Good morning, and welcome to Kirkland's Third Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Jeff Black with Investor Relations. Please go ahead, sir.

Thanks, Jeff. Thank you and good morning and welcome to this Kirkland's conference call to review results for the third quarter of fiscal 2015. On the call this morning, we have Mike Madden, President and Chief Executive Officer, and Adam Holland, Vice President and 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 released earlier this morning in the press release that has been covered by the financial media. Except for historical information discussed during the call, the statements made by the Company Management are forward-looking. They are 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 14, 2015. I will now turn the call over to Mike Madden. Mike?

Thanks, Jeff. Good morning to everybody. The retail environment was challenging in the third quarter, particularly in October, driven primarily by softer than expected traffic. Texas and the immediately surrounding states, where we have large concentrations, the stores comp negative in the quarter and impacted comparable store sales by about a point. The Southeast California and parts of the Midwest were notable bright spots and our fall seasonal business performed well. E-commerce revenue was robust and comped ahead of plan, yet traffic weakness was not confined entirely to Texas and we ran more promotional activities than planned to stimulate demand and manage inventory. Supply chain costs were higher, which also had a negative effect on the gross profit margin. As we had forecast, we experienced some pressure on our operating expenses as we work to get the majority of stores for 2015 opened for the holiday selling season. We are on track to open a net total of 31 stores this year and we will have 11% more stores to open this year versus last as we enter the holidays. We are excited about that, because the new stores are opening above plan on a consistent basis. We think that is due to significant strides we have made in the site selection process and that gives us optimism as we continue our store growth plan. Thus far in the fourth quarter, traffic trends while having moderated somewhat remained challenging, but healthy conversion rates are offsetting that to yield a slightly positive overall comp against last year's increased of 8.2%. Our revised guidance range assumes traffic challenges persist and that has the potential to put some pressure on our merchandise margin in the fourth quarter. However, the bulk of the quarter is ahead of us. The holiday assortment will continue to…

Thank you, Mike. Net sales for the third quarter were up 10.3%, while comparable store sales increased 1.8%. Brick-and-mortar comparable store sales were down 1%. This was driven by 3% increase in conversion offset by 3% traffic decline, resulting in flat transactions. The number of items sold per transaction and the average unit retail selling price were both, slightly down the last year, leading to a small decrease in the average ticket. E-commerce revenue was $9.6 million for the quarter that is a 38% increase over the prior year quarter and accounted for approximately 7% of total sales during Q3. In the third quarter last year, e-commerce was 6% of total sales. Comp sales trends in our brick-and-mortar stores were slightly negative throughout the quarter. Sales results in Texas, where we have our highest concentration of stores weigh down on our Q3 comparable store sales results. The sales weakness was most pronounced in West and Central Texas, along with our border stores. We opened 21 new stores during the quarter, which is on pace to meet our total store target prior to Thanksgiving. At the end of the quarter, we had 2.8 million square feet under lease, which is an 11% increase from the prior year. Average store size was also up about 1% and 7,634 square feet. Third quarter gross profit margin decreased 180 basis points to 37.2%. Most of this contraction was due to a lower merchandise margin, which decreased 105 basis points to 55.2%. Of that amount approximately 55 basis points was due to promotional markdowns to stimulate traffic and manage inventory levels. The remainder of the merchandise margin decline was due to higher than anticipated in-bound freight charges required to process containers through our D.C. during peak season. Moving onto other components of gross profit margin,…

Thanks, everybody. We are now ready to take the questions.

Thank you very much. We will now begin the question and answer session. [Operator Instructions] First question comes today from Brad Thomas with KeyBanc Capital Markets. Please go ahead. Go ahead, Mr. Thomas, your line has been promoted. Perhaps your line is muted.

Yes. We can. Please go ahead.

Okay. Sorry headset must not be working. Good morning, everybody. I wanted to first ask about the guidance. Just as we look at the change in sales, looks like you are really only bringing that down by about 1%, but obviously a more substantial cut on the earnings outlook. Could you maybe help us to just piece of part, how much is sales miss versus incremental markdowns that you are putting into place versus some of the supply-chain costs and maybe some of the store and e-commerce investments that you are making?

Sure. Brad, this is Mike. I will start and Adam can fill in the gaps. In looking at Q4 sales is a big component there, so that is a shift down I think about $5 million or so on the sales line. Margin is probably your second component there merch margin and that reflects our conservative outlook in terms of promotional activity in the quarter in response to some of the traffic softness that we have had. Then I think the third piece of that would be supply chain. In that order, Adam, do you want to add to that?

No. I think that is right. I mean, if you look, we did not give specific Q4 guide, but if you look at high guide to high guide. Brad, you are looking at roughly $0.09 to $0.10 on the sales and roughly $0.08 on merch margin, which year would get most of the delta between the previous Q4 guidance and the guidance we gave this morning. I think the sales component guide reflects the traffic trends we saw in the late third quarter and where we are right now and like Mike said in his prepared comments, most of our selling season is still ahead of us. On the merch margin side, we had a couple of things that came into play. One was the supply chain pressure. This was something that we did not anticipate the level up in third quarter, which decreased merch margin probably about $0.02 and we will see another $0.02 flow through merch margin in Q4. This is that in-bound freight component that Mike mentioned and the rest of it is really promotional activity and we look at this guidance as conservative. Especially on the margin side, there is going to be a lot of other retailers with a lot of promotions out there and we wanted to be conservative when we put out the numbers and hopefully we do better, but this is where we felt like we needed to be at this point time a week before Thanksgiving.

Great. That's very helpful. Then just if I could talk about new stores for a second, it sounds like those are still doing very well in terms of their productivity out of the gate. Just as we step back and think about how new stores are affecting. This year, they had been a bit of a drag from an investment standpoint, the last couple of quarters. I mean, how does that play out in terms of the new store contribution to the fourth quarter, specifically for the year as a whole, do they come in as a drag or as a contributor?

Well, I think you are seeing kind of the inflection point on that, Brad, because yet it has been somewhat a drag coming into the fourth quarter, because we had a lot of pre-opening effect, a lot of compression in terms of the stores opening around the same time, which weighed a bit on our OpEx, but even with the things we just mentioned in terms of the guide on sales and merch margin, we still expect to have leverage on the operating expense line. One of the big reasons for that is the new store contribution and how it affects fixed costs in our operating expense structure, so that is coming through in the fourth quarter and yes we are very encouraged by the openings that we have had. It is a very consistent class so far and it is performing above our internal expectations.

Great. All right, I will turn it over to some others for questions. Thank you.

Thanks Brad.

The next question is from Neely Tamminga with Piper Jaffray.

Great. Good morning. I just want to dig in a little bit more to make sure that we are super [ph] Traffic obviously was weak in October, but do we see positive traffic in September and August and just do they kind of fall down then in October. That is one question. I have got a couple, so let us just do it.

No. Go ahead. You finish.

Okay. I guess for November, I thank you so much for the quarter to-date commentary. I think it is helpful to understand what is going on with you guys right now. As we think about that, did Texas change has Texas been primarily still the drag, so I guess what I am hearing is, there is some sort of whether induced sort of traffic maybe general issue without the retailer. Then there is also Texas sometimes disaggregate that for November for you. Thanks.

Okay. As far as traffic through the quarter and if you recall from our first two quarters, we have not had large traffic gains to speak of, but we have been right around flat slightly negative and that was the case at the beginning of third quarter as well. Always coupled with strong conversion, we have had strong conversion throughout the year. October, there is a little hiccup there. Traffic dropped off another few points in the month and there are a lot of things going on to your point. You know, we do have a concentration in Texas. I think there is a general slowdown maybe in retail generally during that timeframe. As we have come into the early part of the fourth quarter. We are not seeing quite that level of decline in traffic. It is a little better, so I think I alluded to that in the November commentary. As far as Texas goes, early this quarter, it is a little better than it was in October as well, so there is a lot of diversity in our markets in Texas. We do have some very strong stores that are out in the more oil-producing areas and along the border as well that are weighing it down maybe more than what you might think just in the metro areas of Dallas and Houston, so there is a lot of things going on there. I think to answer your question, it is a little better in the fourth quarter so far than it was in third.

Then in terms of your sales volume week, can just remind us - because you do have such a 4Q heavy year. What are some of your key volume week think that we should be navigating and thinking about watching your stores during those key weeks.

Sure. I mean, from here I mean next week is the heaviest volume week for us. Black Friday is our biggest day of the year and has been ever since I worked for the Company, so it is a huge day for us and we have a big plan ahead of us and I feel good about our positioning for that day and really that week end, which is what it has really become more so than just a one day. Then you know there's a little drop in volume in the early part of December and then picks back up right before Christmas, so that week before Christmas would be your second biggest volume week. Then we have a decent amount of traffic even post-holiday with a lot of the after Christmas shopping and events that we run there followed by our January big semiannual sale, so it is a strong set of weeks for us that we have ahead of us, but the biggest ones are next week and then the week prior to Christmas.

Okay. That is helpful. Adam, could you walk us through a little bit more, breakdown the inventory maybe to the extent that you can around and there was a pretty decent increase in inventory, so what portion of that you worried about, what portion of that are you not worried about and kind of why.

Like Mike said in his comments, I mean, we are at an elevated level, but not to the point where we are concerned and a lot of that inventory is seasonal. The Halloween harvest selling through successful as it did is an indicator typically of our Christmas assortment will perform. I think you couple that with the fast turning nature. The fact that we have reduced receipt to account, we feel like it completely manageable. There is not aging issue. It is current. It has got a lot of stuff that we want for this year. Like I said that clearance mechanism we had in January is also there to help us move through any items that are non-seasonal in nature to start the year fresh. Also, obviously, Neely, it reflects the growth in the store count and growth e-commerce and those are natural increases that we haven't baked in there.

Could you disaggregate, maybe Adam, what in the inventory has been e-commerce kind of driven, growth driven as well as store driven? I know that is hard, but I just wonder if you have it handy in your schedule.

Yes. I would say a little more than half of the overall increase is growth-driven. Then there is a component and I think if you look at the end of the quarter we be on Christmas seasonal would be about $3 million higher than we were last year and that was planned. I mean, that is what we wanted from this year. We saw opportunity in last year's assortment to go deeper on some classes of SKUs that were selling really well last year, so we did that so that is a piece of it. Then the other I think is just some overhang from softer sales in Q3 and that would be the component that we are planning for through a stronger promotional expectation for the balance of the year and relates to what Adam just mentioned in terms of what we need to work through and it is manageable given our turn rate.

That is helpful guys. Best wishes this Black Friday.

Thank you, Neely.

Our next question is from Kristine Koerber with Barrington Research Associates. Please go ahead.

Good morning. Just a follow-up on the promotional activity during the quarter, so if Harvest and Halloween sold through pretty during the quarter, what are you marking down?

Well, I think it gets into some of the other area of the assortment Kristine. While the core has not been performing as well as we would like to see. I think we are on top of that, I think, the mix there it was kind of in a shift mode and we are working through that. I am not worried about anything content wise in the assortment, so while the core has been a little soft, lamps have been a little soft. That is competitive category right now and we have been reducing that assortment a bit as we worked through the year, so there are some things. Yes. I mean, that we are having to work through, but nothing that that I see is really holds the assortment that we can't fix.

Okay. The fall seasonal did well and you are kind of having some challenges within the core product.

Well, I think it is more traffic-Kristine. I mean, yes. I mean, some of the core product is little higher in terms of how much we have on hand simply because we have not had the foot traffic that we need that we would have that normally move through at the rate that we planned, so I think it is more that and it is just a adjusting some of those core buys going forward to make sure that we are matching pace with sales trends.

Kristine, I will just add to that the conversion metric is one of the barometers for the health of the assortment. In the conversion, we are still up in Q3, so I think that just bolsters Mike's point that the traffic is the reason for any level inventory overhang.

Okay. Then you mentioned California and the Southeast is a bright spot during the quarter. How is traffic in those regions?

It is better than certainly what we called out related to Texas in that Gulf coast area. California has been the strength. The Midwest, there is pockets of the Midwest that that we are doing really well and kind of that upper Midwest, Michigan, Ohio area and then we are doing really well in the Southeast Georgia, Alabama, Florida has been good traffic. It is mixed, but in a strength throughout the country in different areas, but for that concentration there in Texas.

Okay. Then as far as the real estate pipeline for 2016, can you give us any color on what you are thinking as far as store openings and timing of openings?

Yes. For this year, we are basically complete with our schedule. We will have 42 stores opened going into the holidays. We may have one more pop up before in January. We are working through. As we walk into '16, we as we have said before anticipate that pipeline to come earlier in the year and we are well positioned to have a good chunk of the opening schedule open in the front half. Even beyond the same the front half spread across the front half, so that we are not so concentrated which is what we had this year, so next year's class should be very much more front loaded than you saw this year.

Okay. Then just one last question, can you give us a percentage of customers that purchase product online and pickup in stores during the quarter?

Sure.

Just shy of 70% and that is not a customer's. That is revenue, so that the amount of revenue that we had generated through the side 70% of that was shipped to store.

All right. Thank you.

The next question comes from David Magee with SunTrust. Please go ahead.

Yes. Hi, everybody. A couple of questions here, one is on the conversion during the quarter, that being up, which is good to see. If you were to somehow take out the impact of being more promotional would that number still be positive do you think?

Yes. That is obviously hard to do, but yes. I think it would pay. I mean, we were running before we got a little more heavy in the way of promotion, we had a nice conversion gain. If you go back into the prior quarters, you had to so yes - when we get them in the store, they are buying whether…

If you were to adjust the current trends for traffic, would you say the conversion on the Christmas seasonal is higher year-to-year?

Yes. It is hard to confine conversion to the category level. We are seeing early strong results out of that assortment, so that is part of the conversion gain, so I think that is a component of, yes.

I guess, a better way to ask that would be adjusted for traffic are you satisfied so far with the Christmas seasonal sell-through, because as I understand it is not promoted right now so?

That is right. I mean we have got some planned percent ops and things that we do, but yes I mean we are pleased so far with the progress in an assortment, so that is a good sign.

Then lastly on the extra inventory at the quarter end just to make sure I understand this, so this is in your opinion core product for the most part the efforts there.

I think it is. I mean it is not seasonal, we are heading into the seasonal period here with that and we just talked about it and it is early performance. It is more everyday product in some of the core categories that we carry and just letting that come back in line over a few months here should be all we need.

Would you want to a forecast now what the inventory might look like at year-end?

I think we will wait and be really specific there. The one thing I would say is as you start to go into the end of the year we are going to start being up against the effect of that port slowdown which held our inventory level low beginning really about this time last year and continuing on through April, so that is something to keep in mind you look at a year-over-year compares as we go forward.

But would you be quantify or just for that variable?

Yes. We will do that when we get to the comparison and we talk about it.

Okay. Great. Well, good luck guys. Thank you.

Thanks, David.

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

Good morning. Thank you for taking the question. My first question is just a little bit more on Texas. I wanted to see if you could be a little bit more specific as to what you are seeing and your Dallas and Houston and San Antonio open markets?

Anthony, I would call it out as we are softer in the Western part of the state some of the markets like San Antonio, along the border Austin and further west. It is offset a bit by Dallas and Houston being a little stronger and then we are also seeing some weakness in Oklahoma and Louisiana.

Okay. That is helpful color. Also, you spoke a lot about the additional supply chain costs, so heading into the next year, I know you have not provided guidance specifically for 2016, but would you expect to leverage the supply chain costs?

Anthony, this is Adam. For what we have experienced in Q3 and what is going to bleed over the margin in Q4, these inbound charges that we are very I would call discrete items through the quarter should not happen again next year. We have had planned measures in place for a while to avoid those type of charges and it plan from earlier in the year was to get our second facility up and going in Jackson to defray some of those charges. As Mike mentioned, we weren't able to get that facility up and going fasten enough and created a bit of an in-bound backlog, which calls these per diem and demurrage charges that we saw, so those charges yes. Those should be leveragable next year. Overall supply chain I think you probably not going to see the leveraging effect until we get a more robust chain all the way back to court, which could include the form of the West Coast Bypass as well as the second facility outside of Jackson.

I think next year we do have opportunity to kind of hold the line on supply chain costs given the measures that Adam mentioned so that discrete component it should not occur.

Got it. Okay. In terms of any expense reduction that you can take to try to offset some of the weaker top-line performance?

It is kind of line-by-line as we look ahead. If you are talking about the fourth quarter, there is not a whole lot we can do. We can control some of the marketing spend, but I think it is important that we maintain activity there to continue to drive traffic. As we go forward, I think we have passed a lot of the fixed cost investments that we have made, so holding the line on corporate expenses is going to be really important and we certainly intend to do that going into the next year. Then really just beyond that it is looking at every line item and seeing what you can control best and put that into place.

Okay. Thank you.

Thanks.

[Operator Instructions] The next question is a follow-up from Brad Thomas with KeyBanc Capital Markets.

Yes. Hi. Thanks, guys. Just a couple of other follow-ups if I could, first just in terms of what you are seeing out there, could you tell us what you are seeing from a competitive standpoint? Do you think that those you are up against are seeing the same issues and are increasing their level of discounting?

It is competitive space. I think there are a lot of promotion going on, but it is hard to really pinpoint by retailer. We have certainly baked that into our fourth quarter plans and we think the season is going to be a little more promotional given the slowness overall that was in place towards the backend of Q3, so we plan for that.

Great. Then just in terms of some of the new system and processes that you all have in place. It has obviously been something that has helped the Company do a great job over last few years from a comp standpoint, but as you kind of see how the system work over a period, where sales have slowed down, maybe Mike could you speak to how - it is helping you with your markdown cadence or any risk should there maybe?

Well, I think the systems have really helped us achieved the strong of positive comp quarters that we currently still have in place and a big part of that is being able to identify core merchandise, which now makes up almost 40% of our total sales. Everyday products that have a steady sales rate and that was a big win as we implemented a lot of those systems and processes and we have benefited from that. I think going forward, the core now that is in place I think we need to some deeper scrutiny as to knowing when to pull back on some of those items and no one to inject the new to make up for that volume and I think the bigger opportunity going forward system-wise is regionality. We are doing a little bit of that now and it is an initiative that we have really been working on with our merchants and planners to get more store specific with our assortment we get along way to go there but we do have tools in place to help us with that, so those are all sales and margin drivers as we look ahead that we really have not fully experienced yet.

That is great. Then if you hit your guidance, where would you expect free cash flow for the year to shake out or where would you expect your cash balance to be?

Well, it would be somewhere in the range of - it is a wide range, but, say, mid-60s to maybe $70 million. Of course a lot of that depends on the fourth quarter operating performance, but you would recall we did pay out a $26 million dividend earlier in the year. We will have some more share repurchases ahead of us, which we will use some of the cash and we have got a slightly higher CapEx number really due to that end of the year timing issue that I mentioned, so it is still a very healthy cash balance and we feel like we are well positioned to make the investments we need to make going into the next year.

Great. Then if you would hazard a guess at this as we think out to 2016 any sense for what level of comp you may need to generate operating margin expansion next year?

It is early, Brad. We are going to give a lot of color on that next time we speak, but I think that we can with a modest comp, achieve that. I mean, there are some roadblocks potentially to that for all the retail particularly, when you talk about labor costs for us. I think supply chain is going to be a focus, but something I think we can hold path. If we can comp and continue this growth plan and it would be more front-ended, we do have the opportunity I think to generate leverage at a three comp range.

That is great. Thank you for all the answers and good luck this holiday season.

Thanks Brad.

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

Thank you, everybody, and we appreciate your attention and time on the call today and we look forward to talking with you next quarter.

Thank you, sir. The conference is now concluded. Thank you for attending. You may now disconnect.