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The Container Store Group Inc. (NYSE:TCS)

Q1 2014 Results Earnings Conference Call

July 08, 2014, 04:30 PM ET

Executives

Anne Rakunas - ICR

William A. Tindell III - Chairman and Chief Executive Officer

Melissa Reiff - President and Chief Operating Officer

Jodi L. Taylor - Chief Financial Officer

Analysts

Gary Balter - Credit Suisse

John Heimbach - Guggenheim

Patrick O'Brien - Morgan Stanley

Simeon Gutman - Morgan Stanley

Daniel Binder - Jefferies

Operator

Greetings and welcome to The Container Store, First Quarter 2014 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) I would now like to turn the conference call over to Ms. Anne Rakunas of ICR. Thank you, Ms. Rakunas, you may begin.

Anne Rakunas - ICR

Thank you, operator. Good afternoon everyone, and thanks for joining us today for the Container Store’s first quarter fiscal year 2014 earnings call.

On today’s call are Kip Tindell, Chairman and Chief Executive Officer; Melissa Reiff, President and Chief Operating Officer, and Jodi Taylor, Chief Financial Officer.

After Kip, Melissa and Jodi have made their formal remarks, we will open up the call to take questions. I need to remind you that certain comments made during this call 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 risks and uncertainties are referred to in The Container Store’s Press Release issued today.

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 showing the GAAP versus non-GAAP financial measures is available in The Container Store’s press release issued today. If you do not have a copy of today’s Press Release you may obtain one by visiting the investor relations page of the website at containerstore.com.

I will now turn the call over to Kip. Kip?

Kip Tindell

Thanks, Anne. Hello everyone. Thank you for joining us today to talk about our results for the first quarter of 2014 and I hope everybody had a great 4th of July. Net sales for the first quarter were $173.4 million, an increase of 8.6% over first quarter of fiscal 2013. We thought our sluggish sales were all because of weather and calendar shifts in the fourth quarter. Going into this first quarter, we had what everybody have weather and calendar shifts for Christmas that began last November and continued into the spring, but now we’ve come to realize it’s more than just weather and calendar consistent with so many of our fellow retailers we’re experiencing a retail funk. I mean, so many retailers that we talked to are experiencing that. Our comparable store sales declined 0.8% in the first quarter. They declined 0.8% and that’s after 15 consecutive quarters of comp store increases.

It’s important to remember that historically the first quarter of The Container Stores by far our lowest quarter from both the sales and profitability standpoint, it’s a very small seasonality quarter for us simply put, it represents less than 0% of our annual earnings, so we’re disappointed with the first quarter and yes we are surprised by slightly negative comp stores sales increase, but the first quarter has very little impact on our full year earnings results.

We are confident the customer enthusiasms for our brand and employee morale are -- at all time high. I mean we continue to experience slight traffic declines and in this surprisingly tepid retail environment, but we feel like our brand, an employee morale are just as good actually better than they have ever been. And consumer seems to be if you guys know, consumer seem to be buying homes and automobiles and even high ticket furniture which has kind of been in the doldrums since the great recession. But most segments of retail are a little like us, seeing more challenging sales certainly than we had hoped for early in 2014. So, we are not alone in this, but we will absolutely not rest until we turn these slight traffic declines we’ve been experiencing and the slight traffic increases we have exciting initiatives that we feel like we’ll take that slight traffic decline and turn it into a slight traffic increase and we have very exciting initiatives that Melissa will go into shortly at hand that we think will have a terrific impact on average ticket increase which is what we’re most skillful at doing and tough times we have a long history of having a great deal of success at raising average ticket.

Regarding our second and third quarters, we believe that these two quarters will improve slightly to flat to slightly positive and we’re being cautious about, talking about those but we do feel that there will be some improvement in the second and third quarters and then we’re like every other retailer I mean we’re very much looking forward to the fourth quarter as we comp against the worst weather we’ve had in our history last year and we believe we’ll see but we know we’ll see market improvement and our sales trends in the fourth quarter which is our most important quarter. I mean, one thing we know for sure is that chances are very, very, very high that we won’t have the worst weather in our 36-year history again this fourth quarter. And it was darn unfortunate to have it right after we went public.

Historically, over 60% historically over 60% of our profitability has been derived in the fourth quarter, so from a profitability perspective fourth quarter is very, very important for The Container Store. We joke its like a basketball game, it’s really all about the fourth quarter for us, wish it wasn’t that way but it’s always been that way. We have both our Christmas campaign and our annual Elfa sale in the fourth quarter, our two biggest seasons simultaneously. So fourth quarter is 60% of our profitability and this year we expect it to be perhaps even a little more than that total percentage of our total profitability.

We are pleased that during the first quarter in order to preserve our brand and to protect gross margin, we did not accelerate promotional levels, we recognized that consumers have an inordinate appetite for promotional levels right now and we recognize that this continuous to be an incredibly promotional consumer environment. We are very proud and thrilled with our average ticket growth, right now as always and the service that I wanted for employees to provide our customers everyday.

As I mentioned, we feel that we are really adapt at offsetting occasional traffic declines with average ticket growth. I mean think about it, last year average ticket increased there robust 5.6%. The previous year average ticket increased 4.2% all of our employees are so proud of our ability to do this, it’s just something that we’ve always been able to do when traffic levels were not exactly what we wanted.

I think it’s a huge differentiator for us, so we can flat out rates average ticket with the very best in our industry because of our great great sales people. We won’t rest until we turn the traffic slight declines into slight gains, but what we’re really anxious to do with the job before us is to do is to get those average tickets up truly robustly, and so Melissa how are we going to do that? Tell us how we are going to do that, average ticket payments, talk about the traffic thing but you know how are you going to do this average ticket thing?

Melissa Reiff

Okay, well we’ll talk about it. Thanks, Kip and hello everyone. But first I want to talk about our new stores just for a little bit. We continue to be very pleased with their performance. Our average first year for a while adjusted EBITDA margin on new stores has historically averaged 23%. And our invested capital have seen a payback of about 2.5 years, I think that’s really important to reiterate those two points again.

We opened three new stores in our first fiscal quarter -- in King of Prussia Pennsylvania this past March 8, our second store in the Seattle area April 12 and our first store in Rhode Island in the Providence area May 17. And we just relocated last month our 20-year old Oak Brook Illinois store to a beautiful space after successful Oak Brook center which is right across the street from our Oak store wagon; it’s a gorgeous outdoor mall for those of you not familiar with it.

We had a very successful grand opening. We received a glorious welcome from our customers we’ve had for 20 years as well as new customers. And the remaining stores to be opened this fiscal year are in Los Angeles California, August 9 at Farmers Market at The Grove, in Salt Lake City Utah at Fashion Place Mall opening October 18, in Chicago in the South Loop Area in what’s called the Roosevelt Collection, opening November 15.

And you all may remember that last quarter we announced that we have accelerated our annual square footage growth from 10% to 12% minimum. And today, well we are just typically to announce that we are also opening our eight stores this fiscal year at the end of January 2015 in the Phoenix market -- Glendale to be specific. And that enables us to meet that 12% minimum scripted footage growth even in this fiscal year.

You know it normally requires about I want to know about eight to 10 months for us to open a new store the way we like to open a store once the lease is signed.. But we’re really worked diligently to even add that additional store in this current fiscal year so that’s really terrific. So four more stores opened this year, a total of eight grand openings, seven net new stores by the end of fiscal 2014.

Tomorrow is a big day for us, because POP! will be available in all of our stores on/and online. Yes it’s our new customer engagement program POP! - perfectly organized perks, our program that rewards customers with special communication, the prize of the light gifts and exclusive offer that will be available in all 67 stores. Customers there simply have to sign out and begin being surprised and delighted by The Container Store. It’s so simple, so easy. And if customer is not in one of our stores to sign up, all they have to do to become a POP! star is to enroll online at Container Store.com.

For some of you on the call may remember that we cracked at our POP! program to be simple, relevant, emotionally engaging and designed specifically to improve customer frequency, traffic Kip, there’s what we were talking about -- traffic. We launched the program in just our California stores almost one year ago and already we know that the program is increasing POP! star traffic, and what’s really wonderful POP! stars of a higher average tickets than non POP! stars so of course we love that too. Currently, we have around 330,000 POP! stars that hey watch those number store after all stores and online after the program beginning tomorrow.

In addition, we have expanded the rollout of our ATHOME personalized in-home organization designed service beyond just the Texas market having successfully just launched the service in the Manhattan market with 12 really outstanding organizers. I’ve met all 12 of them and they are really outstanding. Again, this has been our most requested service in all of our 36 years. Our customers don’t want DIY, they just want someone they can trust to do it for them. Organize every area of their home, a whole soup to nuts an A to Z program which makes their time start busy like obviously more efficient and enjoyable. And that’s exactly what we are getting at.

Our ATHOME organizers go directly into our customer’s homes and design solutions for them, organizing every thing, using of course The Container Store products. We are bringing this service to additional markets such as LA and Chicago and the Washington DC market by the end of this calendar year and then to the rest of our stores in 2015.

The results so far with this service are really exciting with the average ticket, average customer ticket in excess of $2000 for ATHOME customers. That’s incredible we think when our average ticket on our stores is around $60. We really see this having a significant impact in the coming months as we continue to roll out in more markets and certainly of course in the long term.

And lastly, as many of you know from our last call, we’ve been talking about closet domination. Actually for the past several months, and so we wanted to make sure that we are offering our customers many closet solutions, choices, getting her what she wants, when she wants it anywhere, anytime and so I bet you probably been wondering exactly what we mean by that. Well, get ready because we are over demand delighted to announce today that we will launch a brand new exclusive custom solid drawer-and-shelving closet solution later this fall. The new product collection will be a higher end offering than our current assortment and will provide our customers with custom built solutions traffic from the highest quality materials and with a variety of choices in wood grain finishes and extras, all the bells and whistles, including lighting and storage options for shoes, jewelry and handbags.

This new closet collection will be custom and made to order with service from our end store expert sales people, our ATHOME organizers and of course our installation services. Our customers have been asking for even more luxurious closet offering as they think about their dream closets, which we know is a area of their home that they want to be well appointed, beautifully designed and a reflection of their styles while of course also remaining functional and efficient. Many customers simply want a more custom built look, and this new collection is just that -- quality, custom solutions with again all the bells and whistles, and a superb customer service that our customers expect from that to go along with it.

So if you can hopefully tell we are very enthusiastic and very optimistic about this collection of service because we know it’s going to appeal to our loyal customers that’s also going to attract new customers to our brands. We expect that the average ticket on our new closet collection will be much, much higher than our over 2000 current average ticket that we are experiencing with our ATHOME service. And therefore, we believe it will contribute very meaningfully to comp store sales increases in the long term.

As I said earlier, this new solid drawer-and-shelving closet collection will roll out later this fall in our seven stores in the Dallas/Fort Worth Metroplex, with planned roll out to the rest of our stores beginning in the spring of 2015. We really do believe that this is again change or it could be our most significant product launch to date in 36 years, so how cool is that. So we cant’ wait to tell you more about it and hopefully maybe even show it to you very soon.

So lots happening here at The Container Store. We will continue to focus on our solutions based selling as opposed to items, continue to focus on proprietary products like our new solid drawer-and-shelving closet collection that I just spoke about, both of which of course insulate us from the giant internet retailers. Its not – it’s just not a factor because you cannot show them proprietary towards the product, and almost no one tries to sell solutions over the internet. It’s not easy, but we do it. So that’s it from me today. Thanks for listening and now Jodi, you are going to review our first quarter financial results and discuss I believe our outlook for fiscal 2014.

Jodi L. Taylor

Yes, thank you Melissa. Good afternoon everyone. I’d like to begin my remarks with a review of our first quarter results and then discuss our outlook for the year. Net sales in the first quarter were $173.4 million which was up 8.6% from the first quarter of fiscal 2013. Sales in The Container Store retail business were up 8.9% to $149.7million and our third party sales at our Swedish subsidiary Elfa were up $1.5 million, or 7%, from the first quarter of 2013.

As we discussed on our fourth quarter call, the first quarter was historically by far our lowest quarter for the sales and profit contribution. We ended the quarter with 66 stores and approximately 1.65 million of gross square footage as compared to 60 stores and approximately 1.5 million of gross square footage at the end of the first quarter 2013.

Our comparable store sales for the quarter decreased by 0.8% which included 1.5% increase in average ticket. The weather driven extension of the Elfa sale that we spoke to in the fourth quarter also resulted in a shift of approximately 4 million in sales at our TCS business into the first quarter due to more merchandised deliveries being recorded into the first quarter this year. Our comp store sales metric recognizes a sale when the product is purchased, but in the financial statements revenues are recorded when the product is delivered.

In the first quarter of fiscal 2014, approximately 26% of Elfa sales were derived from The Container Store with the balance of sales primarily derived from Scandinavia.

The growth in third party sales in the quarter was primarily related to a promotional campaign as well as improved market conditions in Scandinavia. We remain cautiously optimistic that these improving trends in Europe will continue.

Consolidated gross margin decreased by 30 basis points to 58.1% from 58.4% in the prior year period. Gross margin in The Container Store retail business decreased 70 basis points to 58.2%, primarily due to the extension of our annual Elfa sale and to a lesser extent the appreciation of the Swedish krona versus the U.S. dollar year-over-year. The Container Store gross margin declines were partially offset by the increase in Elfa’s gross margin of 60 basis points to 40.9% primarily driven by leverage of fixed cost during the quarter.

As a percentage of sales, consolidated SG&A increased to 52.6% from 52.3% in the first quarter of fiscal 2013 primarily due to public company cost which we did not incur last year, as well as to a lesser extent due to investments in future growth in strategic initiatives.

Our net interest expense in the first quarter of 2013 was $4.3 million compared to $5.6 million in the first quarter of fiscal 2013 with the year-over-year decline due to lower interest rates achieved through refinancing of our term loan facility at the Container Store last year.

Our tax rate for the quarter was 35% compared to 29.6% in the first quarter of last year. The increase in the effective tax is primarily due to a shift in the mix of projected domestic and foreign earnings, as well as fluctuations in the valuation allowance recorded against domestic earnings in the first quarter of fiscal 2013.

Our expectation is that our tax rate for the full year 2014 will still be approximately 38.8% as outlined on our fourth quarter conference call. The net loss for the quarter was $3.6 million compared with the loss of $4.8 million in the first quarter of last year, and our loss per share was $0.07, compared with the net loss per share attributable to common shareholders of $925 last year.

Again, our first quarter has historically always been our quarter with lowest sales and a net loss due to seasonality of our business. Last year’s net loss per share reflect $22.3 million in preferred distributions. As a reminder, we did retire our preferred stock in connection with the IPO in late fiscal 2013. On an adjusted basis, net loss per share in the first quarter of 2013 was $0.07.

Turning to our balance sheet, we ended the quarter with $8.6 million in cash on our balance sheet, $361.6 million in outstanding borrowing and combined availability with cash on hand of $68.8 million. We ended the quarter with well-managed inventory of $94.6 million as compared to $91.2 million at the end of last year’s first quarter, up only 3.8% on a sales increase of 8.6% with six additional new stores. So we’re very proud of that.

Next, I’d like to turn to our outlook. We expect consolidated net sales for the year to be $820 million to $830 million. Comparable store sales to increase in the 1.5% to 2.5% range and earnings per share to be in the $0.49 to $0.54 range based on our weighted average of $49 million diluted common shares outstanding.

Included in this outlook, is the expected impact of the additional eight stores opening that Kip discussed which we are very excited to be able to add this year. Since this store will not be opening until January 31 of 2015, it will have limited sales that we can obtain in this fiscal year with the full amount of pre-opening store cost, which we expect will reduce our 2014 earnings per share by $0.02.

We are assuming a tax rate as I noted of 38.8% and annual interest expense at today’s LIBOR rates of approximately $17.5. A few additional comments that I have regarding the expected comp and SG&A cadence this year, first on comp; our quarterly comp expectation for fiscal 2014 are as follows; Second and third quarter flat to slightly positive and fourth quarter mid single-digits, again noted due to the extreme weather of last year. Two, we expect the impact of the initiatives that we’ve outlined that we’re very excited about to really be most beneficial to sales in the later part of the fiscal year.

And as noted last quarter, the impact of the cost associated with these plants initiative including the rollout of the POP! program, the ATHOME rollout into nearly half of our stores and new custom closet program will be most significant in the first half of the year with some modest impact still into the third quarter.

As a result, we expect consolidated SG&A as a percentage sales in the second quarter of fiscal 2014 to delever from second quarter of last year by approximately 100 basis points from the 46.7% last year to delever slightly in third quarter, but to improve considerably as a percentage of sales year-over-year in the fourth quarter.

As we had said before, fourth quarter is seasonally our most important quarter and in fiscal 2014, we expect to deliver nearly 70% of our full year earnings per share in the fourth quarter. And third, in fiscal 2014, please remember we will also have the incremental cost including additional payroll and professional fees associated with becoming a public company which is approximately $1.5 million beyond what was incurred in fiscal 2013.

So with that, I’d like to turn the call back over to the operator so that we can take your questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now be conducting question-and-answer session. (Operator Instructions) Our first question is from Gary Balter of Credit Suisse. Please go ahead.

Gary Balter - Credit Suisse

Thank you.

Melissa Reiff

Hi, Gary.

Gary Balter - Credit Suisse

Just on the stuff that you’re doing exclusive custom, like the higher end that you’re going to be introducing in the store, how does the pricing compared to Elfa?

Kip Tindell

It’s you know we’re introducing a higher end product than Elfa. What we discovered is that, that customer that really represents 83% of our sales, 30% of our customers represents 83% of our sales and she buys everything in the store at around 200% ratio to average. But she buys Elfa at only kind of low-to-mid 100% ratio that average for. She’s not putting it in the master bedroom closet. She’s putting it in the kid’s room. She’s putting it in the laundry room. She’s putting it in the guest room. And we believe that she wants more upper end product for her bedroom, particularly that best customer.

So this is our -- we refer to it as a Lexus added to the Toyota line. I mean, Elfa is the best closet system in the world, but it needs this Lexus added to the Toyota. It is more expensive. It’s not going to be branded Elfa. It would be branded “The Container Store”. It would not be on sale when Elfa is on sales. It’s not Elfa, its The Container Store. And we think, it will go hand in hand with our Toyota that is Elfa and bring in this customer and tempt some of the other customers to go to this new – it’s hard to describe over the telephone. You might call it Texas closet, we’re joking.

People been asking for years and frankly we said no, we want you to buy Elfa, and now we’re saying, let’s let her buy what she wants to buy, if she wants that solid built-in, more wooden look rather than more metal look, let’s let her have that. It’s the best quality system we believe ever. We have that good housekeeping seal of approval that is Elfa to compete against the other several people that are doing something somewhat similar.

So, the same gross margin pretty much. We’re trying to get and I think we’re going to succeed at having it be the same very high gross margin we have on Elfa. So, while we don’t know what the cannibalization will be, we think it would be like Lexus, Toyota hand in hand, not much cannibalization at all, and just kind of allowing us to better dominate as we should all of the closet business in the United States, whether she want solid, that look or kind of see through more ventilated Elfa look.

Melissa Reiff

Hi, Gary, it’s Melissa; it’s about giving her choices, Kip. It’s about giving her as I said earlier what she wants. And it is going to be more expensive, but I think its going to be an incredible collection and really round out our assortment.

Gary Balter - Credit Suisse

And just one follow up, you brought down the guidance for comps in Q2 and Q3, could you talk about your thoughts behind doing that?

Jodi L. Taylor

Sure, Gary. We’re certainly doing everything we think we should and can do to try to both improve traffic and average ticket. But in this sort of more tepid environment that we’re in, we really felt as though the appropriate thing to do was to really lower that guidance for the next two quarters particular in light of the fact that these – some of these great initiatives we’re talking about don’t really have much of an impact to the shorter term. So that was really sort of what drove our thinking. We didn’t want to unrealistic expect that trends will dramatically turn quickly.

Kip Tindell

Well, these initiatives will absolute impact average ticket. I mean average ticket on these goods are 60, 70, 80 times what our overall average ticket is, so you get a few percentage points of sales on something that’s 70 times your existing average ticket I mean you move that needle. Comp store sales have only two components, is traffic and average ticket. And so what we trying to outline for everybody is -- here’s what we doing about traffic and we really believe the POP! will move the needle on traffic, but what we really think we can do something about is this average ticket thing and we’re really excited about it. Melissa, can you go over the timetable again of both the...

Melissa Reiff

Well, POP! again it will be rolled out to all stores and online tomorrow. And the response is been...

Kip Tindell

Sales been what they are in the first quarter, we wish it was all – everything was rolled out this quarter, but this kind of a phased-in thing.

Jodi L. Taylor

Tomorrow, right. So – and then we’ve got ATHOME in the Manhattan market and all of Texas and we’re going to be rolling that out to Chicago and LA and DC as I said earlier by the end of the year and then we’ll roll out to the rest of the market for ATHOME next year. And then again, we’re going to piloting this new exclusive custom solid drawer-and-shelving closet solutions, we’re going to be piloting that this fall. And so I do think that’s going to impact more of the longer term than short term because we’re going to be piloting that in the Dallas/Fort Worth Metroplex, but it certainly – the plan is also impact at least in those Texas stores this fourth quarter coming up.

Kip Tindell

But I think that we’re planning to roll that out end of the first or second quarter of the new fiscal year.

Melissa Reiff

2015, yeah, exactly.

Gary Balter - Credit Suisse

Thank you very much.

Melissa Reiff

Thanks, Gary.

Operator

Thank you. The next question is from John Heimbach of Guggenheim. Please go ahead.

John Heimbach - Guggenheim

Hey, guys. So just going back to the new closet product, what are the thoughts early on here about creating space forward in the store, the training that you’re going to have to provide incremental training to the folks in the store and then marketing it kind of getting the word out? Thoughts on all of those as you think about the Texas pilot and then I have a follow up on the closet?

Kip Tindell

Let Melissa answer that, but we’ve had major Elfa introductions before and so we have lot of experience in introducing new products of this significance. This is probably the biggest ever. With that kind of average ticket, I mean, there’s a – we’ll be able to find plenty of square footage for that. There’s a lot of duplicity if you will and some of the Elfa closet things, so I think there’s some room there. And another think that I meant to mention earlier and did not is that the way this product will work there is no inventory on it. And so, profit in retail I believe is volume, plus margin plus annual turn. This thing kind of has sort of infinity annual turn, because there’s no inventory on it. But I’m sorry, go ahead Melissa.

Melissa Reiff

Hey, John, it’s Melissa.

John Heimbach -Guggenheim

Hi.

Melissa Reiff

Yes. We are working right now on crafting. Sharon Tindell, our Chief Merchant, and our visual team and others training were working on the displays in our store right now for this product collection. And we don’t see any problem with that at all. We are working on the training program. Everybody in our store will be trained on this collection. And then of course we will go into even more man in the dessert in-depth selling with our sales people who absolutely and have all the knowledge to sell this product to our customers.

Its going to hand-in-hand John with our ATHOME organizers and our installation service, because we will sell the customer on this collection in the store, but then the ATHOME organizer and the installer will go to the customer’s home, do all the measurements, because this is custom, custom, custom. And then the product will shift directly from the manufacturer to the installer and they will install it and then the organizer will organize it or do whatever needs to be done.

So we also have a quite – well I think it’s a quite robust marketing plan to support this, albeit the pilot is in the Dallas/Forth Worth area. But I’ve always been of the opinion in my marketing career that you got one chance to make that big kind of volcano, big impression happened and we want to do that and we’re working very diligently on the public relations, because you know we’re quite adapt to that. We’ve got a whole plan there. We will talk about this in social. We’ll use every medium of our kind of magical marketing mix that we can and of course be prudent and strategic in doing so. So, yeah, we’re very excited about it and I can’t wait for you to see it.

John Heimbach -Guggenheim

And then as a follow up, if you think about it -- does this do anything for you on the B2B side, cause you know we’ve talked in the past working with maybe home builders to have the real product deal from products or other product you know put into a newly built home or remodeled home. Does this do much on the for you on the B2B side, in getting this product eventually into the hands of developers for their houses?

Kip Tindell

Well B2B is going really well and as we said before it’s found to be the most rapidly growing part of our business for you the foreseeable future, and what we’re discovering is that people from throughout different industries are very excited to talk to us because we are The Container Store and they are very excited to have the opportunity to buy B2B from us.

Elfa is a major, perhaps even a majority of our B2B sales so far we certainly want it to be the whole store, and we don’t have this particular solid closets planned to be a major component of the B2B but we just don’t know yet. I’m certain it will be. It’s got the margin for us to play in that arena as well and the strongest of sales have been for Elfa with B2B, I think that’s nothing but this certainly can make a lot of sense and give them the same option we are giving the consumer.

But this is really just meant to be our top customer who is in there buying the coat hangers and the shoe boxes and everything else, she’s our best customer and she’s not putting Elfa in her master bedroom closet and we are confident that this will be the nicest system on the planet and you know it shall put this in there. I mean it’s everything we know after 36 years of designing closets, so we are doing I think well. We designed great closets and so we are finally as Melissa says, giving her what she wants.

John Heimbach - Guggenheim

And then lastly, you talk about the funk. When you look at geographies, categories, talk to your customer, is there anything more than just a consumer malaise, because again, you are not, you are not low income, right so you would think you have side stepped it a little bit more, what’s your best guess as to the kind of the source of this?

Kip Tindell

Well you know what we know from our involvement in national retail federation and all of that is that over the past several months, this funk, this retail funk seems to be not just limited to sort of lower end retail, it’s also hitting the higher end retailers and certainly as to a surprising extent all of a sudden, we don’t see any geographical differences between it, it seems to be all over the place. We have a pretty robust database.

Our highest end customer seems to be a little bit in frequently shopping us for some [darn] reason and so does the – and we have a very uneven economic recovery still so for a long time it was the lower end retailers were suffering in the higher end were doing better and we were doing better. Now it seems to be more democratic, it seems to be kind of across the board. So all we know to do is to accelerate our efforts to increase traffic with initiatives designed to do that, and to really hit the average ticket thing because even if the traffic stayed – even if it was a zero, if you can have a five or six or better percent average ticket increase you’re going to have some nice 3%, 3.5% of comp store sales increase.

Melissa Reiff

And one of our biggest differentiator John as you know is our expert sales people who we provide so much training and so much confidence building and so much knowledge and that has drived that average ticket. And I don’t know of any other retailer that can do that quite like we can.

John Heimbach - Guggenheim

Alright, thank you.

Melissa Reiff

Thanks.

Operator

Thank you. The next question is from Simeon Gutman of Morgan Stanley. Please go ahead.

Patrick O'Brien - Morgan Stanley

Hi, good afternoon. This is Patrick O Brien on for Simeon.

Melissa

Hello Pat.

Patrick O'Brien - Morgan Stanley

Perhaps you could talk about the future pipeline past stores that you called out. And can you talk maybe about the availability of size and the quality of locations you basically are you seeing some kind of margin improvement on the real estate side of things?

Kip Tindell

Well we are not seeing a lot more retail real estate development. Unfortunately, that’s not really happening. That doesn’t matter, I mean we are very excited about new store locations that we have in the pipeline or even more excited about the experience of our new stores never before still have our new stores contributed so much to the profitability of the company. We’re still getting this 23% maybe even a little better. First year, four walls EBIITDA which is you know that’s why we are opening so many stores 12% is a lot compared to what most retailers are doing right now, but I think its 23% first year four walls EBITDA that’s a wonderful business opportunity. The internet sales are growing, we don’t really believe that people are going to quit going to bricks and mortar and its all about Internet. Internet sales aren’t that great across the retail sector either, but as long as these sort of Indianapolis level locations yield even more profitability than our exciting LA and Chicago locations, I think we’ve got to try to pick up the pace on you know at least 12% sales.

And we emphasized on the last call another thing that’s happened is that we kind come of age after 36 years we truly are the first call a developer will make for this type of retail and we are getting what used to be considered sort of department store, anchor pricing and location within the few centers that are being developed. And you know we are perfectly happy to go in and redo a book store something else on our own CapEx dollars, if that’s what we need. But we remain as tricky as ever about locations. We really want the corner of Maine and Maine and we’re just delighted to learn that the corner of Maine and Maine in Kansas City cost a lot less than a dozen LA and our sales are pretty much close to the same.

Simeon Gutman - Morgan Stanley

Hi, it’s Simeon and I was able to jump on. Just a follow up. And looking at the top program, now that you have a growing list of emails granted from the markets where you’ve been in and I can see from my own embarks a greater flow of communication. Can you talk about the response of the conversion rate, how closely you are tracking it, who’s clicking through the website or someone ends up buying something in the store, you were able to track that as well?

Jodi L. Taylor

You know, Simeon, hi. We actually don’t have that data here in front of us to be able to speak specifically, but yes, we do have the ability to track any and all communications that we are doing to each and every one of our POP! members. So I’m not sure what the click-through rate. We’re still continuing to sign up on the path of the sales in those markets that have the POP! program up coming from top numbers, so I think it’s up to 48% if I’m not mistaken Melissa.

Melissa Reiff

Yes, POP! stars is 48% of that POP! store sales are from our POP! stars.

Jodi L. Taylor

Okay, that’s a massive…

Melissa Reiff

48% of POP! Store sales are from our wonderful POP Stores.

Jodi L. Taylor

And you remember Simeon, today really the primary market that we’ve have POP! in has been California, so it’s just now starting to move further beyond California.

Melissa Reiff

We need another.

Jodi L. Taylor

So yeah, we’re not quite to where we’ve got any experiences other than Californian but we are very excited to know how this rolled out based on what we have seen so far.

Simeon Gutman - Morgan Stanley

Yeah you pilot in California because they have the weirdest privacy laws and if you can do it there you can do it anywhere. And also, the sign up ratios are so much higher than we planned, I think that people signed up better in Iowa and Texas than they did in California we are delighted with the ratios we got in California.

Jodi L. Taylor

Yeah, we are already seeing. I’m sorry, Simeon I’m just going to comment that we are already seeing because we’re -- Scottsdale and Vegas and a few other stores that those customers are really sharing with us not only their email addresses because this is an email based program, you have to give us your email so we can track the person, so we can surprise and delight you every month, but they are giving us their phone number, they are giving us their mailing address and the percentage that we are receiving is incredibly gratifying.

Simeon Gutman - Morgan Stanley

Got it. And so I guess presuming in those where you have the ability to directly communicate or direct market, are you seeing that it is driving traffic going back to the traffic driver that we talked earlier. Are you seeing a direct impact when you send some emails out and you were able to bring people into the store?

Melissa Reiff

We are Simeon, they are coming back. I mean, it’s amazing. In the test in California, one of the perks for the month we would be talking with one of our vendors and we gave out POP! stars a little goody bag, a free product. And you just wouldn’t believe these people would drive two and three hours to receive that little goody bag product and there of course they shop. And their average ticket is higher than non-POP! stars.

Simeon Gutman - Morgan Stanley

Yes that’s not really designed for average ticket but wonderful enough it has a positive impact there.

Melissa Reiff

It sure does.

Simeon Gutman - Morgan Stanley

Thank you.

Melissa Reiff

You bet.

Operator

(Operator Instructions) And the next question is from Dan Binder of Jefferies. Please go ahead.

Daniel Binder - Jefferies

Hi, good afternoon it’s Dan Binder

Melissa Reiff

Hi.

Daniel Binder - Jefferies

My question was around the comp guidance for Q4, given your current view that maybe it’s not all weather and we’re in a bit of a funk, it’s a pretty big stretch to get mid single from where we just finished. Just trying to understand how much of that is -- if you can pars it to how much of it is easy comparison versus initiatives versus some underlying assumption in the core?

Kip Tindell

All right. Well, I let Jodi answer that question, but something I want to just comment on this, there’s a 7% comp store sales differential between stores that had a lot of weather and stores that had some weather in the fourth quarter. And so, we’re just up against the easiest comps in our entire history. Go ahead.

Jodi L. Taylor

Yes, Dan, it would be primarily due to the expectation of improving weather since it has been such a significant impact to us in the fourth quarter. Secondarily would be the impact of the initiatives, but far more because of the weather.

Daniel Binder - Jefferies

And on the – your earlier comments about not promoting, I’m just curious in this kind of an environment, why not promote a little bit more to try and get the traffic?

Kip Tindell

We’re not – we do some promotions. What we’re trying to emphasize is we did not do more promotions this period than we did a year ago. We are beginning to feel like our consumer -- everybody is reacting more to – retailers are just training -- is the most promotional environment I’ve ever seen in my career I think. And so, we’re not stubborn, we’re not overly proud.

We have the best relationships with our vendors in the industry and we can gain their participation, and if we need to do more of that we’ll do more of that. We still done some of it, but if we need to more of it we will. We’re flexible about that when we hit the weather last year we kept Elfa on sale for an additional period of time. We’re not foolishly proud on that and we’re very confident of our ability to get our vendors to work with this to pass on those discounts when and as needed.

And my wife Sharon, is our Chief Merchant, we’re looking at that. We’re looking at SG&A reduction. We’re looking at sort of limited impact gross margin, more price promotion, and we’re doing everything that we’ve learned to be able to do in our careers when we get little unexpected patch of sluggish sales.

Melissa Reiff

Yes, and I think the point, Kip, is that we’re strategic with that, we’re certainly not proud. We’ll do what we need to do without harming the brand. But I think we’re very strategic with our sales and our promotions and if you were in our store right now most of the time throughout the year we have either a collection or a section of the store something on sale, which again we work with our vendors to pass that on so that it makes it very profitable.

Daniel Binder - Jefferies

And then just finally if I could, can you give us any kind of definition on success in these new initiatives whether it’s where you see those businesses for the custom closet, the ATHOME initiative? How would you define success in the first year? Is it maybe a level of sales or percentage of the mix or number of transactions, any help if you can give us on that -- what you’re expectation look like?

Kip Tindell

Well, I guess we’ve avoided in the call, in the quarterly call, getting too specific on that since we’re still in the test mode. But you’ve got a product that we think is the biggest thing we’ve done maybe in our history, it’s got 60 or 70 times the average to the overall average ticket.

And so, if it amounts to very mini percent at all of total sales it really phrases your average ticket and that falls straight to your comp store sales increase. So, let’s say we’re able to take traffic from minus half to plus a half and then if you add some points to this average ticket thing, you get back to where we need to be.

Melissa Reiff

Yes, I think the short answer to your question Dan is with regards to both ATHOME and the new custom closets offering that we’ll have, those are both going to be – the report cards so to speak will be average ticket without a doubt, seeing that grow. As we said it has always grown at this company. That’s not a new phenomenon for us. We are very proud of our average ticket growth that we’ve seen.

Kip Tindell

5.6 last year.

Melissa Reiff

5.6% and 4.2% the last two fiscal years, so certainly it’s been growing nicely.

Kip Tindell

And that’s without this kind of initiative.

Melissa Reiff

Right, and then you get all the frequency from the POP! Star, introduce them all this new wonderful collection, here you go.

Kip Tindell

So, for us its easier to raise average ticket than it is to raise traffic and I think that’s probably -- because we have these well paid, well trained sales people and then we have the average tenure in our buyers is like 17 or 18 years, so we’re bringing* in higher end product that the customers been asking for. Gosh, the average first-year employee at The Container Store gets trained, how many hours Melissa?

Melissa Reiff

Over 280.

Kip Tindell

280 hours. And industry average is less than 10. So, we’re good at training. This product is like a lot of products out there, that’s why I jokingly call it – you call this the Texas closet, and it’s just a matter of expediting the rollout of it, because sales are little more sluggish than we thought.

And you know, there are little more sluggish than we thought in the first quarter. I mean we’ll see in the second and third quarter. We try to be very conservative and mindful of how they were in the first quarter by lowering the second, third comp estimate. But like everybody we’ve had comp store sales in the double digits and we’ve had them negative but not very often, so we’ll see how long this persists.

Daniel Binder - Jefferies

Thanks.

Operator

Thank you. We have no further questions at this time. I would like to turn floor back over to management for any closing remarks.

Kip Tindell

Okay. Well, I think this retail funk is real. Yes, we’re little surprised by it, but we are not immune to it. We are very mindful of our employee morale and our customer morale. People haven’t stopped loving us. I mean they seem to love us more than they ever have. We’re very confident of that. And I think it’s important to remember the first quarter is our least important quarter, simply put, it represents less than zero percent of our annual earnings.

We believe the second, third quarters will improve. I’m trying to be very modest and conservative in how we project that, but we’re confident they will improve for lot of reasons. But we’re of course looking forward to that fourth quarter as we comp against the worst weather we’ve had in our history, but also believe that everything that we’re doing will help a little bit more in the second quarter, a little bit more in the third quarter, little more in the fourth quarter.

And with the historical 60% of the earnings occurring in the fourth quarter and as Jodi mentioned this year we expect that to be 70% of the earnings in the fourth quarter. That’s when it counts. We wish we were like a basketball game *where all that matters is the fourth quarter, but that’s just the way our business is and we’ll take it. We’re going to maximize that fourth quarter.

We’re attacking the slight traffic declines with other initiatives beside just POP!. POP! is just main one. And we’re increasing average ticket with all of our abilities, but the ATHOME and closet domination things I think will really give us tailwinds on that. We’re very pleased to get to 12% minimum square footage growth even this fiscal year.

It normally takes eight or 10 months to open a store, but we wanted to get that one signed and illustrate that we’re not just doing the 12% next year, we’re doing 12% right now, and we’re proud of our employees kind of pitching in. It’s kind of like the family around the dinner table where you’re holding hands and we’re saying okay, we’re going to grow at 12% square footage or better and we’re going to somehow get that stubborn traffic thing up to slightly positive.

But we’re going to do what we best with this average ticket thing and we’re going to really make some inroads there. And the Container Store is not designed to have a minus 0.8% comp store sales increase.

Melissa Reiff

Decrease.

Kip Tindell

Decrease. We get 3%, 4%, 5% or better, we do fabulously well. So it’s almost joyful. It’s kind of like going to war together and doing that thing that we do best which is average ticket growth. So, thank you again for all of your time and your interest today and we look forward to updating you again next quarter particularly on that average ticket thing. Thank you again.

Jodi L. Taylor

Thanks everyone, thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. And thank you for your participation.

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Source: The Container Store Group's (TCS) CEO William Tindell on Q1 2014 Results - Earnings Call Transcript
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