The Brand House Collective, Inc. (TBHC) Q1 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Kirkland’s First Quarter 2016 Earnings Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jeff Black of Investor Relations. Please go ahead.

Thank you. Good morning and welcome to Kirkland’s conference call to review results for the first quarter of fiscal 2016. 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 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 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 SEC, including the company’s annual report on Form 10-K filed on April 8, 2016. With that, I will turn it over to Mike.

Thank you, Jeff and good morning to everybody. The first quarter was in line with our expectations and we are pleased with the progress we made on the strategic priorities that will enable us to drive our full year performance. As you will recall, our full year guidance, which we have maintained today assumes a year-over-year decline in earnings in the first half as we invest in the supply chain and continue our shift to a more front loaded store opening schedule. We expect second half earnings to be above last year’s levels as we leverage our store growth and benefit from progress on various productivity initiatives. We are on track with that forecast, which includes bringing inventory levels back into alignment by the end of the second quarter and opening our new stores much earlier in the year. At the same time, we are moving forward on a set of price, merchandise and marketing initiatives to drive our long-term strategic plan. I am optimistic about the progress we are making and believe we are well-positioned as we approach the crucial fall and holiday selling seasons. One of the biggest improvements we are focusing on involves our supply chain. Our e-commerce channel has grown at an accelerated pace and now accounts for 7.5% of our total revenues. Until now, order fulfillment for that channel has been operating out of the same distribution center as our brick-and-mortar stores. The combination of this growth was an 11% gain in source square footage in 2015 and a planned 6% to 8% increase for ‘16, coupled with the more complex flows of seasonal goods, has added to the demands on our distribution network. All of these factors strained our supply chain in 2015 and we absorbed considerable dislocation around our peak seasonal build last fall. To address these issues, we made a number of important adjustments already, including the new e-commerce fulfillment center and a more efficient process for new store openings. Additionally, we are working to further increase our supply chain capacity by introducing a West Coast bypass operation later in the year. Something that is commonplace for companies our size. The result of these initiatives will alleviate a tremendous amount of pressure relative to the last few years as we approach our critical seasonal build. Our supply chain work has important long-term implications for the business. It supports each of the pillars we have identified that transform Kirkland’s into a high-performing nationally recognized home decor brand of choice. These include improving in-store productivity, enhancing our omni-channel platform, optimizing our real estate development and reinforcing a culture of continuous improvement. It will also provide some short-term comparative benefits as we cycle against elevated freight cost, higher labor costs and a series of operational distractions that came into play in the back half of 2015. We are already unlocking better efficiency across the organization and that should enable us to take a more proactive posture to support our fall and holiday merchandise offerings. We are pleased with both the transition and the trajectory of the direct-to-consumer channel. E-commerce revenue grew 28% in the quarter. While we had some startup cost inefficiencies during Q1 which put pressure on both e-commerce sales and labor costs in fulfillment, we are quickly gaining momentum. The new fulfillment operation is already achieving better output metrics for the direct channel and we expect further improvement as we move through the year. We continue to see a path to increase the direct channel penetration to 10% over the next few years. We are taking a holistic approach to market development that takes into account existing and new stores as well as e-commerce growth. We believe we are in a favorable position, vis-à-vis, pure direct players given our unique merchandise assortment, value pricing and store footprint. Our Ship to Store model accounts for about two-thirds of our direct revenues at present. Our customers use our stores to visualize ideas and we are achieving strong attachment rates on e-commerce promotions geared to in-store pickup. Looking forward, we are working on ways to improve the experience by accelerating delivery times and offering more options for the customer. We recognized the competitive nature of the business and we have begun to test free shipping provided the customer hit certain thresholds. Importantly, we are also laying the groundwork to fulfill some e-commerce orders from store inventory to streamline our distribution process. And finally, we have expanded our supplier direct fulfillment program with new vendors in Q1 and plan to add more over the rest of the year. We are optimistic about its expansion and the positive impact it can have on the channel and its profitability. Higher ticket categories like furniture, art and wall decor are popular online and allow us to carry multiple styles that are not available in stores. To further enhance direct sales in the furniture category, during the first quarter, we introduced a special order program in our stores, which leverages our e-commerce fulfillment and Ship to Store model. We will have more to talk about as we develop and refine our e-commerce model and we look forward to updating you in coming quarters. We have made considerable progress to bring our overall inventory levels back into alignment with sales during the first quarter. Planned promotional activities combined with tight management of our receipt plans to the sales rate have allowed us to improve our position. We are in the final stages of this process and on track to enter the third quarter on plan with the year-over-year inventory levels in line with to slightly below the expected sales gain for the back half, which should provide us with improved margin visibility. As noted in the release, we opened 14 new stores during the quarter. We have been able to open new stores earlier in the year, which frees up operational resources for peak season activity. This has been possible because our pipeline is full, allowing us to be more selective in the deals we choose to pursue and the timing of our construction activity. The heavier new store openings scheduled during the quarter led to expense pressures in occupancy and store payroll due to pre-opening activities, but will obviously benefit from this class of openings as we enter the holiday period. Optimizing our real estate is one of our top strategic priorities. Our loyalty program and our e-commerce channel are providing a wealth of data on our shopper. We have added that to a much more analytical site selection process to refine how we look at growth in new and existing markets. We are pleased with the new store openings thus far in Q1 and we are adding analytics to better assess competitive dynamics by market to optimize our market spacing and minimize cannibalization. We are also looking at ways to create a more consistent store, one that’s easier to plan, allocate, visually present and operate. That will involve new standards for site collection and additional innovation in merchandising. The special order program I mentioned earlier reflects this. The program allows customers to order various styles of seating and benches that aren’t offered every day currently in our stores. It’s too early to gauge success, but it’s just one example of how we are thinking about adding special buys and new categories and additional selection within existing businesses. As expected, traffic remained the challenge during the quarter, particularly in Texas. While our ability to affect macroeconomic headwinds is sometimes limited, we are able to control where we invest our marketing dollars to drive traffic. Therefore, we are reallocating marketing spend in more productive areas beyond our FSI programs and we are optimistic they can drive stronger results. While some specific macro issues are affecting traffic, we are pleased with our merchandise assortments. We continue to enhance the interaction between merchandising, visual presentation, marketing in stores and this strong linkage again supported an up-tick in conversion during the quarter. Categories including mirrors, clocks, furniture and fragrance were stronger in the quarter and our Easter seasonal business performed very well. So we are encouraged by that as we approach the second half with healthier inventory positions. With that, I will turn it over to Adam to cover the financials. Adam?

Thank you, Mike. Net sales for the first quarter increased 9.8% with comparable store sales increasing 0.5%. This was in line with our projections and reflects the growth in our store base, continued strength in e-commerce and positive response to our seasonal assortment. E-commerce revenue continue to increase at a healthy rate, generating $9.8 million for the quarter, which represented a 28% increase over the prior year quarter and accounted for approximately 7.5% of total sales during Q1. Comp sales trends in our brick-and-mortar stores were relatively consistent as we move through the quarter. Geographically, comparable store sales results were similar to what we experienced in the fourth quarter of 2015, with Texas and Louisiana weighing down on our comparable sale stores results. Combined, these two states affected total comp by almost 1.5 points. Encouragingly, two of our largest states of our store count Florida and California, continue to show positive results. We opened 14 new stores during the quarter and closed eight, ending with 382 stores, representing 40 more units than the end of Q1 last year. First quarter gross profit margin decreased approximately 215 basis points to 38.1%. This decline was driven by three factors: First, merchandise margin declined 60 basis points to 55.8%, primarily due to planned promotional markdowns to manage inventory levels. While the promotional environment was competitive, we are pleased with the reduction in inventory and we will now be able to achieve our target of being back on inventory plan during Q2. Inbound freight charges were smaller component of the merchandise margin decline in Q1 and showed improvement versus the back half of fiscal 2015 as we executed on our supply chain initiatives. Moving onto the other components of gross profit margin, store occupancy cost increased 98 basis points as a percentage of net sales during the first quarter, which were in line with our expectations due to the increased level of store opening activity during the quarter. Eight of the 14 new store openings occurred in late April and did not have time to contribute the level of sales needed to offset pre-opening rent, payroll and advertising costs. Outbound freight costs, which include e-commerce shipping, were down slightly as a percentage of sales. Similar to Q1 last year, we saw approximately two-thirds of our e-commerce revenue fulfilled via ship-to-store. Finally, central distribution cost increased 61 basis points. As Mike mentioned, we executed the transition to our new e-commerce fulfillment facility in Jackson, Tennessee during March. Startup costs and inefficiencies, especially labor costs, put additional pressure on the quarter. Looking forward to the end of the year, we expect that our lower inventory levels combined with improvements in our supply chain structure will help improve the flow of goods both in-stores and to customers homes. Operating expenses for the first quarter were 32.3% of sales, which is slightly down the last year. Store related expenses de-leveraged during the quarter, reflecting higher healthcare costs as well as marketing expense. We recognized the benefit in the prior year related to our healthcare plan, which drove a negative comparison of the current year. Marketing costs were higher as a percentage of sales, partly due to the increased new store opening activity as we opened 14 stores in Q1 this year versus only one store last year. Store payroll de-leveraged during the quarter. This was within our expectations, also reflecting the higher store pre-opening activity. Corporate related expenses leveraged during the quarter, driven by a favorable comparison to our retired CEO’s post-employment benefit charge from last year, but also by lower professional legal fees, which reflects the hiring of our General Counsel and continued tight management of these expenses. E-commerce related operating expenses were relatively flat to the prior year quarter as a percentage of total revenue. Depreciation and amortization increased approximately 18 basis points as a percentage of sales. The tax expense for the quarter was approximately $594,000 or 39.3% of pretax income, resulting in net income for the quarter of $0.06 per diluted share. Moving to the balance sheet and cash flow statement, at the end of the quarter, we had $38.2 million in cash on hand, inventories at the end of Q1 were $69.1 million, an increase of 19% over Q1 last year. This was in line with our expectations and we anticipate inventory levels to be back on plan by the end of Q2. As Mike mentioned, part of our supply chain initiative includes incorporating a West Coast bypass operation later in the year. This bypass will allow us to gain ownership and control of our product earlier in the pipeline to better manage our business, especially during our peak holiday season, without increasing our working capital requirements. The bypass will improve service to our West Coast stores, take pressure off of our Tennessee distribution center and provide us with more control over our seasonal product flow. At quarter end, we had no long-term debt and no borrowings were outstanding under our revolving line of credit. During Q1 2016, cash provided by operations was $2.7 million, reflecting our operating performance and changes in working capital. Capital expenditures were on plan at $8.7 million, with approximately 79% of CapEx relating to new stores and existing store improvements, followed by 11% relating to supply chain improvements and IT system improvements accounting for the balance. As mentioned in our press release earlier today, we are reiterating all of the components of our 2016 guidance that was provided on March 11, 2016, earnings release. Thanks and I will now turn the call back over to Mike.

Thank you, Adam. As many of you know, Kirkland is celebrating its 50th year in operation. Back in 1966, Carl and Robert Kirkland founded the company with a belief that great style can come at a great price always. The concept has evolved and thrived through a tremendous economic and social change, but that vision continues to guide our strategy. The organization is stronger than ever and I am confident that Kirkland’s best years are ahead of us as we build on our founding principles. We have a lot to look forward to in the back half and we look forward to updating you on our progress. Operator, we are now available to take a few questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Brad Thomas of KeyBanc Capital Markets. Please go ahead.

Yes. Hi, good morning Mike, Adam and Jeff. How are you?

Brad, how are you?

Good. Thanks. A couple of questions if I could, first one is just sort of off asking about inventory, it sounds like things are moving in the right direction here, but anymore color around how you ended the quarter and how things are tracking from a seasonal perspective versus more of a core perspective would be greatly appreciated?

Brad, inventory position, we are very pleased with the progress we made and continue to make on getting back at the position we intend to be going into the back half. Year-over-year comparisons are still a little tricky given last year’s port slowdown and subsequent flow that started to really occur about this time last year. So you are still showing about – I think we show about an 18%, 19% over the prior year right now. But as we go into the back half, as I said in my comments, I would see the inventory level be on a year-over-year basis, up less than the expected sales increase we have in the back half, which if you look at store count and look at your comp assumptions would be in the 10% to 12% range. So, inventories to be up year-over-year, a little bit less than that going into the back half, which is considerable progress on where we have been. So, we are very happy about that. From a seasonal standpoint and looking at core, core has continued to be a significant of our business, 35%ish of the overall business. So, we do everything we can to protect that part of the business. Seasonal categories have been successful for us for the last few years and we are planning a slight increase there going into the back half. We saw good results in the spring seasonal aspects of our assortment, and we are excited about what’s ahead looking at fall and then deeper into the holiday period.

Great. And then as we connect the dots from inventory to merchandise margin, can you help us think about how trends play out in merchandise margin over the next couple of quarters?

Sure. I mean, I think we are still dealing with some promotional activity in Q2. Q2 happens to be a little bit more lighter quarter in terms of volume and a little more promotional historically. So, you will continue to see some of that in Q2. But as we go into the back half is where we would see improvement start to come in on the merchandise side. We also have some inbound freight reductions that we think will help margin going into the back half as well as all the things we mentioned in our comments, Adam mentioned in his comments about supply chain changes we are making and the improvements we expect there.

Great. And then the last if I could, I know you are not giving specific second quarter guidance. But just as we think about the tougher comparison that you are up against, maybe any thoughts that you might have in terms of how we should maybe model comps earnings for the second quarter would certainly be welcomed?

Well, without going into specifics, Brad, that you are right about the comparisons. I think we are up against a 6.7 or so in the second quarter and that was little bit more heavy in May and June than July. So, as we think about second quarter and as we plan the year originally, we expected earnings to be down in the second quarter. And we expected the comp increase to be a little bit less given the comparison we are up against. So that’s directionally how I will look at it.

Got it. Are you thinking that comps would still stay positive in the second quarter?

I think around flattish is about the way to think about it.

Perfect. Well, certainly setup for some nice momentum as we move to the year and so thanks for all the color and best of luck.

Right, Brad. Thanks a lot.

Our next question comes from Jeff Van Sinderen of B. Riley. Please go ahead.

Good morning. And just kind of follow-up on traffic in Q1, obviously, there has been a lot of discussion about it in the industry. So, just wondering how you think about that in terms of what you saw outside of the oil patch in your brick-and-mortar stores? And I guess, how you look at that in the context of what the broader traffic is in the kind of centers you are in?

Sure, Jeff, this is Adam. We certainly did see a heavier weighted impact for the two states we called out in the prepared remarks. That being said, we did see some positive traffic trends in some of the other states. So, we are not negative across the board although these states that we called out unfortunately are disproportionately higher in terms of sales and earnings contribution. Therefore, they have more of a negative impact. But as we move into the back half of the year, when we started to see the traffic declines, especially in Texas, Louisiana, we are hopeful that some of these traffic comparisons will ease up a bit.

Okay, good. And then anymore color you can give us on where you stand at this point with supply chain? Obviously, you have got a lot of work behind you with the new center up and running. Just wondering maybe when and how we see the benefit start to manifest from that? And I think you talked about second half and then any update on other supply chain initiatives that are still in the works, maybe more color on the West Coast bypass and what we should expect there?

Yes, I will start with that. And what I would say there is really buckets we are thinking about with supply chain as far as 2016 go. One is the fulfillment center move that completed in March. And as I said earlier, after the move and the start-up phase, we are starting to see better metrics coming out of that as we expected and we expect that to continue as the year progresses. Secondly is the West Coast bypass operation and that will help us in multiple ways, but first being in no particular order, first would be the ability for those West Coast stores which would when you add up all the geographic areas that would be affected maybe about 40 stores that will see better service when you are not having to bring it all the way to the interior and ship it all the way back out. Those stores will be receiving their merchandise at the right time and with the rest of the chain. So, we have struggled with that in the past and that will help us on that aspect. Secondly, it will alleviate pressure on our Tennessee facilities, because we won’t be bringing all of the flow into those facilities. And thirdly and importantly, it provides kind of a governor on our flow. So you got a facility that – and we are a highly seasonal business. We can time that flow better with that facility in place and allow our DC to manage the goods in an orderly fashion as we flow seasonal product out to the stores. Presentation is very important to us. And we want the stores showing the product in the order that we have kind of envisioned when we buy it. And this will give us much more capability in terms of being able to control that and better service our stores. So it’s a long-term play. You can think way long-term that as we grow and continue to get bigger, we will need more infrastructure in our supply chain, maybe a second DC. But this is something that we will need anyway that will help that flow management that is crucial for us, especially as you get into peak. So the West Coast is the second one. And thirdly and I won’t dwell on it too much, but to say that we are investing in a systems upgrade on our e-commerce fulfillment that will – the move was one thing, it addresses capacity, it addresses some automation that we added. But when we get further benefits once we upgrade our warehouse management system that we used to run that aspect of the operation. And we see some efficiencies coming out of that as well. The timing of all these things is the current year. And it’s going to come in phases. But we intend to have it all in place before the peak part of our selling season, which with e-commerce, is a little bit deeper into the year. You are talking about third quarter here. So hopefully, that provides a little color.

That’s extremely helpful. I appreciate that. I will let someone else jump in. Thanks a lot.

Thanks Jeff.

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

Good morning guys. Thank you for taking the questions. So Mike, in your remarks, you did mention about the fact that you are looking to minimize cannibalization, just wondering if that was any notable impact in the quarter or is this more your thinking about the future as far as cannibalization is concerned?

Yes. It’s more future driven there, Anthony. To say that we have no cannibalization is an overstatement. So I am not going to say that. I mean we are doing in-fills. It does have an impact. We are doing a better job of measuring it, especially when we get upfront when we are evaluating a deal. With all those analytics, I mentioned that we really added to the process, we have a better way to track cannibalization. And we are beginning to be able to avail ourselves of those capabilities. But there are some spot markets where I think we have built it out and we are seeing some cannibalization, but its healthy cannibalization. I think it’s more a statement on going forward as to what is the ultimate store count in each market and how do we address that with the growth in e-commerce.

Got it, okay. So thanks for that clarification. And also, any impact from the new overtime rules that you can mention?

Well, Anthony, this is Adam. As you know the final rags came out last week. And we are still evaluating their impact. The latest regulations seem to be a little onerous than we had earlier anticipated. But we will have more to say on that as we move through this next quarter.

Got it, okay. And also if you end the year roughly at the midpoint of your EPS guidance, where do you think your cash position will be at the end of the fiscal year?

North of $60 million, Anthony.

Okay. And lastly any thoughts about a share repurchase program?

That’s a topic that we would be in discussion with our Board on, Anthony. Obviously, it’s always something that we address at that level. And when we have something to talk about, we will share it.

Thank you very much.

Thank you.

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

Yes. Hi, good morning guys. This is actually Mitch in for David.

Hi Mitch.

Hi, curious about in-store conversion rates above and beyond the incremental promotions, could you quantify what conversions would be when you are backing out that impact?

That’s a tough one to do. Our promotional activity was a little higher than last year. As we mentioned, conversion was positive. I think that does play into that, but not enough – the numbers we are seeing would not suggest that that’s the whole reason conversion is up. We have made a lot of improvements in terms of how we message and how our teams are connecting in terms of visually in the stores and pulling that off. And we think that’s a big driver to conversion. But promotions certainly have an effect. But I think it’s a combination of things. And it’s hard to really quantify the components out that way.

Okay. And then you mentioned that traffic is still challenging. And I apologize if I missed this earlier, but what could be done differently on that front to help stimulate that, is there any initiatives that can share from a marketing standpoint that are planned for the back half of the year?

Well, one thing that we have talked about and we have mentioned here is evaluating our current marketing programs, a big part of which is e-mail, which right now, the metric on e-mail suggest that, that is still a good return in driving traffic to our stores. We see it when we run our advance and the immediate impact that that can generate. The other – maybe the second large component of our marketing spend right now is our FSI program, which we are a little less happy with what we are seeing out of that. So we are looking – as we look into the back half, we are looking to adjust some of the spend from that into other areas. One large well name would be digital that we are considering as a more effective way to drive traffic. So we will be adjusting the back half spend a bit to position those dollars in areas that are driving traffic at a cost that’s acceptable from a budget standpoint.

Okay, that’s helpful. Thanks for the color guys.

Thank you.

There being no other questions, this concludes our question-and-answer session. I would like to turn the conference back over to Mike Madden for any closing remarks.

Thank you, everyone for your attention on the call today and the questions. We appreciate them. We look forward to updating you as the year progresses. Talk to you next quarter.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your line.