Jeff Black - SCR Partners Woody Woodward - Chief Executive Officer Mike Cairnes - President and Chief Operating Officer Nicole Strain - Interim Chief Financial Officer.

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

Good morning and welcome to Kirkland's Third Quarter 2018 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 Mr.

Jeff Black with SCR Partners. Please go ahead..

Thank you. Good morning and welcome to Kirkland's conference call to review results for the third quarter of fiscal 2018. On the call this morning are Woody Woodward, Chief Executive Officer; Mike Cairnes, President and Chief Operating Officer and Nicole Strain, Interim Chief Financial Officer.

The results as well as the 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 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 company's Annual Report on Form 10-K filed on April 3, 2018. I will now turn the call over to Woody..

Thanks, Jeff, and good morning to everyone on the call and thank you for attending. I'm happy to speak with you today as the CEO of Kirkland's. As you may know, I joined the company at the end of the third quarter, after leading Crate and Barrel as President and Chief Merchant.

I have a deep understanding of the home decor demographic and strong experience, innovating product and developing brands. While it's too early to speak to specific plans for 2019 and beyond, I do want to open the call with some directional comments that should be useful as you think about Kirkland's.

Since coming on board, I've spent lots of time visiting stores, meeting Kirkland's employees and doing some deep dives with a particular focus on merchandising, product design and branding. One of my first impressions is that Kirkland's has a robust operational focus.

I want to commend Mike and the executive team on their progress in creating a lean structure that supporting fast and effective decision making.

I'm very supportive of ongoing initiatives to improve efficiency and believe the foundation that's been established will enable us to move quickly to put Kirkland's on a path to sustained earnings growth and that's a goal we all share. I am also a firm believer in Kirkland's value proposition. We offer quality product for compelling price.

I want to be clear at the outset that my strategic focus will be to reinforce Kirkland's as a source for customers looking for home design ideas, while staying in the lane of affordable home decor. Our goal will be to continue to surprise and delight our current loyal customers, while testing and learning how to broaden our appeal.

I'm truly excited to work with Mike and our team to all of Kirkland's. We will continue to attack the fundamentals as we work to innovate the products to improve both consistency and relevancy. My overall impression is that the potential to grow the company far outweighed any near-term challenges.

We will have a lot more to update you within the coming months and I look forward to reporting back on our progress. Now I'll turn the call over to Mike..

Thanks, Woody. Third quarter results were in line with the second half projection we outlined in August. We achieved improvement in profitability, driven by positive comparable sales and continued progress on operating performance.

We remain on track to deliver a solid fourth quarter, and we're excited to welcome our merchant leader Woody's caliber as we build out our strategy for 2019 and beyond. We are aligned in our goal to continue to enhance the foundational aspects of the business, while accelerating the merchandising and branding initiatives.

We believe that the powerful combination that will generate long-term sales and earnings growth. Total sales increased approximately 7% in the quarter, reflecting a reacceleration in e-commerce growth and an improvement in brick and mortar traffic and sales metrics.

In addition, our class of 2018 stores are performing well, responding to the attribution modifications we made to our real estate strategies. Our seasonal categories performed well in the third quarter with strong performances from fragrance and candles, textiles and pillows, furniture, as well as floral.

The wall decor categories remain challenging, as we are in the process of updating these assortments. The EBITDA margin improved versus the year ago quarter as well managed operating expenses offset headwinds in the supply chain industry. Inventory is in alignment with full-year revenue projections, which sets us up for success.

I'd like to call out a few advancements in the business that will improve the customer experience, support growth and increased profitability. First, we completely rolled out Buy Online, Pickup in Store enterprisewide. We are ahead of schedule as we are adding SKUs and both this now represents over 10% of e-commerce sales.

The customer feedback has been highly favorable and we're improving add-on sales at the brick and mortar point of pickup. This is a major milestone for the business as it gives us additional arsenal for the holiday season in years to come. It drives traffic, adds profitability and ultimately punctuates Kirkland's as an omnichannel retail player.

Secondly, we made major enhancements to our supply chain efficiency. We significantly improved the flow of our DC operations, which added 20% plus more capacity. We improved our truck utilization and streamlined our routes. Meanwhile, we continue to make strides in overall operational effectiveness and efficiency of our e-commerce fulfillment center.

All this work is important in allowing our product to flow better for this holiday season and mitigate industry cost pressures. In addition, we brought on a new CIO and a new VP of store operations, both experienced in these roles. This is another giant step forward as we enhance the leadership talent of Kirkland's.

Finally, we stood up a next generation store, the store has a bright and updated feel as well as improved shop ability through flexible fixtures, purposeful navigation, product rationalization and improved site lines to help the customer journey.

The store has been up over 10 weeks, and we're absolutely thrilled with the customer reaction and performance. Will be more to come as we integrate the learning’s and elements from this store to our existing store base and new stores going forward. I'm going to pivot to our holiday season. We're taking lessons learned from last year into this year.

Think of Q4 in three stages. In the first part of the season, we have another great assortment of Christmas product for decorating the home. Clearly that product is resonating as we're coming off a very encouraging Black Friday weekend and our holiday product is selling through nicely. Then the customer shifts her mindset to gifting.

What will be different this year, is that we're following up with a terrific lineup of themed gift products available in store and online. Then comes the third stage, post-Christmas. Last year, we relied on clearance to carry us through January.

This year, you will see new relevant products, such as decorative storage, trend right floral and inspiring modern farm house home decor product to fill the gaps when the Christmas decorations come down. This will help drive traffic, while maintaining margins.

As we look to 2019, we'll continue to invest in high return projects, in addition to e-commerce that includes initiatives to advance our next generation store and improve our supply chain.

Relating to tariffs, we've already taken steps to offset the impact of the 10% tranche through vendor contributions, some surgical price increases and promotional shifts. This affects roughly 25% of our product.

Assuming the tariffs increase to 25% at the beginning of the year, we've built a plan that includes deeper vendor contributions and broader price increases where we believe we have elasticity. In addition, we believe we can leverage our newly formed analytical capabilities to lower discounts.

We'll have more details later once we get definitive word from the G20 Summit and finalize our plans. At the same time, direct sourcing will come into stronger play in 2019 and beyond, we've hired direct sourcing director and we've taken steps forward that will broaden our manufacturing network and help with product costs.

In summary, we're continuing to enhance the foundational aspects of the business in pragmatic steps. The addition of Woody will accelerate the merchandising and branding aspects providing a powerful combination in the evolution of the business. With that, I will turn it over to Nicole to discuss the financials in more detail..

Thank you, Mike. Net sales for the third quarter increased 6.6% compared to the same period in the prior year. Consolidated comparable store sales increased 1.4%, which included an approximately 23% increase in e-commerce. This was on top of the 0.7% comp increase in stores and a 41% increase in e-commerce in the prior year.

In our brick-and-mortar store, while we continue to see negative traffic as have seen in the industry, we did experience an improvement in trend from prior quarters. Traffic was offset by an increase in conversions and a higher average ticket.

We opened six new stores and had no closings during the quarter, ending with 432 stores, which is the net year-over-year gain of 17 stores or 4%. We opened 22 stores through the third quarter and have now opened the remaining stores to get to our 25 planned openings for the year.

Our 2018 opening continue to outperform our expectations with average unit volumes and sales per square foot trending above our comp store base. We continue to refine our analytics around new store performance and the optimal store model. E-commerce generated $18.8 million in revenue during the quarter were approximately 12% of total revenue.

This increase was driven by a combination of increases in website traffic and conversion. Our third-party drop ship channel continues to grow as a percent of our e-commerce revenue accounting for just under 30% in the third quarter, compared to approximately 20% in Q3, 2017.

As Mike mentioned, we completed the rollout of BOPUS in the third quarter with an initial count of roughly 200 SKUs. As of today, we have increased the number of available SKUs to over 500 and are seeing increases in BOPUS sales and in-store add-on sales and we continue to receive positive customer feedback.

As we increase the percentage of e-commerce sales that are picked up in store or shipped by third parties, we expect to continue to see improved profitability in this channel.

Moving on to margin, gross profit margin in Q3 decreased 120 basis points from the prior year to 30.2% excluding a one-time adjustment as we prepare for the upcoming lease accounting guidance change, gross profit margin decreased 70 basis points from the prior year to 30.7%.

And as a reminder, both the current and prior periods have been adjusted to include depreciation related to store and distribution center assets. Merchandise margin decreased from the prior year by 30 basis points to 55.4%, primarily driven by an increase in inbound freight.

Similar to other retailers, we have seen an increase in inbound rate affecting both ocean and Intermodal and an increase in fuel costs. The increase in rates is partially driven by demand outpacing supply as many US importers accelerated shipments before tariff went into effect.

Merchandise margin includes the direct cost of merchandise, as well as product shrink damages and inbound freight. Outbound freight costs, which include e-commerce shipping, increased 20 basis points as a percentage of net sales, which was driven by an increase in e-commerce penetration.

Improved route efficiency and truck utilization offset fuel and rate pressures on transportation of our products from the DC to the store. Store occupancy costs increased 80 basis points over the prior year quarter. Excluding the one-time adjustment mentioned above, store occupancy cost deleverage 30 basis points as a percent of sales.

Central distribution costs decreased 10 basis points as a percent of sales compared to the prior year quarter. Moving on to operating expenses, operating expense for the third quarter was 30.8% of sales, which was down approximately 190 basis points to last year, when we exclude the CEO transition charges.

Store operating expenses decreased by 110 basis points as a percentage of store sales over the third quarter of 2017, and that was due to a favorable workers' compensation insurance adjustment, leverage on fixed charges and expense control.

E-commerce expenses decreased by 140 basis points as a percent of e-commerce sales due to leverage on fixed cost components, partially offset by incremental advertising expense. Corporate expenses, again excluding the CEO transition charges decreased by $150,000 or 60 basis points year-over-year.

Depreciation and amortization remained flat to the prior year as a percent of sale. Our tax benefit for the quarter was approximately $700,000 or 20% of the pre-tax loss, and that's compared to 35% in the prior year period. Again, the lower tax rate in 2018 is primarily due to the changes included in the Tax and Jobs Act of 2017.

We ended the quarter with a net loss of $0.18 or $0.13 adjusting for the CEO transition charges, and that's compared to a loss of $0.15 in the prior year quarter.

And moving on with the balance sheet and the cash flow statement at the end of the quarter, we had $23.8 million of cash on hand and that's compared to $27.9 million in the prior year period. We had no long-term debt or borrowings outstanding under our revolving credit facility.

And as a reminder, the third quarter is consistently the low point of our cash balance for the year. Our inventory balance at the end of Q3 was in line with our expectations at $113.8 million compared with $104.8 million in the year ago quarter or an increase of 9%.

The increase in inventory is due to store growth over the prior year and anticipated fourth quarter sales. Year-to-date fiscal 2018 cash used in operations was $20.8 million compared to $12.3 million in the prior year. The primary drivers were working capital changes and a decline in operating performance.

Capital expenditures were $25 million, compared to $23.6 million in the prior year. Of the $25 million just over 60% related to new stores and existing store improvement and the remainder of the e-commerce supply chain and other system investment. During the third quarter, we repurchased approximately 690,000 shares at an average cost of $9.51.

Year-to-date through the end of Q3, we have returned $10.4 million to shareholders with approximately $9 million remaining under our existing authorization. We are reaffirming our 2018 outlook for diluted earnings per share in the range of $0.50 to $0.60, and that excludes costs in the second half of the year related to the hiring of the new CEO.

We are updating other components of our guidance, we expect square footage growth in the range of 3% to 4% driven by 25 openings and 13 to 15 closings. We expect total sales growth year-over-year in the range of 3% to 4%, which implies a flat to modest comp growth.

The anticipated effective tax rate for the year is 30%, and includes the impact of stock compensation activity, primarily related to the CEO transition during the year. And finally, we are increasing our expected capital expenditure range to $29 million to $31 million as we have accelerated some IT projects that were budgeted to start in 2019.

Thank you. And now we will open it up for questions..

[Operator Instructions] First question comes from Brad Thomas with KeyBanc Capital Markets. Please go ahead..

First of all, I wanted to welcome you Woody and maybe ask if you could share a little bit more about where you see some of the biggest opportunities and potentially weaknesses of Kirkland's, as you look at the state of the business today..

Yes. Thanks, Brad. I'd love to. First of all, I'd like to say that I'm surprised that there's as much talent and operational rigor around the opportunities than I thought, especially in merchandising. But on a negative side, and not negative because it's fixable, I see our stores being somewhat over cluttered and the need for some product editing.

These are things that I think are fairly quick and easy to fix. I think, we have a lot of opportunity in extending our assortments and I have a hypothesis or some new categories that will be unveiling in the next earnings call when I'm ready to talk about the total vision for the future. I think that we have very good talent.

Our store presentation upgrade and continuing ongoing operational initiatives really give me a lot of optimism about the future. So I hope that that gives you my six weeks of total knowledge. But I'd like to just leave by saying that I'm very optimistic about what I'm seeing here at Kirkland's and the opportunities for the future..

I guess zooming in on some of the financials here.

Could you just give us an update on, as we think about the tariffs, the percentage of your products today that look like they are exposed to what could potentially be the 25% tariff on January 1st?.

Yes. So, at least on the list that affects the 10% that's roughly a quarter of our products..

Got you. Okay and....

This is Mike, I'll build on that. As I'd mentioned in my earlier commentary, so far we have already implemented the 10% tranche through vendor contributions. We've taken some very surgical price increases and made some promotional shifts to offset the impact of the 10% tranche.

Now, as we contemplate the 25% potential, we have built a plan around that, that has deeper vendor contributions, some broader price increases where there is elasticity and we will be looking at lowering our discounting to help offset that as we go into 2019..

Got you, okay.

And with respect to the direct import opportunity, could you talk about how quickly you can scale that opportunity, particularly as you look to next year where there is this potential tariff headwind?.

Sure, Brad. So here's where we are in that process. We have hired a Director for direct sourcing. We've begun laying out the process of the product category plans. Woody and I are already talking to some agents. We've built a roadmap. Woody and I both have deep experience in direct sourcing.

And the obvious implication is the opportunity on margin and cost reductions on the product. But what we're probably even more excited about is the opportunity to have a broader net of product opportunities and manufacturing options. And I think that's where you can sometimes get greater value.

I believe Kirkland's at times has been a little comfortable and a little monolithic in its vendor choices and this will open up more possibilities going forward. We expect that impact to start to really take root more second half of next year and the greater impact 2020 and 2021..

That's great. And it sounds like the holidays are off to a good start here. Clearly some nice momentum with the positive comp in 3Q. I guess, can we talk about the margin dynamics here of 4Q, a little bit more. I think to get into your implied 4Q guidance here that we will need to see the operating margin up about 150 basis points or so.

Can you just talk a little bit more about the puts and takes on margins here for 4Q and your line of sight on that?.

Yes. Let me kind of talk about how it's shaping up and then I'll answer your question directly on the margin side. So as I mentioned, we are off to a good start. We're really thrilled with Black Friday week and Cyber Monday, it says that our holiday product is really working.

And when you have that, that means you -- you don't have to promote out as much on the back end of that. So that's part one of your answer. In addition to, we have some things in the pipeline that are different than last year. We have a gift guide, that's new. We have Buy Online, Pickup in Store, that's new.

Buy Online, Pickup in Store by the way is margin accretive, because it's going to ride at the same level of margins that you would see with a store purchase. And we have more emphasis this year on gift cards, which is also new and I think that will pay dividends more so in January.

And then having the new product in gifting, having the new product post-Christmas, I think will also give us something to market, something to sell at a higher margin rate. And last year, when the sales started to tail off, we started to get more promotional in nature.

So I think from a comparative basis, I think we're in a much better position than we were from a year ago. So I like where we are. I like our prospects for Q4 as we go forward..

That's great. Thank you all so much. Good luck this holiday season and thanks again for the help..

Thanks, Brad..

Okay. The next question comes from Jeff Van Sinderen with B. Riley FBR. Please go ahead..

Hi, good morning. And let me say congratulations on the improving trends. And I guess for Mike or Nicole, whoever wants to take this.

Did you guys give inventory per foot? I wasn't sure if I heard that and then maybe where should we expect per foot inventories to be as we end the year and the fiscal year? And then maybe if you could just touch on, if you hit guidance where the cash level might be at the end of the year?.

Okay. So we don't and didn't give inventory per location or per square foot, but I can say, we're roughly 2% above last year and really right on our plan for where we expected to be at the end of the quarter. Similar position expected on inventories for the end of the year.

And then as far as cash, I would say, it depends a little bit on our share repurchase activity. But if things continue as they -- as we expect, we probably end the year down to last year by between $5 million and $10 million..

That's helpful. And obviously, you need a little bit more inventory per foot if you're going to comp positive most likely unless you're getting a lot more efficiencies. And then for Woody, first, let me say, welcome aboard. I know it's early for you.

But just to clarify, it sounds like you're not planning on pulling the rug out from under the existing customer pun intended.

And then when should we noticeably see your influence on the overall merchandise assortment? I guess maybe how do you think about your increasing influence going forward?.

Yeah. And thank you for noticing that. I'm not a run puller out there. I love that comment, but because I honestly respect the current customer, she has been loyal to Kirkland's, we want to make sure that she is engaged in part of our, what I would not calling a turnaround, but a refresh of the Kirkland's brand.

I love the DNA of this Company, it's very value-driven and I want to stay with that proposition, because there's a lot of white space I believe above the big box value players, but below the specialty players. And I think there is a space in there that would just perfectly work for Kirkland's. So generally, I'm really optimistic about the talent here.

And also when does the results -- well, I mean, I came in our first day and we did a style out. So it's already happening. I'm diving right in and we were able to make tweaks and edits for even as close-end as January's floor set by, I believe that we are not quite as clear as we need to be when the customer walks into the store.

Our store should be the maximum expression of our brand and we had just a little too much going on to really be clear about what the statements that we're trying to make are.

So we went to use some slight editing and I think, it gives more clarity to the customer when they walk in about what we're really trying to stand for going forward in the product.

But in terms of new product categories, new potential opportunities, I think that we can make it possibly -- we rushed something at the end of the second quarter and certainly going into the third and fourth quarter with quite a bit of new opportunities. But more to come. And I appreciate the question..

And then I just had a follow-up on the direct sourcing piece.

I may have not heard it, but did you give a target percent of direct sourcing for next year? Just, I guess, maybe also some timing around the thoughts of kind of when you get to the next level of direct sourcing?.

Jeff, we did not give a target level at this point, and as we bring on our new Director of Sourcing, as we look at our merchandising strategy on the back half of the year, we'll be in better shape to give you more thoughts around that down the road.

But I really like the track that we're on right now and I think it's the right track for us and I think, it's going to pay dividends over time..

Okay, good. It sure should be a nice boost to your margins over time. Thanks for taking my questions and best of luck for the rest of holiday..

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

Yes, good morning and thank you for taking the questions, and welcome aboard, Woody.

So just wanted to get a better understanding on how should we think about the add-on sales opportunities with BOPUS now in place?.

Yes, good morning, Anthony.

It's a muscle that we are developing right now, as you well know, BOPUS is brand new for us, we rolled it out enterprisewide in Q3 and what I can tell you is a couple of things, one is the customer is really voting for and we're getting really great feedback on it, and the stores week over week over week are continuing to get better and better in terms of suggestive selling and add-on sales with BOPUS.

So I like the trend we're on, and as I mentioned, we're actually ahead of where we expected to be at this point, as we continue to add in more and more SKUs and I like the prospects of what it can give us in Q4, but particularly in 2019..

Got it, okay.

And as far as the tariff impact, so, you mentioned the current 10% affects 25% of your merchandise, if it goes to 25% in January, what percentage of your merchandise would be impacted?.

It's the same percentage of the merchandise, because as it is, same with -- just escalates the tariff percentage. Obviously, it has a bigger impact on our margin but --.

So we are working to do -- we're working through those plans. We'll know more after this weekend and we're working through those plans and we're -- we will be ready at that point..

So which product areas would you say, you have the greatest pricing elasticity in?.

It's -- it's really hard to nail it down, it's really across the board, but the nice thing is that a lot of the product that we have for Kirkland's is exclusive to Kirkland's, and so it is not -- there's not a lot of items that have identifiable singular prices in the minds of the consumer.

So some of this is going to be a little bit trialed by air, some of it is going to be based on the analytics of what we're seeing in terms of the lift and we'll have to kind of work our way through that as we go through the year. I think in the end, I think, it's going to make us a stronger retailer, truth be told..

[Operator Instructions] Okay, seeing no further questions in the queue. This concludes our question-and-answer session. I would like to turn the conference back over to Mike Cairnes for any closing remarks..

Thank you. On behalf of Woody and myself, we want to thank this wonderfully talented team. We appreciate what you're doing to evolve the business and we thank you in advance for what we will become..

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