Okies are one group of people who know a thing or two about clouds. So, when I penned these words in December 2018 about home décor retailer, Kirkland's (KIRK), I probably should have had more faith in my Okie roots.
“I'm getting more and more suspicious the looming clouds may actually be storm clouds.”
In full disclosure, I don't short stocks so it wouldn't have benefited me anyway. But, I suppose others could have earned a few bucks. At the time, Kirkland's was trading in the $9 range. Since reporting first quarter results on June 6th, it's dropped below $3.
Back to the forecast - Kirkland's is definitely in the eye of an earth-rattling thunderstorm. Until the skies clear, it would be impractical to try to fully assess the damage. But, to be clear, damage doesn't always equate to devastation.
Just over a year ago, in April, 2018, just a few weeks after releasing 2017 full-year results, Kirkland's announced its CEO and president, Mr. Michael Madden, was resigning. Mr. Madden had 18 years with the retailer. In September of 2018, the Nashville Post confirmed Mr. Madden's resignation was directly related to the retailer's lack of performance.
From fiscal 2009 through fiscal 2018, annual sales grew year-over-year due to organic growth and geographic expansion. Yet, as the average square footage per store crept upward, the average net sales per selling square foot lost ground. In fiscal 2016, the average slipped below $250 and dropped to $225 for fiscal 2018.
In late October 2018, Steve “Woody” Woodward took the baton as Kirkland's new CEO. He is considered a giant in the home décor industry. In 2016, Better Homes and Garden named him an influential style maker. Mr. Woodward's career spans executive positions with Pier I (PIR), Illuminations, The Bombay Company, Fossil (FOSL) and Crate and Barrel Holdings.
Despite the industry's optimism about Mr. Woodward's experience, I've hesitated to declare him a natural fit at Kirkland's. For starters, I've questioned whether Mr. Woodward has much in common with a Kirkland's customer. He and his wife, an interior designer, have lived in more than nineteen homes, refurnishing each “top to bottom” with, more than likely, wares from higher-end retailers. The majority of the furnishings in his last home in Evanston, Illinois were purposely sourced from his previous employer, Crate and Barrel while the remaining items came from Restoration Hardware (RH), Pottery Barn and West Elm, part of the Williams-Sonoma family (WSM) and Mitchell Gold + Bob Williams.
Mr. Woodward, himself, acknowledged the disconnect in his first earnings call.
“I want to be clear at the outset that my strategic focus will be to reinforce Kirkland's as a source for customers looking for home design ideas while staying in the lane of affordable home decor.”
Then, on the fourth quarter earnings call, there was actually a lot of focus on and discussion about the retailer's value proposition. Mr. Woodward certainly seemed to be talking the talk. As a Kirkland's loyal, many of the statements did resonate.
“We believe that design, price and quality are bundled together in how the consumer views value.”
“I think that we require the customer that expects us to give her a better look for the dollar than she can find at other retailers.”
“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.”
Still, visits and purchases by Kirkland's loyals continued to wane. When the retailer reported 2019 first quarter results, sales of $129.6 million were 9% less year-over-year. The decline was primarily driven by negative traffic and a smaller average ticket in brick-and-mortar locations.
“In our brick-and-mortar stores, we continued to see the same softness throughout the quarter as we referenced in our last call with double-digit declines in traffic and comp store sales.”
In fairness, Kirkland's is hardly the lone retailer facing challenges driving foot traffic to brick-and-mortar locations. But, the decline in average ticket could well be pointing toward a disconnect relative to that “affordable” adjective. Curiously, in its 2018 annual report, the retailer changed its definition of “strong value proposition”.
“While we carry some items online and in our stores that sell for several hundred dollars, our average item price is approximately $10 to $15, and our items are perceived by our customers as affordable home décor, accessories and gifts.” (emphasis added)
It is pertinent to note this statement differs from the version in previous annual reports.
“While we carry some items in our stores that sell for several hundred dollars, most items sell for under $30 and are perceived by our customers as very affordable home décor, accessories and gifts.” (emphasis added)
Yet, a simple test of the modified definition proved false.
Of the 178, approximately 1/3 were on sale. Of the 1/3 on sale, 45% were originally priced above $15. Further shadowing the validity of the claim, of the 178 items, 35 were monogrammed products. Had the monogrammed offerings been grouped as one item rather than counted individually, it would have lessened the total priced at $15 and under to only 146. Of course, applying the same methodology to the total would also decrease the denominator.
On the other hand, 865 items, or 30.5%, were priced over $100 with 51 crossing the $500 threshold. Source
By any standard, the average item price of Kirkland's New Arrival offerings would not equal $10 to $15. Rather the majority, 1,536 items or 54%, were priced between $25 and $99.99.
With this evidence, I became curious about the retailer's Clearance selection. Of 478 items, 256, or approximately 54%, were priced at $15 or less. When applying the 25% green tag clearance promotion, the number grew to 288. By either measure, a price of less than $15 definitely represented the majority and could justify the claim. And, yet, the value proposition definition does not and would not specify clearance-only items.
Realistically, Kirkland's website inventory would, obviously, be loaded with higher-priced items. It is simply not feasible for the retailer to carry all of the products requiring a larger footprint in its stores. And, yet, even if the items priced above $100 in the New Arrivals section of the website were excluded from the equation, there is no mathematical way the average item price would fall between $10 and $15 when only 10% of the remaining items are priced at $15 or below. Furthermore, a recent visit to a brick-and-mortar location seemed to validate that the lack of items priced $10 to $15 is not strictly a characteristic of the website.
As a K Club member, I had been rewarded a coupon featuring $10 off a regular-priced purchase of at least $10. Now, for me to consider the coupon truly valuable, the items purchased would have to total $20 or less. I will admit upfront that, perhaps, the coupon's eventual expiration may have been related to the timing of my upcoming vacation. As I weighed the decision of saving $10 against saving my funds to spend on vacation, I couldn't justify using the coupon. I left the store empty-handed. The availability of qualified items was simply lacking, both for myself and for gift-giving. Again, perhaps it was the timing but it certainly felt otherwise, as though there was hardly anything to choose.
Yet, regardless of my latest visit, the unanswered question is why Kirkland's would purposely change the wording associated with its value proposition. Perhaps the answer lies in wait, in the aftermath of this storm.
Weathering This Storm
Kirkland's warned in its fourth quarter report that the first half of fiscal 2019 (ending February 1, 2020) would be gloomy.
“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 comp over the second quarter of 2018.”
When the first quarter turned out to be worse than expected, the retailer was forced to lower its full-year guidance. It didn't help when the U.S. and China trade dispute resulted in bigger tariffs.
“A portion of our lower guidance for 2019 is related to a lower projection for gross margin as the 25% tariff comes into effect.”
Yet, despite the battering to both its earnings statements and its stock price, Kirkland's and Mr. Woodward continue to look past the storm.
“We’re very optimistic that the goods that we have coming in, that we believe will really change the trajectory of the company, are on schedule and should start landing at the end of the second quarter and make us a fresh new look with our new floor plans and our new store assortment with the third and fourth quarter.” (emphasis added)
There are three categories expected to change the trajectory of the company - rugs, bedding and tabletop. Mr. Woodward noted the deficit shortly after his arrival.
“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. We just didn’t have that in our mix.”
In introducing these key categories, Mr. Woodward's experience and designation as an “influential style maker” should prove beneficial.
First, Mr. Woodward insisted the lines be proprietary.
“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 following things on the same looks that other retailers had, to really approach it with our modern farm house aesthetics.”
Second, he ensured the lines were recognizable as a Kirkland's product.
“We are very bullish about our new product assortments that we’ve got coming in, such that it will be identifiable to both our core customer as well as new customers.”
Kirkland's was one of very few retailers not yet employing a direct sourcing model. The third requirement for the new categories was to employ the retailer's newly-developed direct sourcing model.
“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.”
To prep stores for promoting these new categories, changes to the floor plan were mandatory. Displays are being de-cluttered and 15% of the items stocked in stores moved to the website.
“We've added in a dining table to show off our table top business, a queen-sized bed that will show off our bedding business and a loveseat that will show off our rug business.”
The rug category is not going to bolster Kirkland's updated definition of its value proposition. The retailer will be offering 20 options at $199 each. Still, the retailer feels confident the rug category will offer tremendous value to its consumers.
“These rugs, all 20 of them, are price-tagged, your choice, at $199, which puts us significantly below the marketplace for rugs that we feel like our customers will really resonate with.”
On the other hand, the table top business should distinctly bolster Kirkland's ability to average $10 to $15 on items. This category should include dozens of options in dinnerware, glassware, flatware and textiles with the vase majority priced below $10 each.
“We are doing all of our dinner plates, bowls, mugs, and salad plates all at a very low everyday price that I think will be stimulating for the customer to say we’ve done the creation for them, we’ve made the decision. It’s ultra-durable. It’s for everyday use. And I think our customers will see that as a huge value.”
Looking beyond the present storm, it is conceivable Kirkland's may achieve its updated definition of a value proposition, an average item price between $10 and $15, by the end of fiscal 2019. After all, Mr. Woodward did remind everyone patience was necessary as soon as the earnings call started.
“The strategy we are executing was never going to be a first quarter story.”
I've never doubted Mr. Woodward was a big-time player in the industry. My doubts were always centered on his fit with Kirkland's. But, he certainly appears to be talking the talk when it comes to understanding the needs, values and desires of Kirkland's customer.
Often, with big-time players come big-time plays. This strategy, the introduction of three key categories of new product lines, is akin to swinging for the fence, a hail Mary, a half-court trey. If it fails, Kirkland's could be too damaged to recover.
Additionally, Mr. Woodward opted to walk his talk. On June 10th, he placed approximately $100,000 of his personal money on the line and invested in nearly 43,000 shares of Kirkland's stock. Now, losing $100,000 would probably not devastate Mr. Woodward's personal wealth. But, it is a ray of hope, a show of faith in this strategy.
And, few would disagree Kirkland's needed a show of faith, a ray of hope.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in KIRK over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.