Good morning, and welcome to Kirkland's First Quarter 2021 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instruction] Please note this event is being recorded. I would now like to turn the conference over to Tripp Sullivan with SCR Partners. Please go ahead.

Thank you. Good morning, and welcome to Kirkland's conference call to review results for the first quarter of fiscal 2021. On the call this morning are Woody Woodward, Chief Executive Officer; and Nicole Strain, Chief Financial Officer. The results as well as notice of the accessibility of this conference call on a listen-only basis over the Internet were announced earlier this morning in a press release that has been covered by the financial media. 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 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. I'll now turn it over to Woody.

Good morning. Before we begin, I want to recognize the skill, commitment, creativity and innovation of the entire Kirkland's team. They responded well to every challenge we faced and they've delivered on the opportunities to serve our customers, drive profitability and evolve the Kirkland's brand. For the quarter, we generated a comp increase of 75.3%, which reflected a 95.1% increase in store comps and a 42% increase in e-commerce. GAAP earnings for the quarter were $0.11 and adjusted earnings were $0.12, our most profitable first quarter in over five years. As all become evident in our prepared remarks this performance could have been even stronger, absent the weather impacts and inventory constraints. And we are pleased with the profitability we're generating. While we started off the quarter with a multi-week period of winter storms in our markets, we made a nice recovery in our comp trends in March and April. We were very deliberate in choosing profitability over promotions this quarter and maintaining our focus on key items. As the economy began to reopen with vaccinations and state restrictions dropping in most of our largest markets, we began to see a little more competition for the wallet share that we expect to be short-term in nature. We're seeing signs that the big lift to home furnishing that was happening pre-pandemic and throughout the past year are sustainable due to the appeal of work from our -- from home and hybrid approaches to work. Other factors such as strong housing market and the decreased store-based competition further support the sustainability. The momentum created by our evolution into a value-oriented specialty retailer continued this quarter. Our profitability is accelerating even with very deliberate pace of transformation. We provided a strong foundation for a robust outlook over the next two years -- two…

Thank you. As Woody mentioned, the evolution of our merchandise and the changes in our infrastructure and cost structure generated a profitable first quarter, which included some significant headwinds from supply chain delays, and abnormally tough weather impacting our store footprint in February. Historically, our full year profitability has been heavily weighted to contributions in the second half of the year. While we have seen and expect to continue to see, real improvements in profitability in the third and fourth quarters, we believe there is more room for earnings improvement in the first half of the year, as we continue to execute this transformation. Before I get into the details of the quarter, I wanted to make the overarching comment, that the year-over-year comparisons for comp sales, percentage of sales and other metrics are heavily skewed by the necessary actions we took last year during the pandemic, with store closures, the channel shift to e-commerce and the macro trends that existed then and now. Breaking down sales within the quarter, we had a comp decline of 3% in February with a strong start and finish for the month, but extreme weather in the southeast impacting the two weeks in the middle. Our stores closed last year in the middle of March. And most remain closed for the remainder of the quarter, resulting in a comp increase of 134% in March and 196% in April. The total comp increase of 75.3% included an increase in e-commerce of 42% on a 32%, increase in the prior year. Excluding the impact of the COVID-driven store closures from the prior year, we had a total comp increase of just under, 16%. The sales impact of the weather in February and inventory shortages within the quarter was approximately $12 million. As expected, we started to…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question will come from Jeremy Hamblin with Craig-Hallum Capital Group. Please go ahead.

Thanks and good morning. I wanted to start with just getting a sense around trends and thinking about, it sounds like there's been some kind of positive and negative takes in May. As we look at towards your expectations on Q2 and recognizing that this quarter probably has the most noise, is there kind of a range of expectations that you are looking at, based on the information you have now and understanding where some of the inventory constraints have been. Anything that you can call out in terms of your expectations on Q2 sales?

Yes. I think, a couple of -- just to reiterate the positives definitely are, we're getting back into a better inventory position in those key categories, which really has the most impact overall on our average ticket increase that we expected year-over-year. And then on the downside, the piece of what we're seeing in the softness we expected, just as we're comping in Q2 pent-up demand and a lot of focus on home decor things opened back up last year. But also, we had expected at some point in time that there would be a temporary reallocation of spend towards travel and entertainment, as people felt more comfortable getting out. So I definitely think that we're starting to see some of that. But again, expected the Q2 comp to be tougher based on what last year looks like. I think based on what we saw in May, which May was impacted similar to the first quarter with limited inventory until we got into the last week. I think it will be tough to comp -- positive comp last year in Q2. So I don't know if that helps give you any context. And some of that we expected when we planned out the year, we had a 77% increase in e-commerce that we knew we would be tough to comp year-over-year. So I think I would say, from here expecting to be slightly down from a comp perspective to where we were last year.

Okay. That's consistent with our expectation. And in terms of -- I actually want to break it down into that e-commerce channel, where you have kind of endless aisle, you're driving towards that and ship from vendor options that maybe are not as impacted with inventory constraint. But I wanted to just get a sense for performance with e-commerce. A, throughout Q1 and whether or not that showed a little more consistency where weather impacts probably lower on e-commerce. And then, as we are sitting here in Q2, is that a category or channel? Again, you had huge performance, up 77% last year. Is that something where you're expecting e-com to be kind of flat or down here in Q2? Any color that you can share around that e-commerce business?

Yes. I think I'll start with the numbers and see if Woody may have something to add about the third-party drop-ship channel, because we are definitely continued to be pleasantly surprised by that channel. From an e-commerce comp perspective, I do think that we can comp positive. I think it will be a single-digit to low double-digit comp increase and a lot of that driven by that third-party drop-ship channel. And to your point, we did not see the same impact from inventory levels in that channel. It was about 50% of our e-com sales for the quarter and it also drives a significantly higher ticket. It was more than double our own inventory e-commerce ticket in Q1 and have continued to add elevated brands and think there's a lot of continued potential in that channel.

Yes. Nicole mentioned about this particular ship-direct-from-vendor channel they did experience some of the similar problems with inventory that we experienced in our own inventory. However because we can toggle between what we're showing up on the website, we can kind of make those adjustments that are invisible to the consumer. But we're really pleased. We've built a team now that is really going after the endless aisle -- curated endless aisle. And our whole assortment seems to be kind of coming to a much improved way that the store assortments look very similar to what we're doing from the ship-direct from vendor. So we're really optimistic that that's going to continue for the next several years being a big opportunity for us.

Got it. Thanks. And then gross margins I wanted to just see if we could hone in a little bit more a lot of noise around gross margins. Wanted to make sure that I understood the call outs that you had. So freight impact I think you called out was 400 basis points drag in Q1. And that you expect it to be a similar level in Q2 that you're going to have some positive impact from the inventory normalizing versus I think what you've been calling out since Q3 of last year. And I think you called out that that would be roughly 100 basis points to 150 basis points. Just in terms of any of the other items and kind of I think typically Q2 has a lower gross margin than Q1. I think some of that's seasonality of the products that you sell, but any additional color you can point us to here in Q2 on gross margins?

Yes. I think based on timing of inventory and all of those things that you mentioned I'd probably look at Q2 gross profit this year more similar to Q1 of this year than maybe it is in most years.

Okay. Great. And then I also wanted to just ask about capital allocation and you had a little bit of noise on the balance sheet because I think you had inventory drag on your cash flows, which was expected based on where the levels ended at the end of 2020. But you also had a little bit of drag around your AP and accrued expenses. Do you expect that to normalize? Is that just kind of timing of when the quarters end and so forth? But should some of that be recaptured on the balance sheet? That's part one of the question. And then part two is your buyback program hasn't really gotten going yet. And I don't know if that's just being opportunistic. If there is levels you're looking at? And part three of the question is are there other considerations when you have such a significant cash balance have you looked at things like a special dividend as a potential option?

Yes. Starting at the first one. So when we ended the year with $100 million in cash we have said there's about a $30 million impact as we rebuild inventory. And part of that was actual an increase in inventory. And the other piece was that we received more of the inventory towards the end of the quarter so that we hadn't paid for it the same that we would have in a normal cycle. So I think what we're going to see this year from a timing impact is potentially a working -- a negative working capital adjustment just because we are trying to pull forward inventory to make sure we're not in the same place with sales misses because we didn't get inventory in. So, yes, I think by the end of the year that normalizes back out. But I think within the year we're going to be trying to pull up orders within a two week to four week timeframe. So already in the Q2, Q3 timeframe we're paying for some of the harvest and Christmas merchandise before we sell it. And so that will just be elevated. So I think there'll continue to be a little bit of noise, but the number I called out is from year end that reduction to fund that may get to $45 million, but I think then we'll recover back from that. And then on the share repurchase piece. I noted in Q1 we repurchased 1.4 million of shares, and we actually had a new more aggressive plan that we put in place near the end actually in the middle of the quarter. So I called out May being the same as the quarter, which again is 1.3 million, but in one month more aggressive than we've been to date. And to your point, we are considering all options and we'll continue to do so. And if we don't need the cash, then we are looking at what are the right things to do with that, and definitely returning it to shareholders and either share repurchases or some sort of dividends are all on the table. And I think, I missed the third one. What was it? That was the third one or the second one. Did I?

Yeah, you rolled it in together. I'll appreciate it. I appreciate you taking all the questions. I’ll hop back into queue, and congrats on strong execution.

Thank you.

Thanks, Jeremy.

The next question will come from Anthony Lebiedzinski with Sidoti & Company. Please go ahead.

Yes. Good morning. Thank you for taking the question. So, I appreciate the color about the second quarter. And looking forward to the back half of the year, the same-store comparisons get a little bit easier, especially in the fourth quarter. So with that in mind, plus the fact that you are working hard to improve your inventory levels would it be reasonable to assume that you will have positive comps in the back half of the year?

It is. And I think to that point, we expect it to sequentially increase quarter to quarter from Q2 to Q4 the comp.

You know, Anthony, one of the things last year we experienced during the third and fourth quarter was significant inventory shortages. And we are recovering at this point. But the other section of that is, try and get the merchandise sort of all lands together and create a very beautiful impact on the floor in terms of really showing the vision of the merchants in terms of the trends. And that should start regulating or start normalizing here in the second quarter we're fully expected to be in great shape for the third and fourth quarter. But this quarter and next quarter are very important for our merchandise transformation in that, this is where we accelerated some of the quality aspects, design aspects look. So we're really looking forward to this – the back half of this year.

Got it. Okay. Thanks for that. So and Woody you mentioned that, as far as direct sourcing you're at 38% as of the first quarter. How should we think about for the balance of the year as far as where you think you'll wind up for direct sourcing and kind of the impact on margins that will have?

Yeah. It's a very positive story. That 38% though represents the orders that we've written for the back half of the year. So that's a pretty good number to hang on to. It could be as high as 40%. And we're growing that in a way that, we are taking advantages of any design opportunities or better pricing. A couple of aspects that, I mentioned on the last call, was that the unforeseen benefit that we're getting is that our – some of our domestic vendors have really sharpened their price points. So we said all along that, we would let this direct sourcing get to about 50% of our purchases, and then evaluate whether we want to go even higher. Right now, I would say that, the agents in our countries that we're buying directly from are really hitting their stride and – for example in this particular quarter, we're going to be landing our first upholstery from China, which is really an exciting – it will make our stores look more like a real home furnishing retailer and the scale while a little bit smarter, the price points are super sharp and the products look great. So the direct sourcing is really a smart way for us to balance out our risk. As of last year, we were very dependent on China. And this year, we're balancing towards Vietnam, India and other countries, and so you'll see our penetration in China going down and the penetration in some of the other countries going up, which would give us better opportunities to not be so dependent on one port or one supply chain.

And on the financial impact, getting to 38% to 40%, another 75 to 100 basis points of margin improvement. And I think specifically in Q3, we're comping some pretty tough margin rates just from early sell-through of seasonal. So I think that will help us to balance that out.

Got it. Okay. Thanks. And I guess the last question for me, as far as the store opens and closings. So, you actually opened a couple of stores in the quarter. You mentioned one of them I think was a former Pier one location. So, how should we think about them as far as store openings for the balance of the year and also store closings as well? Thank you.

Yes. For the balance of the year, we have one store that was -- it's not actually an opening, but it's been closed for over a year now, because of a tornado in Arkansas, so that one will reopen back up. I think, we'll have a handful less than five closures between now and the end of the year and again have another large portion of our leases coming up for renewal at the end of our fiscal year. So, if we have increased closings that will be at the end of the fiscal year. So I'd say five or less within the year and the others will be at the end of the year. And really again, just like last year, depends on how much progress we're able to make in negotiation.

Got it. Okay. Thank you, very much. Best of luck.

Thank you.

Thank you.

The next question is from John Lawrence with Benchmark. Please go ahead.

Good morning.

Good morning.

Good morning.

Woody, could you speak a little bit. You mentioned, I guess first thing would be competitive environment. Some people might be looking at price to drive traffic. Could you speak to that first and then we'll go from there?

Yes. I think, the competitive environment is working in our favor right now, because remember that we lost our largest competitor Pier one last year and while that doesn't immediately fold into our sales, you start seeing that, because home furnishing is one of those less frequent purchases. And so, we're starting to see some benefits from that. I think that overall, the part that we are the most proud of right now is that, while we're doing this direct sourcing and it's helping us with our product margins the real benefit to that is the look and quality of our products and better packaging. And I think, our customers are starting to really give us credit for maintaining value price point, while actually giving the consumer a lot more quality and a lot more value in terms of design.

Yes. Great. And could you follow that with loyalty card all of that? What -- an update there?

Yes. We've been really pleased with our loyalty program. In fact, since the launch, we're seeing a loyalty consumer spend around $10 more or 27% more per transaction, when compared to the non-loyalty customers. And so far, new loyalty customers are spending -- the brand-new ones are spending about $20 or 53% more than the non-loyalty customers. So, like we said in the previous calls, our loyalty program is a multi-phased approach. So we've got a lot more what I would call bells and whistles coming to enhance that program and make us really the retailer of choice to our most loyal customers and they represent a huge portion of our sales and our profitability.

Yes. Thanks for that. And last question for me. You mentioned some of the new vendors, some of the new brands you've had on e-commerce. What can you say about negotiating with those vendors as far as -- with all the store closings within the industry are some of these vendors wanting to deal with you more because of the doors that you have? And what are you seeing from those vendors at this point?

Yes. I think there's probably two reasons. One, they're looking for distribution just because of some challenges in their distribution model and the lack of new stores opening, and so we're getting some of that. But the other side is the elevation of our store, and our store look and our website is now able to -- so you look at a KitchenAid or Cuisinart and our assortments look parallel with what they're offering. So it really is kind of a two-pronged approach. They have been very -- we have a lot more people knocking on our door saying, can we be part of your curated endless aisle. And we've been pretty pleased with the results so far. Of course, some of those vendors have also experienced some of their own inventory shortages and supply chain issues. But really and truly we're pleased with the results that we're getting, we're pleased that the opportunity for the customer is where they can buy some of those great brands from their trusted store Kirkland's. And then at the end of the day, we may evaluate whether there is a key item or two that we want to bring in to enhance fourth quarter gift giving. So all items or all ideas are on the table and these vendors have been really great to work with.

Great. Congrats on the success. Look forward to hear more. Thanks.

Thank you, John.

Thank you.

And the next question is a follow-up question from Jeremy Hamblin with Craig-Hallum Capital Group. Please go ahead.

Thanks for taking the follow-up. So I want to come back to direct sourcing here. You're clearly tracking ahead of prior expectation in terms of penetration of that business, generating strong margins seeing really impactful results on what you're doing on the e-commerce side of your business. So I wanted just to get a sense of thinking about the long-term, I think you'd spoken to direct sourcing getting to that 50% threshold and then maybe pausing and revisiting after that. And then just thinking about where direct sourcing can go and contributions in terms of both margin, but also in quality of goods, should we be thinking about direct sourcing as potentially being a bigger portion of your total business? And then along with that kind of same question along the lines of e-commerce. It sounds like drop-ship has been tremendously successful thus far. You're now at 30% penetration on e-commerce overall. Is that something where you may end up tracking towards what many of your peers do where e-commerce is going to be greater than 50% of your business long-term?

Well, let's -- both really good questions Jeremy. Thank you for asking. Let's start with the direct sourcing. Our goal was to start it off a couple of years ago, we hit the 20%. And then our goal this year is to hit 30%. We'll probably get about 38% to 40%. What we are needed to do is make sure that our agents and supply chain gets a little bit more accustomed to this business model. And so, we had some things to do on our side and some things to let them get up and running. But the result that we're seeing is spectacular merchandise at a great value. And so, I think that when we say that we'll pause at 50% I don't really see a reason why we would, if everything was moving along as we projected. Remember that most of our competition has significantly more than 50% of their distribution or 50% of their purchases coming from a direct source environment. So I would say that, we'll pause but for like two seconds and then we'll say, let's keep increasing it because we like what we're getting. And then the other side of that on the e-com becoming a larger portion. Yes. We said that we'd like to get healthy with being in the 50-50 range, 50% store contribution sales and 50% e-commerce in the future but that doesn't -- what that really says is that we're listening to the consumer and we're letting them kind of lead the way. This ship-direct from vendor has been so successful for us and they loved that we have curated it. So that it's not literally just a bunch for home furnishing, but their home furnishings that look like they fit to the lens of what Kirkland's stands for from a kind of a casual home furnishing lifestyle look. So, I think there's vast opportunities there. Like the vendors from the Cuisinart and KitchenAid, we have many more vendors approaching us now saying they want to be part of our direct ship. And yes we have a few issues there with the systems and that we're working back in the house on to make that more fluid and easier to manage. Nicole, do you have anything to add?

No. I think before we had said, we thought we'd end up in that 2x to 3x – 2 to 3 year time frame likely 50% store sales and 50% e-commerce. But we're not driving to that number for the sake of getting to that number. It really is just we are pushing e-commerce as the growth engine of our company and to Woody's point the customer will dictate where we end up. If that's 45% or 60% and we're just going to make sure that we are set up to be able to service those sales in a way that our customers expect wherever they happen.

Thanks for taking the follow-up. Best wishes.

Thank you.

Ladies and gentlemen this concludes our question-and-answer session. I would like to turn the conference back over to Woody Woodward for any closing remarks.

Thank you, operator. As always, we're available for follow-up questions over the next several days and weeks and we look forward to seeing you online and in our stores. Thank you.

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