Jeff Black - IR, SCR Partners Mike Cairnes - Acting CEO Nicole Strain - Interim CFO

Brad Thomas - KeyBanc Capital Markets Jeff Van Sinderen - B. Riley Anthony Lebiedzinski - Sidoti & Company John Lawrence - Coker and Palmer

Good morning and welcome to Kirkland's First Quarter 2018 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 first quarter of fiscal 2018. On the call this morning are Mike Cairnes, Acting CEO; and Nicole Strain, Interim Chief Financial Officer. The results as well as the notice of 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 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 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 3, 2018. With that, I will turn it over to Mike.

Thanks Jeff. It's a pleasure to be here with you this morning. For those, I have to yet to meet, let me start with the quick introduction. I was Kirkland's Chief Operating Officer since November 2016 before being named acting CEO this year. I've spent the majority of my career in the home décor sector and a wide variety of merchandising, operations and senior leadership roles, most notably at Michaels Stores. I came to Kirkland's because I saw an incredible opportunity to grow the brand. I believe we are very well-positioned to exploit trend-right style and value as an omni-channel specialty retailer of home décor. I have just as much conviction about our ability to execute on that opportunity as I did when I joined the Company and I look forward to updating you on our progress. On our fourth quarter call, we outlined a solid plan for 2018 that incorporated a number of initiatives to grow revenue and improve our overall operating efficiency. I'm pleased with our performance to start 2018. I'll spend some time this morning updating you on where we're seeing success and where we still need to make more improvement. In short, we are realizing progress on fundamentals while setting the stage for the future. We achieved record sales in the quarter with positive comparable store sales, while growing merchandise margin. Overall, the results demonstrate that we're delivering a better customer experience with new and exciting products supported by improved clarity across our merchandise presentations on the back of improved operational efficiency. At the same time, we're making strides to improve financial performance as we strengthen our omni-channel platform and control operating costs. We have accomplished some of the underlying initiatives over the past year, yet we still have more work to do. I'm extremely proud of the way our team has come together in a recent transition and I'm confident that we're on the right path to achieve our targets and grow the long-term value of the business. Total sales increased 7% in the quarter with EBITDA increasing. Our store performance has improved in both existing and new stores, and we maintained a strong pace of growth in e-commerce. We’re very pleased with our furniture performance, which was up 7% over last year. Strength in the category was driven by plan changes to the product mix. Fragrance had a similarly strong performance as the customer is responding to a reset of our jar wax to a higher quality product and assortment. Customers are freshening their homes with seasonally appropriate and trend-right pillows and throws. These micro categories grew over 16% in the first quarter. We realized significant double-digit sales in floral, as we reset the category to a lifestyle theme, and it’s working. We have identified some opportunities to spur our momentum in the fall and holiday quarters. For example, we are making significant adjustments to our product mix in art, and we’re addressing mirrors with a revitalized basics program. We’re also planning some deeper investments in categories to support our fall and holiday business. This will include a more thematic approach to gifting with special product sets and in-store features. These types of category refinements are driving stronger conversion in ticket, and we feel great about the direction our merchandise team is headed. Financial performance in the quarter benefited from solid traction on initiatives to control costs and increase operating efficiency. We’re employing better analytics to augment our forecasting and marketing initiatives, and that’s allowing us to optimize our couponing and promotional activity in a surgical and strategic way. Brick and mortar product margin improved versus the year-ago quarter, and we were able to offset headwinds from an increase in direct shipping for an overall gain in the merchandise margin. Expenses remained well-controlled. We leveraged overall operating expenses and we are addressing supply chain cost pressure with better truck utilization and streamlined routing. We finished the quarter in a strong capital position with $58 million in cash and no borrowings outstanding. We intend to maintain a conservative capital structure and we have ample flexibility to make investments to achieve our strategic goals and return excess cash to our shareholders. As mentioned in our fourth quarter earnings call, we’re making investments to accelerate high-return projects that can improve the customer experience, support growth and increase efficiency. These include an upgrade to buy online pick up in store to support our e-commerce business and investments focused on customer retention and new customer acquisition. Sales growth at kirklands.com accelerated 39% in the quarter against a 32% gain in the prior year. The channel was a key driver for comparable store sales. E-commerce expenses leveraged on the larger sales base, and continued expansion of direct shipping from vendors is aiding overall profitability. We’re on track with plans to rollout BOPUS this year and we’ll continue to expand vendor direct shipping, improve the assortment and enhance the mobile experience. In marketing, I am pleased to announce we’ve re-launched our loyalty program. This was a new and improved program designed to deliver greater customer value and drive better margin as a byproduct. We’ve also shifted some dollars into new customer acquisition and this includes added spend on digital where we’ve introduced a new influencer program to foster and support inspiration. As an example, we utilized social media to launch our first licensed product, the Trisha Yearwood collection. We received positive reviews, strong sales of the featured products and touched new customers. We've got an additional licensed collection in the pipeline for 2018. As you know, we've slowed our store growth as we focus on enhancing our omni-channel strategy. We're in the preliminary stages of an initiative to transform the in-store experience to better support our omni-channel platform and showcase our merchandising focus. We've kicked off an exciting new initiative as we align with the top retail design agency to stand up a best-in-class test store this year with the objectives of creating cohesive product stories, simpler customer navigation, theater to our stores and highlight our omni-channel opportunities. These are just some of the examples of how we're staying disciplined and keeping the ball moving forward. I feel great about Kirkland's progress on the fundamentals and the strategy we're pursuing to profitably grow our share of the home décor market. The teams are approaching the business with greater discipline and better data, and that's starting to drive the sales with a commensurate improvement in the margin. I am proud of the way our team is coming together and optimistic about the prospect to continue to improve financial performance and the opportunity to drive long-term value for our shareholders. With that, I'll turn it over to Nicole, to discuss the financials for the quarter.

Thank you, Mike. Net sales for the first quarter increased approximately 7% compared to the same period in the prior year, despite significant weather impact. Consolidated comparable store sales increased 1.4% which included a 39% increase in e-commerce revenue. In our brick and mortar stores, we continued to see a higher average ticket and positive conversions offset negative traffic during the quarter. We opened 10 new stores and closed 3, ending the quarter with 425 stores, which is a net year-over-year gain of 24 stores or 6%. We are projecting to open an additional 10 to 15 new stores in fiscal 2018 with roughly half of those in each of Q2 and Q3. With only a few months of sales, the 2018 new stores are outperforming our expectations. E-commerce generated $17.3 million in revenue during the quarter, accounting for approximately 12% of total revenue. This increase was driven by a combination of increases in website traffic and conversion. A third-party drop ship initiative accounted for 24% of our e-commerce revenue in Q1 compared to about half of that in Q1 2017. Moving on to margins. Gross profit margin in Q1 decreased 50 basis points from the prior year to 31.8%. As a reminder, both the current and prior periods have been adjusted to include depreciation related to store and distribution center assets. Looking at the margin components. Merchandise margin increased 35 basis points to 56%. Merchandise margin includes the direct cost of merchandise as well as product shrink, damages and inbound freight. Product margin continued to benefit from a higher IMU and more strategic promotional activity, which offset pressure from inbound freight. Outbound freight costs, which include e-commerce shipping, increased 65 basis points as a percentage of net sales, which was largely driven by an increase in e-commerce penetration. Store occupancy costs deleveraged 15 basis points as a percent of sales compared to the prior year quarter. And finally, central distribution costs deleveraged 5 basis points to the prior year as a percent of sales. Moving on to operating expenses. Operating expense for the first quarter was 31.7% of sales, which was down approximately 110 basis points to last year. Store operating expenses remained relatively flat to the prior year as a percent of store sales. E-commerce expenses leveraged 160 basis points as a percent of e-commerce sales and corporate expenses excluding the CEO transition charges, decreased $1 million or 130 basis points year-over-year, primarily due to a reduction in corporate salaries and stock compensation expense. Year-over-year, we had an increase in EBITDA of $1.3 million $2.4 million adjusted for CEO transition costs, getting us to $6.5 million for the quarter. Depreciation and amortization remained relatively flat to the prior year as a percent of sales. The tax benefit for the quarter was approximately $500,000, which included $135,000 benefit from hurricane employment credits. Excluding this discrete item, the tax rate for the quarter was 24.4% of the pretax loss and that's compared to 36.3% in the prior year period. The lower rate in 2018 is due primarily to changes included in the Tax and Jobs Act of 2017. We ended the quarter with a net loss of $0.06 or flat adjusting for the CEO transition charges, and that's compared to a loss of $0.09 in the prior year quarter. We will continue to work to improve our performance in the first half of the year, so we are happy to have the first year-over-year improvement in profitability since 2015. And moving to the balance sheet and the cash flow statement. At the end of the quarter, we had $58.2 million of cash on hand and no long-term debt or borrowings or outstanding under our revolving line of credit. Inventories at the end of Q1 were $83.2 million, which was an increase of approximately 15% over Q1 last year. Most of this increase is due to growth in total sales year-over-year with some additional timing impacts. Our per store inventory increased just over 1% compared to the prior year. Year-to-date fiscal 2018 cash used in operations was $8 million, which reflects our operating performance and changes in working capital. Capital expenditures for Q1 were $11.1 million compared to $5.6 million in the prior year quarter. We expect similar annual capital expenditures to the prior year. Of the $11.1 million, 60% related to new stores and existing store improvements and the remainder to e-commerce, supply chain and other system investments. During the first quarter, we repurchased approximately 316,000 shares at an average cost of $9.42. To-date, we have repurchased 420,000 shares at an average cost of $9.83 under our current share repurchase authorization, which leaves just under $6 million available. We are reaffirming our 2018 outlook provided on March 16, 2018, which includes annual diluted earnings per share in the range of $0.50 to $0.60 and that's inclusive of the CEO transition charges. We expect to -- we continue to expect earnings improvement in each quarter relative to fiscal 2017 with the exception of Q2, which included favorable adjustments in the prior year. Related to our Q2 outlook, the second quarter of 2017 included favorable onetime adjustments of $0.10 related primarily to favorable shrink results and an adjustment to capitalize a month of extra lease charges. Excluding those adjustments, we expect the second quarter of 2018 to be roughly in line with prior year results. Thank you. And we are now ready for questions.

[Operator instructions] The first question comes from Brad Thomas with KeyBanc Capital Markets. Please go ahead.

Hi. Good morning, Mike and Nicole. How are you?

Good morning, Brad.

Let’s see here. Nice results here in the first quarter. Obviously, the positive same store sales and getting EBITDA higher year-over-year. I guess, I was hoping to just ask a high level question. The first quarter is typically a smaller one for you, obviously the fourth quarter is the all important quarter. I guess, as we look ahead through the year, how much do you think -- how well do you think you're positioned for this execution in 1Q to continue through this year?

Thank you, Brad. We feel very good about our positioning through the year. In that, what we are doing right now is a blend of foundational and fundamental work and positioning the Company for the future. So, we're going to continue our best practices for merchandise process, we're going to improve analytics and leveraging data, and continue to build out effective marketing channels for new customer acquisition. Meanwhile, we're focusing on customer service in store. We’ve contracted a third party to measure our customer satisfaction. And that gives something tangible for the store teams to shoot for. And then, from there, we springboard the business as we look to stand up a next generation store and bring on line BOPUS.

Great. And as we think about same store sales, Mike, you obviously highlighted a number of the initiatives you have underway. But, how are you thinking about maybe the cadence of same store sales as we move through this year and as the comparisons get a little bit tougher?

Yes. I still think -- I feel good about the guidance that we have in place where we will be putting up between a 1%, 2% comp sales for the year. And I feel like we can achieve that through the year.

Great. And then, obviously, you all continue to do a very good job of growing the e-commerce business and I would imagine that BOPUS will further support elevated growth. Could you just talk a little bit about how e-commerce is affecting your profitability and could it affect your profitability as we move through the year and roll out BOPUS?

Yes. I'll take that one. So, I think for Q1, and it varies a little bit by quarter, the e-commerce business is equally in the first quarter or more profitable than our store business. In addition to that, I would say, there are several opportunities in both stores and e-com to work to improve the profitability. BOPUS is going to be one of the larger item for e-commerce that will start in the back half of this year. But also as we just dig further into those businesses, we do believe there is further opportunity in both for improved profitability.

Great. Thanks for taking my questions and congratulations again on the quarter here.

I appreciate it, Brad.

Okay. The next question comes from Jeff Van Sinderen with B. Riley. Please go ahead.

Hi, everyone. Let me add my congratulations to the team on a solid Q1 as well.

Thank you, Jeff.

So, Mike, I think we can probably credit you to at least to a pretty good degree with strong operational execution in Q1. And now that you're acting and hopefully permanent CEO, maybe you can drill down a little bit more on sort of some of the strategic things that you're most focused on as we head into fall and holiday, and if you could maybe touch on some of the specific changes that we should expect in merchandise content for second half without giving away too much competitively?

Yes. Well, first of all, Jeff, I really credit the team. I'm just really pleased how the overall team is just galvanized around our vision. In terms of some of the strategic things that we have on tap, as I mentioned, we're going to be standing up a next generation store. We're internally calling it Janus, which is Greek for god of new beginnings. We'll have that up by Q4. This will be a rapid test and learn store. It's a great way to wring out a store of the future by doing it with live customers. We’ll have a financial person as part of that team because what you want to make sure is whatever you build for the future has the ability to hurdle whatever financial costs go into it. On the e-commerce side, we will be standing up, buy online pick up in store as we previously mentioned. We'll have that up by fourth quarter, and we will monitor that very closely to determine how quickly we expand on that for the balance of the year and going into 2019. You asked about merchandising. And what I'll say about merchandising, there's been a number of things put in place for merchandising. For one, in 2017, we converted our buying team to omni-channel buyers. We put in place a more defined planning process and structure that leads up to where the team is walking all merchandise presentations before they hit the floor. And I continue to be impressed how the buyers are developing and raising their game in terms of business acumen. And last year, we did a full-on category rationalization and reduced the overall assortment by about -- and skew count by about almost 20%. All of that is beginning to bear fruit in 2018. And what we want to do, as we've now kind of focused in on the micro categories, is now pull that up and make sure that we are getting credit in store for the key stories that we want to tell. So, as an example, I'll take floral as an example. This is where we re-imagined the category and we created this retro New York street floral market cart and we represented it in a fantastic way, and the sales took off on that. We have customers asking if they could buy the cart that goes with it. Well that's theater and that's what we're trying to do is make sure that we are telling our store -- getting credit for the stories that we're telling and bringing those to life. We still have a lot more work to do in the store as it pertains to that aspect of merchandising. And meanwhile, we continue to hit some of the underperforming categories. And I'm pleased with that progress as well.

Okay, great. And then, sort of as a follow-on to that. Can you give us a little bit of an update on how you're proceeding with direct sourcing?

Sure. So, we have initiated a direct sourcing initiative. And we have identified already items that we will be bringing direct from factory where we're already getting a cost reduction on those items. Some of those will be starting to flow in Q4. And with that, what we have effectively done is we've stood up the initiative and we have aligned with our partners with that. And we're proving the concept and proving the logistics of this is what we're really doing in Q4. We really see more of the impact of direct sourcing to be 2019, 2020 and beyond.

Okay. And then, if I could just squeeze one more in. I know obviously you're working on sort of the new concept store, the Janus store. Just wondering I guess at this point, maybe you could just kind of give us your latest thoughts on branding and marketing and plans to evolve those areas or is it kind of early maybe to talk about changes there or plans or how are you feeling about that?

So, it is early in the process. We are in the very early process of relooking at our overall branding. And with that, we will be introducing some of those elements into this next generation store. But also in marketing, one of the things that we did was we have revamped our loyalty program. And we rolled that out in April of this year, at the end of Q1. So, what we did was a consumer insight study. And what we found is that many of the customers didn't even know that they were part of a loyalty program. Many customers didn't understand the mechanics of it. So, effectively, they were telling us that they were not giving us credit for the program. In addition, this was a program that was points based, meaning the customer redeemed a $10 award certificate at the time of purchase of. So, we were basically just marking down transactions that they were already planning to make and plus it was stackable. So, we moved to a program that's more surprise and delight. Over time, we will evolve the program to more of a robust CRM and therefore increasing the value and increasing the margin.

Okay. Well, that certainly seems like a pretty significant opportunity for you. Thanks for taking my questions. Continued success and best of luck in Q2.

Thank you, Jeff.

Okay. The next question comes from Anthony Lebiedzinski with Sidoti & Company. Please go ahead.

Yes. Good morning and thank you for taking the questions. Certainly, a good start to fiscal ‘18. So, just wanted to follow up on the couple of questions. You talked about the direct sourcing. Just wondering about what’s the margin difference that you think you can achieve for direct sourced products versus the products that are not direct sourced?

Yes. Good morning to you too, Anthony. On the direct sourcing side, I would say a couple of things. A, we're still very early in it. We are seeing cost improvements that are better than 10% on some of the merchandise that we have begun to initially source. And as we get deeper into the categories, we'll have to see if that holds or if it's something different than that, but the early prognosis of it still looks very good. I think the other part I would comment on direct sourcing is that when you look at our overall assortment, approximately 30% of our assortment is products that we repurchase. And those would be the first products that we would be targeting because we're a high fashion business and we're turning over product. And so, those products would be less affected by direct sourcing, but we're really angling for more of the core products.

Got it, okay. And then, you mentioned also that you're improving your discipline, you’re using more analytic data. Are these like the main differences that you're looking -- that you're doing so far compared to your predecessor?

It is certainly helping. So, what we have done is we have built, albeit some very simple analytical tools that were not in place before, which allows us to predict margin based on the lineup of offers that we have planned. And therefore, we can go in and we can modulate the promotional cadence accordingly and that's a -- that is clearly a win for us. And it's something that many best in class retailers already have, but we also think we can take it to another level.

Got it, okay. That sounds good. And then, Nicole, you also mentioned that there was significant weather impact in the quarter. And you sort of guess as to how much your same store sales were impacted by the weather.

Yes. So, it's difficult to estimate exactly. But roughly a third of our regions were directly impacted, meaning stores in those regions were closed for all or a portion of the day. So, as we looked at that and the indirect impact that was also felt throughout the rest of the chain, rough estimate, 50 to a 100 basis points of comp of weather impact in the quarter.

Got it, okay. Well, thank you and best of luck.

Thank you Anthony.

Okay. The next question comes from John Lawrence with Coker and Palmer. Please go ahead.

Good morning.

Good morning, John.

Congratulations. I’ll put my congratulations in there as well for a good start.

I appreciate that.

Can you -- couple of things. Can you talk a little bit -- you mentioned the 18 class of stores doing better than plan. Can you comment, as you assess that and sort of dissect that information, how much do you think, if you break that down, is to better side selection, better merchandise presentation? How would you sort of look at that at this point?

John, what we did last year was we took a step back and a deep dive into our real estate selection process. We did a quantifiable review of the different triggers of success. And then, the common threads where stores were underperforming. We analyzed some of these factors through control groups, reviewed many different attributes. Market types, co-tenancy, position of the center et cetera. We also looked at how we operationalize new stores, how we hire, how we train. So, I don't think we have it all figured out. We are more dialed in and we're pleased with our early 2018 class performance. And the other point I would make too, as we are slowing our store growth, this allows us to be more selective as we're pushing more of our capital toward e-commerce and high ROI initiatives.

Right. Thanks for that. And as you look at -- and you might have mentioned it in your comments, but Michael, as you look at 39% growth on e-commerce business and that -- if you break that down a little bit, and you commented on the core product versus the new product, what are the metrics in that that the merchandising team are looking at to say that incremental product is winning? I assume, there is operating metrics that talk to you about that incremental product and what kind of return it's bringing, I guess from an attach rate or what's working on the web?

Yes, sure. We are -- we certainly look at that channel of business. So, the ability to third party which is about 20% of that e-commerce business today, what it does is it helps us expand our assortment, while at the same time putting the logistics on someone else's back. So, when you're a smaller specialty retailer, this effectively becomes an extended isle for us and I think a part of our strategy going forward. So, a good part of that of business is accretive to the overall e-commerce business. But managing it all under one umbrella so that it make sense is going to be the key.

Great, thanks. And one last question. Nicole, if you ex out the severance payment, you might have mentioned it and I missed it, but there is obviously some other leverage points within -- and you touched on some leverage points. Part of that was the cost structure I assume that you changed at end of the year. Can you touch on that? And I assume as sales go up, some of that cost structure still leverages, despite the onetime non-recurring cost?

Absolutely. So, I think, we saw cost control, improved cost control across multiple areas of the P&L. But you're correct, on the operating expenses line, we were seeing significant leverage in e-commerce as a lot of those costs are fixed or somewhat fixed. Also, corporate expenses were down year-over-year. And that in part was due to the restructuring in Q4, but in part again was due to cost control, and just looking at all of the lines and the opportunities that exist and just overall improved management from our team.

Great. Thanks and congrats again, and good luck.

Thank you, John.

Okay. This concludes our question-and-answer session. I would like to turn the conference back over to Mike Cairnes for any closing remarks.

I just want to simply thank our team for a very good start to the year. And I'm looking forward to updating everyone on our progress as we continue to March in 2018.

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