The Container Store Group, Inc. (NYSE:TCS) Q4 2022 Earnings Call Transcript May 16, 2023

The Container Store Group, Inc. beats earnings expectations. Reported EPS is $0.46, expectations were $0.16.

Operator: Greetings and welcome to The Container Store Fourth Quarter 2022 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 of Investor Relations. Thank you. You may begin.

Caitlin Churchill: Good afternoon, everyone, and thanks for joining us today for The Container Store’s fourth quarter and fiscal year 2022 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 June 2nd, 2022, as updated by our quarterly reports on Form 10-Q and other public filings with the US 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’ll begin today’s discussion by reviewing highlights from our fourth quarter performance and the great progress we made in fiscal 2022 against our strategic initiatives, before discussing our current views and plans for 2023. Jeff will then review the details of our fourth quarter financial results, followed by our outlook. We will then open up the call to questions. Excluding the impact of non-cash impairment of goodwill, we delivered results for the quarter in line with our expectations. This included the anticipated decline in general merchandise and Elfa Custom Space sales as a result of slower traffic and customers purchasing fewer spaces.

As a reminder, we were up against a tough comparison given our decision to not anniversary a very successful 2/22/2022 event from last year. Along with the strategic discontinuation of our Closet Works wholesale business. Given these factors and the ongoing challenging macroeconomic environment, fourth quarter consolidated net sales declined 15% and adjusted earnings per diluted share was $0.18 compared to $0.46 in the prior year. During the fourth quarter and throughout fiscal 2022, despite the backdrop, we maintained a strong focus on executing our strategic initiatives of deepening our relationship with customers, expanding our reach and strengthening our capabilities. The following accomplishments would not have been possible without the unwavering support from our teams and their efforts allowed us to plant numerous seeds for future growth.

In fiscal 2022, we launched multiple new large scale programs to improve our product offering and customer experience. Five noteworthy accomplishments I want to discuss today include launching The Container Store Custom Spaces Branding and Preston Product Offering, introducing new product categories to give customers a compelling reason to shop, significantly improving our e-commerce experience, relaunching our Loyalty program and opening new small format stores in key markets. During the year, we introduced new branding custom spaces to move our offering beyond closets to key areas of the home, including closets, living and garage spaces. In addition, we brought to market a newest premium wood based line Preston. We added a minimum of two Preston displays to all stores in our custom space studio and created a new destination on our website for customers to find inspiration and to connect with our newly established in-home design specialist.

During fiscal 2022, we had an average of 95 in-home design specialists who sold $75 million in total sales with more than a quarter of them selling over $1 million each in custom spaces. We began refining our general merchandise assortment to not only drive profitability, but also to make room for new products that complement our core storage and organization solutions. We successfully launched several new categories to further entice customers and we’re pleased with their performance thus far. These categories include home fragrances, sustainable cleaners and our new private label, Everything Organized Collection, which features patent pending designs. Also, we are very proud to have recently been named to Forbes’ Customer Experience All-Stars list, which we believe is a testament to our strong retail net promoter score of 80 in Q4.

To create a flagship experience across our brand touchpoints, we significantly improved our e-commerce platforms. During the year, we enhanced our BOPIS experience, which recently drove a record level BOPIS Net Promoter score of 72 and we rolled out Express Checkout to all stores, which now accounts for 20% of all store transactions. We’re also pleased with the response to our mobile app as we’ve seen over 450,000 1st time downloads and a 4.8 star rating in the Apple App Store. Additionally, we improved the functionality and design of our website, including over 40% faster page speeds, timely customer communications and a redesign of our navigation and is now easier than ever to search, shop and check out online or to connect with an in-home custom space designer.

Regarding our Loyalty program, we launched Organized Insider this past year to not only attract new customers, but also to reward a deeper level of engagement with existing customers. The new Loyalty program has been well received and accounted for nearly 80% of total sales in fiscal 2022 and a 57% higher average ticket than non-Loyalty members. During the fiscal year, we enrolled nearly 900,000 new members to our program and with our new Vice President of Loyalty in place we’re looking forward to continuing to refine our program to further increase customer engagement. Finally, we are pleased to have opened three new small format stores this past year in Colorado Springs, Colorado, Salem, New Hampshire and Thousand Oaks, California. We are encouraged by the customer response to our new small format stores, as illustrated by our strong NPS scores, which recently for the month of April averaged 87 across all three, which gives us continued confidence in our long-term store expansion goals.

As we look to fiscal 2023, we expect it to be a tough year considering the intensified macroeconomic headwinds which are driving reduced traffic and lower average tickets. Despite this backdrop, we remain committed to investing in our long-term growth prospects while still proactively managing our cost structure. We believe the actions we are taking position us well to deliver on our goal of low double-digit operating margins when the macroeconomic environment improves. As we continue to focus on gaining market share in spaces over $2,000, which is an important enabler of our path to $2 billion in revenue, we aim to bring better awareness to our new custom space branding and provide a whole home solution to our customers. We plan to increase the number of in-home designers to 150 this year with design training focused on selling premium spaces.

In addition, we plan to build on the success Preston is having and we have product enhancements planned for the year, including premium in draw and toe kick lighting, mirrored glass, aluminium frame doors, slim shaker profiles and new on trend colors like night sky blue and lakeshore green. This year, our custom space campaigns are expected to not focus on an individual line, but afford customers discount on any of our three lines. Elfa, Avera or Preston and are plan to be evenly spaced throughout the year. We also are working to create a custom spaces portal for customers to review their design, sign their purchase agreement, manage their payment and track the status of the custom space life cycle from inspiration to installation. We are also exploring the ability for customers to experience their design space through virtual reality technology so they can visualize and interact with their space, making their purchasing decision easier.

VR technology also enables us to showcase custom space finishes and accessories that we may not carry in every store. And we intend to start piloting this in late fall. As we look at general merchandise under the leadership of our new Chief Merchant, we are focused on continuing to refine our assortment in a manner that best aligns with our customers shopping journey and has the most potential for growth, including college, travel, dining and entertaining and home decor. We strategically started our college campaign earlier this year to align with parent and student prep timelines, and we’re thrilled to offer new college essentials like a single serve coffee maker, sleek desk lamps, vintage fans and essential oil diffusers. For the second year, we are partnering with Dormify the online destination for dorm decor.

The partnership is expected to expand this year with five of our stores in key college markets featuring Dormify pop-up shops with selections of on trend mix and match bedding and more. We’re also excited about the ability to dropship Dormify products from our website beginning in Q1. The benefit of dropship allows us to expand our assortment without having to carry additional inventory and we intend to expand this capability with additional vendors quickly thereafter. With regard to new product, we anticipate introducing nearly 1000 new SKUs this year from innovative brands such as Cadence and Canopy, both of which are entering brick and mortar stores for the very first time. The Cadence travel system will be exclusive to us and features customizable, magnetic and leakproof capsules to store personal care products in.

As part of our college assortment, the Canopy humidifier features no-mist technology, which is free from bacteria and particles, creating an optimized environment for beauty and wellness. These products will bring notable newness to The Container Store and we are proud to partner with and help grow these innovative brands that have demonstrated success selling directly to customers. While we intend to continue focusing on our core offering of storage and organization, we are excited for this newness we are infusing into our assortment and we intend to embark on a new campaign to demonstrate to customers how our curated, innovative and solution oriented products can help transform their lives. We tend to strengthen our e-commerce presence with a focus on expanded content and storytelling, introducing new ways to shop and enhancing our custom space and mobile app experience.

Our content aims to highlight what makes products unique and encompasses more videos across our product detail pages. New ways to shop online include a college shop with a frictionless one click experience so students or parents can add curated and bundled dorm essentials to their cart with ease. In addition, we’re working on a new arrivals online experience where customers can see and shop the amazing new products we’re offering and we anticipate launching this soon. Taking customer feedback into account, we plan to consolidate orders, so they are receiving fewer boxes and provide new ways to make appointments with our in-home designers throughout the site. Regarding new stores, we expect to open six new stores during fiscal 2023 versus our original expectation of nine stores due to delayed timelines given the current environment.

The three stores that were originally slated for the end of the fourth quarter of fiscal 2023 are now expected to open in early fiscal 2024. We still believe there is substantial white space and a path to open at least 76 new stores over time. We expect and are planning for the challenging macro headwinds to continue for the entirety of this fiscal year, with sales decline being more pronounced in the first half while still negative than the second half. We are cognizant of the importance of cost management and are continuing to evaluate all areas of our business to ensure an efficient cost structure to position us well to deliver our long-term goal of low double-digit operating margins. We are prioritizing investments in the areas of the business that have continued to drive strong productivity while also investing in our strategic initiatives, which we believe will position us well to gain market share when the macro environment improves.

With that said, we made the very difficult decision to take immediate cost management action, including elimination of open roles and a reduction of force of approximately 15% at our support center and less than 3% at our store and distribution center operations. These actions are intended to keep our SG&A expenses just below 50% of consolidated sales in fiscal 2023. Despite these difficult decisions, we have a solid foundation and the right teams in place to make progress towards our long-term goal of $2 billion in sales and low double-digit operating margins. With that, I’ll hand it over to Jeff to discuss our results and outlook in more detail. Jeff?

Jeff Miller: Thank you, Satish, and good afternoon, everyone. As Satish reviewed, after excluding the impact of goodwill impairment, we delivered fourth quarter results in line with our expectations despite the challenging macro environment and unique sales headwinds we faced due to not anniversary our 2/22/2022 event from last year and the discontinuation of the Closet Works wholesale business. Consolidated net sales decreased 15% year-over-year to $259.7 million, including a 430 basis points negative impact from the unique sales headwinds I just mentioned. By segment, net sales for The Container Store retail business were $245.5 million or 14.3% decrease compared to $286.5 million last year. The decrease is inclusive of a comp store sales decrease of 13.1%, driven by the 14.2% decline in our general merchandise categories, which negatively impacted comp store sales by 870 basis points.

Custom spaces comp store sales declined 11.4% compared to fiscal 2021 and negatively impacted comp store sales by 440 basis points. The discontinuation of the Closet Works wholesale business in fiscal 2022, partially offset by sales from new stores made up the remaining 120 basis points to the total 14.3% TCS net sales decline year-over-year. For the fourth quarter of fiscal 2022, our online channel decreased 6.2% year-over-year, and our website-generated sales, which includes curbside pickup, decreased 8.3% compared to last year. Website-generated sales represented a total of 24% of TCS net sales in Q4 compared to 22.4% in Q4 last year. Unearned revenue decreased to $15.7 million in Q4 this year versus $22.6 million last year driven by the pullback in customer spending that we are experiencing.

Elfa third-party net sales of $14.2 million decreased 25.3% compared to the fourth quarter of fiscal 2021. Excluding the impact of foreign currency translation, Elfa third-party net sales decreased 17% year-over-year primarily due to a decline in sales in the Nordic markets and Russia. From a profitability standpoint, our consolidated gross margin for Q4 increased 190 basis points to 58.9% compared to 57% last year. By segment, TCS gross margin increased 50 basis points compared to last year, primarily due to decreased freight costs and favorable product and services mix, partially offset by a more promotional discounting. Elfa gross margin increased 200 basis points compared to last year, primarily due to price increases, partially offset by higher direct material costs.

Consolidated SG&A dollars decreased to $124.3 million compared to $127.1 million in Q4 last year. As a percentage of sales, SG&A increased 630 basis points year-over-year to 47.9%. The increase is primarily due to the deleverage of compensation and benefits, occupancy and other costs on lower sales. During the fourth quarter, we conducted impairment tests of goodwill and indefinite-lived intangible assets and determined there was a total noncash impairment of goodwill in the amount of $197.7 million. Our net interest expense in the fourth quarter of fiscal 2022 increased to $4.8 million compared to $3.2 million last year. The year-over-year increase is due to a higher interest rate on our term loan and interest on borrowings on the revolving credit facility.

The effective tax rate for the quarter was negative 1.7% compared to 31.5% in the fourth quarter last year. The decrease in the effective tax rate is primarily related to impairment charges taken during the fourth quarter, which negatively impacted the effective tax rate by 292 basis points. Net loss for the quarter on a GAAP basis, inclusive of the $197.7 million goodwill impairment charge, was $189.2 million or $3.85 per diluted share as compared to GAAP net income of $23.2 million or $0.46 per diluted share in the fourth quarter of last year. Adjusted net income was $8.8 million or $0.18 per diluted share as compared to last year’s adjusted net income of $23.2 million or $0.46 per diluted share. Our adjusted EBITDA decreased to $29.2 million in the fourth quarter this year compared to $46.4 million in Q4 last year.

With respect to the full year, consolidated net sales declined 4.3% to $1.05 billion and GAAP net loss was $158.9 million or $3.21 per diluted share. Adjusted net income was $37.2 million or $0.75 per diluted share. Turning to our balance sheet. We ended the quarter with $7 million in cash, $167.9 million of total debt and total liquidity, including availability on our revolving credit facilities of $107 million. Our current leverage ratio is 1.4 times. We ended the quarter with consolidated inventory down 11.5% compared to the fourth quarter last year. The decline is the result of our prudent actions to reduce inventory purchases given the pullback in customer spending we are experiencing and expect to continue to see given the challenging macro environment as well as lower freight costs.

Capital expenditures were $64.2 million in fiscal 2022 versus $33.4 million in fiscal 2021, with the increase related primarily to investments in our stores and technology. Free cash flow this year was a use of $4.9 million versus $23.6 million generated last year. Now for our outlook. For the first quarter of fiscal 2023, we expect consolidated net sales to be approximately $200 million to $210 million, driven primarily by a comparable store sales decline in the 23% to 19% range. The expected consolidated revenue declines were also inclusive of a 250 basis point impact for the strategic discontinuation of our Closet Works wholesale business and, to a lesser extent, continued Elfa third-party sales headwinds. New store sales are expected to partially offset the impact of these headwinds.

We expect net loss per diluted share in the first quarter to be in the range of $0.19 to $0.13. After adjusting for an estimated $2 million of severance expense associated with the previously mentioned reductions in force, we expect adjusted net loss per diluted share to be in the range of $0.16 to $0.10. The implied year-over-year operating margin decline for the first quarter is expected to be more than entirely driven by SG&A expense 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 first quarter. Interest expense for the first quarter is expected to be approximately $5 million, driven by higher interest rates and our effective tax rate is expected to be approximately 30%.

With respect to fiscal 2023, we expect consolidated net sales in the range of $885 million to $900 million, driven primarily by comparable store sales declines in the mid to high teens. We expect more significant declines in comparable store sales in the first half of the fiscal year than the second half. This outlook also assumes a 100 basis point benefit related to the impact of new stores, inclusive of a partial offset due to the strategic discontinuation of our Closet Works wholesale business 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 a more promotional environment. Our outlook, therefore, assumes a gross profit range of $525 million to $540 million.

In an effort to minimize SG&A expense deleverage in this difficult macro environment, we made the decision to take immediate and proactive measures to reduce costs while still investing in our strategic initiatives. Our proactive cost reducing actions include the previously mentioned elimination of our support center open roles and an almost 15% reduction in force at our support center. Furthermore, there is a planned reduction in force at our store and distribution center operations by less than 3% and reduced scheduled hours in line with current customer trends. In addition to payroll-related actions, we are proactively reducing marketing and other costs with the goal of keeping our SG&A expense as a percent of sales slightly below 50% for the full fiscal year.

The total dollar impact of these actions on a quarterly basis 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 4% or $32 million to $40 million in operating profit. We expect net income per diluted share in fiscal 2023 to be in the range of $0.07 to $0.17. After adjusting for the estimated $2 million of severance expense previously mentioned as well as an approximate $5.6 million of discrete income tax expense expected to be recorded in the third quarter of fiscal 2023 related to the expiration of certain stock options granted in connection with our initial public offering in 2013.

We expect adjusted net income per diluted share to be in the range of $0.21 to $0.31. Capital expenditures are expected to be approximately $45 million to $50 million. And with this outlook, we 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 opened in fiscal 2023 or the first quarter of 2024. We had previously communicated plans to open nine stores in fiscal 2023 as a result of delayed time lines due to the current environment, we now plan to open six stores primarily in the second half of fiscal 2023 and three new stores in the first quarter of fiscal 2024. The remaining capital is related to investment in e-commerce, technology infrastructure and software projects and, to a lesser extent, maintenance.

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 60% to 75%, which is inclusive of the previously mentioned discrete income tax expense expected to be recorded in the third quarter of fiscal 2023. We remain committed to delivering on our long-term goal of $2 billion in sales and low double-digit operating margins. Though the duration of the current macro headwinds has impacted our originally contemplated time line for achieving these goals. This concludes our prepared remarks. I’ll now turn it over to the operator to begin the Q&A session.

Q&A Session

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

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

Operator: Thank you. [Operator Instructions] Our next question comes from Kate McShane with Goldman Sachs. Please proceed with your question.

Operator: Thank you. Our next question is from Chris Horvers with JPMorgan. Please proceed with your question.

Operator: Thank you. There are no further questions at this time. I would like to turn the floor back over to CEO, Satish Malhotra for closing comments.

Satish Malhotra: Yeah. I just wanted to say, once again, thank you for joining us today and wish you a very good night.

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