Greetings, and welcome to The Container Store Fourth Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, the conference is being recorded.

It is now my pleasure to introduce your host, Caitlin Churchill, Investor Relations..

Good afternoon, everyone, and thanks for joining us today for The Container Store's Fourth Quarter and Fiscal Year 2020 Earnings Results Conference Call. Speaking today are Satish Malhotra, Chief Executive Officer; and Jeff Miller, Chief Financial Officer. After Satish and Jeff 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, expectations regarding liquidity and goals, our anticipated financial performance and our plans in response to COVID-19 and the potential impact of COVID-19 on our business 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 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 June 17, 2020.

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 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 Satish.

Satish?.

one, through continuous improvement, which entails capturing operational efficiencies through process reengineering and leveraging technology in a way that allows us to become more efficient. Operational efficiencies will be reinvested back into the business to support our strategic priorities.

Two, by becoming an employer of choice, and fostering an environment that is diverse, inclusive and equitable, the recent hiring of our new Head of Diversity, Equity and Inclusion, will support this critical initiative.

Three, by expanding our focus on environmental, social and governance initiatives, I'm proud to announce that as of today, the power used by all of our stores, distribution centers and corporate office will now be offset by our investment in 100% renewable energy.

Additionally, we will perform a materiality assessment in fiscal 2021 and have just hired a new Head of ESG to support this effort. And finally, we will strengthen our capabilities by creating a more streamlined organization that is aligned to our strategic priorities.

And as previously mentioned, we have made several critical hires to complement our current leadership team. We are thrilled at The Container Store's ability to attract great talent, including the recent addition of our new Chief Information Officer, Preeti Saha.

In summary, these strategic priorities that I've just laid out are expected to drive market share gains and effectively double our business over time, and all the while unleashing the enriching benefits of organization to our customers. In closing, I could not be prouder of our teams for their accomplishments that they achieved before my arrival.

They navigated a challenging and dynamic environment throughout fiscal 2020 incredibly well. And they're hunger to win has fueled this powerful brand. Additionally, these results could not have been made possible without my predecessor's steady leadership and resolves to survive.

As we look ahead, we are eager to make The Container Store the best version of itself. I'll now turn the call over to Jeff to review our financial results and outlook in more detail..

Thank you, Satish, and good afternoon, everyone. As Satish shared, our fourth quarter performance exceeded our expectations. These results underscore an unprecedented year that required discipline and dedication from all of our teams. I could not be more proud of our results and the strong footing with which we enter fiscal 2021.

For the year, despite the impact of COVID-19 and resulting store closures, we delivered sales of $990.1 million and adjusted EPS of $1.24. These compared to sales of $916 million and adjusted EPS of $0.30 in fiscal 2019.

Fiscal 2020 includes approximately $17.7 million of incremental sales and $0.07 of incremental adjusted EPS related to the 53rd week. And turning to the fourth quarter, consolidated net sales, inclusive of the 53rd week, were $314.7 million, a 30.4% increase year-over-year.

By segment, net sales for The Container Store retail business increased 31.3% to $294.2 million compared to $224.1 million last year. As previously mentioned, the 53rd week contributed approximately $17.7 million of incremental sales to the fourth quarter.

And as a reminder, in Q4 of 2019, we had 51 store closures in the last few weeks of the quarter, of which 19 were closed longer than seven days. General merchandise categories were up 41.6% in Q4, contributing 19.4% of the 31.3% increase.

Custom Closets sales, driven by our annual Elfa sale, were up 22.2% and contributed the remaining 11.9% of our sales increase. Sales from our online channel were strong in Q4, increasing 72.2% over the previous year. When you include curbside pickup, our website generated sales in Q4 were up 92.7%.

These represent a total of 27% of TCS net sales compared to 18.4% in Q4 last year. We ended the quarter with a normalized level of orders taken but not shipped, totaling approximately $1.3 million. Elfa third-party net sales increased 18.8% to $20.5 million.

Excluding the impact of foreign currency translation, Elfa third-party net sales increased 5% year-over-year. From a profitability standpoint, our consolidated gross margin for Q4 was 59.3% compared to 59% last year. The 30 basis point increase was driven by higher intercompany profit on sales of Elfa product at TCS this year as compared to last year.

By segment, the gross margin at The Container Store decreased 60 basis points primarily due to increased shipping costs as a result of higher mix of online sales and an unfavorable mix of lower-margin product and service sales. These costs were partially offset by less promotional activity.

Elfa gross margin decreased 70 basis points, primarily due to higher direct material costs. Consolidated SG&A dollars increased 16.4% to $123.4 million compared to $106.1 million in Q4 last year. As a percent of sales, SG&A decreased 480 basis points versus last year.

The decrease is primarily due to the leverage of occupancy and payroll costs on higher sales during the quarter. Our net interest expense in the fourth quarter of fiscal '20 decreased 29.6% to $3.7 million from $5.3 million in the prior year.

The decrease is due to a lower principal balance on our senior secured term loan facility with lower interest rates. The effective tax rate for the quarter was 25.8% compared to 29.7% in the fourth quarter last year.

The decrease in the effective tax rate is primarily due to the impact of discrete items on higher pretax earnings compared to fiscal 2019. Net income for the quarter on a GAAP basis was $35.1 million or $0.69 per diluted share, this compares to GAAP net income of $12.5 million or $0.26 per diluted share in the fourth quarter last year.

Adjusted net income for the fourth quarter of fiscal 2020 was $35.7 million or $0.71 per diluted share. Included in both GAAP and adjusted earnings per share for the fourth quarter of fiscal 2020 is an approximate $0.07 benefit from the 53rd week.

Our adjusted EBITDA increased 66.8% to $59.5 million in the fourth quarter this year compared to $35.7 million in Q4 last year. Turning to our balance sheet, we ended the year with $17.7 million in cash, $166 million in net borrowings on our term loans.

Total liquidity, including availability on our revolving credit facilities, was approximately $126.8 million. Our current leverage ratio is approximately one time. We ended the quarter with consolidated inventory up 5.2%.

And while we've been able to keep inventory reasonably in stock, we continue to chase inventory in certain categories due to supply chain disruptions, and have adjusted our lead times accordingly. These adjusted lead times, along with increased sales, have led to increased inventory investment.

We are very pleased with our strong free cash flow performance. We generated $121.1 million in free cash flow during the year, up significantly from last year when we utilized $2.9 million in free cash flow.

We used a substantial portion of that free cash flow to pay down the balance on our term loan by approximately $78 million during the fiscal year and drive down our leverage ratios. The approximate $78 million pay down is inclusive of a $25.5 million payment we made during fiscal fourth quarter 2020.

Total CapEx for the fiscal year was approximately $17.2 million. We deferred approximately $12 million of certain cash lease payments in the first quarter of fiscal 2020. Of that amount, about $4.7 million remains deferred at the end of the fourth quarter, almost all of which is expected to be repaid in fiscal 2021.

As we enter fiscal 2021, we are very pleased with the start of our fiscal first quarter. We continue to see strength in our Custom Closets and general merchandise categories. As a reminder, we will be lapping certain pandemic-driven store closures that occurred in the first quarter of fiscal 2020.

As a result, we expect Q1 consolidated sales growth to be approximately 50%. Adjusted EPS in the first quarter is expected to be approximately $0.09. Embedded in our earnings outlook is the continued impact of incremental shipping surcharges and higher commodity prices on our gross margin.

However, we do expect Q1 fiscal '21 gross margins to improve over last year. The expected gross margin improvement over last year is due to a lower mix of online sales in the first quarter of fiscal '21 as compared to last year when we experienced temporary store closures and more promotional activity.

As it relates to SG&A in our first fiscal quarter of '21, we expect to leverage fixed costs on higher sales volumes when compared to the same period last year.

However, we don't expect SG&A leverage to be at the same levels we experienced in the second half of fiscal 2020 as we restore certain expenses that were temporarily eliminated in response to the pandemic combined with seasonally lower sales in Q1 as compared to the second half of the year.

We're not providing full year guidance at this time due to the unusual and dynamic environment in which can create a wide range of possible outcomes. However, I will share a framework that will hopefully be helpful as you think about bottom line dynamics for the full FY '21 as we cycle an unprecedented fiscal 2020.

In a scenario where sales increases are in the low single digits compared to last year, we would expect 150 to 200 basis points of operating margin contraction in fiscal '21 compared to fiscal 2020.

The expected operating margin contraction is related to the combination of lower gross margins and higher SG&A in terms of dollars and as a percent of sales. As it relates to gross margin, like other retailers, we are seeing freight and shipping cost headwinds, along with higher commodity prices.

We plan to employ multiple methods to help mitigate the impacts of higher cost which include vendor negotiations, actively managing our supply chain, along with adjusting our retail pricing and promotional cadence.

On the SG&A side, we plan to restore certain expenses that were temporarily pulled back in fiscal 2020 as part of our pandemic management strategy, such as reinstating 401(k) match and merit increases. The gross margin and SG&A pressures will be evident in Q2 and will build through the remainder of the year.

In fiscal 2021, we currently expect total CapEx to return to historical levels.

We expect CapEx to be approximately $47 million, and it will include investments in technology infrastructure and software projects, existing store merchandising and refresh activities, our Elfa product manufacturing capabilities and new store development, inclusive of one location opening in fiscal 2021 and another anticipated in fiscal 2022.

Additionally, we expect interest expense to be approximately $14 million and our effective tax rate to be approximately 30%. In closing, overall, we are proud of our fiscal 2020 performance, and the strong footing in which we have started fiscal 2021.

We look forward to executing on the strategic priorities, Satish laid out and updating you on our progress throughout the year. That concludes our prepared remarks. I will now turn the call over to the operator to open up the lines for questions..

Thank you. We will now have our question-and-answer session. [Operator Instructions] Our first question comes from Steven Forbes with Guggenheim Securities. Please proceed with your question..

Satish, you mentioned higher conversion and spend right among customers who visit your stores.

So just curious if you could provide a little more context here, right, as we think about the current, I guess, channel penetration rates in the business? And maybe you can talk about the typical customer journey, right? Those customers who are purchasing a lot, do they visit the store first, often, what is the difference in conversion and/or spend? Any sort of numeric statistics that you can speak to would be helpful..

Thank you for the question. Look, what I will tell you is based on some of the research and studies that we've done. Obviously, any time that we can greet a customer and then engage with them, we see both our conversion and our average ticket increase.

And that's why we feel very excited about our ability to add host into our stores and to ensure that we have zoning ready for our employees. It's something that we're very excited about.

We've actually just undertaken an industrial engineering study, where we're now pulling back some payroll that we would spend on non-selling activities and reinvest it back on to the selling stage so that we can be available for those customers that walk into the door..

And there's opportunity on the conversion side and the online part of our business, too, where we're investing, Steve, where we -- where we can make it easier for our customer to interact throughout our website, whether it's through search, through payment methods with our recent announced strategic partnership with Afterpay.

We can find multiple ways to get higher conversion, higher ticket with our customer base regardless of channel..

And then maybe just a quick follow-up, it might be a little early, but I feel like it's top of mind and certainly for myself.

As we think about, right, the potential for the return, right, of -- or reacceleration in unit growth, you mentioned testing a small format store, I believe, right, next year, and then you also mentioned a store and in-store concept.

So any sort of thought on the right cadence of growth, whether it's on a footage basis or how far out, right, is that store within the store concept and still sort of in idea formation stage? Or do you have partners in mind?.

Right. Well, Steve, as I mentioned, our second priority is definitely to expand our reach. And we definitely recognize a significant white space out there to open our new doors as well as the shop-within-shop concept, assuming we can find a quality retailer which we're confident we are looking for.

But our immediate focus is to really maximize the productivity of our existing channels. And I think that is the right focus for us to take.

And particularly, when you think about our stores and e-commerce business and how they're going to really greatly benefit from all of that product newness, collaborations, the private label, sustainably sourced products and the way that we will introduce Elfa sets and grab and go.

So -- I mean that's just one sliver of how we're looking to increase our growth within our existing footprint. We talked about the area of excitement that's going to -- that we look to bring about and really foster a deeper engagement with our customers and our excitement around amplifying our Custom Closets market.

So there are just a few areas of focus that we have in the immediate term to improve our productivity. And that will, in concept, be in the same manner as we look to explore what our future footprint is. As I mentioned, we have just hired our Vice President of Real Estate, and he can have joined us at a better time as we work through our growth plans.

But we are confident that we will be testing a smaller store footprint in fiscal 2022. And that's going to give us a lot of information for us to deploy our future growth plans..

[Operator Instructions] Our next question comes from Tami Zakaria with JPMorgan. Please proceed with your question..

So my first question is more longer term. I think you mentioned on your call that you see a $20 billion TAM for your business. I thought that was very interesting. So can you talk about the growth that segment has seen in the U.S. over the last few years.

And looking ahead, as you built on these initiatives, you talked about, do you believe you can start growing in line with this segment's growth? Or is there opportunity to outgrow the market? Any thoughts on the long-term growth potential you see..

Yes. Thank you, Tami, for the question. Look, we're really excited about the expansive addressable market, right? It's one of the reasons we called out the $20 billion opportunity. And we're so eager to get started on it that we've already kicked off several key initiatives that are going to allow to capture that growth immediately.

We talked about -- when you think about deepening our relationship with the customers, we talked about how we're already growing our sustainably sourced products to 10% of our assortment. We're in the midst of rolling out dedicated end in our stores. Our website now, spotlights are user-friendly in-depth guide for all of our sustainably-sourced items.

And then we're going to be launching The Home Edit collection, sustainable collection later this summer. That's just one example of what we're doing to capture this growth immediately. We've already started to accelerate the expansion of our private label business.

We've added host, as I mentioned earlier, and we're personalizing our interactions with our customers through targeted e-mails. When I think about our expanding our reach, I have to say I was extremely happy with the way that our targeted Avera promotion has allowed us to successfully deliver premium spaces averaging over $6,000.

It was a great way for us as a company to focus on a promotion and really see what we are capable of, and the results have been quite impressive. We're also bringing our B2B business in-house and we expect to see further growth coming from that. Jeff mentioned the implementation of some of our e-commerce strategic partners with Navar and Afterpay.

We're piloting Instacart right now in Texas, and it's doing very well. And so when I think about the size of the prize and our ability to quickly go after it, hopefully, the actions that I've just stated demonstrate that we're not waiting. And we are really excited in eager to go after that growth as quickly as we can..

Yes. Satish, I would add to that, we are the only retailer that has the unique position that we have, right? We talked about it already in the priorities that you -- that we're laying out here on this call is going to allow us to tap into that marketplace even more efficiently, more effectively..

Totally agree..

Got it. Super helpful. And then a quick follow-up.

Can you remind us what percent of your sales is currently Custom Closets? And given other products are seeing a nice benefit from all these collaborations, what's your sort of vision for the Custom Closets business in terms of its contribution to the total business, like where do you see the mix of this Custom Closets line go over time?.

Yes, Tami, right now, our custom Closets business is approximately 50% of our total. And as we continue to heavily focus on Custom Closets, we expect for that to continue to grow along with it. We're not necessarily sharing projections on how fast it's going to grow.

But certainly, it's part of the -- our ability to double our business to $2 billion over the next few years, that's a big piece of the equation..

That's right. And primarily, the reason we're not able to tell you the mix there is because all of these initiatives are going to be driving growth. And each of the priorities will contribute at various stages. And so, it's difficult at this stage to donate what percentage is going to be grown by which particular channel..

There are no further questions at this time. I'd like to turn the floor back over to management for any closing remarks..

Well, thank you so much for joining us today, and we look forward to making The Container Store the best version of itself. Have a great afternoon..

Ladies and gentlemen, this concludes today's conference. You may now disconnect your lines at this time. Thank you for your participation, and have a great day..