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Edited Transcript of KIRK earnings conference call or presentation 15-Mar-19 1:00pm GMT

Q4 2018 Kirkland's Inc Earnings Call

NASHVILLE Mar 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Kirkland's Inc earnings conference call or presentation Friday, March 15, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael B. Cairnes

Kirkland's, Inc. - President & COO

* Nicole A. Strain

Kirkland's, Inc. - Interim CFO

* Steven C. Woodward

Kirkland's, Inc. - CEO

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Conference Call Participants

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* Anthony Chester Lebiedzinski

Sidoti & Company, LLC - Senior Equity Research Analyst

* Bradley Bingham Thomas

KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst

* Jeffrey Wallin Van Sinderen

B. Riley FBR, Inc., Research Division - Senior Analyst

* Jeff Black

SCR Partners, LLC - Partner

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Presentation

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Operator [1]

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Good morning, and welcome to Kirkland's Fourth Quarter 2018 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.

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Jeff Black, SCR Partners, LLC - Partner [2]

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Thank you. Good morning, and welcome to the Kirkland's conference call to review results for the fourth quarter of fiscal 2018. On the call this morning, we have Woody Woodward, Chief Executive Officer; Mike Cairnes, President and Chief Operating Officer; and Nicole Strain, Interim Chief Financial Officer.

The results as well as the 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 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 Securities and Exchange Commission, including the company's annual report on Form 10-K filed on April 3, 2018.

I'll now turn it over to Woody.

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Steven C. Woodward, Kirkland's, Inc. - CEO [3]

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Thanks, Jeff, and good morning. Thanks for joining us to review the fourth quarter and our plans for 2019 and beyond. Today, we'll spend more time than usual to review our plan in detail. Since speaking with you last quarter, I've had an opportunity to dig deeper to understand our customers, suppliers and how our product resonates. As we all know, the sector continues to experience rapid changes in consumer shopping and purchasing patterns, and the challenges related to that are significant.

After a more full assessment of our strength, I remain optimistic that the issues that have hampered Kirkland can be solved, and we're in a position with the company for profitable long-term growth. We have a strong value proposition, great talent in the organization and a solid plan we're executing towards.

Overall, 2018 was a challenging year. Strength in e-commerce helped to drive a modest increase in total sales for the year and the merchandise margins stabilized following several years of decline. We're pleased with the progress in these key areas but it was not enough to overcome traffic challenges that persisted in the fourth quarter.

As we outlined in our third quarter call, we had a strong November. Seasonal categories, including fragrance and candles, textiles and floral, all performed well. December was more mixed. Gifting assortments performed well. We had a continuing channel shift in the lead up and immediate aftermath of Christmas impacted brick-and-mortar sales. January traffic was further hampered by weather and port delays that constrained inventory flow.

We experienced solid traction on newness in the final month of the quarter, but we need to strike a better balance with clearance to drive post-holiday traffic. There are some very important learnings there and the teams did some heavy lifting during the year on operational and merchandise initiatives that can improve the business over time.

As we look forward, we're accelerating the pace of change and taking meaningful full steps to further transform the business and address changes in the home decor retailing sector.

The plan we're outlining today puts us on the path to accomplish our goals. It starts with fast-tracking our transition by building on the work begun in 2018 to enhance the customer experience and improve efficiency. For example, Buy Online and Pick Up in Store is driving a better omni-channel experience. It is early stages in terms of its potential impact on revenue and profitability. The name -- the same can be said of markdown and promotional optimization. We captured some low-hanging fruit in 2018 as it relates to destacking promotions, but there's more value to come from leveraging analytics to improve promotional efficiency.

We also see significant opportunity to manage freight headwinds and achieve lower product costs via the online going work in supply chain and direct sourcing. Mike will go over these in more detail in a moment.

The takeaway is that we're pleased with our initial progress and believe each one of the major pillars we outlined in 2018 have further room to improve our business.

The second part of our plan includes initiatives to increase traffic to Kirkland's via our omni-channel platform. The first of these involves extending our assortments. As many of you know, our mix of product is highly seasonal, and we're known for seasonal, and it's a destination category in fall and holiday. While it differentiates Kirkland's, we believe that we can achieve the same recognition in additional categories, which can positively impact performance outside of the fourth quarter. These include new categories, such as area rugs, tabletop and bedding products and accessories. Each of these have large addressable markets, and each of these are important to our Kirkland's customers.

The second involves addressing the existing assortment. We have some seasonal and fashion-oriented categories that are doing well. We have some areas of the assortment that need a reinvention. We improved elements of the art assortment in 2018, but we believe there's a big opportunity to introduce more freshness and add a stronger point of view in wall and lighting.

Overall, we believe there's opportunity to invest in our top key items with greater conviction. Let me give you an example. In late fall, we ran a 1-day candle event, and we sold over 50,000 candles and lifted sales across the brand. And it accomplished several positive aspects. It serves as a new handle to drive traffic and new customers. We were also able to do so in a margin-positive way since the promotion was surgical and only jar candles were on sale. It also brought awareness to our fragrance category.

In 2019, we want to take that key-items theme and plan ahead. This will allow us to buy better and deeper while mixing up our messaging to the consumer. This is an example where we will significantly increase our purchases on top key, proven items.

Finally, we're developing a future state plan for infrastructure. We're seeing traffic shift from stores to online, our growth in e-commerce reflects that. To address these long-term changes, we're testing a store of the future that has more elements geared towards improving the customer experience for omni-channel. We are slowing store growth as we continue to analyze this.

At the same time, we're evaluating a fulfillment model that moves e-commerce distribution closer to the consumer. Things we're doing have sizable, strategic and financial benefits, but there's much to overcome and hard work ahead. Traffic trends remained under pressure thus far in the first quarter, and it will take time to see the benefits of our work. While we're excited about the changes we're putting into place, we don't expect meaningful improvement to begin until the second half of 2019.

We have a strong customer proposition, a healthy balance sheet to support our strategy, and we're optimistic about our prospects to improve performance and create long-term value for shareholders.

Now Mike will walk you through a bit more detail of our 2019 initiatives.

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Michael B. Cairnes, Kirkland's, Inc. - President & COO [4]

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Thank you, Woody. As Woody mentioned, we did not achieve all that we hoped in 2018, however, we were successful in laying the groundwork and making progress on the key initiatives in 2018. I want to add detail on what was accomplished in 2018 that resonated in the results and what is in progress and in play for 2019.

We strongly believe that it's a pragmatic and focused plan to improve our performance while aggressively addressing the macro issues. Our collective plan in merchandising and operations can be summarized in 4 themes: one, product revitalization and reinvention; two, merchandise margin expansion; three, omni-channel growth, profitability and infrastructure; and four, supply chain optimization.

I'll start with number one, product revitalization and reinvention. In 2018, as Woody mentioned, we did make assortment improvements in many of the fashion-oriented categories: furniture, fragrance, textiles, seasonal gifts and floral. Collectively, these categories represented positive comp sales. Our biggest misses came in wall, frames and lighting categories.

With that context, we have taken the following actions. We've reorganized the merchandise organization. This will result in a stronger focus on wall décor as well as in-house design that will improve consistency in design across all categories.

The reorganization enables us to lean in on the categories we want to turn around, and it supports the new categories that Kirkland's will be introducing in second half: tabletop, rugs and bedding. It will dovetail into our direct sourcing initiatives, enable us to stand up private brands and ensure success of our new product categories.

These important organizational changes were made prior to the beginning of our fiscal year, and the teams are off and running. Another key element to support our product initiative is the elevation of quality across the assortment as we create greater alignment with our vendors while raising the bar. We believe that design, price and quality are bundled together in how the consumer views value.

In summary, for product revitalization and reinvention, we have built the structure, and we are actively getting ahead of the playing cycle to drive key items, address underperforming categories and add new products.

I'll now move to the second key initiative, merchandise margin expansion. We spoke about this in 2018. And we did make some progress, though not as much as we'd wanted. Merchandise margin was essentially flat, while product margin was up 30 basis points. We were successful in putting in place to forecast tools to line up the marketing coupons and merchandise promotions to inform us of the overall margin rate. From there, we were able to modulate or tweak the promotions to drive into our forecast.

As we move into 2019, we have added analytical muscle to identify the most productive promotions as well as root out the inefficient promotions and take a more aggressive approach in destacking our promotional cadence.

In addition to the price and promotion work, we're making rapid progress in another lever for merchandise margin: direct sourcing. We're using an agent model and building our capabilities as an importer of record. We've integrated direct sourcing as part of our process road map and begun collaborating with our merchandise team. My prior experience in this space has told me that the hardest part of direct importing is not the sourcing aspect itself; it's the change management with the buying team. I'm really pleased with our merchandising organization in terms of adapting to this new model.

Meanwhile, we're building our penetration goals. As this gets more definition, we'll share those goals with you. Obviously, we are starting from a place of virtually 0 direct sourcing, therefore, the upside potential is great. The benefit is not just the cost savings but the ability to expand our network of factories of high-design, high-quality, affordable home decor products.

To tie up the merchandise margin expansion initiative, we have levers that have moved from concept to early adoption, price and promotion analytical effectiveness, and direct sourcing.

I'm now going to move to omni-channel growth, profitability and infrastructure. Before I talk about our approach, I'll speak to the current landscape of our e-commerce business. We have 3 channels of e-commerce: one, pick up in store, either pick up from existing inventory or Ship to Store; vendor direct fulfillment; and three, direct-to-consumer, where we ship directly to the consumer from our e-commerce fulfillment center.

Our overall e-commerce growth in 2018 was 22%. Our goals from a channel perspective are to accelerate growth in BOPUS and vendor direct and drive more profitability out of direct-to-consumer.

Starting with BOPUS, we were able to stand it up last year on schedule. In Q4 last year, we did over $4 million in BOPUS sales. We started at 250 SKUs and methodically ramped it up. Our goals are to accelerate SKU count and improve the service aspects to achieve growth.

We're excited about the potential of BOPUS for multiple reasons. It's a service that consumers desire because she gets instant gratification, it drives at full margin and it drives traffic and add-on purchases. Strategically, it allows us to compete against pure e-commerce players. Today, we've got over 1,000 items on BOPUS, which is over 15% of our total e-commerce sales, and we'll continue to build on that.

Turning to vendor direct. We're excited about our growth in this channel because it's very profitable, allows us to grow our assortment without assuming inventory liability and impacting our logistics. That segment grew over 70% last year with over 100 vendors. To drive this business more aggressively, we're currently scoping a new platform that will enable better scalability of the product management workflow and reporting and lead to a more cohesive consumer experience. We'll have this implemented by Q3 of this year.

Moving to direct-to-consumer. This is a business where we have revenue and profit upside and opportunity to improve our customer service. Today, we fulfill all e-commerce orders with our owned inventory through one stand-alone fulfillment center that's based in Jackson, Tennessee. We're evaluating options to get our distribution closer to the customer. Meanwhile, we continue to make exciting enhancements to improve the aesthetics and streamline the navigation capability. We're leaning in on mobile improvements, as we did a system enhancement that resulted in 60% faster page load speeds for mobile devices. We are pleased with the progress of our digital marketing effort as the number of followers on social media, Facebook and Instagram combined was up 36% to 1.9 million.

Our active loyalty e-mail database has increased to 4.6 million with solid open and click-through rates, and our influencer community expanding.

As we bolster our e-commerce capabilities, we are reviewing the brick-and-mortar presence and store model that best complements our omni-channel strategy. Stores will remain an important ingredient of our digitally connected future. As such, we conceived a next-generation concept store and opened our first one last year. It updates the visual presence, provides purposeful navigation, supports omni-channel, it has the potential to attract younger customers. We're very pleased with the sales lift and superb customer feedback.

Our goal in 2019 is to refresh our group of existing stores with key elements of the next-gen store and measure the lift relative to the capital investment. This is exciting and potentially could add more arrows to our quiver to drive top line sales.

In summary, we have a solid and thoughtful omni-channel growth, profitability and infrastructure approach that is rooted in developing a more profitable model that differentiates from the prototypical e-commerce-only competition.

Number four is supply chain optimization. As Kirkland's has added more stores, increasing proximity from one single distribution center along with the macro pressures of rising transportation cost, it has further burdened product and -- product flow and profitability. This is part of the escalating gross profit challenge in 2018 and previous years.

In 2018, we accomplished some things to mitigate these pressures by relaying out the current DC operations at 20% more capacity, and we improved our truck utilization and streamlined our routes. We're now putting in place a more permanent and systematic solution that will have material impact.

First, we will be standing up a 3PL, which stands for third-party logistics, distribution center in Texas by the end of Q3 that will serve approximately 100 stores. This will create significant efficiencies and improve flow. Normally, 3PL bills add additional operating costs until you achieve scale. In our case, we'll see an immediate annualized savings of over $1 million.

In addition, we are further expanding our West Coast bypass. The West Coast bypass allows us to dropship and transfer allocated product directly to the West Coast store, which bypasses all the transportation costs to and from Jackson. We are very confident in the leadership and the team to make significant strides in supply chain optimization in 2019.

To wrap up, in 2018, we made some progress, and we laid the groundwork in the 4 key initiatives that are now in full swing for 2019: product, merchandise margin, omni-channel, supply chain. These initiatives are proven and pragmatic. Our eyes are wide-open, and we acknowledge the environment and trends to date in 2019 are a headwind for us. The leadership team is hyper-focused, and we believe the plan can start to improve the second half performance and significantly benefit in the long term.

I'll now turn it over to Nicole.

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Nicole A. Strain, Kirkland's, Inc. - Interim CFO [5]

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Thank you, Mike. Net sales for the fourth quarter decreased 3.8% or $8.5 million compared to the fourth quarter of 2017. Fiscal year 2017 included a 53rd week, which accounted for approximately $10 million of sales. Comparable store sales decreased 3.3%, which included an approximately 15% increase in e-commerce revenue, and that's on top of a 2% combined comp increase and 35% increase in e-commerce in the prior year.

In our brick-and-mortar stores in the month of November, we continued to see the strength of our seasonal decorating assortment with both positive traffic and a high-single-digit comp sales increase. As we move into December, we saw traffic decline, driven heavily by the week before and the week of Christmas. Those trends continued through the month of January, with double-digit traffic and comp store decreases. While weather definitely played a role in the January sales decline, we saw softness in traffic across our store base. Overall, the traffic decline was partially offset by an increase in conversion. We opened 3 new stores and closed 7 during the quarter, ending the year with 428 stores, which is a net year-over-year gain of 10 stores or 2.4%.

E-commerce accounted for $25.1 million in revenue during the quarter or approximately 12% of total revenue. Traffic increased during the quarter by over 35%, which was offset by a decrease in both conversion and average order value. For the quarter, approximately 45% of our e-commerce sales were fulfilled in store. This percentage increased throughout the quarter as we added SKUs and further messaged our Buy Online, Pick Up in Store option.

The third-party dropship channel also continued to grow as a percent of our e-commerce revenue. As we move forward, we intend to focus on increasing the in-store fulfillment and the third-party dropship channel as well as focusing on improving profitability in the direct-to-consumer channel.

Moving on to margin. Gross profit margin in Q4 decreased 85 basis points from the prior year to 34.4%. Merchandise margin decreased from the prior year by 40 basis points to 52.6%, primarily driven by an increase in inbound freight and a decrease in product margins, which was partially offset by an initiative to improve vendor compliance. We continued to see an increase in inbound rates affecting both ocean and intermodal and an increase in fuel costs. And again, these increases in rates were partially driven by the supply shortage as many U.S. importers accelerated shipments before tariffs went into effect.

Additionally, inbound freight costs were impacted by port delays on the West Coast in January. Outbound freight costs, which include e-commerce shipping, decreased 15 basis points as a percentage of net sales. The higher e-commerce penetration and resulting increase in shipping costs was more than offset by improved route efficiency and truck utilization for transportation of product from the distribution center to our stores.

Store occupancy costs increased 5 basis points over the prior year quarter. Central distribution costs increased 60 basis points as a percentage of sales compared to the prior year quarter, primarily due to increased labor caused by product flow disruptions.

Moving on to operating expenses. Operating expense for the fourth quarter was 24.7% of sales, which was down approximately 30 basis points to last year. Store operating expenses decreased 30 basis points as a percentage of store sales over the fourth quarter of 2017 due to a decrease in store labor, which was partially offset by incremental advertising expense.

E-commerce expenses increased 280 basis points as a percent of e-commerce sales, primarily due to incremental software costs and advertising expense.

Corporate expense decreased $1.2 million or 30 basis points over the prior year due to a severance charge in the fourth quarter of 2017 and lower corporate salaries.

Depreciation and amortization remained flat to the prior year as a percent of sales. The tax expense for the quarter was approximately $5.2 million or 27% of the pretax income compared to 40% in the prior year period. The lower federal rate in 2018 is due primarily to changes included in the tax and jobs act of 2017.

Our full year tax rate was 35%, which included 9% related to stock reward activity and a 14% state tax rate from the lower pretax income as it relates to our tax structure.

We ended the quarter with net income per diluted share of $0.95, or $0.97 adjusted, compared to income of $0.79 in the prior year quarter.

And moving on to the balance sheet and the cash flow statement. At the end of the quarter, we had $57.9 million of cash on hand, and that's compared to $80.2 million in the prior year period. We had no long-term debt or borrowings outstanding under our revolving line of credit. The year-over-year decrease was primarily driven by share repurchases of $15.7 million during the year and timing around payables. Our inventory balance at the end of Q4 was in line with our expectations at $84.4 million compared with $81.3 million in the year ago quarter or an increase of 4%. The increase in inventory is primarily due to store growth over the prior year.

Year-to-date fiscal 2018 cash provided by operations was $22.3 million compared to $45.1 million in the prior year. The primary drivers were working capital changes, specifically related to accounts payable and payroll-related accrual timing.

Capital expenditures were $28.8 million compared to $28.4 million in the prior year. Of the $28.8 million, just over 40% related to new stores, 30% to technology investments and the remainder to existing store and distribution center maintenance, store remodels and lease buyouts.

During the fourth quarter, we repurchased approximately 569,000 shares at an average cost of $9.42. For the year, we repurchased just under 1.7 million shares at an average cost of $9.52. As of our fiscal year-end, we had $3.7 million remaining under our existing authorization.

And now turning to our expectations for fiscal 2019. For the full year, we anticipate total sales to be flat to up 2% compared with fiscal 2018. This level of sales increase implies no net new store growth and same-store sales in the range of flat to up 1%. We expect to open 5 to 7 new stores and close roughly the same number. The openings will be concentrated in Q2 and Q3, and the closings near the end of the year.

We are seeing traffic softness to start the quarter at similar levels to what we experienced in January. We expect to see continued traffic challenges throughout the year, with improved trends in the back half of the year as we implement the merchandising strategies we discussed.

We expect negative comp sales in the first half of the year, with some improvement in trend in the second quarter, in part due to the easier comps over the second quarter of 2018.

Full year diluted earnings per share are expected to be in the range of $0.15 to $0.30. We expect earnings improvement in the third and fourth quarters, with a sales lift from new product assortments and the realization of many of the profitability initiatives mentioned by Woody and Mike earlier in the call.

We expect a higher loss relative to 2018 in each of the first and second quarters, with the most significant decrease in the first quarter due to the comp store decline and investments related to initiatives, which we expect to have long-term financial benefits.

Our income tax rate is anticipated to be 25%. We expect total capital expenditures in the range of $21 million to $23 million. As mentioned, we're further slowing store growth, which reduces the allocation of capital expenditures for new stores to approximately $3.5 million.

Over 50% of the capital will be dedicated to e-commerce and supply chain initiatives focused on long-term revenue and profitability growth. Based on our earnings estimate for 2019 and the projected level of capital expenditures and share repurchases, we expect a similar cash position at the end of fiscal 2019 to the balance at the end of 2018. We do not expect any borrowings on our line of credit during the year.

Thanks, and now I'll turn it back to Woody for some closing comments.

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Steven C. Woodward, Kirkland's, Inc. - CEO [6]

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Thanks, Nicole. Despite the tough year, we're optimistic that we can achieve improvements in the back half of this year that roll forward.

We're moving quickly on a range of initiatives that will improve the business. On the merchandising side, product time lines are a reality, particularly as we're talking about adding substantial new categories. We have a solid leadership team in place and a plan that can change the course of the business.

I want to thank all of our associates for working hard to bring our initiatives to life. And now, operator, do you want to open it up for questions?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today will come from Jeff Van Sinderen of B. Riley FBR.

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Jeffrey Wallin Van Sinderen, B. Riley FBR, Inc., Research Division - Senior Analyst [2]

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Good to see that you're taking the bull by the horns to accelerate the programs that you're -- that are working. Maybe you can speak more about which merchandising initiatives you feel are most critical to your plan in 2019 and when we'll start to see those reflected in the stores? And then maybe speak to how much of your plan you feel sort of falls under the test of the act category for 2019? And how much is building on areas of success from 2018?

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Steven C. Woodward, Kirkland's, Inc. - CEO [3]

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Great. Thanks, Jeff. Okay, so the minute we realized that we needed to absolutely diversify from the fourth quarter, we started investigating and asking customers and also looking at the industry. Remember that I have about 40 years' experience in the home furnishing industry. So I was really kind of amazed that we were lacking some of the large category drivers that really benefit most retailers in the first, second and third quarters, and we just didn't have that in our mix. We were into many tertiary categories that we were able to cut off the long tail and reduce -- and have a SKU rationalization.

But let me get into specifics. Of the 3, wall décor and bedding and tabletop, which are all 3 very large categories in the total scheme of home furnishings that we really were participating in, we have a plan for the back half of the year -- let me back up for just a second, we wanted to make sure that when we introduced those that they were proprietary, which is taking us a little longer than going into the open market because we felt like we needed to -- if we're going to introduce those new large categories, we needed them to be proprietary and unique and not follow on the same looks that other retailers had. So we really approached it with our modern farmhouse aesthetic.

We've also done some of these new categories with our direct sourcing model, and that's why most of these categories land at the beginning of the third quarter and will benefit in the third quarter and fourth quarter.

I would say that, that's about 2/3 of our growth. The other 1/3 comes from taking our proven key item winners that have been actually key-item winners for years, like we mentioned in the candle, and we picked the top 10 and we bought them double with conviction. So that provides us about a $10 million incremental lift in the third and fourth quarter as we roll those out and have bought them with almost no risk because the customer has already voted for those.

We also made sure that as we were looking at these new categories that we wanted to lean in to our benefit that our customers believe we have about being a value-oriented retailer. And so, for example, we're introducing rugs, 20 rugs onto the floor in a new fixture that was custom built for us, and we had to take some time to that rolled out. And these rugs, all 20 of them, are priced at near choice of $199, which puts us significantly below the marketplace for rugs that we feel like our customers will really resonate.

So that's why most of this benefit that we're seeing comes in the third and the fourth quarter, but the real, I think, benefit that we hope for and we will achieve is that it will help us next year in the first and second quarters, especially to offset some of our poor performances that we've had over the years in 2 quarters that we just weren't set up for success with.

Does that answer your question, Jeff? Or did you have a follow-up?

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Jeffrey Wallin Van Sinderen, B. Riley FBR, Inc., Research Division - Senior Analyst [4]

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No. Yes, that helps, and I do have a couple of follow-ons. On the, I guess, being in a better position as you think about 2020, early 2020, do you feel like you didn't have enough merchandise that was clearance around promotion? I think you talked about changing the mix there or balancing the mix of promotion in new merchandise in early 2020. Maybe just touch on what you feel like was not right in the mix in early 2019?

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Steven C. Woodward, Kirkland's, Inc. - CEO [5]

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Yes, and let me answer that in a couple of parts. One, coming in from other retailers and looking at our turn, we probably turn our merchandise too quickly because we're in so many seasonally dependent categories. So we need to build up a core business that we can rely on that delivers sales growth over the regular times, because we're -- we always seem to be chasing that next seasonal category and we didn't have the impetus to build up on our core business. So we'll be slightly -- we're actually going to treat the turn the same on all of our current assortments, and the whole inventory investment will come from the new categories and the key items that I listed earlier.

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Jeffrey Wallin Van Sinderen, B. Riley FBR, Inc., Research Division - Senior Analyst [6]

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Okay, that's helpful. And then I do have another one, and it's kind of a multipart one, so if you can bear with me a little bit. Woody, I know it's early and change is in process, but now that you've been there a little bit of time, could you maybe give us a little bit more on your longer-term vision for Kirkland's without giving a -- away any sensitive competitive information, obviously? But maybe talk about how you'd like to see the store environment evolve and the customer experience improve? How marketing, promotions, discounting will play into that?

And then I respect the conservative target metrics you've provided for '19. And as we think further out about FY '20, what do you see as the most impactful P&L to drive improved margins?

And then if you could comment on how you are thinking about real estate lease renewals, new stores, e-com, omni-channel, and how you'd like to see that mix evolve? I know it's a lot there, so maybe you can just hit some of the highlights?

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Steven C. Woodward, Kirkland's, Inc. - CEO [7]

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Yes, that's good. And I'm going to answer the first part and then turn it over to Mike to answer the FY 2020 in real estate and some of the things that we have -- we think really deliver a much improved year for both 2020 and the future.

First of all, the long-term vision we actually started with some groups that came in and gave us -- did a lot of market research, a lot of customer research. We are going to be rolling out a new brand logo message that kind of ties around our next-generation store learnings that I feel really excited about. The long-term vision for Kirkland's is to be the best home furnishings in the -- specialty retailer in the value space. So we think that there's space above the big box less-service-oriented retailers and the very specialized retailers with -- that are at the higher price points. So we do have some editing to do in that particular area because we're in some tertiary products, but I think that what we have to do is find our definable space: What is -- what are the things that customers only come to Kirkland's for? Or what do they think of the minute they think of Kirkland's? And I think we have some of those that we already win at. We win at the sentiment wall décor area. We win at our seasonal products, which we probably have one of the best seasonal buyers and the best seasonal assortments out there. We win in the fragrance and the floral. But some of those are relatively small in the impact, and we need to win at some of the bigger categories to make us more relevant to really furnish for home and still do that at a value proposition.

So our long-term vision is to really be more relevant to the customer in the home furnishings retail arena but not change our value proposition. We kind of like where we sit right there, and I think that we've acquired a customer that expects us to give her a better look for her dollars than she can find at other retailers.

From a marketing standpoint, we are being very cautious this year. We're not landing most of our new categories until the back half of the year, and we'll be doing a launch marketing for each one of those categories through all of our 4.6 million in the database. But we want to make sure that we're fully set before we come out in 2020 with a very extensive rebranding and look to our marketing. And I'll turn it over to Mike.

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Michael B. Cairnes, Kirkland's, Inc. - President & COO [8]

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So let me answer your question on merchandise margin, and I'll unpack it in 2 areas. So as I mentioned in the script, we have now stood up a price and promotional analytical team as of this year. And in doing so, what this team will now start to do is look at our overall price and promotional effectiveness. So last year, we built in the forecasting capabilities. Now we are in a position to take it another, bigger step forward to look at the overall effectiveness of what we do when we combine our marketing coupons and our merchandise promotions so that we can lean in on the promotions that are working the best and then we can rid out the ineffective promotions that are affecting overall merchandise margin. And that has kicked off, and I expect that we will start to see some benefit in Q2, more of that benefit later in the year, in Q3 and Q4.

On direct sourcing, we needed the merchandise vision to catch up with our direct sourcing efforts, and we are now there. So we have hired a Director of Direct Sourcing. We've signed on an agent that is focused on China, and we're now interviewing agents for India. We have built it into our process road map, and we have already now started taking orders direct to factory. So we are off and running on it. I'm really pleased with where we are at this point.

We are now in the process of defining what we believe those penetration and financial goals will be as it relates to that. And the way we're getting there is we have taken some products that we already purchased where we already know the cost up from our current vendors, and we are looking at what that cost/benefit will be direct to factory, and then we're looking at a roll-up category by category to see what makes sense in terms of what we move direct to factory. We will bundle that up, roll it up, and we'll be in a position later on to let you know what that full benefit will be over the next 3 years. We're very excited about what that -- those prospects could be. We will get some of that benefit later this year, but most of that is definitely going to come in 2020 and beyond on that.

Relative to real estate, I'll break it down into several parts. So last year, we did a deep dive on real estate in looking at multiple attributes in terms of market type, co-tenancy, positioning, and I felt like the class of 2018 was much more dialed in, performed reasonably well and exceeded the previous classes. And as I also mentioned, last year, we stood up what we refer to as a next-generation store. It provided purposeful navigation, it updated the visual presence, it supported omni-channel, and we think it will lean in on attracting younger consumers. We are really excited about how that store performed. Now we need to do a full-on test of that store and compare that to the capital investment that goes into that. So that is in full swing as we speak.

And then finally, we're now prepared to deal with the store model as the consumer shifts more to online. And so we are evaluating that store model as it relates to the omni-channel world and the footprint that it represents, and more to come on that.

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Operator [9]

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The next question will come from Anthony Lebiedzinski of Sidoti & Company.

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Anthony Chester Lebiedzinski, Sidoti & Company, LLC - Senior Equity Research Analyst [10]

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Thank you for the thorough review of your strategic plans. So as you look at the new product categories that you're about to launch, just wondering about the addressable market, if you could just do a deeper dive into that as well as the competitive nature within that. Is it as competitive as your core existing categories? Or less? Or more? If you could just maybe touch on that, please, first?

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Steven C. Woodward, Kirkland's, Inc. - CEO [11]

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Sure. Thanks, Anthony, for the question. Of course, there are no categories that are uncompetitive at this stage of the game. We seem to be able to win in some of the most competitive categories, such as floral, Christmas, other seasonal products, fragrance, which are very much competitive categories. We just weren't in the big ones. So I would say the addressable market in all 3 of those categories is in the $60 billion to $70 billion range, and we weren't participating in that one. I mean, it's -- yet our ship to direct from the consumer showed that our customers really come to us for rugs already. We just weren't carrying them in the store. And I think part of it was that we were slightly worried about giving up fixed room space and really leaning into some of these categories. So they are the categories that really drive the home furnishings business. All 3 of those categories, which would include rugs, which we said that we are going to be in the value price point of your choice, $199; tabletop, which we approached totally different than in my past life. So we'll be very differentiated from other consumers, and we're leaning into a very maxed-out value-oriented price point, all revolving around the farmhouse look. So I'm really excited about that. And that category involves dinnerware, glassware, tabletop textiles, flatware. So it's more than just -- it's a bigger area.

Now also to support some of these new categories and new businesses, we've had to make some decisions on our floor spacing. We had to declutter the stores, so we took about a 15% SKU reduction out of the stores and moved those SKUs online. And then we've added in a dining table to show off our tabletop business, a queen-sized bed that will show off our bedding business and a loveseat that will show off our rug business. And those actually, we needed to include those because while they are very good sellers on the ship direct, we just felt like that was just an essential to get onto the floor to make us look more meaningful. For example, we sell a tremendous amount of dining chairs, but we don't have a table to put it around. So a lot of these really made sense to make us look like more of a specialty lifestyle retailer at a great value. And so we've already got these products that we've developed, they're now on order. And that's why -- and I'm a little disappointed that we can't get them quicker in, we've certainly tried and done everything we could. But generally, when you're doing proprietary products, it does take at least 6 or 7 months to get those developed and written.

So yes, your question is right. These are competitive categories. We're approaching it in a uniquely Kirkland's way at an exceptional value. And I feel very confident that they're going to win.

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Anthony Chester Lebiedzinski, Sidoti & Company, LLC - Senior Equity Research Analyst [12]

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Got it, yes. So just getting back to the quarter, I know you guys touched on weather. I know it's something that probably you want to -- you don't want to comment on too much, but just wondering if you could perhaps share with us what you thought was the impact of the weather? Obviously, there are a lot of -- other companies have talked about the polar vortex also. Just wondering, if you could just comment on what you thought that, that was in the quarter as well as the first quarter to date.

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Nicole A. Strain, Kirkland's, Inc. - Interim CFO [13]

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Yes, Anthony, this is Nicole. So we have done calculations internally. It's probably not something we want to talk about specifically but definitely just with the number of store closings we saw week to week weather definitely played a role. I think I mentioned in my comments that we also saw softness across the rest of the chain. So don't want to blame it all on weather. It definitely played a role in the quarter and then the first part of Q1, but as far as quantifying specifically, if it continues, again, there's softness across the category, we probably won't get into that.

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Anthony Chester Lebiedzinski, Sidoti & Company, LLC - Senior Equity Research Analyst [14]

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Okay, got it. And then as far as the impact of tariffs, anything that you can share with us as far as what that was for the quarter or anything that's -- you want to call out for -- as far as for 2019?

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Michael B. Cairnes, Kirkland's, Inc. - President & COO [15]

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Anthony, yes, for tariffs, as you know, we -- as it relates to the 10% level tariffs, we were able to bring in vendor contributions, we took surgical and select price increases, and we feel like we adequately mitigated any impact on the tariff as of yet. We are obviously, like everybody else, in a wait-and-see mode to see any changes in the tariff. The postponement of the 25% tariff is one we'll continue to keep an eye on. With that, if that were to be inactive, we already have a plan in place for that, but right now we're going to continue on with the -- what we've already put in place for those select price increases that we have in place, and we see very little impact of that in 2019 unless something else changes.

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Anthony Chester Lebiedzinski, Sidoti & Company, LLC - Senior Equity Research Analyst [16]

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Got it, okay. And lastly, within your EPS guidance for the year, are there any embedded additional share repurchases in that number?

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Nicole A. Strain, Kirkland's, Inc. - Interim CFO [17]

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There are. I think what I'd generally say is we want to continue to be on the market repurchasing shares as it makes sense. We are expecting that number to be lower than the repurchase number for 2018.

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Operator [18]

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(Operator Instructions) Our next question will come from Brad Thomas of KeyBanc Capital Markets.

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Bradley Bingham Thomas, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [19]

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Thanks for all the details on the strategic plan. My first question was around stores, and you've given a lot of color around that on the call today here and working towards the store of the future, if you will. I guess my question was from, one, I apologize, if I missed it, but what's the gross openings and gross closings here for this year? And then, I guess, Woody, as you think about turning around the business, trying to accelerate same-store sales, are you committed to continuing to open stores? Are you still signing leases? Where do you think maybe it make sense to look at putting a hold on opening new stores until you accelerate same-store sales?

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Michael B. Cairnes, Kirkland's, Inc. - President & COO [20]

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Yes. In terms of new stores in 2019, what we indicated is that we will open up a small number of stores in the range of 6 to 8, and we'll close about the same number. So we are slowing the pace down of new stores. We are doing that as we evaluate our model going forward.

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Steven C. Woodward, Kirkland's, Inc. - CEO [21]

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Also, Brad, just to lean on to the question that you had about our current store base. I felt like we needed to make some changes in categorizing the merchandise so that it was clear when the customer walk in the door. So we used to be kind of a scattered approach, and now we're trying to pull anything that's floral together, anything that's fragrance together, anything that's furniture shop, wall décor, so that we look more meaningful and destination-oriented as the customer walks to the store. We also try to reduce some of the clutter in our stores. So we -- to allow some of these new categories, which are bigger, we've also decluttered the store with what I call the long tail of things that aren't really that productive. And some of those went away, and some of them went online. So it accounts for about a 15% SKU reduction in store.

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Bradley Bingham Thomas, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [22]

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Got you, okay. And then I apologize if I missed it. I'm sure it'll be in the K, but do you have the merchandise margin percentage for the full year and what it ended at?

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Nicole A. Strain, Kirkland's, Inc. - Interim CFO [23]

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54.2%, which was basically flat to the prior year.

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Bradley Bingham Thomas, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [24]

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Great. And then, clearly, there are a lot of levers that you pull and initiatives you have in place to try to reduce the cost of inventory you're procuring I guess, Woody, as you think about the value proposition to Kirkland's, for the customer, obviously, there's something you should feel like you should be able to charge more for, others that you need to provide a better value. But as you blend it all together, what do you think can drive the most success for Kirkland's as you think about that merchandised margin and trying to pull that as a lever?

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Steven C. Woodward, Kirkland's, Inc. - CEO [25]

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Yes, our merchandise margins, our product margins are fairly healthy. It's what we do to it afterwards, and that we're really working at. I think Mike mentioned the whole initiative for pricing and promotion. Sometimes we are so -- we have a merchandise promotion and a coupon laid on top of that. And I'm not sure the customer actually gets exactly what the price is going to be. So we're decoupling those and unlayering it all, so they have a much clearer value proposition. I think our product represents a good value, and our direct sourcing will enhance the costing of that. But really, I'm not planning on having to take a lower price point across the board but also not a significantly higher. I think that we do win by being a value retailer in this space, and I really like that part of our DNA and want to make sure that we are providing the lower-alternative cost than some of our specialty retailers that we compete with. So that's kind of the ongoing goal. The direct sourcing helps. Of course, we are one of the very few retailers left that don't do direct sourcing. And so that should give us a benefit. Although it's small in this year's plan because we are just rolling that out, but I think by the end of the day when we have that up to a much higher percentage of our total purchases, it could help substantially on our product margins and our value equation.

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Bradley Bingham Thomas, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [26]

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Great. And then just a couple of modeling questions as it relates to how we think about seasonality. I think if I heard you right, you are thinking 1Q same-store sales potentially negative, that the earnings will be lower year-over-year. If you could confirm that, that'd be great. And then as we think about 2Q, I mean, it's the easiest comparison at the year in terms of same-store sales. Are you thinking that we can get into positive territory for same-store sales in 2Q?

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Nicole A. Strain, Kirkland's, Inc. - Interim CFO [27]

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Yes, so just high-level, I think when we look at Q1, and a lot of this is just based on profit trends rolling from January into February, are expecting a down comp and then mid- to high single digit. Also I'd say, for Q1, expecting product margins to be -- and merch margin to be relatively flat to Q1 of 2018. And I think we mentioned in the call, there are also some OpEx initiative dollars buried in Q1 and Q2 that are related to standing up a lot of the initiatives that we talked about. So definitely, look at Q1 year-over-year as a lower earnings per share. For Q2, we're basically looking at it as getting a lot closer to flat comp sales because, again, the comps that we're comping against in 2018 was down over 3. So I think we will continue to be on an EPS standpoint, negative to 2018 but making up some of that ground from Q1 to Q2.

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Bradley Bingham Thomas, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [28]

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Got you. And then the big wild card is, of course, 4Q. And I presume at this point, you are modeling for 4Q '19 to have, I guess, higher EBIT year-over-year?

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Nicole A. Strain, Kirkland's, Inc. - Interim CFO [29]

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Yes, actually, yes. It's actually Q3 and Q4, because we -- a lot of that is based on the new assortment at the first part of Q3. So it's not all weighted to Q4. I'd say the improvement is split equally between Q3 and Q4.

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Operator [30]

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Ladies and gentlemen, this will conclude our question-and-answer session. At this time I'd like to turn the conference back over to Mr. Woodward for any closing remarks.

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Steven C. Woodward, Kirkland's, Inc. - CEO [31]

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Thank you very much, and we appreciate your interest, and we're optimistic about the future. Thanks.

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Operator [32]

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