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

Steven Forbes - Guggenheim Securities LLC Matthew J. Fassler - Goldman Sachs & Co. LLC.

Greetings, and welcome to The Container Store First Quarter 2018 Earnings Conference 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 like to turn the conference over to your host, Shannon Devine.

Thank you, you may begin..

Thank you, operator. Good afternoon, everyone and thanks for joining us today for The Container Store's first quarter fiscal year 2018 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 call regarding our plans, strategies and goals and our anticipated financial performance may constitute forward-looking statements and are made pursuant to and within the meaning of the Safe Harbor Provision 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 important factors are referred to in The Container Store's press release issued today and in our Annual Report on Form 10-K filed with the SEC on May 31, 2018.

The forward-looking statements made today are as of the date of this call and The Container Store does not undertake any obligations 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 of the non-GAAP financial measures to the most directly comparable GAAP measures is also available in The Container Store's press release issued today. A copy of today's press release may be obtained by visiting the Investor Relations page of the website at www.containerstore.com. I will now turn the call over to Melissa.

Melissa?.

We completed the initial work on our pricing initiative and just implemented those changes we tested that demonstrated success. The expected benefits from this initiative are factored into our revised outlook for fiscal 2018.

One of the actions from this initiative includes the addition of selected opening price point products in certain product classes, for example, hangers and storage totes. We also modified pricing in our other categories based on deep data analytics and competitive consumer insight work.

In some instances, prices were adjusted, and in others, we refined our message to the customer as it relates to value, promotions and quality. And we're encouraged by the initial improvement in customer price perception scores that we have seen from these efforts.

As a reminder, the objective of this initiative is to maximize sales and gross profit dollars, while at the same time improving price perception. So in closing, it was a strong start to the year and we have reflected this in our revised guidance for fiscal 2018.

We have seen encouraging results and learnings as we make progress against all of our strategic priorities. Our sales revitalization efforts are making a difference and we are reaping the benefits of our fiscal 2017 Optimization Plan.

Through this process we have leveraged external expertise as well as developed improved internal capabilities and hired key talent across multiple areas including pricing, consumer insights, technology, marketing strategy and analytics and merchandising and planning.

We continue to narrow our leadership span of control for an intense focus on strategic areas of the business. And we have made changes that have improved accountability and resulted in greater empowerment throughout the organization. And of course, we look forward to building on our progress during fiscal 2018.

So now, Jodi, will you go over our financial results and outlook in more detail, please?.

Sure, and thank you, Melissa, and good afternoon, everyone. For the first quarter ended June 30, 2018, our consolidated net sales were $195.8 million, up 6.9% compared to the prior year period. Sales for The Container Store retail business were up 7.8% to $180.1 million driven by a 4.7% comp store sales increase as well as new store sales.

As you saw in our earnings release, this comp performance included an estimated 190-basis point benefit from recognition of deferred sales resulting from fiscal fourth quarter 2017 Custom Closets orders that were delivered and installed in the first quarter of fiscal 2018.

Custom Closets contributed significantly to our first quarter comp store sales and we once again saw a positive contribution from our other product categories as Melissa shared.

We ended the first quarter with 91 stores and approximately 2.3 million gross square footage as compared to 87 stores and approximately 2.2 million of gross square footage at the end of the first quarter of fiscal 2017. Now turning to Elfa International AB.

Elfa's third-party net sales were $15.7 million, down 1.9% compared to the first quarter of fiscal 2017, primarily due to lower sales in the Nordic and other markets, partially offset by the positive impact of foreign currency translation during the quarter, which increased third-party net sales by 1.2%.

Moving on to profitability, in the first quarter, consolidated gross profit dollars increased 10.8% to $114.8 million and consolidated gross margin increased to 200 basis points compared to the prior year period.

Gross margin at The Container Store retail business was up 140 basis points, driven primarily by lower cost of goods associated with our Optimization Plan. Elfa's gross margin decreased 170 basis points from the prior year period, primarily due to impact of higher direct material costs, which will partially offset by production efficiencies.

The consolidated gross margin increase of 200 basis points was primarily due to increased sales of higher margin Elfa products during the first quarter of fiscal 2018.

Moving on to SG&A, as expected, SG&A increased 160 basis points during the first quarter due to approximately $4.9 million of final consulting Optimization Plan expenses, which added 240 basis points to – which contributed 240 basis points of deleverage.

This increase was partially offset by an SG&A improvement of 80 basis points, primarily due to ongoing savings and efficiency efforts. New store preopening expenses decreased this quarter to approximately $346,000 from $1.4 million in the first quarter last year.

We opened one store in Bridgewater, New Jersey in the current year period compared to one store opening in the prior year period.

The decrease year-over-year is primarily attributable to a shift in the timing of new store openings, as the company incurred preopening costs in the first quarter fiscal 2017, first store that opened early in the second quarter of fiscal 2017.

Our net interest expense in the first quarter of fiscal 2018 was $7.9 million, up from $4.2 million in the prior year period due to the August 2017 amendment to the senior secured term loan, which increased the applicable interest rate margin.

We continue to actively monitor the debt capital markets for opportunities to re-price our term loan facility and reduce our interest expense. The effective tax rate for the quarter was 34% compared to 37.4% in the first quarter of last year.

The decrease in our effective tax rate is primarily due to lower statutory rates as a result of the Tax Cuts and Jobs Act enacted in fiscal 2017, partially offset by a benefit for the re-measurement of deferred tax balances recorded in the first quarter of fiscal 2018, as a result of a reduction to the Swedish tax rate.

On an adjusted basis, our effective tax rate for Q1 was 25.4% compared to 37.3% in the first quarter of last year. Our net loss for the quarter was $6.8 million or $0.14 per share as compared to net loss of $7.7 million or $0.16 per share in the first quarter of last year.

On an adjusted basis, excluding the costs associated with the Optimization Plan, our adjusted net loss was $4 million or $0.08 per share as compared to a net loss of $5.5 million or $0.11 per share in the first quarter of last year.

Adjusted EBITDA nearly doubled moving to $12.4 million in the first quarter this year compared to $6.4 million in Q1 last year.

Turning to the balance sheet, we ended the quarter with $14.1 million in cash, $299.7 million in outstanding borrowings and combined availability on revolving credit facilities and cash on hand of approximately $84.7 million. Our net debt position was down approximately $31.7 million from last year.

We ended the quarter with inventory down 0.9% compared to the end of the first quarter of fiscal 2017, despite the increase in stores opened from 87 at the end of the first quarter last year to 91 at the end of the first quarter fiscal 2018.

On a per store basis, inventory levels at TCS were down 5.8% with the decline largely due to improved inventory management combined with lower product costs as a result of the Optimization Plan. Given our stronger than expected fiscal first quarter results, we are raising our outlook for fiscal 2018.

We now expect consolidated sales to be in the range of $890 million to $900 million based on a comp store sales range of up 1.5% to up 2.5%. We expect GAAP EPS to be between $0.30 and $0.40 and adjusted EPS to be between $0.38 and $0.48 on a weighted average of 49 million diluted shares outstanding.

This raised outlook reflects the tailwinds that we discussed as well as some headwinds that we are now facing, namely foreign exchange and fuel. It also reflects a higher level of digital marketing spend, given we have been pleased with the results of our digital marketing efforts thus far.

We expect our tax rate for the full fiscal 2018 to be approximately 30% and our annual interest expense using forward LIBOR rates, but not assuming a refinancing between now and year-end to be approximately $30 million.

In fiscal 2018, we still expect to spend approximately $38 million in capital expenditures for our planned two store openings and two relocations, $11 million to $12 million of our fiscal 2018 CapEx will be invested in our second distribution center expected to open in the Northeast in late fiscal 2019, as well as technology projects, maintenance spend on our existing stores and our Elfa business, and we would expect to incur similar $11 million to $12 million of CapEx spend for this DC in fiscal 2019 as we complete the project and bring the new facility online in late fiscal 2019.

We still plan to generate positive free cash flow once again in fiscal 2018, which we continue to expect to utilize for further debt reduction. Now, with respect to the second quarter specifically, here is the few call-outs.

One, we expect our comparable store sales increase for Q2 to be towards the low-end of our full year comp store sales outlook range.

Q1 was stronger than the full year outlook range, given the significant Custom Closets benefit to comp store sales in Q1, both in the recognition of Q4 deferred sales, as well as the closet-related campaigns that were more heavily weighted to Q1.

In addition, we are making some changes in our B2B business to improve our go-to-market position to capitalize on the mid to longer term opportunities that we see. We expect these changes to benefit our B2B business, but they will create some near-term disruption which we factored into our outlook.

And lastly, there is a small Q2 impact resulting from the timing of our sale campaigns, which are shifting as we test and learn. In some cases, we're modifying the scope of our campaigns and in other cases the timing of our campaigns, all with the goal of increasing effectiveness and driving improvement in full-year sales and EPS.

Number two, Q2 EPS will be burdened by incremental marketing expense spend of approximately 100 basis points due to the launch of our new brand marketing campaign. So from an earnings perspective, we would expect the year-over-year improvement in adjusted EPS to be at or below the levels seen in Q1.

And then number three, we expect incremental interest expense of Q2 – in Q2 of approximately $1.6 million or $0.02 per share, since the refinancing of our senior secured term loans didn't occur until mid-August last year.

Four, and finally as a result in – or as a reminder, in Q2 of last year, we incurred $6.7 million of consulting expenses that were recorded to SG&A that we do not anticipate this year. It's therefore important to share to look at our results and performance on a full-year basis given these shifts.

In summary, we're very pleased with the strength of our first quarter top and bottom line financial performance, both of which exceeded our expectations. We are encouraged by the progress we're making and remain focused on continued discipline execution of our key strategic initiatives.

We look forward to updating you on our second quarter fiscal 2018 earnings call. Thank you. Now, I'd like to turn the call back over to the operator, so that we can open up the lines for your questions.

Matt?.

Great. Thank you. At this time, we will be conducting a question-and-answer session. Our first question is from Steve Forbes from Guggenheim Securities. Please go ahead..

Good morning. Good afternoon..

Hi Steve..

I guess it feels like morning..

Okay..

The – I guess to start with the flagship store, right, the Dallas there. Obviously, looking at some of the pictures and so forth, I haven't had a chance to visit yet, but if you think about some of the merchandising changes, maybe some of the smaller ones like the Elfa Door & Wall Rack touchscreen display or some of the other ones within the box.

I mean how long do you need before you can start rolling out some of these initiatives to the chain? Do you envision doing it piecemeal or do you – do you want to sit back this year and digest the remodels as a whole and come up with a more methodical approach? Like how do you – how are you thinking about approaching kind of the initiative in general?.

Yeah, Steve, it's Melissa, and I'm so glad that you've seen some of the pictures.

Obviously, it's still so early, we just launched it last month, and we do want to take a methodical and a very strategic approach to analyzing what's working, what's not, listening to employees, listening to our customers with all of our customer intercepts to know what is the right thing to do to roll out to existing and new stores.

So, we've got our metrics in place, we've got the economics in place, we're going to continue to be evaluating it, we're very excited about you mentioned the Door & Wall Rack, we've also – I've mentioned in my remarks about our new organization studio, we're just very excited to test and learn, and this is The Container Store of the future.

And as I said to that so far Steve the feedback has really been positive, but there is things that we've already learned, that we've made mistakes on, that we're correcting, and then there was many things that we're really digging, but it's going to take some more time for us to really decide how we're going to roll it out and when to other stores..

And then a two-part follow-up.

So, on that first question there, can you remind us the new store at Oklahoma and the relocations in Colorado, Virginia, are those going to be in next-generation formats? And then the second part, you mentioned the goal of reducing interest expense or the rates right on the term loan, can you help us kind of understand what you think right is the potential timing of the initiative in the magnitude of the savings, I mean, is it a 2018 kind of goal to get that lower?.

Yeah, right, Steve, I'll take the first and Jodi can take the interest expense one, if you would Jodi. The Oklahoma City store and the two relocations in Denver and Tysons, they will all three be less than 20,000 feet.

And we will be taking some of the learnings from Albuquerque, and yes some from even NorthPark if we can and apply them to those stores where it makes sense..

And then Steve on the debt question, we are actively monitoring the debt capital markets and looking for opportunities to re-price our term loan facility, and obviously the goal of that would be to reduce interest expense and increase EPS.

We do not have any of – any savings – any specific savings factored into outlook, outlook is using current rates and assuming those occur throughout the year. However, of course our goal would be to do it sooner than that, and we'll just have to keep you posted as we have any new information..

Yeah..

Thank you both..

Thanks, Steve..

Thank you..

Our next question is from Matt McClintock from Barclays. Please go ahead..

Good afternoon. This is Kate Howard (00:27:26) on for Matt. So congrats on the quarter even without the benefit from the 4Q shift, it looks like one of the best comps in a number of years.

I know you mentioned the ongoing positive contribution from other product categories, would you be able to break that out for us today?.

Yeah, we can break that out.

Custom Closets contributed was, Jodi, 4.2%, right?.

Right. I mean Custom Closets was the significant contributor as Melissa said in her remarks, particularly because we had the combination of the deferred revenue benefit we spoke of 190 basis points plus it is a strong selling period for us with closet campaigns. So that drove the majority of the comp.

But we had 50 to 80 basis points in the last couple of quarters and other products category comps being positive which we're very excited to see, because we had been seeing declines in those categories prior to that, so..

So, it contributed positively the other product categories. And Kate (00:28:24), we recently hired our new EVP, John Gary of Merchandising and Planning, and his focus is on those other product categories and Sharon Tindell, our President and Chief Merchant, her focus is on Custom Closets.

So we think we've got the best of both and, of course, they're working very closely together, because we're one store and one brand.

But it was a combination of Custom Closets, other product categories, our marketing campaigns, our targeted offers, our free install, it all came together beautifully, but it was strategically thought out and, of course, we are too pleased with the results and thank you for your congrats..

Great. Thank you for that color. And so, also as a part of that pillar to own the Custom Closets, you've noted that the company is focused on growing the B2B channel, and then today noted the changes for the go-to market position.

Could you give us an update on the strategy there?.

Yeah, absolutely. We always are very diligent in looking at all parts of our business continually and making appropriate changes as we think necessary for the future of the company and all stakeholders.

And we just recently moved the responsibilities for our B2B channel to Gretchen Ganc, who is our new EVP or she started in December of EVP of Strategy & Analytics.

And we just felt like after further digging in that we needed to step back and more formalize a go-to-market strategy and direction for our B2B channel to really capture the full opportunity. I mean it's mostly Elfa and we own Elfa. It's exclusive to us. There's a huge opportunity there.

So we just really wanted to make sure that we've got the right strategy in place with the right partners. So therefore we probably will see some moderate growth in the next couple of quarters. So we may have to take a little bit step backwards to take the short-term pain for long-term gain for the future.

But we know it's an important channel and a great opportunity, but Kate (00:30:20) it's really important to remember that it's a very small tiny part of our business right now, even though it's a pretty rapidly growing business.

But we're going to step back and look at it and we want our cake and eat it too, so we're going to maximize it the right way..

Great. Thanks so much..

Thanks, Kate (00:30:37)..

Our next question is from Matt Fassler from Goldman Sachs. Please go ahead..

Thanks so much. Good evening almost. And I have a number of follow-up questions. First of all, if you could just help us size the 190 basis points spillover in terms of delta in book sales that have been essentially or delivered sales that have been booked in Q4.

How much big of an impact is that than you have typically experienced in the spillover from the fourth fiscal quarter to the first? Is that the change in the contribution of that – of those deferred sales or is it just in absolute terms 190 basis points.

And if so, kindly remind us what it was last year?.

Sure. Matt, this is Jodi, I'll take that, and we did as you may recall at the end of Q4, we had deferred sales up about $3.3 million year-over-year. We ended at 11 – just over $11 million compared to $7.7 million the year before. During the quarter, we did a really great job of clearing out our Elfa orders from the end of the fiscal year.

And with virtually all of that year-over-year increase in deferred sales in Q4 then being realized in Q1. So to answer your question, the 190 basis points is the net incremental impact, it's not just the impact from this year, because we have....

Yeah..

...deferred sales at any given year. One thing, I think it's important for you to know is, that does not in any way hurt Q2, as we had strong Custom Closets selling throughout Q1, and you'll see when we later file our 10-Q that we had deferred sales that were $2.4 million higher than last year at the end of Q1.

So we are – by no means did we take away from Q1, when we recorded the deferred sales coming from Q4. So hopefully that makes sense..

If anything you should talk about compares of anything that might give you a bit of a tougher comp in Q1 of next year, but depending on how your written sales track....

Yeah..

Okay..

That's right..

Secondly, on gross margin drivers, can you talk about sort of the progression of where you are in the cost optimization effort as an impact for cost of goods? And also, I know this is sort of hand-in-hand perhaps of closets, but just talk about the contribution of you said the mix shift to Elfa within TCS was helpful to you, if you could just help size what kind of mix shift that was? How big that mix shift was?.

I'll take the first part, the gross margin question. We as you'll recall really didn't start to see meaningful flow through of our cost of goods project, the Optimization Plan, cost of goods project until Q4 of last fiscal year. So we saw in Q1, flow through as we anticipated we would see it's flowing through right on track.

And we expect to continue to see that flow through occur through third quarter of this year. So we would expect year-over-year to see gross margin improvement through Q3 from the benefits of that project..

And so, is the run rate – I'm sorry, is the run rate that you just achieved sort of indicative of the run rate we should see – where you should see until you cycle the launch of that initiative?.

From the flow through perspective, yes, but what also has to be taken into consideration to, Matt, is the fact that, when we have a strong Custom Closets quarter which is what you see on a recognized basis in both Q4 and Q1 as compared to Q2 and Q3, they represent a higher portion of total.

Elfa is the higher gross margin product for us, because of the consolidated benefits we receive there.

So that tends to cause the lift year-over-year to be even a little bit higher when that mix tends to be even stronger towards Elfa with the strong Elfa selling that we are seeing, which kind of leads to your second question around Elfa and Custom Closets is being largely driven by Elfa.

Elfa still dwarfs any other of the Custom Closets categories we sell.

Remember though that Custom Closets definition does also include the closet department accessories and we also had a very strong closet sale this year exact same timing as last year, but similar to how we did for kitchen, we changed the way we structured that sale and instead of it being across the board 15% of the entire department, the entire category from April 1 through mid-May, instead we chose select items and advertise those at 25% off.

So same exact format change to what we did kitchen, we did the closet and saw just like with kitchen saw very positive customer response to that..

Matt, it's a much more deliberate and targeted approach than just a blanket discount across the department..

Great. And then lastly, if I could, you spoke at great length about your efforts in digital and in social in particular.

Is there a way to size the social media footprint that you've launched or in the midst of implementing relative to what you had in the past?.

Not in terms of impressions..

Yeah..

We do track the PR type impressions we get and those are definitely largely around both the NorthPark launch and the brand marketing that we just....

Brand marketing..

...did..

And the digital just continues to perform through our media mix model as well as the social. So it's really matter of combination, we're just kind of firing on all cylinders and it's all kind of coming together.

And we'll – we continue to evaluate it very consistently, very strategically as we move forward through the rest of the year, and we'll continue to do that into next year as well. So, yeah, I don't know how to answer that any other way, Jodi.

Just from a spend perspective, digital spend is definitely on the rise and represents a much greater percentage of total. If you look over the last two years, it's grown to where it's – before we know it's going to be more than half..

Right. But we're still spending, Matt, about 4% of revenue on marketing, it's just reallocating it in a – I think a smarter and much more strategic data analytics driven way, and it's producing the results.

And so we're going to continue, but we're as I mentioned in my remarks, we're doing a lot of this in real-time which is really wonderful and it's paying off..

Thank you..

I hope that answers. Thanks, Matt..

Absolutely, thank you..

Thank you..

Thank you..

Great. Thank you. This does conclude the question-and-answer session. I'd like to turn the floor back over to management now for any closing comments..

Okay. I think that's it. Well, great, thank you guys so much for your interest and support of our company and we will very much look forward to talking with you in November with hopefully similar results. Thanks so much..

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