff:]

Yeah, right, Steve, I'll take the first and Jodi can take the interest expense one, if you would Jodi. The Oklahoma City store and the two relocations in Denver and Tysons, they will all three be less than 20,000 feet. And we will be taking some of the learnings from Albuquerque, and yes some from even NorthPark if we can and apply them to those stores where it makes sense.

[Jodi Lynn Taylor:]

And then Steve on the debt question, we are actively monitoring the debt capital markets and looking for opportunities to re-price our term loan facility, and obviously the goal of that would be to reduce interest expense and increase EPS. We do not have any of – any savings – any specific savings factored into outlook, outlook is using current rates and assuming those occur throughout the year. However, of course our goal would be to do it sooner than that, and we'll just have to keep you posted as we have any new information.

[Melissa Meyer Reiff:]

Yeah.

[Steven Forbes:]

Thank you both.

[Melissa Meyer Reiff:]

Thanks, Steve.

[Jodi Lynn Taylor:]

Thank you.

[Operator:]

Our next question is from Matt McClintock from Barclays. Please go ahead.

[Unknown Speaker:]

Good afternoon. This is Kate Howard (00

[Melissa Meyer Reiff:]

Yeah, we can break that out. Custom Closets contributed was, Jodi, 4.2%, right?

[Jodi Lynn Taylor:]

Right. I mean Custom Closets was the significant contributor as Melissa said in her remarks, particularly because we had the combination of the deferred revenue benefit we spoke of 190 basis points plus it is a strong selling period for us with closet campaigns. So that drove the majority of the comp. But we had 50 to 80 basis points in the last couple of quarters and other products category comps being positive which we're very excited to see, because we had been seeing declines in those categories prior to that, so.

[Melissa Meyer Reiff:]

So, it contributed positively the other product categories. And Kate (00

[Unknown Speaker:]

Great. Thank you for that color. And so, also as a part of that pillar to own the Custom Closets, you've noted that the company is focused on growing the B2B channel, and then today noted the changes for the go-to market position. Could you give us an update on the strategy there?

[Melissa Meyer Reiff:]

Yeah, absolutely. We always are very diligent in looking at all parts of our business continually and making appropriate changes as we think necessary for the future of the company and all stakeholders. And we just recently moved the responsibilities for our B2B channel to Gretchen Ganc, who is our new EVP or she started in December of EVP of Strategy & Analytics. And we just felt like after further digging in that we needed to step back and more formalize a go-to-market strategy and direction for our B2B channel to really capture the full opportunity. I mean it's mostly Elfa and we own Elfa. It's exclusive to us. There's a huge opportunity there. So we just really wanted to make sure that we've got the right strategy in place with the right partners. So therefore we probably will see some moderate growth in the next couple of quarters. So we may have to take a little bit step backwards to take the short-term pain for long-term gain for the future. But we know it's an important channel and a great opportunity, but Kate (00

[Unknown Speaker:]

Great. Thanks so much.

[Melissa Meyer Reiff:]

Thanks, Kate (00

[Operator:]

Our next question is from Matt Fassler from Goldman Sachs. Please go ahead.

[Matthew J. Fassler:]

Thanks so much. Good evening almost. And I have a number of follow-up questions. First of all, if you could just help us size the 190 basis points spillover in terms of delta in book sales that have been essentially or delivered sales that have been booked in Q4. How much big of an impact is that than you have typically experienced in the spillover from the fourth fiscal quarter to the first? Is that the change in the contribution of that – of those deferred sales or is it just in absolute terms 190 basis points. And if so, kindly remind us what it was last year?

[Jodi Lynn Taylor:]

Sure. Matt, this is Jodi, I'll take that, and we did as you may recall at the end of Q4, we had deferred sales up about $3.3 million year-over-year. We ended at 11 – just over $11 million compared to $7.7 million the year before. During the quarter, we did a really great job of clearing out our Elfa orders from the end of the fiscal year. And with virtually all of that year-over-year increase in deferred sales in Q4 then being realized in Q1. So to answer your question, the 190 basis points is the net incremental impact, it's not just the impact from this year, because we have...

[Matthew J. Fassler:]

Yeah.

[Jodi Lynn Taylor:]

...deferred sales at any given year. One thing, I think it's important for you to know is, that does not in any way hurt Q2, as we had strong Custom Closets selling throughout Q1, and you'll see when we later file our 10-Q that we had deferred sales that were $2.4 million higher than last year at the end of Q1. So we are – by no means did we take away from Q1, when we recorded the deferred sales coming from Q4. So hopefully that makes sense.

[Matthew J. Fassler:]

If anything you should talk about compares of anything that might give you a bit of a tougher comp in Q1 of next year, but depending on how your written sales track...

[Melissa Meyer Reiff:]

Yeah.

[Matthew J. Fassler:]

Okay.

[Jodi Lynn Taylor:]

That's right.

[Matthew J. Fassler:]

Secondly, on gross margin drivers, can you talk about sort of the progression of where you are in the cost optimization effort as an impact for cost of goods? And also, I know this is sort of hand-in-hand perhaps of closets, but just talk about the contribution of you said the mix shift to Elfa within TCS was helpful to you, if you could just help size what kind of mix shift that was? How big that mix shift was?

[Jodi Lynn Taylor:]

I'll take the first part, the gross margin question. We as you'll recall really didn't start to see meaningful flow through of our cost of goods project, the Optimization Plan, cost of goods project until Q4 of last fiscal year. So we saw in Q1, flow through as we anticipated we would see it's flowing through right on track. And we expect to continue to see that flow through occur through third quarter of this year. So we would expect year-over-year to see gross margin improvement through Q3 from the benefits of that project.

[Matthew J. Fassler:]

And so, is the run rate – I'm sorry, is the run rate that you just achieved sort of indicative of the run rate we should see – where you should see until you cycle the launch of that initiative?

[Jodi Lynn Taylor:]

From the flow through perspective, yes, but what also has to be taken into consideration to, Matt, is the fact that, when we have a strong Custom Closets quarter which is what you see on a recognized basis in both Q4 and Q1 as compared to Q2 and Q3, they represent a higher portion of total. Elfa is the higher gross margin product for us, because of the consolidated benefits we receive there. So that tends to cause the lift year-over-year to be even a little bit higher when that mix tends to be even stronger towards Elfa with the strong Elfa selling that we are seeing, which kind of leads to your second question around Elfa and Custom Closets is being largely driven by Elfa. Elfa still dwarfs any other of the Custom Closets categories we sell. Remember though that Custom Closets definition does also include the closet department accessories and we also had a very strong closet sale this year exact same timing as last year, but similar to how we did for kitchen, we changed the way we structured that sale and instead of it being across the board 15% of the entire department, the entire category from April 1 through mid-May, instead we chose select items and advertise those at 25% off. So same exact format change to what we did kitchen, we did the closet and saw just like with kitchen saw very positive customer response to that.

[Melissa Meyer Reiff:]

Matt, it's a much more deliberate and targeted approach than just a blanket discount across the department.

[Matthew J. Fassler:]

Great. And then lastly, if I could, you spoke at great length about your efforts in digital and in social in particular. Is there a way to size the social media footprint that you've launched or in the midst of implementing relative to what you had in the past?

[Jodi Lynn Taylor:]

Not in terms of impressions.

[Melissa Meyer Reiff:]

Yeah.

[Jodi Lynn Taylor:]

We do track the PR type impressions we get and those are definitely largely around both the NorthPark launch and the brand marketing that we just...

[Melissa Meyer Reiff:]

Brand marketing.

[Jodi Lynn Taylor:]

...did.

[Melissa Meyer Reiff:]

And the digital just continues to perform through our media mix model as well as the social. So it's really matter of combination, we're just kind of firing on all cylinders and it's all kind of coming together. And we'll – we continue to evaluate it very consistently, very strategically as we move forward through the rest of the year, and we'll continue to do that into next year as well. So, yeah, I don't know how to answer that any other way, Jodi

[Jodi Lynn Taylor:]

Just from a spend perspective, digital spend is definitely on the rise and represents a much greater percentage of total. If you look over the last two years, it's grown to where it's – before we know it's going to be more than half.

[Melissa Meyer Reiff:]

Right. But we're still spending, Matt, about 4% of revenue on marketing, it's just reallocating it in a – I think a smarter and much more strategic data analytics driven way, and it's producing the results. And so we're going to continue, but we're as I mentioned in my remarks, we're doing a lot of this in real-time which is really wonderful and it's paying off.

[Matthew J. Fassler:]

Thank you.

[Melissa Meyer Reiff:]

I hope that answers. Thanks, Matt.

[Matthew J. Fassler:]

Absolutely, thank you.

[Jodi Lynn Taylor:]

Thank you.

[Melissa Meyer Reiff:]

Thank you.

[Operator:]

Great. Thank you. This does conclude the question-and-answer session. I'd like to turn the floor back over to management now for any closing comments.

[Melissa Meyer Reiff:]

Okay. I think that's it. Well, great, thank you guys so much for your interest and support of our company and we will very much look forward to talking with you in November with hopefully similar results. Thanks so much.

[Operator:]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you again for your participation.