Greetings, and welcome to The Container Store Second Quarter 2023 Earnings 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, Caitlin Churchill of 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 2023 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 would like to remind everyone that certain matters discussed in today's conference call are forward-looking statements relating to future events, management's plans and objectives for the business and the future financial performance of the company that are subject to risks and uncertainties.

Actual results could differ materially from those anticipated in these forward-looking statements.

The risk factors that may affect results 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 26, 2023, as updated by our quarterly reports on Form 10-Q and other public filings with the U.S. Securities and Exchange Commission.

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 our 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 and investor deck 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..

Thank you, Caitlin, and thank you all for joining our call today. I will begin today's discussion by reviewing highlights from our second quarter performance. Jeff will then review the details of our second quarter financial results, followed by our outlook. We'll then open up the call to questions.

As we discussed on our last call, we expected a challenging quarter on consumer spending impacted by long-term inflationary pressures, substantially increased interest rates and overall market uncertainty.

And that is essentially what we saw a continued year-over-year decline in our customer traffic and fewer units being purchased by them, especially in our core and more value-oriented categories. The monthly cadence of our sales decline was steepest in July, which we primarily attribute to customer distraction with summer travel.

Those declines did slightly moderate in August and September. Additionally, we benefited from the earlier than planned start of our 75th Elfa anniversary event, which assisted us in delivering sales and adjusted EPS above the high end of our expectations.

However, as we look to the second half of the fiscal year, we had slightly lower revenue expectations, and we now expect to be contending with challenges in gross profit driven by sales mix and in SG&A expenses, all of which are driving changes to our full year outlook, which Jeff will go over shortly.

For Q2, overall consolidated net sales were $219.7 million, down 19.4%, compared to the prior year period of $272.7 million. From a profitability standpoint, we delivered gross margin expansion, driven primarily by freight tailwinds and shorter run general merchandise promotions, which was a learning we took away from our Q1 test.

The gross margin expansion partially offset the significant expected SG&A deleverage, leading to adjusted income per share of $0.01. This was above the high end of our expectations and driven by the execution of our SG&A reduction plan.

The sales headwinds notwithstanding, I am pleased with how our organization has remained focused on executing across our strategic priority of deepening our customer relationships, expanding our reach and strengthening our capabilities. We are aiming to position ourselves for outsized share gains when the market normalizes.

Let me now provide some key highlights on our most notable accomplishments in Q2. As it relates to store experience and customer service, we are proud to receive high marks for our efforts in this area. Our store's Net Promoter Score remained strong at 81 for the second quarter.

This score is a testament to the dedicated efforts of our store specialists. Their expertise extends from conducting educational demonstration of our new premium product to providing exceptional service and specialized knowledge in their respective areas.

Our Organized Insider loyalty program remains a key to deepening our customer relationships with the average ticket more than 45% higher than non-loyalty members. Experts, our highest loyalty team members, are spending 5x more than our enthusiast numbers. In Q2, we enhanced the journey of our insiders through ongoing storytelling.

Now when a customer joins the program, they receive engaging educational communication about our organizing solution, custom spaces and in-home services to ensure they understand all that we have to offer them in their transformational journey with us.

On the product front, we continue to enrich our assortment with more premium and upscale items, which we believe not only drove new customers to shop with us but was also positively received by existing customers as well.

In fact, recent customer intercept validated that our new premium products are giving customers more reasons to shop with us and that they see The Container Store as a one-stop shop for both their organizational and home beautification needs.

For example, we saw a great success with our back-to-college campaign, which gives us the opportunity to engage with new and existing customers during an important milestone each year. To recap our 2023 effort, we ran our annual college offer where college parents and college students could sign up to receive 25% off their purchases.

Curated a complete and compelling college shop with new-to-us categories in stores and online and activated pop-up stops in 36 college campus bookstores nationwide. Our college offer brought in 35% new customers, saw a 68% increase in sign-up and drove a 43% increase in sales compared to last year.

From our pride and food underbed storage to multidirectional moving fan, to an innovative 3-drawer charging cart from Dormify, we attribute the campaign's success to positioning The Container Store as a one-stop shop for college with our enhanced and expanded assortment.

In addition, we launched our uncontained branding campaign during the four-product spotlight. This campaign supports our ongoing expansion into strategic growth categories that complement our core offerings, including on-the-go travel, dining, entertaining, home decor and textiles.

We introduced more than 400 new products across these categories in September. And like college and other new product introductions, we have shared sales have exceeded our expectations.

We consider over 85% of the general merchandise in this introduction to be premium and includes brands like Cadence, which offers original magnetic travel capsule, the civically known for a socially conscious artisan-made homegoods and Fortessa known for its innovative break-resistant barware.

This gives us confidence in our direction and focus on bringing in more upscale and premium solutions, particularly those that complement our premium custom spaces. Though this new product is a sales tailwind, it does come at a lower gross margin, but some of our more mature and larger volume, core and value-oriented product category.

While we do expect to improve the margin profile of these new more premium products, lines over time, we have updated our full-year outlook to reflect the current impact of this mix on our gross margin.

As we move into the remainder of the year, customers will see more new products and seasonal assortments during key periods, giving them more reasons to shop with us. Earlier this month, we introduced more than 1,000 products as part of our seasonal holiday offering, supported by an instore and online holiday shop.

Digital and traditional marketing, including an elevated direct mail look book. Approximately 80% of this assortment is new and almost half is considered premium, and 55% is limited distribution or exclusive to The Container Store. We believe it is our best holiday assortment yet.

There are more gift-giving opportunities, along with curated premium decor than we've ever had during this time period. For example, customers will discover festive table arrangements and decor that complement our holiday trends, including a collection of artisan-crafted stoneware from Be Home.

Additionally, customers can explore elevated gifting opportunities like exclusive and timeless leather travel essentials from Cuyana, innovative and premium pet brands like table and hidden, premium gift wrapping, holiday storage essentials and so much more.

On the Custom spaces side, we have continued to see relative strength compared to our general merchandise performance and resilience in our premium Avera and Preston line despite the challenging environment.

With interest rates as high as they are, coupled with fewer homes in the market, we do believe we could benefit from customers investing in their homes more, which is one of the reasons we are being very intentional with our focus on strengthening our customer spaces offering.

We ended the quarter with 135 in-home designers, who are focused on selling premium spaces and growing more than 85% of premium sales in Q2. The effort we are putting into improving lead contact time, quality service is reflected in our custom spaces Net Promoter Score, which continues to trend positively, an increase to 81, up 2 points from Q1.

Additionally, we are adding an incremental investment in marketing in the second half of fiscal 2023 to support overall custom space awareness and lead generation. As previously shared, we look forward to start launching Garage+ by Elfa in November, which bridges the gap between our entry-level Elfa Classic and premium Preston garage offerings.

It pairs strategically with our Garage general merchandise. With features like lighting, fully enclosed wall and rolling cabinet and heavy-duty work bay, we are bringing to the market to rethink our customers' want at a competitive price. Moving on to new stores.

We are successfully expanding our reach with an average of over 60% new customers shopping with us in these locations. We opened our San Mateo, California location before the end of Q2 and our new Woodland Hills, California locations just over a week ago.

We continue to be pleased with the productivity of our small-format stores, specifically with the faster adoption of customer spaces, which is averaging 39% of sales per store. In addition, the Net Promoter Score for our small-format stores remained incredibly strong at 83.

Looking ahead to the remainder of the fiscal year, we expect to open 3 more small-format stores for a total of 5. Our previously announced Miami location will be shifting to fiscal 2024 due to construction delays.

To highlight one of our technology initiatives in Q2, we have started testing AI-generated content on our website to create efficiencies and personalize the online experience for our customers.

This content is now automatically generated based on sophisticated prompts that incorporate customer reviews, [indiscernible] partner content that allows us to enhance product display pages, providing even more compelling reasons to buy and greatly improving search capability.

And finally, as I've said many times, our employees are the lifeline of this company, and all contribute to its long-term stability and growth. Investing in our people and recognizing their contribution is critical in remaining an employer of choice.

In Q2, we announced the reinstatement of our annual employee pay increase for eligible employees effective October 1. Like everyone, our people are contending with inflation, higher cost of living and other economic pressures, and we firmly believe this pay increase was the right thing to do.

We also added back some store payroll hours and our revised SG&A outlook now reflects these decisions. Additionally, we launched a new recognition program, TCS Appreciates. This program facilitates peer-to-peer celebration to acknowledge the ways that our team members exemplify our company's foundation principles every day.

Before I turn the call over to Jeff. I want to reiterate our conviction in our strategy that we believe will serve us well and deliver share gains when consumers begin prioritizing investments in their homes and market conditions normalize.

We have a strong balance sheet in place and believe we are navigating today's environment with exceptional discipline while ensuring we further strengthen our competitive position. With that, I will now hand it over to Jeff.

Jeff?.

Thank you, Satish, and good afternoon, everyone. As Satish reviewed, we continue to contend with a tough macro backdrop and industry pressures that impacted our second quarter performance. However, our results did exceed our guidance ranges. For the second quarter, consolidated net sales decreased 19.4% year-over-year to $219.7 million.

By segment, net sales for The Container Store retail business were $208.5 million, a 19.8% decrease compared to $259.9 million last year. The decrease is inclusive of the comp store sales increase of 20%, driven primarily by the 20.4% decline in our general merchandise categories, which negatively impacted comp store sales by 1,320 basis points.

Custom spaces comp store sales declined 19.3% compared to last year and negatively impacted comp store sales by 680 basis points. Sales from new stores more than offset the discontinuation of C-Studio third-party sales year-over-year, which benefited total TCS net sales by 20 basis points.

For the second quarter, fiscal 2023, our online channel decreased 21.7% year-over-year, and our website-generated sales, which includes curbside pickup, decreased 16.4% compared to last year. Website-generated sales represented a total of 21.8% of TCS net sales in Q2, compared to 20.9% in Q2 last year.

Unearned revenue decreased to $18.3 million in Q2 this year versus $22.1 million last year and reflects the pullback in customer spending that we are experiencing. Elfa third-party net sales of $11.2 million decreased 12.5% compared to the second quarter of fiscal 2022.

Excluding the impact of foreign currency translation, Elfa third-party net sales decreased 10.7% year-over-year, primarily due to a decline in sales in the Nordic markets. The decline in Elfa third-party sales reflects the continued challenging macroeconomic environment in the Nordic and other regions due to higher inflation and interest rates.

From a profitability standpoint, our consolidated gross margin for Q2 increased 100 basis points to 57.6%, compared to 56.6% last year. By segment, TCS gross margin increased 10 basis points, compared to last year, primarily due to lower freight costs, partially offset by unfavorable mix and increased promotional activity.

The unfavorable mix was primarily related to a shift in sales mix to lower margin general merchandise products during the quarter and the increased promotional activity was primarily related to custom spaces as we had an earlier than planned start of our 75th Elfa anniversary event.

Elfa gross margin increased 500 basis points compared to last year, primarily due to price increases. Consolidated SG&A dollars decreased $9.4 million or 7.9% to $109.3 million, compared to $118.7 million in Q2 last year, which reflects the cost management actions taken in the first quarter.

As a percent of net sales, SG&A margin increased 620 basis points year-over-year to 49.7%. The increase is primarily due to deleverage of fixed costs associated with lower sales in the second quarter of fiscal 2023. Additionally, SG&A spend in Q2 last year included a $2.6 million net benefit from a onetime legal settlement.

During the quarter, we completed impairment test of goodwill and indefinite-lived intangible assets and concluded there was a total non-cash impairment of goodwill and the TCS reporting unit in the amount of $23.4 million. Our net interest expense in the second quarter of fiscal 2023 increased to $5.2 million, compared to $3.8 million last year.

The year-over-year increase is primarily due to a higher interest rate on our term loan and to a lesser extent, higher borrowings on the revolving credit facility during the quarter. The effective tax rate for the quarter was negative 2.6%, compared to 25.9% in the second quarter last year.

The decrease in the effective tax rate was primarily related to the impact of discrete items on a pretax loss in the second quarter of fiscal 2023 as compared to pretax income in the second quarter of fiscal 2022.

Net loss for the quarter on a GAAP basis inclusive of the $23.4 million non-cash goodwill impairment charge was $23.7 million or $0.48 per share as compared to a GAAP net income of $15.7 million or $0.31 per diluted share in the second quarter of last year.

Adjusted net income was $365,000 or $0.01 per share as compared to last year's adjusted net income of $13.8 million or $0.27 per diluted share. Our adjusted EBITDA decreased to $17 million in the second quarter of this year, compared to $35.9 million in Q2 last year. Turning to our balance sheet.

We ended the quarter with $10.2 million in cash $173.2 million in total debt and total liquidity, including availability on our revolving credit facilities of $104.3 million. Our current leverage ratio is 2.3x. We ended the quarter with consolidated inventory down 8.8% compared to the second quarter last year.

The decline is primarily the result of lower freight costs and inventory year-over-year. Capital expenditures were $22 million in the first half of fiscal 2023 versus $32 million in the first half of fiscal 2022, which reflects the planned pullback in capital spending in fiscal 2023. We are continuing to invest primarily in our stores and technology.

Free cash flow in the first half of this year was a use of $1.3 million versus a use of $5.3 million in the first half of last year. Now for our outlook. As Satish alluded to, we have updated our outlook to reflect certain items impacting the top and bottom-line that I will discuss.

While the macro backdrop remains tough, we continue to be extremely disciplined in investing in inventory, planning our campaigns, managing our expenses and allocating our capital while simultaneously making prudent investments in alignment with our strategic initiatives and longer-term growth plans.

For the third quarter of fiscal 2023, we expect consolidated net sales to be approximately $220 million to $225 million, driven primarily by a comparable store sales decline of mid-to-low teens.

The expected decline in comparable store sales is reflective of a pullback in our core and value-oriented products in the third quarter compared to our previous outlook. The expected consolidated revenue declines are inclusive of continued Elfa third-party headwinds, which we expect to be more than offset by new store sales.

We expect adjusted net loss per share in the third quarter to be in the range of $0.08 to $0.04. The implied year-over-year operating margin decline for the third quarter is expected to be more than entirely driven by SG&A, primarily due to fixed cost deleverage on lower sales.

Our SG&A spend expectations for the third quarter have increased from our previous outlook and include incremental investments in primarily store payroll, pay increases and marketing.

From a gross margin perspective, freight is still expected to be a tailwind to gross margin in the third quarter in comparison to last year, partially offset by unfavorability within our general merchandise product mix.

Our outlook reflects our expectation that we will continue to drive increased sales from our new general merchandise product, while also seeing greater pressure on our higher margin and core general merchandise products. Interest expense for the third quarter is expected to be approximately $5.3 million, driven primarily by higher interest rates.

We expect income tax expense in the range of $2 million to $2.5 million, primarily driven by discrete tax items in the third quarter. This discrete tax expense is primarily related to the expiration of certain stock options granted in connection with our initial public offering in 2013.

As a result of these discrete items, our effective tax rate is expected to be in the range of negative 50% to negative 145%.

With respect to fiscal 2023, our press release outlines our current versus prior outlook, the key changes are as follows; we now expect consolidated net sales in the range of $870 million to $885 million, or $5 million lower than our previous outlook.

We continue to expect less significant declines in comparable store sales in the second half of the fiscal year, driven by our planned cadence of new product introductions and campaigns and easing comp comparisons from the prior year.

The implied low to high teens fourth quarter comparable store sales declines are primarily related to our planned custom space campaign cadence in fiscal 2023 compared to last year.

We believe there could be more Elfa product sales headwinds in the fourth quarter in comparison to the third quarter due to the pull forward of our Elfa product line sales during the fiscal year. Elfa is planned to be on promotion one more time in fiscal 2023 as compared to fiscal 2022.

We have reduced our gross margin projection by about 100 basis points for the fiscal year. Embedded in our updated gross margin projection, we believe freight will continue to be a tailwind to gross margin in fiscal '23, partially offset by increased promotional activity and mix dynamics within the general merchandise category.

We are seeing lower-than-expected sales of our higher-margin core and more value-oriented general merchandise products, while our new premium general merchandise product, which is lower margin, has performed and is expected to perform better than originally expected.

Our outlook, therefore, assumes a gross profit range of $504 million to $513 million. We have revised our expectation for SG&A savings to approximately $37 million for the year versus the previously planned $45 million.

The change in our savings estimate is primarily related to incremental investment in store payroll and pay increases for eligible employees. We believe this incremental investment is important to maintain superior customer service levels and to recognize our team, who are the lifeblood of our culture and operations.

We've also made additional investments in marketing to support our custom space business and further awareness of new product introductions.

We now expect to reduce overall SG&A expense by approximately $17 million in the second half of the fiscal year compared to the second half of fiscal 2022, with the fourth quarter total dollar savings contributing almost two-thirds of the anticipated decline.

Our outlook assumes operating margins of approximately negative 2% to negative 1% or operating loss of $20 million to $13 million, inclusive of the $23.4 million non-cash goodwill impairment charge in Q2 that was not reflected in our prior outlook.

Interest expense for fiscal 2023 is expected to be approximately $20.5 million driven by higher interest rates. Our effective tax rate is expected to be in the range of 0% to negative 4% due to the previously mentioned discrete income tax expense of approximately $2.8 million expected to be recorded primarily in the third quarter of fiscal 2023.

We expect net GAAP loss per share in fiscal 2023 to be in the range of $0.82 to $0.70.

After adjusting for the $23.4 million non-cash goodwill impairment charge, the $2.5 million of severance expense incurred during the first quarter and the $2.8 million discrete income tax expense, we expect adjusted net loss per diluted share to be in the range of $0.24 to $0.13.

Capital expenditures are still expected to be approximately $45 million to $50 million. And with this outlook, we now aim to be free cash flow neutral to slightly positive in fiscal 2023. Almost half of our planned capital expenditures are related to new stores planned to be opened in fiscal 2023 or in fiscal 2024.

As a result of construction delays at our planned Miami, Florida small-format store location, we are now planning to open 5 new stores in fiscal 2023 and 4 new stores in fiscal 2024. The remaining capital is related to investment in e-commerce, technology infrastructure and software projects and to a lesser extent maintenance.

This concludes our prepared remarks. I'll now turn it over to the operator to begin the Q&A session..

[Operator Instructions] Our first question comes from the line of Kate McShane with Goldman Sachs. Please proceed with your question..

Hi. This is Emily Ghosh on for Kate.

We were wondering if you could provide more detail on your expectations for promotions around holiday, how this might compare to last year and then promotional activity so far this year?.

Hi. Yes. Thank you for the question. We obviously learned a lot during our Q1 quarter around how to think about our promotions. And clearly demonstrate our ability to manage our promotional levers in Q2, delivering sales and adjusted EPS above the high-end of our expectations.

So similarly, as we think about the back half and into holiday, we'll be looking at our promotional cadence with a level of scrutiny just like we did in Q2. We don't anticipate there being a significant change relative to LY other than the fact that we do have our normal Elfa promotion that we have every year..

Thank you..

Thank you. [Operator Instructions] Thank you. Ladies and gentlemen, we have reached the end of our question-and-answer session. And with that, this will conclude today's teleconference. You may now disconnect your lines at this time. Thank you for your participation..