Container Store Group Inc (TCS) 2013 Q3 法說會逐字稿

Greetings and welcome to The Container Store third quarter 2013 conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Farah Soi of ICR. Thank you, Ms. Soi. You may begin.

Thank you, Operator. Good afternoon, everyone, and thanks for joining us today for The Container Store's third quarter 2013 financial results conference call. On today's call are Kip Tindell, Chairman and Chief Executive Officer, Melissa Reiff, President and Chief Operating Officer, and Jodi Taylor, Chief Financial Officer. After management has made their formal remarks, we will open the call to questions.

I need to remind you that certain comments made during this call may constitute forward-looking statements and are made pursuant to and within the meaning of the Safe Harbor provisions 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 risks and uncertainties are referred to in The Container Store's press release issued today. The forward-looking statements made today are as of the date of this call and The Container Store does not undertake any obligation 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 showing the GAAP versus non-GAAP financial measures is available in The Container Store's press release issued today. If you do not have a copy of today's press release, you may obtain one by visiting the Investor Relations page of the website, at containerstore.com. I will now turn the call over to Kip. Kip?

Thank you, Farah, and good afternoon, everybody. Thanks for joining us on our first conference call as a public company. We've been in business 35 years. This is the very first one we've ever had. In fact, I was joking that it seems kind of -- we've only been public for two months, but we're already having our first quarterly conference call.

We're very, very pleased with our operational performance in our third quarter. The 10.8% sales increase for The Container Store's retail business was driven by strong performance against both our new and our existing stores. We began the year with 58 stores, and during the third quarter we opened two new stores, for a total of six new store openings, including one store relocation in fiscal 2013.

We opened stores also on a combination of new and existing trade areas, with openings in Orlando, and Tampa and Boca. It was a big year for Florida, as well as Palo Alto, California and Reston, Virginia. Additionally, we relocated our very undersized and older format Fort Worth, Texas store to a bigger and better location. We've been very, very pleased with these new stores that we opened in 2013 and they continue to exceed our expectations.

Comparable store sales increased 4.7% in the third quarter, 4.7%, our 14th consecutive quarter of same-store sales increases. These sales results, in combination with our strong product margin and expense management, drove adjusted earnings per share of $0.11, $0.11, even as we absorbed the new costs associated with being a public company.

I want to take the opportunity to thank everyone who contributed to our very successful initial public offering on November 1, including our, first and foremost, our dedicated employees, our loyal customers, our beloved vendors, and all of our supportive shareholders. Yes, we could not be more thrilled, more humbled, honored by the reception we received from the market. By taking this path, we're able to facilitate broader employee ownership of The Container Store, which is very important to us, increasing our ability to operate a business where everyone associated with the business thrives.

Having been private company for 35 years, it's been truly joyful and career fulfilling for us to be able to get stock in the hands of so many of our great employees, who are stunningly well received larger than most directed share program, as well as by offering stock options to so many employees at the IPO. Wonderfully enough, and get this, our directed share program included offering participation to all employees at The Container Store. The directed share program included offering participation to all employees at The Container Store, and we issued stock options to all full-time employees who have at least two years tenure with The Container Store. That resulted in almost 1,100 employees, 1,100 people.

We're so very proud of this. I truly feel that morale in our Company has never been higher and that our culture has never been stronger. We believe it's culture that drives the value of the Company, and we look forward to continuing to deliver long-term value for all of our stakeholders. Our yummy employee-first culture, where we operate based on our seven foundation principles and adhere to the tenets of conscious capitalism, results in high employee satisfaction and extremely low employee turnover. This enables us, for instance, to invest very heavily in training programs that in turn drive the great store experience and loyalty of our customers. We're so very for fortunate that our customers don't just like The Container Store, they love The Container Store.

Something else that's so very important and also driven by our foundation principles is our relationship with our incredibly innovative vendors, who we really view as true partners. In fact, it's hard to tell a vendor from an employee around here. We've done business with so many of our vendors for literally decades and have cultivated a deep partnership with them that's resulted in the world's most celebrated collection of storage and organization products, including very, very significant proprietary product that's unique to The Container Store. Well over half of our products are proprietary.

My wonderful wife and our Chief Merchant, Sharon Tindell, and our incredible team of buyers introduce over 2,000 new SKUs each year on our base of 10,000 SKUs, ensuring our collection is always extremely fresh, extremely relevant, by working closely with these wonderful vendor partners throughout the globe on differentiated, highly differentiated product development.

I couldn't be prouder of our Company and the team we have in place, a team that I often refer to as the best in retail. The management team, with an average tenure of over 17 years, with amazing bench strength in all of their teams, our customized solutions-based selling approach -- solutions-based selling approach -- and our unique and comprehensive product offering that generates industry-leading product margins enables us to invest in the training and development of our employees that result in an unmatched store experience for our customers. That is the major driver of our success. After all, we sell the hard stuff. It's so true, stuff that's hard to sell. We couldn't do it without the commitment we make to our employees and without the incredible support of our vendors. I can't stress this enough. Our investment in employees and our strong vendor relationships contribute immensely to the success we enjoy. These two important differentiators keep our customers, well, dancing in their closets and in their pantries.

So with the base of 63 stores today and with potential for over 300 locations in the United States, we have incredible opportunity for store growth. As we look to this remarkable runway for growth, all of us at The Container Store are excited and extremely energized by the many opportunities that are ahead. The best is truly yet to come.

Melissa is going to go over some key operational highlights from the quarter. Melissa?

You bet. Thanks, Kip. And hello, everyone, and thanks again for joining our very first call. We're really happy that you could join us this afternoon.

As Kip mentioned, we did achieve strong performance in both our new and existing stores and our third quarter, driven by a number of key events that were supported by our focused and marketing -- targeted marketing efforts.

I'd first like to start with the most important element of The Container Store's growth story, and that is our new stores. We opened two beautiful new stores in the third quarter of fiscal 2013, with much excitement and fanfare, as always. Kip mentioned our Reston, Virginia store at Reston Town Center. That opened on September 21. And then our beautiful Palo Alto, California store opened in the fabulous Stanford Shopping Center on October 26. As some of you, I hope, may have experienced first-hand, we really do grand open a store unlike any other retailer. It's a proven strategy for us, with the goal for that store to immediately begin performing like a mature store, as opposed to a strategy where it opens slowly and you ramp up sales over several years.

And to accomplish that, it's not easy. It really does take a lot of work on the front end, about nine months out from the opening, to really understand the community, ingratiating ourselves. It takes a lot of time and money and energy and focus. And we do this in a variety of ways, all of which lead to incredibly strong returns on the investment that we make in our new stores.

And in the third quarter, we continued to see significant growth in and benefits from our customer engagement program, POP, P-O-P, Perfectly Organized Perks. I hope some of you are already maybe a POP star. We rolled this out in our California stores July 15; and the program is now in all of our 10 California stores, including our new Palo Alto store.

Through the end of the third quarter, we had over 131,000 customers enrolled to be POP stars in the very short time that we've been testing this program. And since July 15, we have experienced improved traffic trends in those stores and remain very optimistic about the future of this unique, what we call, surprise and delight program for our passionately brand loyal customers. Our plan is to roll out this program to all stores during 2014. So I can't wait to update you further on this as we launch it company-wide.

Okay, just wanted to talk a little bit about Elfa. As you may know, I hope you know, Elfa is our highest volume as well as our highest margin product at The Container Store. It's our wonderful Swedish shelving and drawer system that can be customized to fit all storage and organization needs. We say it's the foundation of every well-organized space. And we're so delighted, because our Elfa sales have been strong all year. And that trend continued in our third quarter during our annual shelving sale, where our Elfa shelving components, we offered at 25% savings, as well as installation at a 25% savings.

And speaking of installation, this is another exciting growth area is our installation business. When customers have us install their space for them versus them installing it themselves, they are enjoying is much faster. As Kip says, they're dancing in their closets more quickly. And they are increasing their propensity to return and purchase another space. Just what we want.

It's that potato chip theory that we've been talking about for years with Elfa. You can't just have one Elfa space. Elfa installation transactions for comp stores were very strong throughout the third quarter. We're proud that more than 52% of our installable Elfa sales included installation, and this is up from very low single digits just a few short years ago.

As I hope you know, here at The Container Store we are all about -- well, we're about a lot of things -- but we're a lot about training and communication, again driven by our commitment to our seven foundation principles. As we continued our focused efforts in this regard in the third quarter, on our Man in the Desert selling, which is 100% about selling the complete solution to every single customer, not merely just an individual item or product, really connecting with our customer, intuiting her needs and selling her, every single customer, exactly what she wants, needs, expects and deserves, as it has for many years now, this serves to drive our average ticket which increased 5.8% in the third quarter for our comp stores. We historically and will continue to always be very proud of our ability to drive average ticket increases.

Another exciting initiative I want to share a little bit more about is our At-Home service that we're initially testing here in our home market, the Dallas-Fort Worth Metroplex. Over the years, I believe that our customers have asked for this service more than any other from us. And we continue to learn and refine this service here in Dallas-Fort Worth, as we go into customers' homes and organize for her at any level she wants, soup to nuts. Whether she wants us to transition her closet from winter to spring, or organize her entire home, the point is, we will do it for her. So I will look forward in our next call to updating you further, as we gain more learning from our testing of this program. And our plan is to gradually roll this service out to other markets, and we will announce them as we launch those in those specific markets.

And then just a few comments that occurred about our two big campaigns during the third quarter that I wanted to share. As I mentioned before, our annual shelving sale ran from August 26 to October 20. And it's when we reduce the price of all shelving and installation by 25%. We thrilled our customers this year with new, fabulous product added to our shelving assortment for this year's sale, and we supported the event with a robust marketing campaign.

We also created a lot of excitement in our store, with free weekend demonstrations that we advertised that included a shelving demonstration and a demonstration on specifically organizing your craft room, because that's becoming incredibly popular. This year's sale was another great success. So we are very happy about that.

In late October, we launched our Glorious Gift Wrap Wonderland, which is the focus during our Christmas season. And hopefully, all of you had a chance this year to experience it. It just gets better and better each year. It truly is the world's most celebrated collection of gift wrap, ribbons, totes, bows, tins and tie-ons, really everything you need to make your gift packaging just as beautiful and special as the gift itself.

And our stores looked really extra fabulous this year. And those of you who live in New York and Los Angeles, specifically, maybe visit our Century City store, you may have seen our spectacular store windows that featured really cool dresses designed and created by our employees, made out of our exclusive signature gift wrap and packaging. And boy, it received a lot of press, so we were really excited about that, too.

During this time, we also hosted our free gift wrap and bow making demonstrations in our stores throughout the season which, again, our customers love. And our stocking stuffer collection was our biggest assortment yet, with something really fun and functional for everyone on our customer's list. And we mailed catalogs to our customers to support our stocking stuffers and Gift Wrap Wonderland in late November. The entire Gift Wrap Wonderland campaign was, of course, supported by another creative and robust marketing plan.

So in closing, I just wanted to speak for just a moment to really what is at the core, the real core, of everything we do. And that is, of course, our focused efforts in letting our customers know what we stand for, about our foundation principles, and our commitment to conscious capitalism.

We featured a note from Kip in our shelving sale catalog in support of that message, in-store, online and through our fabulous blog, whatwestandfor.com. And we have big, big plans coming up to continue our What We Stand For marketing and advertising in our fourth quarter, and really throughout all of 2014. We have a big launch next week and I'm really so excited about this, as we continue to tell the story of our stakeholder model and conscious capitalism, asking the question, what if everyone associated with a business could thrive?

I hope maybe I've piqued your interest a bit. So I hope so. And you'll really have to watch for us next week, because we have a lot of activity that's going to be occurring with our What We Stand For campaign. So now I'm going to pass it over to Jodi Taylor, our CFO, who's going to review our financial detail in much more detail.

Thanks, Melissa, and good afternoon, everyone. I'd like to begin my remarks with a review of our third quarter and year-to-date results and then discuss our outlook for the year. What I do speak to profitability, it will be an adjusted basis, since our nonrecurring IPO-related costs had a significant impact on our quarterly GAAP results. Please refer to our press release for our GAAP results and a reconciliation of GAAP to adjusted numbers.

We increased our total sales in the third quarter by 7.3%, to $188.3 million, from $175.4 million in the third quarter of last year. Sales in The Container Store retail business were up 10.8%, to $163.7 million, and our third-party sales at our Swedish subsidiary, Elfa, were $24.6 million.

We ended the quarter with 63 stores at The Container Store, as compared to 58 stores as of the end of the third quarter of 2012. As Kip said, we continue to see strong sales in both our new and existing stores. Over the last several years, in fact, our new stores, on average, have generated first year sales volumes of approximately $7 million and strong returns on capital, resulting in an approximate 2.5 year pre-tax payback period.

Our comparable store sales for the quarter increased by 4.7%, on top of 4.3% in the third quarter of 2012. The 4.7% comp was driven by a 5.8% increase in average ticket. In addition, our third quarter comps benefited from the anniversary of Hurricane Sandy and the timing shift of our annual shelving sale. These benefits were offset slightly by the later Thanksgiving holiday and Cyber Week that resulted in some sales being pushed into the fourth quarter this year. We have factored the Thanksgiving holiday and Cyber Week shift into our revised fourth quarter outlook.

Moving on to our Swedish subsidiary Elfa, whose third-party sales represent only 13% of our consolidated sales on an annual basis. Elfa's third-party sales were $24.6 million in the third quarter, compared to $27.7 million last year. The 11.3% decline was due to the sale of an unprofitable German subsidiary in the fourth quarter of last year, as well as the continued weak macroeconomic environment in Europe. The unprofitable German subsidiary that was sold fourth quarter last year generated $2 million of sales in the third quarter last year. So if you exclude this impact, Elfa's third-party sales were down 4.3%. It is very important to note that the power of Elfa to our consolidated results is the very high consolidated gross margin we achieve for this exclusive product at The Container Store retail business, which represents approximately 24% of our sales at The Container Store annually.

Our consolidated gross profit increased 8.5% in the quarter, to $112.9 million, from $104.1 million in the third quarter of last year. Consolidated gross margin increased by 60 basis points, to 60% from 59.4% in the prior-year period. Net sales at The Container Store retail business represented 87% of our consolidated sales in the third quarter of fiscal 2013, as compared to 84.2% in the third quarter of fiscal 2012.

Since gross margin percentage is higher in The Container Store retail business, this led to an improvement in consolidated gross margin. Gross margin in The Container Store retail business decreased 20 basis points, to 58.9%, due to a weaker US dollar compared to the Swedish Krona. Elfa gross margin increased 170 basis points, to 40.5%. The Elfa gross margin increase was driven by favorable direct material and freight costs, as well as realized operating efficiencies from improvements that were implemented over the past 12 months.

It is important to note that Elfa's commodity purchase contracts are for short-term periods. Elfa from a seasonality standpoint, the third quarter is the largest volume quarter of the year at Elfa, when they're shipping to all accounts in advance of the important fourth quarter and therefore realize the highest volume-related efficiencies.

The consolidated SG&A expense of $88.8 million increased from $81.7 million in the third quarter of fiscal 2012. As a percentage of sales, consolidated SG&A increased to 47.2% from 46.6% in the third quarter of fiscal 2012, with the increase driven primarily by increases in expenses incurred in preparation for our initial public offering, expenses associated with operating as a public company, as well as the timing shift of direct mail expenses at The Container Store retail business.

We recorded $14.6 million of stock-based compensation expense during the quarter, as we accelerated vesting of certain stock options in conjunction with the IPO. The remaining annual stock compensation expense for all issued and outstanding options at this juncture is approximately $1.1 million per year going forward.

Our net interest expense in the third quarter of 2013 was $5.8 million, compared to $5.1 million in the third quarter of fiscal 2012. The increase resulted from the April 2013 amendment and increase in borrowings under our senior secured term loan facility of $90 million, which reduced our interest rate on the facility and allowed us to pay distributions on the senior cumulative preferred stock, which carried accumulating rate of 12%, as compared to the current pre-tax interest rate on this term loan facility.

Note that we were able to reprice our term loan facility post-IPO, and that brought the interest rate down to LIBOR plus 3.25%, with a 1% LIBOR floor, effective as of November 27. This was partially offset by a $31 million repayment on the loan subsequent to the completion of the IPO in November. Our annual interest expense at today's LIBOR rate is expected to be approximately $17.5 million.

Our effective tax rate for the quarter was tax expense of 39.9%, compared to a tax benefit in the third quarter last year of 33.2%. The unusual tax rate this quarter is a direct result of the IPO-related stock-based compensation expense, which is deferred for tax purposes until the options are exercised. As with certain other deferred tax assets, we have recorded a valuation allowance against the stock-based compensation expense, which results in the unusual tax rate. Our tax rate on adjusted net income demonstrates a more normalized rate, with the IPO-related stock compensation expense excluded. Our adjusted earnings per share guidance for fiscal 2013 contemplates an estimated effective tax rate of approximately 38% for the year.

Before I discuss net income and earnings per share, I want to point out that for both the quarter and year-to-date periods, I will be referring to adjusted net income and earnings per share in both periods. The adjusted earnings per share is based on adjusted net income using an adjusted diluted weighted average share calculation for the quarter. This calculation assumes the IPO transaction took place at the beginning of each respective period, thus eliminating the lack of comparability due to the IPO taking place at the beginning of the third month of our third quarter.

A reconciliation of GAAP net income and net income per share to these adjusted numbers on an adjusted share basis can be found in the financial tables included in our earnings press release issued today. As a result of the factors I just described, adjusted net income for the quarter was $5.2 million, or $0.11 per diluted share based on 48.8 million adjusted diluted shares outstanding, as compared to $5.3 million, or $0.11 per diluted share based on 47.9 million adjusted diluted shares outstanding in the third quarter of last year. Our earnings press release includes details of our year-to-date financial performance, so I'm not going to go into that in the interest of time here.

As you all are aware, our initial public offering transaction closed on November 6, 2013. Net proceeds from the IPO were used to eliminate our 12% senior cumulative preferred and junior cumulative preferred stock, with the balance of the preferred stock converted into common stock at the IPO price, so that we now solely have common stock on our balance sheet.

We also used the net proceeds of $31 million from the over allotment option exercised by the underwriters to pay down outstanding borrowings on our senior secured term loan facility. We ended the third quarter of fiscal 2013 with $10.8 million in cash on our balance sheet, $369 million in outstanding borrowings, and $68.1 million in availability under our $75 million US revolver facility and our $26.7 million Swedish revolver facility.

We also ended the quarter with inventory of $105.1 million, as compared to $96.1 million in the third quarter of last year. From an inventory standpoint, we entered fourth quarter well-positioned for our annual Elfa sale that runs from December 24 through February 11 of 2014.

Now I'd like to turn to our outlook. For fiscal 2013, consolidated net sales are expected to be $754 million, based on opening six new stores, inclusive of one store relocation, with an increase in comparable store sales of 3.4% for the year. Adjusted net income, which excludes certain items that we do not consider in our evaluation of ongoing performance and distributions accrued to preferred shareholders, are expected to be $0.40 per diluted common share, based on estimated adjusted diluted weighted average common shares outstanding of 48.8 million.

Our implied fourth quarter sales and comp guidance ranges take into consideration the various weather events that all retailers have experienced to date in fourth quarter, as well as the shorter holiday shopping calendar. And to be clear, the fact is for us that the vast majority of fourth quarter sales are Elfa-driven, given our annual Elfa sale kick-off on December 24 and runs until February 11. So, unlike many other retailers who generate the vast majority of their fourth quarter sales during the holiday period, there remains a substantial portion of fourth quarter business still to be done at The Container Store until our fiscal year concludes March 1. Our biggest sales period are in January and February, and we're encouraged by the trends we continue to see in Elfa sales, as Melissa mentioned earlier.

In fiscal 2013, we will also have incremental costs, including additional payroll and professional fees associated with the becoming a public company, representing roughly $1 million, with approximately $500,000 of this expense to be recognized in the fourth quarter that we did not have at all in fourth quarter last year.

As it relates to capital expenditures, we expect to incur approximately $41 million of CapEx in fiscal 2013. The vast majority of this will be spent on new store construction and related costs. The rest will go towards our existing stores, our new and existing distribution and production facilities, and our corporate infrastructure.

Our long-term financial objectives include annual square footage growth of 10% or more per year, and we expect to achieve that in fiscal 2014. We plan to open seven new stores, including one store relocation, compared to six new stores with one relocation in fiscal 2013. Our next opening will be in King of Prussia, the Philadelphia area, which is scheduled to open on March 8.

And with that, I would like to turn the call back over to the operator so that we can take your questions.

Thank you.

(Operator Instructions)

Gary Balter, Credit Suisse.

Thank you, and congratulations on your first quarter as a public company.

Thank you, Gary.

A couple questions. Could you talk about POP Star? You gave us some details that said it's working, but could you give us a little bit more detail about how many people you signed up? And if you will -- you may not -- the impact it's having on the stores where it's in?

You bet. Gary, hello, it's Melissa. Thanks for the question. And as you know, I love to talk about POP, our customer engagement loyalty program. Through the end of the third quarter, Gary, we've enrolled about 131,000 POP Stars. And so we have big plans for that to continue to grow, grow, grow. And we have definitely seen, Gary, a notable lift in transactions in those California stores, both when we compare their performance prior to the rollout on July 15 and also against the rest of the stores where POP doesn't exist yet. So this is a very large strategic focus for us. In 2014, as I said, we're going to be rolling this out to all stores.

And we learned, Gary, that from surveying our customers, that the one thing they really wanted from us was not necessarily discounts at all. It was more communication from us, more an opportunity to feel even more a part of the brand, to participate even more. More communication. So we really feel like that this POP program, we've waited 35 years to offer this to our customers. And it's a unique and a special one. It's not like the typical retail or point-based one, 100%. It's more of a surprise and delight. And we're continuing to learn from our test in the 10 California stores, and excited to make this a very strategic focus for 2014 and know it's going to drive average ticket, it's going to drive traffic, conversion, et cetera.

You know, I think what's different is yes, 35 years, you still don't have a frequency program. But I think most retailers tend to get into just sometimes unprofitably giving away gross margin on the frequency programs. Our customers who don't like us, but love us, they don't want just a discount. They want hugs. They want communication. They love the Container Store. So I think this program is better than most. I think it takes that type of company for people to sign up for it. But we also have just experienced an amazing conversion rate in California. Do you remember the conversion rate that we've experienced so far in California? I've been so impressed by it. It's several times what we expected.

Yes, exactly. It's over a third of the customers that walk in the store sign up to be a POP Star.

So a third of these busy Californians that are coming through the registers are signing up for this program. That's amazing. And if we can hold onto that as we roll it out nationwide, I think it's going to be tremendously beneficial for traffic.

Yes.

So this is being rolled out in 2014 to all stores?

Yes, sir. That's our plan, Gary.

And then second question, and I'll let somebody else ask. You talked about Elfa Europe, and it was down 11.3%, partly because of closing one area. So as we go forward, should we be expecting that that should be positive, like was the impact more than 11.3% from the closing?

I'll take that, Gary. Remember that I stated that of the 11.3% decline, approximately $2 million of those sales that declined were due to the closing -- or the sale, excuse me -- of the unprofitable German subsidiary. We accomplished that sale at the end of January last year. So when you exclude that, the decline in third-party sales at Elfa was down 4.3%. And remember that Elfa's third-party sales are only 13% of our total consolidated sales. And Elfa's sales to The Container Store continue to be very, very strong and really are the main driver to Elfa and to the consolidated company. So as I think you're all aware, the power of Elfa to our consolidated results is the very high gross margin we achieve for this exclusive product that's 24% of our sales here at this Container Store segment. And we certainly are cautiously optimistic, as you look forward, there's some more promising signs in Europe for 2014. So we'll have to see. One other --

I'd just like to emphasize that again, the Elfa Company's third-party sales to retailers in Europe have struggled with the four-year recession in Europe a little bit. But that's not what's important to our Elfa business. The reason we bought the company, the value of Elfa has to do with our consolidated sales of Elfa product, which bring them a very nice gross margin and bring us an extremely high gross margin in the high 60s, actually, at retail. That consolidated gross margin is what the Elfa business is all about. So their third-party sales are down a little bit. But importantly, our own Elfa sales, that we buy from Elfa and experience that wonderful consolidated gross margin on, is what's important. And those sales continue to, by design, far outpace our overall sales increase.

Thank you very much.

You're welcome.

Chris Horvers, JPMorgan.

Thanks. Good afternoon. Pulling apart some of the one-time calendar items that you had to anniversary and the shifts, can you talk about the cadence of business during the quarter? Did you see a slowdown as the government shutdown loomed, and did it bounce back as you proceeded forward into November?

Chris, we're not going to start talking about our monthly comp performance. But I think it's important to note that in the third quarter, we had a lot going on in terms of shift. So we had, as you may recall, in September we had the shelving sale that shifted some sales from second quarter into third quarter, with our 53rd week and the Labor Day shift therein. And that benefited us in September. Then in October, we were benefited by the anniversarying of Sandy in those stores that were impacted in the Northeast. And in November, as we're all well aware, we had a shorter holiday calendar, where this year we just had a couple shopping days after Thanksgiving versus more than a full week last year. So even if I were to tell you what the monthly comps were, I really don't think you'd really find them very useful because of all these movements. But yes, we definitely feel -- we're very proud of our comps for the month.

Okay. Fair enough. And then on the margin side, can you give us a little more detail around some of the constituent margin drivers in gross margin and SG&A? So for example, the Swedish krona, what sort of impact was that and how do we think about the fourth quarter? Any detail on occupancy, leverage that you may have driven in SG&A would be helpful, as well.

Okay. Sure. On the gross margin side, as I'd mentioned, The Container Store's gross margin year-over-year in third quarter was down 20 basis points. And that was exclusively due to our Swedish krona rates being -- inventory of Elfa that we purchase at The Container Store is purchased in Swedish kronor from Elfa. And those rates, because of the dollar, were slightly higher. So that impact was relatively modest, but was an impact for us in third quarter. And we don't purchase far out on our contracts, so we're definitely always watching for opportunities in terms of our Elfa rates for Swedish krona.

But at this point, we don't expect a material difference year-over-year. The rates appear to be relatively consistent, if you look at today's rate of Swedish kronor versus last year. In addition, on the expense side, we did see some leverage of the occupancy that kind of went into the blender of all the SG&A expenses that we spoke of. But on a consolidated basis, the real answer to the year-over-year quarter difference was very much related to the incremental costs in our numbers related to public company.

I will say that most currency analysts are forecasting stability to improvement on the dollar to kronor. We hope to see that in the coming year. It's an important thing for us, because 24% of our sales are Elfa. When we're given the opportunity, and when we have a stronger dollar, we do increase our foreign contract purchases; and when the dollar is not cooperating, we buy at the market rate.

Chris, one thing I should have mentioned on expenses, I didn't finish the sentence. In addition to the public company costs, we also had some timing shift of some direct mail expenses that added to the third quarter expense structure. Primarily the benefit of that was in second quarter.

Okay. Thanks very much.

You're welcome.

Denise Chai, Bank of America.

Thank you, and congratulations on the quarter.

Thank you, Denise.

Just wanted to ask first about your ticket drivers, because 5.8% growth is, I think, far in excess from what we've been seeing. How much of that was Elfa, given the shelving sale shift and also the strength in Elfa's installation sales? And can you also give us any color on non-Elfa ticket?

We don't have that information right in front of us, but --

Can we get back to you? We don't have that, but we can get it.

I think it's just important to realize, we think we have the best retail sales force in retail. The average -- we put in 263 hours of formal training for each first-year employee. One of our core competencies is what we call Man in the Desert selling. We have long tenured employees that actually really care about our customers' storage and organization problems. So one of our big competitive advantages is that we can increase average ticket with that sales force much more readily than we could with a less sterling, average salesperson. So that's something that I think gives us a huge competitive advantage. The better your salespeople are, the more you should emphasize average ticket increase. And we emphasize that hugely.

Right. And that 5.8%, Denise, for the third quarter, we were very proud of. I can tell you that Elfa, as I said earlier, Elfa sales all year long have been performing better than the other departments. But we don't get into the sales by department or campaign. But as Kip said, the average ticket and our ability to readily increase that with the focus, the training, the Man in the Desert, the complete solution, is a big differentiator, huge differentiator for us.

Got it. Okay. Thank you very much. And just one other. Can you give us a sense of the annualized run rate for stock-based compensation going forward?

I sure can, Denise. This is Jodi. It's $1.1 million per annum, based on all the outstanding options right now.

Okay. Great. Thank you very much.

You're welcome.

Thanks.

John Heinbockel, Guggenheim.

A couple of things on sales. I know you have a pretty good track record here of new stores exceeding budgeted expectations. How are Reston and Palo Alto doing, at this point, versus your budget?

We --

Go ahead. They're doing well.

They're both very good.

The stores are -- I'm just going to say it -- we're happy with our new store performance than we ever have been in our history. But what specifically, Jodi?

Yes. It's fair to say, John, that every one of our stores from the class of 2013, all of the five new, plus we of course relocated Fort Worth. Every single one of them is exceeding our expectations. And we really do believe that when we're able to look back at the class of 2013 openings, that we're going to have some really great stores in that base.

Do you think they're exceeding the budget by more than last year's vintage, or about the same?

You know what? I don't think I should be specific yet, only because, remember that some of these stores have just opened. So you're right. You're starting to compare very partial year estimates.

But every single one is exceeding.

And I'm comparing to our pro forma expectations.

We were thrilled with last year's new stores, as well. So we're very, very happy with our new store -- we're extremely happy with our new store performance.

And what about e-commerce growth? Any metrics on that?

Sure. Our e-commerce numbers right now -- if you include the click and pick up business that is originating through the web, is in total right at 11%, if you look at the year-to-date period this year, which is up slightly over last year. So we are seeing a little bit of an increase in the web penetration. It is growing at a greater rate than the rest of the store, by a little more.

Click and pick up, since we don't pay commission in the stores, we credit that to the stores, which is the humane thing to do. But it's really an internet sale. So if you add those together, it's about double, in the 11% range, what the pure internet sales are.

Right. And John, like we talked before, we wanted to be able to offer our customer to shop whenever, wherever, however she would like in any channel. So online and click and pick up and other opportunities we have ahead of us, go shop, click and pick up, all of those are important.

And then just lastly, and conceptually, you did reference that it takes a tremendous amount of energy to get these stores off to the starts that they get, how do you think about capacity for store openings from an organizational standpoint going forward? 10% ends up being six, seven, eight a year. Where do you think the limit is over the next three to five years? Is the capacity there to do one a month, at some point?

We've -- our guidance is at least 10% square footage growth. But actually, we spent most of our history growing at a faster rate than that. Our compounded annual growth rate since inception is still 22.4%, Jodi? And so that would suggest that The Container Store spent a lot of time growing at faster than 10% square footage growth. We're not saying we're getting ready to do that right now. One thing that would help a lot is that real estate communities development picking up, which I'm optimistic we're going to see that. Retail real estate development, as so many of you know, is still a tad slow out there, but the economy seems to be getting better. Most people think that will pick up. That also yields more real estate opportunities for us that are turn key, as opposed to heavier CapEx. So we tend to run a little faster in that real estate development climate than we do when it's a little bit tighter. So I think that suggests good possibilities for the future, as well.

And the other thing is that, and Melissa is wanting to jump in here, too, but since before the Great Recession, we are now the first call on just about any developer's list. We're, we say, the belle of the ball. The store we just opened in Palo Alto, we could have never gotten that location before 6 or 8 or 10 years ago. We finally have come of age. The brands and the retailers that get the best locations in the best centers at the best economics; that's us now. And so we can't wait for real estate development to pick up. And we can't wait for our real estate expansion future. I'm sorry, Melissa, go ahead.

No, no, Kip. I was going to add, John, specific to your question that yes, we can do one a month and even more. It's all scalable. And our grand opening strategy is unique, as I said and as you know. And it does take more up-front money, time, energy, focus and a lot of other things to make sure that store opens, kind of like a big old volcano, right out of the chute. But it is scalable, and it also has to do a lot with our incredible store structure and supporting that new store, and the quality of incredible managers and store teams that we are able to attract and hire and retain, and train.

Thank you.

Thank you.

Dan Binder, Jefferies.

Good afternoon. My question was around average ticket growth. I was curious, how much of that is being driven by increase in average unit retail or inflation versus units per transaction?

We see no inflation, almost at all. It's better selling. It's a solutions-based, as opposed to an items-based, form of solution. So help me with the math here, Jodi. We have an average ticket of what? And then an average individual unit price of what? So it's 7 or 8 or 9 items that goes into the average basket, the average sale. And that number keeps going up. We want that number to go to 9, 10 or 11. And that's how we teach our people to raise average ticket. The good thing about having a still checkered economy is that, at least in the home furnishings, housewares industry, we don't see globally any inflation whatsoever. So it's just pure better selling on the part of our wonderful salespeople.

Right. And our average ticket is approaching $60 in the store.

And do you think the -- I guess the implication is the transactions are still slightly negative. Is that still something you think is a function of the checkered economy, as you put it?

Transactions.

Well, most retailers have experienced traffic declines for several years. The vast majority of retailers have. But we don't accept that. We're working very hard to make sure -- there's a big difference between a minus one and a plus one when it comes to traffic, even if you have a 4% or 5% average ticket increase. So we've spent most of our history with about half of our comp store increase comprised of average ticket and about half of it on traffic. And we're working hard in any climate to get that traffic up, as well. In fact, marketing is, we believe, one of our core competencies. Melissa has talked about the POPs program. We'll get that average ticket, but we've got to somehow go against the tidal forces of retail of the past few years and endeavor to have the traffic number up a little bit, too, rather than down a little bit too. Because you combine those numbers together and it makes a huge difference.

Right. And also, Dan, remember, we did see a definite improvement in our transaction trend during the third quarter. So that's a good thing.

If I could, just one other question. On the ticket, and how it looks on the web, I guess with the in-store experience, you have an opportunity to really grow that basket. As e-commerce grows in the mix, I realize it's not growing a lot faster than the stores, but is it harder to do that basket growth online, or do you do a fairly comparable job with suggestive selling?

It's a great site. People love it. They think it's just a really robust and wonderful. So we get an awful lot of compliments on it. And technology has always also been one of our core competencies, so we're --

And I think our online, as Kip said, we're very proud of our website and the way it functions, the way it navigates, the creative aspect of it. And we're the only retailer that I know that can also sell and do Man in the Desert selling online, and sell the complete solution. So that's a differentiator, another differentiator for us and it kind of insulates us from the Amazons of the world, for example. So our product, we're not obviously apparel. It is hard goods. It is storage and organization. But we're going to continue to play in that space and have it complement and work synergistically with our stores. And that average ticket online is higher.

Yes.

Great. Thanks.

We emphasize that it's a solutions-based form of retail, rather than items-based form of retail. And it's easier to sell somebody's solution face-to-face in a store than it is online. But we're endeavoring to try to do solutions-based form of retail online, as well. And that both insulates us from other forms of competition, as well as opens up an opportunity for more growth in the online business.

And what other retailer has what we call our customer solutions department, this great group of people that literally design closets over the phone? So again --

Pretty good trick. Design a closet over the phone.

It's a pretty good trick. And we're trying to give it to her any way she wants it, in terms of purchasing.

Great. Thank you.

Thanks.

Matt Nemer, Wells Fargo.

Good afternoon. Just a couple questions. One, the comp from Q3 to Q4, you did a 4.7%. The implied comp is a 3.1%. And I think that was pretty well telegraphed. But could you help us understand how you would rank the factors that drive that? Is it primarily Sandy? Is it the shelving sale? Is it weather? Is it the calendar? How should we think about the puts and takes, and which ones are the bigger ones?

Yes. I wish I could answer you precisely on that, Matt. To be very candid, it's very difficult to precisely determine the net positive benefit of any of those individual variables to the quarter. The shelving sale shifting, the Sandy impact, and then the holiday calendar shift, throwing that all in the blender, we do believe it was a benefit to the quarter. But in terms of being able to precisely point that for you, I would feel uncomfortable doing that.

Okay. That's fair. I just wanted to get a feel for the various factors. I guess the other question I wanted to ask, and you alluded to this in your script, you said that you've seen a positive response so far to the Elfa sale. But is there anything that you can point to this year in terms of the Elfa sale that's different, whether it be mix or basket, any sort of new trends that we should be thinking about around the Elfa sale season?

Planning season.

Again, we started the Elfa sale December 24. And we have, like we do every year with every campaign, more intense training, more follow-up with the customers. We also have made incredible improvements to our custom design center, which is our proprietary design system in our stores. So we're really encouraged. And the Elfa sale actually concludes on Kip's birthday, February 11. So it's a little early to say anything else, but all indications, like all year long, Matt, it's just been -- the Elfa sales have been traffic.

The custom design center is just a computer system where we're playing in the closet with the customer. And this new version of it is massively better. It's much better than the previous one. And we were close to capacity many hours of the Elfa sale, particularly towards the end. The business we do in the final days and the last week of the Elfa sale is just gigantic. And it's like O'Hare Airport at Christmas week. And so this faster, better custom design center will allow us to have higher comp store sales increases on our biggest days of the year. And we're very excited about experiencing that for the first Elfa sale.

It's much more efficient. This tool is much more efficient. Very user-friendly.

Okay. That's really helpful. And then just one last housekeeping question for Jodi. Do you call out the impact of the direct mail timing shift? And how should that affect the fourth quarter, if it does?

There's not an impact as it relates to fourth quarter. It was a shift between, primarily between the second and the third quarter.

Okay. And what was the size of that? Did you call that out?

I didn't, but I can. It was almost $800,000.

Okay. Great. Thanks so much.

You're welcome.

Thank you. That is all the time we have for questions. I would like to turn the floor back over to management for any closing remarks.

Well, I guess we did it. (Laughter) We want to thank everybody for joining us today and for your interest in and support of The Container Store. And on behalf of our entire wonderful team here at The Container Store, also want to wish you and your families a very Happy New Year. And here we go, the best is yet to come.

Yes. Thank you, everybody.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.