Greetings, and welcome to The Container Store Third Quarter 2023 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Caitlin Churchill, Investor Relations. Thank you, Caitlin. You may begin..

Good afternoon, everyone, and thanks for joining us today for The Container Store's Third Quarter Fiscal Year 2023 Earnings Results Conference Call. Speaking today are Satish Malhotra, Chief Executive Officer; and Jeff Miller, Chief Financial Officer. After station Jeff has 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 the 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.

Satish?.

first, through outstanding premium assortment. As we shared, we are pleased with the restructuring of our new paint general merchandise and see an opportunity to grow this offering with an improved margin profile.

This includes high-quality auditing and baskets to company a Preston client and crystal glass and barware completes a trusting franchise offering premium general merchandise to complete our premium customer space is essential to serve the needs of our customers and offer them a phone solution under one roof.

Decentralized with private label business through our new sourcing capabilities that we brought in-house last year. Our growing everything organized collection is a great example of an exclusive value-oriented offering that can work in any space and complement out of the solution.

The healthy margins private label products provide and the opportunity to develop products that seamlessly integrate with customer space make this area crucial to our general merchandise growth. Currently, 40% of our general merchandise assortment is private label, and we see an opportunity to increase it further over time.

Lastly, we believe we can achieve growth in general merchandise through our discovery category that complement our core offering. Discovery categories like home fragrances and undergo travel solutions continue to trend positively, presenting us with significant opportunities in these areas.

Before I close, I want to touch on our updated outlook for the remainder of the year and our disciplined focus on capital allocation. With respect to store openings, we are on track to end fiscal 2023 with 5 new locations and recently celebrated our 100th store openings in Livingston, New Jersey.

We continue to see high penetration in customers business a high-satisfaction in our small format stores with an average debt promoter score of 81% in Q2. In regards to fiscal 2024, we plan to open four new built-to-suit locations, which, as a reminder, require far less capital outlook.

We also plan to relocate our San Francisco store in late June and have made the strategic decision to close our store in Los Angeles at product market. We closely monitor the profitability of our stores and decided it was not in the company's best interest to renew the lease when it ends in August of 2024 due to a significant rent increase.

Furthermore, given the current environment, we are not committing to the timing of future store growth beyond 2024. While we continue to see significant opportunities to expand our national presence, it will be done in conjunction with our goal of sustained positive free cash flow.

Despite the current macroeconomic difficulties and the obstacles encountered within our core general merchandise categories, we remain optimistic about the growth opportunities we have identified. Our belief in the transformative power of the organization, coupled with the demand for it and our unique solution-oriented offerings fuels our companies.

Narrowing this focus with the passion and the strength of our team lays a solid foundation for enduring success. And now I'll turn the call over to Jeff.

Jeff?.

Thank you, Satish, and good afternoon, everyone.

As Satish reviewed, while we continue to face similar challenges to our top line that we experienced in the second quarter, particularly within our general -- core general merchandise categories, -- we are able to deliver earnings results in line with our original guidance range through disciplined promotional activity and tight expense management.

For the third quarter, consolidated net sales decreased 14.8% year-over-year to $214.9 million. By segment, net sales for The Container Store retail business were $202.5 million, a 15.4% decrease compared to $239.3 million last year.

The decrease is inclusive of a comp store sales decrease of 16.8%, driven primarily by the 20.4% decline in our general merchandise categories, which negatively impacted comp store sales by 1,380 basis points. Preston space comp store sales declined 9.2% compared to last year and negatively impacted comp store sales by 300 basis points.

Sales from new stores benefited total TCS net sales by 130 basis points. For the third quarter of fiscal 2023, our online channel decreased 26.3% year-over-year, and our website-generated sales, which includes curbside pickup, decreased 15.6% compared to last year.

Website-generated sales represented a total of 21.8% of TCS net sales in Q3, which is consistent with Q3 last year. Unearned revenue decreased to $17.5 million in Q3 this year versus $18.8 million last year, which is reflective of the decline in overall sales.

Elfa third-party net sales of $12.4 million decreased 4.2% compared to the third quarter of fiscal 2022. Excluding the impact of foreign currency translation, Elfa third-party net sales decreased 4.9% year-over-year, primarily due to a decline in sales in Nordic markets.

From a profitability standpoint, our consolidated gross margin for Q3 and increased 140 basis points to 58.3% compared to 56.9% last year. The 140 basis point increase in gross margin was primarily driven by a higher mix of custom space sales this year.

By segment, TCS gross margin increased 40 basis points compared to last year, primarily due to freight tailwinds, which were partially offset by product and service mix headwinds driven by general merchandise as well as the expected impact from the incremental promotional activity in Q3 of this year.

Elfa gross margin decreased 170 basis points compared to last year, primarily due to unfavorable mix, partially offset by price increases to customers. Consolidated SG&A dollars decreased $9.7 million or 8% to $111.8 million compared to $121.5 million in Q3 last year, which reflects the impact of cost management actions taken in the first quarter.

As a percentage of net sales, SG&A increased 380 basis points year-over-year to 52%. The increase is primarily due to deleverage of fixed costs associated with lower sales in the third quarter of fiscal 2023. Our net interest expense -- in the third quarter of fiscal 2023 increased to $5.2 million compared to $4.4 million last year.

The year-over-year increase is primarily due to higher year-over-year interest rates on our term loan and to a lesser extent, higher average borrowings on our revolver during Q3. The effective tax rate for the quarter was negative 34.5%, compared to positive 33.8% in the third quarter last year.

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

Net loss for the quarter on a GAAP basis was $6.4 million or $0.13 per share as compared to a GAAP net income of $4.2 million or $0.08 per diluted share in the third quarter of last year. Adjusted net loss was $4.1 million or $0.08 per share as compared to last year's adjusted net income of $4.1 million or $0.08 per diluted share.

Our adjusted EBITDA decreased to $12.8 million in the third quarter this year, compared to $22.2 million in Q3 last year. Turning to our balance sheet. We ended the quarter with $16 million in cash, $184.7 million in total debt and total liquidity, including availability on our revolving credit facilities of $99.6 million.

Our current leverage ratio is 2.8x. We ended the quarter with consolidated inventory down 14.3% compared to the third quarter last year. The decline reflects a concerted effort to tightly manage inventory in the current environment and is primarily the result of lower freight costs and fewer inventory units year-over-year.

At TCS, on a unit basis, on-hand inventory was down approximately 15% year-over-year driven by general merchandise. Capital expenditures were $33.4 million in the first 9 months of fiscal 2023 versus $46.6 million in the first 9 months of fiscal 2022, which reflects the planned pullback in capital spending in fiscal 2023.

We are continuing to prioritize investment in our stores and technology. Free cash flow in the first 9 months of this year was a use of $6.7 million versus a use of $27.7 million in the first 9 months of last year. Now for our outlook.

As noted in our press release, we have updated our full year outlook to reflect our year-to-date results and updated outlook for the fourth quarter. For the fourth quarter of fiscal 2023, we expect consolidated net sales to be approximately $200 million to $205 million, driven primarily by a comparable store sales decline in the mid-20s.

The expected decline in comparable store sales is reflective of weather challenges we have experienced in January as well as continued pullback in our core and value-oriented general merchandise categories.

As it relates to custom spaces, in addition to the already anticipated pull-forward headwind related to the third quarter 75th Elfa anniversary sale, we are expecting additional pressure from the Elfa product line primarily during a planned non-promotional time period in the fourth quarter.

We expect the consolidated revenue declines were also 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 fourth quarter to be in the range of $0.12 to $0.09.

The implied year-over-year operating margin decline for the fourth quarter is expected to be driven by SG&A depreciation and other fixed cost deleverage on lower sales.

In addition, we expect gross margin to be relatively flat in comparison to the prior year as a result of the net impact of continued freight tailwinds and an unfavorable product mix from general merchandise. Interest expense for the fourth quarter is expected to be approximately $5 million, driven primarily by higher interest rates.

The effective income tax rate for the fourth quarter is expected to be approximately 21%. Capital expenditures for the full fiscal 2023 are now expected to be in the range of approximately $40 million to $45 million. Based on our performance to date and our fourth quarter outlook, we are expecting free cash flow to be slightly negative in fiscal 2023.

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 is from Steven Forbes with Guggenheim Securities..

Satish, given all -- given the focus on conversion, right, and awareness improvements here, as we look out.

Can you maybe give us some preliminary thoughts on how you're thinking about the event calendar for next year? And have you guys sort of identified why the conversion -- the design to conversion rates differ between the product lines? Like is there any sort of targeted efforts, right, that you've sort of identified that you can incorporate into the event calendar?.

Yes. This is Satish. Thanks for the question, Steve. So firstly, when it comes to the event calendar, the thinking that we have for fiscal '24 is to separate some of the lines that we have traditionally showcase for our customers.

So rather than having a combined custom space event with all of our lines, we look to kind of separate them so they can each have their moments, in particular, as we see really strong progression of in-store sales with Elfa and then utilizing our in-home specialists driving our Preston and Avera sales.

With results -- and quite frankly, I would tell you the conversion rate for Elfa is extremely high, as you can imagine, because not only is it available for customers for a do-it-yourself option, but it also allows us to design for our customers and for them to really benefit from the modularity of the Elfa offering.

When we think about the lines in particular, more premium lines, as you can imagine, and this is the efforts that we've been on, in particular with Avera is that it takes our specialist some time to get comfortable with the lines and with their selling approach, and we've definitely seen great improvements with our Avera conversion lines.

And similarly, we expect that to happen with our Preston line. As I mentioned, we have about 140 in-home designers and they've gone through rigorous design trainings to enhance their design and selling skills.

Our more tenured designers are already performing quite well in annualizing sales from anywhere from $700,000 to $800,000 and are making great progress on their design to sales conversion rates. And obviously, that's slightly pulled down with new individuals that we're training and bringing into our company.

So look, all I will tell you is that we've seen great success in conversion with Elfa.

We've seen great success with Avera and we believe as our more -- as our more tenured designers get comfortable with selling Preston, we should expect in fiscal '24 to get the benefits of them now being accustomed with all the new features and functionalities that we bought with Preston, including their abilities to utilize the design tools that are in their hands to start to benefit quite well with that conversion rate..

Maybe just a quick follow-up for Jeff. You commented now this year sort of looking at slightly negative on free cash flow.

Any sort of preliminary thoughts as we think about the rebalancing of growth versus profit into next year? And sort of what leverage that the business can pull to maybe keep the business in sort of a free cash flow neutral to positive state?.

Sure, Steve. We’re in the early stages of planning our fiscal 2024, so can’t necessarily comment too much in detail. But as we think about the business moving forward and maintaining and sustaining free cash flow as we’re in this growth mode, focused on the growth mode, there are a number of levers that we have.

And right now, we’ve – in the call earlier, Satish spoke to the fact that we have 4 stores open, planned to be opened in 2024, and we have no plans for store expansion outside of 2024. So we’re pulling back from a capital expenditure perspective, certainly will help on a free cash flow perspective in fiscal 2024, I would expect that.

As it relates to expense management and working capital, we see a line of sight of working capital opportunities specifically in inventory, one of our largest areas of working capital, and we’ll be working towards that as we get into 2024 plans of actions around that.

And of course, we’re always looking for efficiencies on the expense side, and we’ll continue to focus in on that, as we work through our line of sight for fiscal 2024 with the aim and site positive to neutral free cash flow..

Our next question is from Kate McShane with Goldman Sachs..

We wanted to ask about marketing. Obviously, with Steve's question just walked through the messaging and the event calendar.

But -- is there any change happening with the percentage spent as a percentage of sales on marketing? Or are you shifting dollars in any way to improve this messaging?.

Yes, I'll take the first part of that question, and then I'll let Jeff talk about the percentage to sales. Look, the change that we're making in our marketing is really to be more mindful of understanding that customers are still not really aware that we off to our customer spaces. And the approach that we're taking is a far more integrated approach.

And what I mean by that is our ability to -- whether it's through e-mails or our sites or even embedded within our general merchandise is really allowing customers to understand the importance of making sure they have the right space and how that space can be optimized for them and then how our general merchandise truly is acting as a finishing product for that more optimized space finished off with really some vital organizational tips to ensure that they're able to maintain their transformational achievements once they're being able to fully embrace what we have to offer.

So that's what you should expect to see now and into fiscal '24 is us taking more of this integrated approach rather than it being siloed out between a customer space messaging that then differs from a general merchandise messaging that then differs from a services offering..

And just to add to that, Kate, in terms of dollars spent in marketing, as a percent of sales, we remained relatively consistent throughout fiscal '23. And as I said earlier, we're still early in the plans for 2024.

But I think the focus will be more around making those dollars work harder for us as Satish was outlining and the approaches of how we're doing it. And the team that we have here, The Container Store has been working very diligently and finding ways to be much more efficient with the marketing dollars that we have to have the biggest impact.

And I think Satish outlined some of those ways that we feel like would have the biggest impact. We've been focused on making sure we're operationally efficient from an SG&A perspective.

And implied in the Q4 guide is SG&A savings of $15 million, up to $15 million, which we started the fiscal year taking actions and we had a range in -- we saved $30 million through Q3 with an initial $15 million through Q4 for total potential savings of $45 million on a year-over-year basis.

With that in mind, we'll continue to focus on marketing as a key aspect of engaging with our customer and maintaining those messages and making sure they're much more efficient..

Okay. And then our second question was just on the guide for comp in the fourth quarter.

Is that primarily a function of the adverse weather trends that you mentioned in your prepared comments and the lapping of some of the tougher compares? Is there anything else within the mid-20s decline that we should be -- that's driving that?.

Embedded in our guidance for Q4, if I were to speak to the high and low end, it's really based on the January trends we saw at the time we were putting together. The high end of the guidance assumes some normalization from what we were seeing in January. And from a weather perspective, it did impact us quite a bit.

We had 6x more store impacts in January than we did in the previous year. When I look at the entire quarter, February last year, did have more weather impacting, but we're still early in February, we don't know. So when we developed the guidance, we assumed some normalization from the January trends at the high end of the guide.

The low end of the guide, assumes that January trends continue through the remainder of the quarter.

And as I said in my prepared remarks, the -- it's reflective of the continued pullback in the core and value-oriented general merchandise and we also are seeing more pressure in the nonpromotional time periods for the Elfa product line based on what we learned during Q3..

Our next question is from Christopher Horvers with JP Morgan..

So my first question is, do you have a sense of how much the Elfa anniversary sale pulled forward demand from -- into the third quarter from the fourth quarter. It's always been a big event here in the spring, and I know you moved it forward. and it drives a lot of seasonality in that business.

So I was curious if you had put some thoughts and numbers around that..

Chris, I don't have a number to speak to from a pull-forward standpoint. But certainly, we are seeing that just on the normalization of the quarters from a revenue top line perspective, and that's what was anticipated in our Q4 guide..

Got it. And then I guess as you think about what is left for the -- you mentioned like outside of the promotional period, there's not as much responsiveness on the Elfa side. So I guess, what is sort of exist now in the fourth quarter to drive that business.

And as we think about the upcoming year, should we assume that the Elfa sale goes back to its normal timing?.

Well, just to clarify, Chris, this is Satish. We do -- we are -- in Q4, we do have an Elfa event. And so the event that we were talking about earlier was our 75th anniversary event, and that was an added event from what we normally do.

And so that is something we didn't pay attention to and as we think about fiscal '24 our expectation is to still have 4 Elfa events throughout the year.

So we're -- the event that we have currently doesn't end until mid-February and we still have 1.5 months left to close out that quarter from that event, and we definitely will continue to go after customers that have experienced a purchase with Elfa and see what we can do to make sure that they are able to take full recognition of those installations to what other potential Elfa opportunities exist as well as completing those Elfa purchases with completion products.

So we still have a lot of exciting things to engage our customers with as we finish out Q4..

Got it. And then I guess my last question is, as you think about like the current freight environment, more general merchandise is, I think, more from Asia. And then obviously, there's some stuff going on in the Middle East.

So how are you thinking about the duration of this freight tailwind that you've seen in the gross margin line? And what are your thoughts on -- could that turn to a headwind? Or you contracted out? Or how are you managing that?.

Yes, Chris, the -- in terms of freight, certainly, we've experienced the benefit of tailwinds through fiscal 2023 based on the lower freight costs that we've been seeing throughout the fiscal year. We would expect that to continue a little bit, not as much in fiscal 2024 in the first half of the year.

But when we look at the Red Sea situation and some of the disruption that's going on there, we have limited routing through the Suez Canal, about less than 1% of our freight goes through there. The impact on global rates on the spot rates hasn't impacted us yet. We have about 85% of our shipments are under contract.

And certainly, we're watching it as we move forward. It could be a potential risk, depending on how prolonged the situation is, but from a volume standpoint, we don't have a whole lot of volume going through that part of the world..

There are no further questions at this time. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation..