Good day, and welcome to the Kirkland's Second Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jeff Black, of SCR Partners. Please go ahead.

Thank you. Good morning and welcome to the Kirkland's conference call to review results for the second quarter of fiscal 2019. On the call this morning are Woody Woodward, Chief Executive Officer; Mike Cairnes, President and Chief Operating Officer; and Nicole Strain, Chief Financial Officer. The results as well as the notice of accessibility of this call on a listen-only basis were announced earlier this morning in a release that's been covered by the financial media. Except for historical information discussed during this call, the statements made by the company management are forward-looking and made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties which may cause 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, including the Annual Report on Form 10-K filed on March 29, 2019. I'll now turn it over to Woody.

Thanks, Jeff, and good morning to everyone on the call. We appreciate you joining us to review the second quarter and our plans for 2019 and beyond. Trends in the business remain challenging in the second quarter, driven primarily by restore traffic. We're taking additional steps to address near-term concerns, including tracked tariffs, and we're focused on accelerating the existing initiatives we've outlined to transform the business. We have much work ahead of us, but I want to start this call by stressing that our team is executing against a carefully thought out plan, a plan we firmly believe will improve the vibrancy of the brand, and return the company to profitable long-term growth for our shareholders and associates. We believe that we have the capital and the talent to accomplish our objectives, and we're doing everything we can to accelerate the execution of these goals. While we'd obviously like to see better top line trends here in the short-term, we've made notable progress on several important initiatives in this quarter. E-commerce sales reaccelerated in Q2, with increases in both traffic and conversion in the channel. We're also seeing solid performance from the new categories that we've added to broaden Kirkland's reach with new and exciting customers. Sales of rugs as well as the new tabletop assortments in textiles and housewares and dining products are encouraging, have made plan, and have ample room to grow. In launching new categories, considering our price value inflations and our curated assortments, we've placed our emphasis on offering better quality. The Kirkland's brand must stand for great value and great quality. For example, our Turkish 5x7 rugs for $199, come in at a compelling value price point, and there is the same quality and designs available that you might see in premium home décor…

Thank you, Woody. I'll cover two topics. First, an update of how we are supporting the holiday season this year. Then I'll walk through our future plans to transform the infrastructure of the business. As we go into the second-half of the year, we continue to make excellent progress on the initiatives we outlined in the last call. For starters, we successfully stood up a 3PL distribution center, south of Dallas, on schedule. This distribution center is servicing and delivering to 99 stores, over 20% of our store chain, in addition to creating a smoother flow of product that saves approximately $1 million of transportation cost on an annual basis. Meanwhile, we are starting to dial in on the promotional levers to drive top lines sales and move inventory. We were happy with our Labor Day promotions, they were simpler and clearer, although deeper than our normal intensity, it proves to drive sales, inventory, and margin dollars. In addition, the trajectory of our e-commerce sales is accelerating on the back of streamlined checkout, increased speed, and site design improvements, along with improved back-end fulfillment operation. I'm very proud and excited about our store execution. It completely resets the entire floor merchandise presentations to accommodate the new products, while continuing to up their service level to the customer as evidenced by rapid increase in BOPIS orders and by the increase in conversion rate. I'll now pivot to the transformative work that will be going on for the balance of this year into 2020. In light of this quickly-evolving and disruptive retail dynamics, we are accelerating our plans to reposition the infrastructure of the business, so it better correlates with where and how the consumer buys home decor. We have the capital, the runway, the expertise, and the team that has constructed…

Thank you, Mike. Net sales for the second quarter decreased 10.5% or $14 million compared to the second quarter of the prior year. The change in sales includes a comparable store sales decrease of 11.2% and an increase in store count of 1.2% or five stores. Comparable store sale includes the 21.5% increase in e-commerce revenue, and a double-digit decline in brick and mortar sales. And that's on top of a 3.9% combined comp decrease and a 14.5% increase in e-commerce in the prior year Q2. In our brick and mortar stores, we continue to see double-digit declines in traffic and a decline in average ticket contribute to the sales decline. The macro channel shifts in the increasingly promotional environment both have contributed to the traffic declines. E-commerce accounted for $20.6 million in revenue during the quarter or approximately 17% of total revenue. We saw increases in traffic and conversion which were offset by a decline in average ticket. For the quarter approximately 60% of our e-commerce sales were fulfilled in store, which supports our initiative to drive online sales and leverage our store base to increase the profitability of the e-com channel. For the first half of the year, the impact of declining brick and mortar sales on our fixed costs has resulted in significant expense de-leverage. We are aggressively focused on right sizing our infrastructure to maximize the profitability of our omnichannel model. Gross profit margin in Q2 decreased 530 basis points from the prior year to 22.2%. And that was primarily driven from de-leverage and store occupancy and distribution costs and a decline in merchandise margin. Merchandise margin decreased from the prior year by 130 basis points to 51.9% driven by a decrease in product margin from both product mix and incremental discounting, which was partially offset…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question today will come from Anthony Lebiedzinski of Sidoti & Company. Please go ahead.

Yes, good morning, and thank you for taking the questions. So first, I just wanted to start with perhaps the Q3 to-date trends, are you guys seeing kind of similar results as the second quarter, or can you comment on that as to how you're trending so far through the first week of September?

Well, our August was relatively consistent with previous trends as we introduced new products and the floors were somewhat disrupted with getting new categories on the floor. We have seen an uptick in trend starting in September for the first four days, which we're optimistic about, and we're hopeful, but we're optimistic about, and we see -- we're hopeful, but we're not out of the woods yet in terms of trends and traffic.

Got it, right. So as far as your marketing spending plans, can you elaborate on that as to how you're looking to try to gain both your existing customers to come more to your stores and also perhaps reach out to some new customers?

Because of budgets being relatively conservative in our marketing spend, depending on because of the trends, we're putting most of our marketing dollars into driving digital increases. But where we do have some of our traditional marketing campaigns, we're an approach where we're engaging and educating our current customers as to new categories. We feel like they are our best bet for communicating out to the world that they've seen a change in Kirkland's, a better floor set, a better quality improvement. And then we did take a slight portion of our money and drive towards prospecting new customers into the store. But I firmly agree the new customers in the store has to be earned over a period of time where customers come in that are our current customers and tell people that we have more relevance. Remember that in the past customers were kind of a location that you came to at the end of your decorating process when you bought your seasonal products, your wreaths, your Christmas products, and maybe some candles, and we're trying to make the transition to become relevant throughout the entire decorating process, so to buy a rug, and a dining table, and tabletop products, and bedding, it just takes a little while to get that customer engaged and let them know that we're now qualified for the entire decorating process.

Got it, okay. And then as far as the number of potential store closures, I know you're not prepared to give a specific number for that, but would you say that - would most of those be done at lease maturity or do you think you'll need to exit out of store leases early? And also, while we're on that subject, can you give us maybe a sense as to how many of your stores are on profitable, on an perhaps EBITDA negative basis, if you could share some of those metrics that would be very helpful.

Yes, good morning, Anthony.

Good morning.

So, what I will say is the following. We've been looking at this for a while. Currently less than 10% of our store base is EBITDA negative. And perhaps the majority of those stores tend to be in the west or the northeast. And we just initiated this process with a third party. And we are looking at all opportunities to dramatically increase our store profitability. So that also includes rent reduction. Yes, there'll be some closure of unprofitable stores, but we're also, as outlined with our infrastructure changes, we're going to be leveraging our store asset base for e-commerce shipping and therefore get better flow through from the stores. So we'll be taking a portfolio approach as we get into this. And I'm very confident that in the next three to four months we'll be in a position to update you more specifically where all that stands.

Yes, I think, Anthony, very specifically, not just looking at them as they come up for term renewal, but looking at holistically, as Mike said, our entire portfolio, and addressing them regardless of term.

Got it, okay, that's helpful. And, obviously, you have a number of initiatives that are in the pipeline. You mentioned that at some point you would expect to return to profitable growth. Can you give us a sense as to when that could happen?

Yes, I think as we look at 2020, we definitely and will release more specifics when we get to that point, but do think there is the opportunity to improve profitability. But again, it's the year with a lot of changes and resets to our infrastructure, so we'll give more details on that in the future, but there's a lot of things that we have on the initiative list that will impact future profitability that would still be in play in the first part of 2020.

Got it. All right, well, thank you and best of luck.

Thank you.

Thank you.

Our next today will come from Jeff Van Sinderen of B. Riley FBR. Please go ahead.

Good morning, everyone. What does the excess inventory consist of, is it just one of the mill, or are there any concentrations to be aware of? And also, can you add more color on how you're handling that? And then it's kind of a multi-part question here, but can you speak more about the cost reduction in place for second-half that we should expect, do you think that those are -- just kind of looking at the other operating expense line, are you still thinking it's evenly split between Q3 and Q4? And then, are there other areas you've identified where you could further reduce that line going forward?

All right, Jeff. This is Woody here. I'm taking on the inventory, and then Mike will probably handle the second-half of that question. On the inventory, I would say half of the overage is quite intentional with the purchasing of new categories, and being in stock on those new categories. And they're mostly core category, so they don't have the same short life that a lot of our seasonal product carries. The other half is just simply mixing your sales plans in the first two second quarters. Although we've done a good job of liquidating any product that would be considered more seasonal, so anything that's left in our overage we feel good about is relevant, high-quality, good merchandise. So we were really not in a position yet where we have lumps of core products. So we're going into our number one selling season in the third and fourth quarters, so that we can probably get a number that we feel really great about. So inventory, not a huge concern; we did specifically buy that up, but anyway, so I'm going to turn it over to Mike, I got a dirty look when I say that.

So, just a bolt-on on the inventory part, our strength historically at Kirkland has been our seasonal product, and it's the initial selling of our harvest set is an indicator we have very little concerns about any overhang of seasonal products of both in our fall and Christmas assortments, which we feel very strong about. Regarding the cost reductions, we are still well on track to take the $10 million of cost reductions. Second-half of this year, which will also carry into 2020, and yes, it's relatively split 50-50 in Q3 and Q4. Meanwhile, we'll continue to look at additional cost reductions as needed without disrupting the business, and specifically anything that would interfere with top line sales, and in any movements, any forward movement on our infrastructure changes.

Okay. And then, I know you mentioned some early success in your prepared comments, but are there changes that you've made so far to the Web site and in-store merchandise content? Obviously, there're some new categories there. Can you give us any more color on what you're learning, where you're seeing the traction, how the customers are responding, even if only on a relative basis? And then I guess what other changes to merchandising should we anticipate heading into 2020 to the extent that you can talk about that?

Okay. So, several good points there, first of all, fully engaged right now in tabletop and rugs on the floor. So, those are hitting their plans. The tabletop I would say was a full homerun, both in the dinnerware and in the home textiles. Rugs made as planned, we are going to be looking at some adjustments there, but I feel really good about both those introductions. The third introduction happens next week in fact, the next two weeks. We land the bed and the bedding on the floor. So that will be our third and the final introduction to new product, brand new products into the store. Our products that are more ongoing, we're having some uptick in art. We just announced the Dolly Parton partnership with her original artwork. We've got some musical artwork that seems to be taking hold. Our seasonal product seems to be working. But the overall problem is still when you're having a double-digit traffic decline, it's really hard to offset just the overall sales trend with those traffic declines, and we haven't been able to absolutely ensure that our traffic is improving quite yet. Now, for the first part of next year, we did say on the last call that we would be introducing a line of upholstered furniture starting mostly with a chair, a recliner, a chair, and then going forward with some other upholstery in the first-half of next year. So, we're really excited about that. Like I said before, we want to be considered as one of the players for the entire journey of somebody redecorating your home, not just at the very end of the home cycle purchase, and so, it's all very intentional. Our stores are saying, and our customers are saying, they love the new floor set, it's more open, it's easier to shop, and we're getting a lot of credit from both store associates and store employees that the other whole assortment and store looks fresh and new. So, we just need to let that take place. And then just to address your question on the e-commerce and the Web site, we feel great about our ability to accelerate our e-commerce sales, we're continuing a slate of improvements, both on the front-end and the back-end of our e-commerce experience. We're getting smarter on the promotional levers that drives it. We're very excited about our acceleration on buy online pick up in store, which is now approaching 30% of our e-commerce sales, and we're now building out the ability, the muscles on ship to store. As I mentioned in the previous opening comment, and then we will be bolting on in 2020 ship from store, which I think will take us to a whole another level. So, this is an area where we're continuing to invest in, and leveraging the store as an asset base in combining with our e-commerce capabilities for a true omnichannel model.

Okay. And then just one more if I could, given some moving parts, how should we think about gross margin for second half?

Yes, built into our guidance is that sales and margin trends relative to last year will remain pretty consistent through the back-half of the year.

Okay, thanks for taking my questions and best of luck.

Thank you, Jeff.

Thank you, Jeff.

Ladies and gentlemen, this will conclude our question-and-answer session. At this time, I'd like to turn the conference back over to Woody Woodward for any closing remarks.

Thank you for being on the call today, and we look forward to our next several calls of hopefully improved results. Thank you.

The conference has now concluded, and we thank you for attending today's presentation. You may now disconnect your lines.