Brand House Collective Inc (TBHC) 2005 Q4 法說會逐字稿

Welcome to today's Kirkland's, Inc. conference call. Today's conference is being recorded. Now at this time I would like to turn the conference over to Tripp Sullivan.

Good morning and welcome to this Kirkland's, Inc. conference call to review the Company's results for the fourth quarter and full year fiscal 2005. On the call this morning are Robert Alderson, Chairman and Chief Executive Officer, and Renny Faulkner, Executive Vice President and Chief Financial Officer. The results, as well as notice of the accessibility of this conference call on 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 14, 2005.

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

Good morning. Thanks, everyone, for joining us. The primary purpose of today's call is to report sales and earnings results for the fourth quarter and the full year fiscal 2005. I will summarize some of the key aspects of our financial results and also comment on key strategies and initiatives that are underway. Renny will review the fourth quarter and full year financial statements that were included in the press release and provide some commentary about financial guidance for the first quarter and full year fiscal 2006.

For the fourth quarter, we reported net income of $0.51 per diluted share, consistent with the revised guidance we issued last month. We reported net income of $0.59 per diluted share for the fourth quarter of fiscal 2004.

As previously announced, comp store sales for the quarter decreased 5%. Customer traffic declines in both mall and off-mall stores were the primary contributor to the comp sales decrease. The declines in customer traffic were partially offset by higher conversion rates and an increase in our average dollar transaction.

As has been the case all year, our off-mall stores performed noticeably better than our mall stores during the quarter. Off-mall stores produced a comparable sales increase of 4/10 of 1% for the quarter, compared to a 6.6% decrease in our mall stores. Average sales volume in our off-mall comp stores was 7% higher than mall comp stores during the quarter.

This performance differential is especially encouraging since the holiday season typically produces a steeper sales ramp up for mall stores as compared to off-mall stores. Our new store class of 2005, which is exclusively off-mall, also produced encouraging results and outperformed our internal sales targets.

From a merchandising standpoint, we produced healthy comparable store sales results in the furniture, candles, textiles, alternative wall decor, and mirror categories. These categories were successful throughout fiscal 2005, and represent areas of the merchandise mix where our buyers have been able to consistently identify unique trend-right items, reflecting our customers' preferences and styles. However, these category increases were not enough to offset a disappointing seasonal assortment and our inability to anniversary the sales results of our gift novelty category from the fourth quarter of fiscal 2004.

The seasonal category suffered from a lack of uniqueness and differentiation from our prior year assortment. The gift novelty category was de-emphasized this year, as we allocated more open (indiscernible) dollars to our core home decor categories. These categories failed to produce the sales results we needed to make our fourth-quarter comp plan. Needless to say, our merchandising focus for fiscal 2006 is to zero in on the key categories that are not performing and position them for success.

As a result of the sales and customer traffic weakness we encountered during the quarter, we took targeted markdowns to drive sales and manage inventory levels. The heaviest markdowns were felt in the seasonal, art and textiles categories, and these did impact the overall margin negatively versus the prior year. However, we did accomplish a full sellthrough of the seasonal category during the quarter.

We had another active and successful year in real estate as we continue to open stores in off-mall locations, while closing our less productive mall stores. During the fourth quarter, we opened 14 stores and closed one store, bringing our year-to-date activity to 59 openings and 32 closings. All of the new stores are off-mall, and all but one of the closings are mall stores.

As of the year end, we had 347 stores in operation, 210 in malls and 137 off-mall, representing a 60% to 40% venue makeup. Our off-mall stores are larger than their mall counterparts. So, while the overall unit increase was 8.4% for the year, our total square footage increased 16.6%.

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

Thanks, Robert. Good morning. I'll begin with a review of the fourth-quarter income statement.

Net sales for the fourth quarter were $153.4 million, a 6.3% increase from 144.3 million in the fourth quarter of fiscal 2004. The comp store sales decrease of 5% primarily resulted from fewer transactions due to weak customer traffic. Offsetting the traffic impact, customer conversion rates were higher for the quarter, reflecting conversion improvement in both mall and off-mall stores.

The average ticket increased during the quarter in both mall and off-mall stores, reflecting a strong increase in the number of items sold per transaction, offset by a slight decline in the average retail selling price.

Gross margin for the fourth quarter decreased to 34.9% of sales from 37.4% in the fourth quarter of 2004. The principal factor in the year-over-year margin decline was a lower merchandise margin, due to the higher level of markdowns as compared to the prior year.

The occupancy component of gross margin was flat as a percentage of sales, despite the comparable store sales decline. The shift to more off-mall stores with lower occupancy costs helped to mitigate the impact of the sales decline on this ratio.

The other components of cost of sales, freight and distribution costs, decreased about 30 basis points as a percentage of sales, reflecting continued improvement in transportation cost management, despite rising fuel costs.

Operating expenses decreased to 21.2% of sales, from 21.7% of sales in the fourth quarter of fiscal 2004. On a dollar basis, total operating expenses increased only 3.9% for the quarter, despite the increase in the store base and a planned increase in advertising expenses.

The decrease in the overall expense ratio was the result of various actions taken at the store and the corporate level. At the store level, tighter control over payroll expense, as well as decreases in the use of outside storage space and related equipment rental, were the primary drivers in the ratio improvement. At the corporate level, reductions in professional fees and travel costs drove the decrease. Overall, we were pleased with our ability to control operating costs while executing a growth plan for the business, and also dealing with a difficult sales environment.

Depreciation and amortization increased 40 basis points as a percentage of sales, reflecting the new store openings in 2004 and 2005, as well as a reduction in the average term of our leases as we move off-mall.

Interest income was higher than prior year, as rates on our excess invested cash were better than in the previous year. Additionally, revolver borrowings during the quarter were below last year's levels prior to our December clean-down to a zero balance.

Our effective tax rate for the quarter was 39.7% as compared to 39.5% in the fourth quarter of fiscal 2004. Net income for the fourth quarter was $10.1 million, or $0.51 per diluted share, as compared to net income of 11.6 million, or $0.59 per diluted share in the fourth quarter of fiscal 2004.

As for the balance sheet, the Company ended the quarter and the fiscal year in good financial position. Inventories at January 28, 2006 were $49.2 million, or $142,000 per store, as compared to 37.1 million, or $116,000 per store at January 29, 2005. While the increase in inventory over the prior year was sizable, we believe that these levels are acceptable considering the very low level with which we started fiscal 2005.

We had no borrowings outstanding under our credit line at the end of the year, and had $15 million in cash. This compares to no borrowings and $17.9 million in cash at the end of fiscal 2004. For the fiscal year, our capital expenditures were $24.1 million, the large majority of which related to new store construction. Taking into account the landlord allowances we receive when we open new stores, the overall net capital outlay for fiscal 2005 was approximately $12 million.

For fiscal 2006, we are estimating capital expenditures of approximately 25 to $27 million. Net of landlord allowances, we estimate that the net cash outlay for capital investments in fiscal '06 will be 11 to $13 million.

The final topic I want to cover briefly today is guidance for the first quarter and for the full year 2006. For fiscal 2006 we're forecasting net income of $0.25 to $0.35 per diluted share. Key sales and store growth assumptions are as follows. We estimate that comparable store sales will range from a decrease of 2% to an increase of 2% for the year. Total sales are anticipated to be between 465 million and $480 million. These sales figures reflect a 53 week retail calendar for fiscal 2006, as compared to 52 weeks in fiscal 2005.

Our guidance includes plans to grow our store base by 30 stores, comprised of approximately 60 new stores and 30 closings. Thus far in the first quarter, we have opened five stores and closed 17 stores. We expect that our store openings will be more heavily weighted in the second and third quarters, while the majority of our closings will occur in the first and second quarters. Due to the larger square footage of off-mall stores, we expect total square footage to increase approximately 15% during the year.

Additional forecast assumptions include --

A cautious view of customer traffic trends. Our guidance reflects the continuation of these sector-wide trends, especially in the near-term.

Next, a significant improvement in merchandise margin. Beginning in the second quarter, we expect to benefit from easier prior year comparisons, and as we look to third and fourth quarter, we expect our margin to reflect the refocusing and rationalizing that is already underway.

Third, a reduction in our occupancy cost ratio. We will continue to open off-mall stores with more attractive occupancy costs, and close and/or relocate costlier, less productive mall stores to better off-mall venues. Even at a flat comp for the year, we would expect to leverage our occupancy costs in fiscal 2006 by approximately 50 basis points.

Next, an increase in marketing expenses. As our store base continues to shift to off-mall, the need to communicate with our customers more regularly is clear. Our guidance reflects measured increases in marketing spending to support this goal. We expect to spend in the range of 1.5 to 2% of sales in fiscal 2006 on marketing-related activities, as compared to approximately 1% in fiscal 2005.

Our guidance also reflects the adoption of the new accounting standard related to stock compensation, FAS 123R. We estimate that the impact of the adoption of FAS 123R during fiscal 2006 will amount to approximately $0.04 per diluted share. FAS 123R will also have a negative impact on our overall tax rate for the year, as many of the charges taken pursuant to the accounting pronouncement are not tax-deductible. As a result, we are estimating our fiscal 2006 tax rate to be 41%.

For the first quarter of fiscal 2006, we expect a loss of between $0.14 and $0.17 per share. We estimate that comparable store sales will decrease in the range of 4 to 7%. Comparable store sales thus far in the quarter are in the high single-digit negative territory. As we progress through the quarter, we expect the comp sales statistic to improve as we begin to cycle against weaker prior year comparisons.

During the first quarter we expect merchandise margin to be slightly down in comparison to prior year. (indiscernible) operating expenses, we're forecasting them to be higher as a percentage of sales as compared to the prior year, due to our increase in marketing activities during the quarter. Additionally, we will incur a charge during the first quarter related to the termination of our former president and chief executive officer. This charge will amount to approximately $400,000 on a pre-tax basis, or $0.01 per share.

I will now turn it back to Robert for an update on our business strategies and operational plans for fiscal 2006.

Thanks, Renny. Our company has experienced a tremendous amount of change in recent months. Our ongoing search for new talent to lead the Company is certainly an important objective, and we are aggressively at work. Notwithstanding, the transition has proceeded smoothly. We have an experienced and motivated management team, we're committed to common goals to improve our business, and we're not slowing down in implementing the strategies and initiatives needed to achieve them.

In the merchandising area, our challenge is straightforward. It involves a clear vision and strategy, combined with smart execution. In the last couple of years we've had many areas of our overall assortment that did not resonate with our customers. We've strayed from some of the things that attract our core customer and made Kirkland's successful. We've been off the mark on the style, quality, value equation, and lost the important key item mentality and focus. We're committed to immediately returning to those fundamentals.

Understanding the desires of our customers is a key part of our merchandising efforts. We had an amazing response from our customers to research we performed on our 2005 seasonal assortment. We plan to use this research and the knowledge gained from additional targeted research efforts to fine-tune our assortments in the future. We also plan to develop a regular program of communication with our customers through the use of online surveys and e-mail communications that will allow us to continually have our finger on the pulse of the customer and their likes and dislikes. We intend to include Kirkland's credit card holders and other customers in our research, but also plan to reach out to persons who are not currently regular Kirkland's shoppers so that we gain additional insight.

While listening to our customers is an important part of our strategy, I want to say a bit more about the merchandise direction and content of the mix, and its relationship to value pricing. From a style standpoint, we plan to refine our product style by moving from a somewhat narrowly-focused, defined focus on red, gold, burgundy and cream colors and highly-adorned merchandise, recapitalizing on the latest trends in color, texture, shape and function.

While the Kirkland's customer has long favored so-called traditional style, her concept of traditional incorporates a much more diverse merchandise mix than we have been offering. As we work through this style refinement during the first half of the year, our merchandising team is highly focused on SKU control to ensure that our product is presented in a manner that maximizes visual impact, incorporates key item promotions, and generates product sellthrough at historically normal margins.

The value proposition we offer is important to our customers. Cheap and constantly marked down do not necessarily mean or convey value, the value being stylish product of high quality at a great price and sold with acceptable margins. We are reevaluating our pricing and markdown approach to ensure that we're offering great value to our customers while rebuilding a solid merchandise margin.

Kirkland's has long been known for making a strong merchandise statement with key items. During our recent sales struggles, a common theme has been our difficulty in developing, buying, presenting and capitalizing on those key items. An overly broad assortment diminishes visual impact and inhibits sales productivity. We are reducing SKUs and returning to the key item focus in those buying practices.

In this period of leadership transition, we're not standing still and developing initiatives and taking actions. Our merchandising group is full of creative, valuable people, and we will continue to make forward progress so that new leadership inherits an improved, more productive merchandise team and assortment.

Our store operations team as has set lofty but clear and attainable goals for improvement in customer conversion during 2006. If declines in customer traffic continue, conversion represents our best near-term opportunity to improve comp performance. There are several initiatives supporting our conversion goal.

We're continually assessing our field-level management for customer service excellence and initiative. We're striving to ensure that the right people are in place so that we can deliver on the commitment to our customers to provide exceptional customer service as a part of their store experience. Those tactics and incentives are now being rolled out to the field which target customer service metrics, such as conversion rates, to help motivate our field staff to more effectively engage our customers.

We're establishing and upgrading training materials for our store personnel so that they are better equipped to interact more effectively with customers. We're also intensifying our efforts on customer loyalty that we've launched in recent years. We have goals of increasing the penetration of our Kirkland's private level credit card, as well as increasing the amount and ease of e-mail collection at stores -- two proven and important vehicles in establishing long-lasting customer relationships.

Our real estate group continues to execute the strategy of shifting our store base to off-mall venues, and by year end, the majority of our stores will be in off-mall venues. The financial performance of our off-mall stores continues to support this strategy.

We're making good progress on the new store class of 2006. To date, we have approved 43 deals for this class. We've already opened five stores during the first quarter, and expect an additional seven stores to open by end of quarter.

A recent development that we are especially excited about is our completion of the first of a group of four new prototype stores. We recently reopened an existing store in Memphis, Tennessee under the new prototype design developed last year. We will tweak this design for the three other new stores slated to open before the end of the quarter.

We're very pleased with the reopening of Laurelwood Center store in Memphis. Sales have been brisk. The initial feedback we're receiving from customers has been very favorable. We will monitor the performance of the four prototype stores, as well as make value engineering adjustments to the design, with the hope of rolling out the new store design for a substantial part of our fiscal 2006 openings.

Our marketing function continues to develop, and we're learning a lot about what works best for Kirkland's and establishing a professional and effective advertising program. During the fourth quarter our most effective ad spending occurred with our newspaper insert program. Going forward, we're taking measured steps in increasing our advertising with the current preference to invest in this proven vehicle of newspaper inserts.

Finally, our logistics team continues to realize efficiencies from the 2004 opening of our new distribution center, along with its automated systems capabilities. A big part of the team's efforts during fiscal 2005 involved optimizing the freight delivery methods to our stores. These changes resulted in substantial cost savings for the Company, as well as improvement in delivery reliability.

For the year, we received 97% of all receipts through the distribution center, eclipsing our goal of 90%. In fiscal 2006, our goals are to improve merchandise flow from the manufacturer to the distribution center by implementing tools that allow for better visibility on the upstream portion of the supply chain. With that better visibility, we have more control over the timing of goods reaching our stores.

In summary, while we're in a period of transition at the Company, I'm very pleased to see signs of progress across all areas of the business. Our off-mall real estate strategy is the right one, and we're encouraged by the initial success of our new store prototype, which will facilitate a better shopping experience for our customers. Improving our merchandise assortments with stylish, value-priced product, and improving our customer conversion rates through better content and customer service are two huge opportunities for our business. We believe that we have strategies in place that will allow us to execute and achieve those goals. We're confident we will [add] the merchandise leadership component. Our management team is united in its commitment to turn this business around and deliver our shareholders a strong return on their investment in Kirkland's.

That concludes prepared remarks, so now we would like to take questions.

(OPERATOR INSTRUCTIONS). Neely Tamminga, Piper Jaffray.

Thank you for the very clear presentation; I think that's a good one. And in terms of merchandise margin, can you guys speak to kind of where you've been, where you are now? What are some opportunities to really make up some room there in terms of the merchandise margin? I have a couple of more.

Renny, do you want to talk about where we've been?

We don't disclose merchandise margin. That's not a number we've ever published publicly. I would tell you, order of magnitude, if you go back to the 2002 timeframe, the erosion that we've experienced in our gross margins since that time has predominantly been due to eroding merchandise margins. So you're looking at, in round numbers, 400 basis points or so of pullback from where we were a few years ago.

Specific to the merchandise margin, or are you speaking to the gross margin?

Merchandise margin.

And occupancy, obviously this move towards off-mall occupancy should naturally come in anyway? Is that how we should be thinking about it for '06, '07? There should be improvements just because maybe you've been improving comp trends, and also there's just less occupancy expense associated with the off-mall, correct?

That's correct, and we tried to give a little bit of math for everybody to be able to deal with, pointing out that even if we went flat on comp this year, which is kind of the center point of our guidance, we would still leverage occupancy by about 50 basis points. So you can kind of figure out -- you can push the numbers and figure out that if we are able to get this comp restored, the news is even better than that. And obviously, with the flat comp, that's almost entirely a function of the transition that's underway.

In terms of your new store productivity for these off-mall stores, how should we be thinking about that for -- with these 60 store openings? Have you really changed the number of the revenue, the new store revenue we should be working with?

That's a good question. We have been publishing for a while now a new store model of an opening volume of about 1.2 million or so. Really, we're kind of looking at that, and I think as we move forward this year we will probably be presenting in a more formal fashion a refined store model, now that we have a little more history with this 6500 foot footprint. I think for now, that's still a good way of thinking about it, 1.2 million year one. And we still are looking at our kind of typical numbers we've been showing, 60% ROI on the cash investment, which includes both the buildout and the inventory investment. I would stick to those for now. I would tell you, though, that we -- because we are moving entirely towards this 6500 foot footprint, and we've made comments about being ahead of our internal sales model, you can assume that our expectations are walking up a little bit from that, probably more in the 1.3 million, 1.4 million range.

It would seem so in your guidance. Is that what your guidance is implying, is a little bit higher on the new stores?

It is.

And certainly, better content will help that also. That's the other side of it.

It's a high-class situation.

Two good things going on (multiple speakers)

Can you speak a little bit -- the conversion rates seem that they have been improving, and that's a good thing. Just wondering how, as you look into Q1, is that minus four comp assumption -- are you still anticipating improvements in the conversion rate?

I think over the course of the year, we do believe that there will be improvements. And as I said, we've set some very specific but, we think, attainable goals for that. Content is part of it. Better delivery assortment, planning and delivery practices, allocation and delivery practices will be part of that also. And I think making sure that we match up our promotional with our advertising in the most effective way will also be a part of it. So there are a lot of things that contribute to conversion beyond just effort inside the store, but certainly you've got to give them the things to work with in order to make the sale.

Lastly, with this nomination for two board members to your board, I'm just wondering, are these new positions or seats, or is this a replacement situation that someone might be nominating these two board members for? Maybe if you can speak to your commentary on these new board members that are being nominated.

Actually at the moment, I really can't say a lot about it. All I can really say is that we received a letter dated March 6th of this year from [Bardon] Capital Management LLC, which is a shareholder of the Company. And they did nominate two candidates for election to the Board of Directors at the coming annual meeting, which will be in early June. And we referred that letter to the Board's Governance and Nominating Committee for their consideration. And I guess we will have to await more action and a later announcement about that.

Was there a seat vacated from your prior CEO departing?

Yes.

John Lawrence, Morgan Keegan.

First of all, Robert, would you comment a little bit about your comment on, as far as the refinement of the merchandise, and behind that, obviously some SKU control? Can you give us a little better sense of is it expanding the categories, or just deeper in colors, deeper inventory? Talk a little bit about, a little bit to the next level as far as that refinement.

I think -- when you take a look at the merchandise mix, it's not necessarily that the merchandise is bad, it's just that it's been too tightly defined. We've been very much focused on some specific color combinations, and very much focused on this very much over-adorned style of goods. I think if you can think of that as looking at a field of vision through a pair of binoculars, is the best way I can think of describing it, we're going to put those down and look a little wider, because our Kirkland's customer has always had a much wider view of what traditional merchandise has done. And part of that is getting on --

And the other thing that we've done well, very well over many years, is understanding the styles and trends and being -- we don't ever try to set them; we're extremely good followers and we're extremely good at providing new iterations with new product and at great prices, so that we can do things that are on style, but at a price that our customers are really excited about.

So I think you'll see a little bit broader look at the world. In terms of merchandise, we'll be more attuned to the current colors and styles and shapes that are out there. And I think we'll do a lot better job of making the store more interesting and making it more fun again for our customer.

And I think we can, by our planning practices that we now have in place, I think we're going to be much more highly focused on the SKU side. And when you're really interested in having some hero items that you can sell at great quantity, very rapidly at good margins, that we've historically been so good at doing, and you combine that with a commitment to have fewer SKUs and go deeper on the things that you know are going to be winners, I think you're going to see a store that is much tighter, much more focused, and that will be not only easier for the store to manage, but easier for the customers to understand and to shop.

Not to belabor that point, Robert, but what would you say that we would see less of in the store?

Well, as you get into the planning phase and we look at it right now, I think you would see probably a bit less garden. I think you'll see a much more focused SKU set in textiles. And I think on the framed image side of the business, I think you'll see us be a good bit more focused than we have been, with a great deal more focus on trying to get newest and best images, and re-establishing our relationship with the publishers so that we've got it, and we put it out there first, and its -- we have some depth behind it. So maybe those categories on just on the top would be the ones most effective, or more affected. Across the entire group, though, I think you'll see a really strong effort at defining the focus and SKU control.

Secondly, can you talk about real estate? Obviously, the off-mall stores doing well. Can you sort of give us a framework of some of the new stores in '05 in strips? What is the best profile, some of those markets that -- who you're lining up against in these off-mall that really works well, and sort of the optimum type of setup?

As always, we're always looking for the best real estate site. And typically, that's a combination of location, infrastructure and co-tenancy. So we are typically going to -- and then it's got to have a vacancy, or you find there's an opportunity there for you. So power strips have been extremely good to us, and we're the best of the power strip tenants, the big box guys lineup; that's typically where we do the best. We will occasionally look at and do a lifestyle center, but I don't think we will be as interested in those, nor especially if they're not anchored or they don't have a big box or a grocery or an entertainment component to them. So I think pretty much what we've done for the last two years is focus on those opportunities in the power strips, and that's proven to be very successful for us.

Last question. Renny, is there any more room as far as some of the -- you mentioned some of the operating expenses, some leverage as far as getting out of some storage buildings off-site, those types of things. Is most of that done at this point? Is there any room left there?

Really, most of that is done. The acceleration of that. I guess that whole effort in rationalizing that inefficient part of our supply chain where we had those remote storage facilities out in the field, that really began back in 2001 and 2002, and accelerated with the opening of our DC in the summer of '04. So, we're bringing 97% of our shipments now through Jackson. And so that streamlining will continue. But the easy dollars have been gained, in terms of that outside storage piece of the P&L.

And I think just in terms of overall operating expenses, as indicated by the comments I made on fourth quarter, there are always things you can look at. You can always be better tomorrow than you were on expenses today. But I think for the most part, we feel like we're pretty solid there. In the midst of a tough environment, the overall dollar expenses, I believe, only grew somewhere between 3 and 4%. So, not a lot of low-hanging fruit left there.

I think as we continue, I think I mentioned that we were really working hard on the transportation delivery part of this. We'll have more than half of our stores serviced direct with direct shipments by midyear this year, and virtually none with LTL deliveries, less than truckload deliveries. So we're getting much more efficient. And with that efficiency and reduced cost, fewer deliveries. And so you've got to be more targeted with what you send, and there's hopefully not going to be as much excess things that people don't need in the field.

Chris [Rapelgene], SunTrust Robinson Humphrey.

I'm on the call for David today. A couple of questions. First, I was wondering if you could give some insight on when you expect the CEO replacement search to be completed. And secondly, on last quarter's call we talked a bit about (indiscernible) that you had started to look at in China. And I was wondering how that was progressing. Thanks very much.

As to the CEO search, it's one of those things that when we have news we will be right here to talk to you about it in this public forum. So it's one of those things that you really can't comment on except to say, as we did in the script, that we're at work on it. I'm sorry that I can't say more at this time. With respect to China, our merchants have been in China, just got back from a three-week trip. They were working with specific vendors in China on some very specific projects, especially in the current -- in wall art, in textiles, in seasonal, in furniture and decorative accessories. And we continue to have a great vendor partnership. And for the foreseeable future that's the way that we will be doing that. We will be spending more time there, but we will be doing it in a very structured way with our vendors, dealing with -- making sure that we're dealing with factories that can deliver and deliver the kind of quality that we want and deliver the product on time. And so it's really -- when you start talking about sourcing overseas, there are things that are great to source overseas and there are things that you'd rather be closer in on. So we're going to always be cognizant of what's the most efficient way to source goods for Kirkland's. And China certainly has a place, but it's not -- everybody sources in China, so there's not an inherent -- huge inherent margin advantage, typically, to that anymore, vis-a-vis another competitor in the space. So I think we're going to be very good about it and very careful about it.

Laura Richardson, BB&T.

I wanted to focus on some of the merchandising things you guys brought up also. In terms of the seasonal assortment, can you talk about some of the feedback you got in the research you did with customers after Q4, and how you're going to use that next year? Will the seasonal buy be bigger, smaller, the same? How will it be different next year? Then I have a couple of general merchandising questions, too.

First of all, let me get the last one. I think the buy will be probably in gross down about 10%, spread across more stores. So in fact at store level, it will be down. I think what the customer told us -- there were four or five main take-aways, if you collated all this information. First of all, that we needed to do a better job with seasonal gifts. So I think that's one of the focuses that we're -- we've been working on in our recent trip. We need to be less country in the look, and give them more fresh and updated looks. And that's a very, I think, a very valid criticism, and one that we've taken to heart.

Did they say that about seasonal specifically, or merchandising in general?

I think seasonal specifically was where this comment came from, and that we needed more depth in our key seasonal items. I think we disappointed some people by having some really good things that they couldn't get. And of course, when you're at that time of the year, if you don't have it, it's too late. And those were sort of the biggest things that came out of it. I think -- there's always an interest in ornaments and the decorating, and you have to be really careful about that, because that business is over by about the end of the first week of December, it's certainly over. So less of it, more focus, better depth, less country, more gifts. I think that's pretty well the message.

Did you say that the total seasonal buy is going to be down 10%, so per-store it's going to be down even more than that, because there's going to be --

There will be more stores, so we'll be down about 10% in gross. And we think that's really the right thing to do.

I mean, that's a tough category. That seems to be the best way that anybody that I cover manages that category. And then in the assortment in general, I'm trying to envision what a store may look like, let's say, in the second half of this year is when you're aiming to have these changes done. Should there be less inventory in the store, same amount of inventory in the store, just focused like -- you pick a key item, you have it in more colors, a more (indiscernible) presentation of it? Or what should we be watching for?

I think in general, you'll see in the back half of the year, until we do our seasonal build, I think you'll see inventories about where they are right now to down, in terms of size. I think -- I am absolutely committed to the idea that we're going to have fewer SKUs, which means that as we buy in greater depth, we will have more opportunity to do some things that will be more outstanding in the store. I think -- you want the store to stand for something you go in. You want to know what we as a merchant want to tell the customer that we stand for and what we think is a great item. So I think we have been much too broad in terms of the kinds of themes and groups that we tried to put together. And when you're able to do things with key items and fewer SKUs, I think we'll be -- we'll be a much more clearly defined store. And certainly we hope to be clearly using more than red and gold and cream and that kind of stuff. I think that is (multiple speakers)

Green and blue are popular, too.

Yes. It's really -- we have not adjusted to a color palette that really changed a year ago.

When you say things were very embellished or ornate -- I don't remember what word -- the look is going to be a little more streamlined it sounds like.

I think we'll be cleaner, and we'll be architecturally cleaner, if that's a good way to say it. And I think probably an over-reliance on some of the darker resins and -- product tastes shift. Colors shift, product tastes shift, silhouettes shift. Materials that you use to build those products also shift. So I think we've got to be a little more tuned in, and I think we can be. And as I said, I don't think our -- the product that we have in the store is necessarily bad, it's just that it's too narrowly defined. And I think that's the challenge for us, and I think we can very well manage through what we have, but get better in the back half.

Can you give us an example of some key items that were successful for you in the past?

We've been extremely good in key items in lamp categories, doing multiple [buffets], for example, in a box, that were at a great price that we were able to promote and sell through at great quantity. In the garden category, it's really not a terrific thing now, but the statuary was great for us for two or three years. And textiles, throws and pillows and special promotions that we've done there.

Some of our art programs in metal and clocks. And gift and novelty last year, the Moshi trend was huge in the back half of 2004 and carried over slightly into 2005. So I don't know if that -- the candle business, we've done some promotional things, both from size and type and color and function with candles, with candleholders. All of those things have been terrific. And then we've also over the years been pretty good at putting sets of things together, in candles and decorative accessories, and then combining those sometimes with lamps and floral items to create sets of things that sold really well together and were really big items.

So you're taking some of the themey items, like maybe a wine theme or a coffee theme, is what you're talking about there?

We've done nose, and when those things are much on our customer's mind, we're going to try to be there with the product before them. Our job, if we're doing a really good job with our vendors and with our product group, is that we understand those trends. And we know what's coming, and we anticipate it, and we also are good followers.

Is there any additional emphasis among the buying team of finding trends, following trends?

Sure. I think one of the things that we have really been working on in the last two or three weeks has been getting that team working together, and trying to get them to really understand the direction that we want this to go. At the end of the day, great items drive themes. And I think that we're trying to get that buying group really focused on understanding, identifying and working toward putting together great items, and that the great items I think will drive the themes in the store. And part of that certainly is understanding the universe that we're working in.

Makes sense. I'm sure this has already been suggested, Robert, but you would make a great CEO, if you wanted to come back.

Thank you. It's a pleasure for me to be back. I'm enjoying it, and I am enjoying getting back to seeing the people in the stores. And I had a great meeting with them in Atlanta last week. And I intend to be out in the stores a lot, and also working hard with the great team that we have in Jackson. And it's a pleasure, and I love this company. I've been here 20 years, and I'm going to do everything I can to help while I'm here.

Are you still thinking -- what are you thinking about having a separate head of merchandising and a CEO now? Or does it depend who you find as the CEO, basically?

I think it all depends on where the talent falls out. And I think, clearly, the message for Kirkland's is we have to get the merchandise leadership that takes us to the next -- returns us to the point where we are again a dominant merchant in the sector. And that's the commitment that I have. And however that falls out, that's how we'll deal with it.

Peter Benedict, CIBC.

Just a couple more. First, Renny, I'm not sure I heard you correctly. Can you let us know -- the 7% higher sales in the off-mall stores versus the mall locations in the fourth quarter, is that on a per square foot basis? Do I have those numbers right? And secondly, Robert, could you just talk a little bit more about what's different about this new store prototype? I'm not sure if you touched on that. If you did, I missed it.

The 7% number was a volume number, not a per foot number. So that's actually sales per store, 7% higher. It was actually a little bit lower on a per foot basis because of the higher footprint in the off-mall.

About the new store, first of all, it's -- on the outside there's really a different treatment. The inside has, as you enter the store, there's kind of a decompression zone where we let people kind of get into the store and we merchandise around the periphery of it. The checkout counter is -- I think you've seen the Jackson, Tennessee store that we -- has been sort of a transition of this, and the checkout counter is in the front. As you go through the store, we have a different -- finishes, a tile floor that is, I think, very attractive, a lot of use of metal and glass tables, and a redesign of all the fixtures inside the store. The wall by the perimeter is designed to provide more storage of goods, and generally that's true throughout the whole store. The effort has been made to get more on the floor that's accessible to customers and to staff, so that there's not a constant need to be going -- to leave the floor and go to the back and find something to bring it up. So not only have we created viewing areas to see the merchandise, but storage areas to service it also.

The back of the store, initially at least, has been devoted to the wall category, and we have some new fixturing there which provides us more face-outs. The footprint of the store has been changed a bit to provide more area for the selling space and a little bit less for back-room storage, which is in accord with our drive to better supply the store from our distribution center and have less on-site, also to have fewer SKUs and a little bit less inventory.

Inside the center of the store, we have -- we're a little bit more departmentalized in some cases. We have inspiration islands in the center of the store, where we try to put themes or looks or groups of product together to suggest things to customers. The traffic flow in the store, I think, is considerably improved. I think we can move through there. And the full intent of all this is to be less about fixtures and more about product. So I think we will see hopefully less product boxed and stacked, and we'll see more product out, and we'll see more product combinations. We're experimenting with some flat screen TVs in certain areas of some screens, so that we show decorating looks for our merchandise. And we've found those to be pretty interesting to customers and had a good reaction to it so far.

So a lot of different things. It's a decidedly different look, and I think as we have what I hope to be a bit more stylish, a bit more interesting content as we go through the back half of the year, I think we're going to like this. We've got some work to do on it, but good start.

Thanks, Robert. That's helpful. Renny, if I could, just one more question. You talked about the good control of expenses up just under 4% in the fourth quarter year-over-year. Obviously that's not sustainable going forward. Would you venture to give us a range of how much you think maybe the operating expense profile grows, maybe in the '06 period?

Let me -- let me look at that here for a minute. I would say, over the course of the year, fairly consistently with the sales rate.

Okay. So you're expecting basically a flat ratio as we look through the course of the year?

I would say a few ticks up, just because of the advertising increase. So if you're looking for a number, I'm going to throw out -- I'm going to say -- call it maybe 60 to 80 basis points over the course of the year.

That's fair enough. Thanks much.

(OPERATOR INSTRUCTIONS). Robert Wilson, Tiburon Research.

Renny, can you break out the number between compensation and benefits and other operating expenses on the P&L for Q4, or give me a rough approximation? I think you disclosed that in your filings.

We do that in the K, but I do not have that handy right here. We do that in the K.

Can I call you off-line and maybe get that later?

Yes, we can do that.

Second question. Is there a difference in the off-mall locations in the lease term? Is it a longer lease term than your traditional mall stores?

No, it's actually shorter. Typically five years. There are some -- as this venue has gotten a bit more popular with a lot of the former mall tenants, there's been a little bit of pressure in the last six months or so to a year to drive some of those terms to 10 years. But typically, you find five years with some options.

So your depreciation of the buildout is over five years?

That, as I think Renny mentioned in the text, that's one of the things that's driven that increase.

Okay. Could you sort of rehash -- my last question would be what was the primary difference between the strategic direction the ex-CEO was taking, versus maybe what you guys thought was your view on where things should be heading? Is there one major strategic difference of opinion?

I think I've talked about the style of product, or the style -- the definition of style which leads to how you -- what you put into the store, and how you define your customer. And certainly, that has been a major departure. Certainly, the use, or having much broader assortments of product in the store, and not focusing or using key items or big items, I think, certainly was a departure. I could kind of go on for a while there, but that's probably enough to say about it. I really -- I don't know if it's really that productive to talk about that.

Okay. And finally, you mentioned in Q4 you had sort of de-emphasized your core, I guess your gift and novelty categories this past year, and you went towards more the home decor categories. What was the thinking behind that? I don't understand why you would try to move away from giftables in Q4.

We didn't move away from them, it's just that we had that huge Moshi movement that was going on in the prior year. And the sales in that were just amazing. And we just couldn't find -- our merchants just really couldn't find the item or items in that category that would replace those dollars. And so I think we had to reallocate it the best that I think the merchants thought they could do at the time, and it didn't work as well as we hoped.

So it was no conscious decision, it's just you didn't find the hot item?

Yes, we just didn't find that replacement, and so you do the best you can. That item -- an item like that comes along every five years or so, where you see something that remarkable in the marketplace.

With that there are no further questions. I would like to turn the conference back to Robert Alderson for an additional or closing remark.

Thanks, everyone, for participating in the call today. We will be available for follow-up questions after the call. Thanks again.