Kirkland's, Inc.

Good morning and welcome to the Kirkland's 2019 Fourth Quarter Earnings Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference operator by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Jeff Brack of Investor Relations at SCR. Please go ahead.

Thank you. Good morning and welcome to Kirkland's Conference Call to review results for the Fourth Quarter of Fiscal 2019. On the call this morning, we have Woody Woodward, Chief Executive Officer, and Nicole Strain, Chief Financial Officer. The results, as well as the accessibility of this conference call on a listen-only basis over the Internet, were announced earlier this morning in a press release that has been covered by the financial media. Except for historical information discussed during this conference call, the statements made by company management are forward-looking and may pursue to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties, which may cause Kirkland's actual results in future periods to differ materially from forecasted results. The risks and uncertainties are more fully described in Kirkland's filings with the Securities and Exchange Commission, including the company's annual report on Form 10K filed on March 29, 2019. I'll now turn the call over to Woody.

Thanks, Jeff. 2019 was a year of significant transformation for Kirkland's. We took bold steps to reinvigorate our assortment, realign our infrastructure, and improve e-commerce, and we're well along the path of implementing direct sourcing. Overall, the work supports our long-term strategy to preserve Kirkland's valued DNA as we increase relevancy and improve retail fundamentals. During 2019, we reinvented core product assortments and added new categories that make us more important to Kirkland's loyal customer base. We addressed supply chain flow and invested in our omnichannel platform. The results we reported today reflect the depth of the transition, with plans to close 28 underperforming stores and a further reduction in operating expenses. The results also reflect encouraging progress. We achieved strong e-commerce growth in the quarter, and we had better performance in segments of the assortment, including furniture and tabletop. We ended the year with a solid balance sheet, and we believe we're well positioned to execute our vision strategy for Kirkland's. Let me share some thoughts about our key priorities for 2020. It starts with further accelerating product development to build on what we've accomplished in 2019. Our goal is to be in the consideration set for a complete home furnishings project in addition to the finishing touches. Let me elaborate on that. Kirkland's has historically been known as a key resource for accessories when a home decor project is near completion. We've been an ideal stop to pick up a wreath for the front door, a candle for a certain room, some finishing artwork, or even some holiday decor that makes your home happy as a happy place to live. We have a long history there, and this focus has concerned our customers well. At the same time, we've been losing market share to mass merchants and online-only players with an assortment that's too narrowly focused in some cases. During 2019, we added larger furniture pieces, tabletop, rugs, beds, and bedding. We've been more deliberate in our color direction and design point of view, and edited assortments to tell a clearer story to the customer. We have also included occasional chairs, recliners, and large-scale tables for our assortment. The final ad is being tested this year with upholstery. This strategy is to get our customers thinking about us for a complete decorating project. We want to be the complete, casual home decor store where essentially everything goes together with one point of view. That allows our customers to finish their entire room or home, all within a tight budget. Our goal is to move away from being coupled with mass merchant retailers and fit squarely as the value home retail store within the specialty world. Our second goal is to improve Omnichannel via website enhancements, incremental digital spend, and an expanded online assortment. We view e-commerce as an accelerator to our overall business strategy. Our focus on buy online, pick up and store has been a big success, and we're making additional improvements in the supply chain that will help with both speed and profitability. Third, we will continue to increase direct sourcing with the goal of increasing penetration in 2020. We're in the process of moving from the vendor base of primarily wholesalers to a worldwide direct sourcing base. We believe that it can improve margins and quality as we differentiate our assortment to be more exclusive. Fourth, we're investing in marketing spend to drive consumer acquisition and brand awareness. Our stores look and feel better than they ever have. Our assortments are clean, focused, and edited to tell home decor stories, and these elements are starting to take shape with improved sales and margins. We have started to convey our brand messaging to require new customers while educating our current loyal base. With traffic continuing to be a challenge, we are concentrating on growing the back hit size, and the average unit retail by offering unparalleled value at a price. I welcome all of you to see our stores for yourself and let me know what you think. Fifth, we'll continue to preserve our capital to invest in the business. We ended 2019 with over $30 million in cash and no debt under our borrowing agreement. We'll continue to evaluate the store infrastructure, and we'll focus on additional ways to optimize our expense and increase efficiency. We've accomplished a great deal, but emerging as a powerful true home furnishings brand from an accessory store takes time and patience, and that's why we've been conservative with our capital to better facilitate this transition. Now I'll turn it over to Nicole Strain, our Chief Finance Officer.

Thank you, Woody. Before speaking to the specifics of the quarter, I would like to address some of the larger financial items impacting the fiscal year and how we see those affecting us as we move forward. As Woody discussed, we took significant steps during the year to transition Kirkland to a model that can generate profitable growth, and we believe we will make progress down that path in 2020. We rolled out new categories and made significant improvements in both the quality and design of our merchandise. Our full year performance in 2019 reflects margin pressure related to rebalancing our assortments to improve quality and design, while also recognizing the increasingly promotional competitive environment. During the fourth quarter, we experienced strong sell-through of our holiday merchandise and had a new floor set immediately after Christmas. We ended the year with two consecutive months of positive comparable sales, with January up .7% and e-commerce growth pushing 40% for the quarter. In addition to the merchandise changes, our fiscal 2019 results include initiatives to streamline our model to enable us to better compete in the future. We initiated aggressive negotiations with our landlords that allowed us to improve profitability at a number of our locations, and we negotiated an exit out of locations that were unprofitable, which will be closing in the first quarter of 2020. The majority of the benefit of the reduced occupancy costs will be realized in fiscal 2020, but much of the expense was reflected in the fourth quarter of 2019. We will continue to pursue lease negotiations throughout the remainder of our portfolio and to refine our store footprint to support an optimal omni-channel model. We stood up a second distribution center outside of Dallas, which reduced our transportation miles and generated annual net savings. We saw a partial year benefit in fiscal 2019, but will realize the full benefit in 2020. We will implement a new warehouse management system, which will allow us to consolidate our two distribution centers in Jackson, Tennessee, and stand up two e-commerce hubs in the first half of fiscal 2020. This will result in a reduction of distribution center costs, e-commerce shipping costs, and improved SLAs for -to-home orders. Again, most of the capital and the impairment charges were reflected in the fourth quarter of 2019, but benefits will begin in the first half of fiscal 2020. We reduced operating costs by approximately $24 million when compared with 2018 across all areas of our business, which included revisiting the store operating model to prioritize labor to our high-contribution stores, reducing corporate overhead, and initiating a review of all operating costs. Our fiscal 2019 results reflected approximately $10 million of those savings. And finally, we implemented direct sourcing, which will have roughly 100 basis points of margin impact in fiscal 2020 and will have an increase in benefit on product margin as our penetration grows. Direct sourcing will also help us begin to diversify our sourcing outside of China. Our adjusted loss per share for the year was $1.57 versus our guidance for a loss of $1.75 to $2. The table to reconcile to the most appropriate gap measure is included in our earnings release, which was filed pre-market today. The following explanations are all on an adjusted basis. Moving to the quarter, net sales for the fourth quarter decreased .1% or $6.7 million compared to the fourth quarter of the prior year. The change in sales includes a comparable store sales decrease of 2.7%, made up of a .9% increase in e-commerce revenue and a high single-digit decline in -and-mortar sales. And that's on top of a .3% combined comp decrease and a .3% increase in e-commerce in the prior year. In our -and-mortar stores, soft traffic continued and was the primary driver of the comparable store sales decline. E-commerce accounted for $34.6 million in revenues during the quarter, or approximately 17% of our total revenue. We saw a significant increase in transactions, which was partially offset by a decline in average tickets. For the quarter, 63% of our e-commerce sales were fulfilled in-store at a higher level of profitability than -to-consumer sales. Both this accounting for over 30% of our e-commerce sales in the quarter allowed us to be relevant and offer solutions for last-minute holiday shoppers at a level we were unable to provide in prior years. Grids' profit margin in the fourth quarter decreased 460 basis points from the prior year to 29.8%. Merchandise margin decreased from the prior year by 330 basis points to 49.3%. That was driven by a decrease in product margin from both product mix and incremental discounting, and we had a favorable damage adjustment in the prior year. Outbound freight costs, which include e-commerce shipping, increased 20 basis points as a percentage of net sales due to the increase in e-commerce sales. Store occupancy costs decreased by 600,000 but remained flat as a percent of sales compared to the prior year quarter. De-leverage from the decline in -and-mortar sales was offset by negotiated rent savings and lower depreciation due to asset impairments during the year. We continue to believe there is significant opportunity to remove costs from our -and-mortar infrastructure from both renegotiated lease terms and closing of underperforming stores. Central distribution costs increased by 110 basis points as a percent of sales compared to the prior year, mainly due to a change in the methodology of capitalizing distribution costs. Operating expenses for the fourth quarter, excluding depreciation and impairment, were .8% of sales compared to .6% of sales in the prior year quarter, or a decrease of 2.2 million. Store operating expenses increased 35 basis points as a percent of store sales, primarily due to the de-leverage of store labor. E-commerce expenses decreased 170 basis points as a percent of e-commerce sales due to operating leverage on fixed costs. And corporate expenses remained consistent as a percent of sales to the prior year quarter. Depreciation and amortization decreased 10 basis points. We recorded an impairment charge of $12 million in the quarter. Of the impairment charge, $5.6 million related to store impairment, $4.7 million to impaired software projects, and $1.7 million to store fixture and DC impairment. These charges were excluded from adjusted income per share. The valuation allowance recorded in the third quarter continued to impact our tax rate, which was .7% for the fourth quarter of 2019 compared to 27% in the fourth quarter of 2018. The favorable impact of the lower tax rate is normalized in adjusted earnings per share. For the quarter, we had a net loss of $0.35 for diluted share, or income of $0.59 adjusted, compared to net income of $0.95 for diluted share in the prior year quarter, or $0.97 adjusted. And moving on to the balance sheet and cash flow statements. At the end of the quarter, we had $30.1 million of cash compared to $57.9 million in the prior year period. We repaid all borrowings on our revolving line of credit during the quarter. The -over-year decrease in cash was driven primarily by the decline in operating performance, capital expenditures, and share repurchases in the first half of the year. We ended the year with $61 million of availability on our credit facility. Our inventory balance at the end of Q4 was $94.7 million, which is an increase of approximately 12% over the prior year period. The inventory increase includes funding the new product categories released early in the third quarter, as well as inventory from softer sales in some non-seasonal categories. There is minimal risk of obsolete seasonal inventory as we effectively move through all seasonal products during the quarter. Further, we directed excess clearance and overstock inventory to the store closings in the first quarter of 2020. -to-date cash used by operations was $8.3 million compared to cash generated at $22.3 million in the prior year. The decrease is due to the decline in operating performance and changes in working capital. Capital expenditures were $15.7 million compared to $28.8 million in the prior year and were driven primarily by investments in supply chain, e-commerce, and store additions and remodels. As we look forward to fiscal 2020, our goal is to continue to execute on our long-term plan to become the home decor destination of choice for value shoppers, and to transition our infrastructure to support the merchandise strategy, allow our customers to have a seamless purchase wherever she chooses to shop, and return to profitability. We expect the sales trend to improve versus 2019 as we benefit from further assortment improvements, continued momentum in e-commerce, marketing spend, and the closing of underperforming stores. We expect to generate marginally positive EBITDA in fiscal 2020, driven by stabilization in our close margin and expense controls. First, margins should benefit from the initiatives to reduce store occupancy costs, a more efficient supply chain, and our direct sourcing program, offset by an increase in e-commerce shipping as the online mix of our business grows. We will see the benefit of the $24 million in cost reductions relative to 2018 and a reduction of operating expenses as a percent of sales of approximately 150 basis points. And that's after funding incremental marketing spend directed towards customer acquisition. From a capital perspective, we will continue to focus on the conservation of cash to ensure we have the runway to implement the initiatives needed to return our business to prior levels of profitability. We expect to generate approximately $5 million of cash in fiscal 2020 and expect borrowings on our credit facility within the third quarter and to be repaid within the quarter. Capital expenditures will be in the range of $10 to $15 million with us managing to the low end and let our business improve faster than expected, which will allow us to expedite additional projects in the back half of the year. And finally, this outlook does not contemplate either the supply chain or demand risk from COVID-19. We are watching both closely and will react as needed, but are not providing any estimated impact at this time. And now I'll turn it back to Woody for some final comments.

Thanks, Nicole. I want to end by saying a priority of the organization is the safety and wellness of our employees who work so hard every day to make Kirkland's a special shopping experience and our customers who are visiting our stores. We're following the guidance from the CDC as well as state and local public health agencies to respond to the rapidly evolving situation with coronavirus. While there is uncertainty in the near term, we feel good about our strategy we have in place and we're well capitalized to continue to transform the business in 2020 and beyond. With that, I'll turn it over for any questions you may have. Thank you.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speaker phone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this moment, we will pause momentarily to assemble a roster. Our first question today comes from John Lawrence of Baraboo. Please go ahead with your question. Yeah, thanks. Good morning.

Good morning. Yeah, Woody, could you, thanks for that sort of breakdown. Could you give us a sense of the fourth quarter and I know this product set is evolving, but give us a sense of the things that you were really pleased about and what really you thought took hold and sort of the progress of how that goes for the first half of 2020.

Okay. Thanks, John, for asking. It's our pleasure to take questions and one of the things that happened in the fourth quarter was that November got off to a little bit of a slower start, primarily because of some timing between Thanksgiving and the Christmas holidays. So we ended up negative in November. But then we came back with our first positive comp in December in many years, which we were very pleased with. And it was a primary year of our holiday assortments that were really well received and some of the new categories started to take hold. Then we ended up in January with even more improvement with a positive .7% comp. We started off February in pretty good shape before all the disruption in the marketplace. So I'm pleased with the way our customers, our current and loyal customer base is responding to new categories with some of the clear winners being the things that have always been clear winners for us, which are our candleless ornaments, our holiday assortments. But some of the new categories that seem to really be working were the tabletop business, which has been very, very well received. And then to a lesser degree, our rug business has been fairly much what we expected, but we feel like we have more opportunity there. And embedding is still in development, basically, with the last category that we landed. We've also added, you know, embedded in all the merchandise new categories was some edits to the assortment where we took out our apparel that we just didn't feel like reflected our efforts to become a serious home furnishings retailer. And so that was done in the fourth quarter. So we ended up with a very clean inventory going forward, like Nicole said, with very little risk because we didn't carry forward any of the seasonal products. And now we're landing new products which we feel like are very focused and our customers are responding to. So despite the current disruption with the coronavirus and the banking situation and, you know, stock markets, we feel good. We think that we'll emerge from this with a much healthier business. And not only are we bringing along our current customer base, which seems to like our new changes, but we're also acquiring new customers. And so any other color you need on that, you have to answer.

That helps. And certainly, so we'll continue to edit the presentation and when will all the new products, I know you're constantly making edits and certain, but as far as the bedding and all of that, by spring or I would say summer of 20, will the store look like pretty much with all the new product what you want it to be?

Yeah, you know, that's a good question because merchandising is an evolving process. It's a journey that you're never complete because you're always improving. But I think that we came out of business this year and did a floor set right after the holidays that really took hold with our customer and that's why we delivered such a good positive comp in January. It was fresh, it was new. So I think our stores look pretty darn good right now. There's always, you know, the next wave of products coming. Right now we've just landed our outdoor solvent on the floor so we're proud of the way that looks. So it's an evolution. There's still a few issues in the store that I would like to improve on, of course, but the stores are looking pretty good despite the current environment. You know, they're looking real good. So please go in and take a look and let us know what you think.

Great, thanks. And on that subject, as far as China's concerned at this point, any shipping issues or problems with containers as you look forward at this

point? There are. We're having some slowness of some of our products coming in. We ended up the year with a little bit of extra inventory to allow us to mitigate the risk. Now we're starting to see the factories come back online. We do build a little bit of a path into our product flow, especially on holiday products. So I think that we will experience some delays, but last year we also took the initiative with some of the tariffs to move and balance our assortments out of China so that we're not 100% as dependent on China as we used to be. Now we've got, you know, Vietnam up and running. We've got our business in India doing really well and then of course our domestic sources. So we feel pretty good. There will be some disruption, but I don't think at this particular point it's material that we'll have to wait and see because the environment is changing so quickly.

Great. Thanks. Last question. Nicole, do you have a sense of, you could give us the 28 store closures for the first quarter, the amount of sales and the amount of loss that you will be exiting out of those 28 stores?

So the 28 stores definitely represented the first pass at the stores that were either down negative on average. You know, we had some that were significantly negative and some that were slightly positive and trending down. So, you know, total that group accounted for roughly a million dollars in loss. But again, it was really the stores that were trending down. I think from the sales perspective, a lot of them, it was a mixture of low volume stores and high volume stores that just didn't make money because the expense structure was so costly in the areas that they were. So it's the first phase of us looking at our portfolio and trying to get two things down to the most profitable stores and also the stores in the right places to support our omni-channel vision.

Great. Thanks for the color. Good luck.

Thanks, y'all.

As a final reminder, is star then one to ask a question? There are no questions at this time. This concludes our question and answer session. I would like to turn the conference back over to Woody Woodward for any closing remarks.

Thank you for listening. We really appreciate it and stay healthy.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.