Brand House Collective Inc (TBHC) 2004 Q3 法說會逐字稿

Good day, everyone, and welcome to this Kirkland's Inc. 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. Mr. Sullivan, please go ahead, sir.

Thank you. Good morning and welcome to the Kirkland's Inc. third-quarter conference call. On the call this morning are Robert Alderson, Chairman, 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 earlier this morning 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 and uncertainties which may cause Kirkland's actual results in future periods to differ materially from forecasted results. Those risks and uncertainties are more fully described in Kirkland's filings with the Securities and Exchange Commission, including the Company's annual report on Form 10-K filed on April 15, 2004.

With that said, I will turn the call over to you, Robert.

Good morning. Today Rennie and I will comment on Kirkland's sales and earnings results for the third quarter of fiscal 2004, as well as update you on current business trends and our outlook for the fourth quarter. In view of the additions we have made to our management team in recent months, we also want to share some details on the positive changes that are taking place in key areas of the Company.

For the third quarter, we had a net loss of 15 cents per diluted share at the lower end of the guidance we issued on August 26. Taking into account the sales impact from the four hurricanes and the charge related to the credit facility refinancing, the earnings results were consistent with what we had expected for the quarter. As previously announced, comp store sales for the quarter decreased 13.8 percent following a comp increase of 2.7 percent for the third quarter of 2003. The negative comp sales trend was evident across multiple merchandise categories, including our top home decor categories such as wall decor, lamps, candles and decorative accessories. Better performing categories included textiles and gifts.

As we had anticipated, sales suffered from a combination of factors depending on the category. For example, as we discussed on the second-quarter call, we remained under inventoried in mirrors due to the carryover effect of insufficient planning and the earlier failure of a key mirror vendor. Mirror receipts have picked up, however, and sales stabilize somewhat toward the end of the quarter.

Our decorative accessories business continues to suffer from an overly broad assortment that made it difficult to deliver a coherent merchandise statement to our customers. As we have said before, reducing SKUs and focusing our assortment with better planning practices are central themes of our current merchandising strategy.

Consistent with our year-to-date experience, sales for the third quarter generally were characterized by higher average retail prices and lower transaction volumes. While store tracking patterns have remained relatively weak and uneven, we continue to believe that much of our sales weakness in the third quarter was self-inflicted. We see opportunities for improvement not only in our merchandise mix but also in our store level execution.

Our non-mall stores exhibited somewhat better traffic trends as compared to our mall stores. Comparable store sales for the 18 non-mall stores in our comparable store base for the quarter were several percentage points better than our mall stores.

We opened 19 new stores during the quarter and closed three stores ending the quarter with 305 stores in operation in 37 states. We opened an additional 14 stores in November, bringing us to 319 stores today. With three more openings and two closings slated for the rest of 2004, we expect to finish the year with 320 stores in operation, a net increase of 40 stores or a 14 percent growth rate for the year.

The 2004 class continues to perform well, and all of our new store metrics -- sales, occupancy cost, contribution margin and return on investment -- continue to support our continued diversification to non-mall locations.

At this point, Rennie will take you through the third-quarter financial statements that were included in the press release and provide some commentary on our fourth-quarter outlook.

Thank you, Robert. Good morning. I will begin with the review of the third-quarter income statement. Net sales for the quarter decreased 1.5 percent, and comparable store sales decreased 13.8 percent. We ended the quarter with 305 stores in operation, a 9 percent increase from a year ago. Gross margin for the third quarter decreased to 29.1 percent of sales from 33 percent in the third quarter of 2003 and was up sequentially over second-quarter's gross margin of 25.4 percent. The reduced margin was due to a lower merchandise margin compared to prior year, as well as a deleveraging effect on the occupancy component of gross margin due to the comp sales decline. Operating expenses were slightly below plan for the quarter due primarily to modest incentive compensation accruals for store and corporate personnel.

As a result of the comp sales weakness, operating expenses as a percentage of sales rose approximately 4 percentage points for the quarter. Depreciation and amortization rose 90 basis points for the quarter, reflecting the sales trend, as well as increases in capital investment related to new stores and the new distribution center.

Interest expense was relatively flat for the period. Borrowings under our revolving credit facility were slightly higher than prior year, but borrowing rates were more favorable due to the credit facility refinancing we completed in October 2004. One other item to note there on the income statement is the charge of $364,000 related to the early termination and refinancing of our former credit facility.

Turning to the balance sheet. We ended the period with $6.2 million in cash and a balance of 16.2 million under our revolving credit facility. Subsequent to quarter-end, we completed the transition of our cash management to a new arrangement that provides for automated paydown of our credit line and other improvements that will help our cash efficiency. Today we have $7 million outstanding on our credit line.

Total inventories at October 30, 2004 were $50.3 million, 4.5 percent below prior year and approximately 20 percent higher than our total inventory level at July 31, 2004. Due to delays in the processing of imported goods through the West Coast ports, receipts lagged and were inconsistent during the quarter. Merchandise flow improved toward the end of the quarter, and we are continuing to experience strong inflow of new product which positively impacted business during the past three weeks.

Total merchandise inventory at October 31 on a per store basis was $157,000 versus 179,000 at November 1, 2003. Increased productivity at the distribution center has resulted in better flow to the stores, allowing more on-time deliveries and less reliance on off-site storage facilities. We're in our peak selling season now, and we expect to finance all of our activities for the remainder of 2004 with cash flow from operations. While we may make temporary use of our credit facility, we expect to pay the line down to a zero balance by January 1.

The final topic that I want to cover today is our guidance for fourth quarter and our updated guidance for fiscal 2004. While we are pleased with the progress we have made since speaking to you in August, we remained cautious on our outlook for the fourth quarter. Comparable store sales quarter to date have continued to trend in negative territory, although not at the double-digit levels we experienced in Q3.

Our current expectation is that fourth-quarter sales will be in the range of $141 to $146 million. We expect comparable store sales will decline for the fourth quarter in the range of 2 to 7 percent below last year's fourth quarter. Comparable store sales for the fourth quarter of 2003 decreased to 4.7 percent.

Based on these sales estimates, we expect earnings for the fourth quarter in the range of 55 to 65 cents per diluted share. We earned 73 cents per share after a charge of 4 cents per share due to our warehouse lease termination in the fourth quarter of 2003. These fourth-quarter results would produce full-year fiscal 2004 EPS of 30 to 40 cents per share on sales of $390 to $396 million with a decrease in comparable store sales of 4 to 6 percent for fiscal 2004.

Despite this current outlook, it is important to note that it is still early in the quarter and the biggest sales weeks are still in front of us. While sales in some of our key home decor categories have continued to be soft, we have been encouraged by the recent performance of our holiday merchandise. Further, our overall inventory position as to both quantity and content is better than it was 60 days ago or even 30 days ago.

We also are pleased by customers' response to the first wave of our holiday advertising and our Thanksgiving weekend door-buster promotions. Additional marketing activities are planned over the next three weeks.

I will now turn it back to Robert for him to give a status report on the key initiatives and strategies that our team has been working on in recent months.

Thanks, Rennie. We continue with our initiatives to restore Kirkland's to its position as a premier financial performer. In the case of logistics and real estate, we have accomplished much in the last 12 months, and we are already seeing tangible benefits from the investments that we have made and strategies we have established. We expect those benefits to become more evident in fiscal 2005. With respect to merchandise, marketing and store operations, our progress is at an earlier stage. We have new leadership, new energy and new ideas, but we still have much work to do.

First, let me give you a brief update on logistics. We're very pleased with the performance of our new state-of-the-art distribution center. Our inbound and outbound operations are operating exceptionally well at the busiest time of our year, and our stores are benefiting from the ability to carry less on-hand inventory since our delivery capability is greatly improved compared to previous peak selling periods.

We look forward to making additional progress in fiscal 2005 as we seek to improve flow to our stores and outbound transportation efficiency with the goal of lower-cost and better service to our stores while maintaining more optimal store level inventories.

The acceleration of our off-mall real estate strategy has been a big plus in fiscal 2004. We continue to see significantly lower occupancy cost ratios in these off-mall properties, and opening sales volumes have been surprisingly strong. We have completed a thorough evaluation of our lease expirations for 2005, and we will adopt an even more aggressive approach in fiscal 2005 with regard to closing mall stores that are either underperforming or that provide inferior economic returns upon renewal, at times relocating near the mall and in other instances repositioning in the market.

We also have made good progress on new store site selection for 2005 as we continue to target off-mall shopping destinations. Because of the significant number of lease expiration opportunities in fiscal 2005 and the strategic emphasis on repositioning and improving the store base, we currently anticipate that our net store growth for fiscal 2005 will be approximately 10 percent.

In merchandising, as you would expect, our team has been focused on completing fourth-quarter buys and making sound replenishment and allocation decisions to support fourth-quarter business. They also have been working hard on the two initiatives we spoke about on our August call. Emphasizing our core merchandise strengths in home decor and narrowing and focusing our assortments across all categories in order to improve merchandise productivity and make our stores more appealing to customers. We believe we will begin to see the results of significant improvements from our buying and planning practices in the first half of 2005.

We have recently hired two new buyers and reorganized our merchandise categories to provide greater focus. We are also making excellent progress towards improving our planning, allocation and replenishment functions. In addition, we're implementing a much more vigorous assortment planning process to control SKUs, properly support our most important merchandising initiatives, and allow more effective coordination with marketing and visual. All of these initiatives are directed towards delivering a more compelling merchandise assortment to our stores.

Our search for a senior merchandising executive continues, but we have nothing more specific on the search to report at this time.

You have heard us talk about an intensified commitment to marketing, and as most of you know, we added a Vice President of Marketing in August. Working closely with our merchants, our marketing team has developed a multichannel holiday marketing program to highlight our holiday and gift merchandise. This is a new asset for us, and we want to evaluate the entire program once the season has concluded. But we are pleased so far with customer response.

We also have continued to build our base of Kirkland's credit card holders and are excited about the potential to develop closer relationships with this group of loyal and productive customers. We have acquired over 70,000 credit card customers since July and are already communicating with them while aggressively continuing the sign-on effort. The average dollar transaction for this group is significantly greater than our average ticket, so it is a productive effort.

We recently completed a survey of our store managers regarding customer preferences and evaluating our in-store experience. Our next step in this process will be to conduct a survey of our customers beginning in the first half of 2005.

Finally, we're excited about our opportunities in stores to improve our business with new leadership from Executive Vice President and Director of Stores Dwayne Cochran who joined us in November. Dwayne brings a wealth of relevant experience as we seek to improve store level performance and create a substantially more customer-oriented culture. Our people have responded very well to him and his ideas in his first few weeks with the Company, and we are very excited to have him on the Kirkland's team.

In summary we're taking an aggressive but holistic approach to improve financial performance, and we are excited about what 2005 can bring. That concludes our prepared remarks. Operator, we are now available to take questions.

(OPERATOR INSTRUCTIONS). Neely Tamminga. Piper Jaffray.

Great. Thank you and good morning. I have really two questions here. I was just wondering, Robert, if you could give us a little bit more color behind the inventory situation, if you can give us a sense of where you are on a SKU basis, where you were maybe at the beginning of the year, where you are now, where do you hope to be? Is it category specific that you think you are overassorted and kind of what are the plans there? That would be helpful.

And then also if maybe Robert or Rennie can talk about the real estate plans for next year? You talked about an increase of total stores of about 10 percent. I was just wondering how that breaks out between closings and openings? Thank you.

We would be happy to do that. Let me talk first about the real estate. That is a little easier. Right now the plan is 60 new openings, approximately 26 closings for a net of 34. That is about 10 percent store growth on a percentage basis.

We will continue to evaluate that very carefully as we proceed through fourth quarter. We are in very good shape as I said on selections like for the deals that we have for next year. We have signed only 10 leases at this point, and we are watching that very closely. But we believe we have a great opportunity to reposition our store base significantly in 2005 toward lower occupancy costs and improved performance. So I think there is a double opportunity there.

On SKUs the approach that we are taking on SKUs right now is that the greatest impact on SKUs is really going to occur when we move into the first half of 2005. We are evaluating all of the SKUs on a category basis. We are up a little bit relative to last year, but it is not significant. It is not something that is discouraging to us as we look at it.

And in terms of the categories, I think that probably a couple or three that we are going to really emphasize would be in decorative accessories. I think we were generally very very broadly skewed in that category, and I think we can do a better job there. Also, in lamps and art, I think we can better focus those categories and do a much better job as we move into 2005.

And just one follow-up question in terms of furniture. Can you comment on how your furniture sales have been just for the last quarter, please?

Our comp has been down a little bit in Q3, but that business is up nicely in the fourth quarter and we expect it to be a category where we have a significant opportunity in 2005. We are planning it up. I think we are going to see a better quality, nicer group of offerings, and I am really excited about that.

As you know, last year we sold a lot of sinks in the first quarter. We will have those again probably at a lower price point, but our focus will be on accent pieces.

Peter Benedict. CIBC.

One follow-up on the store question there. Rennie, do you envision any charges to get out of some of the leases? 20 to 30 it sounds like you guys are going to get out of. How many of those are leases that have ended and how many are those that you have a kick-out in?

And then secondly, can you talk a little bit, Robert, about what the results were of that store manager survey that you provided? Thanks.

Peter, we are still formulating our plans on the closings for 2005. Of the ones that we have on the drawing board right now, it is a mix. It is a mix of situations where we will be kicking out because of predetermined sales thresholds that we do not need and that give us an opportunity to exit a market. The rest are obviously lease terminations that we are coming off on to give us a chance to either exit a market entirely or reposition within the market in most cases to an off-mall location.

So we don't have a specific answer for you on that. But I would not anticipate anything of tremendous magnitude there in terms of a charge.

I agree with that. I don't think there's going to be -- I think most of these are expirations, and we have a great opportunity here that I think we can exploit nicely and accelerate the repositioning of the store base as I said. We really -- the buildout on these stores, Peter, is really not that great. We give good (inaudible) allowance when we go into these stores. So after a period of time, after four or five years in a store, there is just really not that much left to write-off.

The situation, the practical reality is a situation where you kick out at mid-term and you've got a little bit of unamortized fixed asset charge that you have to write down. But because so many of these are end of term, cumulatively that is not going to be a huge issue.

Peter, you asked about the survey. Most of that information was directed towards gaining field information about the reception to our merchandise. As you know, we have had some places in our merchandise mix through the second and third quarter where we were concerned. So we have correlated that information with our planning for 2005 as we allocate our dollars across the various categories, and I think that has told us that we are still primarily a company that customers know for art and lamps and mirrors and candles and textiles. And I think they have kind of told us that they like to see us in those core categories and don't like to see us branch into some of the things that we have done like fashion. And they also have I think supported our view that we can have a better floral presentation and opportunity for them, as well as in (inaudible) garden presentation in 2005.

So there really were no surprises there. And with respect to the in-store experience, I think what we saw was a continued expression of loyalty and from that customer base a lot of repeat customers, an opportunity to improve the shopability of our stores. As we cut SKUs, our stores would like to have fewer SKUs and we know that, and that will make the store more shop-able to the customer and more easily managed. And I think we will probably try to stabilize our floor moves somewhat as we have a better handle on our assortment planning process in 2005 and that will cut down work and allow them to work more closely with customers.

Robert, was there any mention of customer service levels? I know that is something that you guys in the past have said you wanted to work on. Is that just kind of a work-in-progress here, or you starting to see any benefits from some of those efforts?

I think we are. I think it has been a point of emphasis now with us for 12 to 18 months, but it is still spotty. And I think we have great service and great conversion in some of our stores and we have big opportunities in others. When you have 320 stores, you are going to have some dispersion of capability over that store base.

The thing I am excited about as we go forward with that, Peter, is that our new EVP of Stores is absolutely a guy who is committed to a culture of customer support and customer satisfaction and a strong selling effort with customers. And I think that fits nicely with what I believe now is a better opportunity in our stores because we are going to be getting our stores a more optimal maintained inventory level, much more efficient deliveries. Hopefully fewer SKUs as we talked about. So I think we can reallocate a lot of store labor that has been focused towards the back half of our store and focus it towards the front half of our store. I think it is a big opportunity for us.

One more question and I will jump off. Rennie, can you comment maybe about how you look at the 2004 operating expenses in total? What percentage of those do you think are non-recurring type things that have gone into place for the D.C., etc.? Thanks.

Are you talking about for the quarter or year-to-date or for full-year? Help me to --

I was thinking for the entire year, but as granular as you want to get would be fine. Thanks.

For the entire year, Peter, and I think we actually even broke this out in a prior release, the only really non-recurring items related to the D.C. transition were those incremental move expenses and there was a month or so of double rent that occurred right around the middle of the year.

My recollection on that was it came out to around 2 pennies a share. And then in addition to that, you've obviously got the charge due to the credit facility refinancing that we just disclosed this quarter, which is another penny. So order of magnitude, Peter, 3 cents.

Robin Murchison. Jefferies & Co.

I wanted to ask you just a few questions here as well. Would you all give us any update in terms of the poll for the customer base over the Thanksgiving weekend? What sort of cadence you saw? Certainly the group was spotty to put it nicely. Can you help us out?

I was out there as were virtually all of our management people supporting stores over that weekend. And as you know for the first time we had some special opportunities, selling opportunities in the store. And we had I think a great level of preparation in our stores for the weekend.

We had a terrific -- I thought we had a pretty terrific Friday. We had very steady traffic in our stores early as opposed to last year. We had a positive day. Strong sales went all the way through the day. Usually there has been a lag in the afternoon, and we did not see that this year. It was very very strong throughout the day, and we got some big numbers out of some stores.

Saturday I was stunned by how slow the day started. At 10:30, 11:00 in one of the properties I was in in Atlanta I was wondering where the heck everybody was, not just in our store but throughout the whole property. (multiple speakers)

I think a lot of people wore.

And that softness -- really business did not pick up in any significant way until about 2:00 in the afternoon, and then it was pretty good until about 6:00 and then it died again that night. And then we saw a soft day on Sunday. So a surge and then a fall-back I think is what we saw, and I think that is pretty consistent with kind of the spottiness that I think most people were experiencing.

The --

By the way I would also say they were looking for bargains. I think the customer in the play in the stores I was in were asking about what the deals were, and they have learned the term door-buster. They certainly know how to ask that.

The 25 percent off any single item newspaper insert that was good through November 18 through the 22, have I just missed this or have you guys done this before?

We have never done that before. This is a product of our new marketing group, and that was a very successful offering. It clearly drove traffic and sales for the period of time that it was running. We started another one yesterday, and so far so good with that. So we will have at least one more insert drop to occur prior to Christmas, and we are evaluating what we might do one of -- the last weekend. I don't think we will have enough of certain kinds of goods. It is going to be difficult to aggregate 22 items that you have sufficient quantities to support a major customer response that late in the season. But we are exploring how we might do that. I don't know where we will go with it at the moment.

And presumably in your guidance you guys are thoughtful enough to where I am sure you have considered last year's environment and the environment prior to that in the year prior. Presumably some of these endeavors are obviously meant to build traffic and get the customer in. But it does sound like you feel a little more confident about your positioning and where you are out there within the category, the home goods category.

Well, we do and especially we feel good about where we are in the seasonal category. We anticipated this kind of season, and we bought a number of items in order to be able to position ourselves well and hopefully satisfactorily with customers to drive the business. We have been very diligent about maintaining our markdown cadence on specific seasonal items as we move through September, October and then into November when the seasonal started to move really very nicely. So we feel like we're in great position with respect to inventory on seasonal. We are going to have an on-time sell-through there.

So in terms of quantity of inventory and as it relates to the season and the quarter end, I think we feel very good. Rennie, do you have any comment about that?

No, I think the only thing I would say is if you look just in aggregate at our approach to fourth quarter this year, you know a credible and new marketing program, a better distribution and allocation effort, which is particularly important in a category that is subject to obsolescence like seasonal where you really want to make sure you are targeting the distribution of those goods to the most productive locations, the extra shopping days between Thanksgiving and Christmas. I mean there are some reasons here, and I think we have attempted in our guidance and in our commentary to be appropriately cautious. But I think we have to say they we're in a better position than we were a year ago to have some success in December. You know how will that play out? We have adopted a cautious stance, but we are armed and ready.

Do you have more seasonal than you did last year or less or the same?

Well, we have more in aggregate, but we are operating a number of more stores. So on a store basis, we're about the same. And as I have said, the sell-through -- our December beginning of the month inventory number is exactly where we wanted to be, and we could not have worked that out any better. So we have an adequate amount of seasonal to go through this season and to hopefully boost sales.

And then just last question if I may, I think it was Neely's question about furniture, you mentioned a focus on accent pieces. In the Jackson store I have seen there are some bigger pieces, tables and chairs and that sort of thing. Does that mean that you're not going to go down that road as much and do more accent pieces, or will you continue to do the functional pieces, meaning dining and chairs and benches? And I think you have even had bedframes before in that store.

We have. You are exactly right. We have seen that, and I would suggest to you that the Hallmark of merchandising strategy for 2005 is going to be testing whenever we believe that we can do that.

You know that we are opening some larger off-mall stores. The Jackson store is abnormally large. We believe that the accent furniture at the core of the furniture offering is better suited for the large store base where we have a number of smaller stores. But we are evaluating some of the larger pieces to put in some of the bigger stores in a limited quantity. We are not going to go -- I don't think strongly down that line. There are a lot of things about the furniture business that are good and there are some that are not so good, and we are not in a position to do deliveries and a lot of the things that some of the larger stores can do. So we are going to be pretty careful about how we approach this.

One thing I think you will see is I think you will see this merchandising team put a higher quality group of furniture out there for our customers, and I think they are going to respond well to it and we're trying to react to trends in color and style and I think we will do a good job with that also.

Just one more if I can. Unrelated to Christmas, but any kind of feedback on the midcentury? Does your customer -- is some of that midcentury sort of style stuff, has there been a favorable response? Neutral or --?

Really, we have not done much of it, and what we have done has been in tests. I would say right now our customer has not responded that well. We talk about it -- the global or world piece of that has done pretty well in some of the decorative accessory pieces and some of the small lamps, but it has really not taken hold with our customer in a strong way at this point.

Kevin Foll. Next Generation Equities.

Can you give us transaction average unit retail data if you did not do so? I missed the first couple of minutes of the call. That is the first question and I have a couple of follow-ups.

We typically do not give those stats, but just kind of trendline a little bit of a continuation really of what we had seen thus far this year. You know, a slight pickup in average retail on item retail price, and the softness was in the transaction volume side.

Right. And that is obviously mostly probably mall traffic continuing to be a drag.

I think that is some of it, but I think the deeper we get into the year, and we've talked about this on previous calls, we implement our traffic counters over the course of 2003 so we have been waiting to get to the point where we had good data to anniversary year-over-year. And while the implementation was still taking place and some kinks were getting worked out toward the end of '03, we are beginning to get much more solid year-over-year data and at least a significant sample of stores. And you know, I'm not going to say that traffic is not still a concern, but I think in the scheme of things we think a lot of what is going on here is in our control and things that we can do better whether that is in merchandising, logistics, stores or whatever.

So you can infer from what I'm saying there that it's not just traffic. I mean it's believing there is an opportunity for example to continue to enhance our conversion rate.

So we're not hanging our hat on weak traffic. The mall issue is out there. It has been talked about a lot. Our strategy speaks for itself in terms of our aggressive move off-mall. But we've got a lot opportunity right in front of us that is within our own control.

Okay. And then can you give us some of the specific marketing initiatives that you're going to be doing differently in this holiday? You talked about the mailers, the 25 percent off mailers. Anything else going on differently?

Well, we have -- this is the first time that we have done add-ins, done inserts in newspapers and specifically targeted a number of items. It's really much better done. It is the first time we have ever done it, and it is certainly the most attractively done thing that we have ever had. We will also combine that with some ROP advertising, and we have periodic e-mails going to our customer base. We've got door-buster signage that is done nicely I think in our windows to do the best job that we can at the least lines to suggest a customer should come in our store.

The whole program for the fourth quarter really has come on pretty nicely and been well coordinated, and it is more than we have ever done and I think we are seeing some benefits from it, and I think we can do it even better as we go forward. I think the main thing is we have the merchandise. We have bought the merchandise to support the program and then the linkage with the marketing in a more professional way has made it work.

Okay. You know as you look at the store growth plans for next year it seems like with the current environment it seems like you guys are out looking to still open up a number of stores. Can you give us some comfort that these new stores are performing to plan? Can you tell us maybe what the comfort is running kind of in the stores age one to three-years-old versus the overall company average or something like that to give us some conviction?

Let me come at it this way, Kevin. The number of non-mall stores, which is the predominant share of the new openings in the comp basis, is still only 18 as of the third quarter. So it's difficult to and we have stated that the comp was better there than in the mall stores.

I think a more meaningful observation maybe to make is just to say when you look at the class of 2003 and the class of 2004, okay, the class of 2003 was 42 stores, class of 2004 is going to be 54 stores, of which let's see, 51 are open of the 54 today. You have got a few more between now and year-end. So just round numbers you're talking about 100 stores. You're talking about 30 percent of our entire chain has been opened in the last year. And cumulatively those 100 stores and especially the class of 04 are performing above our internal targets for all those metrics that Robert talked about.

Great. That is helpful.

And I think that what I would say is consider that our decisions about 2005 growth are ultimately today and as we move into the year will continue to be, ultimately a two-tiered judgment. It's where we are going to put our capital. What is the appropriate use of our capital is number one? Number two is, can we manage it? Because the can we manage it question is a very important one in light of the continued softness we have seen in our comp sales.

In other words, if we feel like we've got so many problems in our comp sales that we've got to take all our resources and devote it there, then you would see us shutting down our growth. So I think you can infer that we feel very comparable answering both those questions. Number one, it is a good allocation of capital. And number two, we can manage it.

Rob Wilson. Tiburon Research.

Rennie, what is the size of your new stores the last two years? Have they trended larger than historically?

Slightly.

Okay. And your furniture sales mix, how much has that increased maybe last year and this year?

Furniture on a year-to-date basis?

Yes.

(inaudible).

I mean if your price points are up, is it directly related to furniture?

It is not that big a piece of our business that it would in and of itself make the average retails up. You know it is going to be about 6 percent of our business for the year. So if that is the case, it is just not a big enough tail to wag the dog.

Fair enough. I guess with --?

5 percent last year, so it's -- you know, as we plan -- we're going to plan it -- as I said, we are going to plan it up reasonably next year. So it will continue to grow, but it is not going to become 15 percent of our business or 12 percent of our business. It might be 8 or 9 percent but still modest.

Right. I guess the question I have more than topline is merchandise margins. If I look back historically, it looks like the last eight or nine quarters you have trended towards much lower merchandise margins. What is embedded in Q4, Rennie, as far as your merchandise margin expectation and how should we look at next year?

Well, I think first of all I think you are correct to note that merchandise margin is an area that demands a tremendous amount of our attention in terms of all these initiatives we have been talking about across the company, and it is certainly getting that attention.

I'm checking here in terms of year-over-year. On the merchandise margin side, we are still not expecting our merchandise margin in the fourth quarter to be at levels equal to prior year. We are still expecting to see something of a diminishing comparison. Lower merchandise margins this year than last year in the fourth quarter. But we also see that spread tightening a bit as we proceed with some of these inventory rationalization initiatives and things we have been talking about.

So we're not expecting to set the world on fire with margin in the fourth quarter. The guidance would certainly indicate that. But we see a lot of opportunity in 2005 when we do.

And what is the opportunity you are seeing that maybe I'm not seeing? A look at a highly competitive space, and I'm just curious what are you seeing that maybe I am missing?

Well, I will comment on a couple of things, and Robert may have some more details to share here. I think that when we look at the things that we are doing as a company, part of what we are really communicating by our actions is that our processes and maybe even to a certain extent structure and certainly decision-making in the merchandising area and it really crosses also into logistics has not been ideal. The easiest example, Rob, is look, if you are over-skewed and over-assorted, you're asking for a margin problem. You are just asking for it. And we think that there is opportunity in margin simply by managing that equation better.

There is also opportunity for margin by taking the investments that we have made in this new distribution center and playing those out in the form of more intelligent allocations to our stores. In other words, if the stuff is where it is going to sell, it is going to have a higher margin than if it is where it is not going to sell.

Now a macro example of that is the way in which we have managed our holiday merchandise for fourth quarter. It has been a very different approach because we have had the ability based on the capabilities we now have out at the D.C., we've had the ability to be much more thoughtful and quite honestly we've had the ability to be later in our allocations on Christmas. Because we've got the ability to turn the allocation decisions more rapidly.

So I guess those are some maybe high-level thoughts for you on why we continue to see as we go into the first half of '05 some actions that we believe are very tangible and very doable to address the margin erosion we have seen in the last several quarters.

I would only say in addition to that, that I think we are going to make a very concerted effort as we go in and through 2005 to distinguish ourselves in merchandise from the marketplace. That won't happen overnight, and we may not be successful every time we try it, but we are certainly working hard with our vendors and our product group to try to make that happen. And I think that certainly gives you an opportunity for a better initial markup and at the end of the day a better sell-through and higher margins.

Okay and finally, Rennie or Robert, you guys generally in your Qs you give us the top performing categories and maybe some lesser performing categories. Could you provide those for Q3?

The best categories were textiles and gifts. And I think we might have even mentioned that in our commentary. The best categories were definitely textiles and gifts, and Robert, do you have comments on the (inaudible), some of the key home decor categories I know?

Well, the art business was pretty good. It was just barely off. So I would have to say the wall decor business continued to be good and certainly Rennie is right that textiles and gifts continue to be category leaders. As we look forward and talk about Q4, we expect good performance in the art category and in mirrors and our lamp business is doing better in Q4. The candle business is performing better in Q4. The gifts continue to be strong, and the best story of all is the seasonal. So there is some good news sprinkled in there.

Okay. Well, thanks for taking my call.

John Lawrence. Morgan Keegan.

Robert, would you start off just by on the real estate again, you have talked about the new stores performing. Off-mall continues to do what you want it to do. Longer-term you have mentioned that it is a more aggressive strategy to be off-mall. Have you changed that? Are you just looking for sites? Two years out what percentage could be off-mall?

Percentage of the store base? Or --

Yes, percentage of store base.

Well, I think generally I would say that sometime in 2006 if we continue to grow at reasonable rates that probably will be deep in the third quarter that we expect to be roughly 50-50 in the store base between mall and non-mall. And actually by the end of that year, it could be 55/45 non-mall to mall. And as we get out into 2007, we would expect that to be more of the 65/35 non-mall to mall.

We are not going to be totally out of the mall business for a number of years, but in terms of a percentage of store base, there is no question that there is going to be a fairly rapid repositioning over 2005, 2006 and 2007. And we think that portends very well for our margins and for capital and for store performance.

Okay. Secondly, Rennie, have you been able now that you have operated the D.C. for a period of time, have you been able to get as far -- I know there is a lot of moving parts -- but have you been able to get a sense for on an apples-to-apples comparison sort of the expense structure of that D.C. and the logistics costs compared to what you have before and what you can say there long run?

I think I would start by saying we are very pleased with where we are just several months into the launch of the D.C.. It is doing and they are doing, the management and the team out there -- great team out there -- are doing everything that the Company has asked them to do to fulfill our needs for fourth quarter. And I think we are beginning to see in the last 30 to 60 days, I would say, we're beginning to see some of the efficiencies that were underlying our whole strategy of going out there. So when you go into 2005, I think what I would tell you is we see efficiency opportunity on a year-over-year basis in 2005 for that facility. You have to bear in mind that when you go into a facility like that you do have an expense ramp-up of sorts because there are just things you need that you never needed before. Okay? Maintenance and security and various other things that you need.

But as we head into next year we think that on a total distribution cost basis there is efficiency opportunity. And I would just prefer -- I would prefer not to quantify that until we are in the position of giving our 2005 guidance.

Okay and just separately on the advertising budget, is most of that being just reallocated, or obviously what would be the percentage increase in ad budget?

Are you talking about for 2005?

Yes. For '05.

We're still working on that, John. I think that you can anticipate that we will have an increase in the marketing budget in 2005. That probably goes without saying. We have hired a VP of Marketing, we're building a credible and experienced effort in marketing.

So will it go up? Yes. And it will go up -- it will go up faster than the sales rate. Okay? But we're still working on our final budgets for 2005, and I have said this before, I don't think you're going to see us take a historical tendency has been to spend less than 1 percent of sales and advertising. That is not going to become 4 or 5 percent overnight. That is not going to happen.

David Magee. SunTrust Robinson-Humphrey.

Just a couple of questions. One, in the past when you have had an issue of being over-assorted, the subsequent year or so you were able to bounce it back pretty quickly with regard to operating margins. I'm curious now I guess this is a compare and contrast question. What is the potential in terms of next year and what maybe similar or different to last time you were in this kind of situation say three or four years ago?

I think there is an opportunity, but I really don't want to promise an overnight turnaround because we are attacking SKUs. This is a different situation that is more related I think to content than it is to quantity. And if you're referring to 2001, we had a major sell-off that kind of launched that. But we were beneficiaries of some very hot merchandising trends over the course of that next 18 months or so. So I think this is a little different situation, and I don't think historically you can compare it.

What would be your guess as to the number one seasonal product this Christmas?

Well, certainly the Moshi pillow is what we call it, it is the squeezable pillow that we have been featuring, and that certainly started out in a standard cylinder and then went into neck rolls, and then we have done it in animals, animal shapes and some other things like Nemo.

Nativity sets have been a very strong seller for us this year. Some of our door-buster items in the textile categories such as chenille throws have been a great item. Our collection, I guess you would call it, of Very Snowman offerings have continued to be strong. I think we had good selection there. And our Christmas floral has been terrific. I think if you have been in our stores, you saw the Christmas jackets, or I guess that is what you would call them, they have been a terrific item. And we have done really well with Christmas wall art. This is the first time we've ever done any offerings specifically that were seasonal and they have been received very nicely.

So it has been a sort of a very broad success story in terms of numbers and types of things. I think things that have not worked as well have been the tech stuff such as the things with motion and light.

Thank you and just one last question. When you say that the class of '04 new stores are performing well, can you remind me of what the goal is as far as sales per foot and where you might be relative to that goal?

Sure, David. What we have historically said is that first-year volumes of high million 1s to 1 million 2. And you know, -- let me just do it here real quickly -- you know plus or minus around 250 a foot.

Okay. Where might you be relative to that goal?

Is this when I will need to go back and figure out exactly what the words I said a minute ago? David, we're trending above that number.

Okay, and would that also be the case for '03 class?

The '04 class has been thus far -- you have to also understand when we give these numbers we are trying to let people know what we're seeing, but also the '04 class is obviously younger. So we are trying to extrapolate on less data.

The '04 class, and we believe by the way largely because of the predominant mix of off-mall stores in that class, has opened stronger than the '03 class did. So I would say that plenty of good news inside that '03 class.

The mall stores inside that '03 class have not met expectation generally. Some have but as a group really have not. And I think part of what happened in the '03 class and what we continue to see there is one of the reasons why we get evermore confident about going off-mall.

So in summary 2004 has opened stronger than 2003. It is still early in the class of '04 but we are encouraged. Off-mall is the direction that remains the right strategy for us.

Great. Thank you and good luck.

Peter Benedict. CIBC.

With the accelerated venue diversification that you spoke about for next year and about the 10 percent store growth, is that a level we should kind of extrapolate maybe out the next couple of years in order to get to that mix of off-mall stores, Robert, that you mentioned, 55, 65 percent? I think those would be the assumptions. I want to see what your thoughts are there?

Peter, I think that that is probably a good way to build your model. We certainly hope that that assumption proves to be a conservative one. Our objective is to get this business turned around inside 2005 and restore our growth to a higher level.

I mean we know that is where our capital is best deployed. We believe the right thing to do is accelerate the transition as Robert described from some of these mall stores, and I think over the next year or two that may lead to a higher number of closings as we accelerate that transition. I hope your 10 percent extrapolation is conservative. It is probably a good place for now.

Okay. I agree that is the best place to put your money. On the third-quarter gross margin, Rennie, down about 400 basis points. Can you give us a flavor for what the contribution was from merchandise margins, and how much of that 400 came from the merchandise margins being down? Thanks.

Roughly half of the 400 basis point decline would be attributable to merchandise margin. The other half attributable to the deleveraging on occupancy.

Kevin Foll. Next Generation Equities.

I know it's early to be talking about '05 expectations, but I guess what are your early on thoughts on comp expectations or targets for '05, and when in '05 do you see the comp trends start to accelerate and what are the drivers you see there?

Kevin, good question. I just think it is too early. We are focused intently on the next eight weeks. We are focused intently on getting comps back to positive territory. We want it as soon or sooner than you do. So we need to probably defer on that.

Fair enough. Thanks.

Ladies and gentlemen, we have no further questions on our roster at this time. Therefore, Mr. Alderson, I will turn the conference back over to you for any closing remarks.

Just thanks everyone for being on the call today and for your interest in Kirkland's, and we look forward to talking with you further. We are also available for any follow-up questions that you may have today. Thank you.

Ladies and gentlemen, this does conclude today's Kirkland's Inc. conference call. We do appreciate your participation, and you may disconnect at this time.