Kirkland's, Inc.

Good morning and welcome to the Kirkland's third quarter 2020 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist 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 telephone keypad. 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 Tripp Sullivan of SCR Partners. Please go ahead.

Thank you. Good morning and welcome to Kirkland's conference call to review results for the third quarter of fiscal 2020. On the call this morning are Woody Woodward, Chief Executive Officer, and Nicole Strain, Chief Financial Officer. The results, as well as notice of the accessibility of this conference call, are 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 made pursuant 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. Those 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 10-K, filed on April 10, 2020, and quarterly reports on Form 10-K and Q, filed on June 4, 2020 and September 9, 2020. I'll now turn it over to Rich.

Thanks, Tripp, and thank you to all of our Kirkland's team members who take care of our customers and each other in our stores, distribution center, and home office. They make this success possible. This quarter represents a continuation of the momentum we established late last year with steps we took to make the company nimbler than ever. We now have a better cost structure, a more efficient infrastructure, a merchandise mix that continues to improve, and an overall far cooler brand. Our ultimate goal is to be a specialty retailer where customers can furnish their entire home on a budget. We're at the beginning of a cycle where we are making that goal achievable at Kirkland's and making these improvements sustainable. These are exceptional results we are reporting for the third quarter. which sets up well for what is typically our strongest quarter of the coming year. Unlike past years, when the third quarter was mostly about creating a launching point for maximum velocity in the fourth quarter, we were able to generate a positive store comp, an e-commerce comp of nearly 50%, an increase in our cash position to $37 million, GAAP earnings of $0.82, and an adjusted earnings of $0.66. The significant improvements in our merchandise and gross margin and the reduction in operating expenses were evident in the results, in addition to big contributions from e-commerce. We generated a 1.2% increase in net sales with 51 less stores from a comparable period a year ago, with an 8.9% comp in total for the quarter. For November, we were able to maintain strong momentum, particularly in e-commerce, and continue to prioritize margin and profitability. While Blockbody has become more spread out over the month, we were still pleased with the sales that day and on Cyber Monday as well. The shift to online at the expense of store traffic that we have previously referenced was evident last month. And we were able to capture that demand. There are a number of well-documented trends in the industry that are working in our favor with people staying at home, shopping online, as well as less store-based competition. We came to market share with several of these competitors in bankruptcy or liquidation, and our omnichannel presence has put us in the right place at the right time. We got the message that customers love to buy online, and they are leading us to the right places. However, there are far more trends occurring within our business that we are creating, that are within our control, and more importantly, we believe are sustainable over the long term. I want to spend a little time this morning exploring these adjustments in our merchandise mix and model in more detail. We have purposely brought our existing customers with us on this transition in our merchandising strategy. We didn't leave them behind while we grew the customer base. I recognize that was a concern for most brands that have undertaken a transition like we have taken over the past two years. But we didn't abandon our price point. We left our customers options to buy with better quality and have a relevant assortment at a great value. We've maintained a steady pace to improve quality with stable pricing because we've taken a portion of the savings gained from our direct sourcing strategy and put it into the quality of the merchandise. As I've noted before, the customers are already getting the improvements we're putting out there. They're seeing the improved quality and improved design as well. They are increasingly coming to us for their complete decorating projects instead of only buying the finishing touches. A great example would be in our furniture assortment. Along with tabletop, furniture has been a runaway success for us. In that category, we've been able to improve our product from non-wood to full wood furniture at the same price point. The transformation we are making in our existing model is evident in our more effective marketing, the continued growth and profitability of e-commerce, and the significantly improved margin profile and leverage inherent in our business. Our marketing is on point, and we have a more mature way of handling promotions. The big initiative we have been ramping up is the launch of our new loyalty program that took place the third week of October. In the weeks since that launch, we're seeing an increase in sign-ups, and we've already added hundreds of thousands of people to our loyalty program. During the quarter, e-commerce accounted for almost 24% of our sales, compared to 16% of total sales just a year ago. And e-commerce was profitable in every month of the quarter for the second quarter in a row. Our shift direct from vendor channel was up 122% for the quarter, with 480 basis points of margin gains. As we noted last quarter, in the very near future, we expect to add some select brands in this channel as we grow with a focus on extending from where we've been strong in kitchen and tabletop. The dedicated group within Kirkland that focuses on this channel has made a lot of progress since we formed it earlier this year. And we expect to have more to report early next year and in the years to follow. During the third quarter, we replaced our existing e-commerce distribution center with two more efficient hubs. These hubs should begin to help the profitability in our shift direct to consumer channel beginning in the fourth quarter. The store base is more productive with 51 less stores. The growth in e-commerce is offsetting the lost sales from these closed stores, but we are still working to overcome the challenges with foot traffic in the stores. This is not a problem unique to Kirkland and is more structural in nature, but we have a higher markup and an increased basket in the stores that we believe is sustainable. We were clearly able to be more productive with a tighter inventory position than in past years. As Nicole will describe later, the tighter inventory is somewhat of a governor on our top line this quarter and next. This is particularly partially a legacy of the orders we needed to cancel during the pandemic and also supply constraints across much of the sector. While we might have fewer SKUs in the short term, we're selling at a higher price point We are maintaining a promotional discipline, and we're getting a larger portion of the newer product. The leverage in our model is substantial. With the $45 million of annualized operating costs we have pulled out of the business through cost containment, the efficiencies and changes in our labor costs and staffing model, while the right way to think about this improvement is more sequential than a year-over-year basis in terms of our overall profitability, We believe our two to three year EBITDA margin targets are certainly achievable. With the cash we generated this quarter, the level of cash we are now expecting at the year end, and the increased visibility in the business, the board has authorized a new $20 million stock repurchase authorization. We noted last quarter that we wanted to see another quarter of result before we considered allocating capital to repurchases. With our expectations that we will be debt free at year end and cash is expected to grow in our historically strongest quarter, we believe this is a good way to deploy a portion of our capital. Nicole, why don't you walk us through our results in more detail?

Thank you, Woody. What we saw in the third quarter results was the incremental consumer demand that is benefiting many of our home decor competitors, but also the beginning of what our model can look like with the foundational changes we have initiated. Within the quarter, we had strong e-commerce sales with a year-over-year increase of 50%. Our store traffic improved from Q2 levels and outperformed our segmented shopper track that continues to be negatively impacted by pandemic-related challenges. The changes we have made to improve the quality and design of our merchandise, as well as category shifts towards higher ticket items, continues to have a positive impact on our sales. We had early sell-through of our harvest seasonal merchandise and a similar trend in our Christmas collection, which led to a November sales comp increase of 5.5%, which included a year-over-year increase in e-commerce of over 50%. We saw a significant increase in our gross profit margin of 840 basis points, which was driven largely by gains in product margin from simplifying our promotional message and also reducing the depth of offers and the inherent stacking of entire store couponing. We will continue to move towards more targeted, customer-specific discounting while always having incentives to encourage customers to purchase. We benefited from lower store occupancy costs from the closure of underperforming stores and negotiated rent reductions. We also saw favorability from lower freight costs from our DC to our stores, driven by lower inventory levels and a rate decline compared to 2019. Gross profit margin was negatively impacted by e-commerce shipping, with online sales making up 24% of our total sales and the store-fulfilled nodes dropping to 35% of e-com sales. We do expect the percent fulfilled in store to moderate closer to 45% to 50% in the midterm. Finally, distribution costs increased year over year, driven by a capitalization entry based on inventory level and timing. We saw the benefit of our cost reductions with a decline in operating expenses of 810 basis points, or 11.3 million, driven by the more efficient store labor model, corporate headcount reductions, and a justification exercise for all overhead expenses. Excluding current year performance-related compensation accruals, this represents a 25% reduction in operating expenses, which we expect to be largely sustainable. We expect to continue to see improvements in profitability from higher margins and reduced costs, along with further leverage from continued growth and top-line sales, all of which should better position us to reach our long-term financial goals. Breaking down the comparable sales increase of 8.9%, we had strong comp increases in the first two months of the quarter, driven by the earlier sell-through of seasonal harvest products, followed by a drop-off to a flat comp in October with seasonal sales having been pulled forward into September. As a reminder, beginning in September of last year, we were much more promotional, so we are comping that impact on those sales and margins. The 49.9% e-commerce comp increase was driven by the direct-to-consumer channels, with our third-party dropship revenue up 122%, and our own products shipped directly to customer up 77%. both of which were offset by lower increases in the store-fulfilled channels. During the quarter, we closed six stores, resulting in a count of 381 stores. Year-to-date, we have opened no new stores and closed 51 underperforming stores, or 12% of the store base since the start of the year. We expect roughly 10 additional closures near the end of the fiscal year, but are still working through negotiations with landlords. Gross profit was 36.1% of sales compared to 27.7% in the prior year quarter. Of the 840 basis point increase, 940 basis points related to an improvement in landed product margin, primarily from reduced discounting. Direct sourcing accounted for roughly 100 basis points of the landed product margin improvement. In the latter part of the quarter, we saw initial cost pressures from shipping constraints and rate premiums, specifically on products sourced from China. While we have clearly been able to navigate through these pressures and we expect significant year-over-year margin improvement in the fourth quarter, the negative impact on landed margin is expected to increase throughout the remainder of the fiscal year, causing year-over-year gains to be less than what we experienced in the third quarter. Store occupancy costs declined by 300 basis points from the prior year, due to the closure of underperforming stores, negotiated rent reductions, and the leverage of increased sales. Breaking that down, 280 basis points was generated by rent restructuring and the remainder by sales leverage. On the prior call, I mentioned that close to a third of our leases had a term renewal in the next 6 to 12 months. We are actively working through those renewals and are continuing to have success in locking in lower rates. Outbound Freight which is the movement of our merchandise from the distribution center to the stores, decreased by 70 basis points from the 2019 quarter, driven by reduced drought, rate decreases, and sales leverage. The reduced droughts were driven by store closures and fewer routes to continuing stores, primarily due to higher inventory levels in the prior year. We also saw a rate reduction of roughly 10% year over year. DC costs increased 170 basis points, driven by the timing of inventory capitalization and the year-over-year decline in inventory. Excluding this timing effect, distribution costs declined by 20 basis points, with productivity improvements offset by the channel mix shift, with labor costs to pick and ship e-commerce orders exceeding labor costs to ship cases to our stores as a percent of sales. We completed the closure of the Jackson e-commerce distribution center at the end of September. We allocated a portion of our retail distribution center to fulfill e-commerce and stood up our second e-commerce hub within the quarter. This reduced our distribution center total square footage by over 200,000 feet, or roughly 16%, and placed e-commerce distribution much closer to the end customer, which will decrease parcel costs but also increase speed to the customer. We are still in ramp-up mode for these new facilities and expect to improve throughput and efficiency in the upcoming year. E-commerce shipping costs increased 180 basis points as a percent of total sales due to the higher mix of ship-to-home sales. Operating expenses exceeding impairment improved to 27% of sales compared to 35.1% in the third quarter of 2019. or a reduction of $11.3 million on a higher sales base. Store operating expenses made up 600 basis points of the reduction, driven by the store labor model implemented at the beginning of the fiscal year and aided by our reduced operating hours, leverage from closing underperforming stores, and an overall review of operating costs. Ecom operating expenses increased 10 basis points as a percent of total sales but leveraged 160 basis points as a percent of e-com sales, as dollars increased by only $167,000 on the $12 million growth in revenue. Advertising expense declined by 1 million, or 70 basis points compared to the prior year, which included advertising support for the new product category rollout. We continue to shift our spend heavily towards digital channels. Corporate operating expenses decreased by 2 million, or 140 basis points, driven by reduced headcounts, reduced corporate office space, and an overall expense review. Performance-related compensation accruals in the current year account for an additional 100 basis points relative to the prior year. EBITDA excluding impairment and other minor non-operating expenses for the quarter was 18.7 million, or 12.7% of sales, compared to a loss of $3.1 million in the prior year quarter, or an improvement of $21.7 million. For the quarter, our tax rate was based on a year-to-date discrete calculation, further impacted by evaluation allowance. A normalized rate of 23.3% was used in the non-GAAP adjusted calculation. Our earnings per share, including non-cash impairment, normalized tax rate, and other minor non-operating adjustments with 66 cents compared to a loss of 53 cents in the prior year. The GAAP earnings including these items was 82 cents compared to a loss of $1.61 in the prior year. We ended the quarter with $37.2 million in cash and no outstanding debt, which is a build of $9.6 million from the Q2 level and an increase of $33 million year-over-year, $58 million considering the revolver draw in the prior year, Combined with availability on our revolving credit facility, we had total liquidity of $106.9 million. With our typical cash build in the fourth quarter, we expect to conservatively end the year with approximately $65 to $75 million of cash. We do not anticipate any borrowings for the remainder of the year. Inventory at the end of the quarter was $83.9 million compared to $140.2 million in the prior year. or 40% lower. The prior year levels were elevated by the rollout of new categories, and we currently have 12% fewer stores, but we are down approximately 20% to our plan. The significant receipt cuts we made while our stores were closed in April, followed by vessel and port shipping constraints, has impacted our sales to some degree since the latter part of the second quarter. Because we protected seasonal buys, the inventory shortages have been in our core everyday products and have been much deeper in some key product categories. We expect to continue to see a sales impact in those categories in the fourth quarter, but expect to return to near planned inventory levels by the end of fiscal year. Year-to-date cash provided by operations was $14.5 million compared to cash used of $62.4 million in the prior year. or a change of 76.9 million. The improvement is due to better operating performance in the second and third quarters, 42.3 million improvement year-over-year, and changes in working capital, 34.6 million year-over-year improvement. The working capital changes are primarily driven by lower inventory levels, offset by lower related accounts payable. Additionally, we received a $12.3 million income tax refund from the CARES Act NOL Carry Back in the second quarter. Capital expenditures were $7.6 million compared to $12.8 million in the prior year and were primarily driven by investments in supply chain and e-commerce. We still expect capital spend to remain below the low end of the initial range we communicated of $10 million for the year. The financial goals we provided on the second quarter earnings call continue to be relevant as we execute the transformation of our business over the next two to three years. We summarized those goals in our earnings release this morning. Rather than reading through those again, I'd like to reinforce the overall message we're communicating with our long-term annual financial targets. First, they all indicate how we expect to achieve top-line growth, margin improvement, and cost reductions over this multi-year period. with specific targets to improve our gross profit rate to the low to mid-30% range, improve EBITDA margins at a high single-digit range, and improve operating income margins at a mid-single-digit range. Second, it's worth noting that those are annual targets. With the seasonality in our business, we typically see stronger performance in the second half of the year compared with the first half. And lastly, from a liquidity perspective, our main goal will continue to be maintaining a healthy balance sheet. Within this model, we expect to generate excess cash annually and will allocate first to projects to drive growth and or reduce costs, but are also happy to announce that the Board authorized a $20 million share repurchase program. We intend to be disciplined and opportunistic with our share repurchase program and will provide updates with each earnings announcement regarding activity under the plan. With that, we are now ready to take questions.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. And our first question will come from Jeremy Hamblin of Craig Hallam Capital Group. Please go ahead.

Thank you and congratulations on the really strong results. I wanted to start by asking you about the composition within your same store sales for Q3. What did you see on average ticket in the quarter and how was that split between average unit retail and units per transaction?

So we saw basically a 20% increase in the quarter in average unit retail. Our items per transaction held relatively consistent.

Got it. And in terms of, you provided so much great detail that I missed some of the things, but in terms of the components of the 840 basis points year-over-year improvement in gross margins. Can you just run through those again?

Sure. So product margin was favorable by 940 basis points. Ecom shipping, unfavorable 180 basis points. Store occupancy, favorable 300 basis points. Outbound freight, favorable 70 basis points. DC costs unfavorable 170 basis points. That was a timing and an accounting entry that will slip in the fourth quarter. And then miscellaneous other unfavorable 120 basis points.

Okay, got it. And then just looking forward and kind of running through how those various components you expect to play out here in Q4. It sounds like, again, there's maybe some impact on your inventory levels and maybe not quite as much product margin benefit in the quarter, but can you run through kind of your range of expectations around those particular line items?

Yeah, I think the only thing I would say there and the only real difference going from Q3 to Q4 is the inbound freight that we talked about. And again, we still expect to see significant improvement. It may be closer to the Q2 level than the Q3 level. We will continue to have favorability in the store occupancy line. We will likely still have unfavorability in e-com shipping just based on consumer preference that likely continues throughout the rest of the year. The DC cost timing impact that we had in this quarter, we would expect to see some of that reverse into the next quarter. So that one will definitely flip.

Got it. And I wanted to just get into the direct sourcing initiative here. You know, that looks like that's been a big success, improving quality of product and keeping prices low. You know, what have you learned so far in the last 12 months from this initiative? And how do you expect, because I'm guessing that you probably see margins, you know, that would be 500 to 600 basis points lower on the direct source versus third-party sourced. But how do you expect to use the potential benefits of that program? Is it going to be going to the consumer?

uh with low in the form of lower prices is some of that going to flow through um to your uh bottom line in terms of you know higher gross margins um any color you could provide on that all right thanks jeremy um first of all what we've learned so far on direct sourcing since it's new for our company it's slow and steady is what wins the game i mean we might have gone a little faster on direct sourcing But remember, this is an infrastructure change, and it's a change to our company. There's been a couple unknown benefits that we've received from the direct sourcing. One of them was the sharper price points we got from our wholesale vendors that were knowing that they were now having to compete with us if we were getting direct sourcing pricing. So there's been kind of a benefit on both sides, both the better pricing, certainly the better quality has been out there for both sides of the fence, both the direct sourcing and the wholesale sourcing. The other thing is that we are still in the ramp up stage. This is a multi-year program that will help us. We've learned that we need to provide more design information to get the kind of products that we're looking for. And I would say that from a costing standpoint, We're just at the beginning of realizing where those costs can be passed on to the financial benefits of the company or whether we should be doing continued upgrades of quality. But we are further along on the quality upgrade. So more and more of the benefit, I think, comes to us in a financial way as we grow that sector of the business. But like I said at the very beginning, slow and steady is the way to go on the sourcing because there's lots for us to learn. Remember that most of our competitors do the majority of their sourcing through direct sourcing, and we're still at the early stages of that. I do think that it's helping the look of our product in our stores look more exclusive and more cohesive and certainly more design-oriented, and we've been able to maintain prices and get better quality.

Great. Thanks for that color. And then You know, in terms of thinking about you've got, I think, a two- to three-year target of getting to 40% to 50%. Can you give us a sense of where you might expect to be 12 months from now on your direct sourcing initiative? Are we going to be looking at like 30%, 35%? Or how much progress can you make in 2021?

Well, we will make more progress in 21 because remember that in this year, we had to cancel a significant amount of orders due to the pandemic, and a lot of those orders were direct storage. So I would say that growing it by 10, 15, even 20 basis points, but we're going to let it happen naturally and organically because we don't want to force it, especially since our other vendors are coming through with such desirable price points. And we need to make sure that they get the benefits as being long-term Kirkland suppliers. And so we're looking at it very evenly. But it is a huge opportunity for us over the next two or three years.

Great. And then on your loyalty program, I wanted to, you mentioned that you've gained a substantial number of customers here just in the last six weeks. where does your total loyalty program stand? And, you know, are there additional benefits, you know, to thinking about, or additional color, I should say, on how those loyalty members are spending versus your non-loyalty customers in terms of, you know, ticket size, frequency of transaction, et cetera?

Jeremy, let me take the first part, and then I'm going to turn it over to Nicole because she might have some some very specific information on. Remember that our loyalty program is a multi-phase program. We launched it, but there's a lot more excitement coming. As we learn more about what triggers customers' behavior, as we get more into the CRM aspects of our business, our customers have always been loyal to Kirkland. And now, when we lost the program, We just kind of coasted for a while, but now that we've reinstituted it, we're getting a big surge of customers. And not only the current customer base, but it looks like a younger, more appealing customer. So we're excited about that. And Nicole's got some possible specifics that she's looking up on her phone right now. Oh, you don't have it? I don't have it.

I wasn't looking at it on my phone. So I think we measure the loyalty program in active purchases. So roughly 7 million people in the plan. What I would say about historically when we had a loyalty program before we changed that a few years ago is we really saw a lot more frequency of purchases in the top tier group. And when we changed the loyalty program and took away the points accumulation, we really saw a drop off in that area. So that is really one of the, I think, you know, adding new customers is definitely a piece of it and having something that we can promote to push return visits. But having something that benefits that, you know, that highest tier and most important customer I think is going to be one of the biggest wins of re-instituting the program.

Great. Thanks for that. Just a couple other things, and I'll hop back in the queue. Just shipping rates, we've seen surcharges being placed by the key distributors. In terms of the impact that you're seeing, are you looking at your shipping rates in terms of what you're potentially charging for your customers for kind of sub-hundred dollar orders, you know, any changes that you potentially implement to that to help offset, you know, some of the higher costs associated with, you know, higher surcharges?

Yeah, a couple of things. So actually within the quarter, because we have done a lot of things with the hubs and getting closer to the customer, even though our shipping costs were up, the shipping costs as a percent of ship-to-home sales actually was favorable year over year. So we have been able to absorb that. I think a lot of the things that we're doing now on the direct-to-consumer channel in general is looking at the things that we ship via that channel, meaning, you know, historically we might ship an $8 item and pay $8 to ship it. And so really looking at that is you know, a minimum AUR. How can we bundle things? How can we look at that a little bit differently? So had already done a lot of those analytics beforehand. We are seeing rate increases to some degree. We're also seeing caps on pickups from our parcel partner, which has made us zone skip and do additional things to try and get around that. But I would say All in all, we are actively working on all options to offset cost increases and don't expect that to be material as we move forward.

Great. And then you guys have made some changes to your operating hours and obviously reduced substantially the number of stores you had. What were the total number of operating hours down in Q3? And then what do you expect in terms of operating hours to be down for Q4?

Yeah, I don't know that calculation off the top of my head, but I can definitely work on that one and get back to you. I will say in general, we had taken three hours out of every store when we reopened after closing down for COVID. We had made the decision in November and December that we would expand back out for peak, and so I would expect the decrease in operating hours to be much lower in the fourth quarter, but that after Christmas peak will go back down to the hours that we had before, which was the three hours per store less than what we were last year.

Great. Thanks for the color. I'll hop back into the queue.

Thanks, Jeremy.

The next question comes from John Lawrence of Baraboo Growth. Please go ahead.

Thank you. Good morning. Morning. Good morning. Yeah, Woody, would you give a little more color on the product categories throughout the quarter and sort of how they lined up with what you told us for the first half of the year and just, you know, when you came aboard and some of those projects and some of those new categories that you talked about, how they've worked themselves into the mix and why you're excited about those. Okay.

Well, first of all, I'm going to go back to kind of the thing that we've been establishing over the years, and that's our seasonal product. It was exceptionally received, better quality, and we had, you know, very improved sell-throughs, both of our harvest products and now into Christmas with the Christmas products. one of the biggest wins. And that's something that we've learned we're good at. Customers recognize this is a great place to come and buy their seasonal product. But underlying that, we've seen some very, very impressive benefits to a couple of categories. One, furniture. We've been able to use furniture to, like I said on the call earlier, improve our quality and improve our design. And we redesigned some of our largest volume lines And they're now just hitting the stores and being received. It's subtle. It's not dramatic. It's still going to be a best seller. But we were able to improve the quality and keep the price points the same. So the furniture has been kind of an overall runaway success. And we have a lot of runway there. We have very big sights on the future of the furniture business within Kirkland. as we're learning how to deal with it through our infrastructure and learning how to source it in a more effective way. The second category that has just been a runaway success is anything related to tabletop. We came out with our own exclusive line of dinnerware called SimpleThings, some textiles called SimpleThings, and it's just been a resounding success. And what's also been a success are the things that surround that, the glassware, flatware, just the ins and outs of that business. And so we're going to be expanding that in most of our stores, certainly testing it first in 30 or 40 stores, and really expanding that tabletop assortment. But to really show a little bit more of a dominance, this is probably where we're getting the benefit of one of our major competitors not being here, and that was a huge category for them. The rug category, I'd say, is still in development. It's improving as we speak. We're not giving up on it. It's been good. But we just needed to make sure that we were satisfying the customer with what they were really looking for. Our core categories have probably been hit the hardest in terms of some of the inventory shortages. But I look at that as a real positive. We needed to make changes in our art and walled decor category, our mirror category. And the pandemic allowing us to lower the inventory allows us to take fresh eyes and look to the future as to what do our customers really want from us in art. We used to be a much more dominant player in wall decor in our business, and we're intending to gain that back. But we had to kind of do a pause, and it's given us a chance to look forward. The assortments that are coming in for January and February, I think, are a spectacular improvement to what we'd had before in terms of look and design at the same kind of price point. So I think we're going to be giving our customer a real reason to shop. Hopefully they'll be using their gift cards that they're purchasing now in December and coming in January and February and March with a whole new fresh look of some well-designed product, but still in the line of our casual farmhouse style. So does that answer your question, or would you like me to embellish more?

That's great. Thanks for that color. Sure. The follow-up to that is you mentioned some of these categories and the factories and some of your vendors that realize now that you're in this space. I assume that's what you're talking about when you mention better wholesale deals. And obviously... more or less pitting some of these vendors against each other. Is that fair?

Yeah, or maybe not pitting them against each other, but then looking across the bow and saying, hmm, I've got to sharpen my game. You know, we had to ask for better packaging because we were having, you know, last year we had some damage issues. And there's just no excuse for that. So we went back to all of our vendors simultaneously, both wholesale and direct shipping, and improved our packaging so that we could get it to the customer in a more elegant way. And I think everybody has just realized that we have a big opportunity here at Kirkland. And we should take advantage of the fact that some of our competition is gone. And maybe we have a new opportunity to satisfy customers in a bigger way. And I think the overall thing that's helping our vendors right now is looking at us as a holistic home permissions resource, versus just buying items and key items and trying to deliver that through high traffic. Traffic is an ominous and complex thing that we all have to deal with in retail right now. So we had to come up with solutions of how do we win even with flats or declining traffic. And that's why we went on the basis of adding higher AURs and better design to the product so that we could sell more to each customer that walks in the door.

Thanks a lot. Congrats on the progress. Sure. Thank you, John.

The next question comes from Chris Sakai of Singular Research. Please go ahead.

Hi, good morning. I just had a question, I guess. Currently, what are you guys experiencing as in-store foot traffic due to COVID restrictions, and is it better or worse than expected?

That's a really good question because we all read all those articles that were in the news about that people were going to not shop on Black Friday. We did work very diligently to pull as many sales forward from the Black Friday weekend, not really knowing what to expect. And then lo and behold, people came. I mean, I was in the stores on Friday and we were... busy, and people were wearing masks, and they were being respectful of each other's space. And I think that we're a little bit of a low-risk place to shop, because we're not one of those huge, voluminous warehouse stores that has hundreds and thousands of people. Ours is a little bit more paced. But our stores were busy, and we were proud of the results that we got from our Black Friday following into Cyber Monday. I think people just love coming to Kirkland's because one of our messages is to bring happiness home, and we try to be a happy place for our customers to shop. We really take that seriously. Our store associates have improved so much. They're doing such a great job. and they are really embracing the fact that, you know, we've got to really offer the best we can to our customers every single day, every single customer.

Yeah, I think I would just add to that. We are definitely down more than we would like to be. We had improvement, as we mentioned, in Q3, and we are ahead of ShopperTrack, which is what we always measure ourselves against, and they also break that down into three. to home furnishings and ahead of that measure as well, but definitely are seeing pandemic-related traffic impact and luckily are seeing a lot of that shift to online to support our e-commerce growth. So at this point, just trying to make sure that we can offer the customer the way to purchase that is most comfortable for her and expect that things will settle back out to a more normalized pace once some things are under control with current issues.

Okay, great. And I guess to go to online, do you guys break out the online sales for the quarter?

Meaning the comp increase or the total dollars?

Yeah, I guess the total dollars. The total dollar sales, I guess, is a percentage of the total.

Yeah, so total dollar sales, just over $35 million. It was 24% of total sales.

Okay. And then I guess lastly, do you – As far as curbside pickup goes, has that been a success, and what are you experiencing there?

You know, I'm going to give our stores such credit for this. During the first early couple weeks of the pandemic, we didn't have curbside pickup, and we also didn't even really imagine the contactless portion of that. But our stores organization rallied, and within two weeks, We've got that set up, and yes, it's been a huge success. It will also be a benefactor if we do have certain stores that do have to close temporarily as some way to satisfy our customers. We've gotten better and better at it. Now most of our customers are coming inside and picking it up. versus me asking for curbside. But those customers that do ask for a more contactless way, we've set up signs of special parking spaces in front of our stores that if they just call a number, we will bring their product out to them and have no contact. So, yes, I think it's been a runaway success, and there's been a lot of learning on how to get better and better at that.

Okay, great. Thanks.

The next question comes from Matt Schwartz of Mays Investments. Please go ahead.

Hey, guys. Congratulations.

Thanks, Matt.

Thank you. I got a couple quick questions. So obviously the first quarter was rough on a lot of companies, including yours, with the dramatic decline due to COVID. So, you know, when I neutralized that number, and just kind of throw a conservative Q1 in there. You know, I already have your EBIT margins running for this year. Once I start to plug in some of these assumptions you gave for the fourth quarter, I get, you know, EBIT margins that are already well ahead of your target, like approaching 8% EBIT margins. And I guess the EBITDA margin would probably be you know, something like 400 basis points better. So can you walk me through your assumptions with those margin targets? Because to me it looks like you're there and they're going to be substantially better than that going forward.

Yeah, I think the thing that I would just say on that is there's a lot of unknown. We have a lot of moving pieces and the transformation that we're going through. I do think if everything – works as we'd like it to, then we can hit those targets earlier in the window. And at this point, we'll continue to update those as it makes sense. But there are a lot of pieces. There's a lot of unknown in the macro environment right now and what that may look like as far as top line impact next year. So just want to make sure that what we put out there is something that we know we can achieve. And if all goes well, I do think there's upside to that.

Okay. Thank you. And then also in terms of capital allocation, I think it's great that you announced the buyback. I mean, you're certainly on my numbers, your current multiple is still, you know, half of what your competitors are. and they're generating a ton of cash. So what are your thoughts on capital allocation for additional buyback even beyond what you've announced or dividend or other?

So right now we are continuing to be somewhat conservative about how we look at that, and there will be dollars that we want to allocate to growth and to our own internal investments. Outside of that, the share repurchase, I would say, probably starts out somewhat conservative, but we all believe that our stock is undervalued, and we'll continue to look at that as we move forward with the $20 million authorization. I think at this point, again, if we hit the goals that we have in our model, we will generate significant cash, and we'll continue to look at what the rights right ways are to spend that money and have the best return.

Okay, great. And then lastly, obviously you've done a great job rationalizing the cost structure. Can you help us understand, you know, as your e-com business continues to grow next year, how should we think about your ability to sustain your SG&A and

dollars next year the way that we are looking at that is I mean I think it's important for us as we move forward for a lot of reasons to remain lean I actually think we operate much better than we did before and have much more of a sense of urgency so the way I look at that as we move forward is as the business evolves we will need to reallocate dollars from one area to the next in order to support the right but are not looking at G&A as having any sort of significant increase based on that growth.

Okay. All right. Thank you very much. Congratulations, and I look forward to chatting offline. Thanks.

Thanks, Matt. Our next question is a follow-up from Jeremy Hamblin of Craig Hallam Capital Group. Please go ahead.

Thanks for taking the extra question here. I wanted to get into your, Nicole, I know you've got a third of your leases up for renewal and that you've been diligently working on it. I wanted to just get a sense for the conversations you're having with landlords, how effective, and I know you can drive a tough bargain, but you know, what percentage of those lease renewals are you seeing, you know, dollars and cents lower than what you had before? And can you give us any color on, you know, the types of, you know, maybe total rent reduction that you might expect for 2021? I wonder if Nicole has ever

imagine that she would have a master's degree in real estate negotiations. But I think she's earned it this year. So go ahead and enjoy the benefits of that.

And we actually have a really dedicated person that works on this day to day. But what I would say is probably 90% of the negotiations, we're able to get some benefit. In a lot of cases, it's good real estate and they don't have vacancies. And so what we're getting in those is negotiating to continue with flat rent instead of the escalations that are built into the lease. There are a good percentage where we are getting significant up to 50% rent reductions. And at this point, because we have worked quite a You know, we're through, I'd say, the majority of them that don't have fully executed deals. We'd rather not put out a number on what that looks like, but we'll be able to do that in the near future on what the year-over-year savings are for next year.

Great. Thanks for the color. Best wishes for the holiday season.

Thank you.

Thank you, Karen.

Okay, thank you, Operator. As always, we're available for follow-up questions over the next several days and weeks. But before I sign off, I want to wish everyone on the call a wonderful holiday. Stay safe and healthy, and we look forward to seeing you online and in our stores. Thank you.

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