Brand House Collective Inc (TBHC) 2002 Q3 法說會逐字稿

Good day, and welcome to the Kirkland's, Incorporated, Third Quarter Earnings Release Conference Call. Today's call is being recorded. At this time, for opening remarks and introduction, I would like to turn the call over to Trip Sullivan. Please go ahead, sir.

Thank you, Jennifer. Good morning, and welcome to this Kirkland's, Incorporated, conference call, to review the company's results for the third quarter of fiscal 2002. On the call this morning will be Robert Alderson, President and Chief Executive Officer, and Renny Faulkner, Executive Vice President and Chief Financial Officer. The results, as well as notice of the accessibility of this conference call on the listen-only basis over the Internet were released yesterday afternoon, and the press release has been covered by the financial media.

As we start, let me express that except for historical information contained herein, the statements in this conference call 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 include, among other things, the competitive environment in the home decor industry in general, and in Kirkland's specific market areas, inflation, product availability, and growth opportunities, seasonal fluctuations, and economic conditions in general. In addition, due to the importance of the fall selling season, the fourth fiscal quarter is expected to contribute a disproportionate amount of operating income and net income for the entire fiscal year. Any factors negatively affecting the company during the last quarter of its fiscal year could have a material adverse affect on its financial condition and results of operations. Those and other risks are more fully described in Kirkland's filings with the Securities and Exchange Commission, including the registration statement on form S-1, originally filed on April 23rd, 2002, as amended. Kirkland's disclaims any obligation to update any such factors or to publicly announce results of any revisions to any of the forward-looking statements contained herein, to reflect future events or developments.

I'll now turn the call over to Robert Alderson. Please go ahead, Robert.

Good morning, everyone, and thank you very much for being on the call today. We genuinely appreciate your interest. We are pleased to report to you today on our sales and earnings results for the third quarter. As we entered Q3, Kirkland's was facing several major challenges. The first was that we had very difficult sales and gross margin comparisons from Q3, 2001. We had a 22.9 comp and a 33.1 gross margin performance in '01, very substantial numbers. We also have encountered a very uncertain retail environment. We've had persistent and widespread predictions of a slowdown in mall traffic and a slowdown in consumer spending, and diminished consumer confidence. Also, we have had the threat of disruptions to the retail supply chain, due to the West Coast port labor dispute. Despite that environment, Kirkland's delivered very solid results in our third quarter. Our comp sales increased 9.2%, we delivered a gross margin of 33.0, our earnings per share were seven cents, two cents above the high end of our previously issued guidance. Renny Faulkner will have some additional, very detailed commentary, on the financials in a few moments.

We believe that several facets of our strategy and approach to Q3 helped us deliver results that were above expectations. First, we continue to have very clean and current inventories, and we know that it's axiomatic at Kirkland's that the freshness and newness of our product offering is a real key connection with our customers. At end of Q3, 95% of our inventory was less than six months old, with 84% of it less than three months old. Those were the best numbers we have ever experienced. 85% of the inventory is active; that is, it's performing at a sales rate that would justify reorder if we desired to do so. Our SKU counts continued to show favorable downward trends, as we continued to tighten and focus our merchandise offerings and leverage the capability of our retail management system that we installed last year.

We continue to believe that the condition of that inventory and the value proposition that we offer our customers fueled our positive Q3 results and does put us in a very strong competitive position, as we face Q4 and the need to produce the sales in that very important quarter. In anticipation of a possible labor-related port dislocation on the West Coast, we did take early receipt of a significant portion of our holiday merchandise. This strategy exerted some payroll pressure on our warehouse and on our stores, obviously. However, we had adequate inventory to sell throughout the quarter, and as of the end of the quarter, we had received virtually all of our holiday merchandise, greater than 99%.

Another kind of interesting thing that we did in Q3 was that, after several years absence from the category, we experimented with a limited number of SKUs and a fairly modest inventory amount of Halloween seasonal, Thanksgiving, and harvest merchandise. We were pleased to experience a complete sellout of that merchandise at favorable margins, was a clear plus to our business. We'll continue to evaluate that merchandise group for future business.

Our planning with vendors, with reaction to the West Coast port situation also positively affected the overall merchandise receipts for Q3. We had planned and actually received-- had planned for and actually received $45 million in goods, including virtually all of Christmas, as I've mentioned. So the good news was that we received the amount of goods that we had planned to receive, and that was done despite all the dire predictions of major shortages, and the best news is that our stores are fully stocked for Q4. We also successfully executed two promotional events in the third quarter, a framed art and lamp events, and we had experienced positive increases in the business in those categories and had especially strong results in the art category, which is our leading category.

I'd like to comment a little bit on some trends in the merchandise area, things that we saw that were significant in Q3. First, the performance of our core merchandise group continues to be very strong. We continue to have very strong sales performance in art, lamps, and decorative accessories, which are at the core of our business, and saw tremendous increases in the sales of furniture and house wares, although on dollar amount, they're not as large as art lamps and decorative accessories, so in the core of our business, we had outstanding sales results and continued good margins.

Even in the categories that we actually planned down for Q3, such as lighting, floral, garden, and textiles, we delivered very strong margin performance and improvement over last year, so we were very pleased with those results, and we felt they contributed strongly to our business success.

Also, in the third quarter, transactions continued to be a strong contributor to our sales success. Our dollars per transaction were up 5%, and our number of transactions were up 4.2%. We think that is evidence that customers continue to respond positively to our merchandise offering, which always features great quality, style, and wonderful value. And we continue to experience as a result of all that well-trafficked stores.

As the press release mentioned, our holiday category was an especially big contributor to third quarter sales last year. For the third quarter of 2001, our holiday seasonal sales were 14% of total sales, whereas for this year, the third quarter holiday seasonal sales were 12% of the total. We were hoping for slightly higher sales in the category within Q3. The sales of our core home decor merchandise at favorable product gross margins clearly displaced some of these seasonal category sales. And we continue to blur the line between pure seasonal and our core category, as we present many of our core merchandise items as giftables.

We've also seen a noticeable acceleration of sales in the seasonal category over the past two weeks, as we expected, and as we approach a later Thanksgiving weekend in 2002. And lastly, about the merchandise, I would say that we remain optimistic about our fourth quarter business. We believe we're in great position for it.

We had several other accomplishments that I would like to note to you. We had our store managers meeting Cancun, Mexico, in August. It was a reward to our store group for a tremendous 2001, and it provided us with an opportunity to not only train, but inspire and challenge the store group for Q3 and Q4 of 2002. We also made two key management hires, which I believe we previously announced. Roland Mackey is vice president of real estate and Todd Weir is vice president of logistics. And we also promoted a nine-year veteran of Kirkland's to operations vice president, Tracy Parker. We're already feeling the contributions of these additions, and we expect them to be very important leaders in our company as we accelerate our growth in 2003 and beyond.

I'd like to mention, or update you on our store growth, for 2002. We did open nine new stores during Q3, which brings the year-to-date total, as of the end of the quarter, to 11 stores. The remaining stores have opened over the last two weeks, so that as of tomorrow, all 16 new stores that we intend to add this year will be open and operating, and we also successfully opened two new markets, Phoenix and Denver, and those are working very nicely.

At this point, I'd like to turn it over to Renny Faulkner, our Executive Vice President and CFO and let him take you through the financials.

Thanks, Robert. Good morning, everybody. Let me make a few overview comments about our financial statement presentation, and then I'll take you through the P&L and balance sheet. For those of you not as familiar with Kirkland's, we report numbers on a GAAP and pro forma basis. We completed our IPO back in July, so for internal purposes, we continue to believe that pro forma is the best way to understand our business performance versus prior year. For the third quarter of 2002, the quarter we just completed, there is no need to pro forma the results, since the IPO occurred before the beginning of Q3. However, for the next several quarters, the reason for continuing to use pro forma is so that we can show prior-year numbers and make meaningful comparisons for you against the actual results as we go forward. Pro forma gives effect to the IPO and the application of the proceeds from the IPO at the beginning of all periods presented, and as you'll notice, as perhaps you've already noticed, the most significant pro forma effect is the reduction in interest expense from the debt pay down from the IPO. The pro forma also excludes certain other IPO-related expenses that are mentioned specifically in the press release.

Turning to the income statement, and just moving down the income statement, Robert already mentioned the 9.2% comp on the sales line for the quarter. I'll just say also that we were pleased with the sales results of our new stores as well. The five new stores from the class of 2001 are having an excellent first full year, and the early indications from the class of 2002 are also very promising, and just to reiterate, we are largely there in terms of our new store openings for 2002 and the final count of 16 will be complete by the end of this week, and we're excited to have those 16 stores contributing to fourth quarter.

On the gross margin line, we were 33% flat for third quarter, 2002, against 33.1 for the third quarter of 2001. The gross margin in 2001 was aided significantly by two factors. First, the 22.9% comp sales increase in the third quarter of 2001 generated tremendous fixed cost leverage on the gross margin line, and second, extraordinarily strong early sales of holiday merchandise occurred in third quarter of 2001, above our historical pattern, and this is our highest-margin category, so that also contributed positively to the 33.1 last year. In light of these factors, as a management group, we were pleased to produce the 33% flat for this year's third quarter, which was virtually equal to the prior-year figure.

On the operating expense line, our operating expense ratio was 26.8% this year against 25.9% last year for the quarter. As we anticipated, our operating expense ratio did rise a bit against 2001 levels, and key elements of this 90 basis point increase included, number one, insurance cost increases, much of which was anticipated, including directors and officers liabilities premiums, which increased sharply for the company, upon our initial public offering. Second, travel expense increases, most of which was associated with the store manager meeting in Mexico, as Robert mentioned. And third, increases in corporate salaries over the past year, due to the hires that we have made. As we ramp up our growth over the next several months, we anticipate that getting leverage on our operating expense ratio will remain difficult until the second half of 2003, but I guess I would just reiterate here that that really is as we have anticipated, number one, and number two, if you look underneath the operating expenses and look at the store expenses, as you would expect, with a 9% comp, we were pleased with the leverage in expenses we were able to achieve at store level.

Interest expense was approximately $500,000 for the quarter. This figure was less than we had planned, due to the strong cash flows in the business, which really did two things for us. First, the strong cash flows reduced our need for revolver borrowings to finance our seasonal inventory build-up, and second, the cash flow enabled us to retire the full outstanding balance of our senior term loan that we had put in place in May of 2002. We had previously commented that we hoped to retire this term loan in full by the end of the fiscal year, and in fact, we were able to retire that term loan, in effect, one quarter early because of the cash flows in the business. And as the press release indicated, the extinguishment of this debt did create a $192,000 extraordinary item for the quarter, that appears on the P&L as its own line item. Our tax provision of 41 percent is consistent with the rate we used for second quarter, and it reflects the non-deductible nature of the non-cash stock compensation charge that appears on the income statement. Most of our net income for the year is earned in fourth quarter, as you know. As a result, for those of you looking to forecast fourth quarter, we would expect the marginal tax rate for Q4 to be a little more in the 40% range, slightly down from third quarter.

Weighted average shares outstanding for the quarter reflect new shares issued in the July IPO, as well as the exercise of all warrants in the company at the time of the IPO by the pre-IPO investors, and the exchange and conversion of preferred stock to common stock at the time of the IPO, so just clarifying those weighted average shares outstanding, the basic shares, given those items I just mentioned, were 18.8m for the quarter, diluted shares, 19.5m, and as you bring that down to the EPS line, that creates your seven cents per share, before the extraordinary item, against five cents pro forma for Q3, of 2001.

Turning to the balance sheet, I'll just comment on a few key line items. First, inventories -- inventories at the end of the quarter were $53m, against $33m at February 2nd, 2002. This ramp up reflects a normal seasonal inventory ramp for Kirkland's. I'll also note that on a per-store basis, merchandise inventories at the end of October were approximately 5% below last year at the same time. We continue to expect inventory turns for full-year 2002 to approach the four times mark, which would be up from 3.5 times that we produced for fiscal 2001.

Accounts payable, I'll make a brief comment on this line -- when you look at the number, you see again, somewhat like inventories, a normal seasonal ramp in our payables, versus the year-end lower payables balance. That is, in fact, a normal seasonal pattern. I will say it's a little bit above where we were prior-year, and the reason for that is that we have been able to achieve somewhat better dating terms with our vendors for merchandise this fall, so a slightly higher proportion of our merchandise that we're receiving this fall, we've been able to achieve December dating, as opposed to traditional 30 or 60-day type terms.

As far as debt, now that we've repaid our term loan, our only remaining debt is revolver borrowings. At the end of the third quarter, our revolver balance was $24.7m. We expect to pay this balance to zero before the end of the fiscal year, which will leave us with a completely debt-free balance sheet as of February 1st, 2003.

And finally, I would just like to comment on guidance for fourth quarter of 2002. On the second quarter call, we said that we expected third quarter and fourth quarter comp increases to be a bit lower than first half comps, as we faced the double-digit comp increases from the second half of 2001. At that time, we guided you to a low single-digit expectation for fourth quarter, and we would like to confirm that guidance today. In light of the macro environment, we think that the right expectation for Kirkland's is a 1 to 3% comp, versus last year's fourth quarter comp of 13.9%. I do want to add one footnote to this, and that is that the 13.9% comp from a year ago was in a 52-53 week year, so in other words, 13.9% was a comp for a 13-week quarter against a 14-week quarter. Therefore, the actual sales volumes that were produced in last year's fourth quarter were probably more in the range of, effectively, an 18% or so comp, rather than the reported 13.9%. Simply mentioning that, that we continue to reiterate that we think the comparison is difficult, and that a low single-digit comp is the right place to be on expectation.

As for earnings, we also wish to confirm our previously issued guidance of 75 to 78 cents for the fourth quarter. While we are cautious about the environment, we like our strategy, we like our market position, and the management group here and everybody in our stores is focused on closing out 2002 with a solid performance.

I'll turn it back over to Robert, or I guess really we'll open it up for questions.

Yeah, at this time, we'll be happy to take questions.

Thank you, sir. Today's question and answer session will be conducted electronically. If you would like to ask a question, you may signal by pressing the star key, followed by the digit one, on your touch tone phone. To ensure everyone has the opportunity to ask their question, we will limit each person to one question and a related follow-up. Time permitting, we will return to you for additional questions. Just queue up again by pressing the star key and the digit one.

Our first question comes from Brent Rystrom with US Bancorp Piper Jaffray.

Congratulations, guys. Two quick questions, actually. The comps by month during the quarter, I know you're not going to give me actual numbers, but could you give me kind of a feel for the trend?

Very consistent.

Did you see any fall-off in late September or early October, or did you run through that pretty well?

We came through it really pretty well, Brent. I mean, you'll remember that we made that press release, indicating that we were somewhat cautious, going against some particularly difficult comparisons, and you know, we really were a little bit encouraged by how we finished out. I think, and I guess I'll just-- one clarification, I think that you could gather from things that we've said previously, that you know, it's definitely the case that as we move through the year, the comparisons get more difficult, and so I think it's a fair assumption that October was a modest amount lower than August and September, but again, we were encouraged about how we completed the quarter.

OK. Second quick question -- looking at the gross profit margins for the fourth quarter, we had been planning for the third quarter a slightly down margin. Obviously you performed very well against that. We're also planning a down margin in the fourth quarter. Is it feasible that you could have a flat to up margin in the fourth quarter?

You know, Brent, I really think that the right place to be is to continue to expect that to be down year-over-year. Really, the story in the fourth quarter, the numbers are a little bit different, but the story is very similar to the third, for the two reasons that I mentioned. Number one, that comp in the fourth quarter gave us tremendous leverage on the fixed cost pieces of the margin, and number two, just the extraordinarily strong performance of holiday occurred in fourth quarter of last year, just like in third. I'm not really talking about sales there, I'm talking about maintaining margin, so I really think, you know, we would look at last year's fourth quarter- in fact, I did this in preparation for the call. The margin that we had in last year's fourth quarter was the highest margin that we experienced in the last four years in any quarter. So, that's probably where--

It was exceptional?

Yes.

All right, thank you.

Thanks, Brent.

We'll now to go Doug Novera with Merrill Lynch.

Yes, good morning, Robert. Good morning, Renny.

Good morning, Doug.

Renny, you broke out seasonal sales as a percent of total sales in the third quarter. What-- can you remind us what that was for fourth quarter last year and what you're planning for, for this year?

Sure. It's roughly 20%, Doug. Roughly 20% of the business.

OK. And would you expect an increase this year, relative to that, or somewhat of a decline, as you indicated in Q3?

Well, that's an interesting question, and here's the answer -- as good as holiday was last year, and you may actually remember this from discussions we had a few months ago, but as good as holiday was, our core business was even better, and so we actually would anticipate that holiday might be a little bit higher percent to the total this year, just because we had such powerful sell-through of the core home decor in fourth quarter of 2001. We're excited about our core home decor this year as well; I'm just saying from an overall mix standpoint, holiday percent to the total might even tick up a bit this year.

OK, great. And secondly, can you just comment on the performance of the strip center locations versus mall stores?

Doug, continues to be very positive. Very comparable to the mall stores, and we had some very nice surprises, so we're very positive on that venue as a growth vehicle for Kirkland's, and we'll continue to explore good deals in that piece of business.

Great. Well, thank you and good luck in Q4.

Thanks.

Thanks, Doug.

Our next question comes from Peter Benedict with CIBC.

Hey guys, congratulations. Good job in that third quarter.

Thanks, Peter.

Quick question on kind of your mark-down strategy as you look into the holiday season; can you kind of just give us a review on how you approach that, particularly with the seasonal products, and what your expectations are there? Thanks.

You know, Peter, the way that we'll approach that will be as we approach all mark-downs. Our strategy is, always to use the power of our information system, the experience of our merchandise group, and we'll look at each and every item and deal with them on an item-by-item basis. I think you will be-- it's always-- it would be very unusual to see Kirkland's to take a mark-down across a class or a whole category of goods, and I don't think you'll see in the fourth quarter.

OK, great, and one quick follow-up -- if I remember correctly, I remember something about maybe the monthly comp progression in the fourth quarter a year ago basically peaking in November and then easing up a bit in December and January, sequentially. Is that true?

Peter, I'll take that. The answer is yes and no, and the reason it's yes and no is, November last year was the beneficiary of a comparatively early Thanksgiving. This year is the opposite, so really, if you asked me when was your business stronger last year, November or December, I really don't know if I could tell you, because I think they were both strong, if you adjust for the calendar shift. Having said that, I think that looking to this year, you definitely can anticipate, or I think everyone is anticipating out there, as we are, that December, from a percentage gain basis, will be higher, you just can't overcome that Thursday, the 28th, day.

Understood. Good. Thanks, Renny.

We'll now to go David McKee with Sun Trust Robinson Humphrey.

Good morning, and good quarter. A couple of questions. One, the distribution cost that you alluded to as being a minor factor in the third quarter, with regard to the port situation, any residual risk into Q4 you see from that?

On the expense side, David?

Yes, or residual inefficiencies that you see out there?

David, I really think the answer is no. I think really no material risk there. We are largely, you know, over the hump in terms of the big push -- you know, the big bubble that always hit the seasonal retailer. We commented in the press release about being hopeful that further supply chain disruptions would not happen, and I think hopeful is probably the right word there. You know, no one can predict exactly what will happen, but I guess my answer is that we feel like we're prepared to deal with it without material problems.

David, I just would add that you know, you hear a lot of stories about the container cost, and we've got to remember that we're not importer of record, so those costs are being borne by our vendors, and have not been passed through, so--

Good point. The second question is, the SKU count coming down -- can you put numbers behind that, and should we expect that to be the trend next year as well?

I think we will continue to look at the merchandise mix and evaluate every category and class and sub-class, always trying to, you know, find the most productive of items in that merchandise mix, and go with those, and eliminate those that are not. I think you'll also see us continue to try to be more focused on our-- on properly getting the right inventory levels and SKU counts to our smaller stores, especially the mall-based stores. So I think it's really- it's a matter of focus and tightening and we will continue to press down on SKUs, to have a more productive and easier to manage SKU base.

So this will be an active theme, then, for next year as well, then?

Yeah, it'll be a point of emphasis for us, always.

Yeah. Great. Thanks a lot.

Thank you, Dave.

Once again, that is star one for questions. We'll go next to Robin Murchison with Hibernian Southcoast.

Hi, good morning.

Good morning.

Denver -- which mall did you open in Denver?

We opened Colorado Mills.

OK, that one-- what part-- do you know where that is?

Yeah, it's on the northwest side of the city.

OK. And next year, when you look at your opening schedule, how much of the-- I think it's 35 gross, how many of those stores, excuse me, will be in new markets?

You know, Robin, I can't really tell you right now. I think we will open some new markets in the Northeast and in the Far West, but at this point, we have been terrifically focused on going from a standing start in May of this year and getting our store group open, doing our renewals for next year, and we're working very hard on that group. I mean, we're about, you know, better than halfway into the new store group for next year, but it's a little difficult to tell how that's going to finally roll out. We'll have a lot better information for you next quarter.

OK, good enough. And then last question -- is there anything behind your ability to get better dating terms, or is that just a function of your increasing size, or is it reflective of any sort of pressure on the vendor?

Robin, I really think it's just a factor of our increasing size. We are not-- we don't make dating terms a central point of our negotiations with vendors. The central point of our negotiations with vendors, the top three things, are price, price, and price. So, you know, dating terms, it's nice to have, and it's encouraging that we have it. Quite honestly, it was a lot more important a year ago, when we were leveraged, but we'll take the benefit.

OK, congratulations, and the stores look good.

Thank you.

Once again, that is star-one for questions. Gentlemen, it appears we have no further questions at this time.

OK, thank you very much, everyone. We appreciate you being on the call, and we'll talk to you in another quarter.

That does conclude today's conference. You may disconnect at this time.