Kirkland’s, Inc. (NASDAQ:KIRK) Q1 2024 Earnings Call Transcript

Kirkland’s, Inc. (NASDAQ:KIRK) Q1 2024 Earnings Call Transcript June 6, 2024

Kirkland’s, Inc. beats earnings expectations. Reported EPS is $-0.68, expectations were $-0.92.

Operator: Good morning, everyone, and thank you for participating in today’s conference call to discuss Kirkland’s Financial Results for the First Quarter ended May 4, 2024. Joining us today are Kirkland’s Home CEO, Amy Sullivan; EVP and CFO, Mike Madden; and the company’s External Director of Investor Relations, Caitlin Churchill. Following their remarks, we’ll open the call for your questions. Before we go further, I would like to turn the call over to Ms. Churchill. She will read the company’s safe harbor statement within the meaning of the Private Securities Litigation Reform Act of 1995 that provides important cautions regarding forward-looking statements. Caitlin, please go ahead.

Caitlin Churchill: Thank you. 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 provision 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. A webcast replay of today’s call will be available via the link provided in today’s press release as well as on the company’s website at kirklands.com. Now, I would like to turn the call over to Kirkland’s CEO, Amy Sullivan. Amy?

Amy Sullivan: Thank you, Caitlin, and good morning, everyone. As we have previously communicated, over the past year, we have been dedicated to improving our performance by returning to our value heritage and reengaging our core customer. Kirkland’s has a strong history with an incredibly loyal customer, and we are well positioned in our industry with our value-oriented, differentiated, and curated product assortment to once again thrive. During this time, as we work through our repositioning that is currently underway, we are staying focused on executing our strategic initiatives, controlling the controllable, and driving improvement across all areas of the business. Our first quarter top line results reflect a continued challenging industry environment, with total comparable sales down 3.5%.

However, we continued to see early indicators that our strategic initiatives are gaining traction. Our store channel delivered a 2.8% comparable sales increase, driven by our marketing and merchandising strategies. In fact, overall units sold was almost — was up almost 20% in Q1 compared to last year as growth in value decor offset the lower demand of higher-priced goods. With respect to profitability, adjusted EBITDA improved $1.3 million compared to last year, driven by gross margin expansion and disciplined expense management. As we noted in our press release, following the quarter end, we deployed a number of cost savings initiatives to further align our cost structure with the current business environment. Through these actions, we expect to deliver $6 million in expense savings inside this fiscal year.

We are focused on minimizing any potential impact to our strategic initiatives and most importantly, the customer experience. While these decisions are never easy, we believe they are the right actions to take as we remain focused on improving our profitability and liquidity. We have also retained Consensus, an investment banking firm specializing in consumer-facing companies to serve as a financial advisor to assist the Board in the pursuit and evaluation of potential strategic opportunities to support our efforts and plans. We know to drive success, we must deliver sales growth, and this is where the entire organization is keenly focused. Let me refresh you on our strategic initiatives. First, reengaging our core customer; second, refocusing our product assortment; and third, strengthening our omnichannel capabilities.

Let me dive deeper into each one. First, reengaging our core customer. As we have discussed previously, we are intently focused on keeping a consistent brand voice while leveraging efficient marketing tactics to drive results. Since the start of Q4, we have seen a 36% reactivation of lapsed customers, largely driven by our shift back to home decor and gifts, where we have meaningful category dominance compared to our furnishing strategy. We know our customer continues to feel pressure on her wallet, as many of our competitors recently reported. But we have seen that when we provide a sense of urgency or a call to action type of promotion, she responds. For example, our April Friends and Family event drove positive traffic and conversion in both channels ultimately resulting in positive comp sales compared to the same event last year.

We continue to see positive news from our SMS program, which drove 30% increases in both conversion and revenue this quarter by highlighting timed events with our best offers. In addition, we continue to maximize our e-mail file, expanding our triggered e-mail campaigns to notify the customer if recently searched items are low in stock or back in stock. We reintroduced a birthday award to our loyalty customers to help drive both traffic and frequency in our channels. We expect to continue to benefit from these SMS and e-mail campaigns through the balance of the year as we continue to engage our 17 million core and reactivated customers. Turning next to our second strategic initiatives to refocus our product assortment by bringing back our always something new mindset and delivering curated on trend and seasonally relevant home decor at a great price.

We made strides over the past several months in reducing penetration of our furniture category. And as we continue to rebalance our assortment and introduce more frequent newness, we believe in time, we will return to historical inventory turns above 3 times. Our merchant teams are constantly in the market and analyzing social media to capitalize on trends and lean into the seasonal moment our customers love. We are particularly pleased with a 15% year-over-year sales increase from decorative accessories, which continues to win with the customer, as has our holiday and floral assortment, which continue to be core strength for the brand. Gifts, which we tested and reintroduced in Q4 has been a bright spot and delivered an incremental $2 million in revenue, driven by sentiment, religious and Mother’s Day themes.

Within gifts, we maximize the power of a key item in our beach tote, which ended up being the number three item in the total company in Q1. This is a great example of how our teams are reacting quickly and leaning into on-trend moments our customer loves. Again, as reported by our competitors, we continue to see challenges in high-ticket items such as furniture, mirrors and rugs, while we planned these businesses down appropriately for the quarter, demand did remain soft. As we look ahead, we will continue to monitor the demand and price sensitivity of these categories in holiday, floral, decor and gifts. Finally, let me turn to our third initiative to strengthen our omnichannel capabilities. As we have discussed, we see ample opportunity to improve our e-commerce business.

We have recently retained additional leadership to help oversee our e-commerce strategy, and she is actively identifying and addressing areas to improve results. As a reminder, our e-commerce assortment has a greater penetration of high ticket categories. And while continued softness of these categories weighs on AOV, we are pleased to see positive conversion for the channel overall in the quarter. We are maintaining a dominant share of voice in key categories such as holiday, art, decor and floral compared to our peers. That said, given the results in e-commerce, we are planning the business conservatively for the remainder of the year and are taking actions to rationalize our SKUs to optimize value. In addition, we are continuing to work on plans for a 2025 replatform, which will deliver a more seamless customer experience while improving efficiencies.

With respect to stores, as mentioned in my opening comments, we are pleased with the 2.8% comparable sales growth we drove in this channel. Our store teams are maximizing our new assortment and delivered double-digit increases in conversion and transactions in the first quarter. We believe in the new store growth opportunity in front of us and see it as a potential accelerant to our overall value creation. There is clear opportunity to reenter into many of the markets we previously exited, and we are actively engaging in discussions. However, timing will depend on our capital priorities and investment needs. As we look to the future, we remain confident in our 3 strategic initiatives focused on driving sales growth. We believe these initiatives, coupled with maintaining disciplined operational effectiveness and improved liquidity should give us a path to $600 million in revenue in the next five years, which in turn would enable us to return to adjusted EBITDA margin in the mid- to high single-digit range.

Before I turn the call over to Mike, I want to thank all of our associates, your dedication to our customers and commitment to our initiative is directly tied to our results. It’s an honor to be on this journey with each of you, and I’m confident in our collective ability to return our brand to long-term profitable growth for our shareholders. Mike, over to you.

Mike Madden: Thank you, Amy, and good morning to everybody. As Amy reviewed, we saw a softer start to the year. However, we were pleased with the ongoing progress against our initiatives as reflected in the positive comparable sales growth we delivered in our store channel for the period and the year-over-year improvement we delivered in adjusted EBITDA. Turning to our results in more detail. For the first quarter, net sales were $91.8 million versus $96.9 million in the prior year quarter. The average store count was down 4% compared to the prior year quarter and comparable sales decreased 3.5% for the quarter. The decrease in comparable sales was driven by a decline in the average ticket, offset partly by improvements in conversion and store traffic.

Breaking down sales within the quarter, comps were up 2.4% in February, down 10.1% in March and down 0.9% in April. As Amy discussed, we drove positive 0.8% in the quarter. However, the e-commerce sales decline of 19.1% more than offset the positive store results. E-commerce accounted for 24% of total sales in the quarter, down from 27% in the prior year quarter. From a merchandise perspective, we saw increases versus the prior year and decorative accessories, floral, gift and seasonal reflecting our shift in emphasis to faster turning lower price point items. However, these increases were not enough to offset declines in the higher ticket categories of furniture and mirrors along with rugs and outdoor. Sales performance was consistent across geographic areas with no particular over or underperformance relative to the whole.

Gross profit margin increased 280 basis points to 29.5% of sales, compared to 26.7% in the prior year quarter. The five components of this year-over-year change were as follows: first, merchandise margin increased 70 basis points to 57.5% versus 56.8% in the prior year quarter. Lower freight costs, along with an increase in the penetration of store sales, which carry a higher margin, led to the overall increase in merchandise margin. Second, outbound freight costs, including both store and e-commerce shipping expenses decreased 180 basis points to 5.9% as a percentage of sales compared to the prior year quarter. A reduction in the number of outbound routes combined with lower rates per route were the primary drivers to the decrease. We also benefited from lower parcel delivery costs due to a reduction in e-commerce revenue and lower contract parcel rates.

Third, central distribution costs decreased by 50 basis points to 5.1% of sales, compared to the prior year quarter. Increased efficiency and lower inventory levels led to lower labor and operational costs within our distribution centers. Fourth, depreciation included in cost of sales decreased by about 30 basis points to 1.8%. And lastly, partially offsetting these cost improvements was an increase in store occupancy costs of 50 basis points to 15.2%. This increase was due to deleverage from the overall sales decline. Total operating expenses decreased $1.6 million to $34.6 million, or 37.7% of sales, compared to $36.2 million, or 37.4% of sales in the prior year quarter. The decrease in dollars was primarily the result of disciplined expense management and lower corporate overhead compared to the prior year.

Adjusted EBITDA, excluding impairment stock compensation and other minor expenses was negative $4.5 million versus negative $5.8 million in the prior year quarter. This is primarily the result of the gross margin improvement along with continued tight expense control. Operating loss was $7.5 million, compared to an operating loss of $10.3 million last year. Operating loss as a percentage of sales improved 250 basis points, driven by the expansion in gross profit margin. Net other expense, which is largely comprised of interest expense offset by other income, was $1 million for the quarter, compared to $0.4 million in the prior quarter. Included in these amounts, net interest expense was $1.1 million for the quarter, compared to $0.5 million in the prior year quarter due to higher borrowing levels and higher interest rates.

Our income tax rate for the quarter was an expense of 3.7% of pretax loss compared to an expense of 12.7% of pretax loss in the prior year period. From a balance sheet perspective, our inventory levels continue to be under control and in line with our plan. We ended the quarter with $75.8 million in inventory, a 2.3% increase from $74.1 million at the end of the previous quarter and a 9.1% decrease from $83.3 million at the end of the prior year quarter. We had total borrowings outstanding of $48.9 million at the end of the quarter, which was comprised of $38.9 million under our senior revolving line of credit and $10 million under our FILO term loan. This compares to $34 million under our senior revolving line of credit at the end of the previous quarter.

The increase in borrowings reflects the negative operating performance for the first quarter seasonal growth in working capital and capital expenditures of $0.8 million. As a reminder, given the seasonality of our business, inventories are at lows during the first quarter and began to build during the second quarter on the way to peak in late Q3, early Q4. We expect our borrowing capacity to expand as we increase our inventory position ahead of our peak holiday season, and we expect to use the cash generated during the third and fourth quarters to reduce the borrowings under our senior credit facility. We are continuing our policy of not providing specific guidance given the difficulty in forecasting visibility. However, we do want to provide some color around our expectations in key areas.

For the balance of the year, we expect improvement in sales as we build toward the holiday season, driven by our assortment shift to faster turning categories and our aggressive focus on promotional effectiveness and inventory clearance to ensure freshness throughout the year. Overall, comps for the month of May were a slight improvement to the down at 0.9% we saw in April, primarily driven by an improvement in e-commerce performance, given an easier year-over-year comparison in that channel. As it relates to gross margin, we have seen promotional — we have seen the promotional level intensify in May, compared to Q1. And we expect that to continue into June as we clear the way for our fall offerings to take hold in July and extend into the back half of the year.

In addition, this spring, we began to see tightening conditions around ocean shipping, particularly impacting our imports from China and Southeast Asia. The resulting reduction in capacity is driving ocean rates higher as we approach peak shipping season. While it is still early to determine the level of impact, we expect rates to trend higher for the balance of the year, and we are selectively using the spot market to support our merchandise flow for the critical seasonal time frames. That said, we expect some offset to the increased promotional activity and inbound freight costs from ongoing improvements in many of our supply chain costs, particularly with better management of the labor in our distribution centers and outbound transportation costs.

We expect to deliver gross profit margin expansion in Q2, albeit below the level of expansion we saw in Q1. As for operating expenses, we are managing them very tightly and reducing costs across the business. As Amy discussed, following quarter end we implemented cost savings initiatives that will result in savings of approximately $6 million for the rest of fiscal 2024 and approximately $7 million in ongoing annual pretax savings. These cost savings initiatives include a reduction in corporate overhead, as well as store payroll, marketing and third-party IT expenses. While difficult decisions, we believe these actions are necessary as part of improving our profitability and liquidity trajectory, while minimizing disruption to our focus on our strategic initiatives and the overall customer experience.

While we have seen a softer start to fiscal ’24 top line performance, we believe with these actions in place, we are still positioned to achieve positive adjusted EBITDA in 2024 after two years of losses. With respect to priorities for capital allocation this year, our number one priority for the business right now is returning to positive cash flow. As we make progress toward that end, we continue to focus on reducing borrowings and reestablishing a level of liquidity that allows us to operate the business with more flexibility. The expanded credit facility we closed in January and the cost savings actions we recently implemented were crucial steps to enable our ability to execute our strategy. In addition, we have engaged consensus to pursue and evaluate potential strategic opportunities in support of our plans.

As we stabilize our financial position, we are also focused on reinvesting in the business with e-commerce technology enhancements and targeted store openings and relocations. Looking further ahead, as Amy outlined, we believe our strategic initiatives, combined with the continuation of our operational discipline and improvements in liquidity should enable us to achieve a long-term goal of $600 million in revenue by the end of fiscal 2028. Our sales goal assumes comp growth to return us to average historical store volume levels of $1.4 million through merchandising and marketing initiatives, enhancements to our e-commerce technology to unlock the full potential of that channel and targeted new store growth. On the cost side, we have already taken steps to improve supply chain efficiencies and remove fixed costs from our distribution facilities.

We expect these factors, along with tight management of our operating expenses, provide the path to get back to a mid- to high single-digit adjusted EBITDA margin over that five-year time frame. That concludes our prepared remarks. And operator, we’re now ready to take Q&A.

Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question today is from Jeremy Hamblin of Craig-Hallum Capital Group. Please go ahead.

Jeremy Hamblin: Great, thanks for taking the questions. I wanted to just start by seeing if I could clarify the commentary around trends. So if — so May — can we assume that May is kind of flat or maybe slightly negative, albeit a little bit better than April?

Mike Madden: Yes, that’s a fair assumption, Jeremy, yes.

Jeremy Hamblin: And then I just wanted to make sure that we understood typical seasonality of the business. So I think as I look back historically, Q2 from an absolute dollar sales basis is down from Q1. I wanted to understand if that is kind of the pattern that you expect to play out again this year? And then just to see if I could clarify the commentary around gross margin. So it sounds like it’s a bit more aggressive on the promotions, both for Kirk’s business as well as industry. Are you kind of expecting like a low-20s type gross margin in Q2?

Mike Madden: Yes. I think that’s — you’re in the ballpark there, Jeremy. I think on the sales question that you asked, yes, I mean that is — the seasonal pattern of the business has long been, Q2 has been the lowest volume quarter that we have, and that’s going to be the case this year as it has been. So I think what’s changed versus historically speaking is Q3 is starting to capture some of what used to hit Q4 as the holiday season has kind of expanded itself out. But certainly, Q2 remains kind of the lower quarter in terms of sales volume. And yes, I mean, the promotional activity has been a little bit heavier to start the quarter, but our inventory levels are in line, and we’ve got plans to manage through that, but we do think it will be a little bit more promotional here in the near-term. And then we’re keeping our eye on the impact of these freight developments that are affecting everyone coming over from the Far East.

Jeremy Hamblin: Got it. And then let’s just touch on the online portion of your business. So that obviously has struggled now for some time. And I wanted to just understand the product assortment that you’re offering online versus your stores. And I think what you indicated is in terms of how it skews, it’s a bit more slanted on your online portion of business towards a little bit higher ticket type item. Is that something that you could potentially revamp? I mean, you have a number of peers in the home decor space that kind of slant a little bit more towards the core accessories in the online portion of their business. Is that an adjustment that you’re looking at making on a go-forward basis?

Amy Sullivan: Hi, Jeremy, I’ll take that one. So historically, sort of old Kirkland strategy, new Kirkland strategy, those high-ticket categories, to your point, have always been a larger percent of the total. Part of the sort of compound factor of that has been the growth of the drop-ship business over recent years. And that is the area where we’ve got opportunity to go through and reevaluate how many SKUs we carry, what the value proposition is of those SKUs because if you look at our owned assortment, the majority of our assortment is exclusive to Kirkland and it’s very curated. But with drop-ship, we have less exclusivity. So there’s more comparisons out there to other competitors who are more pure play who operate on lower margins than we do.

So we are absolutely in the process of really doing an overall SKU rationalization of the entire e-commerce assortment to ensure that it better matches our go-forward merchandising strategy for both channels. Now that being said, I think there’s white space opportunity that will always exist online. So I expect there to be a little bit higher, a little more fringe in white space categories for the online channel, but we are actively deploying a new tool as well that’s going to help the merchant team really go through and almost scrub our website in comparison to our main competitors and ensure that our pricing is in line with where it should be. As we think about the things that are working in stores, like the gift category, for example, that I mentioned, as we move forward to a new platform, I think we’ve got opportunities to figure out bundling and other ways to make shipping more profitable because on our current platform with the limitations we have, I don’t want to move too far down the path of these lower ticket items and then impact the profitability of shipping those items.

So it’s a little step one, sort of the cleanup of current assortment on current platform and step to unlock capabilities to better bundle and create baskets as we move to a new platform, hopefully next year.

Jeremy Hamblin: Understood. Thanks for taking the questions And best wishes.

Amy Sullivan: Thank you, Jeremy.

Operator: The next question is from John Lawrence of Benchmark. Please go ahead.

John Lawrence: Hi, good morning. Can you hear me?

Mike Madden: Yes.

Amy Sullivan: Yes.

John Lawrence: Yes. Congrats on the positive comp. We’ve seen several stores over the last few weeks and certainly seeing that traffic is built a little bit and then sort of step one. Can you talk about the store base and the fleet where you were really strong? And was it the average of that 2% up? Was there a lot of variability of that across the country and how many stores were might have been positive versus still struggling a little bit?

Amy Sullivan: I think across the base, it was largely consistent. If you look across the chain, we certainly have some categories of business as we think about how we are allocating products and the reintroduction, particularly of the gift category, for example, there are product types within that assortment that we are thinking of regionally allocating and we’re seeing some strength in different categories through regions as we revamp sort of how we localize our product assortment. But largely, if you just look at top line results, it was pretty consistent across the board, a handful of pretty minor weather impacts in part of our base, but largely consistent.

John Lawrence: Great. Thank you. And Mike, would you talk about the e-commerce and the platform, what ideally better systems, et cetera, down the road? What do you reasonably see as an opportunity for saving for shipping an order across the country? What’s the metric we should look at to be able or what are the possibilities for increased profitability out of that channel?

Mike Madden: As far as e-commerce goes, I think what Amy just in her response to Jeremy covered some of this, as we enhance our technology capabilities online to maybe order — get these orders optimized in a way where the shipping is not as much of a negative impact on margin, I think we’ll have more opportunity to do that. The assortment itself, I think, is the bigger driver, though. It’s getting that right, balancing this growth that we’ve seen in our drop-ship program that I think as we look back at, we probably wouldn’t have moved as quickly there. And I think our profitability would be a bit better than it is today had we kind of metered that growth with what we owned over the last few years. So that’s step number one.

And as we get to optimization through technology, I think we certainly believe the business can be a profitable business for us and maintain that 25%, 30% of the business over the long haul and we have a $150 million-ish e-commerce business that makes money, and we believe in that. So we just need to invest a bit and fine-tune the assortment, I think is those are the priorities.

John Lawrence: Yes, thanks. And next question, and you spoke to it, and I want to make sure I understood the process of relocating some stores and some proven markets and replacing some of those stores. Where does that stand? And I know you spoke to it, but just remind me what that was?

Mike Madden: Well, it’s early on, and we’re early in a turnaround, and we’re building liquidity and the capital that is going to need to do that more aggressively. But while we’re sitting here today, we are active in terms of looking at prioritized locations, and those are going to be historic core Kirkland’s market, primarily in the Sunbelt, Southeast Texas. We’re prioritizing those lower cost markets where we have a lot of customer strength over a long period of time. And we’ll be ready to act when we feel like we have enough wherewithal to do it aggressively. And we’ve been encouraged by some of these markets that as we’ve started to see some fruits of the shifts that we’ve made with the merchandise and the customer, some of these stores that have been historically strong are catching fire faster than maybe some of those that are outside those historic locations.

So that’s encouraging to us, and we want to find more of those. But we’ve got certainly where we are today, we’ve got to be measured about how we do it and do it responsibly.

John Lawrence: Great, thanks. Appreciate the time. Good luck.

Mike Madden: Thank you, John.

Operator: This concludes our question-and-answer session and the conference. Thank you for attending today’s presentation. You may now disconnect.