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

Good afternoon, everyone. I'm Michael Lasser, the hardlines, broadlines and food retail analyst from UBS. Thank you so much for joining us today. We are thrilled to have the team with us from The Container Store. To my far right is Satish Malhotra, who is the company's CEO. He spent a long time, 22 years.

21 years.

21 years at Sephora. He started when he was 12 and used -- got great use out of the products to remain so useful; and Jeff Miller, who is the company's CFO and he joined in 2020. So we're super excited to talk about The Container Store story.

As we think about The Container Store, it brings order to a very disorderly world. It's -- where we want to start off is, Satish, you've been coming up on your 1-year anniversary. The company has made a lot of progress. But what's been different than you expected as you've taken the helm? And what's exceeded your expectations?

Well, first of all, thanks for having me here. Like you said, it's now 13 months, but it does feel like just like I started yesterday. We've been action-packed at The Container Store. I'll answer your question in 2 ways. First and foremost, why I joined The Container Store, because I think it really helps kind of chart the path in terms of where we're also going. First and foremost, I was attracted to the culture at The Container Store. It's really important to me as I left my career at Sephora in terms of the passion and the excitement that I would expect to find and see at The Container Store because it's really important when you think about when you're executing a strategy, the team that then executes that. And The Container Store just had a unbelievable uncanny passion, enthusiasm, as you say, in terms of bringing order to chaos, funded with or the foundational premise of doing the right thing, the 7 foundational values all get doing the right things. And I guess, with this type of culture, anything can really be possible. And then when I took a step back and did my own due diligence, I came to the realization of just how much potential growth exists with The Container Store. We only have 94 stores. And yet, when you go around asking people about The Container Store, they definitely heard of The Container Store. And I think the awareness is far greater than the actual footprint. Most retailers out there pretty saturated in terms of their growth. And I look at it and I'm like, wow, a lot of white space in terms of new stores that we could potentially open, look at the e-commerce business, which had a pretty clunky experience. It's like there's a lot of good that we could do here, coupled with, I think, the very third element that I saw at The Container Store was having a demonstrable impact in the lives of customers. And that was important to me coming, as I mentioned, from Sephora, I have a big fanatic on skin care. And what I realized earlier in my career that there are so many people out there that have yet to really fully embrace and experience skin care. Many of them are just not aware about how to take care of their skin. And as I was experiencing The Container Store, I realize that there are so many folks out there who have yet to experience the power of organization and to get all of the great benefits of that. And so that was really the exciting elements that got me to come to The Container Store. And I think the thing that has surprised me the most there's 2 elements that surprised me the most. One was the level of acceptance of a company that's 44 years old and an outsider coming in, if you think about it. And I wasn't sure whether or not the organization, despite having a fantastic culture was ready for the amount of change that I wanted to bring about. And I was just really taken aback with the level of acceptance. And then all that we've accomplished, as we stated in our fiscal '21 has just been unbelievable, and it's a testament to the phenomenal team, when you can set forth a vision and a strategy, which we did very early on and then still keep the incredible DNA of the company, but yet modernize it and take it to a whole other level. It really is a fantastic experience to have.

Here's what has got a phenomenal store. I mean it sells itself when people go in. What are the debates that we hear when investors talk about the story is, a, how big is the addressable market? And b, while there is a lot of awareness, how do you increase consideration? The consumer might not create in the market for storage and organization products many times throughout the years. Consumer needs to capture many of those shots on goal as many as those opportunities as possible to be able to capture that wallet share. So Jeff, maybe you want to talk about addressable market? And then 2, how do you increase consideration?

Yes, sure. So from an addressable market perspective, from our perspective, we're looking at a $20 billion marketplace. And we just have a very small piece of that addressable market. And as we continue on our path to growth, whether it's in the store footprint, e-commerce or even in our B2B space, we feel like there's a great opportunity, can we take market share despite other economic conditions in the world. So aging our customers in the various areas and channels where they are, we feel like there's a great opportunity going forward, whether it's in general merch or the custom closets area. And of course, custom closets is a specific area that we called out a number of times, being what we estimate to be a $6 billion opportunity for us and most recently, acquiring a Closet Works acquisition, a small wood-based closet. While we do really well in spaces under $2,000, we've talked about that primarily in our help of metal-based component system, we see a great opportunity in that space is greater than $2,000. And that's where the real growth opportunity is for custom closets, not only for a retail customer, but also in the B2B space and just that full customer space and converting those custom closet customers in gen merch and pulling it all together with the in-home services, whether it's in-home design or in-home organization. This creates a full experience for our customers, where others in this type -- in this industry, they only have one piece of the pie. You may be a custom closet provider, but you don't have a full breadth of closet offerings that Container Store does with the lower end and the full high custom and custom closets. And on the gen merch side, no other retailer has the same level of offering that The Container Store does. They may play in it a little bit in different pieces of it, but you won't get it, and they won't have the selling experience that our specialists do in our stores. So when you walk in to a Container Store, we'll give you a full experience of storage and organization in a way to transform your space, whether it's under a kitchen cabinet or redoing your entire cabinet or your entire pantry.

Do you especially have a consideration?

Yes. It's what I would say is -- let me ask you this question, how many spaces in your house do you feel are organized to the way that you would like it to be?

Zero.

There you go.

And I'll take the responsibility because [indiscernible] very organized, if she's listening.

Yes, and I -- but I appreciate the candidness of it because that's the reality. I mean, yes, the addressable market is $20 billion, but I actually think it's much, much bigger than that when you just think of all the households that are out there that have yet to fully embrace and experience what organization has to offer. And I fully experienced it myself and you have to truly experience it to understand the power. It isn't just words that's we talk about the power that organization can really bring in this transformational journey that is truly this change of life that you can have. When I purchased my home in Dallas and we moved, we had about -- we started off around a dozen spaces that we transformed. And then we continued to add on because we weren't done. And the way that we now function as a family, every single member of the family has truly embraced organization. And so some of the benefits that you see, whether it's improved productivity, you can finally get to everything that you want. A sense of motivation. And I'll be honest with you, I'm not a do it yourself. You can ask my wife. But when I go into my garage, and I see my beautiful alpha peg board, all my tools displayed there. There are many a time on actually, it gives me the motivation and the enthusiasm that I actually can go ahead and accomplish the project that had. And it really is a life-changing experience. It's a beautiful thing to have that. And our pantry, we would really kind of stock up our pantry with more items than we truly needed. And many a time, it would go -- it was spoil because they weren't air-type containers. We couldn't really find what we're looking for. And I just showed you to think how much money I was wasting, buying things that would spoil because they were temporary. Or as you may have heard about Wall Street Journal interview was a big fan, I don't know what attracted me to buy batteries. But every time I go into Costco and the batteries are on sale, I would literally buy packets and packets of batteries, and I probably had about 10 years' worth of batteries. I didn't even know I was overbuying and because they weren't stored properly. And so -- and now that everything is fully arranged in our house this is a sense of well-being that we now see and less arguments with the spouse because everything is perfectly organized, I mean those are true transformational benefits. So when you think about consideration, I look at it as just how many people like yourself who perhaps are now familiar with the organization, but perhaps haven't really fully experienced it, that's our opportunity to really touch all of those consumers. I put them in 2 buckets. There are those that are oblivious to it, since hit like we talked about with skin care. They just don't know they need to take care of their skin. And then those that are aware, like, yes, I know and I need to take care of our skin, but are overwhelmed and not sure how to start. And we are in a perfect position, as Jeff stated, given the ecosystem that we have with our custom spaces, in-home organizers and our general merchandise products to really bring it together to help those customers find those premises.

And is it a marketing question? Is it a promotion question? How do you motivate that consumer to want to engage in store organization?

I think it's primarily a marketing effect. I mean we just approach -- we just launched our campaign on 2/22/22, welcome to the organization. And it was it's a beautiful campaign, and we were able to really be overt about the powers of organization. We worked with Drew Barrymore, we were on her show, sponsored. We did a TikTok challenge, which was Show Us Your Drawers. And it was a fantastic opportunity. Everyone has a junk draw, and it was like everyone's embarrassed about it. But no, go out and show that and let us see what we can do to help you. And we've got some TikTok over 6 billion views of that challenge, everyone is on that challenge. And I think that it is very much about our ability to bring about awareness and educate and that will allow consumers to feel confident that they can come into a Container Store, whether it's in-store or online and find a trusted partner that can allow us to achieve those goals. And I've heard many customers. In fact, I was visiting a store recently, and the store manager mentioned to make that a customer had walked into the store, not necessarily to buy anything. She was out on a conference he's doing a presentation, but she saw that there was a Container Store across the street, and she came into the store just to so can to take in the of excitement that The Container Store has to offer. And I think that's a real -- again, how many retailers can you count on that really provides a level of expertise in the business and also provide it through these memorable experience that customers are willing to come in just to feel at ease and that piece when they come to our store.

Yes. I think Satish is right. I mean 2/22 event was the beginning of the message, where it's an invitation to be part of the organization. And then the prop was show us your doors because everyone has that drawer somewhere or underneath your seen cabinet that needs help. And we're just inviting to come to the organization, we can help you. And along with it was our new brand icon that we launched as well that represents not only the 3 aspects of our business, but also shows that it's a happy place too, as it sits.

Well, no one will show your drawers right now.

We appreciate the campaign.

Your business has been doing really well over the last couple of years. Presumably, some of that's because folks have been at home and engaging in organization and increased cleaning and it's been benefiting from more time at home. How do you frame that, whether it's looking at some performance in stores that may have been less in areas that are more reopen versus areas that are less reopen? How do you think about the impact that your business has had from the unique pandemic initiatives?

I'll answer that in a few ways. First and foremost, I think there's no doubt that folks are seeing their place of home, whether it's at home or an apartment, wherever it might be differently. And they're trying to make it a multiuse place, right? Your living room now is not only your living room, but it may well be your kind of pseudo office. And it also may be a place where your children are also doing -- were doing online schooling. And I think that's just been home for a period of 2 years, looking at every aspect of the home or about a sense of realization that things could be better, right? No doubt about that. But I don't foresee that now diminishing just because people are starting to return back to work and kids are returning back to school. I think if anything, the world becomes more and more chaotic, not less chaotic. And folks generally are looking for a way to contain the sense of chaoticness in everyday living. And it does really become this new way of life. And I think people are truly embracing that, trying to understand what can they control, how can they control it in a way that fosters a greater sense of wellbeing. So for me, this is -- it always comes back to all of those consumers out there that still have yet to benefit from organization. And our goal, our promise is to really be more over in a much bigger way in a much more pronounced way to really help educate that. It's no wonder when you see like the Marie Kondos and the Home Edits of the world, why is this such a fan club about those 2 individuals, right, those 2 offerings? And first and foremost, when you dissect like Marie Kondo, I think she essentially offered a way for customers to understand not only how to organize, but also how to let go, right? We all have the difficulty of letting go with certain things that we've acquired over a period of time. And how do you do it in a way that doesn't feel -- you're not feeling remorseful about it and the fact that she says, look, if this item brings you joy you keep it and if it doesn't, it's okay, thank it and let it go. It's quite a liberating experience to have that and Marie all of a sudden can go, okay, I can now do this throughout every part of my house, right? And then you've got the Home Edit that just provides fundamental tools of how to organize, how to organize your refrigerator, your pantry, tools that we're just missing. And I think when you think about what we're trying to do, coupled with a lot of the collaborations that we have, including with Cas Aarssen with ClutterBug, who's on HDTV, collectively, we're able to kind of take this move. And I really do call this a movement, right? As Jeff said, the beginning of the movement to a whole another dimension.

And did this all that -- everything that you mentioned and the interest in the home, did that translate your business with more frequency of visit, more customers who are coming in increased spend per visit? How did it translate to what you saw in the stores?

Yes. I mean certainly, we've seen increased spend. Average tickets are definitely up. It's hard to dissect over the last 2 years because so much has gone on. You mentioned pandemic original rush. We had stores shut down, e-commerce exploded, and we reopened the stores. The customers came right back. And we had events like Netflix series that launch and everything else. It's really hard to dissect the overall business. But the health of the business is good because when we see it growing the past fiscal year in first 3 quarters of '21, you compare to 2019, we see strength not only in the general merch, but also the custom closets, both of them performing quite well to the pre-pandemic levels. And so we've seen new customers discover us during this time period. We certainly see a younger generation customers as we start capturing because our loyalty program that it is now has grown over this time period, but well over 1 million. And we have set for launching a new loyalty program here at the end of this month. So that will be tier-based and really drive engagement in a better way than what we see.

That's great. We are at an uncertain point given everything that's going on in the world. There's -- it's clear that inflation is going to persist for longer and be stronger than what was maybe expected a few months ago. How will those type of macro conditions impact your business?

Yes. I'll do it 2 parts. I'll let Jeff take perhaps the second part, more of the levers that we use. But the first part of it is really what we focused on is pulling back on promotions that we normally have done in our past. And what was important to us and quite frankly, that started before even we were starting to see these price increases within our supply chain. What was important to us as we were looking at the experience with our offering was often we were leading with price first and the discount first. And I think in many ways, it was kind of cheapening the overall experience. And so what we started to do is really rethink the way that we were engaging with our customer. We had a lot of our specialists that were in our stores -- in the back of the store doing a lot of operational tasks, whether it's replenishment or finding and what we decided to do very clearly and think we need to make sure all of those trained -- highly trained experts and specialists who are on the selling floor, engaging with customers to make some operational improvements there. Then we started to change the way we were story timing, really having more user-generated content before and after. There's nothing like a compelling before and after picture of a pantry that you could visualize your own pantry and see it transforming, I can actually get this and achieve that same look and feel, coupled with having our front-of-store demonstrations. So if you go into our stores, we see a completely different front of store presentation that changes out every 8 weeks or so where customers can truly play, touch, feel and learn. As we started to do that, we saw that the consumer was able to really now engage in a way that they weren't before. And so then the promotion became less in the limelight, and it was really around core products that we are offering, those are 10,000 SKUs dedicated towards storage and organization and now 1,600 that are sustainable, bringing that to the forefront so that you can experience really changed narrative that was going on in our stores. And that, I think, helped play really well into kind of what was happening as we were starting to see raw materials and freight prices come up because we're already kind of pulling back. And it wasn't that customers couldn't find a good deal, but it required them to really engage and spend more to get that kind of more of that higher discount. And that was in addition to all the other elements that Jeff has in his toolbox as he's managing supply team.

Yes. So that's a good point on the promotional strategy that we were ahead of before some of the supply chain impact really in the forefront. But we haven't really talked about 2022 and forward from a guidance perspective. We can certainly see like every other retailer, we're impacted not only on freight costs, we're impacted on certain commodity costs like driven a lot by petroleum. We have petroleum-based products. And as we look at that and we see the uncertain world, it's hard to really tell where that's going to fall out. And the way our inventory systems work, it was a little slower working itself in. So we'll be a little bit slower working its way out. But as we look forward, we're happy to see coming out of the third quarter that we had seen freight costs level out, but it's a new world and we're, of course, evaluating the ongoing activity in the world today and how that might impact us.

So 2 follow-ups on that. Number one, has the supply chain overall and all the disruption has improved versus 3 or 6 months ago?

I would say from a pricing standpoint, I think we did see some pricing come back a little bit on the freight side. We've done a lot of things.

Pricing come back meaning like -- pricing come back down.

It's nowhere near where it was. But what we did during this time period is we elongated our lead times, right. It was really about making sure we had the product in place. And we've seen that in our inventory levels as we closed the end of the Q3, we entered into our annual outflow then, very well stocked for that event, probably the best we have been. And we feel good about that, pre-pandemic, we had just opened a second DC, and we had the most inventory that we have had. And so we were actually set up once everything started closing out and supply chain started getting disrupted. And then we kind of caught a wave where we needed to catch back up. I would say, as of the end of the third quarter, our store out of stock levels were almost the same as it was pre-pandemic. And that's saying a lot in today's supply chain where we've been able to elongate those lead times. And of course, we're working with suppliers and vendors, working through those costs and seeing how we can share along the lines of what we're doing from a risk mitigation standpoint, and we're looking at different routes, how we're bring our products in. So there's a lot of different things. And of course, it's final, Satish talked about the promotional strategy, we always have retail pricing changes as well. I mean we're certainly making those changes accordingly, making sure that we remain competitive in the marketplace.

And how have you used pricing? How much has that contributed to sales? Has the consumer been receptive to any pricing changes given the broad-based inflation that's taking place?

We haven't seen a pullback from customers because of it. But we're very thoughtful and mindful about how and where we take pricing. It's a good reminder that we have 50% of our SKUs are private label in nature. So I think it's obviously difficult to do a compare, but we have great quality on that product. There's a lot of pricing that adjustments we can make even in custom closets, again, hard to compare when you think of each individual space being different and tailored to the needs and personalized to the needs of the customer. It's very much top of mind for us. And where I think we've, again, to underscore really made a difference for the customers and explaining the benefits of what they get, right? Quality and the transformation that you see in your life and in many ways, especially within custom closets, it being an investment that you're making in your home, but you can recoup later should you look to sell your home in terms of depreciation that you get from it is quite a powerful sentiment when you're talking to a customer about where we are when the pricing customers for the most part. They understand they see inflation prices, they see it. And as long as it's relative to what they're expecting, and they can understand the value that they're getting in it, they're pretty much well engaged in the category. But we've also introduced additional payment offers like Afterpay where you'll be able to spread those payments of a 4 interest-free installment pays, and that's also allowed customers to increase their share of wallet as well.