Hello and welcome to the Kirkland Second Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode today. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this conference is being recorded. Now, I'd like to turn the conference over to Jeff Black of SCR Partners. Please go ahead.

Thank you. Good morning and welcome to Kirkland's conference call to review results for the second quarter of fiscal 2016. On the call this morning are Mike Madden, President and Chief Executive Officer; and Adam Holland, Vice President and Chief Financial Officer. The results as well as the notice of accessibility of this conference call on a listen-only basis over the Internet were announced earlier this morning in a press release that's been covered by the financial media. Except for historical information discussed during this conference call, the statements made by the company management are forward-looking made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties, which may cause Kirkland’s actual results in future periods to differ materially from forecasted results. Those risks and uncertainties are more fully described in Kirkland’s filings with the SEC, including the company’s annual report on Form 10-K filed on April 8th, 2016. With that, I will turn it over to Mike.

Thank you, Jeff. Good morning everybody. The second quarter was tougher than we anticipated, as traffic declines persisted throughout the period. The declines became more pronounced in late June and into July during our regular semiannual sale event. Traffic issues in the brick-and-mortar channel are not unique to Kirkland's, yet our conversion and average ticket metrics were relatively flat to the prior year and did not serve to blunt the traffic impact. Looking at the product categories, we were pleased with floral and seasonal. Art and ornamental wall decor were below expectations. We're making a number of important changes to improve our conversion trend and I'll go over that in more detail in a moment. Our gross profit margin was primarily impacted by deleverage in occupancy and supply chain cost, resulting from the sales miss. The merchandise margin was down only slightly as we adjusted our promotional cadence toward the end of the quarter. Inventory levels are in good shape and in line with our plans and we managed our cost effectively as operating expenses decreased as a percentage of sales despite the topline pressure. As we announced in our press release this morning, we've lowered our full year guidance to incorporate a more conservative outlook for sales and traffic trends. Our projection assumes that negative brick-and-mortar traffic persists near current levels. That would result in comparable store sales that are slightly negative to flat in the back half of the year. We have seen some sequential improvement in conversion and ticket to start Q3, yet we do not have adequate visibility to project a definitive turn in traffic. So, we believe this updated guidance is prudent. We'll continue to tightly manage our expenses as we move into the back half and longer term. While we're disappointed in the need…

Thank you, Mike. Net sales for the second quarter increased 6.7%, with total comparable store sales decreasing 4.3%. A decline in brick-and-mortar traffic was the primary reason for the overall comparable store sales decline. Geographically, negative store traffic trends were present in most of our states during Q2 with Texas, Florida, and Louisiana weighing heaviest on the store comp sales declines. Our conversion rate in stores, which has been positive for several years weakened sequentially and was flat against the prior year quarter. Our average ticket was also relatively flat during Q2. As Mike mentioned, we are on track with our new store opening schedule, 13 new stores opened during the quarter and we closed four, ending with 391 stores representing 40 more units than the end of Q2 last year. Moving on to e-commerce sales, e-commerce generated $10.5 million in revenue during the quarter and accounted for approximately 9% of total revenue during Q2. This solid performance exceeded our expectations and represented an acceleration of the online business compared to Q1. An increase in website traffic, coupled with a strong increase in the online conversion rate, contributed to the sales increase over last year. Moving on to gross profit, second quarter gross profit margin decreased approximately 251 basis points, to 34.4%. Merchandise margin declined approximately 17 basis points, to 53.9%. Planned promotional markdowns and better receipt flow kept our inventory levels near plan throughout the quarter and we're pleased with the resulting inventory position at the end of Q2. Store occupancy costs increased 139 basis points as a percentage of net sales during the second quarter. Store occupancy expense was as we expected from a dollar perspective, but deleveraged more than anticipated from lower sales. Outbound freight costs, which include e-commerce shipping, were up approximately 22 basis points as…

Thanks, Adam. I think we're ready for Q&A at this moment. So, we'll pass -- we'll move on to that.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Brad Thomas of KeyBanc Capital Markets. Please go ahead.

Thank you. Good morning Mike and Adam. I wanted to first ask about that balancing act between sales and margins and how you're thinking about that going forward? If I heard you right I think you said the merchandise margin was only down about 17 basis points in the quarter. I guess as you all look at the competitive landscape, how the consumer is acting today. How are you trying to decide the payoff that you might get from being more promotional and doing some more discounting versus trying to recapture some of the investments and drag you had in margins last year? Thank you.

Yes, Brad, I'll start on that one. This is Mike. It's definitely a balancing act and every retailer deals with it. In this environment with traffic being a little tougher, it's natural maybe to get a little more promotional. We fortunately coming out of Q2, our inventory positions were getting in much better shape. So, we had some latitude there to control it. And we actually -- as I referred to in the remarks, we actually did control it a little bit, even in July when traffic was really tough. Because what we were doing to juice it really wasn't giving us return that we were looking for. So, I think for the rest of the year it's going to be -- we're going to be promotional -- it's part of our brand, I mean we do promotions. But I think the story that we're trying to tell here is we're going to mix in messaging in the back half that highlights our product more, our newness more, the inspiration around it more while still delivering on that promotional promise that we have. And I think we'll do a lot of testing as well to see what's driving the consumer as we approach the holidays. But I think the inventory position is a big plus for us as we head into that period, because we don't have that pressure that we had last year, that overhang, if you will, on inventory coming into the holiday period.

Right, great. And then in terms of geographically what you're seeing, you called out Texas, Florida, Louisiana as being the weakest states. How has the performance in those states -- how has that trended versus what you were seeing earlier in the year?

Well, in Texas and Louisiana, I think it's been a continuation of what we had seen. Those states had been hit harder by the downturn in oil and the impact that has on those economies. We did see a little bit more broader spread of traffic being down across other states. We called out Florida because of its relative size. We have a lot of comp stores in that state. I think on that one we're starting to see that stabilize a bit as we come into Q3. So, I think the story really when you back up from it is still some weakness in those key states that we've been calling out and not much of a difference otherwise, other than the overall -- little bit of a drop in traffic overall in Q2.

Great. And if I could squeeze one more in on new stores. That does seem to be a bright spot here; it looks like as we calculate it the new store productivity looks pretty good. How is that trending as you look at it and as we think about the timing of store openings in the back half, how is that playing out? Will they be open soon enough to really have an impact on the all-important holiday season? Thank you.

Yes. I mean we have advanced our store opening schedule quite a bit this year. We got another dozen or so to open and they will be open before the holiday season. So, they will have time to impact that. The productivity as you cite, I mean we are pleased with that in -- out of this class of stores this year. I think what we'd like to see is a little more longevity to that lift when they open. But we are seeing good success once we get them open here and they will have an impact as we go into Q4.

Great. Thank you, Mike.

Thank you, Brad.

Our next question comes from Jeff Van Sinderen of B. Riley. Please go ahead.

Good morning. I guess one of the things I wanted to start with what do you think was the culprit in the weaker performing categories? I know that you called out artwork and such, I'm just wondering what you think was at the root of that?

Well, let me back up and talk about it overall. I mean for the most part, if you look at all of our categories, the declines we saw were pretty much in line with the traffic decrease that we were seeing. We saw some positives on the seasonal side and on the floral category. But I did call out art as a weaker performer. And I think when you look at that category, I think our challenge there and we're addressing -- we're already addressing it, is just maybe a little bit of a lack of freshness in that category. I mentioned our core assortments in my prepared remarks. I think the issue I'm getting at there is we need to make freshness and variety more apparent in the store and in art in particular. Staying with the same images, the same SKUs that have been doing well over a couple of years, but they are starting to slow down; we need a little more injection of new in there. And the team is already really working on that and hopefully we will see some progress here as we head into the back half. But I think that's the theme I would want to get across is focusing on newness. Really in that category, it's crucial to have that flow of new images in and out of the assortment, and I think we can deliver better on that.

Okay. And then I guess dovetailing into that, obviously, you're making changes to the assortment that sounds pretty positive. Other than the generalized brick-and-mortar center traffic declines and a consumer that might be a little distracted by things like the Presidential Election, what other factors do you think drove the traffic decline? It sounds like it was a little more widespread outside of the oil patch. And I guess do you think the fact that you're not so much a seasonal merchandise destination in Q2 maybe hurt you a little more for some reason this year?

I think that's -- I think you're hitting on a pretty good point there. I mean Q2 has always been a challenge for us. It's not our sweet spot and any kind of disruption in traffic during that timeframe can have a little bit bigger impact given the -- it's our lowest traffic time frame of the year anyway. It's hard to say, Jeff. I mean we saw a drop; it was pretty confined to the late part of the quarter. We're seeing a little bit better results as we head into Q3. We're optimistic about our assortments in the holidays. We're optimistic about the changes we're making in marketing to drive it. We're positive about the e-commerce business and where it is headed. So, there are some things that we really feel good about. On the macro side, we just -- I think we hit a soft patch there in Q2 and we'll think about that as we plan our assortments going into next year. I think we can take advantage of some more seasonal themes that maybe we haven't been as heavy in to-date to get a little bit more out of that quarter.

Okay, that's helpful. And if I could just squeeze one more quick one in. Just -- could you remind us where you stand on share repurchase in terms of what's left, if there's anything left on there? And would you expect to be more aggressive given where the stock is?

Jeff, this is Adam. Our last authorization finished up back in December of 2015. We currently don't have an authorization out there, but that's something that we're in conversation with the Board with and we'll have more to report on when there's something to report.

Okay. Thanks very much and best of luck through the rest of the quarter.

Thanks Jeff.

Our next question comes from Neely Tamminga of Piper Jaffray. Please go ahead.

Thank you. Neely from Piper. Hey guys, so could we dig a little bit more into the specifics around some of this assortment planning and SKU analysis that you guys seem to be changing? We're intrigued by your commentary around that. Do you going to -- is this much more of a -- I don't want to be sensitive here, a people change that's leading to a process change, or is it a true process change that's leading to the process change? And so within that I guess what we're trying to really understand is could you give us some specific examples as to how frequently the team is refreshing things like maybe using the art example, and how are they doing that? Is it more trade shows? Is it just more meetings? Is it -- just getting a little bit of sense of the how behind this change?

Yes. Let me go back in order to answer your question and just retread a little bit here. Up until a couple of years ago, we really didn't designate -- I mean you would think -- in a lot of retailers you have a lot of basic products. We don't have that many. I mean we're kind of a fashionable home decor retailer. We want to flow newness into the stores, yet there are items that we always want to be in stock on and we call those core. And that typically is something that you could look out a year ahead and think you're always going to be in stock. Well, when we first rolled that out a few years ago, we added a lot of stability into the business because we were able to isolate best sellers or regular sellers and ensure that we were in better stock positions on it and this cuts across all categories. Some categories are different than others. Some are more focused on fashion; some are more focused on basic, but most of our categories are fashion-driven. And so as we progress through that, I think the tendency was to hang on to some of these items, which if I showed you one of the SKUs, you might think well, that's a fashionable item that you want to rotate in and out of the assortment. We've hung on to some of those. And that is what I'm getting at is if core is a little over 30% of the business that might be a little heavy for us. Especially, in some categories like art where I feel strongly that we have got to show a variety of images and newness flashing in and out the store on a constant basis. If you stick too long with the same images, you run the risk of looking a little more stale than you want to and so I think that's what we're getting at. We're not looking at a -- this is not a big system change, it's really buyers and planners working together and being very critical of something that's been in the assortment for an extended period of time that looks more or less like a fashion item that needs to be refreshed. We've promised our customers over the years that we're going to have new products in the stores every time she comes in. We do that. This is not that we have not been doing that, but on the scale that I'm talking about we need to drive it up. And that's a mentality change more than it is anything else. Get out of the comfort zone, take some risks, move on these new products because we got to show that freshness.

That's really helpful. Mike, thank you so much for that. I think we're good on our questions at this point. Thanks.

Thanks Neely.

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

Yes hi guys. Actually just a follow-up on that last question from Neely. It seemed to me a couple of years ago, you all have gotten maybe too low on basics in the store. That was a good thing, just to push that up a bit. Did you go too far?

I think that's what I'm saying, David, that's right. We really -- if you really think about it, what's basic in our store, there's not a whole lot. There's candles, there's sashay packs, there's standard size mirrors and things like that. We have them. But when you start to rotate different styles in that are more fashionable, that have a useful life so to speak, you have to have the discipline on the other side to rotate them out. And I think we could do a better job there. This is not a statement that the whole assortment is off. I mean it's far from it. I think our seasonal products are a good example of how we manage when it comes in all the way out very effectively and hold good margins on. I think it's within the guts of it that we need to just lean a little harder on the newness side than we have been in recent quarters.

Thanks Mike. And with regard to the marketing changes, how confident are you with that, what you're doing is going to have payoff in the third quarter? And then going beyond that is there a risk to changing marketing before the very important fourth quarter?

I don't think so David, because I think what we're doing here is an additive to everything we have done prior. We're really coming out with a statement behind the brand, which we really haven't done. So, we're talking about inspiration. We're talking about newness and calling it out in our messaging and in the store. So, I don't think it carries a lot of risk, and especially when you couple it with, we're not really increasing our spend, we're diverting some of the dollars to digital where I think we have a better chance to make a statement. You can do a lot more through a digital ad than you can in an FSI, that's static and only can carry so much information for the customer, if they even see it. So, that shift is based on what we're seeing out of the FSIs, I don't see much risk there at all. So, I think it's just going to be a better message overall that should create more excitement with the customer than we have, because we haven't done a whole lot of marketing in prior years.

Thank you for that. And I guess just lastly, is there -- your traffic would indicate I guess there is some loss in market share and a piece of that maybe just being cannibalized by your web business. Any idea where some of that traffic might be going to a different -- do you think it's going online to different players or what's has happened to that?

Well, I mean traffic has been a challenge for many of us in the sector. The web is a big piece of that. I mean we're getting our share on the web. The data that we can see out of our loyalty customers would indicate we're starting to pick up a little bit more in the way of web-only shoppers, which is a good thing. I do think there is some cannibalization naturally there, but we're seeing it kind of track in the better direction based on our data. As far as other competitors, there's a lot out there, but we grew the topline 8%. Now most of that's new store growth, but that would suggest that we're still gaining some share overall.

Great. Thanks, Mike and good luck here.

Thanks David.

[Operator Instructions] Our next question comes from Anthony Lebiedzinski of Sidoti & Company. Please go ahead.

Yes good morning guys and thank you for taking the questions. So, first, I just wanted to get a better clarification as far as the seasonal categories, which as you highlighted are doing well. So, when you look at the first half versus the second half of the year, can you give us a sense of the importance of seasonal as a percentage of your sales again first half versus the second half?

Yes, so seasonal the first half, the category is 2.5% of the mix. In the fall, that is over 20%; 22%.

Got it. Okay. And then obviously you are pleased with the news for productivity and you talked about that in response to a few questions now. That being said, in light of the traffic declines that you're seeing, the ongoing shift towards more e-commerce, I mean does it really -- when you take a step back, does it really make sense to open stores that they such aggressive pace that you are?

Well, as we alluded to in the comments, we want to maintain a high degree of flexibility in our pipeline. So, we want to stay in the market, but we definitely are going to focus a lot more on the relocation side of things in the near-term as we continue to assess the things you mentioned, the market penetration and the impact from the direct channel. So, more to come on that, Anthony, but I think the posture here is to consider all the things you mentioned and what that means in this environment. I think it means a little bit of a reduction in our growth rate and more of a focus on the relocation angle because we see good returns out of that.

Okay, got it. And lastly can you give us a sense as to where your in-store pickups are now trending? I believe it used to be around two-thirds of the e-commerce sales were picked up in the store. Is that still the case or have you seen any changes from that?

Yes, Anthony, this is Adam. That ratio is still about the same. It's -- in Q2, it was about a 70%, 30% mix, with 70% being in-store pick up with a revenue and which was similar to Q2 last year. So, we continue to see success there in leveraging those stores as a vehicle for delivering the goods to the customer.

Got it. Okay. Thank you.

Our next question comes from Mark Cooper of Pacific Ridge. Please go ahead. Mr. Cooper, your line is open.

Hello good morning. Can you remind me the -- of the share count reduction is a result of what?

The share count reduction was the result of the share repurchase program that we executed late last year.

Last year? Okay. So, is there -- and that has expired now?

Yes. We went through that authorization at the end of fiscal 2015.

Okay. And then can you tell me the -- and you might have mentioned it, the online sales were up 30%, what was the brick-and-mortar comp?

The brick-and-mortar comp tracked very closely to the traffic decline, which was about a down 7%.

All right. Thank you very much.

Our next question comes from Jeff Matthews of Ram Partners. Please go ahead.

Hi. Can you hear me?

Yes.

Wondering if your online traffic and trends differ at all in terms of merchandise selection, and that's leading you to any of the thinking you're going through with your offering? Thanks.

It's a little bit different results there. I mean we saw -- we obviously had a nice gain on the e-commerce side and so most categories were up. We saw particular strength in furniture, textiles, decorative accessories in the second quarter. We saw the same weakness in art. So, I think a lot of the concepts we discussed around the assortment apply to the web as well.

Thanks very much.

Thank you.

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

Thank you everybody for being on the call. Before I sign-off, I do want to say one thing to our fellow employees down in the Louisiana area, they are dealing with a lot of struggle right now with the flooding. We have a lot of team members down there that are going through some tough times. So, we want to call out that and tell them that we're thinking about them and praying for them. So, -- I just wanted to get that out there. And the last thing I would say is we look forward to talking to you in the coming quarters about the progress we're making on all of these initiatives we talked about today. So, thank you for joining the call today.

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