Q4 2020 International Seaways Inc Earnings Call
Good morning, and welcome to Kirkland's fourth quarter 2020 earnings call all participants will be in listen only mode.
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I'd now like to turn the conference over to Tripp Sullivan of <unk>.
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Thank you and good morning, and welcome to Kirkland's Conference call to review of results from fourth quarter of fiscal 2020 on.
On the call. This morning are Woody Woodward, Chief Executive Officer, and Nicole strain Chief Financial Officer, the results as well as notice of the accessibility of this conference call on a listen only basis over the Internet right.
Were announced earlier this morning in a press release, that's been covered by the financial media.
Except for historical information discussed during this conference call. The statements made by company management are forward looking and made pursuant to the safe Harbor 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 on net.
I'll turn it over to Woody.
Good morning, as we begin I want to thank the entire kirkland's team for their commitment throughout this year and how they work together wherever they were enjoying whatever it takes to produce the results we'll discuss today.
This was a crazy year in many respects and we were focused force to innovate our people were more than ready to meet the challenge.
We always want to finish the year strong and our most important quarter and 2020 with no exception, we had momentum coming into the holidays with a robust November debt some disruptions in December related to.
The new wave of Covid, and then when our new product set to hit the stores and online we saw double digit gains. We've previously disclosed February started off strong as well with a two week period, where we were impacted with the wet winter storms, but we've come back from that as well for the quarter we generated.
On a comp increase of one 8%, which reflects a decline in the store call a 36% increase in e-commerce growth.
GAAP earnings for the quarter were $1 36, and adjusted earnings were $1 40 that brought us to a dollar nine and 93, respectively for the year and reversed sizable losses from a year ago.
We are continuing to evolve into a value oriented specialty retailer, we've been very deliberative deliberate about the pace of our transformation, but we expect the differences we are making in our assortments will be even more evident in 2021 than it was in the past two years.
Wanted to walk through the four components of this strategy and describe how we're bringing our customers along with us plus the investments, we're making in technology and infrastructure to support the strategy.
Let's start with direct sourcing.
We are continuing to mature our direct importing business and achieved our multiyear growth plan. Despite the pandemic related cancellations in 2020.
Until these cancellations and the impact from Covid, we were on pace to exceed our goal of 20% penetration in 2020.
That being said some of our categories, such as mirrors textiles, floral outdoor and gifts.
Our goals for 2021, our goal is to achieve 30% direct sourcing and we had the potential to exceed that.
Our agents are really hitting their stride in the products look great from Vietnam, China, and India, we've been able to diversify our products by moving our core furniture program from China to Vietnam.
We also consolidated our basic near program to a true direct from factory debt.
As you've heard us describe before we're investing some of this benefit from sourcing and margin and some of it in design and quality improvements.
With pricing, we continue to elevate style and quality, allowing us to gradually increase our overall pricing thresholds in key categories such as furniture.
We've experienced an increase in AUR with these improvements and a substantial trend here plus the larger penetration of furniture should keep that growth on a steady path for the next several years.
While we've kept our opening price points, we are slowly growing our better and best offerings. Our customers are voting, yes on the upgrades on style and quality, allowing us to be less promotional and we've also made progress on reducing discount layering, which was hard for customers to understand and rationalizing price points to make sense.
To the customers and improve our margins.
We are constantly benchmarking our competitors and the general market to ensure clarksons is still a strong value player with more style to bring to our customers along with us on this journey.
As it relates to design, our cohesive brand style point of view has allowed us to streamline the aesthetic of our brand so that customers can mix and match with coffee.
We have invested in specific design projects with an eye towards improved design.
She and function.
We're also studying a trend forward color palette each season that crosses all facets of the business.
Additionally, we are partnering with third party design support to continue to bring unique yet timeless design and graphics to our assortments as we evolve.
And on quality, we continue to raise the bar in each category improving materials and make furniture has seen the most significant increase as we have redesigned and resource to best selling items can you give the customer more style and quality at the same day.
Direct sourcing has allowed us to have more control over the craftsmanship from our assortment, while still allowing us to be competitive in pricing.
We've also invested in improved packaging to reduce damaged product.
If we look back where we were two years ago as compared with the rest of the home furnishings landscape, we were in the wrong place and the spectrum.
We had the fact, we had the value pricing, but the quality and style, where sorely lacking and we certainly didn't have a point of view about where we fit in and what can help our customers while I'm hesitant to pinpoint exactly where we are today in the broader home furnishing spectrum, we can still say, we offer tremendous value, but with a much higher level of quality.
Design style of our merchandize, we're supporting the rollout of new merchandise from 'twenty to 'twenty, one and our biggest initiative on that front is the launch of our loyalty program, which took place in October.
Earlier this month Newsweek named our loyalty program. The number one program are all home decor, even with that recognition. We believe there are opportunities to continue to continue evolving in 2021 and beyond.
The home furnishings trends have worked in our favor with people staying at home more and shopping online as well as less store based competition.
At some point there will be headwinds for the industry, but we believe wallet share for home furnishings will remain fairly sizable with consumers as the economy improves.
Another area of our business I want to highlight that our ongoing digital transformation we've.
We've seen the growth continued growth and profitability of E. Commerce, all year and this was a large part of our overall business E. Commerce was 24% of our sales in the quarter compared to 17% a year ago and it continues to be profitable as well.
The specific improvements we are making in our merchandise requires that we also make specific investments in our technology and infrastructure. In addition to the direct ship from vendor groups and the E Commerce hubs I noted last quarter.
For 2021 and beyond we are prioritizing our capital expenditures to continue to fuel our digital transformation.
To help lead these efforts. We've recently brought on my call on S. Senior Vice President Chief Technology Officer. He has vast experience in leading similar digital and technology transformations.
One item to note.
On our direct ship from vendor channel before I talk about stores.
We gave a preview last quarter that we expected to add some select brands this year to extend.
Where we've been strong in kitchen, and tabletop I'm pleased to report that we partnered with brands such as Cuisinart kitchen aid and Viking, which will be added to our website. These leading brands will only be available on our website and we're very excited about the potential of these brands have on the E Commerce business.
Nicole will get into this in more detail, but I want to call out how successful she's been on leading the charge with rationalizing the store base negotiating our landlords and ensuring that the new cost structure, we put in place are sustainable during.
During the fourth quarter, we had 59 less stores than a year ago and total net sales were only down 7%.
We've clearly rationalize the base to a more productive stores and and the strength in ecommerce business is helping to offset the continued challenges in store traffic.
Our stores remain a critical component of our omni channel strategy and on and the maximum expression of the Kirkland's brand and our Assortments that being said, we believe we can improve performance in the stores and that will be an opportunity. We will continue to pursue in 2021 and beyond.
Our strong merchandising the efficiencies in our infrastructure and costs direct sourcing and the growth of E. Commerce, all create substantial leverage in our business model the.
The earnings posted during the quarter and for the year were above what we had planned this time a year ago, but the improvements in cash and liquidity were equally impressive.
A portion of this liquidity at year end was related to the inventory orders, we canceled early on in the pandemic as.
As Nicole will describe in a moment, we will put some of that liquidity back to work with our inventory. The majority of this improvement in cash flow and liquidity. However was due to the operating costs that we've pulled out of the business through cost containment and efficiencies and changes in our labor cost and staffing model.
We will look we will look to benefit from the embedded leverage in the business from 2021 and will continue to actively explore the best ways to allocate our capital to fuel additional growth and returns to our shareholders.
Nicole why don't you walk us through some of the activity in more detail and the adjustments, we've made to our strategic and financial goals.
Before I get into the details of the quarter I also want to thank the entire kirkland's team, including those on the front lines in our stores and in our distribution centers.
On a pivotal role a pivotal year in the transformation of parkland and although we are far from the end of our journey, we were able to accelerate many aspects of our strategy in the past year and it is directly attributed to the dedication of our team.
Although sales trends were inconsistent during the quarter improvement and landed product margin and occupancy cost and operating expense reductions drove the most profitable quarter in our history as a public company.
Many of the changes to our model were made on the second quarter and we have shown on our ability to sustain and refine them throughout the second half of the year.
Breaking down sales within the quarter, we had a comp increase of five 3% in November which included early sell through of holiday product driven by a 49% increase in ecommerce sales, which helped to offset the historical volume in stores on Black Friday.
In December our comp sales declined by seven 5% driven by a double digit decline in stores and flow or ecommerce growth.
Impacting December was the early sell through of holiday inventory the effect of the rise of Covid cases on store traffic and slower E. Comm sales due to the early cut off of guaranteed ship windows from parcel carrier limitations and a drop in fulfilled in store online sales and.
In January with the seasonal sales timing shifts behind us and a new floor set up everyday merchandise. We had a strong sales month with positive store sales and e-commerce growth of 60%, which resulted in an overall comp increase of 15, 7%.
That strong sales trend continued to start the month of February until we hit the second and third week, which included significant store closures and weather impact across more than half of our store footprint.
I'll pick back up at the end of February resulting in a low single digit comp decline.
We expect comp sales to continue to accelerate throughout the first quarter as well.
We compare against the beginning impact of the pandemic on the economy, followed by our store closures in mid March.
While we still outperformed our segment of shopper track, our comp store traffic sequentially worsen from Q3 levels, particularly in December due to the reasons I noted a moment ago.
We continue to see the sales benefit of the changes we have made to improve the quality and design of our merchandise as well as category shifts towards higher ticket items.
We did lose some ground on conversion in both store and online.
To inventory shortages in some key categories.
E Commerce comp increase continued to be driven by the direct to consumer channel with our third party drop ship revenue up 111% and our own products shipped directly to customers up 45%.
Both of these were offset by the end store Hotel channel.
Our fulfilled in store for the quarter was just over 36% of ecommerce sales compared to 52% in the prior year, which is a function of consumer preference store traffic and lower in store inventory. There is profitability upside on our model as the percent fulfilled in store normalize is closer to 45% to 50%.
During the quarter, we closed eight stores, resulting in a count of 373 stores.
During 2020, we opened no new and closed 59 underperforming stores.
Or 14% of our store base since the start of the year.
Gross profit was 37, 7% of sales compared to 29, 8% in the prior year quarter, but.
790 basis point improvement on our gross profit margin Mark the second quarter in a row, we have seen a similar level of year over year gain.
Of this increase 730 basis points was driven by landed product margin from.
Direct sourcing benefits simplifying our promotional message and also reducing the depth of offers and the inherent stacking of entire store couponing.
Throughout the quarter and continuing into the first quarter of 2021.
Inbound freight rate premiums specifically on products sourced from China have negatively impacted our landed product margin.
In the fourth quarter, the elevated freight cost accounted for approximately 200 basis points of margin, we expect to see that impact in double on the first quarter of 2021, but still expect a year over year landed margin growth.
Lower store occupancy costs from the closure of underperforming stores and negotiated rent reductions contributed 130 basis points of improvement.
We expect to see an additional 100 150 basis point improvement in occupancy cost in 2021. This is excluding the much larger benefit on the first quarter due to the unconquerable sales base.
Lower freight costs from our D C to our stores driven by fewer routes from lower inventory levels and store closures, along with a rate decline compared to 2019 added another 70 basis points of improvement.
D C costs remained relatively flat year over year.
On the prior call I mentioned that the 150 basis points of unfavorable <unk> in the third quarter due to the timing of inventory capitalization should reverse in the fourth quarter with improved inventory levels.
That reversal once that happened throughout the first half of 2021 we.
We continue to see productivity on infrastructure improvement offset the incremental cost to pick and pack ecommerce orders.
Saw continued improvement in the output and efficiency of the two E. Com had we added in 2020 throughout the quarter and are pleased with their performance.
Lastly, other adjustments impacting gross profit made up another another 50 basis points.
Commerce shipping negatively impacted gross profit in the quarter by 190 basis points due to the increase on ship to home channel.
Operating expenses, excluding impairment improved to 23, 3% of sales compared to 26, 6% on the fourth quarter of 2019, we continue to see the benefit of our cost reductions with a decline in operating expenses of 330 basis points.
Or $10 3 million driven by the more efficient store labor model corporate head count reductions and a justification exercise for all overhead expenses.
Excluding current year performance related compensation accruals. This represents a 21% reduction in operating expenses, which we continue to expect to be largely sustainable.
A large portion of the reduction in store labor expenses, with reducing our minimum staffing and lower volume periods and at lower volume stores.
The result is a lower basis point improvement in the higher volume fourth quarter, but a similar dollar improvement. This is in line with our expectations. When we shared the 45 million of operating cost reduction and even as we look to accelerate topline growth over the coming years, we will remain disciplined on our cost control.
Store operating expenses decreased 330 basis points as a percentage of total sales driven by the store labor model changes noted and leverage from closing underperforming stores.
We discussed on our prior call.
We expanded our store operating hours during the peak holiday period, and then return to the reduced hours in January.
Standard hours, along with the store sales deleverage and nature of our store labor model changes, resulting in a lower benefit than in prior quarters, which again was expected.
E Comm operating expenses increased 10 basis points as a percentage of total sales, but leveraged 120 basis points as a percentage E comm sales.
As dollars increased by only 100000, a year over year on the $12 3 million dollar growth in revenue.
Advertising expense increased by 300000, or 30 basis points compared to the prior year and we continue to shift our spend heavily towards digital digital channel.
Corporate operating expenses decreased by 2 million or 50 basis points, driven by reduced headcount reduced corporate office space and the overall expense review performance related comp accruals in the current year account for an additional 70 basis points.
EBITDA, excluding impairment and other minor non operating expenses for the quarter was 34 million or 17, 4% of sales compared to $16 9 million in the prior year quarter or an improvement of $17 1 million.
For the quarter, our tax rate was 25, 4% compared to four 7% on the prior year period, both periods were impacted by a valuation allowance.
Our normalized rate of 26% was used in the non-GAAP non-GAAP adjusted calculations for the current year.
And 21, 3% for the prior year period.
Our earnings per share, excluding noncash impairment normalized tax rate and other minor non operating adjustments was $1.40 compared to 62 cents from the prior year.
The GAAP earnings [noise], Inc.
Leading these items was $1 36 compared to a loss of 35 from the prior year.
We ended the quarter with $100 3 million in cash and no outstanding debt, which was a build of $63 1 million from the Q3 level and an increase of $72 million year over year.
Find with availability on our revolving credit facility, which is based on our inventory position. We had total liquidity of $139 8 million.
We ended the year with a higher cash balance than we expected, which is partially due to a lower inventory position than expected we.
We anticipate a use of cash of $30 million to $35 million in the first half of 2021, as we returned to planned inventory levels and more typical working capital timing, but otherwise we expect to remain at a consistent level of cash and no borrowings throughout the year until our normal cash build on the fourth quarter.
Inventory at the end of the quarter was $62 1 million compared to $94 7 million in the prior year or 34% lower we have 14% fewer stores, but were down approximately $18 million to our inventory plan.
We continue to work through vessel and port shipping constraints and see gradual improvements in our inventory position, but now expect the disruptions in our assortment to continue through the first half of fiscal 2021.
The inventory shortages have been in our core everyday products and have been much deeper in some key product categories.
For the fourth quarter, we estimate our comp sales impact of approximately 500 basis points from this key category inventory gaps.
We expect to continue to see a sales impact in those categories in the first half of the year, but expect it to be less and less in the fourth quarter and sequentially improving month to month.
Year to date cash provided by operations was $78 6 million compared to cash used of $8 3 million in the prior year or a change of $86 8 million.
The improvement is due to better operating performance in the last three quarters of the year, which made up a net improvement of $54 9 million and.
And changes in working capital, which made up $32 million.
The working capital changes are primarily driven by lower inventory levels offset by lower related accounts payable.
Additionally, we received a $12 3 million income tax refund from the cares Act.
Act NOL carry back from the second quarter.
Capital expenditures were $8 7 million compared to $15 7 million in the prior year and were primarily driven by investments in supply chain and E Commerce.
Share repurchases during the quarter were minimal debt. We can we will continue to take an opportunistic approach to share repurchases in the future.
Yeah.
We exceeded our progress towards our initial goals set for fiscal 2020 as Youll note in our earnings release, we have increased our profitability targets as we execute the transformation of our business over the next two to three years.
In addition to driving topline growth, we expect continued margin gains and disciplined cost control over this multiyear period to improve our gross profit rate to the mid 30% range improve EBITDA margin to the high single to low double digit range and improve operating income margin to the mid to high <unk>.
Single digit range.
Related to topline growth, we expect e-commerce to grow annually at a rate of 25% to 35%. During this period and average ticket improvement in stores is expected to offset declining traffic.
We expect direct sourcing to grow from the 20% in fiscal 2020.
50% within this timeframe with the growth spread evenly over the two to three years.
We continue to believe that our ideal store counts.
He is in the range of 300 to 350 stores, where we land within that range depends on store profitability and performance as well as consumer consumer shopping preferences post pandemic, but we do expect future store closures to be with the natural lease expirations as we address the majority of underperforming stores this year.
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We continue to strongly believe that our stores are an integral part of our strategy and allow us to represent our style point of view, but also enable us to fulfill a significant percentage of our E com sales in store more profitably than shipping to home.
And lastly from a liquidity perspective, our main goal continues to be maintaining a healthy balance sheet. Within this model, we expect to generate excess cash annually and will allocate first to projects to drive growth <unk> reduce costs, but also will prioritize options to return excess cash to our shareholders and now we are ready for questions.
We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.
If you are using a speakerphone please pick up your handset before pressing the keys.
To withdraw your question. Please press Star then two.
Our first question today comes from Jeremy Hamblin, with Craig Hallum Capital Group.
Okay.
Thanks, and congratulations on an impressive year on managing through the pandemic on.
I wanted to just start actually with the worst thing you were mentioning in the call which was the lease expirations.
2021, I wanted to know how many are.
This year and if you have a sense or kind of a range.
Store closures.
For 2021, and then the timing of.
Perpetual closes.
Yeah, we still have about 20% to 25% of our leases that will come up for renewal and part of that is because we continue in some cases to do shorter term leases on some properties that were continuing to evaluate their performance what I would say, though is we've made a lot of progress in improving margin improving the.
Labor model and.
In seeing average ticket increases in the stores. So the way I look at that.
If I were to give an estimate now I think the range of closures could be from five to 15 again, we're going to look as the natural lease expirations come up I think there is also the opportunity that we may or relocate a handful of stores. So I would say you know on a safe number is probably net 10.
Closures, but we'll continue to give updates as we move throughout the year.
Great and then in terms of those.
Those negotiations what's the average.
The reduction in <unk>.
On that you're getting on these stores.
5% is it flat.
Flat is it.
10% can you give us a sense of the range of reduction that youre getting on the renegotiated.
Renegotiating leases.
Yeah on the ones that come up for renewal that were able to negotiate we are getting closer to a 20% reduction and it really does vary I mean, I think I mentioned on the last call. If it's a good center and there's there's limited vacancy we're locking in for a longer period with our escalation. So in that case, we're not really getting savings year over year.
But we're not taking the escalations that are embedded in the lease in some cases, where we have more leverage the decreases that we're getting are closer to 50, 50% to 60%. So it really does vary but and what we've done.
We've done so far to date, it's about 20%.
Okay.
Okay, and then I wanted to come back to clarify something on the near term trends here that you've seen in Q1, so understand the strong start to the month of February followed by some pretty severe weather in your key geographies.
I think you mentioned a low single digit comp decline I wanted to just clarify was that for the month of February or was that just.
The last week of February.
It was for the month of February So again double digit positive first week, and then really tough two weeks I mean over half of our stores were closed for at least a full day and then the halo impact was much larger than that.
Turn to positive in the fourth week, so that's for the full month.
Okay and then.
Can I ask that question in terms of the store closures or kind of disruptive period.
Can you quantify that.
The total perpetual store days for your 300.
70 had changed locations.
What number of stores operating days were lost in the month of February.
Do you have that I don't have the actual count, but I do know roughly a 175 stores, where it close at least one to two days and outside of that that doesn't include be the partial day is that the stores were closed or the fact that a store might open but have very few customers because.
Weather impacts who don't have a holistic number I mean I can say, we were going from low double digit positive to you know a decent double digit negative comps. So it's a pretty significant gap in a few weeks it seemed to last about seven to 10 days from the holistic point of view the reduction of people coming into stores and store.
Closure. So he was like a three part month first part good mineral park challenging last part growth.
Understood.
From a a lot of your peers as well.
In terms of thinking about Q1.
I know you didn't put out a formal.
Sales target, but do you have a range of expectations on your top line in Q1.
You know I don't know that we want to put out to what's a little bit crazy with Q1 as the comp because we're comping over six weeks of store closure is.
Not really a meaningful comp increase I don't know that we.
Wanted to put out specific guidance I can say that we even with fewer store closures and expect to be from a total sales at least in line with the first quarter of 2019, if that helps.
I'm, sorry say that again.
From a just total sales dollar perspective to be at least in line with the first quarter of 2019.
Gotcha, Okay. That's helpful 2019 I.
I misheard you.
Okay, and then in terms of your Capex expectations for 2021, I might've missed that.
On the summary, I don't think I gave that number I think on previous calls I said between 10 and $15 million I think right now what our 2021 plan would be right in the midpoint of that to $12 million to $13 million I think as we move forward at least at this point I think that's a safe assumption.
To make going forward.
Got it.
And then what are you I wanted to ask you about the evolution of your online channel of business, which.
Is increasing consistently.
In terms of thinking about the next steps on this.
What are the investments you need to make where are the key opportunities in terms of what.
Whether it's.
Ship from vendor ship to stores.
How do we think about what that business is going to look like.
Both on 2021, but then also over the next couple of years.
Right.
We of course love.
The fact that this is moving quicker than we had anticipated mostly driven by customer behavior.
We had always wanted to be.
On the eventual state of being in the 50 50 range between E Commerce and stores, although thats being accelerated right now and in every part of it seems to be.
A benefit for us so I'm going to start first with our own products, which affected both e-commerce and in store, we're making your product transformation, where we're offering better quality and design still keeping our value pricing and that seems to be registering both online equally with in store experience. So one is that our.
Our product Assortments are migrating and we seem to be bringing our customers. The second part is this.
This phenomenon ship from vendor, which is really an exciting part we've added a team now to support that and we believe that there is a substantial growth that we can have towards adding additional layers of opportunity, hence, adding the brands like cuisinart or kitchenaid plus our own designed.
Good.
That are being held by the vendors on the vendors are really.
Stepping up to the plate noteworthy.
<unk> person when they come to you and say, we've got something new for you, which is different from where we were before but that business continues to grow and it's such an easy model for us because we don't carry the inventory and carry almost zero risk. So our risk is just to make sure that the assortments.
Is curated on our website so that the people that are on our website and look at it.
<unk> online as they would in the store, but like I've said the store is always going to be our maximum expression of the brand on those are all the things that we believe represent our style point of view, our price point of view and our quality point of view and then we take a little bit more flex.
Flexibility on our online expansion and that gives us a lot of.
Lot of them.
Okay.
Places to grow.
Yes, we're really excited we do need to make part of it is hoped Nicole thank.
Thinking about the digital transformation, we do need to make select investments over the next several years to enhance each day and can make sure that the website works in the most seamless possible way and then we will start adding some of the creative bells and whistles as we go along the way right now just making sure that functionally as efficiently as possible.
Yes, just a couple of things to add operationally to support the growth on the merchandise changes we will over time, either add additional hubs and our AD ship from store to continue to get closer to the customers. So we did reduce parcel costs, but more importantly improve.
<unk> times on customers and then also from a marketing perspective. This year have had a lot of success and redirecting our spend to digital to acquire new customers and we'll continue to push that towards digital acquisition as well to support the merchandise changes when he when he mentioned.
Great color.
Sure on that.
I wanted to come back to your gross margin for a second because you really posted.
Quite a bit better gross margins in Q4 than we expected nearly 800 basis points of year over year improvement.
Pretty remarkable given the.
The shipping and freight headwinds.
That are being experience, but in diving into that.
Did you provide a little bit of additional color on expectations.
Around.
Whether it's.
E Comm shipping, which seems to be running about at close to 200 basis point drag I assume that that's going to continue.
But then it sounds like your occupancy is settling into kind of this nice range of.
You know of a benefit.
You know that could be let's call it 150 basis points a quarter year over year.
And then I just wanted to get that clarification on you.
Your commentary on the on the DC costs.
You did see some improvement from Q3, but do you expect even more.
<unk> as those two new Dcs or are ramping up but just could you highlight that again for us.
Sure. So a couple of those pieces on the E Commerce shipping you're right. It has in the past two quarters have been about 190 basis point drag I think part of that is.
E Commerce grows that will continue to be a drag on gross profit, but as our mix of fulfilled in store improves with store traffic hopefully in the second half of this year it should.
Percentage drag should decline on the store occupancy costs 100 day 150 basis points is a safe number to use in 2021 on top of the gains that we had in 2020 and then on the DC costs in Q3, we had a negative timing impact of 150 basis points.
Our inventory levels dropped and I expected that to flip at the time in Q4, because I thought we'd be back on inventory plan and you know me.
A little bit of progress, but the majority of that will flip back positively in the first half of 2021, just as inventory levels get back to our plan.
Okay.
Great and then in terms of thinking about your product margin opportunities this year.
On your.
Clearly.
There's been a pretty dramatic change in terms of.
You're doing much more direct sourcing and there are savings that you are keeping some of and sharing.
Quite a bit with your customers.
In terms of thinking about product margin opportunities this year you.
You made such incredible games.
On to ask just about what you're seeing from a promotional level across your industry from from peers, whether or not that's picking up at all.
But any color you can provide on product margin expectation.
Yes, so in the first quarter, if im looking at last year last year's Q1 product margin was in the low 50%. So even though we are expecting the impact of inbound to double suite of roughly 400 basis points in the first quarter, we still have a fair amount of room.
To have a four to 500 basis point improvement in landed margin in the first half of the year. So what I would say, though is because of the tailwind that we had from consumer preference on the back half of the year, where and I think we mentioned this before but seasonal product we sold out on.
You know really early without having to go to a second or third.
Markdowns, which is part of that.
Part of the plan for that product every year and so I don't think that's something we can comp next year. So I do think you know direct sourcing growth will give us some benefit but it will be tough for us to comp the margins that we had at least in the third quarter. This year and I think it'll be you know will continue to be disciplined on our.
<unk> offering, but I think there were just some anomalies this year with the tailwind that isn't it isn't something we should've seen would continue.
Okay great.
And then.
Just last one for me in terms of you know.
Direct sourcing.
So you achieved about 20%.
Last year, you have a two to three year target of getting to 40% 50%.
In terms of.
I'm thinking about the progression.
It sounds like that's going to be somewhat evenly split over that timeframe.
But are there more opportunities is 40% to 50%.
The longer term goal or you know is there you know I think you have peers that have even substantially higher.
Portions of their business that are direct sourced.
Okay, you know any color that you can add on that if Jeremy.
Jeremy that is such a good question because it's one of our.
Key opportunities for the next two or three years. So yes last year as you mentioned, we get about a 20% penetration. This year, our target is 30% will probably exceed that.
4% to 5%, which is really exciting for us because what's happening is that it takes a while to get an agent structure working around the world and they are just now hitting their stride, where we're very impressed with the products that we're seeing from them from main countries like China.
Vietnam and India, but were also looking to other countries and those other countries will just help us.
Expand our horizon on what the direct import ratio should finally be when we put that target out there at 50%. It was more just like a guideline we're going to pause at 50 and say how do we feel like this is working but we do believe that there is probably upside opportunity to increase that but.
On the reverse side of that is that our some of our domestic vendors have really done a great job. So they want the business and they've come back in and even though the playing field in some cases.
So we don't want to put a number out there that forces us to go direct sourcing, but really as opportunistic I want the buying teams to feel like they have the choice to buy the very best product value at the very best style and quality from around the world and sometimes that's here in the U S from a direct importer, sometimes its direct oversee.
These relationships sometimes is direct with the factory like we did with our mirror program. So we want to have as much flexibility in our model as possible and Inc.
So that 50% direct import is just a guideline and will probably exceed that.
Great. Thanks for taking all my questions I'll hop out so others can ask them.
Congratulations on the thank you.
Our next question will come from John Lawrence with comparable growth.
Good morning.
Good morning, good morning.
Yeah, congratulations on the year and I know you've been able to accomplish.
Thank you. Thank you.
What do you would you would you start the conversation on my question just the fact that.
You know you mentioned the fact that the customer response, we've gotten our loyalty up in October.
As you look as you look at the last year or 18 months, what are you seeing that.
The major pieces or you've talked about product quality, we've talked about.
On the couponing process on all of it but what do you think the major couple of pieces or.
From a consumer standpoint on how they relate to the Kirkland brand and maybe what you've seen out of the loyalty program since October.
Okay. Thanks, John.
This is of course are subject, it's dear to my heart, because I feel like it's the nucleus of what we could be in the future.
We are what we sell and so making these transitions is really an important aspect of our total growth strategy profitable strategy and kind of like everything we do so let's start first with the practice Orbitz, we took the opportunity in the last year year and a half to add some new categories and some of those categories are really hitting there.
<unk>, giving us huge growth opportunities the standout winter so far has been tabletop.
We're taking our debt tabletop assortment and expanding it to a 50 store test this year, which almost doubled the space allocation and really will give us an insight as to how far we can take that those kinds of assortments, but really the big win for us over the next several years is redevelop it and re energizing our core product where we're seeing.
Net core products come in early even with some of our inventory disruptions, we're getting a really good read where the customers like the direction, we're going we're giving them a better quality better point of view from a style standpoint, our stores are very colored directed right now so when you walk in you really get an impression of what we stand for and.
Those core categories, and let me repeat what those might be those core categories, our wall decor, which at one point we were.
Very dominant in it I think.
Lost our way a little bit so it's cash.
Coming Roaring back, but we're getting new assortments. The customers are really responding positively. The other one is furniture, where we had to go through some reallocation of our quality and design to make sure that we had a value proposition so that when the customer walked in they really looked at our product is.
Great style and quality, but also at a great value and then there's other categories that we've also had big wins in and then all of them also categories that we've had to redevelop textiles has it been a huge win for us our pillow business, our tabletop textile business anything to do with textiles, and moving some of that innovate.
They've designed to India has really been a great play.
Play for us both in customer acceptance and in product margin.
Other ones, where we're still on the development cycle.
We've got a good robust.
Candle business.
Our business and floral that we're trying to upgrade the quality and make sure that we're offering more of a solution oriented deck accessories has done really really well for us. So we think about expanding that so overall I think that both the new products and core products are important for us to make sure that by the end of this year.
We're in a position that we really love, what we represent and on still critical I walk through our stores and see all of the things that are wrong, but the customers are walking through the stores and seeing all of the things that they like so I think we have to continue to be extremely critical on ourselves as we make this development and like I said in the previous call.
We played three innings in the first couple of years, we're paying about <unk>. This year alone so you'll see some very.
Good substantial progress on our merchandise development and I'm really sorry.
He used with the way the customers are accepting that.
Great Thanks, and just.
On the direct sourcing to go to 30% and exceed debt.
Just give me a sense of the timeline so to move that to 30% is that product, we're dealing with for fall shipments or would that be spring of 'twenty two shipments.
Really all year, we've actually got orders written to hit our 30% penetration right now we have some more orders to write for the back half of the year. It should help us exceed that so I would say that right now 30% in Nevada spread throughout the year and the upside will come by directing some of our seasonal assortments.
Two a higher percentage of direct import for the back alright, great. Thanks.
On the model side I'm going to follow.
Jeremy's question as far as not just gross margin, but obviously, you're you're achieving some of these targets a little earlier, what would you say.
I mean, obviously it has something to do with the top line, but.
Whereas the other surprise is that the 38% gross margin or as a day.
On the cost side.
You're really hitting some of these two to three year targets from Oh.
Okay.
I think it's across the board when we initially set the targets so much with unknown about.
We made a lot of changes in the second quarter end.
Huge changes to the store staffing model and would there be issues that came out on that that we had to tweak and give back you know what with store traffic look like what would in all the individual pieces. So I think just across the board. When we initially put there that we wanted to make sure. It was something that we could hit on it.
Feed in and you know us.
Actually performed better than than you know even.
The top end of what we thought at the time. So it really is just across the board being able to maintain that changes that we've made.
On the.
Ticket benefit from all the merchandise changes on all of those things on holistically flowing through in <unk> and obviously the merchandise changes allow us to pull back on discounting pretty significantly in the half.
750 average basis point improvement in landed product margin for two quarters in a row is significant and it's not something that we thought we'd get that make up that much ground. When we first set those out but you know even though the adjusted targets that we put out are lower than we had in <unk>.
Fourth quarter, the first half of our year is a much different model right now because the top line volume is quite a bit less than.
As we continue to execute the merchandise evolution, we will see the top line growth improve in the first half of the year, specifically because a lot of the changes, we're making are to the core everyday product and having the right offerings and in the first half of the year. So I think for now our model still looks very different than the first half versus the second half.
So it was updated target to take that into account, but that's another piece, we're continuing to work on in the model.
Great last question for me what are you I know, it's early on the new loyalty club, but is there any analytics or anything so far.
Through the holiday season of.
How much more spend you got out of a loyalty club member then didn't on loyalty.
Well, one we do know that the customers are liking it and like I said it on day call. We've got rated by Newsweek as the number one on home furnishings loyalty program and Thats, just kind of our initial flush we get so many more things we can do it with a loyalty program to make it more enhanced we are getting some of those analytics that sometimes it's hard to tell.
Because.
Lastly, with the junior volatility overall clothing stores, we were doing.
We're doing a lot of different things, but we're pleased so far with the with the results from coal did you have any specifics on I think the one thing that I would say that that is very encouraging so we're seeing about two.
It's a reward program accumulate points you earn a $5 reward we see about a 50% redemption of those rewards and in order to redeem them you have to come back within 60 days. So again too early to really say what that means for trips per customer and spend per customer for the year, but that I think is on track.
To really be something meaningful.
Right.
Thank you for your time and congrats again.
Thanks, Sean.
This concludes our question and answer session I would like to hand, the call back over to Mr. Woodbury for any closing remarks.
Well, thank you operator, and as always we're available for follow up questions over the next several days and weeks and we look forward to seeing you on line and in our stores. Thank you very much. Thank you.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.