Container Store Group Inc (TCS) 2015 Q3 法說會逐字稿

Good afternoon, everyone, and thanks for joining us today for a prerecording of management's remarks pertaining to The Container Store's third-quarter fiscal 2015 earnings results. Speaking today are Kip Tindell, Chairman and Chief Executive Officer; Melissa Reiff, President and Chief Operating Officer; and Jodi Taylor, Chief Financial Officer.

In addition to posting a press release with our third-quarter results to our website, we have posted a written transcript of management's prepared remarks on our website as well. A live Q&A session will follow today at 5 PM Eastern and a replay of the Q&A session can be accessed at containerstore.com later this evening.

Before we begin, I need to remind you that certain comments made during this recording may constitute forward-looking statements and are made pursuant to and within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements.

Those risks and uncertainties are referred to in The Container Store's press release issued today. The forward-looking statements are made today, 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 the 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, Anne, and thanks to all of you for joining us for our prerecorded remarks on The Container Store's third quarter prior to our live Q&A. Jodi and I are going to review our third-quarter financial results. And given the importance to our overall business, Melissa will discuss our key TCS Closets initiative in more detail.

I would like to say that although we continued to achieve meaningful traction with our all-important strategic initiatives during the third quarter, and that these initiatives are benefiting overall sales, we are very disappointed with our bottom-line results this quarter. The shortfall versus our expectations was largely driven by expense items, the majority of which are nonrecurring and unusual in nature.

We have a history of strong fiscal discipline and expense management, which has always been a core competency. In response to third-quarter results, we are increasing our efforts to reduce costs and SG&A without harming the momentum and evolution of our major initiatives, specifically TCS Closets. We will provide more commentary on expenses shortly, but I would like to start with a discussion of our third-quarter sales.

Our comparable-store sales for the third quarter of fiscal 2015 were up 0.5% compared to third quarter of fiscal 2014, marking another quarter of comp store sales improvement. The result for consolidated net sales for the third quarter of fiscal 2015 was $197.2 million, up 3.3% compared to the third quarter of fiscal 2014 after converting the Elfa International AB portion of consolidated net sales from Swedish krona to US dollars.

Net sales in The Container Store retail business were $177.6 million, up 5.4% as compared to the third quarter of fiscal 2015, primarily due to new store sales. Elfa International AB third-party net sales for the third quarter of fiscal 2015 were SEK165.9, up 2.1% compared to the third quarter of fiscal 2015. Converting Elfa International AB third-party net sales to US dollars reduced the consolidated net sales results from 5.1% to 3.3% or $3.3 million for the third quarter of fiscal 2015 compared to the third quarter of fiscal 2014, using the prior-year conversion rate for both periods.

Unfortunately, the improving third-quarter sales trends were partially offset by a choppy retail environment and softer-than-planned November that we experienced. The start to the fourth quarter has also been more challenging, which we've reflected in our revised outlook.

But from a sales perspective overall, we were pleased to see improved comparable-store sales performance in Q3 as compared to Q2, with the improvement directly attributable to TCS Closets and Elfa. In fact, the benefit of TCS Closets to comparable-store sales has grown from 30 basis points in the first quarter to 80 basis points in the second quarter and now 180 basis points for the third quarter.

Simultaneously, we have realized strong growth in Elfa comparable-store sales year to date at the end of the third quarter, believing that TCS Closets and Elfa are in fact synergistic and complementary product lines, as designed and planned. TCS Closets is by far the most meaningful initiative in the history of our Company, and these early results are better than expected.

We opened four new stores in the third quarter to end the quarter with 77 stores. We plan to open the remaining two stores in the fourth quarter, which will get us to our 10 stores for the year, including one relocation. We have planned sales and overall economics to achieve our targeted approximate 2 1/2 year payback, and we continue to be very pleased with the performance of these new stores.

Moving on to gross profit performance, overall consolidated gross margin rate declined by 70 basis points in the quarter year over year. As noted, our $75 free ship service is driving incremental sales and is driving profit dollars. It's absolutely a good thing, but of course, it's a headwind to gross margin year over year. Since we didn't offer free shipping in the prior third quarter that results in gross margin reduction year over year, and this headwind will continue until we anniversary the free shipping introduction, which is in April of 2016.

We had a notable improvement in the reduction of other promotional activities impacting gross margin from second to third quarter. Our second-quarter promotional activities were more aberrant and not indicative of our third quarter or planned future activities. We believe we are being more strategic in deploying only the most profitable promotions. As we have shared on previous calls, we have been experimenting and testing and learning in order to ensure this is the case.

Our performance on the SG&A side was disappointing. While the complexity of our TCS Closets initiative drove higher expenses of a penny versus our expectations in the third quarter, this is an investment that is just a prerequisite to realizing the full potential of this major initiative.

However, this is only one piece of our higher-than-planned SG&A line item in the quarter. As Jodi will discuss in more detail here in a moment, we had unusually high healthcare, distribution, and payroll expenses. This is frustrating, given our long history of soundly managing our expenses. And in the third quarter, we did not handle this area as well as we could and should have.

Let me emphasize that we take expense management very seriously at The Container Store. We've updated our forecast to reflect any necessary revised expense estimates. And as I mentioned earlier, in response to this third quarter, we are increasing our efforts to reduce costs and SG&A without harming the momentum of our major initiatives, specifically TCS Closets.

We are diligently focused on expense management paired with revenue creation, despite some unpredictability and additional expenses that resulted in a net loss per share of $0.04 in the third quarter, including approximately $0.03 per diluted share in spend for key strategic initiatives, which was a penny higher than expected.

Fiscal 2015 continues to serve as an investment year for The Container Store as we take necessary steps to properly and strongly support employee training, customer service improvements, and marketing for those strategic initiatives. Accordingly, we believe the greatest impact of the initiatives to sales will come in 2016 and beyond.

I'd like to hand it over to Melissa to share more about the TCS Closets initiative. Melissa?

Thanks, Kip. TCS Closets does provide us with an opportunity to drive comparable-store sales through higher average ticket. The product offering was available in just seven stores at the start our fiscal year, 74 stores at the end of our third quarter, and now since December, we have completed the rollout to all stores right on schedule.

The rollout included a complete remodel of our custom closet department, featuring, obviously, new displays for TCS Closets. But also at the same time, we updated our Elfa displays. And if you haven't already seen them, please visit one of our stores soon.

TCS Closets' average ticket continues to exceed $10,000, while the average number of TCS Closets transactions per week per store is steadily increasing from 0.1 in March of this fiscal year to now more than 0.4 TCS Closets transactions per week per store through fiscal November. Please note that TCS Closets' $10,000 average ticket is for a customer's purchase of just TCS Closets. Any other products that are included in that customer's basket at that same time are currently rung separately.

As Kip mentioned earlier, the benefit of TCS Closets to our comparable-store sales is strengthening and has grown from 30 basis points in the first quarter to now 180 basis points in the third quarter. This momentum has built while we simultaneously realize higher Elfa sales, which is very important to us, since we own Elfa and it has our highest consolidated gross margin.

We made excellent strides in the third quarter, with virtually all markets realizing greater TCS Closets comparable-store sales benefit compared to the second quarter. Selling closets is in our wheelhouse and our goal is to dominate the closet category.

At The Container Store, we have always had a very strong closet-related business that continues to rise as we add incremental sales of TCS Closets. Elfa alone represents about 25% of our annual retail sales, and our closet department represents approximately another 14%. And then many of our other 14 lifestyle departments also have products that can be used in the closet in many ways. We believe that our percent of sales related to closets will continue to grow in the future.

We have a strong competitive advantage in that there is no other comparable retailer doing this high-ticket, high-quality custom closet business. And we also offer the complete solution for our customers -- not just the closet of their choice with many options to choose from, but also the full array of closet organization products that accompany the closet. In addition, we have a natural footprint with millions of customers coming to our stores each year for our expert salespeople to work with and to sell them our beautiful custom closets. And while the initial focus for TCS Closets has been the closet, based on customer demand and current trends, we intend to eventually expand the offering of TCS Closet solutions to other areas of the home.

We also believe that we have a unique strategic position that allows us to meaningfully increase overall average ticket with our high average ticket initiatives. And that our highly trained and experienced sales force, which has been selling proprietary custom-designed Elfa product solutions for over 37 years, is absolutely a unique asset to our strategy.

Over the last 12 months ended November 2015, our sales force has sold on average approximately 7.5 Elfa spaces per store per day, and grown these custom-designed Elfa solutions to currently represent approximately 25% of our annual retail sales. We have also concluded the rollout of Contained Home to all stores in December and continue to see an average ticket in excess of $2,500 for the program to date.

POP!, Perfectly Organized Perks, our customer engagement program. We have now enrolled more than 3 million POP! Stars since launch and we continue to add approximately 25,000 POP! Stars per week. We are still leveraging this program to drive traffic and incremental sales.

In summary, yes, we are making great progress on our key initiatives. However, as Kip said, we are disappointed with our bottom-line performance in the third quarter. We will continue to make the appropriate investments in our business to position our initiatives for maximum success. But also we have reflected our revised forecast for expenses in our updated outlook for the year, and we are increasing our efforts to reduce cost and SG&A without harming the momentum of our major initiatives.

We do understand that the world of retail continues to rapidly change and innovate more quickly than ever. And we are proud of what we are doing to navigate through the changes, to innovate and ensure that we are playing to and leveraging our strengths in order to position The Container Store for decades to come as the beloved, relevant, and much-needed retailer it has always been.

Now I'm going to hand it over to Jodi to go through our financial results and outlook in more detail. Jodi?

Thank you, Melissa, and good afternoon, everyone. Starting with our third-quarter results, to reiterate, our consolidated net sales were $197.2 million, up 3.3% compared to the third quarter of fiscal 2014, but up 5.1% when using the prior-year conversion rate for both periods.

Sales for The Container Store retail business were up 5.4% to $177.6 million, primarily due to new store sales. Overall, our third-quarter comp was up 0.5%, which reflects solid comp growth in September and October and a choppy November, as Kip mentioned.

We ended the quarter with 77 stores and approximately 1.92 million of gross square footage as compared to 69 stores and approximately 1.73 million of gross square footage at the end of the third quarter of 2014. The composition of our 2015 class of stores is more heavily weighted to smaller markets. And we continue to expect sales in year one for the 2015 class of stores to be more in the range of around $6 million compared to approximately $9 million, which is the simple average sales volume for our store fleet, excluding the high-volume Manhattan stores. This is expected to drive approximately 20% first-year EBITDA and an approximate 2 1/2 year payback on average.

As a reminder, we have more new store openings in the second half of the current fiscal year, with six out of nine new stores opened in the second half of 2015 compared to three out of seven stores in the second half of fiscal 2014. So both the mix of openings as well as the timing of openings when compared to the prior year will impact your productivity calculations, but we continue to be pleased with the results we are seeing out of our new stores.

Turning to Elfa International AB, Elfa's third-party net sales were up 2.1% from the third quarter of fiscal 2015 in Swedish krona, primarily driven by increased sales in Sweden and Norway, partially offset by lower sales in Russia. However, the strengthening of the US dollar against the Swedish krona led to a negative conversion impact of $3.3 million in the third quarter of fiscal 2015.

The Swedish krone depreciated approximately 17% year over year against the US dollar during the third quarter of 2015, on average. As a result of this conversion impact, Elfa's third-party net sales in US dollars declined approximately 12.7%.

Now on to profitability. Consolidated gross profit dollars were up $2.2 million, primarily driven by increased sales volumes and partially offset a decline in consolidated gross margin. In the third quarter, our TCS gross margin declined 120 basis points to 57.7%.

Ongoing analysis continues to support that incremental sales and profitability are being generated by our everyday free shipping on orders over $75, as we've discussed. Additionally, we are seeing strong sales growth in locations outside our store trade areas through this free ship over $75 service, which is indicative of potential new customers being drawn to the brand.

So while we have realized a benefit to overall sales, the estimated impact of free shipping on the TCS gross margin rate was approximately 90 basis points in the third quarter or about 80 basis points on a consolidated basis. As you will recall, we had assumed a drag of 70 basis points to consolidated gross margin in both third and fourth quarters, so this headwind was slightly above our expectations. Since we didn't offer free shipping in the third quarter last year, this headwind will continue until we anniversary the introduction in April of 2016.

Second, we offered all of our Elfa products on sale in the third quarter during our annual shelving sale compared with last year and all prior years, when we excluded certain items within an Elfa solution, which was frustrating for our customers. This combination of a more comprehensive offering of Elfa product on sale, accompanied by better customer reception to Elfa during the sale, impacted third-quarter TCS gross margins by about 65 basis points or approximately 50 basis points on a consolidated basis.

However, when you factor in the benefit of the stronger US dollar compared to the Swedish krona, which added approximately 110 basis points to consolidated gross margin during the third quarter, the Elfa gross margin at TCS had an overall positive impact to consolidated gross margin, with these two factors combining to attribute approximately 60 basis points on a consolidated basis.

Third was the impact of our test and learn marketing and promotional programs, which impacted third-quarter TCS gross margins by approximately 60 basis points or about 40 basis points on a consolidated basis. As Kip mentioned earlier, this is a notable improvement from the more aberrant higher levels of second quarter.

Lastly, the mix shift towards services that we discussed last quarter impacted our TCS gross margin rate by approximately 25 basis points or about 10 basis points on a consolidated basis. Again, remember that although service gross margin rate is lower than that for our products, the two go hand-in-hand and together drive higher profits. I'd like to emphasize here that all of these factors which negatively impacted the gross margin rate were directly tied to incremental TCS sales and an increase in TCS gross profit dollars in the third quarter.

Elfa International AB gross margin improved 30 basis points to 39.3%, primarily due to lower direct material costs as well as a shift in sales mix, partially offset by increased freight costs. On a consolidated basis, gross margin declined 70 basis points to 58.9%.

Moving on to SG&A, as a percentage of sales, consolidated SG&A increased 250 basis points to 51.7% in the third quarter of fiscal 2015, which was significantly higher than we expected. The year-over-year SG&A deleverage was primarily driven by the following factors.

First, as Kip mentioned, the complexity of our transformational TCS Closets initiative resulted in initiative spend of approximately $1.8 million or $0.03 per share in the third quarter compared to our $0.02 per-share expectations. This equates to approximately 90 basis points of SG&A expense in the third quarter, of which approximately 20 basis points was more than we initially expected.

Second, we incurred higher payroll costs in our stores and distribution center that drove approximately 70 basis points of deleverage, or about 50 basis points in stores and about 20 basis points in the distribution center. We incurred higher store payroll for enhanced sales floor coverage, but also incurred more store payroll than expected in general as we ramped up selling of TCS Closets in our stores and were less efficient than we normally are during this final push of the launch. All but three stores were up and running with TCS Closets at the end of the third quarter.

We normally schedule our store labor as a percentage of sales and flex as needed around sales, which is generally achievable for us with our predominant mix of flexible part-time employees. However, in the third quarter, the desire to provide enhanced sales floor coverage to maximize sales in our stores, combined with ensuring maximum success of the TCS Closets rollout, put more pressure on our payroll costs in store than expected.

Our fourth-quarter outlook includes a plan for store payroll that provides ongoing enhanced store floor coverage that anticipates maintaining our planned payroll costs as a percent of sales, like we historically have done around sales trends.

Additionally, as expected, compared to last year, our DC is incurring higher payroll costs associated with fulfillment of a greater number of orders shipped directly to customers. This contributed approximately 20 basis points of expense deleverage, which we expect will continue until we anniversary the launch of everyday $75 free shipping in April of 2016.

Third, we incurred an increase in healthcare costs of approximately $1 million or about 50 basis points. After elevated healthcare costs in first quarter, we have returned to more normalized healthcare trends in the second quarter, but unfortunately had a number of large claims hit in the third quarter, resulting in higher-than-planned expenses. We have assumed an increased level of healthcare costs will continue into fourth quarter, and this is factored into the outlook I will discuss shortly.

Fourth, we incurred unexpected storage costs of approximately $800,000 in connection with the DC automation project that represented approximately 40 basis points in year-over-year SG&A deleverage. During 2015, we have been adding automation to our distribution facility in a nine-month project that will go live in April of 2016, and we encountered some challenges during our peak inventory period in the third quarter. As a result, we had to utilize some unanticipated non-economical short-term storage options in the quarter. We moved through the issue by the end of November and do not expect any further incremental cost related to this issue.

The magnitude of the SG&A surprise is unacceptable to all of us, as you heard Kip say. We take expense management very seriously and pride ourselves in being able to flex our variable expenses in response to sales trends, which we have a long history of doing. Let me assure you that we have spent substantial time and resources analyzing our third-quarter expense performance, fixing the areas that needed fixing, and reflecting any necessary changes in our outlook.

New store preopening expenses were $1.4 million higher year over year due to the opening of four stores in third quarter of this year compared to two store openings in the third quarter last year. As a result, preopening expenses deleveraged, as expected, by approximately 70 basis points year over year. Our net interest expense in the third quarter of fiscal 2015 was $4.2 million compared to $4.3 million in the third quarter of fiscal 2014.

The effective tax rate for the quarter was 28.6% compared to 34.2% in the third quarter of last year. The decrease in the effective tax rate was primarily due to a pre-tax loss in the third quarter of 2015 as compared to pre-tax income in the third quarter of 2014, combined with a shift in the mix of projected domestic and foreign earnings. These amounts are partially offset by a reduced tax rate in the third quarter of 2014 resulting from a nontaxable gain on the sale of a Norwegian subsidiary.

Our net loss for the quarter was $1.7 million or $0.04 per diluted share compared to adjusted net income of $3.2 million or $0.07 per diluted share in the third quarter of last year.

Turning to our balance sheet, we ended the third quarter with $14.6 million in cash, $365 million in outstanding borrowings, and combined availability on revolving credit facilities and cash on hand of $85 million. We ended the quarter with inventory up 5.2% compared to the end of third quarter 2014, with the increase primarily due to new stores. On a per-store basis, TCS retail inventories actually decreased approximately 4.6%.

Now turning to our outlook. While the biggest volume weeks still lie ahead, given the start to the fourth quarter that Kip mentioned, we are taking a conservative approach to our fourth-quarter outlook. We expect consolidated sales in the fourth quarter to be $222 million to $232 million, including a comparable-store sales decline of 3% to 5%. And now expect diluted net income per share for the fourth quarter to be in the range of $0.19 to $0.22.

This fourth-quarter outlook assumes moderation in the trend of year-over-year operating margin declines, taking into consideration the increasing FX tailwind on gross margins, the abating investment spend, and our efforts to reduce costs and SG&A.

Given our third-quarter performance and updated outlook for fiscal fourth quarter, we are revising our 2015 outlook. We now expect consolidated net sales to be in the range of $785 million to $795 million, assuming a comparable-store sales decline of 1% to 1.6%.

Diluted net income per share for fiscal 2015 is now expected to be $0.10 to $0.13 based on a weighted average of 49 million diluted shares outstanding. This outlook now includes an anticipated $0.08 per diluted common share headwind related to the implementation of our initiatives. We completed the rollout of our initiatives early in fourth quarter.

This outlook also includes the $0.01 drag related to the first-quarter port delays and higher associated freight costs that we discussed when reporting our first-quarter results. Our average SEK rate assumptions for this year remain very close to what we have originally articulated.

Finally, we expect our tax rate for fiscal 2015 to be approximately 36%, which implies an approximate 34% tax rate for fourth quarter. And our annual interest expense at today's LIBOR rates is still expect to be approximately $17 million.

In summary, while we are disappointed with our bottom-line performance in the third quarter, we have a firm handle on the expense issues and have addressed them. Most importantly, we continue to see solid progress on our key TCS Closets initiative, which bodes well for 2016 and beyond, which is when we expect this initiative to more meaningfully impact our sales and profits.

That concludes our prepared remarks. Thank you.