Kirkland’s, Inc. (NASDAQ:KIRK) Q4 2022 Earnings Call Transcript

Kirkland’s, Inc. (NASDAQ:KIRK) Q4 2022 Earnings Call Transcript April 4, 2023

Operator: Good morning, everyone, and thank you for participating in today’s conference call to discuss Kirkland’s financial results for the Fourth Quarter and Fiscal Year Ended January 28th, 2023. Joining us today are Kirkland’s Home CEO, Steve “Woody” Woodward; EVP and CFO, Mike Madden and the company’s External Director of Investor Relations, Cody Cree. Following the remarks, we’ll open the call for questions. Before we go further, I’d like to turn the call over to Mr. Cree as he reads the company’s Safe Harbor statement with the meaning of the Private Securities Litigation Reform Act of 1995, provides important cautions regarding forward-looking statements. Cody, please go ahead.

Cody Cree: Thanks, Jamie. 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 and 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. I’d like to remind everyone that this call will be available for replay through April 11th, 2023. A webcast replay will also be available via the link provided in today’s press release, as well as on the company’s website at kirklands. com. Now I’d like to turn the call over to Kirkland’s Home CEO, Woody Woodward. Woody, over to you.

Steven Woodward: Thank you, Cody, and good morning, everyone. It’s a pleasure to be speaking with you all today. And as I announced this morning, I’ve provided the Board of Directors with notice that I will be retiring from my position at the end of May, and as a result, the board has commenced a CEO transition plan. It’s been an honour leading this great organization since 2018. I have respect for our board and all the great colleagues I’ve served over these past five years. While I couldn’t have predicted all the highs and lows we would face on this journey, I knew our transformation plan would take time and patience. The largest and most successful home furnishings retailers in our industry all took decades to reshape their business, build their reputation and capture market share to become the leaders they are today.

So we knew this is not going to be an overnight success. In fact, the last several years have truly been some of the most challenging periods I’ve ever experienced throughout my career. However, I’m proud of our organization’s ability to navigate this highly volatile macro environment and the resilience of our team makes me proud to serve alongside them. I firmly believe that this organization has made significant improvements across every facet of the business and is in a better position to capitalize on the opportunities that lie ahead. As our board considers its options for my successor, I will be staying as CEO through the end of May to ensure a smooth transition. Ann Joyce, a member of our board, will be stepping in as the Interim CEO.

By way of background, she has served as a senior executive in many senior executive roles throughout the retail industry over the past three decades, including notable brands such as Ralph Lauren, Aeropostale and Chico’s. In more recent years Ann has spent most of her time on boards for various public and private companies in addition to running her own consulting practice in which she advises senior business executives and board members. Ann joined Kirkland’s board as an independent director in June 2021 and has an extensive view into the challenges we currently face and, more importantly, the opportunity ahead. In addition, we announced the promotion of Amy Sullivan, who currently serves as Senior Vice President and Chief Merchandising and Stores Officer to the role of President and Chief Operating Officer.

Amy has been an invaluable member of our leadership team over the past decade and has been instrumental in evaluating the brand — in elevating the brand to a much improved design and quality that we have today. Amy has more than 20 years of experience in senior merchandising roles across the retail landscape, having worked for Express, Lands’ End, Kohl’s and JCPenney. With Ann and Amy in these roles along with the rest of our skilled leadership team, I firmly believe that I will be leaving the company in great hands, and I look forward to rooting for their success from the sidelines. With that, let’s transition over to our performance as we disclosed in our holiday sales release earlier this year. We stated the fourth quarter. We started the fourth quarter with promising sales trends as the month of November and our Black Friday event was relatively successful.

However, soon thereafter, we began to see traffic decline rapidly, both in-store and online, along with experiencing the effects of significant inventory reductions on our merchandise mix, both of which ultimately drove our overall quarterly sales lower on a year-over-year basis. Although disappointing, importantly, we were able to generate over $40 million in operating cash flow, which allowed us to repay $45 million in debt. Even in a volatile customer market with declining customer traffic and a less than ideal merchandise mix, we were able to generate meaningful cash flow and strengthen our balance sheet. But stepping back for a moment, I’d like to provide some perspective on the power of our brand and the potential value that our omnichannel platform can provide shareholders.

If we look at our performance from fiscal 2014 to fiscal 2018, our average annual revenue during that five year period was almost $600 million and our EBITDA margin was almost 8%. We were able to accomplish that with an operating structure that was not as well positioned to support omnichannel growth as it is today. There was no direct sourcing program and we had declining merchandise relevancy with outdated design and quality issues. Since then, we’ve made significant changes to our organization, including digital transformation efforts to create a true omnichannel platform. We removed significant costs from our operating structure, revitalized our brand image with updated logos and refreshed stores, and refined our distribution footprint to provide better coverage across our store and customer footprint.

It wasn’t that long ago during a heightened customer spending environment that we were able to capitalize on these transformative changes and report impressive financial results. Although unprecedented micro — macro challenges soon followed and significantly affected customer sentiment, I firmly believe we have the ability to continue positioning our organization for long-term success with better liquidity and an improved merchandise strategy in place. We believe this sets us on a path to stabilize our business in fiscal 2023 and reinvigorate sustainable growth from there. So how do we get to this point? While the transformative changes that we made over the past few years have been beneficial in elevating the quality, design and sourcing of our merchandise, we also recognize that many of our loyal customers who are dedicated shoppers to our value decor and holiday assortments have felt somewhat neglected through this transition period.

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This customer has been incredibly important for Kirkland’s home throughout our history, and we believe there is an opportunity to reinvigorate this portion of our customer base. While we’re still planning to provide larger ticket items in categories such as furniture and outdoor, we’re going to be working on rebalancing our merchandise assortment with a focus on opening price points, starting in the $20 range and ensuring that our inventory availability appropriately supports customer demand. In fact, we’ve already begun shifting store layouts to more effectively highlight these opening price point items while still showing how they can be a wonderful accent to larger ticket items. As part of these efforts, we’re continuing to push a strong selling culture among our stores level employees to drive improved conversion with this updated merchandise mix.

We’re also going to be much more calculated with our promotional strategy to ensure we’re supporting these value seeking customers, which includes leveraging improvements in our initial mark-up to drive more demand with a higher discount rate. Through this process, we’re evaluating the effectiveness of our marketing and going to be a laser focused on improving the ROI on advertising and marketing spend to ensure that our efforts are ultimately resulting in sales dollars. We’ve developed a very powerful tool with our customer data platform that provides us with ample insight into the customer behaviour and patterns which we will look forward to leveraging in the coming fiscal year to drive these merchandise and promotional strategies in the right direction.

In addition to our revised merchandise strategy, we’re expecting to see some relief from the supply chain show up in our margin structure in fiscal 2023. We are seeing pricing on shipping containers and rates come back to more normalized levels and expecting to see material margin improvements starting in the first quarter of this fiscal year. While this is welcome news, we remain vigilant on our efforts to tightly manage our operating costs across the organization. We’ve also amended our existing credit agreement to further extend our credit availability during peak season and strengthen our liquidity position. I’ll let Mike dive into the details of the new agreement, but it was important for us to secure the added availability and flexibility at what is the lowest cost of capital available to us.

The facility was set to mature in 2024, and this amendment extends the term out to 2028. Overall, I’m very proud of what this organization has been able to accomplish in such a difficult macro environment this past — as this past year, including improving the quality and design of our merchandise, updating the customer, the company’s branding, enhancing the omnichannel experience and optimizing our operating structure with a focus on delivering long-term profitability. We’re well positioned to provide our customers with affordable, stylish alternatives and refreshing their homes. I do believe that we are laying a strong foundation to fully unlock the potential of our platform over time. With that now I’ll turn the call over to Mike, who will provide detailed commentary on our performance in the fourth quarter and fiscal year along with our outlook.

Once again, I’d like to thank our stakeholders for their support over the last several years as we embarked on this journey. Mike, the floor is yours.

Mike Madden: Thank you, Woody, and good morning, everybody. For the fourth quarter, net sales were $162.5 million compared to $176.2 million in the year ago quarter, which includes a 4% decline in store count and a comparable store sales decline of 6.1%. The comparable store sales result was largely driven by a year-over-year traffic decline, partially offset by an increase in the average ticket. E-commerce was 25% of total sales in the quarter, which was similar to the prior year. Breaking down sales within the quarter, comps were flat in November, followed by a decrease of 11% in December and a decrease of 8% in January. Gross profit margin declined 850 basis points to 24.8% of sales, compared to 33.3% in the prior year quarter.

There are five components to this year-over-year change as follows. First, merchandise margin declined 420 basis points to 49.9% versus 54.1% in the prior year quarter. Increased discounting associated with our efforts to reduce inventory levels and sell through the holiday assortment along with higher inbound freight rates, led to this decrease. As we’ve previously discussed, inbound freight rates spiked in late ’21 and early ’22 and much of the product that sold through in Q4 carried the impact of higher freight rates and cost of goods. Second, central distribution costs increased 170 basis points to 6.3% of sales from 4.6% in the prior year quarter. Operational inefficiencies in our distribution centers resulting from elevated inventory levels and uneven product flows led to the increase.

These costs spiked in the first and second quarters and were capitalized as the underlying inventory was held prior to sale. Most of the inventory that sold through during the fourth quarter was burdened by these costs. Third, store occupancy costs increased 140 basis points to 9% of sales from 7.6% in the prior year quarter, largely due to deleverage from a lower sales base. Fourth, outbound freight costs, including both store and e-commerce shipping expenses increased 150 basis points to 8.3% of sales from 6.8% in the prior year quarter. Sales deleverage coupled with additional routes deployed to move more product to stores due to elevated inventory levels led to the increase as a percentage of sales. E-commerce shipping costs were up slightly versus the prior year, reflecting the launch of our in-home delivery service.

And lastly, depreciation included in cost of sales decreased 30 basis points to 1.5% of sales from 1.8% in the prior year quarter. Total operating expenses were $43.5 million or 26.8% of sales, compared to $44.6 million or 25.3% of sales in the prior year quarter, an increase of 150 basis points. We recorded an impairment charge of $1.6 million during the current year quarter, primarily related to underperforming stores. Excluding this charge, operating expenses deleveraged by only 40 basis points due to tight management of expenses at the store and corporate levels. Adjusted EBITDA, including impairment — excluding impairment, stock compensation and other minor expenses was $2.6 million compared to $20.3 million in the prior year quarter.

Our normalized tax rate for the fourth quarter was 18.9% compared to 25.9% in the prior year quarter. Adjusted loss per share, which excludes non-cash impairment and other minor adjustments and includes a normalized tax rate was $0.09 compared to adjusted earnings per share of $0.84 in the prior year quarter. GAAP loss per share, including these items was $0.30 compared to earnings per share of $0.91 in the prior year quarter. Today, we also announced an extension of our existing credit agreement with Bank of America. The amended asset based facility increases the size of the line of credit to $90 million from $75 million, which provides us with incremental line availability and flexibility during our peak season months. The credit agreement was originally scheduled to mature in late 2024.

We are pleased to already have this extension behind us and signed up through March 2028. Moving to our outlook for 2023, we are not providing specific guidance for the year given the lack of visibility around the macroeconomic environment and its impact on customer traffic and conversion trends. However, we do want to provide some color around our expectations for certain key areas of the business. In the early part of fiscal 2023, sales trends have remained challenging, but we are encouraged by the merchandise margin recovery we have seen thus far. Quarter-to-date, comp sales trends are down in the high single-digit range as traffic trends both in-store and online continue to be difficult. Merchandise margins are providing an offset running higher than the prior year in the 150 basis point range.

Merchandise margin is benefiting from lower inbound freight costs as container rates return to pre-pandemic levels and a decrease in product costs through vendor negotiations. Supply chain costs inside our distribution facilities are reflecting lower inventory levels and increased labor efficiency. We’ve made moves to simplify our supply chain infrastructure by recently closing our Las Vegas e-commerce distribution hub and reducing our reliance on offsite storage. Inventories are under control and flowing according to plan, and we continue to be vigilant about operating expense control. With these positive factors in place, our efforts are focused on establishing sales momentum as the year progresses through merchandise assortment adjustments and value added promotional activities.

As we think ahead for the full year and beyond, our priority is returning the business to profitability. Historically speaking, while volatility has always played a part in our results, we’ve been able to maintain EBITDA margins in the mid to high single-digit range over time. Earlier, Woody cited the period 2014 to 2018 where we achieved EBITDA margins in the 7% to 8% range. We’ve made significant improvements in our operations since then, including within our omnichannel capabilities in our supply chain infrastructure. We’ve also tightened up our store base and improved our leasing terms in many of our locations. We remain in competitive sought after real estate locations with steady customer traffic. We’ve done an effective job in reducing our operating expenses and continue to manage each expense line item prudently.

As in the past, top line momentum can generate a sizable flow through effect and yield substantial earnings growth. We believe that with some of the shifts in emphasis in our merchandise assortment, we can garner more enthusiasm from our core customer segment while maintaining interest from those we’ve attracted over the last few years. We are prioritizing more depth in seasonal buys, key items across our home decor categories, and an emphasis on more accessible price points in an environment where home consumers are stretched. All while we continue to feature the improvements in style and quality that we’ve gained over the last few years. Many of the macro issues affecting the supply chain and input costs have abated and with firmer control over our inventory levels and our expenses, any improvement in top line trajectory will have an outsized effect on our earnings power.

Finally, as to capital allocation, our first priority is to reduce borrowings and re-establish a level of liquidity that allows us to operate the business with more flexibility. Once that has been achieved, we’ll focus on growth and ROI opportunities to push the business forward. Share repurchases and dividends have been valuable components of our capital allocation historically and we expect to use them again in the future once our near term goals have been achieved. With that, I’ll turn the call back over to the operator for Q&A.

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Q&A Session

Operator: Ladies and gentlemen, at this time, we’ll begin the question-and-answer session. Our first question today comes from Jeremy Hamblin from Craig-Hallum Capital Group. Please go ahead with your question.

Jeremy Hamblin: Thanks for taking the questions. So I wanted to start with the commentary around adjusting the merchandise assortment. And it sounds like what you’ve suggested is maybe you were a little too aggressive in some of the changes in merchandise assortment over the last couple of years that maybe your value customer felt somewhat neglected. In terms of that rebalancing of the assortment that you mentioned, how long do you expect that to take, what do you think that, that will do in terms of impacting your overall average ticket? You know, how do we think about that in terms of comps getting back from down high single-digits to flat or positive? How is that going to play out in terms of the mix of ticket versus transaction growth?

Steven Woodward: Well, good question, Jeremy. That’s I mean we had a good insight into this year was coming and it might be a challenging year. And we also realized that maybe we pushed our furniture assortment too aggressively. And so while we’re not backing off of the idea of being a complete home furnishings retailer and having the total package, we have let the customer guide us a little bit more fluently. So one, we started making these decisions that we wanted to have more opportunity at the opening price point is for two reasons. One, because that’s what our customer was asking for. And number two was, you know, settling into the fact that there might be recessionary pressures or whatever the macro environment was. So starting in the fourth quarter of last year, we have purchased products in the $20 range and under to be about 40% of our assortment.

Now that’s skew numbers because remember that some of these are huge power skews where we might have ordered, you know, 5,000 before we’ve ordered 10,000. These are proven bestsellers. And not only did we buy it that way, but we’ve also adjusted our visual presentation in the stores to show that and make it easy for the customers that are just coming to spend $20 to $50, that these are the choices that they have. And so I think it’s very clear it does build up. We’ve gotten some traction in the first quarter and we’re enjoying that benefit and it really comes out throughout the entire year and we’ll be fully set and have that equation with the 40% of our purchases in the $20 and under set for the third and fourth quarter. So we’re really excited about it.

And like I said, we’re not reducing our emphasis. We’re just letting the customer guide us now that we’ve got a fully laid out assortment and strategy. And we’ve done a really good job of bringing in these power items and key items for the balance of the year.

Mike Madden: Hey, Jeremy, just to add on to that, because you’re asking about ticket. And one thing I would say our team’s been working on this. Our buys is they start flowing in toward the back half. We’re going to really reflect what we talked about here today. But as it affects ticket, I think the way we’re looking at this is, you know, first of all, we’re still going to have a healthy assortment of higher ticket furniture in the store. But with these other items surrounding it, it’s going to help us drive items per transaction better. And couple that with what we’ve seen in the ticket so far with the higher ticket items driving that historically. Well, now I think we have a better chance to drive IPT and conversion in the stores with this. And that’s kind of how we’re looking at the ticket mix here, knowing that traffic may still be difficult in the near term.