Kirkland : Home Second Quarter 2022 Earnings Call Transcript

Kirkland's Home (KIRK)

Second Quarter 2022 Earnings Call

Tuesday, August 30, 2022, 9:00 a.m. ET.

Officers and Speakers

Cody Cree, External Director, Investor Relations

Steve Woodward, President and Chief Executive Officer

Nicole Strain, Executive Vice President, Chief Operating Officer, Chief Financial Officer

Analysts

Jeremy Hamblin, Craig Hallum Capital Group

Anthony Lebiedzinski, Sidoti & Company

John Lawrence, Benchmark

David Berman, Berman Capital Management

Presentation

Operator: Good morning, everyone, and thank you for participating in today's conference call to discuss Kirkland's financial results for the second quarter ended July 30, 2022. Joining us today are Kirkland's President and CEO, Steve "Woody" Woodward; COO and CFO Nicole Strain; and the company's External Director of Investor Relations, Cody Cree. Following their remarks, we'll open the call for your questions. Please note today's conference is being recorded.

Before we go further, I would like to turn the call over to Mr. Cree as he reads 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. Cody, please go ahead.

Cody Cree: Thanks, Rocco. 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.

I'd like to remind everyone that this call will be available for replay through September 6, 2022. 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 would like to turn the call over to Kirkland's Home President and CEO, Woody Woodward. Woody, over to you.

Steve Woodward: Thank you, Cody, and good morning, everyone. As I reflect on the first half of this year, we've encountered a number of headwinds in our business, whether it be supply

chain issues, rampant inflation or a depressed consumer spending environment. Working through these external pressures hasn't been easy, but I'm proud of the resiliency of our entire organization, especially as we make progress transitioning our company for sustained long-term success.

On today's call, I'm going to go over our performance in the second quarter, the current state of our customer acquisition strategy, our liquidity and inventory management goals for the remainder of the year, and what the consumer spending environment looks like as we head into harvest and holiday selling season.

So let's jump right into it. Our second quarter efforts were focused on re-engaging with customers across our omni-channel platform while intentionally elevating our promotional activity to work through our excess inventory position. We knew that being this promotional, while also experiencing higher costs within our supply chain, would have an impact on our margins. However, we believe this was a necessary step to ensure we are on track to hit our target of being below 100 million in inventory by the end of fiscal year. I'm pleased to report that we remain on track to hit this goal.

While our comparable same-store sales were down about 9% for the quarter, we were pleased to see improved sequential same-store sales trends from the first quarter. Our in-store traffic also improved each month throughout the quarter, with May starting down 17% to only being down 11% by the end of July. Additionally, our in-store average ticket increased 11% -- or 12% compared to Q2 of last year, as a result of our shift to offering larger-ticket items and more products within the better and best categories.

In our omni-channel strategy, we're beginning to see some signs of normalization for e- commerce. Although our year-over-year comp declined 8% sales, for this channel, we were up nearly 50% compared to 2019 when we started to ramp up our e-commerce efforts.

Similar to our in-store strategy, we continue to drive sales in higher-ticket items, and AUR increased across almost all e-commerce channels. While traffic was still down 15% year-over- year basis, we did see trends improve month-to-month throughout the quarter. We still believe that inflationary pressures and the slowing housing market have continued to impact consumer demand for home furnishings, as a majority of our categories were down on a year-over-year basis. However, our furniture category was a bright spot this quarter, with a 13% increase in sales compared to the prior year.

We successfully launched our in-home delivery service earlier this quarter through our partnership with Ryder, which we believe will play an integral role in expanding our customer base and delivering a positive customer experience when ordering larger items like furniture and outdoor.

Overall, the customer demand across the retail landscape remains soft, and it's difficult to predict when the customers will increase spending on discretionary items again. This should not come as a surprise with many of our peers in the retail industry sharing similar sentiments. However, we are seeing more customers turn to value options, so we want to ensure that we have a clear

message that customers have high-style home furnishings options at price points that should be attractive to customers looking for a great deal.

While we've had to pull back on our marketing spend, we improved clarity of our messaging, and began showing after-promotion pricing more clearly online. This is proving to be a vital component to driving customer interest, especially within the furniture sector. We believe the improved messaging around pricing will not only further benefit our store customer base that is very discount-oriented, but also drive awareness with new customers searching for a value.

As a reminder, Kirkland's Home has historically performed well during prolonged recessionary periods, and we want to be in the best possible position to capture value-focused customers.

When we first embarked on our transformation journey, we made a conscious effort to shift away from our historical discount-oriented customer base in favor of a new customer that would be willing to pay a bit more for higher-quality merchandise in new categories. While this strategy initially worked, we had significant market tailwinds driving customer demand for home furnishings. Current market conditions have given us a new perspective, and is causing us to tailor our strategy, at least in the short term. It's still our goal to drive brand awareness and bring as many new customers to our omni-channel platform as possible to shop for new high-quality merchandise we continue to introduce.

However, we will also utilize the traditional high-low retail pricing strategy to further drive interest from our historical customer base of value-oriented customers. It's important to note this type of pricing strategy is common across the home furnishings industry. We firmly believe we will be able to adjust these discounts to still be profitable while convincing customers that our new low price is the right price to buy.

As I spoke earlier, we have been hyper-focused on inventory management to significantly improve our liquidity profile by the end of the fiscal year. We made a clear effort to begin working through our inventory position as we [churn] through excess product that we needed to clear off our balance sheet, knowing we would sacrifice margin. As we were doing this, please keep in mind that we brought in inventory for harvest and began bringing in products for holiday, so the magnitude of this inventory clearance isn't as apparent in the numbers you'll see on our balance sheet for the quarter. As a result of the inventory build preparing for the next 2 quarters, we are currently sitting at our peak inventory position today, which we had planned for and spoken about on our last call.

However, I want to reiterate that our inventory has turned at a faster pace than expected. And this benefit will really start to show in our fourth quarter after we had sold through the majority of our harvest and holiday inventory. This directly relates to another topic of concern among most of our shareholders, our liquidity position. As expected, we continue to tap our revolving line of credit to bring the merchandise for the harvest and holiday seasons. And similar to our inventory position, we believe we are sitting at the peak of borrowings in August. However, as we begin to generate cash flow in the next few quarters, we will start to pay this balance down, in addition to prudently managing our operating expenses to ensure we appropriately maximize the value of every dollar coming into the business. I'll let Nicole drive further into these details later on, but I

want to reiterate that inventory and liquidity remain top-of-mind, and we believe the steps we are taking to put our balance sheet in a better position are working.

Looking to the remainder of the year, the third and fourth quarters are historically our strongest sales quarters, as harvest and holiday seasons drive customer demand. We move our way into these shopping seasons in a much better position than we were last year, with inventory on hand to sell. However, the demand side of the equation is still a bit unknown. While it's difficult to predict, we want to keep our expectations realistic. We are beginning to see encouraging results.

Same-store sales during August continued to improve, with only being down 3% on a year-over- year basis. And we've seen an approximately 500-basis point improvement on [landed] margin from our Q2 rate. During the next 2 quarters, we will continue to lean on inventory promotional activity to drive sales as part of our high-low pricing strategy we discussed. As a result, I expect to see more normalized discount rates across all categories. While these promotional activities will have a drag on our margins for the remainder of the year, we believe it's a necessary step we must take to work through the inventory and bolster demand.

We are also seeing input costs within the supply chain coming down as gas prices and shipping rates start to normalize. However, due to the timing of when we bring in inventory, our margins will likely not see a benefit from this until early 2023. We are keenly aware the macro environment can change on a dime, so we are managing or remaining vigilant in our cost management, and keeping a close eye on promotional levers to drive demand.

From an operational perspective, we believe we remain in good position. We have found an excellent candidate in Mike Madden to be our new CFO. Mike brings extensive experience in our business and industry, having previously served in various senior leadership and executive roles at Kirkland's. We believe Mike could be a stabilizing force for our finance organization and an integral part of our strategic efforts, as we continue down the path for our transformation. While we expect to continue prudently managing operational and corporate expenses, we are looking forward to getting right-sized on our cost structure to evaluate our store footprint and incremental cost savings initiatives that we can implement. We'll likely have more to come on this front in the coming quarters.

Overall, I feel like we've weathered the worst of the current storm. Despite the slowdown in consumer spending and the rising supply chain costs we've experienced over the past several quarters, we are still very committed to executing on our transformation strategy and turning Kirkland's Home into a premier home furnishings retailer. The work we've done since embarking on our transformation has not been lost. We have continued to find success through our omni- channel platform, improved product mix, direct sourcing, and now our in-home delivery option. We stand firmly committed to creating a better company, and we continue to preserve towards our vision of maximizing the value we drive for our shareholders.

And with that, I'll now turn it over to our CFO and COO, Nicole Strain, who will provide detailed commentary on our performance in the second quarter and outlook. As we announced earlier in the quarter, Nicole will be moving on from her role at Kirkland's. I'm proud of what we've been able to accomplish together, and wish her nothing but the best as she embarks on the

next chapter. From all of us here at Kirkland's Home, we want to thank you for everything you've done for this company. Nicole, the floor is yours.

Nicole Strain: Thank you for the kind words, Woody, and good morning, everyone. Before getting into the specifics of the quarter, I want to provide an update on our liquidity and inventory position, and how we expect that to play out for the remainder of the year.

Going back to how we got here, we had accumulated a significant amount of already-produced product in 2021 that had not shipped due to supply chain constraints. We chose to honor those orders and ship that product to ensure we had enough merchandise to satisfy demand. To offset this influx of inventory, we purchased limited new products for the first half of 2022. At the time, we believed this would be a short-term working capital impact and that we would have excess inventory with the expectation that it would normalize by the middle of the year.

Additionally, we pulled forward both harvest and holiday orders to make sure we didn't have the same issues we had in 2021 with missing merchandise. What we didn't expect was the significant drop-off in sales beginning in March. We quickly removed approximately 50 million in receipts from the back half of 2022 and began to ramp up promotions in Q2 to turn this excess inventory into cash. As we mentioned on the last call, we expected early Q3 to be our peak in both inventory and borrowing on our line of credit. And I'm pleased to share that we are where we expected to be, with inventory peaking in August and a current balance on our revolver of 60 million, which we don't expect to go any higher.

As we start to sell through harvest, we are already seeing our working capital improve, and expect to start gradually paying down our revolver and outstanding payables in the third quarter with most of the progress beginning in November. We expect to end the year with inventory in the $80 million to $90 million range and to have less than $10 million borrowed. We intend to manage our inventory tightly and keep it lean throughout fiscal 2023 to further improve our working capital position.

Jumping into our results for the quarter, net sales were $102.1 million, compared to $114.8 million in the year-ago quarter, which included a comparable same-store sales decline of 8.6%, which was driven by the year-over-year decline of in-store and online traffic and conversion, partially offset by an increase in average ticket. Breaking down sales within the quarter, we had a total comp decline of 12.7% in May, a comp decline of 7.4% in June and a 5.8% decrease in July.

E-commerce sales declined by 9.1% compared to the prior-year quarter, and improved from down 15.5% in May to down 1% in July. E-commerce was 28% of total sales in the quarter, which is similar to the prior year. Gross profit was 18.1% of sales, compared to 34.6% in the prior-year quarter. The decline was primarily due to the increased use of promotional activity to move through inventory, as we discussed, as well as higher distribution costs and shrink from the elevated inventory levels, and the impact of lower sales on various fixed-cost components.

Store occupancy costs increased to 15.8% of sales, compared to 14% in the prior-year quarter due to a lower sales base. DC costs increased to 5.5% of sales, compared to 4% in the prior-year period, primarily due to operating inefficiencies with the higher inventory levels.