Logo of jester cap with thought bubble.

Image source: The Motley Fool.

The Container Store Group, Inc. (NYSE:TCS)
Q1 2020 Earnings Call
Jul 28, 2020, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

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

I would now like to turn the conference over to your host, Caitlin Churchill of Investor Relations. Thank you. You may begin.

Caitlin Churchill -- Investor Relations

Good afternoon, everyone, and thanks for joining us today for The Container Store's first quarter fiscal year 2020 earnings results conference call. Speaking today are Melissa Reiff, Chairwoman and Chief Executive Officer; and Jodi Taylor, Chief Financial and Administrative Officer. After Melissa and Jodi have made their formal remarks, we will open the call to questions.

Before we begin, I need to remind you that certain comments made during this call regarding our plans, strategies, expectations regarding liquidity and goals, our anticipated financial performance and our plans in response to COVID-19 and the potential impact of COVID-19 on our business may constitute forward-looking statements and are made pursuant to and within the meaning of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements. Those important factors are referred to in The Container Store's press release issued today, and in our Annual Report on Form 10-K, filed with the SEC on June 17, 2020. The forward-looking statements made today are as of the date of this call, and The Container Store does not undertake any obligation to update their forward-looking statements.

Finally, the speakers may refer to certain adjusted or non-GAAP financial measures on this call. A reconciliation schedule of the non-GAAP financial measures to the most directly comparable GAAP measures is also available in The Container Store's press release issued today. A copy of today's press release may be obtained by visiting the Investor Relations page of the website at www.containerstore.com.

I will not turn the call over to Melissa. Melissa?

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

Thank you, Caitlin, and welcome, everyone. We appreciate you joining our call today. I first want to discuss the highlights of our fiscal Q1 performance that includes of course, the impact of the COVID-19 pandemic. I will also give you an update on our strategic priorities, after which Jodi will review our financial results in more detail. And then, we'll open-up the call for questions.

This certainly continues to be a challenging time due to the pandemic. However, I'm very proud of our company and extend my deepest gratitude to every individual on our teams for their ability to adapt, adjust and work smarter than ever before. It is this ability along with their agility, positive attitude and execution during this challenging and rapidly changing environment that continues to drive us forward. Again, my sincere thanks to our organization.

Our fiscal first quarter, which is comprised of April, May and June, includes the material disruptive impact the COVID-19 pandemic has had on our business. However, our results also demonstrate the resiliency of our business model and our teams. For the quarter, despite a significant loss in store operating days from our temporary store closures and the shift of select locations to curbside pickup, we were able to maintain over 72% of our consolidated net sales generated in the corresponding time period last year. This performance was a result of the strong growth of our e-commerce business that almost tripled versus last year, generating close to 195% sales growth year-over-year. Also as a reminder, in Q1, we were cycling a strong 7.8% comp store sales increase from last year. That increase was driven by strong Custom Closets selling, as well as residual benefits from the January 2019 launch of Marie Kondo's Tidying Up show on Netflix that helped to drive growth in other product categories too.

As we cycle these strong periods of selling Q1 in this year and our stores have reopened, we've seen our sales trends improve. For fiscal 2020, Q2 to-date the month of July only, when you look at retail sales orders taken at The Container Store, we have been able to preserve approximately 90% of our retail sales generated during the same time-frame last year. Pandemic-related disruption, both from a store closure perspective as well as higher-than-normal levels of orders, triggered by the surge in our online business were significant headwinds to overall TCS sales growth and profitability in Q1. We did, however, improve our level of unfulfilled online sales from approximately $11 million at the end of Q4 of fiscal 2019 to approximately $5 million at the end of Q1 fiscal 2020.

We were also pleased to see sequential sales improvement each month as well as strong customer reception to our planned promotional activities, including our successful kitchen and pantry and closet essentials events. As I discussed in May, we made the decision to change the composition and cadence of our campaigns early in the first quarter to adapt to the changing landscape. And these changes along with the increased mix of online sales had a material impact on our gross margin performance, with our online mix being by far the biggest driver of our year-over-year gross margin decline. As Jodi will discuss in more detail, we believe that as conditions normalize, traffic trends become more consistent and the online sales mix moderates, we expect gross margin pressure to begin to ease from these Q1 levels. This is, of course, assuming we don't have to drastically limit store operations again and the mix of online sales does not return to Q1 levels.

Additionally, within The Container Store retail business, from a category perspective, we saw out-performance from Custom Closets in Q1, largely driven by sales of do-it-yourself of Elfa. We certainly experienced customers very interested in buying Elfa during this pandemic as they focused even more on getting their homes organized, accomplishing those projects that perhaps they had not been able to accomplish prior to COVID-19. And in many cases, customers opted to buy Elfa and install it themselves rather than having the installer come into their home. Our expansion of Elfa products into more grab-and-go pre-pack solutions also proved to be very successful, both online and also in-store during Q1. I'm very proud of how Elfa Sweden has managed through this crisis. While they saw a decline in third-party sales due to the impact COVID-19 had on their customers, they executed swift decisions to reduce cost and were able to deliver profitable growth year-over-year in Q1 despite their sales declines.

As we also shared in May, we had to make incredibly difficult decisions with regards to cost actions in light of our temporary store closures. We are very grateful to our teams and also to our vendor and landlord partners, who really leaned in to help us preserve our financial health and liquidity during these challenging times. It is due to this and many other efforts that we were able to deliver positive adjusted EBITDA for Q1 and a significant improvement in year-over-year free cash flow, despite the sales and margin headwinds we faced.

As stores have reopened, we continued to ramp back up our store operations and associated operating costs with employees returning from furlough. To be a bit more specific on our current store operations, with the exception of our downtown San Francisco store, all stores are now operating with doors open to the public with a maximum of about 50 customers in the store at a time. Our San Francisco store continues to provide only curbside pickup and by-appointment shopping at this time. We continue to operate with all health and safety protocols in place, including requesting that all customers wear a mask and providing one if they don't have one, which is in line with local government mandates in the majority of our markets.

Prior to July 6, we had shortened our store hours. However we have now expanded our hours. And on July 13, we also returned to accepting cash and checks. We resumed taking returns in our stores in early June and are continuing to follow the strict sanitization protocols around that returned merchandise. We remain very disciplined, managing cost to sales trends and will continue to focus on operating with a nimble and leaner organization. As performance stabilizes, we also intend to return to more normalized compensation levels across the organization since we did institute temporary pay cuts that impacted a number of our employees. Even as we tightly manage expenses to sales trends in this uncertain environment, we are optimistic about the many opportunities ahead for our brand and are prudently moving forward with the execution of our strategic initiatives in fiscal 2020 and beyond.

With regards to merchandising, we continue to infuse newness into our product assortment. Within our Elfa closet line, we launched new products with a graphite finish in March and had been very pleased with the initial results. We also have continued to generate great social buzz and excitement with our exclusive product offering in collaboration with The Home Edit. This collection has now grown to include 52 products with our most recent addition of the refrigerator and freezer collection that we launched in May. The Home Edit Netflix show is expected to air later in 2020 and we could not be more thrilled with our plans for this partnership and the growth we continue to experience. We've been working on another exciting collaboration as well that we plan to announce later this year.

As it relates to our stores, we continue to operate with the health and safety of our employees and customers top of mind. While we pulled back on all discretionary spend and limited capex for the year, we still plan to open one store in late fiscal 2020. We also expect to continue to test new layouts and sizes of stores. The timing of those of course is somewhat dependent on the ever-changing environment.

As we -- as seen with our recent The Container Store Custom Closets store concepts in our Dallas Galleria store and our Farmer's Market store in L.A., our new concepts have a much greater presentation of Custom Closets with relevant completion products for projects in all areas of the home including lifestyle displays of products by area of the home. With the estimated $6 billion market opportunity for Custom Closets, we expect to continue to aggressively pursue Custom Closets initiatives to gain market share. For example, our virtual design program that we launched in mid-May continues to be well received, building momentum with a strong average ticket. We plan to expand virtual capabilities to all stores, updating the Custom Closets designer role to include selling in-store, in-home and virtually and giving customers a single point of contact across all channels.

We've also made changes to our marketing campaigns to ensure their relevancy and effectiveness in light of the current environment. As I mentioned in fiscal Q1, we ran an extended Kitchen & Pantry event as well as our closet essentials campaign. And instead of repeating our Elfa free installation program from last year, this spring we offer customers up to 30% off their Elfa purchases in order to provide more flexibility for them during COVID-19. Overall, we were encouraged with the customer response to our Q1 marketing campaigns. And combined with our growing POP! Star enrollment, we are pleased with our ongoing efforts to increase our brand awareness. At the end of Q1, we had almost 8.9 million POP! Stars enrolled. Considering that we had many temporary store closings during Q1 due to the pandemic and pivoted largely to website-generated sales, it's quite remarkable to see that we added close to the same amount of POP! Stars, during Q1 that we did in the most recent quarters, prior to the pandemic.

Finally as it relates to supply chain, we were very excited to have our second distribution center up and running for the entire first quarter to help our order fulfillment needs that we experienced from the pandemic-driven surge, in online growth. Both of our distribution centers Dallas and Aberdeen Maryland did a phenomenal job of quickly increasing their output, for online customer orders in Q1. And while we have had to contend with elevated operating costs at our DCs given the pandemic as well as prudent management of inventory, given this backdrop, we are pleased with the improvement in unfulfilled orders we were able to drive in Q1. However, we have had some delays associated with these unfulfilled orders, as we've had to manage the impact of the pandemic on our DC operations as well as we approached inventory purchases in a temporary closed store environment, with conservatism. Our teams are working diligently to get caught up and fulfill these orders. And as of now, we are back to shipping orders taken online within 48 hours of receipt for all in-stock inventory.

In summary, while an incredibly challenging time to operate in retail, I'm very pleased with how we have navigated through this crisis. We've stayed nimble and flexible and disciplined, while making sure that our employees and customers are safe and we will continue to operate with the same focus going forward. As we have reopened stores, we are encouraged with the results we are experiencing. Looking ahead, while we are optimistic that sales and margin performance will improve as fiscal 2020 progresses, we remain disciplined and agile in managing our business in the still uncertain environment.

I would like to acknowledge the announcement in our release today, that our Chief Accounting Officer, Jeff Miller will be succeeding Jodi Taylor as our Chief Financial Officer as of August 31st 2020. Jodi will continue to serve as our Chief Administrative Officer and Secretary and will ensure a seamless transition, as Jeff assumes his new role. I want to thank Jodi for her continued partnership and for everything she has done for the company as CFO, over the past 13 years, including her pivotal role in our IPO process in 2013 and the build-out of our public company functions and financial processes. More recently, all of the efficiency and optimization work we've done as well as the development and execution of the initiatives to revitalize sales and profitability that we have done could not have taken place without Jodi's tireless efforts. She has been a trusted partner and a dear friend to me personally. And I along with the Board, are pleased to be able to announce this smooth CFO transition, while we continue to benefit from Jodi's participation and contributions in her capacity, as Chief Administrative Officer. Jodi has created a strong bench within our financial organization and I have the utmost confidence in Jeff assuming this role. Jeff has been with The Container Store for seven years, serving as our Chief Accounting Officer. He has worked closely with both Jodi and me over the past seven years and I'm thrilled to announce his appointment, as Chief Financial Officer. Congratulations Jeff.

And before I turn the call over to Jodi, I just want to once again thank our teams for their hard work and dedication to The Container Store. We've always been a purpose-driven employee-first culturally laden business, and we see that as more important than ever today. We believe that companies that are best positioned to succeed are the ones that commit to growing sustainably and the ones that align their mission and business strategy with solutions that benefit people and their communities. And with that in mind, we have established an ongoing diversity and inclusion task force and I'm very pleased with this team and the progress they have made. And we will soon announce our specific plans for this initiative both internally and externally as we are eager to execute them.

Now, I'll hand it over to Jodi to go through our financial results and outlook in more detail.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Thank you, Melissa, and good afternoon, everyone. Before I begin, I want to congratulate Jeff on his new role. One of the key attributes of our company that I am most proud of is the caliber of our people in our accounting and finance team that I have been privileged to lead the last 13 years. I'm confident that this transition will be a smooth and seamless one and look forward to ensuring that in the coming weeks before Jeff formally takes the CFO reins on August 31st. I also look forward to my continued close work with Jeff, Melissa and our leadership team in my role as Chief Administrative Officer and Secretary.

Now turning to our results. Our first quarter performance was materially impacted by the COVID-19 pandemic. But as Melissa mentioned, we are incredibly proud of the adaptability and dedication exhibited by our teams as we navigate through this crisis. Given that stores were temporarily closed or working with limited operations during the majority of the quarter, we will focus our commentary on total sales and will not be reporting comparable store sales for this period.

For the first quarter, consolidated net sales decreased 27.6% year-over-year to $151.7 million. As you will recall in our May 12th remarks, we noted that for fiscal Q1 to-date at that time, we had maintained approximately 76% of the total retail sales orders generated in the corresponding time period last year. We are pleased that we're able to maintain a similar level of performance for the entire quarter despite having to cycle strong Custom Closets sales from last year during the second half of fiscal Q1 and despite a loss of a significant number of store operating days.

When you look at our brick-and-mortar store operating days during Q1 this year, we lost about 20% of our operating days due to complete closures. Around another 20% of days we were open, but this was only in part of June and with shorter hours, limiting customers to a maximum of 50 and also including curbside pickup. The remaining 60% of our store operating days in Q1 were in a modified operating model, while we offered only curbside pickup and appointment-only business for very few customers at a time.

Our online channel continued its strong performance, delivering sales growth of 192.3%, nearly triple last year's first quarter results. Online sales represented approximately 47% of our TCS Q1 net sales. And when you include curbside pickup, our website generated sales in Q1 represented a total of 67.5% of TCS net sales, compared to only 16.3% in Q1 last year.

By segment, sales for The Container Store retail business were $139.4 million compared to $195.1 million last year, improving sequentially each month as the quarter progressed. Our Custom Closets business performed slightly better than company average, declining 22.7% versus last year while other product categories fell 33.5%. As Melissa mentioned, we saw strong interest in our Elfa products and solutions including more sales of DIY solutions, as well as strength in our grab-and-go pre-pack solutions, which sold very well online. We also altered our promotional cadence for Custom Closets with the onset of the pandemic to make our offers more appealing to customers wanting to use our great Elfa solutions to get organized while spending more time in their homes.

Within our other product categories, we saw strength in our core categories like kitchen, office, and storage those products customers were using to organize areas of their home while quarantining. Our impulse categories were not surprisingly the weakest, including products in the travel, tower and gift packaging departments.

At Elfa, their third-party net sales decreased 14.6% to $12.3 million. Excluding the impact of foreign currency translation, Elfa third-party sales declined 12.5% year-over-year due to the impact of COVID-19 in Europe. From a profitability perspective, our consolidated gross margin for Q1 was 51.6% compared to 57.2% last year. By segment, gross margin at The Container Store was down 760 basis points, driven primarily by increased shipping costs associated with a higher mix of online sales and to a lesser extent, increased promotional activity as we worked to drive digital sales with a large number of stores temporarily closed and store operations significantly disrupted during the period.

As mentioned, Q1 online sales represented approximately 47% of sales at The Container Store compared to approximately 12% during Q1 last year. Given our stores are now reopened and as our online mix begins to normalize, we would expect gross margin pressure to abate from the levels we saw in Q1 at TCS so long as stores remain open and online mix doesn't return to the levels we saw in Q1. Also gross margin increased 640 basis points, primarily due to favorable customer and product sales mix and to a lesser extent direct -- lower direct material costs.

Consolidated SG&A dollars declined 20.9% to $86.3 million compared to $109 million in Q1 of last year, driven by the meaningful cost reduction actions we took in response to COVID-19's impact on our business during the quarter. As a percentage of sales, SG&A increased by 490 basis points versus last year, primarily driven by deleverage of occupancy and other fixed costs on a sales decline, partially offset by reductions in payroll, transportation and marketing costs. It is important to note that in a normal environment the operating profit impact of a higher online sales mix is typically accretive, given the higher average ticket and lower-than-store fulfillment costs that more than offset the lower gross margin of an online transaction. However, in Q1 the challenges of COVID-19 and the associated disruption led to supply chain inefficiencies including higher labor costs that weighed on profitability.

Other expenses increased to $800,000 in the first quarter of fiscal 2020 due to severance costs associated with the reduction in workforce as a result of the COVID-19 pandemic and the related temporary store closures. Our net interest expense in the first quarter of fiscal 2020 decreased 13.3% to $4.9 million from $5.7 million in the prior year, due to lower interest rates combined with the lower principal balance on our senior secured term loan facility and partially offset by a higher balance on our revolver.

The effective tax rate for the quarter was 29.3% compared to 30.5% in the first quarter of last year. The change in the effective tax rate was primarily due to stock compensation expense and the jurisdictional mix of income. Our net loss for the quarter on a GAAP basis was $16.7 million or $0.34 per share as compared to a GAAP net loss of $4.1 million or $0.08 per share in the first quarter of last year. On an adjusted basis, excluding certain COVID-19-related and severance costs incurred, adjusted net loss per share was $15.5 million or $0.32 per share as compared to last year's adjusted net income of $4.1 million or $0.08 per share.

Adjusted EBITDA was $4.5 million in the first quarter this year compared to $10.6 million in Q1 last year. We were pleased with our ability to deliver positive adjusted EBITDA results for the period despite the headwinds we faced. This reflects our efforts to manage costs including cash lease payment deferrals to preserve our financial health and liquidity in a highly uncertain period. While we recognize all rent expenses we normally would on our income statement, approximately $12 million of certain cash lease payments have been deferred from our first quarter of fiscal 2020, the benefit of which is reflected in our first quarter of fiscal 2020 adjusted EBITDA. Less than half of these lease amounts are expected to be repaid in the second half of fiscal 2020 and the remaining amounts are expected to be repaid primarily in fiscal 2021. We're very appreciative of the ongoing collaboration of our landlord partners during this time.

Turning to the balance sheet, we ended the quarter with $63.5 million in cash, $308.7 million in outstanding borrowings, and total liquidity including availability on our revolving credit facilities of approximately $106.9 million. We ended the quarter with consolidated inventory down 9.4% and we have continued to tightly manage our working capital. We are very pleased that despite the challenging backdrop we generated positive free cash flow in Q1 and improved liquidity. Reflecting the impact of all the swift actions we've outlined, we expect to deliver positive free cash flow for the year. We also continue to expect our total capex for fiscal 2020 to be in the range of $12 million to $15 million.

While we're not providing further financial guidance at this time, we did want to provide you with an update on our operations quarter-to-date about four weeks into the second quarter of fiscal 2020. As of today, all of our stores are open and operating with limited customers inside with only our downtown San Francisco store operating with appointments and curbside pickup only. As Melissa shared, for Q2-to-date, when you look at our retail sales and take into consideration customer orders taken and not yet delivered to a customer, we are maintaining approximately 90% of the total retail sales generated for the corresponding time period last year. From a liquidity perspective, we continue to feel good about our position and as of today, liquidity is relatively unchanged from the end of Q1. This reflects a revolver balance of $18 million, down from the $78 million at fiscal 2019 year-end as we paid down $20 million on our revolver borrowings in Q1 and another $40 million earlier in fiscal Q2.

That concludes our prepared remarks. I'll now turn the call over to Latanya to open up the lines for questions.

Questions and Answers:

Operator

Thank you. At this time, we will conduct a question-and-answer session. [Operator Instructions] Our first question comes from Steven Forbes with Guggenheim Securities. Please proceed with your question.

Steven Forbes -- Guggenheim Securities LLC -- Analyst

Good evening.

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

Hi.

Steven Forbes -- Guggenheim Securities LLC -- Analyst

Hi everyone. I wanted to start with the sales retention comments, right? So, you're talking about demand orders implying a 90% retention rate in July. But can you give us some color on how that retention rate evolved during the course of the month? Maybe talk about when you think inventory levels will be sort of normalized right for you to capture all of that demand. And if there's any specific call-outs between Custom Closets trends versus other product categories during the month of July?

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Hi, Steve, how are you? Let me take that and Melissa, I'm sure you're going to want to add a few points here. But first off, as it relates to the fiscal July call-out/we did of 90% retention, I think it's important to remember that, last year in Q2, our comps were up 5.4%. And actually, July was the strongest month of Q2. So we were up against an 8.3% in Q2 -- or in fiscal July. So we're not up against a low benchmark in July, so I wanted to make sure that was known. And in terms of any specific call-outs, we have seen really across the store, again, same comments as what you heard us say in our remarks in terms of Elfa continues to sell well. And then also we're seeing strength across our core storage and organization products. We're in the midst of our Customer Favorites store and that sort of highlights key storage organization departments across the business.

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

Customer Favorites sale, we're in the middle of that right. Yeah, the key core storage and organization, the obvious one is the kitchen, the closet, the office storage continue to perform well.

Steven Forbes -- Guggenheim Securities LLC -- Analyst

Thank you. And then as a follow-up, right, so you talked about the rent deferrals. I think it was less than half what you paid in the second half remainder in 2021. But I guess how does that impact the P&L here for -- in cash flow right for the back half or was this just a second quarter impact as we think about the cash flow outlook?

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Yeah. Steve, we did defer about $12 million in rent payments in Q1. And each case is different, but approximately $5 million of that $12 million will be repaid. We'll from a cash flow perspective come out in the second half of the fiscal year more heavily weighted to Q4, which is when we generate a lot of our cash. And then that remaining amount of approximately $7 million will go into fiscal 2021 or beyond, but is more heavily weighted to the first half of fiscal 2021. So from a P&L perspective there's no impact, because we've taken the full hit of rent, regardless of whether paid in cash or not on the P&L. From an EBITDA perspective, it will cause some shifts of those amounts and also for cash flow like you said. However, with our reductions, we've done to capex and the way we're managing the cost in the business, we still feel very good about where we sit from a liquidity perspective, from a cash flow perspective. And you heard me say we still expect to be able to generate free cash flow as we proceed through the fiscal year.

Steven Forbes -- Guggenheim Securities LLC -- Analyst

And then one last quick one. On the reduction in payroll, maybe just give an update and sorry, if I missed it in the prepared remarks just where we are and where -- when you anticipate sort of a normalization in underlying payroll costs.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Yeah. I'll start. Melissa may want to add as well. As the stores are reopened, we have ramped up as you can imagine store operations and have returned our employees to work, but we're remaining very disciplined about our costs and we're managing those to the lower sales trends that we're achieving. So the goal here is to strive to keep the percentage of spend that we do of sales consistent with what we've historically spent even if it's a declining sales trend. One thing to note is in Q1, we did have hazard pay in our distribution centers. That was in effect for the entire quarter, but we discontinued that by the start of fiscal Q2. That was a call-out of about $900,000 that did hit in Q1 that will not hit unless, of course, there's a resurgence. Everything always has that asterisk, but is not anticipated to hit for the remainder of the year. We also right now, Steve, are in a situation where we issued some temporary pay cuts. We are slowly reversing those and expect those to be reversed out as we move through the rest of the calendar year, but basically planning to manage payroll quite tight still and try to manage it as close to sales trends as we possibly can.

Steven Forbes -- Guggenheim Securities LLC -- Analyst

Thank you. And best of luck.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Thank you.

Operator

Our next question comes from Kate McShane with Goldman Sachs. Please proceed with your question.

Kate McShane -- Goldman Sachs & Co. -- Analyst

Hi. Good afternoon. Thanks for taking my question. My question is centered around inventory. You gave some great detail there. I just wondered going into the second half, how you're thinking about being positioned from an inventory standpoint. And are you seeing as a result of the pandemic continued or any kind of disruption in terms of factory capacity when it comes to your products?

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Yeah. Let me -- hi, Kate, I'll start on that. And the short answer is, we are leaner in inventory right now than we would like to be on certain items, because as we noted, we ended the quarter with inventory down 9.4% and started the pandemic quite conservatively in terms of the order flows we have coming in not knowing what we would sell and where and quickly reacted and have pushed to build inventory where needed in key SKUs. But we are chasing in a few categories. And like every retailer, we've got 700 vendors, I believe approximately in all merchandise categories. Some are better than others, some have had COVID issues. So we're really just very much on top of that. Our merchants are doing a fantastic job working with supply chain and bringing product in as quickly as they possibly can.

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

And we've made some good improvements. I mean, we have with that which is great. So the high sales volume categories is what we're chasing, but we've just been on it doggone it. And of late, I've been really pleased with what we've been receiving, and so it should really help.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Kate, one other thing is, we did always expect inventory to decline this fiscal year year-over-year, because last year opening up the second distribution center, we were building inventory for two facilities. And now we're sort of rightsizing that so that we have the adequate levels at both facilities because Dallas continued to support the entire chain, while we were receiving product in Aberdeen. So some of the working capital generation from inventory was always envisioned for this fiscal year, just not quite to the degree that we saw in Q1.

Kate McShane -- Goldman Sachs & Co. -- Analyst

Okay. That's very helpful. And then my second question was just with regards to the competitive landscape, especially going into the second half. It does sound like just in general, retail was maybe a little less promotional than usual just in order to figure out demand from only one channel, etc. So as things open up here and stores open, how do you see the competitive landscape evolving, especially when it comes to promotions and discounting?

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

Well, we're executing our fiscal 2020 marketing plan, which is going to be highly focused on digital spend for obvious reasons. And it will be somewhat of a reduced spend from fiscal '19. So we're proceeding with that. And obviously we along with others in the home sector have benefited from so many customers being at home. And our mission -- our vision is to help them accomplish their projects and make the most of their home. And so that has certainly been occurring and particularly, with our virtual in-home that we've been doing that has been really well-received and we're going to be rolling that out to all stores as well. So I'm cautiously optimistic about the year. I think the competitive landscape has not really changed that much for us at all and we're just going to continue to focus on what we do best and focus on our differentiators and just be very prudent and cautious and agile and nimble and flexible in running the business.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

And Melissa, I want to just add real quick. Kate, on the margin side of that because from a promotional perspective, our margin degradation we saw at TCS in Q1, 75% of that degradation was because of the surge we saw in online going from about 12% of total sales last year to 47% this year. So the balance was due to promotional activities and we definitely did see during at least the first quarter initial part of the pandemic customers opting more into the promotions that we were offering up to them, but as Melissa said, really our goal on these promotions is just to stay relevant to our customers. And I think what also might be helpful for you to know is we did talk about how margin is expected to abate as we see a different share of online versus brick-and-mortar and certainly have seen that as we've moved into Q2. So just as a note, while it's still early in Q2 and I know we're not sharing outlook, I can share that year-over-year our decline in gross margin trend has significantly improved since the beginning of the quarter.

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

So for the month of July.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Right. Fiscal Q2 to-date [Phonetic].

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

Right.

Kate McShane -- Goldman Sachs & Co. -- Analyst

Thank you.

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

And the preservation of the sales went from 72% to 90%, so.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Right.

Operator

Our next question comes from Tami Zakaria with JPMorgan. Please proceed with your question.

Tami Zakaria -- JPMorgan Chase & Co. -- Analyst

Hi. Thank you so much for taking my questions. So I just wanted to understand the first quarter performance a little better. Last time you spoke in May I think you mentioned you were retaining 76% of sales and eventually, you ended up with around 72%. So could you elaborate on that a little bit? Did you see a slowdown in demand, given probably some customers pantry-loaded on some home items or was it more your supply chain issues like what drove the slowdown in 1Q?

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

It was -- go ahead.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Yeah. I think, the biggest explanation Tami is as we proceeded into the quarter, we were up against steeper Custom Closets sales from last year. We'd had a very, very successful Elfa free installation promotion in calendar May and June. And with our stores closed essentially until June 8th I think, is the day we sort of reopened unlocked the doors it's much more challenging. We tried very hard virtually and other ways Melissa spoke of but it's more challenging to sell Custom Closets in a closed store environment. So with an impaired -- I call it impaired model of operations for our stores, it made it harder to lap those Custom Closets sales even though our incremental volume was growing every single week and we were seeing larger sales. I can tell you Tami we did -- we exceeded our expectations for the quarter in terms of sales and in terms of really all through the P&L. So we're pleased. We knew that would be a tough bar to lap.

Tami Zakaria -- JPMorgan Chase & Co. -- Analyst

Got it. So just a follow-up on that. So basically you saw incremental improvement in store performance. But given Custom Closets was up against steep compares and it's a higher -- much higher ticket item, that's why you, sort of, saw a slowdown in May and June. Is that the right way to look at it?

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

That's correct.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Yeah. That's right. That's why the percentage to last year didn't improve albeit the dollar volumes escalated. So we were doing more per week. It was just up against a bigger bar. So the percentage challenge was there.

Tami Zakaria -- JPMorgan Chase & Co. -- Analyst

Got it. And then you mentioned July was the strongest month of the quarter last year. Was it -- I'm sorry if I missed it, but was it due to some specific campaign that you decided not to run this year or it was just overall a strong month.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

We just had strong business.

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

Yeah.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Yeah. Nothing specific to call out.

Tami Zakaria -- JPMorgan Chase & Co. -- Analyst

Okay. And if I may ask one last question. The Elfa segment gross margin was very impressive. It leveraged a lot. Do you expect that to continue as you look to the rest of the year? And then also you mentioned, customer mix being a tailwind for Elfa in the quarter. Could you elaborate on that a little bit as well?

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Sure. I'll start with the customer mix. With The Container Store having sales down 28%, we pulled back quite a bit on our purchases particularly at the beginning of the pandemic. And the inter-company margin that Elfa records in their segment is lower for TCS than it is for their third-party sales that they do. So having mix -- it was both in that mix, but also what they had is customer-wise in Sweden they had their -- some of their customers that are simply more profitable were the ones that were doing better business which is good to see. So they also from a supply chain perspective and efficiency perspective continued to do well. So to your first part of your question, we have planned their margin up this year. They did exceed our expectations in Q1. I would expect it not to continue quite at that rate, but we do expect them to see good gross margin trends this year.

Tami Zakaria -- JPMorgan Chase & Co. -- Analyst

Got it. Super helpful. Thank you so much.

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

Thanks, Tami.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Thank you.

Operator

Thank you. That is all the time we have for questions today. I would like to turn the call back over to management for closing comments.

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

Just thanks again everyone for joining our call. We just appreciate your support and interest as always and we will look forward to talking with you next time. Have a great day.

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Thank you.

Operator

[Operator Closing Remarks]

Duration: 43 minutes

Call participants:

Caitlin Churchill -- Investor Relations

Melissa Reiff -- Chairwoman, Chief Executive Officer and President

Jodi Taylor -- Chief Financial Officer and Administrative Officer

Steven Forbes -- Guggenheim Securities LLC -- Analyst

Kate McShane -- Goldman Sachs & Co. -- Analyst

Tami Zakaria -- JPMorgan Chase & Co. -- Analyst

More TCS analysis

All earnings call transcripts

AlphaStreet Logo