Caitlin Churchill; Investor Relations; Kirkland’s Inc
Amy Sullivan; Chief Executive Officer, Director; Kirkland’s Inc
W. Michael Madden; Chief Financial Officer, Vice President of Finance; Kirkland’s Inc
Jeremy Hamblin; Analyst; Craig-Hallum Capital Group
John Lawrence; Analyst; The Benchmark Company LLC
Operator
Good morning, everyone, and thank you for participating in today’s conference call to discuss Kirkland’s financial results for the second-quarter ended August 3, 2024. Joining us today are Kirkland’s Homes, CEO, Amy Sullivan; EVP and CFO, Mike Madden, and the company’s external Director of Investor Relations, Caitlin Churchill. Following their remarks, we’ll open the call for your questions.
Before we go further, I would like to turn the call over to Mr. Churchill, as she reads the company’s safe harbor statements within the meaning of the Private Securities Litigation Reform Act of 1995. That provides important cautions regarding forward-looking statements. Caitlin, please go ahead.
Caitlin Churchill
Thank you. 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 provision 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. A webcast replay will also be available via the link provided in today’s press release as well as on the company’s website at Kirklands.com.
Now I would like to turn the call over to Kirkland’s CEO, Amy Sullivan. Amy?
Amy Sullivan
Thank you, Caitlin, and good morning, everyone. I will begin today’s discussion with a review of highlights from our second-quarter performance and will then provide an update on the progress we are making against our strategic initiatives before turning the call over to Mike, to review our financial results in more detail.
Our second-quarter comparable sales performance reflects the sequential improvement from the first-quarter as we continue reengaging our core customer, refocusing our product assortment and strengthening our omnichannel capabilities.
For the quarter, total comparable sales declined 1.7%, reflecting a 1.8% increase in comparable store sales growth, which was offset by a 10.6% sales decline in e-commerce, while we continued to see year over year declines in average ticket, given our ongoing work to rebalance our assortment and reduced penetration and higher ticket slower turning categories, overall units sold were up approximately 20% compared to last year.
With respect to profitability, adjusted EBITDA improved $3.3 million compared to last year as we drove gross margin expansion despite increased promotional activity by maintaining a disciplined approach to cost and expense management. As a reminder, in May, we executed a number of cost savings initiatives to improve our profitability and liquidity.
Through these actions, we continue to expect to deliver $6 million in expense savings by the end of fiscal 2024. While the second-quarter is historically our smallest quarter from a sales and profit perspective, it is an important transition as we prepare for our peak season. Within the quarter, we strategically took advantage of key holiday shopping events such as Memorial Day and 4 of July.
We also reintroduced seasonally relevant micro trend collections, such as Mother’s Day gifting and back-to-campus decor, improving our consumer relevance within the summer months. Our Halloween and harvest assortments arrived in stores in July, and we are pleased by the early reads we have seen, giving us confidence in our strategies as we enter the important back half of the year. While the consumer backdrop remains challenging in the home sector, we remain encouraged by the response to our brand repositioning.
This now leads me to our discussion on our strategic initiatives. First, re-engaging our core customer. We remain keenly focused on strengthening and retaining an authentic relationship with our core customer and are pleased by another quarter of positive reactivation rates of our lapsed customers.
Over the last 12 months, we have seen a 39% reactivation of lapsed customers driven by continued focus on seasonally relevant high-value décor. As you have heard from our peers, the overall cost of marketing has increased and the cost of customer acquisition is high in an election year.
With this in mind, we maximized cost, efficient marketing strategies and focused on building our customer data profiles within our lowest volume quarter to allow us to maximize our reach and the impact of our marketing spend in the back half. Our K Club loyalty program was enhanced at the end of Q1 by the reintroduction of a birthday reward resulting in 40,000 redemptions in Q2. We also kicked off an incentive campaign to drive profile completion within her K Club account, focused on obtaining her birth date and cellphone number, enabling us to have even more touch points with her throughout the year.
This leads me to the continued success in our SMS text program. The file buys continues to grow and as currently at 1.2 million subscribers during the quarter, we launched triggered SMS campaigns to match the success we have seen and triggered e-mail campaigns. In both channels, email and SMS, we continue to drive improved conversion through back-end stock and price drop messaging, particularly when focused on seasonally relevant product categories.
Last, we are continually enhancing our social media presence to increase engagement with our over 3 million followers while expanding our reach across all platforms. During the quarter, we focused on video content with plans to grow our TikTok presence during the upcoming holiday season. We were thrilled to see our Halloween in-store shopping real go viral with now over 5 million views across all platforms.
Overall, we are encouraged by the consistent improvement in customer reactivation in store traffic and overall brand engagement. And we believe these learnings and enhancements will have an [E] difference greater impact in the back half.
Now on to our second strategic initiative, refocusing our product assortment. With our always something new mindset, we delivered more frequent newness in key categories such as floral and decorative accessories, as well as highly seasonal micro collections throughout the quarter. We believe increased frequency of product launches are key to keeping our customer, highly engaged, driving increased visits and ultimately improving inventory turns to our historic norms.
Diving into the details, our holiday and floral categories drove double digit sales increases year over year with Halloween being the standout winner in the quarter. The reintroduction of gift and impulse continues to exceed our expectations, driven by key items such as the carry [Altocor] and Monogram jewelry box.
With respect to our high ticket furnishings categories, in line with our sector and competitors, we continue to see challenges in items such as furniture, mirrors and rugs. While we planned these businesses down appropriately for the quarter. Overall demand remains soft. We will continue to evolve these categories to meet the value demands of the customer and for wallet without sacrificing style or quality.
As we look ahead, we will continue to monitor the demand and price sensitivity of the high ticket categories while driving more substantial growth in holiday floral decor and gift. These growth categories are significant contributors to the back half, and we remain optimistic on the continued success of these seasonally relevant assortments.
Finally, let me talk about our third strategic initiative, strengthening our omnichannel capabilities. As we have discussed previously, given the challenges in our e-commerce channel, we have been planning the business prudently and actively working on our long-term digital strategy with new leadership, reviewing all aspects of our e-commerce channel. We are finding opportunities for improvements, but most importantly, developing our business case and road map for our future re-platform.
While we did see year over year conversion improvement in the channel, largely driven by the successes in our holiday and floral product categories that was offset by the declines in our furniture, rugs and wall categories. In the near term, we are actively implementing a new pricing tool to help our e-commerce merchants better analyze the marketplace, particularly for our drop-ship assortments. We expect to see the initial impact of this new tools for our peak holiday season.
With respect to our store channel, we remain encouraged by the positive results we continue to drive for increased traffic conversion and items per transaction. Throughout the quarter, all three metrics remained positive, driven by our highly engaged store teams. We realigned to the store leadership organization within the quarter, allowing us to further unify our field and recognize the talent and leadership that exists within the organization.
Our stores capitalized on new product launches and seasonal promotions to create unique shopping experiences personalized for their market and their deep understanding of the customer. With new holiday and gift product arriving in our stores later this month, we remain optimistic in the results we can drive in this channel and the back half.
Longer-term, we have shared that we clearly see whitespace for new store locations, especially within many of the markets we have previously exited, the timing will ultimately depend on our capital allocation priorities. Modernizing our e-commerce experience and ultimately syncing it with our in-store experience remains key to meeting the demands of our omnichannel shopper. We remain committed, to a unified experience that meets her whenever and wherever she wants to shop.
As I wrap up, I want to thank our associates. It is their ongoing passion for our brand and dedication to our customer that is driving the progress we are making towards our strategic initiatives. I am so proud to be part of this team as we position Kirkland’s for long-term success.
Before I turn the call over to Mike. As noted in our release, we continue to be engaged in the pursuit and evaluation of potential strategic opportunities to support the company and our initiatives. This process is ongoing, and we remain laser focused on pursuing a path that will both keep our business on solid footing and create value for our shareholders. We look forward to sharing more when appropriate, but we do not intend to comment further at this time.
And now over to Mike.
W. Michael Madden
Thank you, Amy, and good morning, everybody. As Amy, reviewed we continue to be pleased with the ongoing progress against our initiatives as reflected in the positive comparable sales growth we delivered in our store channel for the period and the year over year improvement we delivered in adjusted EBITDA.
Turning to our results in more detail for the second-quarter, net sales were $86.3 million versus $89.5 million in the prior year quarter. The average store count was down 4.4% compared to the prior year quarter and comparable sales decreased 1.7% for the quarter. The decrease in comparable sales was driven by a decline in the average ticket and e-commerce traffic offset partly by an increase in store traffic and omnichannel conversion.
Breaking down sales within the quarter, comps were down 0.2% in May, up 0.5% in June and down 5.3% in July. The month of July was impacted by tougher e-commerce comparisons and POS disruptions related to an IT outage with one of our vendors. We drove positive comparable store sales of 1.8% in the quarter driven by relative strength in June and July.
With respect to our e-commerce business, sales declined 10.6% compared to the prior year period, offsetting the positive results in our store channel. The sequential improvement in trends in our e-commerce channel from Q1 was largely driven by easier year over year comparisons at the start of the period as the channel continues to face headwinds with respect to its higher ticket categories.
E-commerce accounted for 25% of total sales in the quarter, down from 27% in the prior year quarter. From a merchandise perspective, we saw increases versus the prior year in holiday gift floral, decorative accessories and fragrance, reflecting our shift in emphasis to faster-turning lower price point items.
However, these increases were not enough to offset declines in the higher ticket categories of furniture, mirrors, wall decor art. Sales performance was consistent across geographic areas with no particular over or underperformance relative to the whole. Gross profit margin increased 100 basis points to 20.5% of sales compared to 19.5% in the prior year quarter.
The components of this year over year change were as follows. Merchandise margin increased 90 basis points to 52.1% versus 51.2% in the prior year quarter. The increase was largely driven by favorability in inventory shrinkage compared to the prior year, as well as slightly lower freight costs, both of which helped to offset the increased promotional activity during the period.
Outbound freight costs, including both store and e-commerce shipping expenses, decreased 80 basis points to 7.2% as a percentage of sales compared to the prior year quarter. Improved management of outbound store routes, along with lower rates per route were the primary drivers to the decrease. We also benefited from lower parcel delivery costs due to reduction in e-commerce revenue and lower contract parcel rates.
Depreciation included in cost of sales decreased by about 30 basis points to 1.8% and central distribution costs were flat compared to the prior year quarter at 6.1% of sales. Lastly, partially offsetting these cost improvements with an increase in store occupancy costs of 100 basis points to 16.5%. This increase was largely due to deleverage from the overall sales decline.
Total operating expenses decreased $4.5 million to $31 million or 35.9% of sales compared to $35.5 million or 39.7% of sales in the prior year quarter. The decrease in dollars was primarily the result of reduced advertising costs asset impairment charges and corporate salaries and benefits expense.
In addition, we benefited from a change in Tennessee state tax law that resulted in an $800,000 tax refund received in the quarter. Adjusted EBITDA, which excludes stock compensation and severance charges, was negative $10.2 million versus negative $13.5 million in the prior year quarter. This is primarily the result of the continued tight expense control, along with gross margin improvement.
Operating loss was $13.3 million compared to an operating loss of $18.1 million last year. Operating loss as a percentage of sales improved 480 basis points. Net other expense, which is largely comprised of interest expense, offset by other income was $1.3 million for the quarter compared to $0.6 million in the prior year quarter.
Included in these amounts, net interest expense was $1.4 million in the quarter compared to $0.8 million in the prior year quarter due to higher borrowing levels and higher interest rates. Our income tax rate for the quarter was a benefit of 0.8% of pretax loss compared to earnings expense of 3.5% of pretax loss in the prior year period.
From a balance sheet perspective, our inventory levels continue to be under control as we prepare for our fall and holiday season. We ended the quarter with $92.8 million in inventory, a 22.4% increase from $75.8 million at the end of the previous quarter and a 6.3% decrease from $98.9 million at the end of the prior year quarter.
We had total borrowings outstanding of $62.7 million at the end of the quarter, which was comprised of $52.7 million under our senior revolving line of credit and $10 million under our FILO term loan. This compares to $38.9 million under our senior revolving line of credit and $10 million under our FILO term loan at the end of the previous quarter.
The increase in borrowings reflects the negative operating performance for the quarter. Seasonal growth in working capital and capital expenditures of $0.4 million.
As a reminder, given the seasonality of our business, inventories are at lows during the first-quarter and begin to build during the second-quarter on the way to peak in late Q3, early Q4. As expected, our borrowing capacity expanded from last quarter, and we expect that to continue as we increase our inventory position ahead of our peak holiday season. We expect to use the cash generated during the third and fourth quarters to reduce the borrowings under our senior credit facility.
We are continuing our policy of not providing specific guidance given the difficulty in forecasting visibility and due to the ongoing review of strategic alternatives. However, we do want to provide some color around our expectations and key areas.
First, as a reminder, this year’s fiscal calendar includes 52 weeks compared to last year’s 53 week fiscal calendar. The extra week last year resulted in approximately $6.6 million in revenue. While our comparable sales results are calculated on a like-for-like calendar, we anticipate the timing shifts associated with the 53rd week to impact other reported quarterly results more meaningfully for the balance of the year.
Specifically, we expect the calendar shift to benefit results in Q3 as a smaller week at the beginning of the quarter is replaced by a relatively larger week pulled into the end of the quarter. This shift will negatively impact Q4 in turn and the fourth-quarter comparisons to prior year we’ll also be negatively impacted by the loss of the 53rd week.
That said, as we move into the second half of the year, we continue to expect improvement in sales compared to the first half of the year. And as Amy reviewed, we are encouraged by the early reads we have seen with our fall and holiday assortments thus far. We believe we will continue to benefit from our assortment shift to faster-turning categories, which began in earnest at the end of September last year, as well as our aggressive focus on promotional effectiveness and inventory clearance to ensure freshness throughout the year.
While we expect the promotional environment in Q3 to be relatively consistent with what we saw in Q2, we do expect to see slightly more pressure related to freight, given the impact we began to see in late Q2 related to the tightening conditions around ocean shipping, particularly impacting our imports from China and Southeast Asia.
As for operating expenses, we continue to manage them very tightly and as we announced last quarter have taken actions to reduce costs across the business. While the economic environment remains challenging, we believe we are still positioned to achieve positive adjusted EBITDA in 2024 after two years of losses.
With respect to capital allocation, our number one priority for the business right now is returning to positive cash flow. As we make progress toward that end, we continue to focus on reducing borrowings and reestablishing a level of liquidity that allows us to operate the business with more flexibility.
As we stabilize our financial position, we are also focused on reinvesting in the business with e-commerce technology enhancements and targeted store openings and relocations. We continue to believe in the long term opportunities still ahead and with ongoing operational discipline and improvements in liquidity, we believe we will deliver on our long-term goal of $600 million in revenue and adjusted EBITDA margin in the mid to high single digit range by the end of fiscal 2028.
That concludes our prepared remarks. And operator, we’re now ready to take Q&A.
Operator
(Operator Instructions)
Jeremy Hamblin, Craig-Hallum Capital Group.
Jeremy Hamblin
Thanks and congrats on the improved results. I wanted to just get started here in talking about trends. It sounds like you’re pleased with the initial start and wanted to see if you might be able give a little bit more clarity on that in terms of whether or not, you’re comping positive quarter to date how comparisons stack up for the remainder of the quarter.
And then just in terms of, you know, this split between how your e-com business is doing versus your retail store, if you kind of expect that and to continue. I know that the comparisons are actually a little bit easier or I’m sorry, a little bit tougher in queue three on your e-com business versus what you saw in Q2?
Amy Sullivan
Jeremy, I’ll start. And then Mike can jump in with some more color on that, from August or quarter to date perspective, we’re seeing a similar comp trends to Q2 and finished the month really strong. So as you know, from following us over time as we build into this true fall and holiday season, that’s really when the strength of the brand starts to accelerate.
And as I shared, we’re really pleased with Halloween in particular, oftentimes that as an indicator of how Christmas will perform, Christmas is actually arriving in stores the first wave of it this week. So we continue to feel optimistic about the back half. I would certainly say the consumer environment is requiring more promotion just to sort of incentivize her.
And again, particularly in the higher ticket categories. So I don’t necessarily see that part of it. It’s improving overnight, but the penetration of holiday and guest and textiles, the areas where we’re really winning in our historically strong categories for us become even more meaningful as we move into the back half. So that’s sort of where we’re thinking about the balance of the year.
And then in terms of kind of brick and mortar versus e-commerce. E-commerce is the biggest part of our miss is really coming from the drop-ship business, which I think as we’ve shared in the past is very heavy and furniture wall rug, those high ticket categories. And so we’ve seen that we can definitely stimulate sales with discounts and we will be surgical about that to balance driving demand, but also making sure that those sales are as profitable as they can be.
But I would say I expect that challenge to continue in the e-com channel a little further into this year on the things that we can control, we will control. And then as we’ve shared as we think about sort of next year in the future, I think there’s some incremental upside we can think about as we get closer to a re-platform.
Jeremy Hamblin
Got it. Good color. And then in terms of just following up on the comment about the consumer and cheese requiring a bit more promotion and so forth. How should we be thinking about, you know, gross margin as we look into the back half of the year you guys have had improved gross margin year over year, both in Q1, Q2. And wanted to get a sense for whether or not you were expecting that same type of momentum to continue here in Q3 and Q4 as well?
W. Michael Madden
Yeah, Jeremy, yeah, I think those are the call-outs that we made related to the promotional environment. We expect that to continue so that’s a little pressure on margin. And then I also called out the freight on some of the higher freight costs that we endured on the inbound in second-quarter of those goods will be selling through in the back half. So that will create some pressure as well.
Having said that, we still feel like we’ve got opportunity on the merchandise margin and we certainly have opportunity on all the other cost line items that we’ve experienced, solid reductions year to date said that our gross profit, we still see the potential to expand that in the back half. So we still, aside from a little bit more promotional pressure and some freight pressure, we think we can overcome that with all the other things that we have put into place this year and what we’ve experienced in the first half.
Jeremy Hamblin
Just to clarify, in terms of seeing gross margin up in the second half of ’24, are you more likely to see them gross margin up in Q3 or Q4?
W. Michael Madden
I would say Q3 on that just because and I called out the of the calendar shift a bit in my prepared remarks, we get more sales in the third-quarter this year. Given that shift you’re taking a week from the early are that that November-ish type week and you’re replacing it with an earlier week in the third-quarter.
So that’s going to create some more leverage on some of the more fixed costs. So I see more opportunity in the third quarter than the fourth. But I think we have opportunities in both averages weigh the third a little bit heavier than the fourth.
Jeremy Hamblin
Got it. Thanks for the color. Good luck and I’ll hop out of the queue.
Amy Sullivan
Thank you.
Operator
John Lawrence, Benchmark.
John Lawrence
Yeah, good morning. Thank’s for the time guys. Could you talk about we’ve had some stores lately and then it seems like remind us a little bit how will we get into the stores just a little earlier this year?
Amy Sullivan
Yeah, we you’ll probably recall from last year, we had a really strong holiday season last year as well. And it’s a big trend in the market overall, so we definitely brought it in about a week early this year. I would say there’s opportunity to maybe even accelerate that further as we move into future years. But we definitely got an early benefit of a set date as well as it was a really strong right out of the gate and got some really good full-price selling out of that set.
John Lawrence
But what sort of appeared from store visits that, traffic was up during that period of time, whether they would just window shopping, et cetera, but seems like a lot of transactions for that only Halloween stuff.
And can you give a sense of you’re talking about [49%] reactivation rate. Can you talk about the fleet of stores and now if you’re doing positive comps, can you talk about maybe what percentage of the fleet is positive at this point?
W. Michael Madden
Yeah, on that part, John, we are slightly positive in the stores year to date and we were in the second-quarter, we’re seeing positive traffic pretty much across the board in our store in our locations. I think it’s as it always it’s a mix of some are down and some are up, but I think we called out geographically, we’re seeing consistent performance across the chain. And so it’s pretty you know if we’re slightly positive, we’re kind of slightly positive in most places I would say, there’s always outliers, but there’s nothing really to call out there it is different.
John Lawrence
So in that in your base region and you might have mentioned and I missed it, but what’s the plan on maybe some of these new stores in your trade area that you think could be really successful. Is anything started, they’re still waiting for capital for that?
W. Michael Madden
Well, we were largely waiting for some capital there to kind of give us the room we need to do that more aggressively, but we have identified a lot of locations that we know we would go to and we do have a couple that are actively being pursued. So stay tuned for more on that, but we’re excited about the ability to get back and build some stores. I mean, I think we’re missing some customers in some key markets and we’re anxious to get back into those markets.
John Lawrence
Last question for me. I mean, when you look at the Halloween set, looks a little different, some new items assume that same type of freshness goes to the fourth-quarter with holiday stuff coming in.
Amy Sullivan
Yes I would say, we have a good amount of newness in the holiday assortment as well as if you’ll recall, last year was the first time we reintroduced gift in Q4. And so the success that we saw and that we really doubled down on the investment in that category as well.
So the customer will feel significant newness, particularly as we move sort of October to December, which I think will give us continued momentum on positive traffic, improving inventory turns, but there is a lot of new arriving, as I said before, starting this week throughout the balance of the fall holiday season.
John Lawrence
Great, thanks guys, good luck in the second half.
Amy Sullivan
Thank you.
Operator
This concludes our question and answer session and concludes the conference call. Thank you for attending today’s presentation. You may now disconnect.
