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Kirkland’s, Inc. (NASDAQ: KIRK) Third Quarter 2023 Earnings Call Transcript, November 30, 2023
Kirkland’s, Inc. beats earnings expectations. Reported EPS is $-0.05, expectations were $-0.53.
Operator: Good morning, everyone, and thank you for participating in today’s telephone convention to discuss the monetary effects of Kirkland for the third quarter ended October 28, 2023. We’re joined today by Kirkland’s Home Interim Executive Director Ann Joyce; President and Chief Operating Officer Amy Sullivan; Executive Vice President and Chief Financial Officer Mike Madden; and the company’s external director of investor relations, Cody Cree. Following your comments, we will open the call for your questions. Before I go any further, I’d like to turn the floor over to Mr. Creates as I read the company’s Safe Harbor within the meaning of the Private Securities Litigation Reform Act of 1995, which provides vital caveats regarding forward-looking statements. Cody, please come in.
Cody Cree: Thank you, Jamie. Except for the old facts discussed in this call for convention, statements made through control of the Company are forward-looking and are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. The statements involve known and unknown dangers and uncertainties, which may cause the actual long-term effects of Kirkland to differ materially from those anticipated. These dangers and uncertainties are described in more detail in Kirkland’s filings with the Securities and Exchange Commission. To remind everyone that this call will be playable until December 7, 2023. A webcast will also take place via the link provided in today’s press release, as well as on the company’s online page at kirklands. com. Now, I’d like to turn the floor over to Kirkland’s interim CEO, Ann Joyce. Ann, it’s your turn.
Ann Joyce: Thank you, Cody, and hello everybody. Before we delve into our results, I must thank all of our affiliates at Kirkland’s for their continued commitment to the good fortune of this logo. This team has spent the last few months evaluating and taking corrective action in all areas of the business, as we prepare for the vital holiday season. We knew those efforts weren’t going to be easy as we continued to face tough macroeconomic headwinds, but I think the moves we’ve taken and the ones we’re making plans can allow us to pull back. to the profitability of this effort. Last June, we discussed the possibility of supporting the Kirkland logo from its roots, while proceeding to modernize and update it where appropriate and where we’ve had good luck.
The groups have worked tirelessly to make significant adjustments to product, marketing, operational efficiency, spend management, and culture, and I must thank them for all their efforts. Our workers are our greatest asset and are experts in their field, in this logo and love our customers. While the third quarter continued to face challenges, we began to see the first signs that our strategic repositioning was resonating with our consumers. In fact, we saw sequential innovations in traffic and comparable sales each month of the quarter, as well as an increase in gross margins. On a macro level, inflation continues to be a challenge for our customers, especially in the more expensive categories such as furniture and wall décor.
However, we have been able to improve traffic and requests by focusing on less expensive pieces such as ornamental accessories, seasonal decor, and gifts. As a result, our omnichannel traffic decline increased from 14% in August to 6% in September. and 4% in October. Our comparable sales in the third quarter improved from a 13% decrease in August to a 9% decrease in September and a 6% decrease in October. Additionally, our product margin improved across 110 core issues, resulting in an overall year-over-year improvement in third quarter gross profit margin from 130 core issues to 26. 3%. During the quarter, we continued to see other promising signs from the core of our marketing strategy. It is critical for us to re-engage our unwavering consumers and we are very encouraged to see a 20% increase in unused consumer reactivation in the third quarter.
We are seeing sequential improvement in traffic and conversion with less discounting and improved profitability. We believe those trends are a result of the strategic shift in product mix and marketing. As we discussed on our last call, we have renewed our emphasis on seasonally relevant value home décor. We are encouraged by the performance of our Decorative Accessories category during Q3, which had an 8% increase in sales and a 23% increase in margin dollars. We also saw unprecedented early selling of our holiday product during Q3. Although we did have some margin impact from the lingering effects of the remaining higher priced assortments in furniture and wall décor that required higher levels of discounting, we believe that these will have less of an impact on our business as we continue to optimize our merchandise assortment.
Also, unsurprisingly, during our holiday sales period, those larger price categories have less of an effect on our business. Focus on operations. We have continued to improve our field and accuracy in our stock flow. We ended the third quarter with 17% less stock than last year, although we still have stock and on time with products for the holiday season, putting us in a smart position to meet the demands of our peak season. The power of our supply chain continues to increase through the effective use of technology, contract negotiations, and procedural improvements. For example, we closed any of our e-commerce centers and consolidated our e-commerce operations at our distribution center in Jackson, Tennessee. Cost containment continues to be critical to our operations and during our third quarter, we were able to reduce our operating expenses by more than $2 million compared to the prior year period.
Overall, we’ve made significant strides shoring up the operations to support the strategic repositioning. There is still work to be done, but the changes we’ve made so far are working, and we are establishing a mindset across our teams, focused not just on cutting expenses, but on sustainable cost efficiencies through process change that we believe will benefit us for years to come. As we continue to demonstrate our ability to execute our strategic repositioning, we expect to impact Q4 more significantly than originally anticipated. Our teams across the business have been reenergized by the progress we’re making and we’re better engaging our consumer base as they decorate, entertain, and shop for gifts this holiday season. As a result, we are encouraged by a low single-digit increase in comparable sales at a much improved merchandise margin in November, which includes Black Friday.
Amy will communicate more about that in her commentary. As we reflected on the initial phase of our recovery strategy, we knew it would be an era of transition as we delved deeper into identifying short-term methods and returning to the ability to generate profits and growth. Many of our initial adjustments are already driving prices up as we continue. to see advanced trends and positive visitor response. Overall, I remain confident in our team’s ability to meet the expectations we have set for ourselves. We are determined and committed to giving the company back the ability to generate profits and, in the end, offer a price to our shareholders. Now I’d like to turn it over to our President and Chief Operating Officer, Amy Sullivan, to provide a more detailed commentary on the impact of our strategic initiatives.
Amy Sullivan: Thank you, Ann, and hello everybody. I’d like to echo Ann’s thanks to our entire organization. I’ve been incredibly inspired and encouraged through the determination and drive to pivot and make effects this year. On our last call, I defined five short-term strategic projects that we are executing to return to successful growth. While we expect those elements to evolve as we continue to reimagine the odds for Kirkland, I’d like to update you on the progress of each of the initiatives. First, we continue our relationships with our core visitors and are positive about the progress we are making in driving engagement and acquisition. Prior to August, our virtual marketing tactics were heavily aimed at converting internet sites and generating traffic from beyond online shoppers, and we saw an average of 17% year-over-year. Annual decline in online traffic.
As a result, we temporarily shifted our virtual marketing strategy to key omnichannel consumer demographic and geographic targeting to drive more visits online and to our physical locations. We controlled to slow the decline in our e-commerce traffic from -17% in the first part of the year to just -3% in October. On the physical side, we advanced traffic from an 11% drop in the first part of the year to a 4% drop in October. In November, traffic at our outlets remained positive for the first time in 2023. Most recently, we piloted an exclusive SMS crusade with video, giving 1 million SMS subscribers access to an exclusive holiday lookbook and coupon offer. We achieved the highest volume of clicks and earnings of any cross-SMS to date.
We are thrilled with the promising early results of this innovation and look forward to further utilizing this tool as we move into the new year. I could not be more pleased with the rapid turnaround of our marketing strategy and how it is progressing, recognizing there is more to be done. Second, we have rebalanced our category mix and will be known for always something new as we deliver curated seasonally-relevant home decor at a great price. In the third quarter, we were still transitioning our category mix that began to see promising results from our strategy shifts as the quarter progressed. Most notably, Decorative Accessories delivered an 8% sales increase in the third quarter and best represents our future growth potential and value décor.
We are also pleased with the effects of the season on our Christmas assortment, which generated a 3% increase in sales. We have reintroduced our Gifting category for this holiday season, which we expect will drive further sales in the fourth quarter of this year, and we expect this activity to continue year-round in 2024. We are encouraged by consumer reaction to those pivots, which will position us to generate more successful demand. Thirdly, by putting our visitor at the center, we try to provide them with a seamless omnichannel experience that allows them to respond anytime and anywhere they need to shop. We have a new Operations Manager who is driving our entire domain through engagement, contests, and incentives. Our incredible team generated a cumulative 248 basis points in conversion rate in the third quarter, and I’m pleased with the percentage that this trend continues in the fourth quarter, as it generated a small positive single-digit increase in sales in November.
As we expand our long-term strategy, we’ve begun benchmarking our entire store portfolio to compare real estate, visitor experience, and location in our products and marketing strategies. We are now focusing on our e-commerce business. We are pleased with the overall improvement in our conversion, which has increased across 17 core issues year-over-year. Since our last call, we’ve conducted an end-to-end assessment of our overall on-site experience. Through this process, he highlighted the limitations of our existing site, as well as the responsibility to maintain the latest generation [ph]. As a result, we are building a new e-commerce strategy, defining its role in driving sales and profitability through a modernized visitor experience. Other projects will remain as we continue to expand our plan.
Fourth, we are a valued specialty retailer and must execute with efficiency and consistency in our end-to-end operations. It is imperative for us to remain disciplined in our operational effectiveness through supply chain efficiency, tech enablement, and cost containment. With more normalized levels of inventory this year, our supply chain has stabilized, allowing us, with the help of process improvements in labor management, to achieve approximately $500,000 in savings in Q3. In addition, we have enhanced our ecommerce demand forecasting model and our team has done an excellent job managing increased ordering unit demand without disrupting the customer experience. As we look ahead to our future, we are committed to the discipline in our overall cost structure to improve liquidity, returning to historic adjusted EBITDA levels and strategically investing capital for the long-term growth of the brand.
Last but not least, our affiliates revitalize our corporate culture day in and day out. We are committed to our consumers, shareholders, and team members as we optimize our bottom line, stay agile in our strategy, and celebrate our victories together. I now envision a continuous improvement in our profitability and monthly sales trend. As we look ahead to 2024, I’m excited about the prospects as we realize the impact of those strategic projects over an entire year. We remain committed to delivering long-term pricing for our consumers and shareholders while reimagining Kirkland’s long-term. “With that, I’d now like to turn the floor over to Mike, who will provide a detailed look at our monetary functionality in the third quarter and our outlook for the rest of the year.
Mike, over to you.
Mike Madden: Thank you, Amy, and hey everybody. Net sales for the third quarter were $116. 4 million, compared to $131 million in the prior-year quarter, which included a 5% reduction in average store count and a 9. 2% decrease in comparable sales. The reduction in sales due to a reduction in the average price, as well as a reduction in in-store and online traffic, specifically or partially offset through an increase in conversion rates on either channel. Breaking down sales in the quarter, compositions fell 13% in August, 9% in September and 6% in October. E-commerce accounted for 27% of total sales in the current quarter and last year. Sales of e-commerce products fell 8. 5% and in-store sales were down 9. 5%. On the product side, the biggest drops in sales were in furniture, wall ornaments and crops.
These declines were partially offset by gains in ornamental accessories and strong early Christmas sales. Sales functionality was consistent across geographies, with particularly larger effects in Florida and weaker effects in Texas and the West. Gross profit margin increased from 130 foundation issues to 23, or 26. 3% of sales, compared to 25% in the prior-year quarter. The five parts of this year-over-year update were: First, product margin increased by 110 core issues to 54%, compared to 52. 9% in the prior-year quarter. Lower freight rates and stock levels, as well as increased product flow, resulted in higher product margins. Second, central distribution prices were reduced to 6. 1% through 110 foundation issues. The percentage reduction in sales is largely due to the reversal of prices capitalized the previous year, as inventory levels decreased from the second to the third quarter.
With a normalized inventory flow this year, capitalized costs increased slightly along with the seasonal inventory buildup. On a cash basis, distribution center costs were $500,000 lower than the prior year quarter, reflecting improved labor efficiency and lower inventory storage costs. Third, occupancy costs increased 130 basis points to 12.1%. This increase as a percentage of sales is primarily due to deleverage from the sales decline. The actual cash rent is down slightly versus the prior year quarter. Fourth, outbound freight costs, including both store and ecommerce shipping expenses were 8% of sales, flat compared to the prior year quarter. This comparison reflects a reduction in shipments to the stores in the current year, resulting from lower inventory levels, offset by deleverage from the overall sales decline.
Finally, the depreciation and amortization included charged to sales was minimized through 40 foundation issues to 1. 5%. Total operating expenses, excluding impairment charges, decreased by $2. 1 million to $37 million, or 31. 7% of sales, compared to $39. 1 million, or 29. 9%. of sales, in the quarter of the previous year. The reduction in dollar terms is basically due to discounts in the company’s salaries and general expenses, as well as a reduction in the number of retail outlets. These minimizations were partially offset by planned increases in stores. Spend hours preparing for our Christmas sales season. Similar impairment charges to underperforming retail outlets and generating assets were $0. 3 million for the quarter, compared to $0. 2 million in the same quarter a year ago. Adjusted EBITDA, excluding impairment, share-based reimbursement and other minor expenses, was negative $3. 2 million, compared to negative $1. 7 million in the prior-year quarter.
This was basically due to weaker operational functionality in August and September. In October, our adjusted EBITDA loss was lower than a year earlier due to increased margins. On a quarterly basis, our operating loss was flat at $6. 7 million. . Net interest expense was $1. 2 million for the quarter, compared to $0. 7 million in the prior-year quarter due to higher interest rates. Our source of income tax rate for the quarter was a 16. 8% lead, compared to a rate of 0. 8% in the prior-year period. From a balance sheet perspective, our stock levels remain below and in line with our expected stock flow. We ended the quarter with $105. 2 million in stock, down 17% from $126. 3 million at the end of last year. .
We had $62 million of notable loans, compared to $60 million in the prior-year quarter. Let’s move on to our outlook for the rest of the year. At the start of the fourth quarter, the environment remains challenging, but our earnings and margin trends have taken a step forward. In November, we recorded positive single-digit sales as well as a strong increase in product margin. As a reminder, November is the most difficult monthly sales comparison to last year, when sales were flat. year, December comps were down 11% and January comps were down 8%. Traffic also turned positive in November, but we remain cautious about assuming a similar trend for the remainder of the quarter, given the current macroeconomic uncertainty. Customers continue to cut back on higher priced purchases, however our seasonal offering has been well earned so far, as evidenced by our visitor conversion rate and improved product margin.
With less transparent inventory compared to last year, we expect product margin improvement to continue for the remainder of the quarter, origin chain pricing continues to normalize, and we are managing operating expenses very strictly. Year-to-date, operating expenses have decreased by approximately $10 million compared to the same nine months in 2022. We expect operating expenses to be down in the fourth quarter from a year ago after adjusting for the additional week in this year’s retail calendar. As a result, we expect a strong year-over-year improvement in adjusted EBITDA for the fourth quarter. In the fourth quarter of 2022, adjusted EBITDA is $2. 6 million. Beyond this year, our goal is to return to a medium to higher level. adjusted EBITDA margins, which are in line with our previous average.
As Amy noted, we are starting to see improvements in sales and product margin as a result of our pricing and promotion strategies. We have already taken steps to improve our source capabilities, improve the power of our source chain, and eliminate constant prices from our distribution facilities. We are looking at other tactics to optimize our operational charge structure. Significant discounts have been made in recent years, but there is still more room to cope with and redeploy. The combination of those points paves the way for a return to the old adjusted EBITDA grades. In the coming quarters, we’ll get updates on our progress in each of those spaces. Finally, I would like to reiterate our priorities for capital allocation.
We continue to focus first on cutting debt and restoring a point of liquidity that allows us to operate the business with more flexibility. To date, we have reduced our loans from $62 million at the end of the third quarter to $35 million. In doubtful economic conditions, we are evaluating tactics to increase our borrowing capacity to ensure we have the mandatory liquidity buffer and boost our recovery efforts. Once this step is complete, we plan to focus our efforts on reinvesting in the business. From there, we can start looking at percentage buybacks and dividends as additional tactics to return the price to our shareholders. That concludes my opening remarks. I step by to hand it to Ann for her final comments and then move on to Q&A.
Anna?
Ann Joyce: Thanks, Mike. Before I answer your questions, I wanted to reiterate my thanks to our committed members for what they have completed in such a short time. Achieving the innovations we have been talking about today has required a lot of effort. amount of effort and determination. While there is still much work to be done, it is vital to recognize the works that have driven the trend of our business in such a tight time frame. Our forward effects are energizing our organization and we have no slowdown goal. We move into 2024 with a renewed sense of optimism and a plan that will result in greater monetary effects. I very much appreciate all of our stakeholders and the help we continue to get as we strategically reposition the business in a challenging customer environment. I firmly believe that our patients will pay off in the long run. Operator, we are now in a position to ask questions and answers.
Operator: Thank you, ma’am. Ladies and gentlemen, we will now begin the question and answer session. [Operator Instructions] And our first question comes from Jeremy Hamblin at Craig-Hallum. Continue with your inquiry.
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