Brand House Collective Inc (TBHC) 2003 Q2 法說會逐字稿

Please stand by we're about to begin. Good day and welcome to this Kirkland's incorporated conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Mr. Tripp Sullivan. Please go ahead sir.

Thank you. Good morning and welcome to this Kirkland's conference call to review the company's results for the second quarter of fiscal 2003. On the call this morning will are Robert Alderson, president and Chief Executive Officer, and Rennie Faulkner, Executive Vice President and Chief Financial Officer. The results as well as notice of the accessibility of this conference call on a listen only basis over the Internet were released yesterday afternoon in a press release that has 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 provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks an 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 & Exchange Commission including the company's annual report on form 10-K filed on May 1st, 2003. For fiscal 2002, Kirkland's has reported net income and earnings per diluted share accordance with generally accepted accounting principles and additionally on a pro forma basis to exclude certain effects of the company's July 2002 initial public offering. For a description of the pro forma adjustments please refer to the reconciliation pro forma information that was included in yesterday's press release. With that I'll turn the call over to you Robert.

Thanks. Tripp and thanks for joining us today. Three weeks ago we announced our second quarter sales results. We also held a conference call to discuss those sales figures and revised estimates for the second quarter. Given we went into considerable detail on our second quarter sales and earnings results on that call we'll briefly comment on the final results and then update you on the trends we're seeing in our business as we approach the end of August. Rennie will provide additional commentary on the second quarter results as well as the earnings guidance that we affirmed in yesterday's release. For the second quarter, earnings came in at 4 cents per diluted share in line with and the high end of our revised guidance issued earlier this month. As previously announced comp store sales for the quarter decreased 9/10 of 1% following a comp increase of 16.7% for second quarter of 2002.

Total sales rose 5.7% as we began to experience the positive top line impact from our new store openings. As previously reported gross margins for the quarter were negatively affected by two factors. First, a perceptible shift in consumer preference towards lower price categories such as candles decorative house wears and textiles. Second, the heavy mark down activity taken in June and July.

On the positive side, expense control was excellent throughout the quarter. From a merchandise standpoint, the categories that performed well in the second quarter generally are the ones that drove our business in the first quarter. That is, wall decor, candles textiles and house wears.

Product offerings in our gift categories are also good performers. We continue to distinguish ourselves in the space through new and innovative product development and we ended the quarter with very exciting product assortments in place across all these categories.

As we have discussed previously, certain of the categories presented challenges for us in the second quarter. In particular, sales increases in lamps, garden and decorative accessories were tough to achieve as we faced prior year comp increases from 23 to 48% in those categories. It is important to note that sales comparisons in those categories eased as we entered the second half and we're optimistic about the new programs in these categories which we will introduce during the third and fourth quarters.

While we sacrifice gross margin during the quarter as we aggressively cleared merchandise that was not performing to our expectations, the positive result of this clearance effort was that we ended the quarter with inventory levels on plan and new product assortments in place. We reported to you on our sales call three weeks ago that we had begun to see the financial benefits of our clearance efforts in the form of improved sales and margin trends. We are now three and a half weeks into the third quarter and we've continued to see positive indicators of better business in our stores.

Our arts sale which will continue in our stores through the end of this month has been a successful event, and overall sales and margin have been trending favorably. While business is better over the last six weeks, it is still early in the quarter, and business is not consistently so robust that we are comfortable projecting these early results across the entire quarter. However, we are pleased thus far with our August sales and margin results and our inventory levels. Most importantly we think we have significantly stronger merchandise offerings in our stores than we did in the second quarter. Our goal is to continue to create excitement in our stores throughout the third quarter with new merchandise programs being introduced including the categories of lamps and garden and the continuing buildup of holiday merchandise as we approach the fourth quarter.

Again this year, we expect holiday merchandise to be a significant contributor to fourth quarter sales. However, we are modifying our holiday merchandising strategy this year by introducing the seasonal goods more gradually, in smaller quantities and fewer SKUs as compared to last year. The early response from customers has been favorable but again too early to make a call. More to fall here on our third quarter call.

In connection with our sales release three weeks ago we updated you on our new store development activity. We now are almost three weeks into the third quarter and we continue to be encouraged by first the progress we are making on our plan to open a net 30 new stores in this fiscal year, and second, by the initial performance of this class of new stores which is tracking well versus expectations. However, with a large number of stores opening late in Q3, we will again remain caution about projecting early results across the balance of the year.

We are on track to open 18 new stores during the third quarter, which is our busiest quarter yet, and four in the fourth quarter. As previously reported, expectation on new stores of 60% mall, 40% off mall has in fact materialized. This year's class of new stores will include Kirkland's entry in the five new states, Delaware, Massachusetts, Minnesota, Nevada and Utah.

The breakout is balanced across small medium and large markets. The dispersion is weighted to the northeast and Southeast. We are also well under way on our leasing activity for 2004. Leasing opportunities for 2004 remain plentiful and we are progressing nicely on that class. We expect to update you on our store opening plan for 2004 when we report third quarter results. At this point I would like to ask Rennie to take you through the second quarter financial statements that were included in the press release and provide some commentary on our third quarter and fiscal 2003 outlook.

Thank you, Robert. Good morning, everyone. I'll begin with the income statement for the 13 weeks ended August 2nd, 2003.

Net sales increased 5.7%, and comparable store sales decreased 9/10 of 1% for the quarter. Sales increases throughout the quarter were driven by unit volume offset by decline of average retail price.

Gross margin for the second quarter decreased to 29.7% of sales from 34.4% in the second quarter of 2002. The decline in gross margin percentage was primarily the result of heavy mark down activity undertaken in an attempt to drive sales and position inventories for the second half of the year.

The occupancy and distribution components of gross margin also experienced negative leverage due to the comparable store sales decrease for the quarter.

Operating expenses were higher than prior year, as a percentage of sales, but below plan. We had planned for modest expense growth year over year, but we did a nice job managing operating cost in the midst of a difficult sales environment. Most of the favorable expense variance versus plan was due to good control of payroll expense at store level. Interest expense continued to benefit from low borrowing rates and strong cash flows as revolver borrowings during the quarter were modest.

Our effective tax rate for the quarter was 39.5% and diluted earnings per share for the second quarter came in at 4 cents, in line with the revised guidance that we issued on August 7th.

Turning to the balance sheet, the company is in excellent financial condition as we enter the second half of the year.

Total inventories at August 2nd, 2003, were $41.9 million versus $39.5 million at February 1st, 2003, and $41.2 million at August 3rd, 2002. With total inventories less than 2% above prior year levels, on an increase in the store base of 9%, we feel very good about inventory levels as we head into third and fourth quarter. If you look at actual on-hand inventories in or stores on a per-store base we were carrying slightly less merchandise in the average store at tend of second quarter 2003, versus the end of second quarter 2002. We anticipate a significant flow of new merchandise into the stores during September and October, and with today's lean inventory levels, our stores are in an excellent position to receive these new goods and display them for our customers.

I also want to direct your attention to our revolver balance at the end of second quarter. We entered fiscal 2003 with no debt, and $4 million in cash. At the end of the first quarter, we had borrowed $11 million under our credit line. At the end of the second quarter, we had borrowed 12.1 million. The majority of the year to date revolver draw funded our final 2002 tax payment in April 2003. We still anticipate financing all of our activities in 2003, with cash flow from operations and incremental borrowings under our revolving credit line. We expect our credit line borrowings to peak around November 1st at $18 million or less and seasonal cash flow should reduce this balance to zero before year end.

I want to briefly reiterate the third quarter and fiscal 2003 guidance that we gave on August 7th. As Robert said we have been pleased with the first three and a half weeks of the third quarter, but we have almost ten weeks left in this quarter, and don't want to get ahead of ourselves as far as expectations for either Q3 or Q4. Accordingly, for the third quarter, we still are expecting earnings per share of 4 to 6 cents based on comparable store sales in the range of flat to negative 2%, and gross margins of approximately 32%, or roughly 100 basis points below prior year.

This estimated EPS range is before taking into account an anticipated one-time charge of 4 cents per diluted share related to the expected termination of our existing warehouse leases in connections with our plans to lease a new distribution center beginning in the second quarter of 2004. Likewise, we are still expecting earnings per share for fiscal 2003 of $1.02 to $1.07 before the one-time charge of 4 cents per share with a comparable store sales increase for the full year of 1 to 2%. If we can deliver earnings in this range, then our third and fourth quarters combined earnings per share would total 92 to 97 cents, reflecting earnings growth of 18 to 24%, versus the last two quarters of fiscal year 2002.

That concludes our prepared remarks. And operator, we are now prepared to take questions.

Thank you Sir. If you would like to ask a question on today's call you may do so by pressing star 1 on your touch tone telephone. Again if you would like to ask a question you may do so by pressing star 1 on your touch tone telephone. And if you are on a speaker phone, please make sure your mute function is turned off, to allow your signal to reach our equipment. Once again, that is star 1 if you would like to ask a question, we'll pause a moment to assemble our roster.

we'll take our first question from Brent Rystrom with Piper Jaffray.

Good morning guys, congratulations on getting the number out. Couple of quick questions for you. Could you review for us just kind of some of the dynamics of the non-mall stores versus the mall stores, what is your expectation, what sort of relative contribution you expect?

Sure, Brent. Let me – maybe what we'll do is I'll take it is relating to, sort of, existing store base and comps and Robert can fill in that with comment on new stores and what we're seeing in non-mall mix in the class of 2003.

As we've discussed before, non-mall stores still represent a relatively small portion of our store base. Out of approximately 260 stores, roughly 23 or 24 of those are non-mall stores, Brent. And they're only eight, actually that's not right. There are only 11 that are really in our comp base right now.

But several things I think we can say. I think first of all, we are seeing these non-mall stores generally comp at or above the comp rate of our mall stores. Number two, consistent with what has been our stated expectation, we still expect that these non-mall stores, and it's been our experience year to date, that these non-mall stores will typically have volumes somewhat below the mall stores. But the profitability of the non-mall stores is generally going to be a little bit above the mall stores, because the occupancy advantage. And again, those are generalizations but those are the trends that I would highlight.

And you're actually saying that's your plan and you're saying you're confirming that's kind of what you're seeing?

That is what we're seeing.

Okay.

The unfortunate thing that I always have to say is it is a small sample so you have outliers. We have this one, we have this one store, that's one of the best stores in the entire chain that happens to be in an outdoor center. And so you know, I'm, for example, excluding that because I think that would be misleading to use that. But just adjusting for all those sorts of factors I think the basic idea of somewhat lower top line, generally better occupancy cost, is adding up to basically positive outlook for our experience in non-mall. And then Robert can add thoughts on the class of '03.

So far I think, Brent, most of the generalizations that Rennie just made have held true for what we've opened outside the mall in 2003. We've had some very strong openings outside the mall. We opened in Peoria Illinois, (inaudible) Potomac Mills have been great. Colorado Springs, [Porjet], [Quohoc] Beach. All of those have been very outstanding openings. And we're very encouraged by them.

So I think you'll continue to see us as we work into 2004, continue to work in this same range of about 60-40. It might at some point become 50-50. But we like the non-mall venues as an alternative because we believe the productivity advantage that it gives us. And it certainly puts us in a nicer position when we negotiate versus a mall venue.

Quick follow-on on that. From an implication perspective what would you look at the mall base format, refresh for us if you were remembering on that what is the potential build-out of that and what you're seeing so far what are the implications of the non-mall implications being added to that built-out opportunity?

You talking about did --

Yes, sir yes, sir.

Generally non-mall opportunity, 450 to 500 stores in the mall is probably about where our targets are set now. You know, we've also hasten to add that our experience with being in some of the lesser malls and smaller market is sufficiently positive that maybe that's a conservative number.

We talked time to time about the Brier Patch acquisition in 1998. How we have been successful. A lot of small town mall, like Rocky Mountain North Carolina, Gadsden Alabama. So I guess you've always got that asterisk. But generally up to the right expectation brand would be 450 to 500 near term view in terms of the mall opportunity.

And I think, gosh, you know, it's hard to sit here when only 10% of your store base is off the mall. But we're positive that off the mall opportunity being least as much as that. That's really count how we get to that thousand-store number.

I would agree with that and I would say that when you look at the small market opportunity that Kirkland's has, I think it's, I think you have to make a very different or take a very different view of a dominant, well maintained, well leased, well positioned property in a small market, versus which might fall into someone's C category because of the size of the market or whatever, versus a second or third or fourth tier property in another kind of market. And I think we've been well able to take advantage of those kinds of situations.

Just so we could -- different vein here but so we could kind of gauge your comment on, you know, so far in the quarter you're pleased. I can understand your hesitancy to, you know, say too much for fever getting people too excited too early. Could you give us a sense of how the comps flowed in last year's third and fourth quarter? Do we start that 9% comp in the third quarter, did it start strong and end weak, did it end, give us a sense for that third and fourth quarter.

I really think that the third quarter, each month in the third quarter last year was really -- watt pretty strong, Brent. You know, one of the things that it will be interesting to figure out and probably the only thing that I would highlight is maybe unusual is the fact that as you look at our September last year, we have to remember that that was against the 9-11 event in '01. And so you know, maybe, you know, as we look at percentages across the three months maybe we feel like September, I don't know, maybe provides a little bit more kind of numerical opportunity, maybe, than October or August. But it was -- it was pretty good the whole quarter.

Okay. How about the 4 Q?

Excuse me?

How about the 4 Q? Did business start off okay in November and then tail off? I'm trying to recall how that worked.

Well, discounting for the fact that the calendar was a little bit strange last year, because of the late -- the late Thanksgiving which obviously had a negative impact on November. I think when you adjust for all of that, the truth of the matter, Brent, it was really tough throughout. And if anything, we saw recovery toward the end of the quarter, partly driven I'd say the latter part of December and even into January, partly driven by what was some pretty intense mark down activity as we pull customers into our stores and with heavy mark downs and cleared our seasonal category. So short answer, pretty tough throughout the quarter. Probably even tougher earlier than later.

Final quick question for you. The power outage. Did you guys experience much impact from that and if you did can you give us an idea of how many store days you might have lost?

I don't think it was terribly significant. We don't have a lot of stores in that northeast quadrant yet and I believe we have -- had five stores down for a couple of days. But you know, it's not -- I think it --

Not material?

Not material.

All right. Thanks guys. Looking forward to the 3Q.

Thanks appreciate it Brent.

We'll take our next question from Rob Wilson with Tiburon Research.

Thank you. Rennie, can you talk about trends in merchandise margin for the month to date?

For the month to date? I would say, and I guess we've stated inside the guidance we've given for Q3, we stated we expect the quarter to be about 100 basis points below prior year. Which, I'm sure you're looking at your model, that would represent pretty significant recovery from second quarter. I would say we're tracking well to that kind of a number.

Would it be fair to say that that with would imply merchandise margins or you're planning them down for Q3? Or is my modeling incorrect?

I think that if you've got merchandise margins planned down for Q3, to the tune that I kind of described there, 100 basis points or so, I think that's probably where you ought to be.

Okay. You would, I guess last year in Q3, you had suggested that lamps and art were especially strong. And I wonder if you could, maybe Robert, if you could comment on what you're doing in those two categories this quarter.

Well, the -- you're very familiar with some of the comments that we've made about the lamp category over the last couple of calls. And I would -- I think the best description for changes or new trends there is that a lot of new direction and new programs. We've done a great job clearing lamps, and we're getting ready to go into an event that will begin in September. And we're well prepared in terms of inventory for that event. I think you'll see changes in direction that will be more -- changes in materials that make up the lamps, I think you'll see some changes in focus away from promotional Buffet pairs toward table lamps and other larger places.

There will be some price point changes, hopefully for the better. I think we'll do -- I think we're maybe coming back a little bit toward the traditional, little bit more conservative and traditional in style. So I think all that's good news for us.

On the wall decor side, I think it's an introduction of some really exciting new programs with some very successful vendors. Some new, higher price points in the category, some direction, more direction in the metal wall pieces, and we're across the whole line, I think we're doing a really good job in presenting boxed gifts in all of our categories, which are going to be -- they're very strong for us in the third and fourth quarter. I think the big news in wall decor is probably alternative wall decor. That’s the thingthat’s are different than framed art. I think we'll be strong as we get into the balance of the year.

That's helpful. Rennie, can you talk about inventory levels at the end of this quarter, where you expect them to be?

At the end of third quarter?

Yes, sir.

Let's see. We would expect them to be obviously we're in a period of time right now where we're ramping as we always do with our seasonal product, and with just overall higher inventory levels in the stores as we build towards fourth quarter.

Right.

Let's see right now we are at 41.9, and I would say -- I would say you ought to probably be expecting mid 50s.

Okay.

55, 56 million.

And finally, you guys, did you put in your traffic counters in August?

Yeah. They're completely installed, Rob. But it's going to be a while before we develop a baseline of information.

I understand.

And really begin to compare that. But we'll start to draw those reports shortly. And begin to try to make some comparisons on traffic versus stores and look at some conversion numbers and try to determine where we're doing a really good job in things like customer service and relating sales to traffic and conversion rates. So we'll try to use that, all of that data is rapidly as possible. But to really compare traffic I think is going to be a while.

Certainly. Just curious if they were there. Okay.

They're there.

Thank you. Great quarter.

We'll take our next question from Robin Murchison with Jefferies and Company.

A lot of my questions have been answered but I have two. Are there any new trends in home décor, thematically, is there anything that you see either currently or on the horizon?

Some of the trends that have been with us for a while are still there. The casual sort of Tommy Bahama type theme is still -- remains strong. I think our thrust is probably in our stores. We have a very traditional customer. And I think we're still going to have things for that traditional customer. But we're going to continue, probably if you describe the theme of the store, it's going to be casual contemporary for the next few quarters. And I think it's a great opportunity for us to not only reach our traditional customer, but to expand that customer base.

Okay. And second question, you named five new states you were going into, Delaware, Massachusetts, Nevada, Utah and what was the fifth one? I got Delaware, Massachusetts, Nevada and Utah.

Minnesota.

What were the time frame of going into these states?

We are already in Delaware, already in Nevada. Massachusetts will be a late Q3. Actually you've got it right there. Minnesota will be in Q3. I'm sorry, Robin.

And what -- can you give us any idea of the receptivity of the concept to these new states?

Nevada has been very good so far. We're very pleased with the one store that we've opened. The -- let me look quickly here and see if I can -- I think we've had good openings, Robin. Just don't want to make too much of it.

I understand. I understand. All right, good luck.

Star one if you want to ask a question. John Lawrence with Morgan Keegan.

Good morning, guys.

Hi John.

Can you comment just a little bit, can you give us any more on the new distribution center, any expectations or how we should look at that over the next couple of years from a model standpoint?

Good question. And I think one that we still, John, I think we just are not in a position to start getting really detailed commentary on financial effects of the D. C. We expect the transaction to close here in the next few weeks. Once that's done I'm going to feel a whole lot better about actually sharing some of the details of the actual -- the lease, you know, the actual long term lease that we're going to enter into.

And as construction moves forward and we get more comfortable with just, you know, the project coming in according to our expectation on cost again I'll feel a lot better about sharing more details. But I think -- I think basically we've talked about coming on line in second quarter of 2004, and we are working as hard as we know how to ensure that not only does the transition happen with minimal disruption to the business, but also, that we manage it with as little excess cost as we can.

And when I talk about excess cost I'm really talking about, number one, trying to avoid the situation of a significant period of duplicate rent in the old facility and the new. And number two, try to avoid within reason excess labor as we make the transition. I just think, if you're modeling in you've got to assume we'll have a little of both of those and we'll need to manage as best we can and we'll be prepared to give detailed guidance on that later in the year.

Secondly. Overall promotion schedule for the second half of '03, is pretty much the same as last year?

Yeah, it is, John. We'll do the lamp event, in September, and that's pretty much it for the balance of this quarter. We're going to be preparing our stores for, throughout October, for the big push in the balance of the calendar year.

Great. Thanks guys.

Thank thank you.

We'll take our next question from David Magee with SunTrust Robinson Humphrey.

Good morning guys. Just couple of questions. With the better business trends of late how much of that do you think is better tone of business versus similar, somewhat easier comparisons in the third quarter relative to the second quarter? Are you happy with the business above and beyond the little bit easier comparison?

The easier comparison is nice but there's been a, I think perceptibly we've had better traffic in our stores in the last four to six weeks. We don't have a way to measure it, but it's anecdotal. And we've had somewhat very balance transactionally and average retail. There's been a few good things going on makes us feel positive about it. And I think there are some external signs that business is better generally. But I think we have always cautioned that before we declare a recovery in a robust kind of way, that we ought to wait -- we ought to see some jobless reports go the right direction. And when we see that, we think it will be you know probably better evidence that that's sustainable.

So the decline in average selling price in the second quarter, do you think that that trend is now reversed somewhat?

We began to see improvements in that statistic toward the end of Q2.

Okay.

And we have continued to see, you know, better numbers on average retail here in August. I will, I guess, take this opportunity to comment on the comparisons. It's still not evident to us that we're in a period of dramatically easier comparisons, David. We had a huge third quarter in 2001. And then obviously, the strong 2002. So you know, I mean, I know it says 9% but I just --

Yeah.

Wouldn’t be doing my job if I didn't remind you that I think it's still tough in terms of comparisons and I would echo Robert's comments.

Sure. Robert, you had mentioned you were being focused in certain merchandise categories in the second half of the year. Can you talk a little bit about seasonal and to what degree that comment maybe applies to the seasonal category which you might be doing differently, with just the seasonal part of it?

I think that we mentioned earlier that we are -- we are putting seasonal into the stores differently this year, perceptibly different. We are a little later putting the seasonal mix into the stores and in smaller quantities. We felt like we transitioned our stores to holiday seasonal much too early last year. And we think we'll have much better flow of seasonal goods into the store relative to the time which they ought to be selling. And we're still taking into allowance getting the proper amount of goods to the stores that historically sell seasonal early. We still have all that in mind. We bought less in seasonal this year. And we have been much more focused in number of SKUs and we have, I think, a great looking lineup. And it's doing well as we said so far. But the inventory levels in the stores are not nearly what they were last year at this time. And we'll have to see how this develops. But you know, so far, so good, David.

So your SKUs will be less in seasonal this year than last year?

Will be, yes.

What would you expect that category to be about the same percent of sales year over year?

Yes, I think it will be.

To more productive SKUs,

I think we'll show them better and I think the combination of that seasonal fewer SKUs, more focused, some really good new stuff, in conjunction with the effort that we're making the box home decor, to make it giftable, and the giftable items we're bringing in the store to complement that seasonal should make Kirkland's an exciting place for customers in Q4.

Great, thanks, and good luck here.

Thank you.

We'll take our next question from Joe Joelson with JMP securities.

Good morning, guys. I had a couple of small questions. One is, would you assume that the tax refund that went out earlier this month is maybe what you're seeing in your stores for the first few weeks?

It's hard to tell. It's probably a piece of tail wind that we're always happy to have. But you know --

Normally like in the tax refund season in February or March, April, do you guys generally see some seasonal business from that?

That would be very hard to say, frankly.

Okay. Also, I was curious how -- what the capital plan was, given that you don't have a lot of cash right now to fund the store growth over the next few years.

Well, at this point in the year, we are into our credit line as many retailers are, just to finance our inventory building towards the peak in the fall. As I mentioned, we will begin paying down on that credit line sometime probably during the month of November, and will clean that credit line to zero and will carry a cash balance into fiscal 2004. And that will be our typical cycle.

Okay.

So basically although we are using the credit line for seasonal needs, we are essentially a self-financing company right now, even with 15 to 18% anticipated footage growth and we really don't have any intentions of departing from that basic model.

Great. And last question. You know, we've been actually looking at buying some of the stock here, it's jumped up here today. And I just -- I'm newer to the story so maybe I don't understand the historical things that people were expecting here. But were you guys generally pleased with the quarter? It seems to be the tone of what the analysts' comments are.

Joe, right?

Yeah.

Well, short answer is no. We were not pleased with the quarter in terms of the performance on the P&L. We -- and I'd encourage you to maybe listen to the replay of our call from three weeks ago if you haven't. We were very disappointed with the quarter from the P&L standpoint. But the silver lining of the quarter and it is a significant silver lining that we talked about today as well as three weeks ago is we did as they say take our medicine in the form of significant hit to our margin in second quarter, and it's really largely a result of that clearance effort that we feel is positively as we do about our inventory position now.

Okay.

So that's really our take on the quarter.

Okay, great, thank you.

Thank you.

Once again, that is star 1 to ask a question. We'll take our next question from Arnold Brief with Goldsmith and Harris.

I guess this is more of a conceptual question. Whenever I work with someone in the gift area being retail manufacturing, the game seems to be to keep the merchandise fresh to take the mark downs on a timely basis. And periodically, some clearance has to be done because it's very difficult to balance that inventory with a consumer when you sort of have to anticipate what he likes and doesn't like and et cetera, so forth. In your case, if I recall correctly, had some margin mark downs in the fourth quarter last year with the weak environment and you've had some more markdowns in the first half of this year to balance and clean inventories. Is this an inherent problem in the industry, the nature of the business that's going to crop up every 12 or 18 months?

Well, we did have markdowns in the fourth quarter of 2002. We made a serious effort to make sure that we didn't cross the line into the new year with any holiday seasonal left. The old days, many years ago, of boxing and holding, that sort of item -- that is sort of item in stores is long since passed. And that was certainly an action that we took. And we did significant markdowns in the second quarter as we mentioned. I think Kirkland's has said quite often, in comments to the public marketplace, about our market-down practice, that our business is best accomplished when we have a constant flow of new goods into the store.

And that in order to do that, and that's one of the things that we're very good at because of the strength of our merchant group, it's necessary to mark down things that are not selling at rates that we would like them to sell. And also, occasionally to make room for new things that come along. Because we're operating in a limited space. So it's a practice that we have employed quite vigorously over the last two to three years, and I think you'll continue to see us stay in that pattern. We're able to do that with our information systems, and we need to take advantage of that.

I didn't mean to be critical of what you were doing. I think you -- you know, you've obviously taken your mark downs amid an effort to keep the inventory clean and have space for new merchandise. I guess the question is more conceptual. Is the nature of business such that it's sort of going to happen again, you know, nine or 12 months down the road and happen again nine or 12 months down the road because it's just so hard to anticipate where the consumer is going to spend his money? Is it the nature of the business I guess is what ayes same, that these periodic quarters with large markdowns have to be anticipated?

Let me -- Arnold, let me come at it from this direction, adding what Robert said. I'm going to grant you a little bit of that thesis in the sense that, you know, we are not a supermarket and we are not Wal-Mart. So we do not have the kind of basics business or, you know, that a drugstore retailer or Wal-Mart or, you know, a supermarket would have. So I'm going to grant that you there's some difference there.

I think, though, that the truth is, you know, we are very focused on trying to become, especially as a public company, more consistent quarter to quarter. And I think while we can be cognizant of the higher, you know, fashion element in our business, in comparison to some of these other companies, I think, you know, all the management group here at Kirkland's would not go so far as to say that's an excuse for us, you know, having, you know, kind of as you said, kind of a clean-them-up mark down situation every three quarters. That's not satisfactory to us.

And one of the reasons quite honestly that we're really disappointed in second quarter. We were not happy that we had to do that in order to get us right for the back half. So I don't know what assurance that gives you other than that we're very focused on it and think that, you know, the challenges of managing a business that is more fashion driven than a supermarket, we have been doing for a long time and pretty successfully. Just applying all the resources that we can to make sure we get more consistent.

Thank you.

And by the way, final footnote, don't think that's unachievable. So while I'll grant you the difference in the business models relative to some of those other companies, don't think by any stretch that what I'm describing here is unachievable and I don't think anybody at our company thinks it's unachievable.

Thank you.

We'll take a follow-up from Rob Wilson.

Yes, quickly, you guys opened Phoenix and Denver a year ago. Can you comment what you're seeing in those two markets?

Phoenix has been strong so far, Rob. We only have one store open. But it's doing very well. We'll have some more later this year. The Denver market's been mixed. Sort of a mediocre and a very good one. So we'll have to watch that, too. We're continuing to look in that market for the right opportunity to augment that group.

Okay. Thank you.

Thank you.

Mr. Alderson, there appears to be no further questions at this time. I'll turn the call back over to you, sir.

Thank you for your participation on the call today. We'll be available today for any follow-up questions you have and we look forward to speaking with you in November. Thanks.

This does conclude today's conference call. At this time you may disconnect.