Brand House Collective Inc (TBHC) 2007 Q1 法說會逐字稿

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

Good morning and welcome to this Kirkland's, Inc. conference call to review the Company's results for the first quarter of fiscal 2007. On the call this morning are Robert Alderson, Chief Executive Officer; Cathy David, President and Chief Operating Officer; and Mike Madden, Vice President and Chief Financial Officer.

The results, as well as noted to the accessibility of this conference call on a listen-only basic 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 May 2, 2007.

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

Good morning everyone and thanks for joining us. The primary purpose of today's call is to report sales and earnings results for the first quarter of fiscal 2007. I will summarize some of the key aspects of our results for the quarter. Mike will review the first quarter financial statements that were included in the press release, and provide some commentary about financial guidance for the second quarter. Cathy and I will then comment on key business initiatives.

For the first quarter ended May 5, 2007 we reported a net loss of $0.38 per share compared with a net loss of $0.16 per share a year ago. Net revenue for the quarter decreased 11.1% to $82.3 million compared with $92.6 million for the prior year quarter.

As previously announced, comp store sales for the quarter decreased 18.8%. Comp sales declined 20.9% in our mall stores and declined 16.8% in our off-mall stores. A decline in customer traffic was the primary contributor to the comp sales decline. Overall customer conversion rates were slightly lower than the prior year quarter, increasing in our off-mall stores, but not enough to offset the decline in our mall stores.

The average dollar transaction decreased 4%, driven by a decrease in items per transaction, partially offset by a slight increase in the average retail selling price. The average dollar transaction performance was consistent between mall and off-mall venues.

From a merchandising standpoint we struggled with negative comps persisting in most of our categories, including framed art, lamps, textiles and furniture. We had positive comp performance in alternative wall decor in gifts; however, the increase in the gift category was inventory driven, and performance in this category has not yet met plan.

We introduced some new merchandise initiatives during the first quarter that have not performed as expected. We will discuss what we have learned and how we're reacting to this performance in a moment. Inventory levels at the end of the quarter were down 1% versus the prior year quarter, and down 4% on a per store basis. We entered 2007 with relatively lean inventory levels. During the quarter inventories increased slightly to a more appropriate level. We have adjusted our order flow to more appropriately match the current sales rate, and we anticipate being on plan at the end of the second quarter.

In real estate we opened 10 stores during the quarter and closed 12. At the end of the quarter we operated 347 stores, 191 off-mall and 156 mall stores, representing a 55% off-mall, 45% mall venue makeup. Off-mall stores are larger than mall stores, so despite store unit growth of only 3%, our total store square footage increased 11% versus the prior year quarter.

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

Good morning. I will begin with a review of the first quarter income statement. Net revenue for the quarter was $82.3 million, an 11.1% decrease from $92.6 million in the first quarter of fiscal 2006. The overall decrease was the result of a comparable store sales decline of 18.8%, partly offset by an increase in the store base.

As disclosed at the end of fiscal 2006, we are now recording breakage revenue representing the portion of our gift certificate and gift card liabilities for which there is a remote likelihood of redemption. During the first quarter we recorded breakage revenue of $165,000, which is included in our total sales figure in today's press release.

Gross margin for the first quarter decreased to 27% of revenue from 30.1% in the first quarter of 2006. Store occupancy costs increased as a percentage of sales by 230 basis points as a result of the sales decline. Central distribution costs increased 30 basis points as a percentage of sales also due to sales deleverage.

Freight costs decreased 10 basis points due to continued improvement in transportation cost management, and changes in store delivery methods. Merchandise margin declined 40 basis points, primarily due to additional markdowns taken and promotions run to drive sales.

Operating expenses were $29.6 million, or 36% of sales, for the quarter as compared to $28.8 million, or 31.1% of sales, for the prior year quarter. Store level operating expenses increased 420 basis points as a percentage of sales, reflecting deleverage due to the sales decline, planned increases in marketing expenses, and higher store maintenance and insurance costs.

At the corporate level our expense ratio was up 70 basis points as a percentage of sales. Total expenses at the corporate level were down versus the prior year quarter on a dollar basis, but deleverage caused by the sales decline led to a higher percentage ratio.

Included in operating expenses, relocation costs associated with our establishment of a store support office in Nashville, Tennessee were approximately $200,000 for the quarter before tax, or less than $0.01 per share. We expect the majority of the cost associated with this move to fall in the second quarter of fiscal 2007.

Our first quarter results also include a non-cash charge related to the impairment of fixed assets of four underperforming stores as required by generally accepted accounting principles. This charge totaled approximately $273,000 on a pretax basis, or $0.01 per share, and is included as a separate line item on the statement of operations in this morning's release.

Depreciation and amortization increased 150 basis points as a percentage of sales, reflecting the comp deleverage, new store openings in 2006 and 2007, and a reduction in the average term of our leases. We also accelerated depreciation on some planned store closings which contributed to the increase.

Net interest income was higher than the prior year, reflecting higher average cash balances and better rates on invested cash. Our effective tax rate for the quarter was 40% compared to 41% in the prior year quarter. Our earlier guidance had estimated the tax rate to be 42.5%, and the recording of a 40% tax rate resulted in a reduced benefit of approximately $300,000, or $0.02 per share, against our previous guidance.

Net loss for the quarter was $7.5 million, or $0.38 per share, compared to a net loss of $3 million, or $0.16 per share, in the prior year.

Turning to the balance sheet, inventories at May 5, 2007 were $49.2 million, or $142,000 per store, as compared to $49.9 million, or $148,000 per store at April 29, 2006, representing an overall decrease in inventory of 1% year-over-year and 4% on a per store basis. We anticipate inventory levels to decrease to approximately $47 million to $48 million by the end of the second quarter, as we execute our semi-annual clearance event in July, and having moderated future on-order to more closely match our sales trends.

The operating losses during the first quarter, combined with an increase in working capital, and cash tax payments resulted in our ending the quarter with $300,000 in cash, with $1.4 million in borrowings outstanding on our revolving credit line. At the end of the quarter we had over $25 million in additional borrowing capacity under our credit agreement.

For the quarter our capital expenditures were $3.7 million, the large majority of which related to new store construction. This amount reflects gross capital expenditures before landlord allowances.

The final topic I will cover today is our guidance for the second quarter. We are forecasting a net loss of $0.35 to $0.40 per share. We estimate that comparable store sales will range from a decrease of 12% to 15% for the quarter. Total sales are anticipated to be between $85 million and $88 million. We anticipate gross profit margins to be higher despite continued deleverage on fixed cost, such as store occupancy and central distribution, due to improvement in merchandise margin.

We experienced significant markdown activity in the second quarter of the prior year. And while we do anticipate higher markdowns than in the first quarter due to planned clearance activity, we expect merchandise margin improvement over the prior year quarter.

We expect to experience significant deleverage on the operating expense line due to the expected decline in comp sales. This guidance for the quarter also includes approximately $0.05 per share in one-time costs associated with the initial opening of our store support office in Nashville, Tennessee. We anticipate the bulk of these costs to be incurred during this quarter.

We anticipate the opening of approximately 12 stores and closing of approximately 6 stores during the quarter. As we mentioned in this morning's release, due to the persistence of adverse trends in the home decor sector, and our ongoing turnaround efforts we have elected to discontinue the practice of issuing annual sales and earnings guidance at this time. Going forward we will issue guidance one quarter in advance.

For the full year we anticipate total CapEx to be approximately $16 million to $17 million. Taking into account the landlord allowances we receive when we open stores, we anticipate CapEx for fiscal 2007 to be approximately $5 million to $6 million.

I will now turn it over to Cathy for an update on current business initiatives.

Our team is obviously very disappointed with the first quarter results we reported to you on Q1 half-light through the quarter on March 15, and I think we were pretty much on target with the severity of the trends described.

Final Q1 financial performance was slightly worse than anticipated due to the sales shortfall. Persistent issues with declining traffic and data conversion trends were primary positive factors. We told you that we were focusing on broadening our merchandise assortment, delivering high-quality trend and color-right assortments, and re-establishing Kirkland's as a gift resource. While we have managed to deliver on each of these initiatives, they did not produce the sales response and definitive merchandise turnaround that we had hoped for. We overemphasized the new initiatives and took our focus off the core merchandise productivity.

The new merchandise initiatives constituted approximately 20% of our SKUs, and they did successfully set a different tone for both the style and quality of the merchandise, and positioned our offering clearly on trend as we planned. We supported these trend statements with strong collateral inside the stores to call out the trend-right changes to our guests, and provided some early, but largely unsuccessful, marketing support in an attempt to drive customer interest and traffic.

Actually, while overall business results suffered noticeably versus last year in our plan, the primary themes performed reasonably well for the dollar investment and number of SKUs deployed.

Given arguably good sales and margin performance, the key question is why didn't this effort lift the overall business? First, we didn't invest strongly in key items within these themes. We had some items that were big winners, specifically in wall decor, textiles and decorative accessories, but we bought each program much too broadly and didn't support those big winners with enough product depth to drive the business, and thereby did some customers (inaudible) sales.

We shared the example with you that within our Gracious Elegance trend statement, 10% of the SKUs accounted for 70% of the business at the time. We did not buy enough to capitalize on the sales potential for this trend. We have reordered the best sellers, and they will be in store later this month, and changed our buying practices going forward.

Second, the secondary themes did not perform nearly as well as expected. Although the dollar investment was not as large, the money spent on the three secondary themes could have been used much more effectively in key items (technical difficulty) primary themes. These secondary statements were definitely more fringe in terms of broad appeal, and we paid for that mistake.

Third, the insertion of gifts into the mix in an effort to drive more frequent store visits was too much of a stretch. The performance of Valentine's Day and Easter merchandise, and especially the Baby, Spa and Wedding programs, suggests that a gift strategy is best executed in our stores by offering our guests wonderful items at a value price, and which are related to our core competency in home decor.

The idea of gift giving is still important. Our focus has shifted from gift giving occasions to offering great items at a great prize that our customers are proud to give. Much of the merchandise we offered was open stock, which is tougher to merchandise in great quantities, and does not create the same excitement as stack out the key items.

While the gross dollar investment here was not great, any ineffective use of inventory investment, store and merchant labor, and precious selling space is harmful. Though not terribly impactful in Q1, we will continue to see some sales and margin impact in Q2 as we clear slow sellers from these gift groups.

Fourth, and perhaps the most important lesson, is that in the effort to affect dramatic but conservative change, we took our eye off the ball. 20% of the SKUs received far too much attention in our buying group, in-store collateral and external marketing pieces, as well as floor positioning and sales staff focus. Consequently we did not drive our core category businesses with sufficient key item purchases to make up the difference. And we clearly let trend-right and style dictate the tenor of our store to our detriment.

For four years Kirkland's has been a sector leader, enjoying a reputation with customers for delivering value via new, ever-changing, different and often proprietary merchandise presented in a treasure hunt environment. Our customers never knew quite what to expect from us, but they did expect that whatever we offered would be different from what others had and at a great price. I don't think we did that very well in Q1. And we certainly failed to price some of our gift and themed merchandise appropriately for a value conscious, middle income customer in an economic environment that rewards the unique combination of price, quality and distinctness. Our customers recognize trends and react to great merchandise, but demand that it be offered at a value price.

But given these business results and hard-learned lessons, what are we doing about it? The simple answer is focusing on key items and great value. We began reacting in Q1 to our early read of the results, and shared some of our action plans with you during the last call. Because of leadtime for merchandise, we were not able to impact the business in quarter, but the second quarter should reflect some of those efforts. We have already started a series of value-driven category events to reflect the change in strategy.

On the headquarter structure side, (technical difficulty) not incidentally we have consolidated all the marketing and visual presentation teams and resources to make sure we support what we buy, how we present it, and what we say about it to the customer with a value message.

Merchandise themes are not inherently unproductive financially, if executed with a key item mentality. Going forward the number of merchandise themes set on our sales floor at any one time will be reduced significantly, as will the number of SKUs in each theme and collection. We do believe that the opportunity to showcase products and combinations helps present great ideas and drives sales. We are giving primacy in floor positioning, windows, in-store collateral, and external marketing to value merchandise and key items. Robert will now make some comments on our efforts on building our team.

Much of our effort in the past many months has been directed toward rebuilding our team. Progress has been slower than we had hoped for; however, we were very pleased with the recent events. Our existing team is responding to the leadership and instruction of our new General Merchandise Manager and head of Planning and Allocation.

Up until now we just haven't been experienced and talented enough at the top of our merchant team to plan, buy and allocate an effective merchandise mix in an environment of tough competition and challenging macroeconomic conditions, and while operating what is essentially two store groups with our mall and off-mall mixture of stores.

We have had the vision, but the execution and process piece has not been there. While we will certainly have some missteps and course corrections going forward, I believe that we're on our way to building a confident, stable and even outstanding merchant team that is already making a difference.

The team building is not just limited to merchants. A weeks ago we added a new Director of Visual Presentation to the group to help the execution of store level merchandise presentation. Since our last call we brought onboard our new Director of Stores, Jeff Ostler, from Hastings Entertainment and Dollar General, who brings a pragmatic and tactful approach to store operations, aimed at maximizing store resources, including our (technical difficulty).

As I said six weeks ago, we have some big challenges ahead. The tough economic conditions are not likely to abate in the short term. None of us can control gasoline prices, housing slumps, mortgage rate increases, and their collective effect on the discretionary income and confidence of our middle-class customer. Our customers don't need anything we sell to sustain life, just to make it better, so the traffic trends may not reverse in the near term. Competition is not going to lessen, rather it may get tougher as other retailers seek to make value statements with their merchandise in an effort to change their current fortunes.

For us, while all those factors matter, none of them are within our control. Success for Kirkland's remains a combination of our still large and loyal customer base, the value orientation of our merchandise, a better located and more financially advantaged venue off-mall, continued strong inventory cash management and expense control, and a deeper, more talented team.

We implemented considerable change after the recent holiday. And while it didn't produce the resoundingly positive results we had hoped for, we did learn a lot, and have been very clear to course correct. On the merchandising side specifically, we just lost focus on doing it the right way, or the Kirkland's way. Our much anticipated turnaround is not going to happen in the second quarter, but I am confident that we will soon experience improvement. Thank you for your confidence.

Operator, we're prepared to take questions.

(OPERATOR INSTRUCTIONS). Neely Tamminga, Piper Jaffray.

Just a little bit more clarity on merchandise margin opportunities. Obviously, you have listed several understandable factors that you can't control. But I'm just wondering in terms of how we are looking at the merchandise margin going forward, is it just a reduction of markdowns, or is there also some sourcing improvements that we could be seeing here that you're working on right now, particularly with Cathy and Sharyn's arrival?

It is Cathy. I think that the key thing for us is thinking in terms of how we offer value, which means that we are not looking to raise prices to increase the margin, but rather buy it smarter. The first quarter saw some damages in some of our categories that we shared with you that has hurt our margins, specifically in the furniture category. I think there was some fallout in some other categories as well.

What we have done, and particularly with the introduction of Sharyn into the mix, is recognize that there are other vendors that we can do business with, and introduce some other people into the mix that allows us to negotiate better cost upfront in terms of how we are buying product.

We are focused on buying our product as smart as we can and as intelligently as we can. But we will go back and challenge the existing products we have and the costs we're getting based on the costs that new vendors may be able to introduce to us. So having done that, we have gone back and had conversations, and particularly on the big key items we have, and the things that we believe will actually deliver the most productive efforts for us. Our focus on this has especially been in the wall category and in framed art specifically as we work to get back the wall business, which we think we have to do.

Cathy, can you speak maybe a little bit more -- every situation is obviously going to be different, but are they coming back with 10% better costs, or is it like more dramatic than that?

I don't know that I could give you specific examples. I think it is more on an item by item basis. We have gone back and said, how can we do this better? And think about shipping better and smarter and across the whole supply chain, consider how we make those changes. But it is closer to -- in the art category it is a little less than 10%, but it is still a dramatic improvement.

Just following up on that, so obviously markdowns are also an opportunity going forward, is that correct? Markdown rate improvements?

Yes, and I think that was a question of a lot of the stuff, the way we bought some of the product this year or the merchandise themes that we talked about. We bought a lot of SKUs, and so we have to take markdowns on the products as we go through those themes and clear those out.

But I think for the most part that what we have -- we have gotten smarter about how we go about markdowns. We have actually changed responsibilities of someone within the merchandise team to focus on maximizing markdown productivity and efficiency. I think we've gotten smarter about using -- surgically thinking about where we need to take markdowns on what, rather than wholesale markdowns at drastic markdown rates. That is making us smarter and gives us a further opportunity for improvement.

As we think about the initiatives and some other process changes that have gotten under way, is there something that could be more reflective in the assortment in Q3/Q4, or are we into early next year on some of these process changes, where the change might be a little bit shown through the P&L?

We started this work in Q1, so we believe it will be more evident in Q3 and Q4. A lot of these things are tactical as we go after them, and we can make the changes quicker than allowing for next -- before next year obviously.

That's great. And I do have one quick housekeeping question for Mike or for Cathy. Just regional performance, did you see anything different by region?

This is Mike. Not particularly. I think we have talked about in the past that the North region, or the stores we have in the North, Midwest and Northeast, haven't performed as well, but on a comp basis I think for the quarter it was pretty similar.

Great. Thank you guys. Best of luck.

I would also mention that I don't think we have done a great job in leadership and managing our stores in the North, and that would include some of the Midwest stores. We are really putting a serious amount of emphasis in getting better people involved there. And we believe that there is a lift in those stores just from running them better. And certainly as we put better merchandise in that stores that we expect some improvement there.

Maybe I should start moonlighting then?

Yes. Absolutely.

Glad to have you. (multiple speakers).

Good luck you guys.

(OPERATOR INSTRUCTIONS). At this time we have no further questions. I would like to provide everyone one final chance to signal for questions today. (OPERATOR INSTRUCTIONS). Mr. Alderson, there appear to be no further questions. I would like to turn things back to you for any additional or closing remarks.

We appreciate everyone being on the call today, and we look forward to talking with you next quarter. Thanks.

Once again that does conclude today's conference call. Thank you for your participation. You may disconnect at this time.