Greetings and welcome to The Container Store conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Caitlin Churchill, Investor Relations.

Thank you. You may begin..

Good afternoon everyone and thanks for joining us today for The Container Store's second quarter fiscal year 2019 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 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. These 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 30, 2019.

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 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?.

Thanks Caitlin and thank you to all who are joining our call today. I would like to begin by sharing the highlights of our fiscal Q2 performance and then speak about the progress we are making against our strategic initiatives. Jodi will then review our financial results in more detail and discuss our outlook.

Fiscal Q2 was another solid quarter for The Container Store, driven by a comp store sales increase of 5.4%, primarily due to strength in our Custom Closets business as well as continued growth in our other product categories.

As you know, Custom Closets represent approximately half of our consolidated sales and with our new Avera Closets product launch this past April, we believe we now offer the most comprehensive collection of Custom Closets available in the marketplace.

Our robust offering includes a full suite of four distinct product lines that positions us to capitalize on the estimated $6 billion Custom Closets market.

In addition, in order to fully service our customers with a complete solution, we offer an important wide selection of complementary products for their solutions, their projects to help them maximize their space and make the most of their home.

In Q2, our Custom Closets sales were up 9.3%, contributing 4.2 percentage points to our comp store sales reflecting broad based performance and positive customer reaction to our core offerings.

This includes ongoing strength in our Closet department as well as our new Avera line and a new gray color of our Elfa Decor product offering that we launched in June. Our other product categories increased 2.2% in Q2 and has had a positive comp store sales contribution of 1.2 percentage points.

This performance reflects the positive impact of our ongoing strategic initiatives, which includes the success of a new and exclusive product launch in May in collaboration with the celebrity organizers of the Home Edit. We are having great fun with them. It's a wonderful partnership that continues to generate social buzz and excitement.

And we recently added more fabulous products to this exclusive collection last month. And speaking of the Home Edit, you may have heard that they have begun production on a new Netflix series Focus on Celebrities, everyday clients and their organization projects.

We are just thrilled to have an exclusive Ambassador relationship with The Home Edit that we intend to grow. In addition to the success of our new product offerings, we also benefited this quarter from improved in-stock levels to support strong sales trends and new product launches.

We are building inventory at our new distribution center in Aberdeen, Maryland, which I will talk more about in just a moment. Our overall consolidated sales in Q2 were up 5.3% to $236.4 million. Performance at The Container Store was partially offset by a decline in Elfa's third-party sales of 2.6% in U.S dollars due to foreign currency translation.

Our third-party sales at Elfa were up 4.5% in local currency.

As expected, we did incur $1.7 million incremental marketing expense this quarter and $1.7 million of expense due to the setup of our second distribution center in Maryland, which was a combined operating margin drag of about 140 basis points and the combined $0.05 impact to earnings per share.

Second quarter adjusted earnings per share was $0.08 versus the $0.10 we reported in Q2 last year with the year-over-year decline more than entirely driven by the just mentioned investments in our second distribution center and marketing. Now I'd like to share just an update -- a quick update on our key strategic priorities. Starting with our stores.

As we discussed in our Q1 call, with only 93 stores today and substantial wide space across the country, we believe there is more than ample runway for new store growth. We plan to start capitalizing on this in fiscal 2020 with the completion of our investment in our second distribution center.

This year, fiscal 2019, we have planned two store openings, including one restore -- I'm sorry, one store relocation. We opened our 93rd store in Memphis last month and are very pleased with the customer response and our early results.

As a reminder, this store is another one of our smaller footprint stores under 20,000 gross square feet and reflects the learnings from our many test and learn activities, including our reimagined Dallas flagship store that we continue to use as a laboratory to test and try new experiences for our customers.

Our Dallas Galleria store will relocate and reopen as a Container Store Custom Closets store in Q3, and we'll have a format similar to our Farmer's Market, Los Angeles store, which after being closed for five weeks reopened as our first The Container Store, Custom Closets store this past July.

We are delighted with our redesigned and rebranded Farmer's Market store that has a substantially increased visual presentation of Custom Closets, as well as many other visual presentations for all areas of the home, over 60 display solutions to help our customers with their projects.

We look forward to building a pipeline of Custom Closets customers while simultaneously generating valuable learnings that we intend to incorporate into our go-forward existing and new store growth plans.

Our recently completed renovation of our Reston, Virginia Store includes an expanded Custom Closets section showcasing all four of our Custom Closets lines, Elfa Classic, Elfa Decor, Avera and Laren. And by expanding the Custom Closets area, we were able to double the amount of closet displays in the store.

Our enhanced design center presentation allows our customers to better experience the features, benefits, style and design of all our Custom Closets options.

We also reimagined our existing shelving department in our Reston store to highlight solutions for various areas of the home such as garage and home office and pantry and laundry, all supporting our strategic vision of providing our customers with complete organizing solutions for their home.

This renovation was completed at the end of September and provides a scalable template that can be incorporated across many of our existing stores as we evaluate the customer response. The successful interplay of our stores and our online channel continue to work well together to drive cross channel sales and Custom Closets leads.

Our robust online channel increased 18.5% in revenue in Q2, thanks to continuous optimization of our digital marketing spend and a more dedicated attention and focus on online merchandising. We recently redesigned our online checkout process, making it significantly easier for our customers to check out.

The new design consolidated our multi-page checkout process down to a simple two-step process. And since it has been implemented last month, we have seen growth in sales, particularly from those customers checking out on a mobile device.

The success we are seeing with our merchandising initiatives as reflected in our comp store sale performance as I previously shared.

And in addition to new product introductions across both Custom Closets and other product categories, the merchandising team has been focused around exclusivity of products, global sourcing to reduce cost and mitigate tariffs and private label. During Q2, we introduced expanded private label products across our kitchen and closet departments.

This includes, for example, our new everything to organizers and refrigerator bins and numerous closet department programs. We anticipate incremental sales and gross margin opportunities from these private label programs as they continue to grow and mature.

The Container Store brand we know has tremendous upside for growth in private label, especially when leveraged with our global sourcing initiative.

We've also seen good success as we added to our collection of grab and go Elfa products taking learnings from the curated collections we created online and adding more box sets that make it easier for our time starved customers to purchase.

New pre-packaged products featured included door and wall rack and a narrow cabinet door organizer that works beautifully in many areas of the home, including bathroom vanities. Our holiday shop merchandise is now available in our stores and online.

We've worked hard to streamline this product collection incorporating our data and customer feedback from last year. We've approached this season more conservatively from an inventory ownership standpoint and instead have enhanced plans to drive sales around our core everyday storage and organization solutions.

For example, from October 14 through November 10, we are conducting our first ever kitchen and pantry holiday sale with the objective to motivate our customers to get organized for the holidays.

I know tariffs continue to be top of mind, so I want to be clear that our outlook for this fiscal year includes the impact of all currently proposed and effective tariffs on Chinese imports.

We believe we are well positioned to manage the higher tariffs and are taking the steps that we have previously discussed to mitigate their impact, such as sourcing options, vendor collaboration and selective price changes.

Fiscal '19 is a year of marketing investment for us and we remain on track to spend the planned approximate $6 million increase in marketing. This increase is dedicated to The Container Store Custom Closets to build awareness of our full suite of Custom Closets and complementary products.

We continue to use our brand marketing tag line, The Container Store Where Space Comes From in our marketing messages and continue to use our media mix model to direct spend and maximize return on investment. Our POP! program enrollments continue to grow and we finished Q2 with over $8 million POP! Stars.

These customers are our most loyal and generate the majority of our sales, and in turn we provide them with special benefits such as early access to our holiday shop collection and early access to The Home Edit exclusive new products. And our collaboration with The Home Edit goes beyond developing exclusive product.

This collaboration also extends our brand reach given the very successful digital and social presence that the Home Edit have, they are an important organization category influencer.

And our trade program was redesigned and relaunched in fiscal 2018 and we continue to see excellent traction with our new updated program, particularly around The Container Store Custom Closets.

While still small, we're pleased to have more than doubled both the number of trade members in our program as well as the level of sales generated by trade members overall.

We intend to continue growing our trade program through new partnerships with professional organizers, architects and interior designers and by promoting our brand with select trade shows and publications.

And finally, we are extremely pleased with the progress of our new second distribution center in Aberdeen, Maryland, which continues to perform on time and on budget. We began receiving product to the facility in July and this month, we began outbound shipments to stores, and direct to customers as we ramp up the volumes shift out of this facility.

The stores that are expected to receive shipments from the distribution center are scheduled to do so by the end of November 2019 with shipments direct to customers gradually increasing through March 2020. At that time we expect half of our direct shipments from the new facility and the other half from our Dallas distribution center.

When the new facility in Aberdeen Maryland is fully operational, we expect to ship about 60% of store and direct to consumer -- to customer orders out of our Dallas distribution center and 40% out of our Aberdeen distribution center, improving delivery time -- times to customers and realizing efficiencies.

We also look forward to generating the estimated $6 million or $0.09 per share improvement and freight savings next fiscal year 2020, when the new facility is fully up and running. We are updating our fiscal 2019 outlook today to incorporate our actual results for the first half of the year and our current views on the remainder of the year.

We now expect our net sales and comparable store sales to be at or slightly above our previously provided ranges of $915 million to $925 million and 2% to 3% respectively. Additionally, we now expect our GAAP and adjusted EPS to be towards the low end of our previously provided range of $0.41 to $0.51.

So in summary, it was a good Q2 during which we continued to deliver traction against all of our key strategic priorities. The work we’ve been doing across stores merchandising, marketing, technology and infrastructure is having an impact and driving our operational and financial performance.

Importantly, all of this work positions us well to capitalize on the many opportunities that lie ahead, and we look forward to updating you on our progress. Okay. So, Jodi will now go over the financial results and our outlook in more detail..

Thank you, Melissa and good afternoon everyone. I will now cover our second quarter financial results in more detail. Consolidated net sales increased 5.3% year-over-year to $236.4 million.

By segment, sales for The Container Store retail business increased 5.9% to $221.2 million, reflecting a comp store sales increase of 5.4% as well as sales contribution from new stores. We saw strength across our Custom Closets business, which was up 9.3%, as well as strong performance from our other products' categories, which were up 2.2%.

Elfa's third-party, net sales decreased 2.6% to $15.2 million due to the negative impact of foreign currency translation during the quarter. On an SEK basis, Elfa third-party sales were up 4.5% year-over-year. From a profitability perspective, consolidated gross profit dollars increased 4.8% to $136.8 million.

Consolidated gross margin declined 30 basis points to 57.9% primarily due to sales mix at The Container Store, which included strong selling of products from improved merchandise sale campaigns.

Gross margin at The Container Store retail business was down 80 basis points, primarily due to successful marketing and merchandising campaigns that drove a higher mix of lower margin products and service sales year-over-year. This was partially offset by foreign currency tailwinds.

Elfa's gross margin increased 110 basis points from the prior year period, primarily due to production efficiencies, partially offset by higher direct material costs attributable to increased raw material costs associated with a weaker Swedish krona.

SG&A as a percentage of net sales increased 110 basis points versus last year, primarily due to incremental Custom Closets marketing expenses as well as healthcare and real estate property tax expenses, partially offset by ongoing savings and efficiency efforts.

Our net interest expense in the second quarter of fiscal 2019 decreased 26.8% to $5.4 million from $7.4 million in the prior year, due to the September 2018 amendment of our senior secured term loan facility. Pre-opening costs increased to $2.3 million during Q2 of fiscal 2019 as compared to $900,000 in Q2 last year.

The increase was primarily due to $1.7 million of costs associated with the opening of the second distribution center. We opened one new store in Q2 of each year.

The effective tax rate for the quarter was 26.8% compared to 30.4% in the second quarter of last year with the decline due to the jurisdictional mix of income and additional tax deductions related to stock compensation.

Our net income for the quarter on a GAAP basis was $3.6 million or $0.08 per share as compared to our GAAP net income of $3.2 million or $0.07 per share in the second quarter of last year.

On an adjusted basis, excluding costs associated with closing down Elfa France operations in Q2 this year as well as the losses on extinguishment of debt in Q2 last year, adjusted net income was $3.9 million or $0.08 per share as compared to adjusted net income of $4.7 million or $0.10 per share last year.

Adjusted EBITDA was $22.4 million in the second quarter this year compared to $24.3 million in Q2 last year. The decrease in adjusted EBITDA was primarily due to the $1.7 million of incremental marketing investment. Turning to our balance sheet.

We ended the quarter with $9 million in cash, $285.8 million in outstanding borrowings and combined availability on revolving credit facilities and cash on hand of $91.5 million.

I should also note, that we adopted the new lease accounting standard at the beginning of this fiscal year, which resulted in a gross-up of our balance sheet by approximately $350 million. As expected, we ended the quarter with consolidated inventory up $22.4 million or 20.2%.

Of this increase, approximately $14.4 million relates to inventory received by the end of Q2 at our second distribution center, and the remaining increase is primarily due to new product introductions, including the new Avera Custom Closets line and new great Elfa Decor -- new greater core from Elfa.

On a per store basis, excluding the inventory associated from the new distribution center, inventory levels at TCS were up 9.6%.

As we previously shared, we expect to carry elevated inventory levels throughout the year as we receive inventory at our new second distribution center, while continuing to ship to most of our stores out of our Dallas area distribution center.

As Melissa mentioned, we just began outbound shipments out of the new facility which will continue to ramp through the end of the fiscal year.

We still expect our inventory position to be more normalized by the end of the fiscal year when our new distribution center is fully operational after taking into consideration inventory ownership of Elfa and new -- of Avera and new Elfa Decor not yet owned last year. Regarding our fiscal 2019 outlook.

We are updating our established outlook for the year as Melissa shared. After factoring in our results for the first half of the fiscal year, we now expect fiscal 2019 consolidated sales and comp store sales to be at a slightly above our previously provided ranges of $915 million to $925 million and up to 2% to 3%, respectively.

We now expect GAAP and adjusted EPS to be towards the low end of our prior outlook of $0.41 to $0.51. On a weighted average of 49 million diluted shares outstanding.

Fiscal 2019 EPS outlook, still includes approximately $6 million of incremental Custom Closets focused marketing, or $0.08 per share and a 50 basis point headwind, as well as an estimated $4 million or $0.06 per share headwind associated with net expenses to get the second distribution center up and running.

The combined headwind in fiscal 2019 related to incremental marketing and the second distribution center is approximately $10 million or $0.14 per share. In fiscal 2020, we continue to expect considerable freight savings from the second distribution center of $6 million or $0.09 per share increase in EPS from fiscal 2019.

We now expect our tax rate for the full fiscal 2019 to be approximately 31% and our annual interest expense using forward LIBOR rates to be approximately $22 million. As Melissa also shared, our fiscal 2019 outlook does include the impact of our currently announced tariffs from China.

I also want to note that retail price changes are an action we've used to protect gross profit dollars, but they do have a slightly negative impact on gross margin rate.

Our current thinking around the quarterly comp store sales cadence for the remainder of the year is that we continue to expect to see comp moderation in Q3 as we are still planning the holiday quarter with conservatism and low single-digit negative comp store sales in Q4 as we are also still conservatively thinking about cycling the strong 8.5% comp store sales we delivered in Q4 last year.

Specific to our third quarter, there are a few callouts. One, we currently expect our Q3 comp store sales to be in line with our fiscal 2019 annual outlook ranges.

Two, during Q3, we expect to spend approximately $1.5 million incremental marketing over last year, in order to support the launch of The Container Store Custom Closets brand marketing efforts, including the introduction of the Avera product line.

Three, in Q3, we also expect to incur approximately $2 million in expense related to the second distribution center. Four, Q3 is expected to utilize a tax rate of approximately 36% for GAAP and adjusted EPS, due to tax implications to stock compensation forfeitures. We now estimate our tax rate for the full fiscal 2019 to be approximately 31%.

And as a result, given the cadence of these investments, we currently anticipate EPS to be down in Q3. In summary, we are pleased with our Q2 financial performance.

We remained focused on disciplined execution of our key strategic priorities to drive sales and profitability while making strategic investments in our brand building campaigns and new distribution center.

We expect to begin to benefit from our second distribution center investment as early as the fourth quarter when our new facilities comes fully online. We look forward to updating you on our progress on our next earnings call. Thank you. Now I'd like to turn the call back over to the operator, so that we can open the lines for questions.

Michelle?.

Thank you. [Operator Instructions] Our first question comes from the line of Steve Forbes with Guggenheim Securities. Please proceed with your question..

Hey guys, it's Steve Kowalski on for Steve Forbes. Thanks for taking my question..

You bet..

I just wanted to start with your learnings from the farmer store -- the Farmer's Market store in Los Angeles, as well as the Reston and maybe any learnings you've had from those in regards to your capital allocation moving forward, unit expansion versus remodels?.

You bet. Well, first of all Farmer's Market as I said in my remarks, we closed that Store for five weeks and we redesigned it, we remodeled it and we reopened it on July 20th. And so far the feedback has been quite positive. I mean, this is our very first concept store of The Container Store Custom Closets store.

I can say that it's still obviously quite early, but initial results are as we expected. The employees are super fired at and we're getting good customer response.

We did expect our Century City store also in LA to pick up some of the other general merchandise sales, because we did rationalize some of the products out of Farmer's Market so that we can increase the Custom Closets footprint, which is over 60 displays. So we are watching it very, very closely.

I hope everybody on this call can get out there and see it. It is absolutely beautiful. And we will be relocating our Dallas Galleria store in Q3 as I said some time in December, and it will also reopen as The Container Store Custom Closets store.

And then in Reston Virginia we've taken kind of a typical -- prototypical existing store and we have greatly expanded the Custom Closets presentation and then we redesigned our shelving department. But we are not changing the name of that store, it will still say The Container Store.

And it will still have the same kind of primary look and feel, as many of our other stores. So we got a lot of test and learnings happening and we're still learning from our Northpark reimagine store that we did about what 18 months ago Jodi, I guess. So we've got and we still using that as a laboratory. So we're very excited about this.

And this will determine our growth strategy going forward with new stores, as well as possible future remodels for the existing stores, because we have about 70 stores, I would say that are pretty typical to a Reston footprint..

Great. Thank you. And then maybe shifting gears to Avera, I know it's still in the early days, but if you're seeing any cannibalization.

How shopping trends have really shifted within the Custom Closets?.

Yes, it's still so early, I wish I had more data, it's just still so early to really discern any potential cannibalization. We are obviously monitoring that very closely. Avera did definitely contribute to our Custom Closets sales growth in Q2 and we expect that to continue. The response by customers has been strong.

The response by the media has been strong. And so again we feel like if this was a void in our offering, and we feel really good about our suite of Custom Closets offerings now and all the finishes and the options that go with it. So we will keep you posted on that as we continue to support it and market it and monitor it carefully..

Great. Thank you..

Thank you..

[Operator Instructions] Our next question comes from the line of Tami Zakaria with JP Morgan. Please proceed with your question..

Hi, Melissa and Jodi. Thanks for taking my question..

Thank you. So my first question -- my first question is around operating margin for the back half.

So are you still expecting full-year operating margin to be flat to slightly up, given that now you're expecting EPS to be in the lower end of the previous guide?.

Hi, Tami. This is Jodi. And I will take that, and let me step back and just kind of frame what we've seen so far for the first six months, as I'm sure you're looking at it. So if you look at the first -- the year-to-date period through Q2, we saw a lift in consolidated, obviously sales are up significantly as you've seen.

We saw lift also consolidated gross profit dollars, those were up 4.6%. Operating income for this period is down $1.6 million, but that does include $6.5 million of combined incremental costs related to the second DC and Custom Closets brand marketing.

And of course for Q2 alone, if you look at the reported, adjusted EPS at $0.08 that also incorporates $0.05 of those same cost, the second DC in the marketing. So obviously without those EPS would have been up nicely over last year. I just think we feel good about the direction we're going here.

We do know that the brand marketing and the second distribution costs are expected to be approximately $10 million, as we said, which will drag this year's earnings, but we feel very good that those, will in the case of the second distribution center, we quantified the dramatic improvement we expect next year, because of the freight savings associated with that.

And then also as it relates to the marketing, obviously, we didn't -- Custom Closets is a longer purchase cycle.

So when doing such marketing, we don't expect that to have an immediate payback, we think that's something that really helps us to capitalize on that estimated $6 billion opportunity that is out there and we know we still are a small player as a part of. So hopefully that answers your question..

It does. Thank you so much. That's helpful. And then my second question is, you mentioned selective price increases to accommodate tariffs.

So can you comment on what you've seen in terms of customers responding to that? Are they purchasing lower volume, but being -- that's being offset by the price increase and where the price increases across the portfolio or only on tariff impacted items?.

Good question, Tami, and I will take that. It's just, let me, let me sort of set the stage as a reminder. First of all, we are confident that with the tariffs that we've seen flowing through our P&L that our actions we've taken, that they are mitigating those costs.

So we don't believe that our results are being negative impacted -- negatively impacted by the actions that we've taken. And price is just one of the many actions that we've taken. Just to give it a little bit more color, we have a total of approximately 2,100 SKUs that have been tariff impacted out of our assortment which is around 10,000 SKUs.

And if you look back at this, right now we have, we are paying tariffs directly on about 17% of our purchases. Where we've taken price, is only on about 470 SKUs.

And we did this very granularly utilizing all of the great work that we had already been doing on our pricing projects, so we're very fortunate that we were already very deep with having a lot of learnings and systems and knowledge and focus around that, so we can use our analytics to help inform the decisions.

It's been, not a one-size-fits-all approach being done very, very literally down to the SKU level. But we have conservatively, Tami, assumed that we would see volume declines with the goal to mitigate gross profit dollar impact where we did take price. So I just did a high level, I would say ,we're very pleased with the approach we take into this.

And we feel like it's worked well..

Thank you. That's actually great color. Thank you so much. I have a quick follow-up on that. So you mentioned you're currently paying tariffs on 17% of purchases.

Can you comment how much it goes up with the impending December '15 tariffs?.

I prefer not to be specific on the dollars with that, but I can assure you that we already are thinking carefully through that and we will make sure that the same actions that we've been considering will be utilized, so that again we've -- we thought of that as we're giving our outlook, so that there is not further risk to our numbers based off of the assumption that will happen..

Thank you. That's super helpful. Thank you..

You're welcome..

Thanks, Tami..

Thank you. There are no further questions at this time, I would like to turn the call back over to management for any closing remarks. Melissa Reiff Thank you, Michelle, and thanks again to all joining the call. We appreciate your support and interest and we look forward to talking to you when we report Q3. Thanks so much. Have a good day..