Jeff Black - IR, SCR Partners Mike Madden - President and CEO Nicole Strain - Interim CFO

Jeff Van Sinderen - B. Riley Brad Thomas - KeyBanc Capital Markets David Magee - SunTrust Anthony Lebiedzinski - Sidoti and Company

Good day and welcome to Kirkland’s Second Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Jeff Black with SCR Partners. Please go ahead.

Thank you. Good morning and welcome to Kirkland’s conference call to review results for the second quarter of fiscal 2017. On the call this morning are Mike Madden, President and Chief Executive Officer; and Nicole Strain, Interim Chief Financial Officer. The results as well as the notice of accessibility of this conference call on a listen-only basis over the Internet were announced earlier this morning in a press release distributed to the financial media. Except for historical information discussed during this 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 SEC, including the Company’s annual report on Form 10-K filed on March 31, 2017. With that I’ll turn it over to Mike.

Okay. Thank you, Jeff, and thanks to everybody for joining us this morning. I am pleased with the progress we made during the second quarter, which was highlighted by positive comparable sales and continued advancement on our strategic initiatives. As we outlined in the release, earnings performance was in line with our expectations and we made significant progress in key areas of the business as we head into our peak selling season. Sales growth of 7% was driven by higher store count and a 1.2% gain in comparable store sales. More effective marketing helped to cut into our traffic decline and we also drove improvements in conversion and average ticket. New stores met our expectations and we are optimistic about the upcoming opening that will complete our 2017 store class. And kirklands.com sustained its impressive momentum. Gross margin was impacted by planned initiatives to reposition certain key categories and increase in vendor direct shipping within our ecommerce channel as well as a promotional retail environment. We also experienced margin pressure from outdoor furniture where we increased the buy from last year. But aside from these specific callouts, we were pleased with margin performance and the remainder of the assortment. We saw particularly strong performance in everyday furniture, ornamental wall décor and lamps. Overall, I am pleased with the way the team executed as the competitive landscape continues to be challenging. Operating expenses remained well controlled and we’re entering the third quarter with a better inventory position and we are armed with some important learnings to inform our plans for 2018. Our balance sheet is in great shape with $48.7 million in cash and no debt. This morning, we announced that the Board has authorized the stock repurchase plan for the purchase of up to $10 million of common stock. With this announcement, we’ll continue to have the flexibility to make key investments to achieve our strategic goals while returning excess cash to shareholders and maintaining conservative capital structure. And we have a history of returning excess cash to shareholders amounting to almost $100 million since 2012 via repurchases and dividends. As we think about the future, we believe there is a significant opportunity for growth as we reshape Kirkland’s for an evolving retail landscape. Our positioning is solid. Home décor that is on the vanguard of style with good product quality at reasonable prices. And we deliver this through a customer experience that is unique and translates well to an omni-channel platform. As we’ve outlined in previous calls, we want to make sure that Kirkland’s remains to some and becomes to others a destination of choice for home décor shoppers. To that end, we’re focused on driving our long-term strategy by strengthening our execution in several key areas, improving and expanding the omni-channel platform, enabling our merchants to drive more style and freshness and reaching new customers through greater brand awareness. We’ve made considerable progress on our merchandising strategy. We’re seeing some improvement in important metrics and believe the initiatives will have further benefit in coming quarters and years. For example, we’ve reduced redundant promotions and are reinforcing that through some changes being made at the point of sale. We’ve eliminated the layering on of coupon activity with our clearance products. We’ve also put through some modest upward price adjustments, particularly in higher ticket categories like furniture where there is more price elasticity. We believe we can do this while maintaining the strong value positioning that is our hallmark. These efforts are supported by richer analytics and additional testing to inform our promotional decisions. Consequently, while the promotional environment remains challenging, we have been able to offset some of the impact of additional traffic driving activities with improvements in our promotional mix and a better margin on clearance inventory. Initiatives to recalibrate several key product categories are also on track. A large part of our cleanup efforts in our textiles and fragrance are complete. As we move through the back half of 2017, flows of new products in each of these categories will bring a much immediate refresh to these assortments. Additionally, we completed the test phase of our initiatives to remove non-productive SKUs from our assortment and recast the floor space devoted to our category presentations. The test store outperformed on a relative basis and we are moving forward with a broader pilot in the second half. Through this process, we have also identified some opportunities in key SKUs that can benefit from better in-stock positions. Our merchandise planning team has done an excellent job of managing inventory while responding to the competitive landscape and providing a leadership in the SKU rationalization initiative. We have created some flexibility for our merchants to pursue opportunities. And as a home fashion retailer, it’s important to be nimble. Tight inventory management led to overall inventory levels a bit lower than planned, down 1% versus the year ago period. We also experienced some delays in getting our product through our West Coast distribution hub. These issues are being addressed and we are now seeing shipments return to normal levels. As it relates to the products, we are very encouraged by the progress of our merchant teams. They have raised their business acumen and are adapting very well to the changes we are making. We continue to believe there is a large margin opportunity as we shore up underperforming categories and bring more science into the process. The initial response to our fall floor set has been favorable, and solid early results are coming from our fall harvest product assortment. We are encouraged about ecommerce. The channel accounted for over 11% of sales in the quarter. And we believe that penetration rate can exceed 10% of revenue for the year. The top-line growth in the channel is strong but we are even more pleased by the recent gains that we have seen in profitability, given the investments we have made to improve fulfillment. Our product mix is well-suited for ecommerce, and we believe we can continue to improve the omni-channel experience. We have now reorganized e-commerce, so it’s under one P&L, and we’ve hired a VP of ecommerce with experience at eBay and Target. For the balance of 2017, we will be focused on building out the team under new leadership and refining our long-term strategy for the channel. That likely will include acquiring additional talent and technology, all of which we believe will fit into our existing CapEx and operating plans. In the near-term, related to the ecommerce, we will continue to expand our third-party partnerships, begin preparations for an improved buy online pick up in store capability, and further refine our fulfillment processes to increase the profitability of our Ship to Home business. We are encouraged about the improvements in profitability in new channel we have already realized and the opportunities that still stand before us. Our stores are at the center of our omni-channel strategy. So, the efforts of our operations team remain crucial to our success. Despite the prominence given to the growth in our ecommerce channel, our stores still facilitate almost 60% of that business through customer engagement on in-store pick up orders. They’re also driving improvements in conversion and ticket that are blunting some of the traffic decline we and many other retailers have experienced. We view the customer experience as one of our biggest opportunities for differentiation and our store operations team is prioritizing the conversion metric while beginning to measure customer satisfaction and engineer processes to ensure the optimal level of engagement with the customer. As it relates to real estate, we’ll continue to expand stores at a modest rate. We’re looking primarily now at white space opportunities, which limits the cannibalization of our existing store base. Given the shift to online channels, the traditional measurement of stores per market is changing. Fortunately, Kirkland’s has plentiful white space opportunities, and we are prioritizing those over filling in existing markets. This has the added benefit of getting the most of e-commerce early on in the process. Our marketing makeover continues its evolution as we approach the back half. We’re analyzing ways to drive traffic via changes in the media plan and we’ve seen some early wins. Our direct mail program is having a positive result, and we are expanding that program in the back-half. We’re also leveraging a revamped digital advertising program that is driving traffic to stores and our sites. And in the back half, it’s important to note that these two programs will together represent a meaningful increase in our marketing reach over the prior year. Over the long term, we think there is an opportunity to better communicate our value proposition to new and existing customers as well as position our image with millennials. We are early on in some branding initiatives that will focus more intently on the younger customer. The combination of our ecommerce and marketing investments will fuel our push with millennials who are more interested in speed and convenience. To conclude, we’re encouraged about the position we occupy and the gradual yet tangible progress that we’re making here. We’ve upgraded the talent across the organization, and we’re pleased that how well our team has come together and united behind strategic initiatives that we believe can profitably grow Kirkland’s and make us a winner in the home décor space. With that, I’ll turn it over to Nicole.

Thank you, Mike. Net sales for the second quarter increased 7%; consolidated comparable store sales increased 1.2%, which included a 40% increase in ecommerce revenue. Geographically, sales are relatively consistent across our regions with Texas remaining soft. We had a positive conversion rate for the fourth consecutive quarter and the higher average ticket, which both helped to offset the negative traffic. We opened eight new stores during the quarter and closed three ending the quarter with 406 stores, representing 15 more units or approximately 4% more than the end of Q2 2016. Ecommerce generated $14.7 million in revenue during the quarter, accounting for approximately 11% of total revenue. This increase was driven by a combination of strong increases in website traffic, conversion and average order value. We also saw a healthy increase in revenue derived from our third-party drop shift initiative, which accounted for a higher portion of ecommerce revenue during Q2 2017 compared to a year ago. Sales via this channel result in a lower initial merchandise margin but the lower carrying and labor costs provide a bottom-line benefit. Moving on to gross profit. Gross profit margin for Q2 decreased 20 basis points to 34.2%. Looking at the components. Merchandise margins decreased 45 basis points to 53.4%. Merchandise margin was negatively impacted by strategically planned promotions to sell-through inventory in several categories, as Mike mentioned, a general increase in promotional offers and a growing mix of third-party drop ship sales partially offset by favorable shrink results. Store occupancy costs decreased 95 basis points as a percentage of total sales during Q2, primarily due to onetime adjustment to capitalized one month of extra charges for our leases. Outbound freight costs which include ecommerce shipping increased 85 basis points as a percentage of net sales, which was driven by an increase in ecommerce penetration. And finally, central distribution costs decreased 15 basis points due primarily to leverage from sales growth. Moving onto operating expenses. Operating expense for the second quarter was 33.5% of sales, which was down approximately 60 basis points to last year. The primary drivers of this decrease as a percent of sales were store payroll, operating supplies and utilities and corporate share-based compensation expense. Depreciation and amortization decreased slightly as a percentage of sales. The tax benefit for the quarter was $1.9 million or 33% of the pretax loss compared to 39.6% in the prior year period. Much of the decrease from last year’s rate is due to the change in accounting rules for taxes associated with share-based compensation. The net loss for the quarter equated to $0.24 per diluted share. Moving to the balance sheet and the cash flow statement. At the end of the quarter, we had $48.7 million of cash on hand, and no long-term debt or borrowings were outstanding under our revolving line of credit. Inventories at the end of Q2 were $73.4 million, a decrease approximately 1% over Q2 last year. Q2 2017 cash used by operations was $1.4 million, reflecting our operating performance and changes in working capital. Year-to-date capital expenditures were $13.8 million with just over 70% relating to new stores and existing store improvements followed by 21% related to IT system investments. We’re reiterating our 2017 guidance that was provided on March 10th of this year which provides for diluted earnings per share in the range of $0.50 to $0.65 for the year. And as a reminder, fiscal 2017 includes the additional week in the retail calendar, which represents approximately $10 million to $11 million in revenue and a minimal impact on earnings. Thank you. And now, we’re ready for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Jeff Van Sinderen with B. Riley. Please go ahead.

Good morning and let me say congratulations on getting back to positive comps.

Thanks, Jeff.

Just a couple of questions on SKU count rationalization. I know you spoke to that, but just wondering if it’s working well in the test, and I think you said you’re rolling out more -- or you’re increasing the size of the pilot. Just wondering what I guess you need to see in order to roll that out further?

Well, yes, the test that we performed was very successful; it achieved essentially what we expected to achieve. We’re taking that to a district this fall before the holiday season. And to your point, we don’t really need to see a whole lot more. And what’s happening as a result is, we are already adjusting future on order and buys to get to that level of SKU count. So, as a reminder, in that test store, we reduced the SKU count by over 10%. And to get in there and do that while business is rolling, you got to pay special attention to the store and actually physically go and move things. As we move forward, we are already implementing some of these learnings into our process, and we won’t have to do that for the full chain. So, as you go into 2018, we should be at our SKU targets that we set out in the test.

Okay, good. And then, just in regard to eliminating some of the coupon stacking that I know you have been working on. I guess maybe any color you can give us on how the customer has been responding to that. Do you think that it’s not really impacting their buying decisions? And then, may be any sense you can give us on, I guess how you are able to pass through some of the price increases, do you think that they are just not really being noticed by the customer on some of the furniture items as such that you mentioned?

Yes. I will start with pricing. It really is a SKU-by-SKU determination. We bring a lot of new products and a lot -- for the most part, unique products. So, we have some ability to move price, and we have tried to, across the assortment -- I am calling out furniture here as an example because it’s a good category to touch on in terms of raising price, we have unique piece. We are the only ones that have it. And we can -- we are challenging our buyers to try to push price a little bit on those unique items that we feel like we can carry through with. And we are doing that across the assortment. So, the pricing is real -- and we think that’s a big part of what we are seeing in our ADT being up, which is -- in our AUR. Those pricing decisions are weighing into that. As far as the promotional changes and the customer reaction, so far so good on that. The big move we made during the second quarter was to eliminate coupon stacking on our clearance category. And so far, we are seeing very few comments or reaction from customer to that change, as I believe they are really -- they expect it; it’s pretty common place practice out there across the retail space. And we are also seeing a nice improvement in our margin on that clearance category. So, that’s been a big win, and we expect that to help us in the back half. There is more to come on promotional staffing. We are making some changes at the point of sale that take a lot of this decision making out of the employee’s hands and make it systemic. It really flows down the line a little bit and that puts decisions into the hands of the employee at a time where we really want them to be serving the customer. So, those changes we are excited about putting through in the third quarter.

Okay. Good to hear. And if I could squeeze in one more. Just wondering how we should think about comps, sort of the comp progression in the second half, we would be thinking that your comps could be positive in the second half or positive in Q4 or…?

Yes. I mean, I think our guidance implies flattish to slightly positive comps in the back half, and that’s what we would factor in.

Our next question comes from Brad Thomas with KeyBanc Capital Markets. Please go ahead.

Yes, thanks. Good morning and let me add my congratulations as well on the solid comp results. I was wondering if you could give us a little bit more color on how trends progressed through the quarter and how August has started out for you.

Early in the quarter, in Q2, the progression was improvement as the quarter progressed. I think June and July were pretty much similar but May was a little weaker. And what was your second question, Brad?

If there was any color on how the third quarter had started out, thus far, just in the context of how the cadence of the business has been progressing, was how I asked.

Yes. I would say, I mean, it’s early, Brad. I would say along with what we’ve said in our guidance and one callout I would have on early read in the third quarter is we’re really pleased to see what we’re seeing out of our fall assortment. That set came on early in the month, and that will be more important as the quarter progress and especially as we get into the fourth quarter with the Christmas assortment. But, it’s always good to see that seasonal come out o f the gate strong. We’re still dealing with a lot of the headwinds that many are with traffic but we’re cutting into it, and we expect more of that as the back half unfolds.

And then, Mike, as you think towards the all important holiday season, could you just remind us as we think about your guidance, what’s contemplated from a promotional standpoint for this holiday season?

Yes. I mean, I think, we’re projecting as we’ve seen pretty much through the first half, it’s a very promotional environment, most retailers are dealing with some level of traffic decline. So, as we look ahead, there are some headwinds, but what we think will enable us to show some slight margin improvement in the back half is the work we’re doing on pricing and promotion and the changes we’ve made in key areas of assortment. We’re going to have a lot of new product flowing in from now, really through the rest of the year in different spots in the assortment. And we’ve done a lot of work leading up to this. So, we’ve cleared a lot of the things that we want to clear, and we’ve got a lot of freshness coming in. So, those things should serve to blunt and block a little bit of this external pressure that we know will be there. So, we try to factor in all those things into our guidance in our forecast.

Our next question comes from David Magee with SunTrust. Please go ahead.

Hi, guys. Nice job on the comps.

Thanks, David.

Couple of things. One is, and I think you just answered this, but just the environment itself, I know it’s challenging out there. Is it just sort of flat lining from what you saw in the first quarter, do you sense any sort of things get a little easier on that front or no?

I would say similar. I don’t think -- it’s been a promotional environment, it will continue to be a promotional environment. We’re prepared for that. We’ve made some underlying changes that are long-term benefits for us that will start to kick in, and we’re driving a little bit more traffic with our marketing. So, all those things come together and you manage your margin as best you can, and we feel like we can do that in the back half, even with a pretty promotional external environment. I don’t sense it getting worse or better at this point, but we’re well ahead of the holiday period right now.

Thank you, Mike. And then, you mentioned new store productivity was on track with expectations. How does that metric compare from a ROI standpoint with historical trends?

I’d say, it’s a little lower, and primarily the reason being we’re going into some markets, still strong by the way, versus history, maybe a tad lower because of cost to enter some of these markets. I mean, we’re going into some bigger markets in other parts of the country, like the Northeast, like the Upper Midwest, like California. And typically the upfront investment is a little bit higher, given the construction costs in those markets. So, that’s really the only callout. It’s a still a very attractive return. We’re getting ecommerce business when we drop into these new markets. And we’re very bullish on entering some of these whitespace opportunities that we have in front of us that many retailers don’t have. So, we’re still very focused on entering the right real estate.

And on the real estate topic, when you think about -- and you sort of alluded to it earlier, mature markets and how many stores you might need. Have you done work on your older legacy markets and have thought about what you might have to do over time just sort of right sizing the market? If you’ve done that, is that a big number stores that might have to be downsized over time in your mind or is it just more of a sort of tweaking?

We’ve looked at that, David. I think if you look at the results in our stores by vintage here, actually the longer we’re in the market, they are still showing really strong comps on a relative basis. I think what we need to do and we’re planning to do is spend a little bit more money on some of these older stores to make sure that they are up to current brand standards in those markets. I don’t believe, to your question that we have a lot of markets where we’re overstored. So, when I call out whitespace opportunities, I am really talking about where we’re not going to cannibalize any other stores, and we still have plenty of opportunities there. But most of our markets are not overstored. If you look at as compared to the competition, which we do every time we look at the real estate deal, those competitors typically have quite a few more stores in each market than we do.

Thank you, Mike. And then, I guess just lastly for me. I know this holiday season you plan to be maybe a little heavier on giftables than in the past. Is that something that will begin to show on your website soon or when you plan to sort of flowing those into the stores?

That will be a little bit closer to the holiday season, David. I am glad you raised it because we’re really excited about that part of the assortment for the holiday period. I think what you’ll see is very attractive gifts, and it will be something that you’ll clearly view as new to Kirkland’s. And I think we think our customers will really engage with what we’ve got in store for them, on the gift front and holiday season. In addition to that, we are doing a little bit more in the way of entertaining pre-holiday. So, we’ve really got these three components, entertaining, decorating and gifting. And you will see us be very intentional about that during the holiday period, supported by marketing, supported by presentation, and all of that in addition to just the core buy that both for fall and seasonal will be up a little bit this year. And it was very purposeful as to how we bought that up. We focused on proven winners and some key items within those categories that we feel like we can drive volume with.

Our next question comes from Anthony Lebiedzinski with Sidoti and Company. Please go ahead.

Yes. Good morning, everybody. Thanks for taking the questions. So, first, I just wanted to follow up about your store growth plans. Mike, in the past, you’ve talked about eventually having about 500 stores; you are little over 400 now. Is that still the case? I mean, obviously, it’s evolving retail landscape. So, I just wanted to get your updated thoughts on that.

Yes. I think, generally speaking, Anthony, that hasn’t changed. We believe we are 500 plus store retailer. I think we are leaning a little bit more into ecommerce than maybe you’d have heard this two years ago. I mean, the success we are seeing with that business, the growth rates, the improving profitability picture, we see that as a big opportunity for Kirkland’s and that will continue to drive some growth for the business. So, all-in-all, in terms of store count, given the whitespace opportunity that we do have, that’s still a target for us.

Okay. And as far as the improved profitability picture. So, last year, you put in the new ecommerce supply chain center in Jackson. As far as capacity of that, are you still in good shape with that? I just wanted to get a sense of if ecommerce continues to grow at this kind of rate, when would be -- at what point would you need to open another supply chain center like that?

Yes. We are working through that, Anthony. I don’t have specific on that. For now, that Jackson facility can handle the volume. One of the reasons, as Nicole pointed out in part of her prepared remarks, we have seen an increase in our third-party direct business online which naturally kind of pulled away from the activity in our DCs, which is helping and extends the life of the space we have devoted to it. And it’s also as byproduct helping us with the profit in the channel right now, as it goes in with a lower margin but it comes out with fewer costs and fewer labor pressures and things like that. So, we are pleased with that growth. And we are looking ahead to being able to leverage the stores more on buy online pick up in store options for the customer and that will additionally help the profitability picture.

And is there any data you can share with us as far as buy online pick up in store, how much of that of your business is that?

It’s a little bit less than 60% or at least for Q2 it was.

Got it, okay. And Mike…

And that is…

Okay. I am sorry, go ahead and finish your thoughts.

Well, I was just going to say that to remind everyone that that is a Ship to Store model right now. And as we look ahead, we would migrate a significant chunk of that 60% over to a true buy online and pick up in store model where we leverage the inventory on hand or in route to those different retail locations.

Got it, okay. And Mike, earlier you mentioned that you’re looking to target the millennials more. I mean, have you done already some of that or maybe you can share some thoughts as to what you’re thinking as to how do you get to that group of customers to be more engaged with Kirkland’s?

Well, I would just say, at this point, we’re keenly focused on. We’re doing a lot of work behind the scenes in our marketing. In addition to the improvements we’re making in marketing on the day to day stuff, we’re building a plan to address this customer segment in a bigger way. We already have some pretty good activity going on with that age demographic, but we need to do more, and that branding that I pointed to will be specifically geared towards that in addition to just refreshing the overall look and feel of Kirkland’s. More to come on that but just wanted to signal that as a focal point for our marketing effort over the next couple of years, as we grow the brand.

Okay. Thank you and good luck.

Thanks, Anthony.

This concludes our question-and-answer session for today. I’d like to turn the conference back over to Mike Madden for any closing remarks.

None, just to say thank you for joining us and we look forward to reporting to you on our progress in the upcoming third and fourth quarters. Thank you.

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