Container Store Group Inc (TCS) 2014 Q2 法說會逐字稿

Greetings and welcome to The Container Store second-quarter 2014 earnings conference call.

(Operator Instructions)

As a reminder this conference is being recorded. I would now like to turn the conference over to your host, Miss Anne Rakunas, from ICR. Thank you Miss Rakunas, you may begin.

Thank you, operator. Good afternoon, everyone and thanks for joining us today for the Container Store's second-quarter FY14 earnings 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 Kip, Melissa, and Jodi have made their formal remarks we will open up the call for your 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 Safe Harbor Provisions for 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 www.containerstore.com.

I will now turn call over to Kip. Kip?

Thanks, Anne. Hello, everyone. Thank you for joining us today to talk about our results for our second quarter 2014. Adjusted net income increased 38.7% to $5.1 million or $0.11 per adjusted diluted common share, compared to $3.7 million or $0.08 per adjusted diluted common share for the second quarter of FY13. Net sales were $193.2 million, up 5.2% as compared to the second quarter of FY13. Company comparable store sales for the second quarter were down 0.4%.

Our gross margin is strong. Our SG&A management is strong, and we continue to achieve increased average ticket growth. We're pleased that this combined with our strong new store growth helped drive our earnings performance with a 38.7% increase in adjusted net income, despite those sluggish comparable store sales.

We also have maintained our pricing integrity, and I think this is really important, in an increasingly promotional retail environment. We're very excited about our new store growth with three more openings ahead of us still this year.

Our targeted annual 12% minimum square footage growth is among the fastest growth rates in the retail industry at this time. We've opened five new stores this fiscal year already, including one store relocation, and three more still planned for this fiscal year as well. They are Salt Lake City area in Murray, Utah, Fashion Place Mall; that store is opening October 18, Chicago South Loop in the Roosevelt Collection opening November 15, and the Phoenix area in Glendale, Arizona, Arrowhead Towne Center opening February 7, 2015.

We're very encouraged by the prospects of our three major initiatives to help increase traffic and average ticket, POP!, Contained Home, and TCS Closets. TCS Closets is in fact without a doubt the most significant merchandising initiative in our history, leveraging our core competency of high service sales of exclusive solutions-based component products and systems. Melissa will update you in more detail on these three major initiatives in a moment.

As we move into the second half of the year, we're well positioned and well invested in our infrastructure -- very well positioned, very well invested in our infrastructure to support our increasing omnichannel customer base and the new store growth that we have had and are planning for the near future.

We continue to be encouraged as we move closer to our important fourth quarter, a very important fourth quarter, always so important to The Container Store, where we will be competing this year against last year's weather, which impacted traffic and sales more than any other time in our history. Historically, over 60% of our net income has been derived in the fourth quarter, but this year because of last year's weather, we expect it to derive approximately 70% of our reported net income for this year.

We'll continue to maximize every customer interaction while also focusing on the long-term health, long-term and medium-term health and growth opportunities of our business as well as to our beloved employees and culture. Thank you so much. Melissa, you want to go into more detail about the initiatives?

You bet. Thanks, Kip and hi, everyone. As Kip mentioned, I wanted to briefly discuss our three major initiatives today in a little bit more detail. Again, TCS Closets, our POP! customer frequency programs, and Contained Home, previously called AtHome. These are initiatives that are designed to drive traffic and average ticket and deepen the engagement with our customers.

So first let's talk just a second about TCS Closets. As Kip said it really is the most significant merchandising initiative in the history of The Container Store. We're preparing for this pilot launch of TCS Closets; we are just so excited about it. Our new exclusive collection of solid, custom-built solutions crafted from the highest quality materials with a variety of choices in wood grain finishes and extras, including lighting, glass doors, island, hampers, and innovative storage options for shoes, jewelry, and handbags. We're planning to launch TCS Closets in our seven stores in the Dallas/Fort Worth Metroplex beginning in November, and of course that includes services in our stores from our expert salespeople, and in the home from our Contained Home organizers and installation service professionals.

TCS Closets is planned to rollout to the rest of our stores by the end of 2015. We really believe the average ticket on an after average master TCS Closet will greatly exceed our day-to-day $60 average ticket, and be much more than the $2,000 average ticket our Contained Home service has experienced to date. Therefore, we do believe TCS Closets will contribute meaningfully to comparable store sales increases in the longer term.

Next, I just want to talk a second about POP!, our perfectly organized perks, customer frequency program. POP! has reached almost one million customer enrollments since launching in all stores in July, and approximately 50% of our store sales are now associated with our POP! stars.

We are in the enrollment phase of POP!, and have enrolled more customers than we had anticipated at this early juncture. As we continue to enroll more and more customers we will be able to further engage and surprise and delight her in a more personalized and targeted way as we enter 2015 and deeper mine our growing data analytics.

And then we have Contained Home. That's our in-home customize, design, and organization service that is currently available in Dallas and Houston and Austin and Manhattan and Los Angeles, and we have plans to rollout in Washington DC later this month, and in Denver and San Antonio in November. The service is expected to be available in all of our stores by the end of 2015.

We are encouraged by the service's average ticket to date of $2,000. Again, much higher than our day-to-day $60 average ticket. So I'd now like to turn it over to Jodi, who's going to review our financial highlights.

Thank you, Melissa and good afternoon, everyone. Now I'd like to review our second-quarter results and then also review our outlook for the year.

Net sales in the second quarter were $193.2 million, up 5.2% from the second quarter of FY13. Sales in The Container Store retail business were up 5.7% to $174.8 million. Our third party sales at our Swedish subsidiary elfa were up 3.7% in Swedish krona; however, due to the depreciation of the Swedish krona against the US dollar, elfa third-party net sales in US dollars declined slightly by 0.1%.

We ended the quarter with 67 stores and approximately 1.7 million of gross square footage, as compared to 61 stores and approximately a 1.5 million of gross square footage at the end of second quarter 2013. Our comparable store sales for the quarter decreased by 0.4%, which included a 1.4% increase in average ticket.

In the second quarter of FY14, approximately 41% of elfa sales were derived from The Container Store, with the balance of sales primarily derived from Scandinavia. Our consolidated gross margin increased by 40 basis points to 58.8% from 58.4% in the prior year.

Gross margin in The Container Store retail business increased 50 basis points to 59.3%, primarily due to an increase in margins on non-elfa departments reflecting a shift in sales mix. This was partially offset by lower margins of elfa branded product just simply due to a shift in timing of promotions that occurred during the second quarter. The Container Store gross margin increase was partially offset by decrease in elfa's gross margin of 160 basis points to 34.7%, primarily driven by a change in their sales mix during the quarter.

As a percentage of sales, consolidated SG&A increased by 10 basis points to 46.8% in the second quarter of FY14, primarily due to public company costs which we did not incur last year, as well as the implementation of strategic initiatives including the rollout of the POP! program and the Contained Home rollout. This was offset slightly by lower sales and marketing expenses at elfa, which were due in large part to favorable timing.

Our net interest expense in the second quarter of 2014 was $4.4 million, compared to $5.5 million in the second quarter of FY13, with the year-over-year decline due to lower interest rates achieved through the refinancing of our term loan facility at The Container Store that we did in November of 2013, as well as repayments on our debt obligations. Our effective tax rate for the quarter was 17.5%, compared to 30.5% in the second quarter of last year. The decrease in the effective tax rate was primarily due to a $1.8 million reduction in tax expense we recorded in this quarter of FY14, primarily related to an expected refund of tax paid in a prior period, partially offset by a shift in the mix of projected domestic and foreign earnings.

Our net income for the quarter was $7 million, compared with $4.1 million in the second quarter of last year, and net income per diluted share attributable to common shareholders was $0.14, compared to net loss per share attributable to common shareholders of $6.06 in the prior-year period. Last year's net loss per share reflects $21.9 million of preferred distributions. As a reminder, we exchanged our issued and outstanding preferred stock for common stock in connection with the IPO in late FY13.

On an adjusted basis, excluding the expected tax refund recorded in the second quarter and the adjustments in the prior year as detailed in the reconciliation table in our press release, net income per diluted common share for the second quarter of 2014 was $0.11, compared to adjusted net income per diluted common share of $0.08 in the second quarter of 2013.

Turning to our balance sheet. We ended the quarter with $15 million in cash on our balance sheet, $366 million in outstanding borrowings, and combined availability on revolving credit facilities with cash on hand of $73.4 million. We ended the quarter with well-managed inventory of $95.7 million, up 5% as compared to $91.2 million at the end of last year's second quarter, and with a store count increase of almost 10%.

Now I'd like to turn to our outlook. We expect consolidated net sales for the year to be $800 million to $810 million, comparable store sales for the year to be flat to up slightly, and diluted net income per common share to be in the $0.52 to $0.57 range based on a weighted average of 49 million diluted common shares outstanding. Included in our outlook is a $3.3 million non-taxable gain on the sale of one of our elfa subsidiaries who's principal asset was a building which we will record in the third quarter of this year.

Due to the non-taxable nature of this entity sale and the tax benefit we recorded in the second quarter of 2014, we now expect our tax rate for the full FY14 on a GAAP basis to be approximately 30%, or approximately 38% on an adjusted basis. We continue to expect our annual interest rate at today's LIBOR rates to be approximately $17.5 million.

Now I'd like to update you on our expectations for comp and SG&A cadence this year. First, on comp. We expect third-quarter comps to be flat to down low-single digits, and fourth-quarter comps to be up in the low- to mid-single digit range, driven by the expected impact of our planned initiatives as well as the cycling of the difficult fourth-quarter weather from the prior year.

Second, we expect third-quarter consolidated SG&A as a percentage of sales to delever significantly given expected deleverage of fixed costs associated with a flat- to down low-single digit comp at The Container Store, as well as expected SG&A deleverage at elfa due to further consolidation of our sales and marketing functions to improve our operational efficiency, which is resulting in some short-term duplicative costs during the third quarter. Remember this also includes incremental costs associated with becoming a public Company that were not incurred in the prior year until we went public November 1 of last year, which was the very end of third quarter.

We expect SG&A to improve considerably as a percentage of sales year over year in the fourth quarter. As we have discussed before, fourth quarter is seasonally our most important quarter, and in FY14 we expect to deliver nearly 70% of our full-year GAAP EPS and approximately 80% of our full-year adjusted EPS in the fourth quarter.

With that, I'd like to turn the call back over to the operator so that we can take your questions. Operator?

(Operator Instructions)

Our first question comes from the line of Simeon Gutman from Morgan Stanley.

Thanks, it's Simeon Gutman. First, thinking about the fourth quarter, Kip and Jodi, you both called out that 70% of net income comes, or should come, this year from that quarter, and that coincides with the annual elfa sale, and you're up against an easy compare. So, going into this year and/or reflecting on prior years, do you ever get a sense, whether it's anecdotally or something in the numbers, about the pent-up demand for elfa customers either purposely deferring their purchase? And then in terms of the elfa sale, is there anything different about how you're going to approach it this year, given that you'll be up against an easy comparison?

Well, this is not Jodi, this is Kip, and we call it a potato chip item. elfa, more than any product I've ever been associated with -- people buy it again and again. And so, if you can introduce people once a year on your highest volume, it's 24% of our sales, highest gross margin, highest volume product -- that simply tends to ensure that they are going to buy more elfa at another time, either on sale or not on sale. So, that's the genesis of that. And the more people we can get to try elfa in a small way during the sale are going to buy it later on as well.

We're a little bit like a basketball game. You know how a basketball game -- you don't really have to pay attention to the fourth quarter. It's always been that way.

We're the only retailer I know that gears up for its two peak seasons simultaneously. We have to gear up for the holiday season and the elfa sale in the fourth quarter. That's why last year's weather had more of an impact on The Container Store than it does most people because, let's face it, January and February are the two worst months of most retailers' business, and January and February are even bigger for us than December. And that's the differential between the 60% and 70% this year.

What would you add to that, Jodi?

The only thing I would add is: Clearly, in my opinion, in this retail climate, you have a consumer who continues to see a lot of promotions out there in all of retail. So, from our vantage point certainly, if you see elfa selling at full price during the year, you can look at the fourth quarter when it's on sale for 30% off, and generally you could argue that that would certainly be quite appealing to the consumer with their current mind set.

What most people are saying, what you read, what the media says, what most retailers are saying is that people are, right now, very choosy about what they are buying. They are responding to price promotion; it's a very promotional environment out there in retail right now. We were delighted to see the response when we had our little -- we're maintaining a great deal of pricing power.

We're not promoting as much as I believe the rest of the industry is right now. We're not overly proud on that. We're balancing it. We did have a couple of three-day -- go into that a little bit, but fortunately, we're able to see really strong elfa sales when we did put the thing on sale here just a few weeks ago. Why don't you go into that?

Right. Most recently -- hi, it's Melissa. The end of August -- to really recognize our back-to-school and dorm customer, we ran a couple of very strategic promotions, which, again, is not really anything new. We've done that throughout the year, for years, but we ran a couple of very strategic promotions, three days each, where we offered 15% off. The first one was online-only or using our click and pick-up service; and then the second time we did it, it was also in store. And Kip's right: We had a great response to elfa, even at 15% off. So, yes, we've got strong pricing power, and we're very strategic with our promotions, and we will continue to do that.

So, I think that, right now, people are more prone to buy elfa or anything else if it's on sale than if it was not on sale, for us and for most of the industry, frankly, that seems to be the MO. And we feel like the approach that we take with our elfa sale, which is our ace in the hole, is the right approach.

Like every year, we look at: Should we increase the discount this year? Should we change anything? And I think, strategically, we think we're exactly where we need to be with it going into the fourth quarter. And of course, this fourth quarter will be a lot more fun than last fourth quarter, assuming we don't have the worst weather in 35 years again.

Just to paraphrase something you just said, and then I think what was implied in Jodi's answer: The discount of 30% sounds like it's going to be the same. What about time-frame-eligible products, other products, adjacent products? And I don't know if you can connect it to the POP! incentive since you have a lot more POP! members, but I guess those type of things and the comparison sort of builds the confidence then, and that's why, hence the fourth-quarter outlook against an easy compare.

Well, I'll add one more thing: With the strength of the US dollar, we had more flexibility to possibly change our discount structure for the elfa sale this year. We chose not to do that.

Right, it's 30% off the same, Simeon. Jodi, what were you going to say?

No, I think from the POP! program, which you're well aware of, that is our surprise and delight opportunity for our customers. So, we will continue to do test and learn with that, which we have been doing, and we will continue to try different offers. And we can't be specific, obviously, as to what that's going to mean for any specific month because that's part of the fun of the program, but certainly as we have opportunities, we will take advantage of those, primarily through that program.

Okay, and then, can you just clarify: You mentioned in the guidance, the sales and marketing effort; I think you said consolidating some areas. Can you just discuss what that relates to?

Yes, I can. elfa has, as you may recall -- they've been really sort of reinventing their business now for the last couple of years. They've consolidated a lot of their operations. They eliminated an unprofitable subsidiary, and those were in the FY12 results. And they are continuing to look for every opportunity they can to make their organization more efficient. And they had disparate sales and marketing functions -- not all concentrated.

And we just, after a lot of discussion, felt as though consolidation there made a lot of sense for organizational efficiency. So, we've moved forward on that, and that is occurring as we speak over in Sweden.

There's a lot -- it's basically SG&A improvement. This subsidiary that Jodi was talking about in her prepared remarks is really just a building, and it was done that way for beneficial tax reasons. But we are consolidating a lot of elfa's far-flung operations in a manner that's yielding a better SG&A situation.

We've had a number of management changes over the last three or four years, and cultural improvement changes that are leading towards a better reception on the part of the labor unions there and the management there to make more efficient some of these operations. It also helps that you have the whole EU mentality, where it is more one Europe, so we don't need a facility in every other country. We're consolidating mostly to southern Sweden where the main production facility is in Vastervik, Sweden, and that's very exciting.

We also, at the same time, have moved marketing and travel-type things to Malmo, Sweden, which allows us to penetrate continental Europe a little bit better than from the small village of Vastervik in more of the middle of Sweden. So, that's a long story, but we're really happy with management improvements and expense efficiency gains, and overall excellent gains out of elfa as they hopefully emerge from a still sluggish, still much more sluggish situation than we have here post-recession.

Okay, thank you.

Thanks, Simeon.

Our next question comes from the line of Chris Horvers from JPMorgan.

Sure, thanks. Hopefully can you hear me; I'm at the airport here. Can you talk about what drove the gross margin pressure in the elfa product? Was that sort of a lack of utilization of the elfa facility passing through, or was that where you focused those two three-day events? And can you also talk about -- with the Contained Home initiative, are you seeing the elfa department outperform in the stores that you've rolled that initiative to?

Okay, this is Jodi. I can take actually both, or anybody jump in, but on the first one, Chris, I just want to clarify: When I spoke to gross margin, I'm talking to elfa segment, not elfa within The Container Store itself. I think that was your question, right? Within the elfa segment, what caused their pressure? Just clarify, if you don't mind, for me; I want to make sure I answer you correctly there.

(multiple speakers) There's been no pressure on the elfa gross margin; it's quite the opposite.

I thought you said there was pressure on gross margin because of mix of elfa versus non-elfa. It's just mix; it's nothing to do with the merchandise margins on the elfa product in the stores?

That is correct. That is absolutely correct, yes. And then your second -- (multiple speakers)

Just to clarify that, I mean, we're seeing strength gross margin-wise across the board, and we're certainly seeing strength with the elfa product as well. And we are feeling good about the strength of the US dollar versus the Swedish krona. So, just to be clear, we don't sense that we're feeling any pressure on elfa gross margin.

And then, Chris, I think your second question was with regards to Contained Home sales, what are we seeing there as far as how those customers are purchasing and what -- is elfa the main appeal of those customers? And the answer is, yes, that elfa is over the majority of the sales that we're deriving from a Contained Home customer when they're spending that $2,000 average ticket. So, yes, that's definitely the case.

It is, in fact, the first thing the customer thinks of with that program -- the first thing the employee thinks of -- but it is a full-store service. It's not just elfa. In fact, we have to work hard to make sure everybody understands that it's not just about elfa. Of course, we'd rather sell elfa than anything else, since we own the factory.

Right, but the Contained Home organizers are going through continued extensive training and then selling the entire store.

Right, but presumably with a $2,000 average ticket, it's -- the elfa organization solution has got to be a big constituent of that, so can you talk about maybe how those elfa departments have performed relative to the base that doesn't have Contained Home rolled out?

We're not going to get into specifics yet on Contained Home, since it's still in a handful of stores, but we are absolutely seeing a lift in stores that have the Contained Home service. That is across the board for us. (multiple speakers)

Trying to get a little further along in the testing before we put out metrics to everybody on that, but, yes.

Okay, and then also, on the POP! stars, I know you mentioned it's about 50% of your sales currently. I think your average customer comes in two, three times a year. Are you seeing a frequency pick up, and can you talk about those metrics at all?

Chris, this is Jodi, I'll jump in. I know Melissa may jump in here as well, but you're right. Our average customer doesn't shop as much as we would like her to. She's in two to three times a year, so remember that -- (multiple speakers)

Which is an industry-wide issue.

And remember that, right now, we've rolled this out to all stores July 15. So, during the second quarter, it was what we're calling the enrollment phase of the program. And, as Melissa said, we had about 1 million people already signed up for the program, and that's representing almost half of our sales tied to a POP! star.

We are well above our expectations in terms of where we thought we would be with how many sign-ups of people in our stores, which we're happy about. But from a frequency perspective, for the majority -- for virtually all the chain -- the customer, when they're signing up for the POP! program, they were already in our store, right? Because this is a program where they're in there, and we're talking to them about it, and we're getting them to enroll, so you haven't picked up that frequency yet. That's something that is to come down the road.

So, in terms of saying to you that POP! materially changed anything short term, it's not that way. We're right now in what we're calling the enrollment phase of the program, with trying to get people signed up.

And the two to three times per year is an all-customer number. The 30% of our customers that represent over 80% of our sales shop at a much more frequent rate than that. And the POP! program is, of course, meant to further cultivate that segment that's over 80% of our sales.

Thanks very much.

Thank you.

Our next question comes from the line of John Heinbockel.

Question -- a couple things. Do you guys -- of the POP! stars representing 50% of store sales -- any general sense of what percent of POP! stars are making up that 50%? Is it a small percentage, as is the same for your total sales, 25%, 30%, or is it broader than that?

I'm not sure I fully understand the question. Are you asking what portion of transactions are represented by POP! stars versus dollars?

No, so, if I look at the number of POP! stars, right? Are 25% of POP! stars representing the vast majority of that 50%? The 80/20 rule -- is it 25% of them? Or is it broader -- you're getting 40% or 50% of -- I'm just trying to figure out how concentrated that 50% is of your sales?

Well, we don't have that now; we're still in the middle of the test for the thing, but it's not going to be nearly as concentrated as the overall customer. We have -- like most retailers, we have some customers that are just not particularly good customers, but there's not many or any POP! stars that aren't very good customers. So, it's going to be sort of the opposite of what you see through the whole; it's going to be very much non-concentrated like that.

Because I guess the question when you think about traffic: How can you generate more traffic without diluting gross margin, right? Because a lot of retailers will generate traffic with lower-margin product, and make it up on higher margin; your margins are so good and you've chosen not to do that. Is there anything you look at and say that there's stuff we can sell that we don't that still has a fairly robust gross that can get people in the door more frequently? Or is that really not a possibility?

We focus on having our highest-margin products also be our highest-volume products, and I think that's the key to having a great gross margin. The reason that we have the gross margin that we do is because we've been given the financial incentive to perfect the selling methodology of those products which carry the highest gross margin, and so we've done that; elfa is a great example. I think the POP! star customer is the one that also tends to buy that sort of multi-faceted, hard-to-buy, hard-to-sell elfa-like component-type product, too, which does carry the highest gross margin and the highest average ticket.

(multiple speakers) I think that Sharon and team are always thinking of products from that vantage point. And as you know, we change out 20% or so of our SKUs on an annual basis. So, to the extent it makes sense within our core categories, we do; but we also, as we talked about before, really try to stay true to our concept. So, I don't think you're going to find us -- John, to your point -- adding candy at the registers or anything; that's just not who we are.

But I think I missed part of your question. I was excited to talk about the -- so weird for somebody to have their highest-volume products also be their highest-gross-margin products, but there was another part of the question I was anxious to answer. Can you repeat it?

Well, the question was more along the lines of, whether it be food containers or things that people -- the average selling price might be less than elfa, it might be a little more consumable or disposable, such that you can get them in the door more frequently, not low margin, but just maybe the mix shifting a little bit to drive more traffic --

Oh, I know. The POP! thing -- the reason that we waited 35 years to introduce the frequency program was really because we felt like most people give away too much gross margin needlessly in their affinity program. So, this is more, as Melissa talks about, surprise and delight. We're kind of giving them hugs; we're giving them more information. Tips of -- my favorite restaurants of the world -- I'm a big food guy; I want to be able to talk to the chef, I don't want a discount. At a store that I don't care much about, I just want a discount.

So, this POP! program is more respectful of gross margin than most of them, and we feel like we're getting good movement, good mobility without needlessly giving away gross margin. And I actually think that the very best way to increase traffic is to get your best customers -- certainly something as broad as that 30% of your customers who are your best 30% of the customers, to shop, who are already shopping at least twice as frequently as the entire customer base -- to get them to shop even more frequently. And that's what POP! is exactly designed to do. Now, we're in the middle of this rolling out nation-wide test, so we're a little reluctant to give fourth- and fifth- and sixth-inning metrics, but it all seems to be moving the way that we logically thought it strategically would, at this point.

All right. One last thing on TCS Closet: Obviously, you're not going to say publicly, but do you have a pretty good sense of how many units you think you can sell, at least in the Dallas stores? I don't know if you are going to look at it monthly or quarterly, but do you have a fairly good sense of what you can sell? And then, how quickly do you think that starts to impact those stores? Do you think it takes a couple of months or is it longer than that?

Well, we just -- if you play with those numbers on your own -- you have an idea of what the average ticket is. You know how many stores there are, and so you start adding those sales of how many of them per day or week or month is the average store going to sell, and then you see what impact that can have to average ticket.

We don't know. We're just about to roll it out to the first store, so it's folly for us to say: Each store is going to sell this many per week or whatever. But we have run all of the numbers; if these stores sells X, it has this impact on it; and if they sell Y -- and it's pretty delightful stuff. We're very excited to be able to provide those metrics soon. Let us get into the test first.

It's still baking in the oven.

Okay, thank you.

Thanks, John.

Our next question comes from the line of Matt Nemer from Wells Fargo Securities.

Thanks so much. Good afternoon.

Hi, Matt.

I was hoping that you could talk to the impact that the unique promotions that you had this past quarter, such as the 25% off elfa in June and the 15% off promos in August, might have had on -- the impact it might have had on your comps and on your gross margin in the quarter.

Sure. So, Matt, this is Jodi. The 25% off elfa in June that you're referring to is something we've done for a number of years, where, in May and June, we run what we call elfa preferred and offer elfa at 25% off, and we do a targeted mailing.

Very specific targeted mailing from our database.

Yes, to our customers. So, that is not something new; we had done that previously. What was a little bit different this year is those that got the May offer were actually able to redeem that offer through June. They didn't just have the month of May, like they had had in a prior year. So, that's the distinction there.

Because we had a misprint in the mailing, and that's why -- because normally, Matt, it's -- the May customers that receive elfa preferred can use it the month of May, and then the June customers that receive elfa preferred can use those the month of June. But this year the only difference to last year was that the May customers could use it through June, as Jodi said.

Right. And then, I assume that you're referring to some of the POP! offers that we're doing as well, which -- we have some very good capabilities to be able to analyze those very carefully, and make sure that they're being profitably done. And that's exactly what we're doing, because part of the program is figuring out which ones customers do or don't respond to, and making sure that we watch all aspects of it, the sales being driven, as well as the profitability being driven from those.

And then, I think, Melissa, do you want to speak briefly to the 15%?

Same thing that we talked about -- is that what you're talking about, Matt, the two, the hug and -- ?

I was just trying to figure out if you think that those had any financial impact on you in the quarter?

The 15% and 25%?

Yes, at the end of the day, Matt, it's a relatively nominal discount, so we don't believe that it had a material impact to the gross margin, as evidenced by the fact that it was still up 40 basis points for the quarter.

Got it, okay.

And I think that we felt like that had a small impact on gross margin percentage, and a significantly better impact on the actual gross margin dollars. And interestingly, at those percentage off levels, we're not really doing what most of the industry is, where they are feeling like you have to do 40% to get any movement at all, so --

That's pretty benign. And then, another technical question: Was there any impact from the krona on the consolidated gross margin?

There really wasn't of any material nature. I think one thing that is important for everybody to understand as it relates to the krona -- because I know we've seen a strengthening of the dollar. We use a cost inventory, so it's always weighting the average cost of everything that we own, and then everything we acquire. So, there is a lag between when we're actually going to sell and cost out inventory with a higher rate versus when we may procure inventory at a higher rate. So, remember: Our inventory on a whole turns about four times a year, so it's not a one-for-one thing at all.

You'll see in our 10-Q that we currently have 47% of our commitments for this year's purchases secured at a rate of 6.8%, compared to last year I believe we had about 70% procured at a rate of 6.7%. So, that, just to give you a little bit of relativity where we're currently at, in terms of our commitment.

Okay, that's super helpful. And then just lastly, I think for the quarter you originally had forecast SG&A to delever about 100 basis points, and you did quite a bit better than that. I'm just wondering what changed versus your original forecast in terms of SG&A expense, and are there any impact items in there that would be considered more non-recurring, like incentive comp?

There's not really anything I would call out non-recurring, other than I think I spoke to the elfa duplicative costs that are occurring in the quarter. They won't actually be, of course, reported below the line. But this decision we made to consolidate further their sales and marketing operations does have some duplicative cost in the short term. That would be probably the bigger thing to call out.

So, the difference, relative to your original forecast, would just be considered general efficiencies and cost management?

Yes.

I would just add to what Jodi said about the Swedish krona -- that it is in the neighborhood of SEK7.25 today. We do engage in forward contracts on that. So, that circumstance is looking better than it has the past couple years. The past couple years, looking backwards, were unusually bad years for the US dollar versus Swedish krona. Things look a lot brighter in that front as we look forward, but we'll see.

Got it. Good to hear. Thanks so much.

Our next question comes from the line of Dan Binder from Jefferies.

Hi, good afternoon.

Hi, Dan.

You talked about the promotional environment being intense. I'm just curious: When you look at the landscape, are there particular players that you're seeing more promotional than not? And given what sounds like reasonably good responses to these three-day sales, would you consider running more of them to drive a better comp?

In a balanced way, I think we can continue to experiment with that. As we get into the holiday season, we're a little more reluctant to do that. Our stocking stuffers, and our decorative packaging and wrap, those things, we have a long history of experimenting with promoting or not promoting those.

We tend to do very, very well without promotion on those items. Their gross margin continues to go up year after year. We talked about in the last call, we're not proud, we're not stubborn. We'll try to play the cost benefit of that volume plus gross margin return as skillfully as our 36 years of experience with doing that has allowed us to do.

What's interesting is that those numbers were fairly low. When we're doing something at 15% or 20% and 25% -- I think a lot of people feel like you can't get any movement at all until you're at 40%, 50%, 60%, 70%. And so, we're going to maintain our pricing power. We think that's really important.

Most aspects of the Business are quite good right now, but comp-store sales are quite sluggish. And I think that we don't want to get to -- we've had many periods of time in our history where comp-store sales were unusually high or unusually low, and they always move back to the middle at some point in time, and we're not waiting around for that event to happen. We have huge major initiatives designed to push it, and lots of smaller initiatives to push it. But when we get there, we want our pricing integrity and our pricing power to remain intact.

And our brand.

So, when you look at the promotional environment, is it more on opening price point from folks like Wal-Mart and Target and Bed Bath, or is it somewhere else in the mix?

Well, like at the college back-to-dorm time, we had new players enter that arena for the first time. They really had very little to offer, if I might say so. They weren't really about -- particularly these freshman girls going off to college, they're not going to leave half their wardrobe at home when they go live in a dorm room. They're not going to leave half their shoes at home.

So, it's not so much that people had a lot of great solutions for their wardrobe and shoes when they got to the dorm room. It's just that they had one or two or three literally, as opposed to hundreds or thousands that we have, but they also have the clothing; they are kind of a one-stop shop. They have the little mini refrigerator, they have all types of things, but can't really compete with us on storage and organization. But they can compete with us on what you need when you're going back to the dorm room, back to school; plus it's all at about half off. And so, we found that to be kind of a promotional environment.

Understood. I'm curious: On the Closet business, how many -- I'm not sure if you've monitored this carefully, but how many requests do you get from customers in a typical store, whether it's on a weekly or monthly basis, for a closet solution that historically you haven't been able to provide?

Hey, it's Melissa. You would be surprised how frequently we get asked for that, and we've been visiting with our stores so much this year, and it just comes up over and over again. It's like, again, they want a loyalty program for the last 35 years, they want us to come into their home for the last 35 years, they want us to offer more of what we talked about before, the whole closet domination, more of a variety. Many customers love elfa, but many customers may want a different solution. So, we're going to have that closet domination, and we're going to have an incredible offering, as we said, that we're going to be launching here in the Dallas/Fort Worth Metroplex next month.

So, when you think closet, you think The Container Store first. You don't just think elfa. Whatever kind of closet she wants, we will have it, and we'll have the best of that realm. This will be the highest-quality, best closet of its type, in our minds, available. And it's a slightly different customer, slightly more -- little bit older and more upscale demographic customer perhaps, has been compared to the Lexus to go with our Toyota. I think they'll work hand in hand.

We're hopeful a little to know there are some members of our Organization that think it could enhance elfa sales, as opposed to cannibalize it. The Lexus/Toyota analogy gets tossed out a lot, but basically some customers want elfa's more open environment, and some people want a more closed or built-in looking environment. And it's very exciting to finally give them what they want. You have to understand: When you own the factory, you're not real anxious for them to buy something other than the stuff you make at that factory.

This is Melissa. I actually think that it could be the same customer as well. I think the customer can want a TCS Closet, and can also want elfa, both, so we're hoping for our cake and eat it, too.

Well, I think that can be -- with that customer you can have this maybe in the master closet, and the other in some of the other --

Pantry, garage, linen closet, kitchen.

So, we're very excited to have these initiatives in various stage of testing, and the really big one, the TCS Closet, getting ready to open up. And then, they will remain in the oven baking and rolling out, as each month, as each quarter goes on. And I think we certainly endeavor and hope to see that show up more and more and more on the stubbornness of the comp-store sales.

But in the meantime, we're going to continue to manage SG&A as we have been, and the gross margin as we have been, and try to make the other metrics offset the sluggishness of the sales. If these initiatives do what they are designed to do, I think we'll have a much different story in the short to medium term on the comp-store sales.

Thank you.

Thanks, Dan.

Our next question comes from the line of Alan Rifkin from Barclays.

Thank you. Couple questions, if I may. Kip, just looking at things a little bit bigger picture -- with your performance not as strong as what you'd like for a few quarters now, do you think there's anything going on with either the performance of the stores by class or geography or any particular markets that are underperforming?

And then, as a follow-up, you guys raised your minimum square footage growth just a short time ago to at least 12%. Is there any reconsideration that maybe you slow things down a little bit until you see a sales rebound? Thank you.

Well, on the square footage growth, never before has the new stores favorably impacted the Company as much as it has. This year, last year, the year before, with these new stores, we're getting over 20% four-walls EBITDA first year out of these new stores. We're particularly excited since we -- I call it the Indianapolis-ing of The Container Store. We discovered that people love us just as much in Indianapolis as they do in Chicago, and the best location in Indianapolis cost quite a bit less than the best location in Chicago, but the sales are surprisingly close to the same. So, we feel it's a rare business opportunity.

I know a lot of people are tempering their bricks-and-mortar locations, and I'm talking to other retailers, think they're going to do it all online. But as long as we're able to open stores in the United States with so many -- such a long runway ahead of us, getting our capital back in -- what's it averaging, Jodi, 2.5 years -- with actually a 22%, 21%, 23% four-walls EBITDA first year, that's great stuff. We're going to continue to do that. I was pleased we're able to hit the new 12% number even this fiscal year, because normally it takes us 10 months to open a store once we identify it.

And then, Alan, I think your other question was about geography and vintage, is that right?

Yes.

Well, we look under every rock.

I was going to say vintage for us, there is generally not a huge disparity, although I will say that as we have -- I think we talked a lot about the fact that we see a large honeymoon when a new store opens. And as we have more new stores coming into the base, up against the prior year, at times depending on when the stores open and come in, that can, in fact, mean that that newest vintage might not be as high in comp performance as some of the older ones. So, we have seen a little bit of that as well.

So, if the new store is still doing north of 20% returns, is there an issue that maybe the stores are reaching maturity quicker than what they used to? I guess I'm just trying to find out what the real culprit is here in comps not being as strong as what we anticipated.

Well, it's been -- I guess the genesis of that tended to be around holiday time last year. You certainly have those easy comps that we're about to meet in the fourth quarter of this year. Between now and then, each of these initiatives and everything else that we're doing to raise frequency and raise average ticket, we'll continue to work better.

So, I can assure you that our Company believes that the employee morale is the best it's ever been, equal to or better than it's ever been, and it certainly appears as though the customers love The Container Store as much as they always have. Occasionally, comp-store sales will get very high or very low, and you have to look under every rock to try to determine what's causing that so that you can enhance it even more or turn it back around, and we're doing that in every manner that we know. And we're very excited about these initiatives that, as we say, are in the oven. And every time we add another store or two or three to these initiatives, that begins to impact average ticket a bit more.

And normally, what The Container Store can do best, what is our wheel house is selling exclusive-to-us products that are component or metric in hard-to-sell products that no other retailer really wants to get into. The mass merchants aren't going to get into selling something like elfa or TCS Closets. You go into the store and salespeople are almost like little architects designing your closet, and so these programs are designed to be right in the wheel house of our competency in terms of selling that type of product. So, we do have high hopes for success of those things.

Okay, thank you very much. I appreciate it.

Thanks, Alan.

Our next question comes from the line of Denise Chai from Bank of America Merrill Lynch.

Thanks for taking my question. Just wanted to go back to what you were saying about SG&A, how there was a favorable timing in terms of lower sales and marketing costs at elfa. So, I was wondering if you could quantify this? And the fact that the second quarter was more favorable, does that mean that it's going to be a negative in the third quarter, because you also referenced SG&A deleverage in the third quarter.

Denise, this is Jodi, and that really wasn't, as you heard me prioritize explanations, it wasn't the major driver to the explanations for the quarter. It was not a real material discussion, but it was warranted to mention because you'll see in the 10-Q that there is separate disclosure on the elfa segment separate from The Container Store. But as we all know, elfa is about less than 15% of profit and sales to The Container Store consolidated.

Okay, thank you. And then, in terms of your comp guidance for the third quarter and fourth quarter, just to isolate traffic, should we still think of traffic as being negative in the third quarter and then turning positive in the fourth quarter when you're up against such a weak comparison? So, just wondering if you can give some color on that, please.

We haven't really wanted to put out there where we think the sales are going to come from, whether it's traffic or whether it is from average ticket, so I don't think that's something we'll be specific on, Denise.

Okay. And lastly, on foreign exchange, are you seeing any kind of margin impact from ForEx, and how much visibility do you have there?

Yes, I mean, you can look at the current rate, and I think I'd mentioned that there's a lag between when you buy Swedish krona at today's rate, and when you actually see that through your gross margin. So, yes, there's optimism for that. Don't forget, too, though that elfa's earnings then convert to fewer US dollars, so there's an offset as well.

Okay, thank you.

We're delighted to see the US dollar/Swedish krona strongly advance from SEK6.40 just a few months ago to SEK7.25. That's always beneficial for The Container Store when you have that happen. We buy forward contracts, and we buy forward contracts for a portion of our purchases, and we buy at the spot rate for those other purchases. So, even as we speak, as we're paying invoices, we're paying the new higher spot rate as opposed to the lower rate, so that's a good thing.

That's a good thing, and that will contribute over the short to medium term to gross margin. And we are -- while we're trying to get the comp-store sales to -- back to where we want them to be, we are proud, and feel like we're making strong progress on gross margin and SG&A and new store growth.

Thank you.

That is all the time we have for questions. I'd like to hand the call back over to Melissa Reiff for closing comments.

Yes, hi, it's Melissa. On behalf of Kip and Jodi, just want to say thank you so much for your time today and your great questions. And we will look forward to talking with you again very soon at the next quarter earnings call. So, thanks very much, guys.

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