The Brand House Collective, Inc. (TBHC) Q3 2017 Earnings Report, Transcript and Summary

Good day, and welcome to the Kirkland’s Third Quarter 2017 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jeff Black with SCR Partners. Please go ahead, sir.

Thank you. Good morning, and welcome to the Kirkland’s conference call to review results for the third quarter of fiscal 2017. On the call this morning are Mike Madden, President and Chief Executive Officer; and Nicole Strain, Interim 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 distributed to the financial media. Except for historical information discussed during this conference call, the statements made by 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 SEC, including the Company’s annual report on Form 10-K filed on March 31, 2017. With that I’ll turn it over to Mike.

Thank you, Jeff, and thanks to everyone for joining us this morning. We were pleased with our overall third quarter performance. Our initiatives to control SKUs, optimize promotional activity and rework targeted areas of our assortment are driving improved performance in sales and merchandise margin. At the same time, operating expenses and inventory remained well controlled despite significant disruption during the quarter from Hurricanes Harvey and Irma and some disruption and cost pressures in our supply chain. Total sales increased approximately 5%. The top line benefited from strong momentum in e-commerce and solid contribution from new stores. Comparable store sales increased modestly and were up 2%, excluding the impact from hurricanes. And we achieved that increase with a gain in merchandise margin over the prior year, reflecting the merchandising initiatives that are taking hold. As I mentioned, Hurricanes Harvey and Irma presented significant challenges during the quarter and resulted in the loss of 359 selling days and the closure of 109 stores during the period. As of last week, we are still down one store in Houston area, but all other locations that experienced downtime have now reopened. We expect the remaining store in Humble, Texas to open this week. We’re seeing favorable trends in the Houston market, which is typical post these events, and we factored that recovery into our estimate of net loss sales. In addition to the hurricanes, we faced pressure on our supply chain as we worked through constraints related to a cyber attack that affected one of our key logistics partners on the West Coast. Downtime caused by the attack led to a temporary logjam of inventory and resulted in higher-than-anticipated labor and transportation costs as we dealt with a compressed flow ahead of our busy season. These issues also likely dampened sales in the early part of the third quarter due to lower store inventory levels. Overall, I’m very pleased and impressed with how our teams have managed through the distractions. We continue to make strong progress on our strategic initiatives, and we’re doing a much better job of blocking and tackling, managing the day-to-day business with better tools and improved cross-functional communication. We’re encouraged by the trajectory of the business as we approach the heart of the holiday season. Our fall Harvest & Halloween assortment helped to drive a mid-single-digit positive comp in October, and we saw strong contributions from our furniture, floral and gift categories during the – during Q3 as well. Our holiday seasonal assortment got off to a nice start in the latter part of Q3 and has performed exceptionally well, thus far, in November, contributing to strong overall sales momentum in the early part of Q4. Seasonal merchandising is a core strength of Kirkland’s, and we’re excited about this year’s offering that complements more robust statements in gifting and entertaining for the holiday. We’ve also completed much of the everyday assortment refreshes in art, textiles, fragrance and gift. For example, our textiles category has been reoriented with an expansion of accent pillows and an anchor position in our holiday cozy shop, a store presentation built for the season to emphasize the comforts of home. We’ve also increased our year- round investment in fashion throws. Fragrance is showing improvement with an updated jar candle assortment, reflecting better quality and esthetics and refreshed offerings in candleholders and oil diffusers. We’ve removed gadgets and toys from our gift assortment and placed more reliance on gourmet food, comfort apparel, personal care and other items geared to holiday activities. And we continue to upgrade our art assortment with enhanced styles and current trends. We are focused on optimizing our mix of price points within the category as we head into 2018. We hope to benefit from newness in each of these categories in the fourth quarter and will apply numerous learnings to our 2018 plan. Our pricing and promotional initiatives are beginning to bear some fruit. While traffic remained a challenge, we were happy with our sales mix for the quarter. Average ticket and conversion were both up over the prior year, offsetting a mid-single-digit decline in brick-and-mortar traffic. We achieved a higher initial markup from alterations in our product mix and price adjustments in less elastic categories such as furniture. That, in turn, enabled us to remain highly competitive while supporting the merchandise margin. In addition, the improvements we made in managing our promotional offers and discounts are evident. We’ve reduced redundant promotional activity, and we’ve augmented our point-of-sale systems to limit coupon stacking and eliminate double discounting on clearance product. We continue to believe that strength in conversion, improvements in ticket and growth in e-commerce can combine to offset any traffic weakness, and we believe these dynamics can carry benefits well into 2018. Our SKU rationalization test continued to indicate success. As such, we’ve incorporated disciplines across the category mix to control and limit SKU creep. Across the entire assortment, our SKU count is down over 10% versus last year, allowing us to invest deeper in the winters, clarify in- store presentations and better manage clearance margins. We’re very encouraged by our e-commerce performance. Kirklands.com continued its strong momentum during the third quarter with sales in the channel up approximately 40%, representing acceleration from the prior year growth rate. We’re focused on enhancing the omni-channel experience, improving our online assortment, driving additional business through our vendor direct drop-ship program and streamlining our fulfillment operation. We believe we’re well positioned to effectively handle more volume this holiday season, and we expect to drive higher profitability over time as we address the supply chain. A portion of our year-over-year growth in the top line was also due to more effective marketing. Our digital advertising program is generating better response metrics, and redemption rates on our direct mailers are strong, driving incremental traffic to both stores and kirklands.com during the quarter. Our creative output and message delivery is continually improving, and we see that as a significant opportunity going forward. Our new class of stores is performing well thus far. We’re on track to achieve a slightly higher rate of square footage growth for 2017, which is largely due to fewer closings than we had originally anticipated as we were able to take advantage of more favorable terms on stores with leases coming due. This year is somewhat of a transition year in our strategy to move to whitespace opportunities, which limit cannibalization while growing our over – overall omni- channel presence. The stores we open next year will also benefit from our SKU reduction as well as the merchandising improvements we’ve accomplished thus far. We’ve updated our guidance to reflect improved comp trends, offset by some higher supply chain costs in the third quarter, yet, excluding the hurricanes, we’re largely on track with our plans for the year. I don’t want to minimize the potential challenges as we approach the holiday selling season. We remain concerned about overall traffic trends and a potential onslaught of marketing as the sector tries to recover from a post- Thanksgiving malaise that complicated last year’s holiday selling season. We’d also like to see some better performance from our art category. The assortment has much improved from a design and style standpoint, and we believe the customer will ultimately respond. That said, I firmly believe we’re moving in the right direction. We’re optimistic about our holiday plan. And looking beyond that, Kirkland’s is well positioned as a provider of value-priced stylish home decor with a relevant and growing omni-channel presence. Our initiatives to control SKUs, optimize promotional activity and evolve our merchandise assortments are gaining traction. We believe much of this is sustainable as we start to leverage the full benefit from these initiatives, continue to develop our marketing program and improve the overall discipline around measuring and executing our business. In addition, our store operations team is focused on measuring improving customer service while implementing process improvements to improve profitability. Overall, we’re encouraged about our overall progress. To be sure, we have much yet ahead, but our team is hungry and up to the task. We look forward to updating you on our progress in the coming quarters. With that, I’ll turn the call over to Nicole.

Thank you, Mike. Net sales for the third quarter increased approximately 5% compared to the same period in the prior year. Consolidated comparable store sales increased 0.7%, which included a 41% increase in e-commerce revenue. Excluding the impact of Hurricanes Harvey and Irma, comparable store sales increased 2%. Excluding the hurricane impacted state, store sales are relatively flat to the prior year with the strongest regions being the Southeast and Midwest. Again, for this quarter, we were able to offset negative store traffic with a positive conversion rate and higher average ticket. We opened 10 new stores during the quarter and closed one, ending the quarter with 415 stores, which represents 14 more units or 3.5% more than the end of Q3, 2016. E-commerce generated $15.3 million in revenue during the quarter, which accounted for approximately 11% of total revenue. This increase was driven by a combination of strong increases in website traffic and average order value. We also saw a healthy increase in revenue derived from our third-party drop- ship initiative, which accounted for a higher portion of e-commerce revenue during Q3, 2017 compared to a year ago. Sales via this channel result in a lower initial merchandise margin but limited overhead costs. Moving on to gross profit. Gross profit margin for Q3 decreased to 160 basis points from the prior year to 34.9%. Looking at the components, merchandise margin increased 25 basis points to 55.7%. Merchandise margin benefited from a higher IMU and an initiative to eliminate stacking of coupon offers, which was partially offset by the growing mix of third-party drop-ship sales. Store occupancy costs increased 10 basis points during the quarter due to sales deleverage. Outbound freight costs, which include e-commerce shipping, increased 125 basis points as a percentage of net sales, which was largely driven by an increase in e- commerce penetration. And finally, central distribution costs increased 50 basis points. Both outbound freight and central distribution costs were impacted by supply chain bottlenecks due in part to our West Coast logistics partner. Moving on to operating expenses. Operating expense for the third quarter was 32.8% of sales, which was down approximately 30 basis points since prior year. The primary drivers of this decrease were corporate payroll and professional fees due to a higher rate of capitalization for supply chain projects, share-based compensation expense and workers’ compensation insurance reserve, which were partially offset by an increase in store labor and advertising expense. Depreciation and amortization remained relatively flat to the prior year as a percentage of sales. The tax benefit for the quarter was $1.21 million or 34.5% of the pretax loss compared to 47.6% in the prior year period. Much of this decrease from last year’s rate is due to the change in accounting rules for taxes associated with share-based compensation. The net loss for the quarter equated to $0.15 per diluted share. Excluding the hurricane impact for both lost sales flow-through and property damage, we had a net loss of $0.10 per diluted share for the quarter. The hurricane impact does not include any insurance proceeds, particularly business interruption, which we will have finalized in Q4. Moving to the balance sheet and the cash flow statement. At the end of the quarter, we had $27.9 of cash on hand, and no long-term debt or borrowings were outstanding under our revolving line of credit. Inventories at the end of Q3 were $107.3 million, an increase of approximately 7% over Q3 last year. Year-to-date 2017 cash used by operations was $12.3 million, reflecting our operating performance and changes in working capital. Year-to-date capital expenditures were $23.6 million with approximately 70% of that relating to new stores and existing store improvements, followed by approximately 25% related to IT and supply chain systems investment. During the quarter, we repurchased approximately 19,000 shares at an average cost of $11.52 a share under our share repurchase program. And now turning to our guidance. As mentioned in our press release earlier today, we’ve adjusted some components of our fiscal 2017 annual guidance, which was provided on March 10 of this year and reiterated in our Q2 earnings release. We expect to end the year with 419 stores, which represents a total unit growth of 3.5% over the end of fiscal 2016 with square footage growth approximating 5%. Total fiscal 2017 sales are projected to increase at the high end of the original guidance of 6% to 8%. That implies full year comparable store sales in the range of flat to up 2%. As a reminder, the year-over- year sales increase includes the 53rd week in fiscal 2017, which represents approximately $10 million to $11 million in revenue. We expect our earnings per share in the range of $0.50 to $0.60 per diluted share, which narrows our previous guidance due to the negative impact of hurricanes, supply chain business disruptions and an estimated tax rate of 41% compared to our prior guidance of 38%. Capital expenditures should be in the range of $27 million to $29 million up from our prior guidance of $23 million to $27 million. The incremental capital expenditures are a result of an additional new store and rebuilding costs from hurricane-damaged stores. Thank you, and we are now ready for questions.

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

Good morning, and great to see positive comps excluding the hurricanes. Mike, I’m wondering if you could just talk a little bit about the supply chain issue. Is that out of the way at this point? And then, also, can you touch on your direct sourcing initiatives, kind of where those stand?

Sure. Yes. So the supply chain disruption, for the most part, is behind us. It was a major distraction. It’s unfortunate the way that played out. Our turn – we have a fast turn on inventory. The seasonal sets depend on the flow, so it’s really important for us. So it just kind of got us a little bit out of whack there. So right now, the fresh products that we have coming in is flowing unabated through our DC. In the long run, I think we still have opportunities to make our supply chain more efficient, both for the retail side and the e-commerce side. We’re working toward that. But this just was a onetime thing that we had to deal with in Q3. And then the other part of your question was direct importing. And we kicked of that initiative. We did that during the quarter, and we’re easing into that. It won’t have much – it won’t have an effect on 2017. But as you move into 2018 is when you’ll start to see the impact that has on our margin. And we continue to believe it’s a big opportunity to drive merchandise margin over the next several years. So that’s a big initiative for us.

Okay, good to hear. And then, any other color you can add on the performance of seasonal merchandise in November? Just wondered if there’s anything else you feel like you can share there, maybe which categories have made the most progress? And then, I guess, where you feel or which categories do you feel like you can see the most improvement in metrics for holiday this year versus last year?

Well, one of the big drivers, Jeff, is our seasonal assortment. We call it a seasonal category. And in the third quarter, it’s dominated by fall product, Halloween Harvest. That performed very well during Q3. We had great sell-through, great product. And as we moved into Q4, that kind of transitions over into holiday theme product. And again, it’s been out – an outstanding start on that category this year. It’s a – it’s not only fresh product, but the linkage between our merchants and our marketing execution is improving, and that’s really helping the performance of that category. So it’s a big driver for us right now. As we move through the balance of the fourth quarter, that will be a big driver. But we’re also seeing good performance out of some core categories, like furniture, to name one, that has been a strong performer for us all year. And then we’ll layer in more gifting, more entertaining products as we get around the Thanksgiving holiday and leading up to Christmas. We felt like we had a little bit of a gap there in those areas last year that we filled with our buys this year as we plan for the season.

Okay. That’s helpful. Thanks for taking my question. And best of luck to the rest of holiday.

Thanks, Jeff.

The next question comes from John Lawrence with Coker Palmer. Please go ahead.

Hi, good morning.

Hey John.

Would you comment a little bit, Mike, on just one more step on the supply disruption? I mean you mentioned the hurricane was a nickel. Can you assign a value of what you think you spent in cost, time or sales that you think had impacted our third quarter?

Yes, the sales part is a little hard to quantify. I mean, if you look at how the quarter progressed, we were definitely softer in August, and we attribute a lot of that softness to the lack of flow on the new product. As that started to come in, we had a much stronger and, I think I said it in the script, a much stronger October. So that’s how I would characterize the lost sales piece. In terms of cost, I think the impact on labor and transportation were probably somewhere between $0.5 to $1 million. And that’s just, again, the flow of the product and how reliant we are on the sets that we lay out in the stores, we have to turn it quickly. So we had to throw a lot of effort to get our Christmas product in the stores on time and all the other sets that we rely on as we got into the new floor sets in the season. So we had to do what we had to do. But again, that’s cleared up now, and we are past that disruptive part of the supply chain.

Great. Could you go a little deeper dive into the marketing? It sounds like, obviously, you’re seeing some things there you really like as far as digital and some of the direct mail. Can you just maybe go a little deeper dive there of what’s – what you see the change is and how that’s driving customers to either the store or the platform?

Yes, one just overriding point I’ll make is our creative output is much improved from where we’ve been in the past. So our team is doing an excellent job of generating creative ways to communicate with our customers. And the linkage, I cited this earlier, the linkage to the rest of the business, those connections have improved so much, and it – the overall execution of everything we do kind of revolves around that. So the marketing effort is much better positioned now than it has been for Kirkland’s. And in terms of tactics, this year, our digital program has been revamped. We’re doing a lot more in the way of calling customers to action through announcing events or sales that we have going. Last year was more of a branding focus for that digital, and so we’re seeing good traffic to our site and our stores from that mode of communication. And then our direct mail example, we just issued a gift guide in our direct mail, which is to focus on that gifting push that we have for the holiday. Very nice piece. The redemptions rates we’re getting on that direct mail are very high, and we’re very encouraged by them. And the longer we do it, the better it gets. So those are just two vehicles that we have in place that we didn’t have last year for the fourth quarter. And that’s in addition to just the improvements we’ve made on the creative and the daily e-blast that we do to our customers that are still very effective.

Great. Thanks for that. And the last question for me is to follow on the direct sourcing. Will it be second half of 2018 before any of that direct merchandise mix is on the floor? Or would it be before then?

That’s a fair way to look at it, John. I would not assume any real impact in the first half. I would focus on the back half there.

Great. Thanks a lot. Good luck.

Thanks, John.

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

Good morning and thank you for taking the question. So just to follow up first on the direct sourcing piece, could you perhaps, Mike, quantify what the margin differential could be for those products?

It depends, obviously, on the item. But – and it’s a long-term process. So if you look at our assortment, we’re going to focus first on the kind of the everyday, more basic component of our assortment. And this is going to take a period of a few years to get up to speed. I don’t believe we’ll be direct importing 100% of our product any time soon. I think you’re talking – we’re talking about 30% at – over the next several years. And inside that 30%, I hesitate to put a firm number out there, but it’s in the hundreds of basis points, not the tens.

Got it. Okay, well, that’s helpful. And also, I was wondering if you could comment on your traffic trends, excluding the hurricane affected stores. Could you perhaps share that with us, if you have that?

Yes, we mentioned – sequentially, they’re improving, I think, is the bigger takeaway here. If you exclude the hurricanes, we were probably in the lower end of that mid-single-digit decline that we cited in the script. So we’re seeing improvement. It’s a little bit here and a little bit there. But as I mentioned earlier, we’ve been able to offset that with a strong average ticket and some good conversion in the stores.

Right. Okay. And then, as far as e-commerce sales, are most of those orders still being picked up in store? And if yes, what’s sort of the attachment rate as far as people buying additional items when they come in to pick up their e-commerce order?

Right now, I would say about half of the revenue is shipped to the store. And that’s declined a bit from where we’ve been given the advent of our drop-ship business, which is now approaching 20% of the overall mix. So it is still a very high number, though. And we rely on that traffic, and it’s important to the stores because we are able to get good attachment rates on those. It’s been a while since I looked at that number, to be honest with you. I wanted to say that it’s about half of the time that we get a purchase, an additional purchase, when that in-store pickup occurs, but it’s a key part of the strategy.

Got it. All right, thanks and best of luck.

Thanks, Anthony.

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

Well, great. We appreciate everybody’s attention today and participation, and we look forward to our next call in March to report the season. Thank you.

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