The Container Store Group, Inc. (TCS) Earnings Call Transcript & Summary

Everyone, I'm Michael Lasser, the hardline, broad line and food retail analyst from UBS. We are super excited to have The Container Store with us today. To my left is, Jodi Taylor, who serves as the company's Chief Financial and Administrative Officer. She's been the CFO since December 2007, and she's been a Chief Administrative Officer since 2016.

So I'm going to start with your recent results, which you showed a lot of progress in a lot of different areas, in particular, your Custom Closets business, was very strong. Maybe some of the other categories didn't live up to what the Custom Closets business did. Can you discuss the Custom Closets performance? And then how did the holiday season influence some of the other categories?

Sure. Hello, everybody. Thank you, Michael. For us, Custom Closets is our #1 strategic focus, and this is an estimated $6 billion market opportunity. And even though it's about half of our sales on a consolidated basis, we still have a small piece of this great market opportunity. So it's a very important part of our business and a key strategic focus for us. We've actually seen 440 basis points of comp contribution come from Custom Closets when you look at the year-to-date through Q3. Overall for Q3, that we reported last month, we were pleased that the quarter kind of played out as we expected. We came in with a 3 comp, despite some holiday weakness that I can speak to. Custom Closets, for us, again, we have 4 distinct lines. We added a new line in April of last year called Avera, and we really feel like we've got this unique market position where we've got the most robust assortment in the marketplace with all the completion products and really considered any style, any budget, any demographic that a customer is looking to achieve. And we combine that with some really great service attributes where we can go in home, in store with great design tools, well-trained professional teams, and we can also install it for you. So a unique situation for us that we're really catalyzing on and seeing some good results come from. Do you want me to talk about the holidays?

Yes. Yes, it seemed like closets is doing really well. Non-closets business, not as well. So give us a sense for where the challenges came in? How much of it was related to the holiday and just some challenges we heard about the holiday of 2019 more broadly? And how is it in forming your plan for next year?

Yes. For us, holidays, I think it's important to keep them in perspective. It's a category that we play in. And our 3 holiday departments, we've made the decision in Q3 to focus more on everyday storage and organizational solutions that do sell well, including Custom Closets, and to deemphasize the holiday categories. So again, overall, 3 comp. Holiday categories were down 12%, and they drove a negative 2 comp contribution. So had they been flat, comps would have been 2 points higher. The rest of the general merchandise outside of the holiday departments was actually up because overall, outside of Custom Closets, we had a negative 120 basis points of comp contribution. So really kind of played out as we expected. Again, sizing it for us, the holiday departments are only, on an annual basis, less than 4% of our total sales. Q3, though, they are about 13%. So it's a bigger story for us. It's still something we intend to play in going forward. But we approach the season more conservatively from a buy perspective, from an investment perspective in terms of setups. I would expect as we pivot to next year, to your last part of your question, that we would do the same. We have put in place some fresh perspective from the buying team in terms of a new buyer. So we're going to make sure the assortment of what we do offer will be fresh, but we will continue, I think, to approach it with conservative next year.

And just for those who are a little newer to the story, so you have closets business, self-explanatory. Then you have non-closets and then the holiday business. Can you give us more description about what the holiday assortment looks like? And then what the non-closets, non-holiday assortment looks like?

Absolutely. I mean the non-closet business is largely complementary products that you could put into a custom space, be it your closet, be it your pantry, be it your office, et cetera. So less products that are unique for us, oftentimes exclusive or private label, that will complement any space in the home to make it more organized. During the holidays, we have what we call a holiday shop, and it includes gift packaging for the holidays as well as stocking stuffers. Stocking stuffers are often those clever gadgets that we have in our stores, many of which are on an everyday basis, but we will bring in things specifically for the holidays, and we do a beautiful job of moving through all of those, and they're out of our stores by right after the holidays. So we sell-through a great portion of them before we ever get to December 26. And then when we reopen our stores December 26, we sell-through the rest of it very, very quickly. It's really the only time we have seasonal products. The rest of the year, we're very much a "non-fashion everything selling sort of retailer" that actually go in our distribution center. I'm most fascinated by the fact that every single product in our DC, even though we have over 10,000 items, is actually touched every week. We don't have a lot of slow sellers. It's all a good assortment.

What's the competitive landscape look like today? Has it become more challenging over the last 9 months?

For us, it's just -- it has not changed much. It's been quite steady. So there's nothing new to call out. Nothing specific that we factored into our expectations.

And when you think about your biggest competitors, who would they be?

It's really everyone, if you kind of think...

And we know everyone pales in comparison to The Container Store, but if you had competitors?

Yes. I mean in the closet space specifically, the #1 competitor -- it's very, very fragmented, the #1 competitor is actually homebuilders. So if you think about -- if you're doing a new home or you're doing a remodel, which is generally when you start thinking about doing a big closet, most folks will go to their builder and have them do it. So our efforts that you may want to talk about a little bit later around B2B and trade are important in trying to get in on the front end with that. Whereas, right now, the majority of our business is direct to a consumer, either working in store, in home with them. The rest of the products vary. So kitchen storage, for example, you can find kitchen storage everywhere. What's key for us is it's going to always be a much, much, much narrower assortment. We focus on getting exclusives because of the volume we can sell per store. We focus on private label, consumers perceive our private label to be at the very highest quality, which is a unique niche for us to have. And then we will always have service levels that are beyond what most companies you go into we're going to have.

You mentioned that the overall competitive environment is stable. How have you factored that into your upcoming quarter? Do you assume that will continue to be the case?

Yes, we have. We've assumed no significant changes.

And 2019 was a year of investment for The Container Store between some marketing and new distribution center. Can you tell us a bit more about the benefits that you're experiencing and the -- and how this has shaped your point for future investments from here?

There's 2 areas that we've invested in this year. One is marketing. As we launched Avera, the fourth closets, the one I spoke to, in April of last year, we felt like we had a really big opportunity to go even more aggressively after that estimated $6 billion market opportunity and to try to better connect The Container Store to Custom Closets. Because, again, our penetration in that is still small in comparison to the opportunity. So we've invested $5 million incrementally in marketing, all of which is devoted to Custom Closets. Additionally, for 41 years, we've operated out of a single distribution center in Dallas, Texas. And with the size company that we are at this point, we really couldn't see some significant benefits to come from having another facility. So we opened in -- just recently in Aberdeen, Maryland, a second facility. This year to do the setup associated with that and all of the -- bringing it online, there's about $6 million of net cost associated with that or $0.09 a share that's hitting. However, we do expect to see significant benefits as we move forward into next year. And as importantly, we've significantly improved our customer service because the typical direct-to-customer line order is going to take about half of the time to get to a customer from when it leaves our distribution center with now having 2 distribution points.

And as you made these investments, have you expanded your addressable market because you can touch more spectrums of what's in demand, the higher end, you've always been the more matched products, but now you can service those who are looking for more sophisticated solutions?

Absolutely. I feel like the addition of the product line that I spoke of, Avera, really complemented, fully online and gave us the opportunity to really fill a niche that we thought was a bit of a void in our assortment, kind of in that mid-tier solution for our customers. So our full lines now for Custom Closets, we have Elfa Classic, Elfa Décor, which is adding wood elements to decor steel system, and we have Avera, the new line, which is kind of a mid-tier solution that's largely with wood elements and then we've got Laren, which is our most customized, highest end product that we've got.

And can you give us a sense of your customer base? You have a loyalty program, the top loyalty program. So you should have a really good appreciation for who your core customer is? Who your part-time or more incremental customer is? And where are you seeing the most success?

So we do have a loyalty program called POP!, Perfectly Organized Perks, and we continue to see good growth of enrollment in that program so that we ended with over 8.3 million folks involved at the end of Q3. It is, and it's still...

It's a lot. You have well-organized people...

Very much so, and they love to be POP! Star, that's what we call it when we've joined the program, which is kind of fun to get people and that gets you excited. But it gives us an ability that we did not previously have to really be very, very thoughtful and targeted in how we communicate to the consumers. So our customers, whether it be text, e-mail or whatever it is that's best to get to them, we have a lot of information about them and we try to use that data smart. We've been investing in the POP! program. We have a team of data scientists to try to make sure we're mining that data as soon as we came in. We're also investing in third-party AI, machine learning services to try to really make sure we're optimizing that opportunity. And it does tell us a lot about who's shopping across our store, and we've definitely seen over -- particularly some of the other efforts around marketing with some of our influencer and brand ambassador programs. We've seen even more broadening of the customer spectrum in our database, which is exciting to see.

What is the typical container store customer look like? And how will that might evolve? Maybe you'll see more sell-side analysts who could use some organizational help?

Well, it's still more female than male, but we have a lot of males certainly shopping in our stores particularly in areas like garage. And certainly, males get involved when we start talking about Custom Closets to a large degree. It is going to be generally a more highly educated consumer, generally going to be more affluent, generally a homeowner. So there's some key qualities that we see consistently. What we are seeing is through some of our efforts with, again, through the brand ambassadors, influencers, we are seeing more millennial customers coming in, generally successful professional millennials that are coming in and really becoming big brand ambassadors as well. Our brand tends to be -- our customers tend to be very social, and our brand tends to resonate very, very well in digital channels and social media, which I think has been part of why we've been able to do that.

And the another area that seems to be somewhat incremental is the B2B space and the trade space. Can you give us a sense of what's been happening there, particularly over the last year as the company has focused on that more aggressively?

Yes. It is a big opportunity, like I spoke to, to be able to get in on the front end to the homebuilders and to the designers, interior designers and architects, is something we've not really focused heavily on previously. It's mostly been direct with the consumer that we worked through in our stores and in home. It's -- combined, those 2 areas are less than 5% of sales. We'd had a consultant to help us to size just the B2B opportunity and then maturity, we think that's $100 million that we can add to the company. So it's a good opportunity. It's one also that really very much aligns with Custom Closets because the majority of what we sell in either of those programs is largely our Elfa product, which is great because as you may or may not know, we own Elfa. We've owned it since 1999. It's our highest margin product, and it's 28% last year of our retail sales. So it's very important to the foundation of our business.

And who would you look to displace in this market? Presumably, it's a lot of small players. And so it's kind of one at a time? And do you have to build an organization to support that? And what does that organization look like?

I would say that it's, going back to Custom Closets, it would be largely, again, the homebuilder, the local very fragmented builder community would be what you'd hope to displace and get in on the front end so that it's easier for a customer to have that perfect closet. It is a little bit of a different selling approach for B2B. Trade is largely selling in our stores and in home, very similar to what we do, but it's marketed a bit differently through trade shows, and so we started to do more of that. Same with B2B, if I get to the right connections and it is a different sales force, those are largely people that are well connected into the builder communities, the hospitality communities, for example, we have a relationship right now with Marriott and they put Elfa products into many of their Fairfield Inn. So that's just a sampling of examples of things we think we can continue to nurture and grow.

And do you have specific people that are out developing those relationships? What -- how big is that organization? How many people do you have? And is that an area of growth where you could hire more of those people?

It is, and we're trying to just be cautious about how we approach it. We don't want to get too far ahead on it. We do have a team right now devoted to it. I'm not sure of the exact count, but there are folks involved in the fields that are involved in just doing B2B sales, even a different compensation model than what we currently do in our stores. The trade program, though, again, largely comes through our stores and -- or, again, through an in-home designer that's going into your home, a free service we offer. And what we do in those cases is if you are certified architect or certified professional organizer or certified interior designer, like any retailers, you're able to get a modest discount on product that you can either take yourself or pass along to your customer. But we think that's fundamental to as you're doing, say, a remodel project, a lot of folks in our echelon of income will utilize a third party, and we'll rely upon the recommendations they make. So being on that front-end could be good.

Yes. It seems like there are a number of different growth avenues for the company, one of which will be the online business. Where is online penetration today for The Container Store? And how big is there an opportunity to expand that?

Well, today, it's about 15% of our total sales at retail...

1-5?

1-5. 1-5 sorry , and it is growing at a greater rate than the overall business. It's grown year-to-date, up about 23%. So I think it'll continue to outpace the rate of sales of the rest of the business because we just have still so much opportunity. But going back to the strategic focus around Custom Closets, even though we provide great digital tools for customers to design their own closets. Most customers that are spending the level that these closets run, typically, would still like to have somebody that comes in home or to the store with them to assist them with redoing their design or creating new design for them before it actually gets executed. So how much of that can actually fully translate to online? We don't think we're a retailer that probably even half ourselves is online. That said, we want to make sure many customers start their journey online. So we want to make sure that we have a very robust website, and we'll continue to invest in that.

And you have made some changes and tweaks to your shipping offers. What are your plans to continue to offer free shipping? And are you planning to permanently move to a $49 threshold as it appears that it's been pretty successful?

Yes. We've been doing throughout 2019 tests of a $49 ship threshold versus $75, and over the holidays, had a period where that was all we fully posted for several weeks for all consumers that were coming to our website. We saw that our -- we have stability around our average ticket and our profitability, which was good to see. So we'll continue to be testing on this just as we have been. Right now, we're not thinking we'll go to it every day, but we're more impulsive in what makes sense, perhaps even with just our pulse -- our POP! Star, so that it's a benefit that people can get on an occasional versus a regular basis.

And how does that change the profitability of the online business when you lower the threshold? Can you still make a pretty healthy margin on those products?

We have seen consistent profitability. So that's -- we've made it up through volume.

And how does the profitability of the online business compare to the store business?

For us, it's quite good. We're generally seeing the average tickets well enough above the free shipping threshold to where it's still a good profitable business for us.

Yes. And you recently opened a new store in the Dallas Galleria that focuses on your Custom Closets, similar to your Farmer's Market stores. So can you just describe both of those? And what those concepts are all about?

Yes, we took 2 of our existing stores, first Farmer's Market in L.A. and then the Galleria store in Dallas. These are both stores that are just under 20,000 square feet, and we have literally changed the name on the front of the store to say The Container Store Custom Closets, so that we're better connecting Custom Closets and are powerful brand, The Container Store. We did these in these stores really to gain key learnings, not because we ultimately think that a more focused Custom Closet store, which is what it is it has more displays of Custom Closets and the complementary products. We think that there's a tremendous amount of learnings we can use that we can then apply to an even smaller footprint, more closet-focused locations. So that's the ultimate learnings we hope to glean from it is a lot in terms of supply chain and selling aspects of it. And so far, we are definitely seeing that.