Good morning and welcome to Kirkland’s Fourth Quarter 2015 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jeff Black. Please go ahead, sir.

Thank you. Good morning and welcome to Kirkland’s conference call to review results for the fourth quarter of fiscal 2015. On the call this morning are Mike Madden, President and Chief Executive Officer; and Adam Holland, Vice President and Chief Financial Officer. The results as well as notice of the accessibility of this conference call on a listen-only basis over the internet were announced earlier this morning in a press release that’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 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 it over to Mike.

Thank you, Jeff. We were pleased that fourth quarter earnings came in slightly above the guidance range we issued in November. Expense management provided most of the lift as gross margin remained under some pressure in the context of a softer sales environment. Overall, 2015 was a challenging year, but also one of maturing and advancement. We drove double digit sales growth with a solid class of new store openings and continued strength in e-commerce trends, yet our profit margin was below our original forecast as we encountered some macroeconomic issues and experienced some supply chain and peak season challenges. Texas and other oil and energy related areas came under pressure during the back half and given our store concentrations, softer trends there had a disproportionate effect on the overall business. Additionally, a stronger dollar limited business along the border, with those stores also performing below company average. We also experienced higher supply chain costs as port-related disruptions earlier in the year gave way to a compressed merchandise flow ahead of our peak delivery period. Due to timing issues, we delayed the full transition of our e-commerce fulfillment operation to a new facility. This delay coincided with heavier new store activity and an acceleration of the e-commerce business resulting in lower gross margins. While earnings for Q4 reflect these macro and internal challenges, we made significant progress during 2015 to support our growth plans and strengthen the organization for the long term. We continue to upgrade our merchandising efforts. Through the development of our core items strategy, we have prioritized everyday items and that’s providing more stability in our overall results. During 2015, we moved forward on a number of initiatives to improve the interaction between merchandising, visual presentations, stores and marketing. Stronger organizational linkage between these groups is crucial…

Thank you, Mike. Net sales for the fourth quarter were up 11.4%, while comparable store sales increased 1.3%. Brick and mortar comparable store sales were down 0.8%. This was driven by a 3% increase in conversion, offset by a 3.4% traffic decline, resulting in a slight decrease in transactions. The number of items sold per transactions was slightly down to last year and average unit retail selling price was modestly higher, leading to a small decrease in the average ticket. E-commerce revenue was $13.7 million for the quarter. That’s a 36% increase over the prior year quarter and accounted for approximately 7% of total sales during Q4. Comp sales trends in our brick and mortar stores were slightly negative starting the fourth quarter, but then improved in December. In mid-January, we experienced adverse winter weather which impacted traffic and store sales by approximately $1 million. Geographically, comparable store sales results were mixed during the quarter, with 15 of our 35 states showing positive brick and mortar store sales performance, but similar to what we experienced in the third quarter, the oil patch in energy states, Texas, Oklahoma and Louisiana weighed down on our comparable store sales results. Combined, these three states impacted the total comp by about a point. We opened 12 new stores during the quarter, 43 for the year, ending the quarter with 2.9 million square feet under lease, which is an 11% increase from the prior year. Average store size was also up 1.5% to 7,600 square feet. Fourth quarter gross profit margin decreased 240 basis points to 40.5%. Merchandise margin, a component of gross profit margin, made up most of that decline as it decreased 154 basis points to 53.7%. Of that amount, approximately 70 basis points was due to promotional mark-downs to stimulate traffic and…

Thanks, Adam. While the first half will be a bit more challenging as we enhanced our supply chain and execute on the bulk of our planned unit growth, we’re very excited about the path we’re on. We’ll be better positioned as we enter our key seasonal periods for 2016, with inventory growth moderated. We’ve improved new store openings and added a scalable e-commerce channel and both of these should benefit as we streamline the supply chain. And importantly, we remain confident about our position within the sector and believe that we offer a combination of product, value and experience that is distinctive and supportive of our strategic plans. We’re encouraged by the opportunity to grow earnings as we expand our niche and home décor and we look forward to updating you on our progress in the coming quarters. Chad, I guess we are now ready to take a few questions.

[Operator Instructions] The first question comes today from Brad Thomas with KeyBanc Capital Markets.

Congratulations on the [NY holiday] here and the opportunistic share purchase.

Thanks, Brad.

I wanted to first ask about inventory and your expectations for markdown cadence and merchandise margins just as we begin this year. Adam, I know you gave some more color around where inventory levels are today. Where are you still out having to do some markdowns and how much pressure do you think that may have on the next couple quarters before you get the inventory in line with where you’d like it to be?

As Adam covered, inventory was up a little over 20%, a part of that was a comparison. I mean, we were up against some lower levels last year due to port congestion. That takes it down to 17%-ish and we have some new store build, not a whole not, but if you compare that with our projected top line growth rate and he called out about a 6% delta, we will weigh on the merchandise margin a bit here in Q1 and into Q2, but not to the level we saw in Q4, because a lot of that product – we’re just kind of heavy, we’re not heavy in seasonal products, that’s already drastically marked down, it’s just adjusting receipt flow and trying to drive a little bit at the point of sale too and combining those two to get us right back in a position as we enter and proceed into the second quarter.

And if I could add a follow-up question about the discussion of the long-term potential for the company, I believe you referenced a high single digit operating margin. Could you maybe talk about some of the inputs to that? Where would you envision a normal or healthy level for merchandise margin? What sort of impact might there be from e-commerce? What kind of sales per store or comp trends might you need to see to add a few points to operating margins from where they came in from last year?

I think it really gets back to some of those longer-term goals I covered in the remarks which is we have a growth plan to get us to a 500 store level over, I’d say, a three to five-year period of time. We’ve got internal plan to drive in-store productivity which we’re geared toward getting that average volume up into the $1.6 million plus range as we continue to improve our store base, but also drive some specific initiatives relative to conversion average unit retail traffic. So that’s a big piece of it. Getting that penetration of the e-commerce business up into the 10% range and leveraging what we’re seeing with ship-to-store even further with supply chain improvements has a big impact. I will point out that profitability is starting to be very comparable to what we’re seeing in the stores, given that two-thirds penetration which we have right now, which is ship-to-store. So that’s been a positive. And then I think it gets to just getting a little better with things that we do on a day-to-day basis. Supply chain is a good example of that, just being prepared to handle that growth. Our store payroll model adjusting and we’re adding some capabilities there, because the expense end of the equation is very important as well. So a lot of it is leverage, but some of it is growth. And then on the merchandise margin end of it, I think it’s just squeezing out a little bit more every year through some of these initiatives, managing our promotions better. So all those things together kind of get you into that 8% range and maybe it can be more, but that’s what we are shooting for right now.

And if I could squeeze in one housekeeping question for Adam, if you have it handy, do you know what the year-end share count was? Just want to have that right after your big repurchase in the fourth quarter.

It’s approximately 15.8 million shares outstanding at the end of the year.

The next question comes from Neely Tamminga with Piper Jaffray.

So a couple big picture questions here from us. On the four pillars of the longer-term strategic plan, just want to key in on a phrase that you had said that you’ve been working on getting the team aligned behind these. Can you expand a little bit more on that in terms of have you actually physically changed some of the KPIs or metrics around compensation for varying groups or weighting just specific targets to kind of mix what is on the same page? Would love your thoughts in and around that. And then if I may also, dovetailing a little bit off of what Brad just asked about around ultimate operating margin target, I just want to speak this back. You’ve done obviously double digit in prior history, you’re now talking about high single. We understand and appreciate it’s a different environment today versus prior. Is the primary delta then pretty much the competition landscape do you think more or is it around just the cost of e-commerce fulfillment or some other structural issue? We just want to make sure we’re understanding that.

I’ll start with a question about the strategy. We’ve added a lot of new people to the team over the last 24 months and one of the things that I felt was extremely important in taking a new role was to lay that foundation. So we spent a lot of time as a team, first of all, just making sure we were gelling and also getting aligned. And what I talked about today was some of the output from that. And we are in the process of looking at how we might incentivize people differently in the context of that plan, but that’s going to play out. I think the important thing to take away is it feels like a new day in terms of what we’ve done. And we are reaching down into the depths of the organization throughout the store base, throughout the distribution centers and our corporate office to ensure that everybody here is marching to the same beat and we’re very excited about having that foundation built and I think it will serve us well going forward. We’ve got a challenging task ahead of us and that kind of leads me to your second question, which is how do we get the performance back to that level that we have shown in the past. And it is a different environment. We’re working in multiple channels now, the e-commerce effort we launched years ago is completely different than what we’re doing now, it’s so attached at the hip with the store base. And that does have an impact on our operating expense structure and our supply chain in particular. And we’re working on a lot of those things right now. So I think that’s the bigger piece in terms of – we’re not talking about 2012 and 2013. I’m not saying that’s impossible. If we execute well and continue to improve our delivery in each channel, I think that the business certainly has the cash flow characteristics and the capability to drive a higher and higher operating margin, but we’re focused on getting it back to that high single because I think that’s what makes sense in the context of the timeframe we’re talking about here internally. So that’s a long-winded answer, but I think the competitive landscape, you asked about that too, it’s certainly picked up. So I think I’d go back to my statement though, I really feel strongly about our position in that landscape. It’s more of an execution thing for us and navigating through these challenges that we face and doing it well.

Absolutely. We obviously agree that you guys are headed in the right direction and support that for sure. Following up a little bit more, maybe this is more for Adam than it is for you, Mike. But I’m thinking just structurally around sales and inventory. I mean, we – I can understand there is little puts and takes here from Q3 to Q4 and Q1 to Q2, but as you do migrate more towards drop-ship, should we structurally think over the long haul that your inventory growth will be that of less than the top line growth that sales growth should outpace inventory growth, is that how you guys are thinking about it on broad strokes to the path to high single digit? And then a specific follow-up on SG&A, everyone is talking about minimum wage increases and what have you and what the impact is to the overall model. What is that in aggregate as we think about your SG&A? It looks like you’re going to leverage on the year, but clearly you’re paying your people too, so could you contextualize what the SG&A component of wage increases might be for you guys?

Sure. I’ll go back to the first part of your inventory question and the answer is yes, of course we want to increase sales at a fast rate than inventory. What piece drop ship plays into that, I think it’s too early to say. It’s still very early, although we’re optimistic with what we’re seeing so far. The key for us is to maintain an assortment that’s unique and is proprietary as possible. On the second piece, [FSA], we have allocated expenses in the second half of 2016 based on what we know today. That’s included in the guidance. We believe we’ve been conservative, but when we know more information of course we’ll adjust.

Our next question comes from Jeff Van Sinderen with B. Riley.

Maybe you can speak a little bit more about marketing plans this year and how we should expect those to unfold?

We’ve been active really in terms of our marketing and what’s driving in an e-mail we do and FSI program that has been continuous, social as well as our loyalty program. And we are not planning a significant increase in our budget this year in terms of marketing, but we do think we will do a better job of allocating those dollars, improving the effectiveness of our e-mail campaign, working on our loyalty program to make sure that it is driving the retention that we need and we’ve really organized our marketing department or in the process of organizing it around acquisition and retention and there is significant work to be done in both. But this year, it looks like a year that the traffic driving and the retention activities are going to be the focus. We will, along the way as a parallel path, be continuing our branding efforts because we do feel longer-term that we still have a lot of work to do in terms of becoming top of mind with the regular consumer out there that may not be as aware of us. So that’s going to be running parallel. But right now, the focus is on retention, maximizing that loyalty program and then maximizing those budget dollars and putting them in the right place and always measuring the results of those tests and activities.

And then I know you spoke to new store performance continuing to be strong. Is there anything new that you are learning there? Any metrics to point to with new store openings in the latest class, openings may be in the second half? And then maybe you could just touch on, I know you said you gave sort of a waiting, but anything in terms of number of leases you have signed so far, maybe how we should think about that and if there is any other detail you could give us on how – if there is any specific numbers we could think about in terms of percentage of store openings in the first half versus second half?

I’ll take the first part and Adam can take the part about timing. I think we’re learning something every day in terms of real estate. We’ve really beefed-up our analytics and user data. We combined the loyalty program data with our e-commerce order data and plotted that essentially on all of the mapping that we use and that is getting us to a position where we know the psychographic profile that we’re looking for and as we look into markets where we’re not as dense and we don’t have the store presence, we can see where best to place those stores and where those customers are. I think what it’s showing us is there are a lot of untapped markets out there and we have focused on our existing footprint, but as we keep working through this, I think we’ll find that we have many opportunities beyond the existing footprint to add stores should we get to the point where we want to do that. The other thing I think that has come out in at least last year’s class, concentrating some of the activity is helpful. We did a lot of openings in the Upper Midwest and having that collection of stores open around the same time has allowed us to leverage some of our messaging and think we’ve gotten a quicker reaction as a result. And as we look at markets going forward, I think we’ve got a little bit more of an eye on doing it that way. If the market will allow, I mean sometimes the real estate is just not there and it’s tight out there right now by the way. Centers are pretty full. So I think that concentration is a big topic and we’re pleased with the new store results. I think we’ll just only get better in terms of the analytics and site selection.

In terms of the timing, we currently have 14 stores either completed or under construction in the first quarter, which is going back in time we haven’t had that for several years. If you look back at our history for the first half of the year, that’s more than we’ve opened in the first half I think for the last four or five years. So that’s a very positive development. Something we have been working towards since we had a new real estate team in, because what we see is when we open a store in our peak selling season in Q4, for instance the 12 stores we opened in Q4 were challenging openings. There’s a lot going on in the business, puts an exceptional burden on the store teams to you’d rather have operating and focusing on existing customers, existing stores versus working on a project of opening a new store. So we see this is a very positive shift that’s going to help. Our goal is to get around 30 stores opened before the end of Q2 and certainly get the remainder opened before we get too far into Q3. And that’s going to be a big benefit, that’s a big part of the year-over-year sales increase for next year as to the timing of those openings.

The next question is from David Magee with SunTrust.

Two questions, one to piggyback off the prior question. It sounds like the new stores are doing well and, as you crest 400 stores this year, you’re not that far away from the 500 target. Why wouldn’t you lift the target now? It seems like the concept we’re working on throughout the country. Is there some sort of headwind in faraway regions that are worth pointing out? Is 500 just a very conservative number?

David, I think it’s one thing at a time and we’ve got a company that’s hovered around 250 to 350 for a long time. And as you pointed out, we are going to break over that this year. So we’ve got an e-commerce business that continues to accelerate, frankly, in the latter part of last year at a rate that was in excess of what we expected. So I think we’re being very measured in terms of how to combine that dynamic with an ultimate store count and what that looks like in the context of an environment where a lot of retailers are shrinking. So I think it’s all about just letting this play out. We certainly have done the research to say that we could do a store count much higher than 500, but at the moment, given all those dynamics, I think it’s smart for us to stay focused on what we have in front of us.

And my second question has to do with the promotional environment and it seemed like that certainly in the fourth quarter and prior to it, the competition was very promotional out there. And judging by your comments, it sounds like maybe it’s gotten a little more benign so far in the first quarter. What is your sense for how that plays out this year? Do you think that as we approach the second half of the year that you’ll see your competition more restrained in promotions and maybe that’s not as much of a headwind this year as it was last year for you?

It’s hard to speculate on that. I think inventory levels are coming down a little bit across the board, which may signal that, David, but our sector is a very promotional sector by its nature and there is a lot of competition that has come into the sector which is driving some of that. We’re a promotional retailer. It’s an important part of what we do. So we’ve got a plan for that to moderate at least within our business and expect that to remain roughly the same in the environment as well.

Do you sense that, on an annual basis, the risk is inherently the greatest around the holiday time and so maybe the outlook for the next couple of quarters is pretty good?

In terms of promotional activity?

Yes.

Typically it is.

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

So just to follow-up on the real estate. You’re looking to open 35 to 40 new stores. Can you give us a sense as to the breakdown between existing and new markets for this year? And then also as far as the store openings, should we expect on a go-forward basis that you’ll be looking to open the majority of your stores in the first half of the year as opposed to the back half as you have done historically?

Anthony, I think we’re going to be – you will see this footprint won’t change that much in the 2016 new store class. There is going to be some infill markets, there’s going to be some stores that are in existing states, albeit there may be new markets. The new data we are getting has been very helpful in understanding what the total penetration of a given market is, especially in existing market when you account for e-commerce business. And that’s helped us shape our footprint a little bit better than we have in the past. In terms of the timing going forward, yes, the goal is – it was last year, even though we weren’t quite able to do it as well as we’d hoped to move the openings to where we are not having any new store activity going on as we get into the heart of the third quarter.

And also, you lowered or actually I should say your CapEx will be lesser than last year. So can you give us a sense as to how much of that is going for new stores, how much is for maintenance CapEx and other initiatives you may have?

Most of that’s going to new stores, Anthony. There will be some supply chain investments that we will need to make, but not to the degree we saw last year. A lot of these supply chain initiatives we’ve been discussing are more operational expense in nature. We will have some system investments, if you are in the e-commerce business, you never get away from that completely. But stores are making up the bulk of that number.

And then also given the lower CapEx and the implied increase in net income, you should be in a position to generate better free cash flow. Last year, you did the special dividend, also a share buyback. How should we think about usage of free cash flow?

Anthony, we talked about the CapEx, it is a little lower. It will help us drive strong free cash flow this year. As you look at the shareholder return activities, we did complete the last authorization and we will be having discussions about what we want do there with our board in the coming weeks and months.

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

Thanks everybody for your attention and interest today. And we look forward to catching back up with you in May. Thank you.

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