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

Today, we're happy to be introducing The Container Store. Today, we have with us Satish, Chief Executive Officer; and Jeff, Chief Financial Officer. Thank you so much for joining us today.

We're starting with an intro question, just to kind of launch this entire conversation with talking about this 2023. And could you maybe talk through some of the bigger challenges for Container Store this year? And maybe what have been some of the bigger wins for the company?

Yes. Sure. I'll take that question. Thank you for having us. First of all, I would say fiscal '23 definitely has been a challenging year given the macro environment that most retailers are facing. The headwinds are real. We definitely are seeing our customers contend with higher inflation, interest rates and just a lot of uncertainty. And because of that, then we see a natural pullback in discretionary spending. And so it's one of the reasons we quickly, in the start of fiscal '23, decided to really put in place some cost-cutting measures, knowing that the first half was going to be tougher than the second half, and feel proud to be able to execute that in the way that we thought we would without disrupting our customer service. In terms of some of the challenges, I would say without a doubt, traffic has been down. It continues to be down, and we see customers that do come into our stores having --buying less transactions, less items because of the pricing. That's why we kind of played around with our promotional cadence to see what we could do to engage with them, and had some great learnings in the first quarter that we are deploying into the second quarter. We're also seeing some of our kind of more traditional storage and organization categories declined much rapidly -- much further than some of our other categories, particularly in the Home Edit line and Marie Kondo and drop-front shoeboxes. So all of those have been kind of more pronounced declines, primarily because we had a lot of success in the prior years. In terms of some of the wins, what I'm really excited about is that newness is working for us. And we started to really get into newness, into new categories like home fragrance. Home fragrance categories that -- and plant-based categories. Both of those categories doing very well and comping over LY, driving the new customers. We completely reimagined our travel department, introduced new brands like CALPAK, Rains, Tuli, and it's really resonated well with customers. They love for example, with CALPAK, not only the durability of the product, but the vibrant colors that it gets to offer, and we're actually chasing inventory because of it. And that kind of led us to pushing a lot of newness for back-to-college. And it was probably the first time that we really expanded our assortment. We've obviously have a relationship with Dormify. We strengthened it further. We introduced dropship capabilities that allowed us to expand our installment without carrying the inventory. And it not only drove new customers but it allowed us to really capture more share of wallet. Typically, a customer would come in and only find certain items that we would necessarily have, in particular, underbed storage or a 3-tier cart, and then we have to go to other retailers to kind of complete that shopping experience. And for the first time, I'd say we captured a significant amount of that basket. And I can testify with my daughter going to college, being a freshman, 90% of her purchase happened at The Container Store because we were able to carry all the products that she was looking for. Cool, innovative products, not only underbed storage but also whether it be a fan or humidifier, all the things that she was looking for, we had. So that bodes well for us in terms of newness and how it's resonating with our customers, and we have a lot more newness planned for the balance of the year and know that we'll make great traction there. In terms of another success, I would say the premium spaces, premium customer spaces, in particular, Preston. We now have 130 in-home designers that have gone through a pretty rigorous training. They've gone through technical training, 3, 4 days in person, where they're now really up to speed in terms of how best to put forth designs that makes sense for the customer. They're not overly complicated and can meet the budget for our customers. And that is really proving to be quite successful for us. In addition, with just all of the new innovation that's coming out of our Preston line. We've just recently launched Domus lighting, which is a European lighting, kind of best-in-class out there in our customer spaces, and it's integrated with your smart homes, so Alexa, Google. We've also put in mesh inserts into our doors, which really enhances the elegance of a custom space. And soon, we'll have concealed hardware as well as in-draw lighting and toe-kick lighting. There are a lot of great things that are coming. I think we can really expand upon that as our customers interact with us. And last but not least, in terms of what is really going well for us. I would say our in-store service continues to be incredibly strong. Our Net Promoter Scores are in the 80s. They continue to do well. Our service levels for our customer spaces also continue to improve. And I think that really is a testament to the spirit and the passion that our specialists have, especially when you consider what they're up against and the headwinds that they're facing.

So maybe we can talk a little bit about the macro headwinds that your customers specifically is facing. How much of your business today do you think is tied to the housing market? And when you think about the demand for discretionary categories, which I think most of your categories fall into, how do you think about how that plays out in terms of prioritization as we move through the year?

It's a difficult question to ask -- to answer, rather because of just the complexity of the consumer and the housing market that they're contending with. One could argue, when you've got a housing boom, you would expect to see a significant increase in volume. The counterpoint to that as well is, today, customers, quite frankly, will not be able to purchase their dream homes that they may have thought they would a few years ago because interest rates are so high. And if anything, they will now have to contain with their homes, and we think will actually bode well in terms of renovations that may happen, and we're obviously there to play with our customers there, make the most out of your home and they can do that with The Container Store. If I take a step back and just look at the psyche of the consumer right now, I kind of put them in 2 buckets, very simplistically. There is a customer that is very much value conscious. So they are engaging with us in categories, looking for a deal. It's very rampant out there in terms of the retail industry. There's a lot of retailers offering promotional discounts and that seems to be the playing field that in order to -- this kind of training that customer. And in order for us to be competitive, we're obviously playing with those levers there. The value consumer also, I think, can benefit from our offering, whether it's Elfa, which is a very modular system and it's a do-it-yourself system, something actually you can take with you if you do end up leaving your home and coupled with our private label assortment, which has smart price points. So I think there is a competitive offering there, albeit it's in the macro environment of highly -- sensitivity around pricing. Then we have another set of consumers that are more of the affluent premium consumer. What they're looking for is really quality and they're looking for customization. And they're looking for products that are going to complete their home. And as I said, we've seen great success with our Preston collection. And what we're looking to do now is enhance our Preston collection with more premium general merchandise. And so funnily enough, in all of our stores, we have a Preston pantry. And our Preston pantry is dressed up with products that we sell and with props. And there's one prop in particular, which is a tea kettle that we have. It's a very elegant, beautiful overpour tea kettle with kind of an ostrich neck. And our customers kept asking about this tea kettle and whether or not we sold it. They wanted to buy the tea kettle. But it was a prop. Our visual merchandise team did such an amazing job popping it out, but it wasn't a kettle that we sold. Until now that is. It is one of those items, it's through fellow, and it not only looks beautiful, something that the statement piece that you proudly display in your home, in your pantry, on your countertop, but also had great precision temperature control capabilities as well. And it got us to think about really enhancing our general merchandise product to complement our custom spaces. And that's what that more affluent consumer is looking for, kind of reasons to come in to shop that will complete our spaces. We recently just partnered with Citizenry as well, which is another amazing company that offers really curated, specialized merchandise, home decor merchandise from around the world made by artisans and have ethically sourced product. And that complements a lot of our Preston designs, whether it's primary closets or even our wall beds that we get to offer as well. And so that's what we get excited about, like we will absolutely work hard to engage the more value-conscious customer. But I think we have a tremendous amount of upside as we think about the more premium affluent customer and how we can engage them with a complete offering.

That's great. My next question was on custom spaces, which I know has been a big initiative of yours since you came into your role. Could you maybe take a step back and talk to us about how different it is today walking into a Container Store when it comes to your closet presentation, versus a couple of years ago?

Yes. I would say it's widely different today than it was 3 years ago, and I will tell you we can continue to elevate not only in stores but also online too. The expression that we have online is fantastic. And I would say, like 3 years ago, we primarily focused on specific lines, in particular, the Elfa line. It was the workhorse for us, and it does well for us, and it will continue to do well for us. But we never really thought about the whole home experience. We kind of treated it as individual lines. And so now what we've done over essentially the last 2 years, we made some really major strategic moves. First and foremost was training our staff to be able to sell more premium spaces. We did that with Avera. We then embarked on an acquisition for Closet Works so that we could really win in the premium wood-based systems. And that's what our customers are really asking for here, you don't want to necessarily always have a metal-based offering. We want to be able to -- if we're going to complete the home, as I competed in my home, you want to be able to pick and choose the right product lines that make sense in your homes. And with the acquisition of Closet Works, which happened essentially right at the end of '21, early into '22 gave us kind of really a license to win in that premium space. And as a reminder, when you think about the $6 billion addressable market in custom spaces, the lion's share of that, over 80%, is in spaces over $2,000. And we hardly have played in that space. So this gives us great opportunity for growth when we thought about it. And then we went around understanding, do we have the right assortment then to offer our customers. And so Preston launched about a year ago in our stores. We transformed our custom closet line to custom spaces to talk about the entire line. And since then, what you've seen us now, we have over 130 in-home designers. We've brought in great technology into our customer spaces where we have a custom portal, which makes it super easy for customers to be able to engage with us, look at their design, find their contracts, pay with us, also follow along when installation is going to happen. We've put in just recently an online scheduler where customers can actually book an appointment either in-store or in-home. We've also brought about innovation in our Preston line. And today, now we have 13 finishes. We've got AirTec edge banding, which is really cutting class in terms of making sure that you've got seamless integration in the systems versus the traditional glue. We have a 6-way glider, that makes it so easy for installation to happen. And so for us, when we think about custom spaces, quite candidly, we're just getting started in being able to win in that premium space. It starts with the team, it starts with training, getting comfortable with that and then mirrored with the assortment that we have. And I think today, we have a really competitive offering more so than we had 3 years ago.

And can we expect the mix of your store to change meaningfully between the general merchandise and the custom spaces...

Yes. I do. I think it's -- definitely, there will be certain stores in particular that will over-index with custom spaces. And there will be other stores that perhaps will under-index given the geographic trade areas that they're serving. But I think over a period of time, that is the actual desire, is to see more growth come out of custom spaces. In particular in the premium side of it, where we get to also benefit handsomely from the margins in that not only do we have the retail margins, but we have the manufacturing margins because we own both of the lines of Elfa and with Preston as well. And then that allows us to get into the home and to not only deliver on one space but multiple spaces. So I think if you fast-forward us 3, 5 years from now, you'll definitely see a higher penetration of customer spaces, in particular within premium. The percentages are up in the air because it really is going to depend on the customer and how the customer interacts. And also as we start to strengthen that premium general merchandise, I think can also really play well in terms of [ to have even ] normalizing some of that penetration between general merchant and custom spaces. If you go into our stores today or even on our website, we just launched about 28 new brands and over 350 new SKUs and it's started to really resonate with our customers. We look and feel quite different even in our stores today than we did 6 months ago, let alone 2 years ago.

Well, I think one of the underappreciated parts of your story is just the opportunity for unit growth. And that's something that you've identified since you've become CEO. So could you maybe talk to us about how you're viewing unit growth going forward, especially in the context of maybe a more difficult macro environment? And can you talk about how these new stores look from an economic standpoint versus your existing store base?

I'll pass that to Jeff who's just sitting here by himself.

Yes. So new store growth, a big piece when we came out and we started talking about the path to $2 billion. And we had a suggested cadence. Certainly, that cadence is not the same, given the macro environment. But when we look at overall capital expenditures, that's what we're managing to, because we're growing through positive free cash flow, we try to maintain between 5.5%, 6% of the revenue per year. So when you look at '23, we have 6 new stores going in, plan to be going in, half of which are build-to-suits, all small-format stores. And when you look at the layout of that store and what we're targeting in these small format stores, it's first year revenue of about $5 million, 20% per while EBITDA is the target. Now given the macro environment, they're not immune to the macro environment like the rest of the store. So from a performance standpoint, not exactly what we are expecting, but still performing quite well in relation to the store base. We're seeing those new stores that we've opened do about 37% of their business and custom spaces. Their NPS scores are higher than the store base. They're in almost mid-80s. And so the customer really is appreciating the new store base, and we're attracting a very similar customer that we have elsewhere, and we're going into existing key markets. We're targeting those customers that we've seen come to The Container Store year after year after year, and we're engaging with them. 60% of the traffic coming into these new stores are those types of customers that we're looking for that we've not seen before.

I have a question actually because that 60% of customers shopping, you are new. Is there anything markedly different between them versus maybe your historical or traditional customer?

When we start looking for locations of a new store, we're taking our customer data that we have over decades. And we're targeting the existing customer base. And we've known tried-and-true who they are, where they are, where they shop in relation to that. And we know that we're not engaging with them yet, which gives us the confidence that there's a big opportunity of white space out there for us to continue to expand our store base in existing key markets, and other markets as well that we haven't actually entered. Primarily as we look at the store growth over time, we see a pathway to at least 76 to 100 more stores out into the future, the case of which will be driven by the macroeconomic environment and our ability to continue to grow the business.

If I can just go to some of the financials. So Jeff will get a lot of questions now. So the guidance for '23, can you talk about what scenarios you're baking in? Because obviously, there are a couple of headwinds that your consumer is facing that Satish walked us through. But there sounds like there's a ton of newness and new innovation and things that you say that the consumer is responding to above and beyond just promotions. So how should we think about the guidance that you've given where that upside maybe can come from to guidance, or maybe where some of the risk is?