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

Good afternoon. I'm Kate McShane. I am the Hardlines, Broadlines and Grocery analyst here at Goldman Sachs. We are here at Goldman Sachs 28th Annual Global Retailing Conference. And it's my pleasure to introduce the members of the management team for The Container Store. The Container Store is the country's leading specialty retailer of storage and organization products and solutions and custom closets. It has over 90 locations nationwide, offering a full suite of custom closets with annual revenue of slightly lower than $1 billion. Today, we have with us Satish Malhotra, President and Chief Executive Officer of The Container Store. Satish joined TCS in February 2021 as the CEO and President, and brings over 20 years of experience, holding various leadership roles at Sephora. And we also have with us Jeff Miller, Chief Financial Officer. He joined the company in 2013 and has been in the current role since August 2020. Satish and Jeff, thank you so much for joining us today.

Absolutely. Thank you for having us.

Thank you.

So you've been about -- you've been CEO now about 8 months, I believe. And you came in at a pretty interesting time given that we were in the midst of a global pandemic. So in addition to learning a new business and company, you also had to steer our company during a time of a lot of uncertainty. So I wondered if you could maybe take a step back and walk us through, what about The Container Store intrigued you enough to take this job? And then from there, can you walk us through how you're approaching running the business for the near term versus implementing new strategies to position the business for the long term?

Sure, absolutely. Thank you for the question. I think what I would say first and foremost is, as I was doing my due diligence about The Container Store, I really fell in love with the culture, the strong culture that The Container Store had to offer. And as I was going through both our online and in-store experience, I really thought there was a really fantastic bones The Container Store will have to offer the consumer market. And I felt with my experience, I could really come in and help take it to the next level. And so since joining in February, I really spent a consumable amount of time with teams across the organization, really trying to understand the core strengths and where those opportunities lied. Yet we even conducted a survey with our loyal customers asking them why they love The Container Store. And through my many conversations, I walked away with that kind of 3 key observations where I felt that by focusing on them and working on them, we can then really take The Container Store to that next level. One of the key observations was I felt that the product offering we are delivering to our customers was very fragmented, right? TCS, as you said earlier on, has built in a unique position as the authority in providing storage and organizations through its Custom Closets line and in-home organization services as well as the extensive general merchandise assortment, but these 3 offerings were treated as a separate distinct almost siloed customer journeys. They weren't ever connected together holistically for the customer. We didn't make it easy for the customer to understand the benefits of each offering and how they complemented that entire experience. I found that while we had over 10 million loyalty members, the vast majority of them never purchased a custom closet, they were only general merchandise customers. They never got to experience the transformation of a custom-designed space. nor do they get the benefit from the help of an in-home organizer like I have. And I think it's very transformational when you get to experience all three and our ability to deliver that now to the customer in a cohesive manner in a unique ecosystem that sets ourselves for success in driving great market share in a very sizable addressable market of over $20 billion. The second observation I had as I was speaking to our most loyal customers was that there was an overwhelming need for organization, right? Our most loyal customers, they really understood those meaningful benefits that they got to realize on a daily basis. It's almost they were awakened to the power of organization, that organization increased their sense of well-being. And customers felt that by decluttering, they could also de-stress, right? Some even sort of boosting productivity. All they saw an improvement in their relationships, like I do on a regular basis now with my wife and my kids in this new way of life that we're living. What I was fortunate to find though all of these customers saw The Container Store has their happy place, where they could find everything they needed to contain the chaos of everyday living. And listening to these customers, I realized that we needed to evolve our approach, our mission, so to speak, and to help educate new customers to the main benefits of organization just like we're seeing with our collaborations with The Home Edit and Marie Kondo today. So now as a mission-led company, we're working to create a movement to take more of an amplified approach in helping customers transform their lives through the power of organization, which, by the way, is our new internal brand purpose now. We believe, I believe that everyone can benefit from organization from childhood to late adulthood. I've just helped my father who's 81 and living with us, helping organize his space, in particular, his regimen that he has for his pills and it's really made a huge difference in his ability to feeling control and be able to take care of himself. And there were many days he was missing taking his pills, or taking the wrong pills. And by organizing his cabinet, it really made a remarkable difference. And that's what we can do across the gamut. The last observation I had was that TCS really had good strong strength and capability to deliver meaningful growth. Our employees, when you speak to them, they're very eager and passionate about making TCS the best version of itself. And we weathered 2020 extremely well right, strengthening our financial position through prudent expense management and debt reduction. We also have the added advantage of owning Elfa International who manufacture our Elfa Classic, Décor and Avera closet lines, which, in some cases, maybe unusual for a retailer to be vertically integrated, but it's proven to be a competitive advantage for us because we get to benefit from both the manufacturing and retail margins here. And I found when I was talking to our employees, whether in the U.S. or in Sweden, that all of them were ready for the challenge of doubling our business all while delivering those enriching benefits of organization to our customers. So the observations essentially served as the foundation layer for our 3 strategic pillars, which aim at delivering to meaningful growth over the coming years. Our first pillar is focused on deepening our relationship with our current customers, but we believe we can gain even greater share of wallet with them. And we're seeing it just in our past activities over the past few months, we have become far more purposeful of introducing Custom Closets now to our general merchandise only customers. In fact, the last 2 Custom Closet events, it was extremely rewarding to see a healthy number of these customers move over and become Custom Closet customers as well. And so finally, we've been able to put the bridge and help the general merchandise customers appreciate and understand the value associated with having a custom space design installed for them. We've also recently added greeters and selling specialists to our stores. And that was funded by nonselling payroll. We had a lot of payroll going towards nonselling activity and by optimizing the backup office, we're able to take that payroll and put it where our customers were. And we're already seeing higher average tickets. We're seeing much greater and improved Net Promoter Scores because of these changes. And very soon, we'll be adding specialists within specific zones of our stores to really help further engage and assist with our customers. And then finally, I would tell you under Pillar 1, it's around creating more of a discovery moments in our store. I really believe in the importance of having these discovery moments, having an opportunity for customers to really engage with products that we have in our stores or online. And we're doing that through new visuals. If you go into our stores, you'll see more consumer, user-generated testimonials and before and after pictures that really do a great job storytelling, the power of what we have to offer. And you'll see it in our front of store presentation. We have 1 right now for Marie Kondo and we see a lot of customers engaging with that presentation or even our in-store demonstrations has constantly witnessed customers touching and playing and engaging with products either at the front of store or through our demonstrations like a very versatile Elfa starter sets. I have 6 of them. And customers, once they play and engage with them, they quickly discover that they need those items and put them in their carts and off they go to check out. And that's what we're trying to promote in our pillar of really deepening that connection with our current customers and expanding our share of wallet. When it comes to new customers, Pillar number 2 is really focused around expanding our reach because we do believe there's potential for us to really go after a whole slew of new customers. And we're already pressure testing that. Today, we do a very good job of selling custom spaces that are below $2,000, but we have minimal share in spaces above $2,000. And I believe we can capture new clients, new customers just by being focused on the premium closet spaces during our events now. A few months ago, we had our stand-alone -- for the first time, we had a stand-alone event for Avera, our most premium closet line, and we are delighted to see our ability to sell not only a variety of custom spaces, right, whether it was mudrooms and basements and annex and traditional closets, but these spaces were averaging $6,000 per space. And what we also saw, which was a great delight to us that of the total customers that shopped during the event, 40% of them were new to TCS. It's a great way to drive new customers by focusing on that premium line. We also believe there's an opportunity to grab new customers by dramatically improving our e-commerce experience. Unfortunately, our website today, it's very clunky. It's slow and it's not at all where I'd like our e-commerce experience to be the load -- I think we can do -- great opportunity for improving our load times, providing more engaging content, relevant site searches and payment options like we did with Afterpay and soon we'll be introducing additional payment types. But I think that is a great way for customers to -- new customers to experience what we have to offer, in particular because we only have 94 physical locations today. And third but not least, as we talk about physical locations, we clearly see there is an opportunity to gain new customers by adding more stores. We're still very early in determining what that footprint is going to look like. But we are excited about offering a hub-and-spoke model. We think there's, like I said, a tremendous amount of white space out there. And by having a combination of both our flagship stores, coupled with smaller, more accessible and convenient located locations, we can drive more customers, more new customers so that they can benefit in the amazing transformation experience an organization can bring. And then finally, our third pillar, which is as important as driving growth, both through existing customers and new customers, is around strengthening our capabilities. We want to drive top line growth in a very systemic and process-driven and profitable manner. And that starts off with making sure we've got the right teams in place. So done a great job attracting great talent, especially in key areas where we needed new talent to come in, whether it was technology, digital marketing, real estate, DE&I and ESG, and these new hires have already hit the ground running, providing a significant boost in their respective areas of responsibilities. For example, our new hired CIO, has already put in place a fantastic robust technical road map and is actively working on delivering shift-from-store capabilities and a mobile point-of-sale solution, which, among other benefits, really allows us to take full advantage of our online assortment and make it available in-store and is working fast and furiously on a customer-facing mobile app. So all great work in terms of strengthening our capabilities through talent. We've got a significant focus on ensuring that we can look at every possible operational efficiencies and the savings that we had, we reinvest that back into the business to help support our strategic pillars, just like we did with our store payroll. And some of the recent hires that we put in place are also working feverishly on ensuring that we can become an employer of choice while expanding our efforts on ESG. So with all that said, I will tell you, look, it is an extremely exciting time to be at TCS. And I'm thrilled at the start that we've had for fiscal 2021, where we've delivered profitability for the -- in our first quarter for the first time in over a decade. And I'm just so proud of how the teams are executing against our strategic growth pillars. So lots in store for The Container Store.

Thank you for that. There's a lot to unpack there, so many new initiatives, so much to look forward to. I guess, I can ask [indiscernible] questions. Actually, I think I'm going to start with the closet piece. Because when I think of The Container Store, I think where maybe you're a little underappreciated is for the closet piece, but it's also a bigger differentiator, I think, for you as well. So I wondered if you could maybe talk -- give us a little bit of an education about the closet space. What do you think the TAM is? Who do you think your competition is? And how -- what would you emphasize as the point of differentiation that The Container Store brings with your Custom Closet solutions?

Absolutely. I think it's, first and foremost, it's important to understand just what is our offering, right? So today, we have 4 lines in our Custom Closet business. We've got our Classic line, which is really the regional Custom Closet system. It's a wall-hanging based system, incredibly strong and customizable. It is a do-it-yourself installation as well. And it provides a great level of mobility in terms of being able to move shelves and drawers, which most systems out there actually prevent you from doing that. They're a bit more fixated in its system. So our Classic system is really a great phenomenal workhorse product for us. Our next system is Elfa Décor, which combines the strength and flexibility of classic system but adds a flare of premiumness of it with wood features and deluxe options with a variety of finishes. And then we have Avera line, which is a system unlike any other in that it is again, a wall-based system, but it delivers an upscale built-in look at an incredible price. And it has features like full extension drawers that open and close to the touch back panels, LED lighting to complete the look. All of those 3 lines are exclusively ours. And through our ownership with Elfa International, we get to benefit from both the manufacturing and retail margins. And then our most premium line is Laren, which provides a custom-built luxury look, and it's a floor-based system that's primarily wood-based. And it offers glass front doors. What I have behind me is the Laren system, and it is a beautiful look and finish. And so those are our lines. And as I mentioned before, our Classic and Décor lines do extremely well in the under $2,000 range. We have significant market share there. There are not a lot of players that offer a solution like ours in that space. Where there is competition is in the space above $2,000. You see a lot of players out there, some national players and a lot of fragmented players. And I think that's where I'm excited about our ability to really go after that market. That's where I think we have got significant share. And our most recent Avera event, we're able to see that we could capitalize on selling premium spaces and not just at $2,000, we're averaging $6,000 with the Avera event. And the secret there, if you think about, okay, what's changed? And I think it was really our approach is getting the organization as a whole focused on Avera business, making sure that the marketing, the training, the installation, the incentive plans were all geared around our ability to sell these premium spaces. And as soon as we focus on it as a company, it was just so satisfying to see the results that we were able to bring about during that event. And I think it leads us very well into the future because there's no stopping us now in terms of really capitalizing on this more premium look, this premium line and being able to increase our average ticket while we're at it. And doesn't mean we'll walk away from the business that we have today under $2,000. That's -- there is plenty of opportunity to go after that, but I also think there's more growth to be had in the above $2,000 line.

I wondered if we could pivot now to more the merchandise side and the partnerships that you have, specifically with The Home Edit and Marie Kondo. The Home Edit was -- this sound funny, but it was a home run. You couldn't watch The Home Edit or follow them on Instagram without The Container Store being tagged and everything. And so I wondered if you could maybe talk about how you view partnerships, how you elongate the interest of the consumer as a result of those partnerships? Any updates maybe with the Marie Kondo line, just launching any kind of early reads that you could talk to us about?

Sure. Look, we -- first of all, we're just thrilled with the partnerships that we have, both with The Home Edit and Marie Kondo. Marie Kondo, her show, Sparking Joy, launched on 8/31, it's a 3-part series, I got to watch all 3 of them. And the shows -- what I loved about the show in particular was not just Marie's opportunity to help educate folks on how to get organized, but really the impact of organization and how it strengthened the relationships, whether it was a father and son working in a garden business or a mother and her children and the work that she was doing at a church, I mean she was really taking organization outside of the home into other areas. But the relationships that came about and really flourished because of organization, I think, was priceless, which is very much what we're excited to do with our own campaign in our ability to amplify the benefits of organization. So as I mentioned earlier, you go into our stores, and now you'll see our front store really positioned well with our sustainable KonMari product line, and you get to find items from the closet to the kitchen to the office. And we're really there helping customers find the right solution for their needs and the response has been very positive to those customers. In addition, we've recently launched our newest line with The Home Edit. The Home Edit wooden collection, and it's made of Palomino woods, one of the fastest-growing hardwood trees in the world. Lightweight, beautiful colors, extensive offering. And again, the customer response has been very favorable there as well. In fact, so much so, we've also seen a great demand for sustainability. So over the last few months, we're actively working on improving the assortment that we have dedicated towards sustainability. We have now 10% of our assortment that is classified as sustainably sourced. And later this month, you'll start to see a leaf icon being introduced both in stores and online that help identify which products are sustainably sourced. I think the advantages of these collaborations, and I appreciate you saying the home run was really about bringing out an awareness on the importance of organizations. And so future collaborations for us, is about is that really nurturing the established ones, but cultivating new ones in different categories. So we have tastemakers today. We have 4 tastemakers that go about promoting kitchen transformations. We've got our brand ambassadors who are working on promoting office and garage projects. We're constantly working at new collaborations that can really help bring about the awareness and the importance of organizations as we are also embarking on our own campaign around talking about the importance of organization as well. So I just think we're in a great position to continue to benefit from people being educated, how that's done and through -- for whatever collaborations that may be, why we also bring about our own voice and amplify it in a much bigger way.

I'm sorry, my light goes off in my office. I wondered if we could maybe talk about the financial outlook a little bit for the rest of the year. Certainly, you have a lot of puts and takes with regards to the top line and certainly gross margin and SG&A. There are supply chain disruptions. There's elevated cost on the product side within the transportation side. And then finally, there is wage inflation as well. So I wondered if you could maybe talk us through how you're thinking about how that looks for the rest of the fiscal year and how you're managing through some of those inflationary headwinds?

Sure. I'll let Jeff take that one.

Great. Thanks, Dave. Yes. So yes, certainly, like all other retailers, we're experiencing the supply chain disruptions like everyone else. And we're seeing it in the form of manufacturer limitations, container shortages, notable freight and shipping cost increases. And we're also seeing higher commodity prices. We have 2 big areas of our business where we are seeing resin prices increase for our plastic related products, and we have steel price pressures as well, which would also impact our Custom Closets. So those things are all driving higher costs from a product standpoint and requiring longer lead times with our vendors to ensure we can service our customers. And we plan to continue employing multiple methods to help mitigate the impacts on these higher costs, which include vendor negotiations, actively managing our supply chain, changing where the routes are, how we're getting it. And along with adjusting retail pricing like other retailers -- retailers out there. And Satish already talked a little bit about promotional cadence and the way we're looking at it going forward. And certainly, as we -- going forward, we'll be able to adjust promotional cadence to help offset some of the headwinds associated with the increased cost. If we think about increased pricing and promotional activity and whether or not that puts pressure on overall sales, the way we're seeing our customers, they're actually seeing the value. They don't see the transactions necessarily as a commodity transaction. They're seeing it as a transformational investment in their lives. And so as that message is continuing to resonate with our customers that are coming in the store, we do think that we'll be able to continue with the promotional cadence that we have planned. And then from an inventory perspective, like I said, we had longer lead times. We're counting on longer lead times, and we've increased stock levels just to handle the higher sales volume activity that we have. And we feel good about where we are, where we ended Q1, and we'll continue to build inventory as we go through Q3, as typically we do, as we build up for our big annual Elfa sale event that starts at the end of Q3 and goes through Q4. But while we're still chasing some levels of inventory, we do feel good overall. When I think about -- from a profitability standpoint, we haven't provided full year P&L outlook, but we did provide some color around what it would look like -- what our profitability would look like in a mid-single-digit sales increase. And that scenario in consideration of restoring certain expenses that we cut back in fiscal 2020, we would see some level of operating margin contraction, somewhere in the range of 50 to 100 basis points at the current time. We do see because of the overperformance in Q1 in the gross margin line, while there is headwinds through the remainder of the year related to gross margin as the average costing of higher commodity and freight costs are going to come through, we do believe that overall gross margin for fiscal '21 will not be down from fiscal '20. And the other thing I would like to say from an SG&A perspective, we do expect an increase in SG&A dollars and associated deleverage in the second half of the year as compared to the first half of fiscal '21. So when you look at fiscal '21, we'll have more deleverage in the back half. Also, what I'd also say is that total -- in terms of total dollars for SG&A, we'd expect them to be in line with the same amount we spent in 2020. However, due to timing of events and other investments, we would expect more dollars in Q3 than in Q4 based on the current cadence.