Jeff Black - IR Mike Madden - President and CEO Adam Holland - VP and CFO.

Jeff Van Sinderen - B. Riley Brad Thomas - KeyBanc Capital Markets Anthony Lebiedzinski - Sidoti & Company David Magee - SunTrust.

Good morning and welcome to the Kirkland’s Fourth Quarter 2016 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 Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Jeff Black, SCR Partners. Please go ahead..

[Technical Difficulty] 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 and 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 the forecasted results.

Those risks and uncertainties are more fully described in Kirkland’s filings with the Securities and Exchange Commission, including the Company’s annual report on Form 10-K filed on April 8th, 2016. I’ll now turn it over to Mike Madden..

Thank you, Jeff and thanks to everyone for joining us this morning. While 2016 was challenging, we're pleased to have achieved a record sales, while making important investments to advance our long-term strategy.

The consumer sector is undergoing a period of significant change and we're entering 2017 with a stronger management team, a solid omnichannel platform and aggressive actions underway to improve our execution and profitably grow our business. Some of the headwinds in the fourth quarter were not unique to Kirkland's.

Store traffic was under pressure in many sectors and regions. Like many retailers, we experienced a solid start in November and a significant slowdown in the three weeks prior to Christmas. This softness in our brick and mortar stores offset strong momentum in our e-commerce channel.

A more promotional environment increased pressure on our merchandise margin, as we brought inventory into alignment to end the year. The macro-environment aside, we took away some very important learnings from the fourth quarter.

For example, we do a great job on the decorating aspect of the holiday period within our assortment, but we think we can increase our relevancy in categories related to entertaining and gifting. Our category mix for Holiday 2017 will be enhanced to address a wider spectrum of holiday shopping needs.

I’ll elaborate more on what we're doing overall to recalibrate our assortments in a moment. We believe we can improve our marketing, which included a significant shift to digital spend in the second half of 2016. We've learned a lot about that medium and we're better positioned or will be much better positioned for the back half of 2017.

E-commerce, which generated a strong 22% increase in sales for the year experienced a high degree of last minute shopping. Upgrades to our fulfillment platform should position us to deliver an even better customer experience during holiday 2017.

We also believe we’ll be much better positioned from a merchandise margin perspective, given the work underway to increase the ROI in our promotions. We see each of these as opportunities to improve our performance in Holiday 2017. Our goal is to transform Kirkland into a high performing, nationally recognized home decor brand.

This is a multi-year effort and we took important steps during 2016 to realize our long term plan. A central component of that plan is continuous improvement.

With the hires and changes we’ve made, our management team now has a stronger balance of leaders with deep knowledge of home décor and experience operating in national omni-channel organizations. These additions coupled with the talented leaders who have been with us provide a solid nucleus to implement change in our company.

The change required to win and reach our goal. I'm very pleased with the level of cohesion we are building within our leadership team, the openness to change and the energy, enthusiasm and fresh ideas we're bringing to bear for the company. We also set the stage to drive more newness into our assortment.

We started refreshing components of our core assortment during 2016. We are moving out lower performing products, right sizing our categories and upgrading our assortments, clearing the way for more frequent introductions of new and fresh products moving forward.

The transition of this effort will continue into the first half of 2017, providing benefits as the year progresses. We cleared a major hurdle in our supply chain during 2016 by getting our West Coast operation up and running.

This allowed us to flow products better during the holiday season and avoid the cost pressures we experienced during peak season 2015. We expect further benefits as we move forward. All of these investments will improve our processes and sharpen our execution to support profitable growth.

Our goal for 2017 is to build on the work that we’ve put into motion. Our guidance reflects continued headwinds in traffic as well as lower square footage growth. We're focused on optimizing our omni-channel model by improving e-commerce profitability and enhancing the store experience.

We’ll continue to tightly manage our expenses as we invest in customer focused initiatives to drive higher sales, productivity. Our balance sheet is in great shape, which gives us flexibility to support our long term objectives.

As I touched on earlier, we think there's a significant opportunity to achieve a more optimal product assortment and use of space in our stores. We have tremendously productive component to our assortment and we want to support that with newness, while eliminating nonproductive SKUs across all of our departments.

In addition to improving our inventory management by removing less productive items, we in turn remove some of the clutter from the store environment to improve the overall shopping experience, which is important to our customers.

In addition to addressing SKUs, we're taking aggressive action to adjust category penetration by identifying under spaced and over spaced areas of the store layout by category. This will better position us to address down trending categories, including art and wall décor.

We’re removing much of the impulse in filler products such as toys and gadgets and replacing it with key items, geared to home decor and home comfort. Moves like these are examples of how we are streamlining our merchandise to provide a clear point of view.

Over the long term, this should reduce out of stocks, cut excess inventory and drive higher customer satisfaction through a better store environment. Another key area of focus in 2017 is our pricing and promotion.

Kirkland has a well-established value message, but we believe we can increase the merchandise margin without compromising that aspect of the brand.

We are a high margin specialty retailer with frequent promotional activity and discounts and that will not change, but we will reduce promotions that have a diminishing return for traffic and an unsatisfactory ROI.

This naturally involves tests around price elasticity, reducing coupon stackability, instilling better clearance discipline and taking credit for pricing power in our initial marks are all areas we are addressing to this effort.

We're already seeing improvement in our average ticket and our merchandise margin as a result of these actions and expect further improvement as we move through 2017.

While addressing the merchandise assortment and the pricing and promotional model represent the key areas of strategic focus for 2017, there are several tactical business objectives that support and complement them. We’re pleased with our omni-channel growth, but strive to make it more profitable for the business.

E-commerce accounted for 8% of our sales and sustained healthy momentum in 2016. We expect double digit growth once again in the channel during 2017.

We upgraded the user experience in the back half and believe there are opportunities to improve conversion and achieve higher profitability as we expand our vendor network for direct shipments and add specific assortments for our holiday periods and seasonal periods.

An upgrade of our fulfillment platform will be in place for the peak seasonal period and will improve our throughput, order accuracy and labor efficiency with a strong ROI.

With traffic continuing to be a headwind and consumer behavior shifting rapidly, our marketing effort must improve and become more of a sales driver and source of brand differentiation. It starts with our team and we have reorganized our resources to better drive traffic and effectiveness.

Our media mix will adjust during 2017 based on results we gather from a series of actions in Q1 and Q2. We are testing new channels of marketing. As an example, we recently dropped a direct mail piece to our top customers and the early reads on ROI are positive.

In addition, we're optimizing our weekend coupon delivery with a focus on margin dollar production. Our event and in-store marketing is benefiting from improvements in creative production and process with merchandising with the goal of improving the store experience.

We believe these improvements have a positive impact on the second half in holiday business. As I mentioned, we're slowing our real estate growth in 2017. We expect a slight gain in store count for the year and we're prioritizing our growth in high density markets and our plans include more relocations, which are generating a favorable return.

Overall, we remain confident about the long term outlook for the business. We have a more capable team. We're making the necessary investments and changes to position our organization to win. Some of our investments will impact ‘17 and all have the potential to drive revenue and earnings growth over the longer term.

I'm very pleased with how the team is coming together and look forward to updating you on our progress in future periods. I'll now turn the call over to Adam and he’s going to cover fourth quarter results and our outlook for ‘17.

Adam?.

Thank you, Mike. Net sales for the fourth quarter increased 2.1% with total comparable store sales decreasing 4.6%. Brick and mortar comparable store sales declined 6.2%, driven primarily from an approximate 6% decline in brick and mortar traffic. Geographically, store traffic was down across most of our states.

Our conversion rate in stores was positive again in Q4, although this was offset by a lower average ticket. We opened four new stores during the quarter and we closed one, ending the quarter and the year with 404 stores, representing 28 more units or 7.4% more than the end of fiscal 2015.

Moving on to e-commerce sales, e-commerce generated 16.2 million in total revenue during the quarter and accounted for approximately 8% of total revenue during Q4, an 18% increase over last year. This increase was driven by continued growth in website traffic, average order value and conversion rate. Moving on to gross profit.

Fourth quarter gross profit margin decreased approximately 149 basis points to 39.0%. Merchandise margin decreased approximately 27 basis points to 53.4%. Our elevated level of promotional activity in mid-December contributed to this decrease.

Store occupancy cost increased 59 basis points as a percentage of net sales during the fourth quarter, but met our expectations from a dollar perspective. Outbound freight costs, which include e-commerce shipping, increased approximately 32 basis points as a percentage of net sales.

Most of this de-leverage resulted in higher e-commerce shipping costs as we saw an increase in our shift to home business in Q4 compared to last year. Finally, central distribution cost increased approximately 31 basis points.

The addition of the new e-commerce fulfillment center and the associated increase in labor costs accounted for most of the increase as a percentage of sales over last year. Moving on to operating expenses. Operating expenses for the fourth quarter were 24.4% of sales, which was up approximately 43 basis points to last year.

Store related operating expenses leveraged 28 basis points during the quarter. Much of this leverage was due to a favorable adjustment to our self-insured workers' compensation and general liability reserve, which equated to 83 basis points year-over-year or $0.07 per diluted share.

We also experienced lower advertising costs during the quarter, which amounted to 22 basis points year-over-year. These benefits were partially offset from higher store payroll expense, which de-leveraged 43 basis points, due in large part to lower comparable store sales. Corporate related expenses de-leveraged 76 basis points over the prior year.

Much of this de-leverage is due to the reversal of a bonus accrual in the fourth quarter of last year, approximately 50 basis points. Other components of corporate related expenses were relatively flat as a percentage of sales compared to last year. E-commerce related operating expenses decreased 5 basis points compared to the prior year.

Depreciation and amortization increased approximately 20 basis points as a percentage of sales. The tax expense for the quarter was approximately $8.4 million or 36.7% of pretax income.

We recorded a discrete item in the quarter, relating to the reduction of the prior year period tax liability, which benefited diluted earnings per share by about a penny. Net income for the quarter equated to $0.90 per diluted share. Moving to the balance sheet and the cash flow statement.

At the end of the quarter, we had $63.9 million of cash on hand. Inventories at the end of Q4 were $75.4 million, an increase of 10.6% over Q4 last year.

As previously discussed on our last conference call, the Q4 2016 ending inventory amount includes the incorporation of our new West Coast operation, which we successfully implemented in August of 2016.

This new operation involves us gaining ownership and control of our product earlier in the pipeline without having a negative impact on working capital. This new in-transit inventory bucket totaled approximately $4 million and is included within the Q4 2016 ending inventory balance.

Adjusted, this equates to a 4.7% increase in inventory year-over-year compared to a 7.4% increase in store count. At quarter end, we had no long term debt and no borrowings were outstanding under our revolving line of credit. Fiscal 2016 cash provided by operations was $51.8 million, reflecting our operating performance and changes in working capital.

Year-to-date capital expenditures were 32.2 million, with approximately 78% of the CapEx relating to new stores and existing store improvements, followed by 14% relating to IT System investments and 8% relating to supply chain. The final item I'll cover relates to our expectations for fiscal 2017.

We anticipate total sales to increase approximately 6% to 8%, driven by higher average store count and continued growth in our e-commerce channel. Please note this level of sales growth also reflects the additional week in the retail calendar for fiscal 2017 representing approximately $10 million to $11 million in revenue for that week.

Total comparable store sales are anticipated to range from slightly negative to slightly positive for the year, excluding the impact of the additional week of sales, which we don't anticipate having a material effect on earnings.

As it relates to store count, we expect open 25 to 30 new stores during fiscal 2017 and close approximately 20 stores resulting in a net store increase of five to ten units by the end of the year.

The cadence of the new store openings will be weighted to the second and third quarters of the year while store closings will occur throughout the first half of the year. Full-year operating margins are expected to be comparable to or modestly below fiscal 2016 levels.

Importantly, there are certain prior year comparisons which we are cycling against in 2017, namely the favorable Q4 2016 workers compensation and general liability adjustment I mentioned earlier. Our income tax rate is anticipated to be approximately 38.0%.

Full-year diluted earnings per share are expected to be in the range of $0.50 to $0.65 and as stated in this morning's press release we expect quarterly earnings will be lower in the first half of 2017 compared to fiscal 2016.

We expect to be cash flow positive in 2017, with total capital expenditures moderating compared to prior years to a range of $23 million to $27 million before accounting for landlord construction allowances. Most of the capital outlay will relate to new store openings with the remainder focused on supply chain systems and other store initiatives.

We do not expect any borrowings on our line of credit during 2017. Thank you and I will now turn the call back over to Mike..

And I will turn the call back to the operator to open up for Q&A. Thank you..

[Operator Instructions] Our first question comes from Jeff Van Sinderen with B. Riley. Please go ahead..

I wonder if you could tell us a little bit more about some of the initiatives that you're working on to increase, I guess upgrading product in that the flow of new product, maybe how and when we're going to see those unfolding in 2017..

Okay. Jeff, this is Mike, thanks for the question. In terms of the assortment, a lot of work being done. We're certainly addressing some of the categories that are in decline namely art and wall decor.

We're doing some refresh there on those presentations as a short-term measure and we’re identifying where we're really winning there which is you know it's nice to see this, we're actually winning in the higher priced items, the more premium energies there.

So we're going to go after that business but more broadly we're really looking at elements across our assortment dealing with our speed count, we think there's an opportunity to bring that down and allocate those dollars to more productive areas of the assortment.

It's not - the way I would characterize this is it's not a statement necessarily on the quality or the content of the product that we have in the stores today. It's very process driven and that's precisely why we were added the people to our team that we have to leverage those skill sets that retail talent that they bring to the table.

So we're going through a major ski rationalization and category rationalization effort, which you know will end up capitalizing on the areas where we think we can grow and generate more productivity inside the store and moving out of areas where we see less productive results.

And that's going to require some testing and some phasing in, but we think it can have an effect on 2017 as we progress more namely back in the latter part of the year and certainly as we cross over in ‘18, a lot of those initiatives and the time that we need to get the process where we want it will certainly be in place.

Another area which is kind of a side bar to that that we're really honed in on and focused is building key items in the business, it needs to be something we are really known for here at Kirkland, really champion items in the store.

And our team is doing a good job right now of identifying some of those key items that we can really blow up and add to the productivity of the business throughout all of our categories..

And is there sort of a timeframe I guess or a way to look at the metrics of I don't know so many new flows over a period of time or is that something you're still sort of working on. It obviously depends by category I guess..

It does, I mean it is something we're still working on, but I would say we're well ahead of the holiday’s assortment this year, really feel good about our preparation heading into the all important back half of the year. We're just further ahead and that's just - that's a good place to be. It does vary by category.

Our lead times run 90, 120 days on just production and flow. So we’re already affecting that, but to your point, it does take a little bit more time to work that in across the entire assortment and we're in the middle of that.

So I think it gets better as we go, but certainly you have to look at the categories and the lead times are pretty similar across the basket that we offer..

And then one more if I could squeeze it in. I’m just wondering how you’re thinking about pricing and pricing analytics going forward.

I know you guys are - you're pretty low ell on price to begin with, but just any anything else they're blowing [ph] [00:24:39]?.

Yeah Jeff, this is Adam. Our concept comes with a lot of promotional activity but that being said, on an upfront price basis, we've known for a while that we are competitive.

And within this, we discovered there are categories with enough elasticity to be able to take prices up when it's prudent, which you know as Mike eluded to in his prepared comments gives us the ability to promote more effectively.

But we're in the thick of it right now, with a rigorous testing program driven around not only pricing in store, but which promotions, which marketing efforts drive ticket and which ones drive traffic. And so, we think we’ll have a little bit more ability to affect the year within that piece before the fourth quarter..

And just to add on that Jeff a little bit, we're trying to limit the over promoting that we felt like we got to in Q4.

Limit the reactive nature of it, overlapping nature of it and using the data to your point, using the analytics that we have to drive those decisions and not as much the feel of things, these things are easily mapped and we want to take that approach..

Our next question comes from Brad Thomas with KeyBanc Capital Markets. Please go ahead..

First I want to ask about the first quarter and see if you give us a little more color about how it's been progressing and how you're thinking it unfolds, particularly in light of the delayed tax refunds..

Yeah, I mean early Q1 traffic trends have remained a challenge and so, but as we move through the year, we expect our trend to improve on several fronts as we gain traction on some of these things. Our comparisons also ease a bit when we get into Q2 and for the balance of the year.

I would point out you know we're seeing positive ticket right now and that’s been a direct result of some of the things we've already been able to put into place. Our merchandise margin has been solid as well and that's helping to offset some of the traffic softness we're seeing so far.

We do think that the delay in tax refund is playing in here, but in terms of quantifying that specifically that's hard to do and that will play itself out over the next several weeks..

And so just as we think of the cadence of the year, I mean, are you thinking that the first quarter our comps might come in down low-single digits or more similar like about mid-single digits as we've just seen in the fourth quarter?.

Yeah, I don't want to get into - we're not guiding - we guiding annual, so comps are running a bit negative right now, but our guidance is for the year which is slightly negative to slightly positive and as I said, we planned in improvements that we expect over the next ensuing few quarters..

And then in terms of the merchandise margin, I apologize if I’ve missed this, but can you share with us where the full-year merchandize margin came in.

And then as you think about the full year and some of these initiatives to improve the merchandising and the promotions, what kind of opportunity do you think there is to improve the merchandise margin..

Hi Brad, this is Adam. The 2016 full-year merchandise margin was very slightly down, approximately 20 basis points. As we move into 2017, what we see is opportunity, our initial mark-up and the pricing promotion strategies Mike outlined earlier. We think that that is one of our bigger opportunities to drive overall gross profit margin next year..

And then as you think about the potential offsets you may have from like a freight and a container rate standpoint.

Do you think that the pricing initiatives and IMU will be enough to offset some potential headwinds or hearing from other retailers?.

Yeah that was contemplating in our plans..

Well just the last question from me, just kind of a modeling housekeeping item, as you look at the $0.07 impact in the fourth quarter that you've just had the benefit.

Any degree to which you'll be able to still see some of that in 2017 or should we be modeling full reversal of that in 2017?.

We are not anticipating to see that type of benefit next year Brad..

But it shouldn't reverse. It’s going to be a comparison issue year over year..

Right, you just wouldn't recognize it again next year exactly. Great, well thank you for all the help and good luck to you..

Our next question comes from Anthony Lebiedzinski with Sidoti & Company. Please go ahead..

So first to Mike, you mentioned that the three weeks before Christmas was particularly challenging with the store traffic down. What would you attribute that to, is it just more competition or just overall the consumer weakness, if you could provide any color on that issue that greats..

Well, it was definitely an overall thing in term of what we gather and we get other sources of data in-house to butt up against our own and there were certainly a lull in activity that was more broad-based during that timeframe and you're hearing from that. You're hearing that from others.

Also we did have a corresponding lift in our e-commerce business. So I certainly I think part of it is a channel shift and we felt some of that on the positive side with our e-commerce business. But with that being 8% of our business, it can’t overcome at the moment that brick and mortar impact.

So I think it was a number of things, I think the channel shift is certainly one of them, but I also think there was a broader consumer thing going on that I to-date haven't heard a really crisp and good explanation for it, but we certainly saw it.

And as we prep for Q4 this year, I think we're taking all of our learnings into account and we are reacting to it much earlier and I'm confident about our ability to have a good fourth quarter this year, notwithstanding some of these macro these noises that are out there..

While we're on the subject of e-commerce, can you share with us what percentage of your e-commerce orders were picked up in store and how do you expect that in fiscal ‘17?.

Well, what we saw - we’re not giving the exact ratios out Anthony, what we saw in the fourth quarter was a little bit more ship to home in the mix than the prior year and I think that was driven from a couple of factors.

One, we ran a few more free shipping promotions than Q4 of 2015 and part of that was be able to make sure we are able to get the product into the customer's hands in time before Christmas. And I think there is another secular shift out there where maybe more folks at that time of year want it to show up from a front doorstep.

And I think those two factors were driving a little bit more of our business. And we certainly as we saw the downturn as Mike just talked about in store traffic.

We did see an uptick in those two to three weeks before Christmas in our e-commerce business, although the total volume involved with that was not enough to offset the loss from the store traffic..

And I may have missed this, but what's the reasoning for the lower earnings in the first half of the year. Looking back at last year, you had the similar scenario where you had lower earnings from the year before.

So, really just the traffic issue or margin, I mean, or all of the above?.

Well, it’s just the collective view and how we plan the business this year and anticipating the fruits from the initiatives that we talked through as well as the comparisons that we have in front of us.

So you know the combination of those few things in particularly and if you look at our you know whether you look at last year or two years back, things as you get into Q2 are a little bit softer than what we're up against. So as we plan the year out that's the way the numbers fall..

[Operator Instructions] Our next question comes from David Magee with SunTrust. Please go ahead..

Mickey had mentioned new clutter in the store this year as one of the goals.

I'm curious what the approach would be with regard to maybe haven't been yet in the store, some sort of you know way to generate ideas of how to decorate an area of a room or things like that?.

Right, we think the declutter comes from two main areas, one is the assortment itself and we talked about some of the moves, I shared an example like around the holidays we really kind of filled the box with some products that you know don't sell at the pace we need and we know we can build in some other areas.

So I think just the overall view of the assortment is going to help declutter the atmosphere in the store and allow us to do more and that's our intention to do more of the things you're talking about, which is, hit them in the front of the store when they walk in with a nice inviting well put together look that prompts add on purchases and builds the basket when the customer comes in.

And we need the space to do that and freeing up and going through this skew and category rationalization effort will help us do exactly that and we'll get to a point where we're really planning space in the store.

So that is certainly part of it, another part of it is the promotional effort that I described and the fact that our promotional strategy right now results in I guess a little bit more clutter in the sense of messages hitting the customer inside the four walls in the store that can be at times confusing.

We want to clean that up and that comes in the form of controlling some of those activities as well as getting the marketing behind the event sooner so that we can have a very clean crisp point of view during our event timeframes, which typically run for several weeks on end.

So we want to have that experience for the customer on that side of it as well with products and promotion that can help get through that decluttering. And that is something the customer talks about. They want to see that cleaner and we are moving fast in that direction..

Is there a demographic right now that you think that you might be under induction and maybe there is a look - a product look that might be beneficial to add to your mix?.

I think that's one that we need to hit a little harder with our product assortment and we've got ideas there as to how we would do that. Some of it is online and I mentioned earlier our expansion of third party.

Part of that expansion is going to be targeted to specific demographics, millennials being one of those, which prefer a slightly more modern up to-date cleaner look than we do.

Now we're rolling a lot of that into our existing assortment today and we've had success with it, but to be very intentional there is something that our teams working on right now..

Thanks for that and just lastly, we've done price checks in the past, you guys seem to have or have always had sharp pricing relative to your immediate competition.

Is there a way to put a message that to your customers so they know that distinction better?.

Yeah, I think it’s part of marketing way to do it and just taking more credit for that. Part of it though is just blocking and tackling of setting you're - getting yourself credit for that in your upfront pricing and we're addressing that.

We've got a price increase built into our model for this year because we feel like in targeted areas of the assortment, we can move price up and the customer isn't showing the inhibition to that.

So we are addressing it that way and what that does if you're able to do that on a bigger scale, you got more room to promote because we're not going to walk away from these promotions, these are important and we fit in that but the up-front pricing can be a driver to help us better message that, David..

This concludes our question-and-answer session. I would like to turn the conference back over to Mike Madden for any closing comments..

We appreciate everyone's attention today and interest in Kirkland on the call and we look forward to the coming quarters as we report success on these initiatives that we’re putting into place, so thank you..

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