The Container Store Group, Inc. (TCS) Q1 2023 Earnings Call Transcript

Start Time: 16:30 January 1, 0000 5:07 PM ET

The Container Store Group, Inc. (NYSE:TCS)

Q1 2023 Earnings Conference Call

August 01, 2023, 16:30 PM ET

Company Participants

Satish Malhotra - President and CEO

Jeff Miller - CFO

Caitlin Churchill - IR, ICR

Conference Call Participants

Steven Forbes - Guggenheim Securities

Ryan Meyers - Lake Street Capital Markets

Kate McShane - Goldman Sachs

Operator

Greetings, and welcome to The Container Store First Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Caitlin Churchill. Thank you. You may begin.

Caitlin Churchill

Good afternoon, everyone, and thanks for joining us today for The Container Store's first quarter fiscal year 2023 earnings results conference call. Speaking today are Satish Malhotra, Chief Executive Officer; and Jeff Miller, Chief Financial Officer. After Satish and Jeff have made their formal remarks, we will open the call to questions.

Before we begin, I would like to remind everyone that certain matters discussed in today's conference call are forward-looking statements relating to future events, management's plans and objectives for the business and the future financial performance of the company that are subject to risks and uncertainties.

Actual results could differ materially from those anticipated in these forward-looking statements. The risk factors that may affect results are referred to in The Container Store's press release issued today and in our annual report on Form 10-K filed with the SEC on May 26, 2023, as updated by our quarterly reports on Form 10-Q and other public filings with the U.S. Securities and Exchange Commission.

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 of the non-GAAP financial measures to the most directly comparable GAAP measure is also available in The Container Store's press release issued today. A copy of today's press release and investor deck may be obtained by visiting the Investor Relations page of the website at www.containerstore.com.

I will now turn the call over to Satish.

Satish Malhotra

Thank you, Caitlin, and thank you all for joining our call today. I will begin today's discussion by reviewing highlights from our first quarter performance. Jeff will then discuss the details of our first quarter financial results, followed by our outlook. After which we'll open up the call to questions.

As we discussed on our year-end call in May, we entered fiscal 2023 with the expectation that the macro environment would remain challenging. And while we cannot control the impact it has on our customers and their spending, we can control our focus and our focus remains steadfast on our strategic priorities of deepening our relationship with customers, expanding our reach and strengthening our capabilities.

We believe this relentless focus and discipline in cost management will enable us to advance our long-term goals of $2 billion in annual sales. While we implemented the cost cutting action plan shared on our year-end call, our cost actions have not kept us from delivering an exceptional customer experience. In Q1, we delivered a record high store NPS of 81.

For the first quarter, we delivered top line sales performance in line with our expectations, although fueled by increased promotional activity from our test and learn approach as we continue to focus on deepening our relationship with customers. These tests unlock key learnings that will inform our go-forward promotional plans and better position us to deliver on our objective for this year.

We believe when we provide customers with a reason to shop with us, they will. Therefore, we tested promotions in the first quarter with various durations and offer types. We saw better results when we created a sense of urgency for the customer. For example, we ran a six-day buy one, get one 50% off offer that performed better on a per day basis than a 14-day offer.

Another example of giving our customers a reason to shop is the ongoing effort we have put into infusing newness and innovation across our assortment. In light of our customers traveling this summer, we gave new life to our travel and on-the-go category with brands like CalPak, Rains and Tubi [ph]. These products are both functional with a fresh aesthetic and include carry-on luggage, duffel bags, laptop backpacks and belt bags, all of which are exceeding expectations.

To note, we are pleased to see that new products are bringing new customers. In Q1, new customers to The Container Store accounted for 24% of new products sales. And we will continue to focus on categories like travel with potential for growth.

College was another area we identified with growth potential. Our annual college campaign kicked off in stores and online in Q1 with a re-imagined and expanded product assortment alongside our partnership with online dorm décor destination Dormify. While still early in the back-to-school season, college shelves [ph] are off to a strong start as a result of the enhancements we have made this year.

We also launched our online dropship program with Dormify and several other vendor partners, which is exceeding expectations. In Q2, we expect to introduce sought after brands that will enhance our core assortment. Like socially conscious home goods companies, The Citizenry, who artisans' crafted products are part of the anticipated 1,000 new SKUs coming to The Container Store throughout fiscal 2023.

We plan to embark on a bold evergreen campaign this fall to showcase our product innovation and newness, and drive awareness of how our curated, innovative and solution-oriented products can help transform lives. While we are pleased with the results we're seeing in response to the newness we are delivering, incremental sales are more than offset by greater than expected declines in the Home Edit and re-condo [ph] collection, and to a lesser extent declines in the closet storage category, driven by drop-front shoe box and jewelry. We believe these greater than expected declines in our more traditional categories are symptomatic of the current macro environment.

With respect to expanding our reach, while we have seen softness in our non-premium spaces, we continue to be pleased with our premium space results within custom spaces. Given the strength we continue to see in the Preston line, we are looking forward to introducing more innovation in the assortment by offering superior European lighting compatible with smart home, as well as diamond weave mesh door inserts that pair beautifully with new Preston colors. We believe these innovative enhancements will elevate the Preston line even further.

Regarding custom space services, we have 133 in-home design specialists who have successfully completed a multi-day, in-person technical design training to enhance their skills and product knowledge. These design specialists are primarily focused on selling Avera and Preston premium spaces, which as a reminder represents a significant majority of the $6 billion custom space market. In Q1, premium spaces sold by in-home design specialists accounted for 80% of all Avera and Preston sales compared to 71% in the same quarter last year, and 75% in the previous quarter.

As we previously shared, our custom garage offering is an area of opportunity we identified to expand. We are rolling out our premium Preston garage solutions to stores and we're excited to announce the all new Garage+ by Elfa, which we plan to launch later this year. Informed by customer feedback on our current Elfa classic garage options, we developed new features and enhancements including closed cabinet, lighting, full-extension and soft-close deep drawers, and a freestanding workbench. These enhancements will truly elevate our overall garage offering.

New online tools continue to elevate and differentiate our custom space experience. We soft launched the My Custom Spaces portal to give customers a centralized spot to review their design, sign their purchase agreement, manage their payment, and track the status of the custom space lifecycle from inspiration to installation. This portal will provide our customers with a smooth and intuitive experience.

In addition, we recently launched an enhanced online scheduler for customers to easily make in-store, in-home or virtual design appointments on our website when they're ready to get started on a space design. As it relates to customer satisfaction of our custom spaces category, our net promoter score increased by 9 points from Q4 of 2022 to 79. This gives us confidence that our continued focus on innovation and service is making an impact.

Turning next to our new store plan. We remain on track to open six new small-format stores in fiscal 2023 and still see a pathway to significantly increase our store count over the coming years. This year's new stores will open an existing key market where we see whitespace. This fall, we expect to open in San Mateo, California; Woodland Hills, California; and Princeton, New Jersey, followed by Gettysburg, Maryland this winter; and Miami, Florida and Huntington, New York in spring of 2024.

Finally, as we continue to strengthen our capabilities, I'm proud of the publication of our second annual sustainability report in Q1, which outlines the progress we have continued to make against our environmental, social and governance strategy throughout fiscal 2022. One highlight I want to note is being recognized by the United States Environmental Protection Agency for our company's use of wind green power.

Our teams are also hard at work with a new partner that will help us measure our Scope 3 emissions, which include indirect greenhouse gas emissions of our supply chain. We are one of the first retailers to embark on this assessment, and we look forward to learning the ways in which we can further reduce our carbon footprint.

To summarize, as we anticipated, it was a difficult start to a challenging year. We have revised our outlook to reflect current trends in the business that we're seeing in Q2. The backdrop notwithstanding, we remain focused in our job, on the customer experience and executing against our strategic initiatives to position The Container Store for long-term profitable growth on our path to 2 billion in annual revenue.

I want to thank all of our team for their unrelenting hard work and optimism as we navigate this dynamic environment. I'm confident that the steps we are taking today position us well to capitalize on the recovery in demand when it occurs.

I'll now hand it over to Jeff. Jeff?

Jeff Miller

Thank you, Satish, and good afternoon, everyone. As Satish reviewed, our first quarter top line performance was in line with our expectations. However, our bottom line results were negatively impacted by our test and learn promotional activity, as we continue to experiment with different events to engage with customers in the current environment, and to a lesser extent, a lower than expected effective tax rate. Offsetting some of this pressure, however, was an ongoing commitment to discipline expense management, including the planned actions we discussed on our last call.

For the first quarter, consolidated net sales decreased 21.1% year-over-year to 207.1 million. By segment, net sales for The Container Store retail business were 195.1 million, a 20.9% decrease compared to 246.8 million last year. The decrease is inclusive of a comp store sales decrease of 19.9%, driven primarily by the 20.5% decline in our general merchandise categories, which negatively impacted comp store sales by 1,360 basis points.

Custom spaces comp store sales declined 18.6% compared to last year and negatively impacted comp store sales by 630 basis points. The discontinuation of C-Studio third party sales year-over-year, partially offset by the sales from new stores made up the remaining 100 basis points, in total 20.9% TCS net sales decline year-over-year.

For the first quarter fiscal 2023, our online channel decreased 15.8% year-over-year and our website generated sales, which includes curbside pickup decreased 10.5% compared to last year. Website generated sales represented a total of 24.1% of TCS net sales in Q1 compared to 21.3% in Q1 last year. Unearned revenue decreased to 17 million in Q1 this year versus 24.7 million last year, driven by the pullback in customer spending that we are experiencing.

Elfa third party net sales of 12 million decreased 24.4% compared to the first quarter of fiscal 2022. Excluding the impact of foreign currency translation, Elfa third party net sales decreased 19.2% year-over-year, primarily due to a decline in sales in the Nordic markets. The decline in Elfa third party sales reflects the continued challenging macroeconomic environment in the Nordic and other regions due to high inflation and increasing interest rates.

From a profitability standpoint, our consolidated gross margin for Q1 decreased 180 basis points to 55.3% compared to 57.1% last year. By segment, TCS gross margin decreased 230 basis points compared to last year, primarily due to more promotional discounting, driven by the test and learn activity previously discussed, higher mix of online sales and associated shipping costs and an unfavorable shift in product and services mix, all of which were partially offset by decreased freight costs.

Elfa gross margin decreased 420 basis points compared to last year, primarily due to higher direct material costs. Consolidated SG&A dollars decreased 10.5 million or 8.6% to 111.4 million compared to 121.9 million in Q1 last year. As a percentage of net sales, SG&A increased 740 basis points year-over-year to 53.8%. The increase is primarily due to deleverage of occupancy, compensation and benefits and other fixed costs on lower sales, partially offset by decreased marketing costs.

We recorded 2.5 million of severance expense in Q1 this year associated with the previously announced reduction in force at our support center, store and distribution center operations. Our net interest expense in the first quarter of fiscal 2023 increased to 5 million compared to 3.2 million last year. The year-over-year increase is primarily due to a higher interest rate on our term loan.

The effective tax rate for the quarter was 23.3% compared to 28.8% in the first quarter last year. The decrease in the effective tax rate was primarily related to the impact of discrete items on a pre-tax loss in the first quarter of fiscal 2023 as compared to pre-tax income in the first quarter of fiscal 2022.

Net loss for the quarter on a GAAP basis was 11.8 million or $0.24 per share as compared to a GAAP net income of 10.5 million or $0.21 per diluted share in the first quarter last year. Adjusted net loss was 10.1 million or $0.21 per share as compared to last year's adjusted net income of 10.5 million or $0.21 per diluted share. Our adjusted EBITDA decreased at 2.9 million in the first quarter this year compared to 28.2 million in Q1 last year.

Turning to our balance sheet. We ended the quarter with 12.2 million in cash, 185.4 million in total debt and total liquidity, including availability on revolving credit facilities of 94.2 million. Our current leverage ratio is 1.9x. We ended the quarter with consolidated inventory down 10.6% compared to the first quarter last year. The decline was a result of lower freight costs and inventory year-over-year as well as our prudent actions to reduce inventory purchases given the pullback and the customer spending we are experiencing and expect to continue to see given a challenging macro environment.

Capital expenditures were 8.9 million in the first quarter of fiscal 2023 versus 17.6 million in Q1 of fiscal 2022, which reflects the planned pullback of capital spending in fiscal 2023. We are continuing to invest primarily in our stores and technology. Free cash flow in the first quarter of this year was a use of 11.8 million versus a use of 14.4 million in Q1 last year.

Now for our outlook. For the second quarter of fiscal 2023, we expect consolidated net sales to be approximately $205 million to $215 million, driven primarily by a comparable store sales decline in the low to mid 20% range. The expected decline in comparable store sales is reflective of a slower than expected start to the second quarter in terms of customer traffic and average ticket.

The expected consolidated revenue declines are also inclusive of 180 basis point impact for the strategic discontinuation of our C-Studio third party sales and continued Elfa third party sales headwinds. New store sales are expected to partially offset the impact of these headwinds.

We expect adjusted net loss per share in the second quarter to be in the range of $0.10 to $0.00. The implied year-over-year operating margin decline for the second quarter is expected to be more than entirely driven by SG&A due to fixed cost deleverage on lower sales.

From a gross margin perspective, favorable product mix and freight are expected to be moderate tailwinds to gross margin in the second quarter. Interest expense for the second quarter is expected to be approximately 5.1 million, driven by higher interest rates. We expect income tax expense in the range of 1 million to 500,000, primarily driven by discrete tax items in the second quarter. As a result of these discrete items, our effective tax rate is expected to be in the range of negative 20% to positive 75%.

With respect to fiscal 2023, given our first quarter performance and expectation for the second quarter, we now expect consolidated net sales in the range of $875 million to $890 million, driven primarily by comparable store sales declines in the high teen percent range. We continue to expect less significant declines in the comparable store sales in the second half of the fiscal year, driven by our planned cadence of new product introductions, planned campaign cadence and the easing comp comparisons from the prior year.

This outlook also assumes a 70 basis point benefit related to the impact of new stores, inclusive of a partial offset due to the strategic discontinuation of our C-Studio third party sales and continued Elfa third party sales headwinds.

From a gross margin perspective, favorable product mix and freight are expected to be moderate tailwinds to gross margin in fiscal 2023, partially offset by increased promotional activity. Our outlook therefore assumes a gross profit range of 515 million to 525 million.

As a result of the payroll-related workforce reduction actions we took in the first quarter along with a proactive effort to reduce marketing and other costs, our goal is to keep our SG&A expense as a percent of sales at approximately 50% for the full fiscal year.

These actions are expected to reduce overall SG&A expense by approximately 10 million per quarter compared to last year, with the fourth quarter total dollar savings being slightly higher. For the full fiscal year, total SG&A reductions are expected to be almost 45 million when compared to last year.

Our outlook assumes operating margins of approximately 2.5% to 3.1%, or 22 million to 28 million in operating profit. Interest expense for fiscal 2023 is expected to be approximately 20 million driven by higher interest rates. Our effective tax rate is expected to be in the range of 300% to 115%, given an approximate 5.6 million of discrete income tax expense expected to be recorded in the third quarter of fiscal 2023. This discrete tax expense is related to the expiration of certain stock options granted in connection with our initial public offering in 2013.

We expect net loss per share in fiscal 2023 to be in the range of $0.10 to $0.00. After adjusting for the estimated 2.5 million of severance expense previously mentioned as well as the aforementioned 5.6 million discrete tax income expense, we expect adjusted net income per diluted share to be in the range of $0.05 to $0.15.

Capital expenditures are still expected to be approximately 45 million to 50 million. And with this outlook, we still aim to be free cash flow positive in fiscal 2023. Almost half of our planned capital expenditures are related to new stores planned to be open in fiscal 2023 or in fiscal 2024. We are planning to open six new stores primarily in the second half of fiscal 2023 and three stores in fiscal 2024. The remaining capital is related to investment in e-commerce, technology infrastructure and software projects and to a lesser extent, maintenance.

This concludes our prepared remarks. I'll now turn it over to the operator to begin the Q&A session.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question is from Steven Forbes with Guggenheim Securities. Please proceed.

Steven Forbes

Good evening, Satish and Jeff. Hope all is well. I wanted to start with the learnings around promotional activity that you mentioned during the quarter. Just curious if you can maybe expand on what you did in terms of breadth and depth during the quarter and whether you were satisfied or unsatisfied with the customer response? Just trying to get a better understanding of what you're sort of planning for the back half year, because it doesn't seem like you're planning to experience as severe a pressure on the gross margin profile of the business in the back half.

Satish Malhotra

Yes. Hi, Steve. This is Satish. Thanks for the question. Look, as I said in our prepared remarks why we delivered sales in Q1 in line with our expectations, there were definitely some key takeaways. For the quarter, that's worth pointing out. One is around promotions. We found that the right promotion can drive profitable results. As we stated, we experimented with different promotional levers both in duration and percentage off to learn essentially what it would take to engage our customers, given the current economic environment of higher interest rates, while still driving profitable results. So we had much better sales and more profitable success with shorter campaigns that drove a sense of urgency than longer campaigns, and BOGOs did much better than a straight percentage off. So we learned a great deal that will inform our go-forward promotional plans in terms of what it will take to engage our customers. It's also worth noting that the promotions actually serve to help offset any resistance to current pricing and to bring storage and organization top of mind for customers, especially given everything that they're dealing with. I think also worthy to point out is outside of promotions that newness is really working for us. As I mentioned before, we're seeing positive results from the introduction of home fragrances and plant-based cleaners, which actually grew 10% collectively this quarter over the prior quarter, and sales from our refreshed travel assortment and reimagined back to college assortment and our new dropship program are also all doing very well, and bringing in new customers. So that was really an important learning for us as we look to win with our customers is what's the right cadence and mix for promotions? What are they really engaging with as it relates to newness? I think another big learning that we found in Q1 worthy of pointing out as well is the additional challenges that we're facing with some of our traditional storage and organization categories. And we're definitely seeing more than expected declines with the Home Edit, the Marie Kondo and to a lesser extent, declines in the closet storage category. But I think, again, that's all really a function of the current macro environment. And then, just to conclude, with what we kind of learned during Q1, really kind of pleased to see the performance of our premium custom spaces, in particular, Avera and Preston, both doing quite well with operation sales positive of Q1 of last year, which is why we're so excited about the innovation coming out of our Preston line with our new European lining compatible with smart homes and our new mesh door inserts. And to tee it off, look, really pleased with our ability, even in this environment, to deliver exceptional customer service. So when customers do come in, we're able to work hard with them to convert them, and also deliver really strong NPS scores 81 for store, 79 for custom spaces. So all of that kind of I think bodes well in terms of when customers come in where we are able to deliver on our best foot forward.

Steven Forbes

And if I can, just a follow up on that, because I'm just trying to better contextualize in frame the second quarter guidance with the full year, second half guidance, because it almost seems like you're sort of calling for or guiding for an inflection and I know compares get easier. But then you got these sort of learnings right around promotional activity. You have newness, right? You have the holiday time period. And so is that the key message right around sort of the second half outlook, is that the inflection is becoming more visible, whether it's all macro related, but also strategic priority-driven?

Satish Malhotra

Yes, so I believe you categorize it correct. And I'll let Jeff add a little bit more. What I would say is, as we think of particularly on Q2, we definitely saw some softness in July, primarily probably due to peak travel season. So we thought it was prudent to kind of revise our guidance relative to that. Having said that, we've got a ton of new exciting products coming to fruition, like we talked about with Citizenry [indiscernible] that's launching is an ethically sourced home goods from around the world that we think will really bode well with our customers. Plus, we have something really special planned for our customers to celebrate the 75th anniversary of Elfa. So that's one of the reasons we were a bit prudent in respect to our Q2 guide. And as it relates to the back half, as you categorize it quite well, we do have some easier compares as we think about what happened last year, and then with all the newness and excitement that we have planned.

Steven Forbes

Thank you.

Satish Malhotra

Great. Thank you.

Operator

Thank you. Our next question is from Ryan Meyers with Lake Street Capital. Please proceed.

Ryan Meyers

Yes. Hi, guys. Thanks for taking my questions. First one for me just kind of curious if you could comment on and highlight how some of the newer stores are performing?

Satish Malhotra

Yes. Hi, Ryan. How are you?

Ryan Meyers

I'm doing well. Thank you.

Satish Malhotra

Good. Look, relative to our new stores, what I would say is, we continue to attract new customers, the three new stores that we've opened. We see over 60% of customers shopping us are new. We also see a higher degree of penetration as it relates to our custom spaces almost at 37%. And our NPS score across all of them actually are in the mid 80s rather, around 83, 84. So we are seeing great consumer response to the new doors that we're opening. Now having said that, they are still dealing or contending with the current macro and climate. They're not immune to that. But we are generally pleased with what we are seeing across those three stores. As you know, we've got six new stores still planned coming up for fiscal '23 and some really great locations. Half of them are actually built to suit locations. So that really means it helps us on the CapEx front. And we are still very much committed to new store growth expansion and believe we still have a tremendous amount of whitespace, given the current economic climate. However, as we've stated many times before, we will be smart around the doors that we open and particularly ensuring that we keep to our goal of generating positive free cash flow, and we may moderate plans accordingly based on that.

Ryan Meyers

Great, that sounds good. Just one question for me. Thank you.

Satish Malhotra

Okay, great. Thank you.

Operator

Thank you. Our next question is from Kate McShane with Goldman Sachs. Please proceed.

Kate McShane

Hi. Thanks for taking our question. We wondered, Satish, if you had a view on how much of what you're seeing is macro versus a prioritization of dollars by the consumer as they focus potentially on travel and services. It also seems like premium is maybe holding up better than non-premium, both in the custom spaces and in the store. So we wondered if you could talk to that a little bit more as well.

Satish Malhotra

Yes. Hi, Kate. Thank you. It's a great question. Definitely, we're seeing as I stated some resistance as it relates to our ability to win on premium spaces. We are able to contend with the customer and excite them. They are committed to those purchases, and we do well there. Non-premium spaces are seeing a softness in particular with Elfa. Although I would say the last few days, we've actually seen elements of it starting to improve, but still too early to tell. I think largely as we look at our consumers, they are very much distracted, either with travel that's going on right now or with interest rates, and are obviously continuing with a level of uncertainty right now. And the things -- those start to normalize. We do expect a return back. And that's what we are getting geared up for and excited about, given all the newness that we are introducing for the back half.

Kate McShane

Okay. Thank you. And then our follow-up question was just on inventory. I know Jeff noted what it was down in the quarter in the 10% range. We wondered if you could parse out what it was down on a unit basis or by store basis and where you're guiding where inventory should be by the end of the year?

Jeff Miller

Kate, this is Jeff. Thanks for the question on inventory. Inventory is down as I stated in the call a little over 10%. And that's really been driven by freight. From a unit basis perspective, it's relatively flat. So as we continue to move through the year, we expect freight costs to continue to average down. But right now, our current inventory projections are to be down just on a year-over-year basis as a result of the freight cost savings that we're seeing.

Kate McShane

Okay. Thank you. If I could sneak just one more question in, Satish. I don't think you mentioned too much about the loyalty program in your prepared comments. And we just wondered if maybe linked into that this quarter at all with some of the data or anything else to help you with your sales in line with expectations for Q1?

Satish Malhotra

Sure. Hi, Kate. Yes, we do not mention anything in our prepared remarks. But I will tell you that our loyalty program still continues to do well relative to how we have talked about it historically. We see our loyalty baskets still be incredibly higher than our non-loyalty baskets, they're up almost 50%. And we see our experts still spending 4x more than our entry level enthusiasts. So again, as we've stated on prior calls, it's a great level of data that we're able to get out of our loyalty program. We are then able to mine that data and to really understand how best to bring customers along in the journey to get them from one category, for example, kitchen into another category which could be storage, and then the third category which could be into custom spaces. So all of that great work is commencing here at The Container Store and still very proud of how our loyalty program is performing.

Kate McShane

Thank you.

Operator

Thank you. As there are no further questions, this concludes today's teleconference. Thank you for your participation. You may now disconnect your lines.