Brand House Collective Inc (TBHC) 2005 Q1 法說會逐字稿

Good day and welcome to this Kirkland's 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 Ms. Drew Anderson (ph). Please go ahead, ma'am.

Thank you. Good morning, and welcome to the Kirkland's conference call to review the Company's results for the first quarter of fiscal 2005. On the call this morning are Robert Alderson, Chairman of the Board, 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 now been covered by the financial media.

Except for historical information discussed during this conference call, the statements made by Company management are forward-looking and made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties which may cause Kirkland's actual results in future periods to differ materially from forecasted results. Those risks and uncertainties are more fully described in Kirkland's filings with the Securities and Exchange Commission, including the Company's Annual Report on Form 10-K filed on April 14, 2005.

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

Thanks Drew. Good morning everyone. Thanks for joining us on our call.

The primary purpose of today's call is to report sales and earnings results for the first quarter of fiscal 2005. In addition, I will elaborate on the news that we announced earlier this week that veteran home decor merchant and retailer, Jack Lewis, will join us as President and CEO. Rennie will review our first-quarter financial statements that were included in the press release and provide some commentary on our outlook for second quarter and the remainder of fiscal 2005.

For the first quarter we had a net loss of $0.09 per diluted share, consistent with our previously issued guidance. Net income was $0.04 per diluted share for the first quarter of 2004. As previously announced, comp store sales for the quarter decreased 10.4%.

The quarter generally unfolded as we had expected, although we had hoped to produce better sales during April when our year-over-year comparisons were somewhat easier. As we evaluate our comp store sales weakness, as we had advised previously, we continue to experience content issues in several key categories, such as framed art and decorative accessories. In art we missed sales opportunities by failing to adequately balance our offerings between large and small art pieces. But more importantly, we also did not offer sufficient image variety to our customers. A lack of sustainable themes or trends in decorative accessories led to planned inventory reductions, and therefore diminished sales versus the prior year.

Further, declines in customer traffic, especially in our mall stores, made comp gains difficult. Once again our non-mall stores performed noticeably better than our mall stores during the quarter. Non-mall stores produced only slightly negative comp sales for the quarter, and average unit volume in non-mall stores was 14% higher than mall stores. This relative out-performance by non-mall stores was evident among comp stores, as well as the new store class of 2004.

From a merchandise standpoint we experienced encouraging sales results in textiles, candles, floral and our alternative wall decor category. We attribute our success in these areas to early recognition of new trends and good inventory flow. Other categories where we failed to deliver acceptable sales performance during the quarter included lamps, furniture and mirrors. As new offerings and inventory flows improve in second quarter and beyond, we expect improvement in all of these categories.

Improving our gross margin was an important emphasis for the first quarter, and we had some early success as we enjoyed the benefits of a leaner, more focused assortment. We ended the quarter with a slight improvement in merchandise margin, despite a more aggressive promotional stance that we adopted in March and April to drive more customer traffic into our stores. Notwithstanding business trends that remain sluggish, we still see opportunity for year-over-year gross margin improvement in the second quarter, as well as the back half of the year. We have continued to build the capability of our buying and replenishment teams. And over the next several quarters we anticipate more consistency in our buying and planning processes, better flow of fresh merchandise to our stores, and fewer inventory imbalances.

On the real estate front we had 9 openings in the quarter and closed 17 stores, 16 of which were in malls. As of quarter end we had 312 stores open, 225 in malls and 87 off mall. We anticipate opening 55 to 60 stores and closing approximately 30 stores during fiscal 2005.

At this point Rennie will take you through the financial statements that were included in the press release.

Thanks Robert. Good morning everybody. I'll begin this morning with a review of the first-quarter income statement.

Net sales for the first quarter were 84.7 million, a 2.5% increase from 82.6 million in the prior year's first quarter. The comp store sales decrease of 10.4% primarily resulted from fewer transactions due to week customer traffic trends. Customer conversion rates were slightly higher for the quarter. The average retail selling price and the number of items sold per transaction remained relatively flat as compared to the prior year quarter.

Gross margin for the first quarter decreased to 31.6% of sales from 31.9% in the first quarter of 2004. The occupancy component of gross margin increase as a percentage of sales due to the deleveraging effect of the comp sales decline. Distribution costs also increased slightly as a percentage of sales, reflecting the increased levels of activity in our distribution center as we continue to deemphasize vendor direct shipments to stores.

Offsetting these factors, merchandise margin, which includes the impact of freight costs, increased as a percentage of sales, primarily due to transportation cost efficiencies from improved store delivery methods. Since our move to the new DC in mid-2004, we have been evaluating our transportation methods and making changes to these methods through a store-by-store analysis. We believe these changes are leading to more on-time, reliable and cost-efficient deliveries to our stores.

Operating expenses increased to 30.8% of sales from 27.1% of sales in the first quarter of fiscal 2004. Although both corporate and store expenses were below plan on a dollar basis, the expense ratio was above plan due to the deleveraging effect of negative comp sales. Key areas of operating expense that saw significant increases included, number one, advertising and store promotion expenses; number two, corporate salaries; and third, professional fees where significantly higher expenses primarily resulted from the completion of the Company's compliance efforts associated with Section 404 of the Sarbanes-Oxley Act. As a tough sales environment persists, we're working to reduce expenses where we can, while still adequately supporting our growth plans.

Next, depreciation and amortization rose 90 basis points as a percentage of sales, reflecting the increased pace of new store openings in 2004 and 2005, as well as the equipment and systems investments from 2004 which were made in connection with the new distribution center.

Interest expense was slightly lower than prior year as we made no draws under our revolving line of credit during the quarter.

Our effective tax rate for the quarter was 39.5%, same as the prior year quarter. And net loss for the first quarter was 1.7 million, or $0.09 per diluted share, as compared to net income of 765,000 or $0.04 per diluted share in the first quarter of fiscal 2004.

Turning to the balance sheet, the Company ended the quarter in solid financial position. Inventories at April 30, 2005 were $48.4 million, or 155,000 per store, as compared to $51.9 million, or 187,000 per store at May 1, 2004. These inventory levels were only slightly above plan as we attempted to manage inventory receipts carefully in a challenging sales environment. Inventory management will remain a key emphasis during the second quarter.

Product newness is a vital tool in attracting and exciting our customers, but we must balance that need with appropriate attention to the reality of the retail environment. With a great deal of our energy devoted to ensuring strong merchandise assortments for third and fourth quarters, we do not want to be heavy on inventory in that August-September timeframe.

As for liquidity, we ended the quarter with no debt and $4.4 million in cash on the balance sheet. We still anticipate financing all of our activities in 2005 with cash flow from operations and borrowings under our revolving credit line. For fiscal 2005, we're estimating capital expenditures of approximately 26 to $30 million, the majority of which relates to the construction of 55 to 60 new stores. Net of landlord allowances, we estimate that the net cash outlay for capital investments in fiscal '05 will be 16 to $18 million.

The final topic I want to cover briefly today is our guidance for second-quarter 2005 and our updated guidance for the full year. For the second quarter of fiscal 2005 we're forecasting a loss of $0.12 to $0.16 per diluted share. We're estimating that our comparable store sales will decline by 7 to 10% for the quarter.

Store traffic continues to be soft, and we anticipate that additional promotional activities will be needed in order to drive top line sales in the near term. For the full year, we're lowering our sales and earnings expectations to account for the persistence of weak traffic and sales trends in our stores. We remain optimistic about our potential to produce improvement in the second half, but with a lack of near-term sales visibility, we think it is appropriate to adjust our guidance at this time.

Now I will turn it back to Robert for some final remarks.

Thanks Rennie.

Earlier this week we announced that Jack Lewis, formerly Chairman and CEO of Garden Ridge Stores, is joining Kirkland's as President and CEO effective May 31. We're pleased and excited about Jack joining our team. As most of you know, we've been involved in a search for a merchant leader for almost a year. That search has been broadly based and centered on finding the best merchant available to lead our already talented merchandising group. As the search progressed and Jack surfaced as a possible candidate, it became increasingly clear that his varied experience in all areas of merchandising and marketing, his specific experience and expertise in our home decor sector, and as merchandising and leadership success at Garden Ridge in both stints with the Company suggested that he was the best candidate and ideally suited for Kirkland's, a merchandise-driven company.

Since Jack was already serving as Chairman and CEO of Garden Ridge, it just made sense to me and the other directors serving on the Board Search Committee to bring Jack to the Company as President and CEO. I look forward to partnering with Jack and remaining active in areas of the business where I have specific expertise and experience, and allow Jack to focus intensely on the merchandising and marketing piece of our business. Jack has a great track record as a team builder and merchandising, and we expect him to continue to build and train our merchandising team and further coordinate our new financial planning capability with buyers and allocators. We also expect that his vast experience in training will expedite the process improvements already underway in merchandising and marketing. Jack's knowledge of logistics and direct importing should also prove helpful to Kirkland's as we continue to push for improvements across our entire supply chain and expedite our steps toward more direct relationships with overseas vendors.

Our Board and management team are excited about the obvious opportunities this hire brings to our Company. We've made great strides in the past few years leading Kirkland's to a place of prominence in the home decor sector. Many significant initiatives are already underway to help us to compete and win even greater market share. Throughout all areas of the business we're making strides and being more productive. We have much to do, especially in producing better sales and margin results. But the addition of Jack Lewis and his specific talents is, I believe, a major step in helping us move the Company to the next level of profitability and performance.

As we've said before, our central objective for fiscal 2005 is to produce a significant sales and earnings turnaround in our business. Traffic trends still suggest that we're facing a headwind as far as consumer appetite for home furnishings is concerned. However, our team is focused on executing sound strategies in every area of the business, and we expect to see improvement in our performance as the year progresses.

That concludes our prepared remarks, operator, and we're now available for questions.

(OPERATOR INSTRUCTIONS) John Lawrence, Morgan Keegan.

Actually this is Adam for John. I wanted to maybe just get a little bit more clarity. It sounds like on the gross margin line at least that you are starting to make some progress on the merchandise margins. I would assume that goes back to the inventory strategy to sort of kind of tighten the mix and focus the assortment a little bit more. I was wondering if we could just get a little bit more color on that, and maybe some examples of some categories where you've seen that working and maybe some ones where you haven't.

Robert will have a comment or two on some specific categories. Let me kind of give you a general response first.

As we commented in the script, we were encouraged, especially early in the quarter, with some of the signs we saw of stronger margins. And we do think that some of those early results were directly tied to our strategy of trying to focus the assortment, as we have discussed in previous call. As we moved through the quarter, if anything the traffic situation got a little more difficult, and we felt as though we had to compete for traffic a little more intensely with promotions and gave up some of those early gains in margin as we moved through March and April. So I think that generally speaking, I think what you're saying is true. But as we moved through the quarter it was pretty difficult out there and we gave up some of those margin gains.

That's understandable, but I guess I'm just trying to focus more on the positives here. Because the traffic and the environment you really can't do much about. But on -- before you (indiscernible) discounting could you say -- could you just quantify how much merchandise margins were up year-over-year?

Merchandise margins, as we said, had slight improvement, mostly driven by the freight component because we're seeing tremendous efficiencies out of our new distribution center. On the pure product side, it was a little bit better, but relatively flat when you look at the entire quarter.

Okay. And then maybe just with regard to several of the different categories?

Following what I said earlier, it would be no surprise that we had success in candles, textiles and alternative wall decor, and margins were nicely improved in those areas. We had good success in the floral category, and I think that was a function of content and inventory as opposed to margin, frankly. On the lamps and mirrors side of the business we enjoyed -- or didn't enjoy, actually -- the margin there was down a little bit. But once again, I think that is a content function, and I think that's going to improve as we get into Q2 and later in the year. And in the case of mirrors, it's already -- that content improvement and flow is already happening.

Okay, great. Thank you very much.

Neely Tamminga, Piper Jaffray.

I just had a couple questions for Rennie here with respect to inventory and gross margin. I think I understand that your initial product margin was about flat. I assume that the markdown component was actually up. But maybe just give us a sense in terms of trend this year, are you planning for the distribution costs to have improved -- I'm sorry, to have increased for the balance of the year because of the DC changes and deemphasizing the vendor shipping. And then also with respect to transportation, I think I have a good sense of what you guys are doing with the regional deliveries, and that certainly seems to be a trend in the right direction. Are we going to see improvement from that throughout the balance of the year? And I will just have a follow-up question.

I'm interpreting that question as being partly related product margin and partly related specifically to the freight component. Is that right?

Yes sir.

On product margin, at the risk of sounding like a broken record, I think all of the things that we've been talking about with respect to focusing the assortment, delivering clearer, more impactful presentations in the stores to our customers, greater depth in key items and in key categories, all of that I think is true. We have also talked specifically about just the skewing down that's been going on over the last several quarters.

Generically speaking, we still like that strategy; we still think that strategy will enable us to show year-over-year gains in margin as we move through second quarter and into the back half. The only caveat to that is coming back to this whole traffic thing, where we have been a little more promotional and felt the need to be a little more promotional both, number one, to generate sales and encourage traffic to come in; and also, whenever you're in a sales environment like we're in, you've just got to be a little extra disciplined on the whole markdown cadence because you don't want to get inventory heavy. As we move into the August-September period, we're going to have to be not only running our business according to our key strategies, but we're also going just to be forced to be reactive to the environment so that we don't get heavy in the pre-Christmas period.

Just real quick on the follow-up there. Where are you planning inventories to be at the end of second quarter, let's say maybe the balance of the year? And tailoring that also with where are we right now in terms of seasonal or carryover inventory with respect to either units or dollars?

Speaking of like Christmas?

No, I mean in terms of as you move from one season into the next. As we head into the summer are you dealing with any (multiple speakers)

We really don't have an issue with so called spring inventory. We're fine there.

I'm looking on the inventory levels. I think we were a little bit low on inventories -- we talked about this a little bit -- at the end of the year. We've pretty much caught up; just maybe even a teeny bit ahead of plan right now. So I think as we move over the rest of the year, you can anticipate our inventory ramp to be kind of traditional. I think probably from the levels you are here until peak around November 1st, I don't know, you've probably got another 10 million or so growth in inventory for the total Company between now and peak.

That's helpful.

And that would be a customary seasonality curve.

Let me come back to the freight part of the question. There are a couple things going on when we talk about distribution costs, and let me separate them real quickly here.

We mentioned distribution costs per se rose a tiny bit as a percentage of sales because of increased activity levels. That's actually been planned, and there's nothing wrong with that. We actually had activity levels in the DC in the first quarter a full 20% more, 20% above the levels that we had in the first quarter of 2004. I'm talking total volume of merchandising inbound and outbound. So with that kind of increase in activity, we're very pleased that we only had a modest increase as a ratio to sales, especially in a down comp environment. That's just basically what's happening in the four walls of that building.

On the freight side, that's really where some of the more exciting things are happening, where we were considerably below our plan on freight, despite fairly steady throughput and volume and overall level of receipts during the quarter. The translation there is things are running well in the building; activity levels are up, which is a good thing; and in a sense what's going on is we're paying for the increased activity at the DC with freight savings. In a sense, that's what you're seeing happen right now early in the year. By bringing more through the DC we're getting better control, we're managing our outbound better, our delivery methods are better, and we're paying for that increased activity out there with more efficient transportation.

I guess just following up real quick on the distribution cost then Rennie, if you're -- and that's great. It sounds like productivity per worker hour is probably up pretty significantly. But I guess what I'm trying to get at is a positive as we lap the new DC opening, are we going to see an improvement in that line item in the second half of this year?

Yes.

Great. Thank you.

(OPERATOR INSTRUCTIONS) Peter Benedict, CIBC.

Couple of questions. Maybe you could talk to some of the marketing efforts you guys have been testing; what you feel has been working, what hasn't and how you kind of see that playing over the second half of the year. And then secondly, can you just kind of comment on your exposure to China given what's going on with all the talk about the potential for revaluation of the won (ph)?

I think one of the issues in -- kind of the underlying issues in all the advertising and promotional things is that it's been very difficult for merchants, not just at Kirkland's, but throughout the sector, to identify strong themes and trends. We're sort of in one of those periods where other than indoor and sort of outdoor living and a few of those things it's been a little difficult for them. So it's really gone more toward the price side of the business as opposed to advertising content and new exciting themes and ideas inside the store. And when you couple that with the traffic situation, it is certainly no surprise to see that we've been doing a lot of things.

Our Mother's Day Mailer, we had a pretty good direct mailer we had pretty good response to. That's something we haven't done a lot of at Kirkland's, and we'll continue to do it on a selected event or season basis.

In the last couple of months in an attempt to drive traffic, we've done a number of things. We've done 40% off items $100 or more. We've done 25% on single items. We've done any number -- Friends and Family. We've done a number of things that have all had varying degrees of success at the given times. We do bounce backs, bag stuffers that allow a customer to come back at a specific time with a deal.

So with our new marketing group, and with our store operations group and the merchandise guys, we spend a lot of time thinking today about how we can draw traffic to the store in an environment, especially in the mall stores, where that traffic is a little bit difficult to get. And that's a little bit about what Rennie was talking about earlier, about where we felt like there was a possibility of some Q2 and second half pressure on merchandise margin.

That's helpful. Anything on the China exposure?

Who knows what's going to happen. We continue to put pressure on China, and I understand now there's some international regulatory pressure to try to make them do that. We have been talking about it for three years. We're in an environment right now in China where we're experiencing rising prices anyway on metal and anything that's petroleum-based. And that really hasn't changed since probably midyear of 2004 when we first began to see that. So we will deal with it when it happens. We continue to be confident that with the volumes that we buy we will continue to be as price effective as anyone can be dealing with Chinese sourcing.

Two more follow-ups, if I could, quickly. How do you think about -- with the inventory being as efficient and lean as it is, how do you think about when is it too lean? Did you experience any out of stock on items that actually did sell? And then secondly, when do you guys plan to expense stock options?

I'll let Rennie talk about the stock options. But I would say clearly that in the -- I believe in Q1 that we did have -- we were too lean to start the year. And I think that honestly is a reflection of a couple of things.

We had some delivery dislocations, which we talked about on the last call. And we also had some transition issues. As you have got to remember, when our new guys took over we were only bought in November of last year, and so they had a lot of work to do just to get the fourth quarter finished, and we did a pretty good job doing that. So you could have expected that as we went into Q1 and beyond we tried to be as candid as we could to the public community by telling them that we were going to be -- we were going to have some product balances, and that has occurred, and we've talked about those at some length, and also that it was going to take us awhile to build in inventory.

I thought probably in my judgment in the first month of the quarter we were clearly impacted by being too lean. As we got into the second half, or the second two months of the quarter, I think it was really more of the imbalance and content issues that affected us as opposed to being too lean in inventories. I'm personally pretty happy with where we are right now in inventory levels in stores.

We're doing some really regrouping inside our stores. We're themeing and categorizing our stores just a little bit differently than we have in the past. And really the impact or import of that move is really to get a little bit more product out on the floor. It will be a little more dense. And also, we're doing a little bit more densely presented windows to show more product to the customer. And that's consistent with trying to drive traffic, as well as letting them know the opportunities that are inside the store that are really great deals. That's consistent with the new signing that we're doing that's really more value-related. So there are a lot of things going on that make that full circle of merchandising, marketing and including the customer.

On the options, we had previously announced our intention to commence the expensing of options in the third quarter, consistent with the SEC guidelines. As you probably know, the SEC has now delayed the effective date as it applies to us until February of '06. While we have not made a final determination, I would say it's likely that we will probably wait, therefore, until February of 2006. All things equal, I would just as soon have a clean cut off at an annual period to do that, and that's probably what we will end up doing.

So it's basically going to be something along the lines of about $0.01 a quarter, so in terms of your full your guidance it's not really that meaningful.

I would say that's right.

Thanks, Rennie.

At this time there are no further questions in our queue. I will turn the call back over to Mr. Alderson for any closing comments.

Thanks everyone for being on the call. We look forward to talking to you soon. Thanks.

This does conclude today's conference call. We appreciate your participation. You may disconnect at this time.