Container Store Group Inc (TCS) 2016 Q2 法說會逐字稿

Greetings, and welcome to The Container Store second-quarter 2016 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, Ms. Anne Rakunas. Thank you, you may begin.

Good afternoon, everyone, and thanks for joining us today for The Container Store's second-quarter 2016 earnings results conference call. Speaking today are Melissa Reif, Chief Executive Officer; and Jodi Taylor, Chief Financial and Administrative Officer. After Melissa and Jodi have made their formal remarks, they'll open the call to questions.

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 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.

These are referred also 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 obligations to update the 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. And I will now turn the call over to Melissa. Melissa?

Thank you, Anne, and good afternoon, everyone, and thank you for being on the call today. In my remarks, I will provide a brief overview of our second-quarter financial results, as well as review the performance of our key initiatives, and the progress we have made on the objectives we set out at the beginning of FY16. I'll then turn it over to Jodi to review our financial results in more detail, and comment on our annual outlook for FY16.

Before turning to the highlights of our financial results for the second quarter, I'd like to remind everyone that we're sharing results of the 13 week quarter that ended October 1, 2016 under our new fiscal year. We are pleased with our bottom line performance for fiscal Q2 despite disappointing sales. As discussed on last quarter's call, sales were challenging at the beginning of Q2, and this trend persisted through August when we retreated from some promotional activity from August of last year.

Sales trends then improved considerably in the month of September, as we now have more comparable alignment of year-over-year marketing and merchandising campaigns. And we are pleased that sales trends in our third quarter to date are much improved from our results in Q2. So we are cautiously optimistic about the second half of our fiscal year, and have a strategic marketing and merchandising plan in place to drive profitable and improved sales trends, compared to the first half of FY16.

Consolidated net sales for the second quarter of FY16 were $205.1 million, up 0.3% compared to the prior year period. Comp store sales declined 4.2% compared to the second quarter last year that ended October 3, 2015.

Our commitment to our SG&A savings program and increased efficiencies resulted in a 40 basis point improvement in our SG&A rate, and we delivered earnings of $0.07 per share this quarter, despite our challenging comp store sales. Regarding TCS Closets and Elfa and our goal of closet domination, sales for both Elfa and TCS Closets remained good during our second quarter. In September, we had our annual shelving sale, and customers responded well, driving strength in the Elfa performance at The Container Store.

And TCS Closets specifically contributed 200 basis points to our overall comp in this quarter. We are pleased with the traction we are gaining with TCS Closets, and the average ticket for TCS Closets remains strong at approximately $10,000. And during the second quarter, we did see a notable increase in the number of TCS Closets sold per store per week.

We continue to deploy marketing support, both online and via other marketing channels, in support of TCS Closets and closet domination. We are reallocating a portion of our marketing spending accordingly, in order to communicate about this differentiated product offering and related services to new and existing customers.

And in response to customer's request, we have launched an updated lighting package for TCS Closets, as well as now giving our customers the option to not have predrilled holes visible in the vertical panels of their solution. Based on the number of customer requests for these options, we believe these new enhancements will be well-received. And in early September, we also launched an enhanced TCS Closets online experience, the first of many iterations and improvements to our online custom closet experience.

If you get a moment, I'd love for you to check it out. The new site better reflects the high quality of our offering, as well as our differentiated service, from space design to installation, and organizing services offered by our Contained Home organizers. Since the site's launch, we've seen an uptick in customers initiating and engagement for TCS Closets design process online, including an increase in customers interested in our in-home service for their TCS Closet solutions.

We're also using new technology to enhance our TCS design and sales process, including our TCS Closets design tool that we believe will enable us to materially shorten the time frame to develop a customer's custom closet design. It will also allow for easier and more efficient sharing of designs with customers. Our utilization of salesforce have provided us with a more efficient way to manage TCS Closets sales, from initial customer inquiry through the installation of the solution.

As we continue through our first year of TCS Closets being available in all of our stores, we are still learning the seasonality of this new product offering. Based on our experience in the holiday quarter last year, we expect some seasonal moderation in TCS Closets sales in fiscal Q3, until after the holiday period. We will continue to refine and improve TCS Closets and its related customer experience, and believe we are well-positioned to build upon the early success of this differentiated product and service offering.

Also related to our focus on closet domination and our efforts to continually improve our product offering to bring even more choices to our customers, we will pilot Elfa sliding doors in our two Manhattan stores beginning this month. Elfa sliding doors are custom-designed to the customer's specifications, and will come in a variety of designs and finishes. With Elfa sliding doors, for example, you can create a closet within a room that provides wall-to-wall enclosed storage, custom-sized to your space.

You can see how these sliding doors have great potential in the New York market, by creating storage and room dividers where there may not currently exist, or one may not currently exist within a living space. Because it's a completely custom product, the pricing will depend on design, but we expect to be a high average ticket starting around $2,000 or more.

Elfa has sold this high quality solutions in Europe for decades with great success, and we're excited that we will offer the Elfa sliding doors exclusively here in the United States at The Container Store. And I do hope all of you have a chance to stop by one of our Manhattan stores to see the sliding doors for yourself.

As you may recall, we launched our customer refinancing program in July with Synchrony Financial. While still in its infancy, we're pleased with the results we're experiencing, and the early acceptance of this financing program by our customers. Our current financing offers have been crafted to promoted higher than average spend, specifically for custom closets.

Early results show that financed Elfa purchases over $500 have a much higher average ticket than non-financed Elfa purchases. In addition to customer's financing Elfa purchases, they are also using the TCS credit card to purchase TCS Closets and other products. And now, just a little bit more about our online store.

In addition to our new TCS Closets online experience, we also launched the My Organized Life gallery in June. This gallery allows customers to post photos of their own organization solutions, resulting in a curated user-generated shoppable tool for customers get even more inspiration, and new ideas for organizing. We've seen an increase in time spent on our site, and an increase in conversion with customers who engage with gallery.

And our newly designed product page is more mobile friendly than before, making it more easier for the customer to check out on a mobile device, resulting in increased mobile traffic conversions in Q2. The product is larger in size on the page than it was before, and add to cart button is higher up on the page. The purchase option such as ship, click and pickup, or click and deliver are much more prominent, allowing the customer to more easily shop how she wants to shop.

Also during the second quarter, we built a media mix model to better understand the impact of media spend on our sales. The model provided insights into the performance of our paid media channels. Additionally, it recommended how to reallocate paid media spend across different channels to maximize the impact on our sales.

We're currently in the process of testing some of the initial recommendations from the media mix model, and are eager to understand the outcomes in the coming quarters. With regards to our new stores, we opened two new stores in the second quarter. One in Palm Beach Gardens, Florida and one in Troy, Michigan.

In the third quarter to date, we have also opened stores in Pittsburg, Pennsylvania and Omaha, Nebraska. We have been pleased with the sales performance of these new stores opened so far in FY16. Finally, we've added two additional locations, one in Baybrook, Texas that opens this coming weekend, and one in Des Moines, Iowa, that opens next weekend for a total of four new stores in the third quarter, and seven new stores in FY16.

The relocation of our Chestnut Hill, Massachusetts store will now take place in the first half of FY17. As part of our continued efforts to evolve our in-store environment, all new stores beginning with our Baybrook store will feature an updated layout that expands the custom closets area of the store, and includes a new merchandising presentation for long-term storage solutions. Also in our stores, we have been actively seeking all ways to operate more efficiently.

This includes utilizing our new Theatro technology to enhance in-store communication and reduce payroll. We're also reevaluating store hours, using traffic and sales information, particularly around extended holiday hours. We're testing the utilization of a third-party for assistance with our merchandising processing in our stores, and for new stores, we have realized numerous efficiencies in operations and training.

And our stores and website are now dressed for the holidays, featuring The Container Store's one-of-a-kind Gift Wrap Wonderland and stocking stuffer collection. We hosted many of our best customers at in-store Gift Wrap Wonderland preview events late last month, and we will be holding free gift wrap and bow demonstrations each weekend throughout the holidays.

Our always highly anticipated stocking stuffer catalog will be arriving in customer's mailboxes this week. It will be followed by other marketing throughout the holiday season.

In closing, I want to reiterate that we are pleased with what we delivered from an earnings standpoint in Q2, but acknowledge there is still work to be done in driving top line sales. This quarter's comp store sales were not acceptable to us, and we are committed to their improvement. We are capitalizing upon our key strengths, and focusing upon what differentiates us in the marketplace.

Our focus on custom closets continues to drive sales, with TCS Closets contributing meaningfully to our results. And our efforts to manage expenses and increase efficiencies throughout our organization are improving our profitability. While the current retail environment remains challenging, and our sales trends are not consistently positive, volatility does continue, we are making progress on many fronts.

As we continue to innovate and test and learn, we will be guided by the evolving preferences of our customers, and we'll make appropriate changes and adjustments as needed. We see some encouraging signs that make us cautiously optimistic, as we head into the second half of the year. And with that, I'll ask Jodi to please review our financial results and outlook in more detail.

Thank you, Melissa, and good afternoon, everyone. Today, I will be reviewing our second quarter FY16 results and then discussing our outlook for the remainder of the year. In light of the Company's fiscal year change, all references to prior year results are based on the recast second quarter ended October 30, 2015. As Melissa shared, for the three months ended October 1, 2016, our consolidated net sales were $205.1 million, up 0.3% compared to the prior year period.

Sales for The Container Store retail business were up 0.9% to $189.1 million, primarily due to new store sales. Our second quarter comp was down 4.2%. TCS Closets continues to contribute to our comp store sales, contributing 200 basis points to our second quarter.

As Melissa mentioned, it was a challenging start to the quarter in July, with those trends persisting into August before we saw an improvement in the month of September. We ended the second quarter with 82 stores, and approximately 2 million of gross square footage, as compared to 75 stores and approximately 1.9 million of gross square footage at the end of the recast second quarter of FY15.

Now, turning to Elfa International AB. Elfa's third-party net sales were down 5.5% in Swedish krona compared to the prior year period, primarily due to the lower sales in Russia and the Nordic market. This was further affected by the negative impact of foreign currency translation in the fourth quarter, as the krona weakened against the US dollar.

During the second quarter of 2016 on average, the Swedish krona declined approximately [0.5]% year-over-year against the US dollar. As a result, the Elfa third-party net sales in US dollars declined approximately 6%.

Moving onto profitability. In the second quarter, consolidated gross profit dollars were relatively flat at $118.4 million. Consolidated gross margin declined 20 basis points, compared to the prior year period.

Gross margin at The Container Store retail business was down 10 basis points, reflecting a larger mix of lower margin products and services, but partially offset by the impact of a stronger US dollar. As we've discussed, gross margin at TCS is impacted by prior SEK exchange rates obtained to purchase Elfa products for TCS. Elfa gross margin remained consistent with the prior year period.

Moving on to SG&A. As a percentage of sales, consolidated SG&A decreased 40 basis points to [46.]6% in the second quarter of FY16, as compared to the prior year period primarily due to cost efficiencies associated with our SG&A savings program, as well as foreign currency exchange rates. This was partially offset by deleverage occupancy costs associated with our comp store sales decline.

New store pre-opening expenses decreased by approximately $1 million to $2.5 million in the second quarter, as we opened two stores in the current year period, compared to three store openings and one store relocation in the prior quarter. As a result, pre-opening expenses leveraged by 50 basis points year-over-year. Our net interest expense in the second quarter of FY16 was $4.2 million, in line with the prior year period.

The effective tax rate for the quarter was 41.6%, compared to 41.1% in the recast second quarter of last year. The increase in the effective tax rate is primarily due to a shift in the mix of domestic and foreign earnings. Our net income for the quarter was $3.5 million or $0.07 per diluted share, as compared to a net income of $3.3 million or $0.07 per diluted share in the recast second quarter of last year.

Now turning to our balance sheet, we ended the quarter with $9.3 million in cash, $333 million in outstanding borrowings net of deferred financing costs, which was down approximately $19.5 million from the same time period last year, and combined availability on revolving credit facilities and cash on hand of approximately $98.8 million. We ended the quarter with inventory of approximately in line with the prior year period, reflecting ongoing efficient handling of inventory.

With regards to our outlook for FY[16], factoring in our first half results, as well as our expectations for the remainder of the fiscal year, we are lowering our sales expectations for the full year. We expect now consolidated net sales to be between $820 million and $830 million. Our comp store sales outlook is now expected to be down 1.5% to down 3%.

We're very pleased to be able to maintain a full year EPS outlook of between $0.20 and $0.30, which reflects the significant work we have accomplished on the SG&A side. This EPS range is based on a weighted average of 49 million diluted shares outstanding.

While we have a number of activities and programs in place, we are optimistic will have a positive impact to sales. In order to make sure we currently manage the business in a conservative and thoughtful manner, we are being prudent as we look at sales and expenses for the remainder of the FY16. We continue to expect TCS and consolidated operating margin to improve, based primarily on the significant SG&A savings program that we have implemented. We expect our tax rate for the full FY16 to be approximately 39%, and our annual interest expense at today's LIBOR rates to be approximately $17 million.

We continue to forecast our FY16 consolidated gross margin to be relatively flat year-over-year. On the FX front, we continue to expect minimal impact to gross margin, based on current US dollar SEK purchase levels. As expected, we experienced a slight FX benefit to gross margin in the first half of the year.

For the second half of the fiscal year, we have SEK contracts in place for nearly all our purchase needs at a US dollar rate comparable to the levels of the prior year. In light of known FX purchase rates, as well as expectations of a comparable promotional environment year-over-year, we expect relatively flat gross margin in the second half of the year.

In terms of SG&A expenses, we were very pleased with the results of our SG&A savings program, and continue to expect these cost savings to become more impactful as the fiscal year progresses. The success of this initiative is a key reason, we are able to reiterate our full year EPS outlook.

Now looking at fiscal Q3 which ends on December 31, while we see an improved sales trends at TCS beginning with fiscal September and continuing early into Q3, it's important to remember that fiscal December could be a challenging sales month as compared to last year. That's because our annual Elfa sale begins before the Christmas holidays, and Christmas season and Christmas Day fall on Saturday and Sunday this year, followed by our third quarter ending on Saturday, December 31, which is New Year's Eve. The holidays falling on weekend days right at the beginning of the annual Elfa sale, may shift more Elfa sales into Q4 than is typical.

And finally, we expect to deliver operating margin expansion in the second half, driven by meaningful SG&A leverage resulting from our SG&A savings program. So in summary, while there is still work to be done to improve top line performance, we are pleased with the bottom line results we delivered in fiscal Q2. We are focused on delivering the second half, and developing our longer-term plans and priorities.

Thank you. Now I'd like to turn the call back over to the operator, so that we can open the line up for questions. Matt?

Thank you.

(Operator Instructions)

Our first question comes from Chris Horvers from JPMorgan. Please go ahead.

Thanks, good evening.

Hello, Chris.

Hi, how are you doing? So I wanted to ask a couple of questions on sales trends. So can you maybe quantify how much improvement that you saw in September? And what's the interpretation around October, did October continue to improve sequentially off that September level, or is it October and September look relatively similar?

Hi, Chris. Yes, as we discussed on our call last quarter, the Q2 sales started out challenging, and those trends persisted throughout August when we retreated from that promotional activity that I talked about in the script. And so, it was really unclear why, but we're very pleased to see the improved -- in sales trends Q3 to date. And we've continued to see the day-to-day volatility, which is why we've comped the way we have for the year. But they did considerably improve in the month of September, and we're pleased to see that that continues so far into October.

So is it sort of less negative, or are you turning positive?

It's --

Chris, it really depends on the day, but it's definitely a significant improvement in trend over where we were in --

In Q2.

In Q2.

Okay. And then, based on how you described the guidance, Jodi, it sounds like you're implying that -- you're putting some extra prudence in the fourth quarter. So is the right interpretation, whatever we think Q3 ends up being, Q4 is probably lower from there, given how the Elfa sales might shift into 1Q, or into the first calendar quarter?

Actually, Chris, what I indicated is that the Elfa sales, since the Elfa sales starts the end of Q3, we think it's possible, because of how the holiday calendar falls this year, that we could see more of a shift of that starting period into Q4 than is typical. So more of a shift between Q3 and Q4, versus Q1.

Yes. I confused the year end timing, [similar versus March]. Totally understood.

And then my last question is, if I look at sort of your comps ex the TCS Closets lift, that trend had deteriorated over the past few quarters. Given that seasonality of the business, because it sounds like that business receeds as you look at your third fiscal quarter here, are you implying that the underlying business therefore is going to comp better, as you look at this quarter?

Chris, I'll start, and then Melissa, you can add if you like. We do expect that the rest of the business sequentially, it has improved in September and October, and we expect that to continue, as we continue to go through the rest of the fiscal year, as compared to what we experienced, specifically in July and August.

Understood. Thanks very much, and have a great holiday season.

Thanks so much.

You too. Thank you.

Our next question is from Seth Sigman from Credit Suisse. Please go ahead.

Thanks. Good afternoon, guys.

Hi, Seth

So I wanted to dig into the closets business, and how that's progressing here. I think you talked about a noticeable increase in closets sold per week. It seems to coincide with the overall business improving also over the last couple of months. But I guess, how do you think about the drivers of that increase in productivity, between kind of the operational drivers and the selling improvements, with also the environment improving?

Yes, we are pleased, as I said, Seth, with the progress we've made, and the traction we're seeing with TCS Closets. And as you know, it's our number one priority as a Company. And the contribution of TCS Closets to the comp is going to vary from quarter to quarter, but in the aggregate sales generated, it's absolutely increasing every month on a year-over-year basis, and we're seeing it increase per store per week. And there's several variables that are really driving that.

We are testing our new design tool which is really going to impact a lot, the process for the customer, make it tighter and shorter, and a better experience. And then, just operationally, we are continuing with our training, to make sure that all of our employees understand how to sell TCS Closets, albeit we have kind of a core team in each store that [are the] specific designers of the closets, and work specifically with the customers. So we're very bullish about it, and very optimistic about it and I'm anxious for our design tool to get rolled out to all stores after we test it.

And the financing roll out, was that a component of driving the improvement also? Can you give us a sense of maybe what percent of the transactions are using that financing today?

Yes, the financing as I said, while it's in its infancy, we really are still pleased with what we're experiencing, and definitely, we know that it is contributing to the custom closet sales, as I said in my remarks, that the Elfa results really show that when you compare that to the financed Elfa purchases versus non, we're seeing a much higher average ticket. So it's just another program that is contributing to some of the positive results that we have, and it's a major focus for our Company. And we're going to continue to support it accordingly with marketing and training resources, so that we can drive incremental spend going forward.

Okay, that's great. And then, just one follow-up question. As we think about the TCS pricing strategy, and ultimately how the value proposition evolves. And this quarter, margins were down just 10 basis points, sounds like you had some cushion from FX there. How do you think about balancing the gross margin rate, with maybe getting a little bit more promotional to drive comps which were obviously down 4% this quarter. I mean, how do you think about that effective balance?

Yes, pricing, as you know, we do routine competitive pricing analysis, and on like items, match for match, we are match for match, we are competitive. I don't think we get near as much credit as we should for that, but it's a balance.

I mean, we're always looking at our pricing, we want to make sure that we are competitive. And we still want to continue, of course, to offer differentiated, many times proprietary high-quality design, high functional products. So we're going to continue to evaluate the range of our price points for the products that we offer.

Got it. All right. Thank you.

Thank you, Seth

Our next question is from Simeon Gutman from Morgan Stanley. Please go ahead.

Thanks. I want to focus first, on SG&A, sort of a multi part question on it. First, can you remind us, Melissa or Jodi, the elements of the cost cuts? And then, how far removed are they from the store level, and/or the customer? Also, part of it is -- I think you suggested that they ramp, that the effect of them continue to ramp, as the rest of the year goes on. But where are we, in the cadence of reaching their biggest benefit or their peak?

Hi, Simeon, it's Jodi and I'll go ahead, and get that answer for you. Let me first just start with the elements of the cost cuts. And as -- first of all, we're very pleased with the progress, that we've seen on our SG&A savings program. We're achieving everything we have set out to, and more so far. And as we had outlined early in the year, we expected to realize many millions of dollars of expense savings, really throughout all areas of our business, including at Elfa.

But the largest category, it's not surprisingly, because it's our largest expense bucket, fall in the payroll and benefits related expenses. To your question about how far from the customer, we are definitely making sure that it is not the sales floor coverage that is being cut. In fact, we're trying as much as we can to improve efficiencies throughout the business, including specifically in the stores through efficiencies, so that we can even allocate more to peak hours on the sales floor.

So it's really been a focus on, looking at how we optimize scheduling, how we improve efficiencies, renegotiating cutting costs throughout the entire P&L, not filling open positions as appropriate. And it's just a myriad of areas that have impacted it. But we're trying to make sure we're doing it in a smarter strategic way, so that we are in no way hurting sales floor coverage in our stores. And of course, the result of this, we expect to be able to have meaningful leverage in our SG&A expenses, even with our conservative sales assumptions, and also expect that the benefit of these expense savings will roll into FY17 as well.

So, I guess, have they reached their peak, as far as the quarter to quarter impact, or they're still ramping, meaning there's more things that are being taken out, and you're becoming more efficient?

They're still ramping. As we had anticipated at the beginning of the year, some of the areas will continue to grow in their impact to the Company as the year progresses, which is really one of the key reasons why we've been able to affirm our EPS outlook, despite a challenging sales environment out there

Okay. And then, a follow-up on, I guess, the comments about quarter-to-date. First, can you share with us how broad-based is it, geographically? And is it the traffic is getting better, are we seeing retail traffic improve? And then, anything that you can discuss among TCS Closets versus other categories, because it stands out, right now, in a pretty tricky retail environment? So any other color would be helpful?

Yes, it really is broad-based across geographically, it really is. Traffic is still challenging for us, and I think for all retailers. TCS Closets, as I said in my remarks, continues to improve and we have programs in place for Q3 and Q4, that we think will drive profitable sales going forward.

And we are looking at all aspects of our business, every single aspect of our business, and testing and learning. One thing that we're doing that we're very excited about is the test with the Albuquerque store, which is a new format, looking at that assortment and the whole -- all categories will be represented, but they could be less in depth. So yes, it is pretty broad-based, Simeon. It really is.

Okay, thanks. Good luck.

Thank you so much.

Thank you.

Our next question is from Steven Forbes from Guggenheim. Please go ahead.

Good afternoon.

Hi, Steve.

With the Baybrook set to open this weekend, I believe you briefly mentioned it in the prepared my remarks, but can you expand on some of the new merchandising initiatives and space allocation changes that will be implemented in this location? I mean, I'm just try to get an understanding of how significant they really are?

Yes, it opens this Saturday, and the custom closet section of the store has been expanded. I have not been there. I have seen pictures, Steve, and it really looks absolutely beautiful, as well as we've expanded for longer term storage. So, and this will be -- this is the new Baybrook store. And then going forward, all stores will have something very similar to this, the expansion of the custom closets, because that is our number one priority, and we will continue to be leveraging that in every way we can.

With that said, what categories in essence, are you reducing the space allocation for in the box, assuming that this store is not the smaller format store that you're opening in Albuquerque?

Right. Yes, it's not the smaller format, but we've reduced some in gift packaging and box, and we've also made some changes to our kitchen section, and we're going to again continue to evaluate that, make it even more exciting and compelling place for our customers to shop and buy.

And then, as a follow-up, can you expand on your marketing plans, as we head into the holiday selling season? I know you, again you've briefly talked about the reallocation towards TCS Closets, which obviously is the focus, but do you think -- how do you think about the appropriate spend rate as a percentage of sales, and the various outlets where you can allocate those expenditures?

Yes, absolutely. Well, as you know, we're a marketing merchandising company, and we, our marketing plan for Q3 and Q4 will support our Gift Wrap Wonderland, it will support our Elfa sales, it will support TCS Closets. And we are also seeing, as I said in my remarks, a shift to more digital.

We have a pretty healthy marketing spend as a percent of revenue, and we feel like that is very, very important. And then, we're also looking at different things we want to do in-store. And this media mix model that I mentioned, again, we're just now testing it, but we really feel like that's going to help us even better maximize our marketing spend. So we feel good about Q3 and Q4, and the additional things that we're going to have -- that we have in place to drive profitable sales.

So Steve, we're not increasing the allocation of dollars. We're just reallocating within the dollars we had intended to spend.

So marketing spend is not a driver of cost savings that you're experiencing?

That is correct.

Thank you.

Thank you, Steve.

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

Thanks a lot. Good afternoon.

Hi, Matt.

My first -- how are you?

Good.

Good, good. My first question relates to some of your comments, just about getting promotions aligned as the quarter progressed. If you could just give us a little more, maybe a reminder on the differences and timing? And just to be clear, as you saw the business slow down initially over the summer, did you change the promotional cadence from what you may have originally anticipated? And if so, did that persist -- is that persisting through the current quarter?

You want to go, Jodi?

Yes, I can start. As far the -- what happened as the quarter aligned, and sort of where the -- where we got back aligned in September, we were in a mode where POP was really starting to grow a lot last year, and did a lot of test and learn activities in the early period, which is now in our recast financials is July and August, particularly in August.

And we made -- we learned -- I mean that's the whole point of doing that. And in some cases, we saw some things that we have done, that we really didn't feel made sense, from a profitability perspective, so we retreated from those. And we're willing to look at it more holistically, in terms of what we can do from a profitability perspective. It did put some pressure on the top line, but ultimately, we think it was strategically the right thing for us to do.

And then, going forward, Matt, the cadence, the shelving sale, the Gift Wrap Wonderland and the Elfa sale, there's some changes in timing, a little bit there, but the cadence is basically the same. And then, we've layered on additional strategic and thoughtful activities for Q3 and Q4.

And was some of that responsive to the change in the cadence of business, or the slow down that you witnessed over the summer, or was that the original -- in the original plan?

The additional actions for Q3 and Q4 drivers was something that we were absolutely planning earlier in the year, and had just continued as business, as something we have to react to here to augment. But Melissa may want to outline just a few more of those areas that we're focused on in the second half of the year, to her point about layering in where it's strategically smart, and we feel confident and profitable.

Exactly, I think as you know, Matt, or you may know, we have about 4.2 million POP Stars now, and continue to enroll about 25,000 a week. So for example, we're going to be testing a different time frame for deploying the perks our POP Stars earn, as part of the earn and burn and spend and get aspect of the POP program. So we're going to be testing that.

We're also going be testing some incentives around TCS Closet purchases. And also opportunity that we think we have connected to -- well, we know we have connected to our third-party credit card partners.

We're also going to be hosting more in-store events, and really taking actions as I said to, leverage what we've learned from the media mix models. So again, it's doing this and more, while always being staying focused on our building even greater success with average ticket, which is one of our biggest differentiators, because our average ticket in Q2 was quite good.

And then finally, most of your comments on POP anticipated most of my follow-up questions. It was on the loyalty effort. But is it safe to say that it's had a consistent impact on the business as you've made your way through the year?

Yes, it is. It really is. I mean, we're continually testing and learning to understand what most effectively really resonates with our POP Stars, because we want to obviously drive incremental traffic and sales, and so we're continuing to dig into that. But they still represent, Matt, among our loyal customers, and again their average ticket remains above the Company average ticket.

Got it. Thank you so very much.

Thanks, Matt.

Our next question comes from Dan Binder from Jefferies. Please go ahead.

Thanks, it's Dan Binder.

Hi, Dan.

With regard to -- with regard to the closets, TCS Closets contribution in the back half, relative to that 2 point contribution it made in the latest quarter, what would you expect that contribution to look like, based on what you know today and your guidance?

We're not going to be specific, on where we think that exact comp number is going to go, but I think Melissa, you did say in your remarks, that last year what we saw -- of course, we didn't have it in all stores at that point, not all stores rolled out until December of 2015. But with stores that were in place at that point, we did see a bit of a slow down, when we were in the fiscal third quarter period, which covered the holidays.

Because of the seasonality of TCS Closets. But that could change this year, we don't know.

Right.

It did contribute, like you said quite a bit to Q2, so we're anticipating that that will continue.

It sounds like you've had some learnings in that business with enhancements to the product, that you mentioned lighting, pre-drilled holes, things like that. I'm just curious, what is the biggest learnings you've had based on customer feedback with the product so far? I mean, you still have fairly big average tickets. Is this -- what are you finding with competition in this space? Do you think the product is priced right, things of that nature, any color you could share, that'd be great?

You bet, you bet, Dan. Closet domination, we talk about it over and over and over again, and it is -- it is a goal that we want to dominate the closet industry. And we feel like the TCS Closets is priced right. And we have Elfa as you know, and we have Elfa decor, and we are always looking to further expand those kinds of custom closet options for our customers.

We're listening to them. We are reading surveys. Our buyers and [Sharon] are continuing to work with our partner on that, to expand TCS Closets to more parts of the home. As I said, we're expanding the Baybrook store, and we'll do that with new stores going forward, and possibly, in the future even retrofitting. So if we really want -- and I also mentioned the improved experience online for our customers.

So the design tool is going to make a big difference, as well. We want to tighten that design turnaround, for every single customer experience, and make it the best possible. So we've learned a lot, and we continue to learn every day, and we're going to listen, and learn and test, and add new things. And again, closet domination, that's what we're number one priority.

And just two more items. With regard to the SG&A, I mean, you're well on your way. Do you have a better sense of what the total savings is going to look like, and what the flow-through will be? Is it nearly 100% of what you cut, or is there an [incline or to] reinvest some of that?

It's over two years. It's over FY16 and FY17. But go ahead, Jodi.

Absolutely. We feel confident that we will have meaningful leverage to our expenses, even with our sales outlook that we have provided today. So, it is absolutely something that by the end of the year, we're confident that we're going to be able to say, we saved many, many millions of dollars that we otherwise would have spent, had we not taken these actions. We know that just in payroll, it will be at least $5 million and more. That number is growing, as we continue to find optimization opportunities.

And then, as I noted, just really throughout the entire P&L, there are categories that we are saving through our efforts here, to just be more efficient. So we're confident that we'll be bringing that to the bottom line.

In terms of reinvesting, we're being very smart about where we choose to do that. Primarily where we've chosen to reinvest has been in-store, for floor payroll coverage. That's really been the only place that we've made a decision to reinvest, right now.

If I look at other retailers that have gone through major cost cutting programs over time, they will try and build structural competitive advantages that allow them to reinvest in things like price, and I realize that you're saying your pricing is competitive. But if the comp store sales don't really move that far outside of that low single-digit range, is there any reason that you wouldn't take some of this cost savings, and just take that extra operating margin -- take margins down a little bit, whether it's through absolute price reductions or promotions?

Well, I mean, we'll look and discuss any and everything. It's -- we just really feel like that our pricing is good, and we are competitive, and we're utilizing tools to make sure that we are. And I -- the promotions, we're going to continue to do those strategically and thoughtfully, and we're going to be smart, and continue to be prudent about our cost savings. And make sure that the morale stays as strong as possible in our Company, and that we're investing in the proper things, whether it's new stores, or expanding custom closets in our stores or new products. We're looking at all of that.

Okay. Thanks.

Thank you, Dan.

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

Hi, this is Erin Reilly on for Matt. How are you doing?

Hi, Erin.

We're good, thank you.

Good. I was wondering if you could touch on the e-commerce business a little bit, in terms of what you're seeing for growth and trends, and the impact you're seeing from switching to more digital marketing spend there?

Jodi, do you want?

Erin, you may recall that we introduced free shipping at $75 in the spring of last year. So we've anticipated that until we cycle that introduction, because we had a [63]% increase in our direct-to-customer ordering sales last year. Til we cycle that, we've always expected that we were going to have more challenged growth in the direct-to-customer only part of our business.

So if you look at the second quarter, we actually saw for website initiated sales, which includes somebody ordering online and either shipping directly to their home, or coming and picking up in the store, we saw an increase of 1.7%. The direct-to-customer piece was actually down 7.7%. And that's partially because we did some test and learn activities with -- around the click-and-pickup area, trying to -- trying to get people to come in store a bit more during the quarter, versus just the direct-to-customer piece of the business, trying to look at it much more holistically.

So we really did not start increasing our digital focus, except around TCS Closets in the second quarter. So the dialing of digital spend in a more meaningful fashion is more second hand -- a second half move, because that media mix model that Melissa referred to, is something that we really just concluded over the course of the last 30 or 45 days.

Okay, great. Thank you.

Thanks, Erin.

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

Thank you so much, Matt, and thanks to you all again for joining the call today. We really enjoyed speaking with you, and look forward to updating you on our progress, and our results for the next quarter. And I just wanted to take this opportunity to sincerely thank our great employees for their focused work this first half of our year. And I wanted to extend my wishes, Jodi and I, to them, and to all of you for a wonderful and absolutely organized holiday season. Thanks so much.

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