Farah Soi - ICR LLC Melissa Meyer Reiff - The Container Store Group, Inc. Jodi Lynn Taylor - The Container Store Group, Inc..

John Heinbockel - Guggenheim Securities LLC Matthew McClintock - Barclays Capital, Inc. Joshua M. Siber - Morgan Stanley & Co. LLC.

Greetings and welcome to The Container Store Third Quarter Fiscal Year 2016 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Farah Soi. Thank you.

You may begin..

Thank you, operator. Good afternoon, everyone, and thanks for joining us today for The Container Store's third quarter 2016 earnings results conference call. Speaking today are Melissa Reiff, Chief Executive Officer; and Jodi Taylor, Chief Financial and Administrative Officer.

After Melissa and Jodi have made their formal remarks, we will open the call to questions.

Before we begin, I need to remind you that certain comments made during this recording may constitute forward-looking statements and are made pursuant to and within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements. Those are referred to in The Container Store's press release issued today.

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 showing the GAAP versus non-GAAP financial measures is available in The Container Store's press release issued today. If you do not have a copy of today's press release, you may obtain one by visiting the Investor Relations page of the website at containerstore.com. I will now turn the call over to Melissa.

Melissa?.

Thank you, Farah, and thank you all for joining our call today. I'd like to begin by providing a brief overview of our third quarter financial results, followed by a discussion of our key priorities, and then I'll ask Jodi to review our financial results in more detail and comment on our outlook.

We were pleased with our bottom line results, as we achieved a 38% increase in earnings per share going from $0.08 in third quarter last year to $0.11 in third quarter this year. This was due in large part to the impact of our well-managed SG&A expenses as part of our SG&A savings and efficiency program.

Our third quarter consolidated sales increased 1.7% year-over-year based on the solid performance of our new stores. Our comp store sales were challenging, down 3.9%. As mentioned in our Q2 call, we started the third quarter with a much improved trajectory over our Q2 comp store sales results.

But as we entered the holiday selling season, we experienced disappointing holiday department sales.

One other notable reason for our comp store sales performance was that our Annual elfa Sale this year was impacted by four fewer selling days in the third quarter compared to Q3 last year, as well as Christmas and New Year's Eve falling on the weekend this year.

TCS Closets delivered a strong performance in Q3, contributing 130 basis points to our comp sales, with average ticket remaining at the same level it has been.

Given our customers' attention during the holiday season shifting to decorating and gifting, we did expect a seasonal moderation in TCS Closets' contribution to our comp store sales from the 200 basis point contribution we saw in Q2. We're pleased, however, that TCS Closets sales continue to increase nicely.

But given the weight of sales in the third quarter, with a large portion of sales driven by the holidays, it's harder obviously to make as much of a comp impact.

Our elfa products continue to be an ever important, highly profitable and differentiating component in the growth of our company and our commitment to closet domination, accounting for about 25% of TCS retail sales.

elfa is also a large portion of our business-to-business program, which we believe has strong sales-driving potential and will be a growing business unit for us in our near and long-term planning. We shared with you all on our last call that, in mid-November, we would launch the pilot of elfa Sliding Doors in our two Manhattan stores.

While it is still early, we're excited about offering our customers yet another solution centered around our commitment to closet domination. And we are seeing an average ticket on sliding doors that's higher than we originally expected during the short period since launch.

elfa, TCS Closets and really all of our custom closet product solutions, coupled with our corresponding in-store and in-home design and organization services continues to be a true differentiator for The Container Store.

We plan to prioritize even more resources toward the development and growth of this critical area of our business as part of our new long-term strategic plan. We will be sharing central elements of that plan by June.

We are now six months into the launch of our customer financing program with Synchrony Financial and continue to be pleased with the results. The number of new cardholders continues to grow, and Elfa financed purchases are still carrying a higher average ticket than non-financed Elfa purchases.

In addition to customers financing Elfa and TCS Closets purchases, they are also using the TCS Credit Card to buy other products throughout the store. Regarding our new stores, we opened four new stores in the third quarter, Baybrook, Texas; Omaha, Nebraska; Des Moines, Iowa; and Pittsburgh, Pennsylvania.

With these four new locations, we ended the quarter with 86 stores and completed our store opening plan for fiscal 2016. We've been very pleased with the overall performance of the seven stores we opened this fiscal year.

The Baybrook, Texas and Des Moines, Iowa stores that we opened in Q3 reflect an updated store layout that expands the custom closets and closet department areas of the store. It also includes a new merchandising presentation for our long-term storage solutions and the right-sizing of our box, gift packaging and container departments.

We're closely watching the performance of these stores in order to determine how to apply these changes to stores moving forward. In fiscal 2017, we plan to open locations in Cleveland, Ohio; Albuquerque, New Mexico; Livingston, New Jersey; and Staten Island, New York. We'll also relocate our Chestnut Hill, Massachusetts store in fiscal 2017.

As previously announced, our Albuquerque store, which is targeted to open in July, will be our first mid-size store format at approximately 18,000 square feet. While all departments will be represented, there is an edited assortment in select departments and custom closets will be a larger portion of the store.

This is the first of many test-and-learn initiatives to optimize our store size and layout to ensure greater efficiency and productivity.

In 2017 – in fiscal 2017, we're appointing a significant portion of our capital allocation toward existing store remodels, with an even greater focus on custom closets, while simultaneously exploring additional store formats. We absolutely believe that our new stores are important to our future on many levels, including customer acquisition.

We have a very strong base of profitable stores and believe we have a long runway for growth with currently only 86 stores in the U.S. We are by no means an overstored retailer, and we'll continue to seek out strategic and profitable real estate expansion for our brand.

Our top priority is to improve our comp store sales results, but we do not believe that thoughtful profitable new store growth and improving comp store sales are mutually exclusive. We intend to do both.

I'd like to talk a little bit our customer loyalty program POP!. We ended the quarter with more than 4.5 million POP! Stars. As we work towards the next iteration of the program, we have partnered with an outside firm to help us evolve the user experience in order to best communicate reward and develop long-term loyalty with our customers.

In the meantime, we continue to implement a variety of ongoing test-and-learn POP! Initiatives. And as both small and substantial wins reveal themselves, we are quickly applying them to our broader customer base.

Also, in the third quarter, we proved out that the media spend reallocation from some of our traditional marketing channels to more digital presence was indeed successful. So, we'll be working to determine how to best apply this media mix model at scale moving forward.

We introduced our brand to new customers during the third quarter through partnerships, cross-marketing and in-store events with a variety of brands, including Southwest Airlines, Whole Foods, Total Wine & More and The Ellen DeGeneres Show.

Regarding our online sales, website-generated sales increased 1.7% for the quarter compared to third quarter last year. This includes online direct-to-customer, plus our Click & Pick Up in-store transactions.

And when standard and expedited holiday shipping windows began to close, we offered our customers a Click & Pick Up incentive to drive sales to the store. We know there is ongoing interaction between online and brick-and-mortar sales and vice versa.

We want to capitalize on that interaction to drive overall business by allowing our customers to shop with us however they choose. We are channel agnostic.

Our goal is to drive our overall business by improving the shopping experience for both our stores and online, again, allowing our customers to shop with us however they prefer for each purchase they make. Our Annual elfa Sale will continue through February 28, 2017.

The total number of elfa Sale days this year is 70 days as compared to 71 days last year due to calendar shifts. And as I mentioned earlier, there were four fewer elfa Sale days in Q3, and we will have three additional sale days in Q4.

And just like we've seen in the past, we do expect our customers to procrastinate and delay their elfa purchases until closer to the end of the sale. In closing, I just want to say that we are pleased. While we are pleased with our EPS increase we delivered in Q3, we are not satisfied with our comp store sales performance.

Our disciplined approach to initiative prioritization and expense control enables us to leverage our key differentiators and implement new ideas in order to achieve top line sales growth and profitability.

We are taking the necessary steps that we believe will drive the results we know we can and need to achieve for the near and long-term success of our company. We must stay very close to our customer and ensure we fully understand her needs and preferences.

It's important that we align our marketing messages and spend, our in-store product offering and experience, and our online tools to better meet her needs in the most innovative, cost-effective and profitable way possible. We are working to introduce new ideas and new products to excite our customers and grow our sales.

Over the next year, we plan to develop and test these new ideas that will strengthen our position in custom closets and other organization solutions. We are also deep into our work on our longer term strategic plan, and as I mentioned, we'll be in a position to share the central elements with you all by June.

So, now, I hand it over to you, Jodi, to go through our financial results please and our outlook in more detail..

Thank you, Melissa, and good afternoon, everyone. Today, I'll be reviewing our third quarter fiscal 2016 results and then discussing our outlook for the remainder of the year. In light of the company's fiscal year change, all references to prior year results are based on the recast third quarter that ended January 2, 2016.

For the three months ended December 31, 2016, our consolidated net sales were $216.4 million, up 1.7% compared to the prior year period. Sales for The Container Store retail business were up 2.3% to $199.1 million primarily due to new store sales. Our third quarter comp was down 3.9%, partially due to disappointing sales in our holiday departments.

TCS Closets continued to contribute to our comp store sales, contributing 130 basis points to our third quarter. We ended the quarter with 86 stores and approximately 2.1 million of gross square footage, as compared to 77 stores and approximately 1.9 million of gross square footage at the end of the recast third quarter fiscal 2015.

Now, turning to Elfa International AB, Elfa's third-party net sales were $17.3 million, down 5.2% compared to the third quarter ended January 2, 2016, all due to the negative impact of foreign currency translation during the quarter, which reduced third-party net sales by 5.8 percentage points.

Moving on to profitability, in the third quarter, consolidated gross profit dollars were relatively flat at $125.7 million. Consolidated gross margin declined 80 basis points compared to the prior year period.

Gross margin at The Container Store retail business was down 110 basis points, reflecting a higher mix of lower margin products and services, and to a lesser extent, increased promotions.

In recognition of the holiday calendar this year and its expected impact on our elfa Sale in Q3, we did add a promotion in November that had a modest impact on margin. In December, we took the necessary holiday promotions to end the quarter clean from an inventory standpoint.

These mix and margin rate headwinds were only slightly offset by the approximate 10 basis point positive impact of a stronger U.S. dollar.

Elfa gross margin decreased 90 basis points from the prior year period, primarily due to increased direct material and freight costs associated with changes in customer sales mix, partially offset by improved production efficiencies.

Moving on to SG&A, as a percentage of sales, consolidated SG&A decreased 250 basis points to 46.3% in the third quarter of fiscal 2016 as compared to the prior year period, primarily due to cost efficiencies associated with our SG&A savings and efficiency program, lower healthcare costs, as well as a positive impact from foreign currency exchange rates.

Additionally, in the third quarter last year, we incurred some one-time storage costs associated with our distribution center automation project that were not incurred in Q3 this year. This favorability was partially offset by deleverage of occupancy costs associated with our comp store sales decline.

New store pre-opening expenses increased by approximately $1.1 million to $2.9 million in the third quarter, as we opened four stores in the current year period compared to two store openings in the prior year period. Our net interest expense in the third quarter of fiscal 2016 was $4.1 million, down slightly from the prior year period.

The effective tax rate for the quarter was 39.7% compared to 34% in the recast third quarter of last year. The increase in the effective tax rate is primarily due to a shift in the mix of domestic and foreign earnings, combined with the expensing of certain deferred tax assets due to the expiration of certain stock-based compensation awards.

Our net income for the quarter was $5.1 million, or $0.11 per diluted share, as compared to a net income of $3.9 million or $0.08 per diluted share in the recast third quarter of last year.

Now, turning to our balance sheet, we ended the quarter with $18.5 million in cash, $338.3 million in outstanding borrowings, net of deferred financing costs, which was down approximately $14 million from the same time period last year, and combined availability on revolving credit facilities and cash on hand of approximately $106 million.

We ended the quarter with inventory up approximately 7% reflecting the increase in stores open from 77 in third quarter last year to 86 at the end of third quarter this year. On a per store basis, inventory levels at TCS were down 3.8%.

With regards to our outlook for fiscal 2016, factoring in our year-to-date results, as well as our expectations for the fourth quarter, we now expect fiscal 2016 consolidated sales to come in modestly below our previously provided guidance of $820 million to $830 million.

We expect both comps and EPS to come in at the low-end of our previously provided ranges. As a reminder, these ranges are comp store sales outlook of down 1.5% to 3% and EPS of $0.20 to $0.30 based on a weighted average of 49 million diluted shares outstanding.

We continue to expect TCS and consolidated operating margin to improve, primarily based on the significant SG&A savings and efficiency program that we have implemented. This is expected to be the case both for Q4 and fiscal 2016 as a whole.

We expect our tax rate for the full fiscal 2016 to be approximately 39%, and our annual interest rate at today's LIBOR rates to be approximately $17 million. So, in summary, while we are pleased with the improvement in EPS we delivered in Q3, we are not satisfied with our sales performance.

We look forward to sharing our outlook for the business with you on our year-end call in May. Thank you. Now, I'd like to turn the call back over to Darren, so that we can open the line up for questions.

Darren?.

Thank you. We will now be conducting a question-and-answer session. Our first question comes from Steven Forbes of Guggenheim Securities. Please state your question..

It's actually John Heinbockel for Steve. So, I want to drill down a couple of things.

One was the remodel program that you mentioned, how many remodels do you think you'll do in 2017? And when you think about the economics of that, kind of rough ballpark cost of a remodeling, what kind of lift do you think you'd get from those projects?.

Hey John, it's Melissa. Nice to talk with you. We are working on our strategic plan right now and haven't finalized it for 2017. So, I can't give you a specific number of how many remodels. But I can tell you that we are looking very carefully at that and allocating our capital appropriately.

We do feel like there's great opportunity for that in many of our stores. As you know, we'll be testing Albuquerque with a smaller format. We're going to be looking at that. And then, we've got – again, we've got our four stores this year that we're opening, new stores, that we're going to take that into account in terms of what that layout looks like.

So, we'll be finalizing all that and we'll be sharing that going forward. I don't have the exact number right now..

Melissa, one thing I might add is that we do intend to take certain attributes of what we did in Baybrook and Des Moines, and roll that into all of our stores, specifically the part where we are creating the permanent home for long-term storage and expanding the closet department area. So, certain attributes will in fact be moved over.

And we do expect, with those in particular, that we should see a nice payback in those pretty quickly, John..

And just sort of as a follow-up to that, if you think about Albuquerque, right, because I think that had always been a possible target as a small market store. Is 18,000 square feet – A, is that about as small as you can go? Is that the model for less dense markets, right? So, it could be bigger than 18,000 square feet in more dense markets.

And then lastly, when you think about the space that you've taken away from – in Albuquerque and given to closets, roughly, how much bigger or how much greater would closets represent in Albuquerque versus where they had been?.

Yeah. Hi, John, again. The 18,000 square foot store in Albuquerque, we can – that is as small as we're testing right now. Now that – we've talked about even looking at other size formats. It could be smaller, and in denser markets, it could be more of a 22,000 square foot. It depends on the real estate that we find and we'll adapt accordingly.

So, in terms of the custom closets section of the store, we do want to expand that. And as Jodi said, we were already – we'll have that in all stores, the closet department expanded, as well as a little bit larger of the entire custom closets department.

So, again, we're looking at all the real estate opportunities and we'll adapt the size format as we feel is right going forward..

Okay, thank you..

Thanks John..

Thank you..

Our next question comes from Matt McClintock of Barclays. Please proceed with your question..

Hi. Yeah. Good afternoon, everyone..

Hi, Matt..

I was wondering if you could talk about those certain attributes of the stores that you're thinking about expanding into your new stores in 2017.

Is that partially the reason why we're seeing such strong performance in your new stores this year, but I guess (21:46) worse than expected comp store sales for the year?.

Matt, I'm not sure I understand the question.

So, could you repeat that again about the new stores?.

Yeah. So, your new stores are performing above your plan..

Right..

Yet your comp store sales overall, so your mature stores are likely performing below plan, right? And so....

Right..

I'm just trying to better drill down into the discrepancy between those two cohorts of stores and what's different?.

Yeah..

Matt, it's Jodi. I'll start just real quickly here..

Okay..

But one thing that's interesting is the new stores absolutely, like you said, are performing better than plan, better than our expectations. And there are only two of those seven stores that were laid out with the new layout that you hear us referring to, the Baybrook model that was done in both Baybrook and Des Moines.

So, they're performing sort of well above our expectations – well as compared to our expectations sort of irregardless of whether they were laid out with the new layout. That said, there are definitely some strong trends specifically in Baybrook and Des Moines.

Whether we can specifically yet attribute those in such a short period of time to the new layout, it's a bit premature to do that.

But we definitely do believe that our focus on custom closets and devoting more space to that in our stores is helpful to our sales, and that's why you hear us talking about trying to expand that even further into more stores next year..

Okay, that's helpful and thank you for that. And I was just – one more question just from the quarter itself. It seemed like some of your Christmas or your holiday merchandising maybe didn't perform as well as you expected. I think you shifted some marketing dollars to the Gift Wrap Wonderland and you promoted that a little bit more.

Can you dive into what went wrong this holiday for the holiday merchandise? And what you think you can do, what's fixable and maybe where you could have maybe even better than expectation?.

Right, Matt. No, I understand. We discussed on our call last quarter that the Q3 sales really did start out with a better trajectory than our down 4.2% comps the previous quarter in Q2 – or in Q2. And yes, we did encounter some disappointing holiday department sales.

And while they were the most notable portion of our overall comp decline, as I said earlier, we also had four fewer days of our Annual elfa Sale in the third quarter compared to last year due to those calendar shifts, and also Christmas and New Year's Eve, as I said, falling on those weekends.

So, what we're – we actually did not shift any additional dollars to the Gift Wrap Wonderland this year. What we're doing now though is we're going to really evaluate what resonated and what didn't with our holiday products as we plan for the future.

We're looking at things like space allocation, the assortment, the purchasing levels, yes, the marketing and merchandising. However, Gift Wrap Wonderland is a very important product category for us that we will continue with, but we are going to figure out what we want to do differently for next year..

Perfect. Thank you very much..

Thank you. Our next question comes from Simeon Gutman of Morgan Stanley. Please proceed with your question..

Hi, this is Joshua Siber on for Simeon. Just a question on TCS Closets.

Are you seeing resistance to the price points there and can you talk about the performance of TCS Closets in different markets?.

Sure. We're not really going to get into the details on the detailed metrics on TCS Closets.

But I have to tell you that we are really – we remain pleased with the traction, Josh, that we're seeing with TCS Closets, while we're also continuing to really work hard and aggressively to quicken the pace of the process and the sales, and that average ticket remains really strong.

And I have to say that just overall, the sales just continue to increase nicely and the Q3 for TCS Closets, Josh, was right in line with our plan.

And as I said in my opening remarks, given the customers – their attention really turns to decorating and gifting during the holiday season, we weren't really surprised that we had that little seasonal moderation from – the comp from 200 basis point contribution in Q2 to the 130 basis point in Q3.

So, the Dallas/Fort Worth store, which is one of our mature stores, in the TCS Closets continues to be strong , and we're seeing that we also have strong performance in more of dense affluent markets.

So, we're very excited about continuing to really refine the selling process and shorten it for the customers so she has an even better experience through technology enhancements and training, and also sharing the best practices among our markets. This is again a huge focus – area of focus for our company..

Okay.

What is the – what is slowing the store growth due to expense growth for next year and what's the plan for capital allocation with lower store opening CapEx?.

Sure. Jodi do you want to....

That's a good question, Joshua. We're basically – we'll come out with a full outlook obviously in May when we release our Q4 results for all of 2016 (27:00) and be real specific as it relates to CapEx. But right now, our thought process is going to be that we allocated a greater portion of capital to existing stores.

As you've heard us discuss here, we do have the four store commitment, plus we have the relocation of the Chestnut Hill store that we'll allocate capital to, and then typical maintenance capital that we would have in our company.

But in terms of the store growth, I would expect the capital to be less allocated, like I said, to new stores, more allocated to existing stores, and the total to be relatively similar to what you see this year..

Yeah..

Okay. Last one, I may have missed this.

Do you have an apples-to-apples comparison on same-store sales excluding the four fewer days?.

No, I don't..

No, we do not. We don't. It's not that simple to do such a calculation. So, we don't have that..

Okay. Thank you..

Thank you..

If there are no further questions at this time, I'd like to turn the call back over to management for closing remarks..

Thanks very much, Darren. And again, thank you all for joining our call today. We look forward to speaking with you in May when we will report our fiscal 2016 year-end results. So, thank you so so much..

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation..