Brand House Collective Inc (TBHC) 2010 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Kirkland's, Inc. fourth-quarter 2010 conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question and answer session. (Operator Instructions).

As a reminder, this conference is being recorded Thursday, March 10, 2011. I would now like to turn the conference over to Tripp Sullivan of Corporate Communications.

Good morning and welcome to this Kirkland's, Inc. conference call to review the Company's results for the fourth quarter of fiscal 2010. On the call this morning are Robert Alderson, President and Chief Executive Officer, and Mike Madden, Senior Vice President and Chief Financial Officer.

The results, as well as notice of the accessibility of this conference call on a listen-only basis over the Internet were released earlier this morning in a press release that has been covered by the financial media.

Except for historical information discussed during this conference call, the statements made by Company management are forward-looking and made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve known and unknown risks and uncertainties which may cause Kirkland's actual results in future periods to differ materially from forecasted results. Those risks and uncertainties are more fully described in Kirkland's filings with the Securities and Exchange Commission, including the Company's annual report on Form 10-K filed on April 15, 2010.

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

Thanks, Tripp, and good morning everyone. We appreciate you joining our call today. The fourth quarter was challenging, but we are pleased with the accomplishments we made as a Company in fiscal 2010.

In historical terms 2010 turned out to be the second-best earnings year we have ever had, second only to the phenomenal performance we had in 2009. However, comp trends were challenging in the back half of the year, and we are responding in various ways to address those trends and reestablish our sales momentum.

I will provide some additional thoughts on these topics in a moment. For now I will turn the call over to Mike Madden, our CFO, who will walk you through our financial results and position.

Thanks, Robert. Good morning everybody. I will begin with a review of the fourth-quarter financial statements and then finish with financial guidance for the first quarter and some performance goals for fiscal 2011.

For the fourth quarter net sales were $139.6 million or a 2.2% decrease versus the prior-year quarter. As previously announced, comparable store sales decreased 7.9%. Average sales per store were down 3%.

The comps sales decline was driven by a 4% decline in transactions and a 4% decline in the average ticket. The decrease in transactions resulted from flat traffic counts and a decline in the conversion rate. The decrease in average ticket was the result of a lower average retail selling price, partially offset by an increase in items per transaction.

Comp sales results were relatively consistent across geographic areas of the country. Among the more significant areas of the country in which we operate we had slightly better than Company average results in Florida and in California, due largely to economic recovery in those areas and easier comparisons.

And slightly worse than average results in Louisiana due to economic dislocations from the oil spill and drilling moratorium; and in Texas largely due to sales declines in our border stores.

Merchandise categories showing comp increases were floral, seasonal and gift. These increases were offset primarily by declines in our wall categories and decorative accessories.

E-commerce sales, which are not included in our comp base, where $1.3 million for the quarter. We launched our new website with a limited number of SKUs in early November of 2010.

In real estate we opened 10 stores and closed six stores during the quarter. At the end of the quarter we operated 300 stores. 241 of these stores, or 80%, were in off-mall venues, and 59 stores, or 20%, were located in enclosed malls.

At the end of the quarter we had 1,927,454 square feet under lease, a 14% increase from the prior year. The average store size was 6,425 square feet as compared to 6,073 square feet last year, a 6% increase.

Gross profit margin for the fourth quarter decreased 320 basis points to 42.3% of sales from 45.5% in the prior year. The components of reported gross profit margin were as follows. First, merchandise margin decreased 261 basis points as a percentage of sales. As expected, higher inbound freight costs negatively affected the margin during the quarter, accounting for 186 basis points of the decrease.

The remainder of the decrease in merchandise margin was equally attributable to a higher rate of promotional activity and markdowns as compared to the prior year, an increase in product damage rates, and slightly higher inventory shrinkage rates.

Second, store occupancy costs decreased 3 basis points as a percentage of sales. This slight decline, despite the negative comparable sales results, were driven by favorable lease renewals, relocations of stores to more productive off-mall locations, and above-plan new store openings.

Thirdly, outbound freight costs increased 55 basis points as a percentage of sales, reflecting deleverage from the comp sales decline and an increase in diesel fuel costs, as well as shipping and packaging costs associated with the initial launch of our new e-commerce capability.

Last, central distribution costs increased 7 basis point as a percentage of sales due to deleverage from the sales decline.

Operating expenses for the quarter were $33.4 million or 23.9% of sales, as compared to $31 million or 21.7% of sales for the prior-year quarter. Deleverage from the comparable store sales decline led to an increase in store wages as a percentage of sales, accounting for 64 basis points of the increase in operating expenses.

Stock compensation charges increased 32 basis point as a percentage of sales as a result of the increase in valuations associated with stock option and restricted stock grants.

Marketing expenses increased 32 basis point as a percentage of sales as a result of an increase in promotional e-mails and other activities, as well as a decline in comp sales. The remainder of the increase in the operating expense ratio is primarily due to deleverage from the comp sales decline.

Depreciation and amortization increased 8 basis points as a percentage of sales, reflecting the decline in sales, combined with an increase in capital expenditures during 2010.

Operating income for the fourth quarter was $22.2 million or 15.9% of sales as compared to $30.5 million or 21.4% of sales in the prior-year quarter.

Income tax expense was $7.9 million or 35.3% of pretax income versus expense of $8.4 million or 27.5% of pretax income recorded in the prior year quarter. Income tax expense for the fourth quarter of fiscal 2010 included a net benefit of approximately $800,000 related to an adjustment to the prior-year income tax provision, partially offset by a revaluation of the state tax rate on deferred tax assets based on tax planning strategies implemented during 2010.

Income tax expense for the fourth quarter of fiscal 2009 included a benefit of $3.3 million related to the reversal of a portion of the valuation allowance on deferred tax assets that had been established in prior periods.

Reported net income for the quarter was $14.4 million or $0.70 per diluted share as compared to net income of $22.1 million or $1.08 per diluted share in the prior-year quarter.

Excluding the impact from the tax items I mentioned, adjusted net income for the quarter was $13.6 million or $0.66 per diluted share as compared to net income of $18.8 million or $0.92 per diluted share in the prior-year quarter.

Turning over to the balance sheet and the cash flow statement, inventories at January 29, 2011 were on plan at $44.5 million or $148,000 per store as compared to $39.4 million or $141,000 per store in the prior year.

While these numbers reflect an increase in the total inventory of 13%, and an increase of 5% on per-store basis, total square footage increased 14% year-over-year and the average store size increased 6%. Therefore, inventory levels are in-line with the prior year on a per square-foot basis.

We expect to end the first quarter with inventory levels in the range of $44 million to $46 million.

At the end of fiscal 2010 we had $91.2 million in cash on hand, an increase of $14.8 million versus the prior year. No borrowings were outstanding under our revolving line of credit.

For the full year cash flows from operations where $36.7 million. Capital expenditures for the full year were $22.6 million. Of the total capital expenditures, $14.4 million related to new store construction, $6 million related to information technology projects, and the balance related to maintenance capital expenditures.

The final item I will cover before turning it over to Robert is to provide some guidance on our outlook for the first quarter of 2011 and some high-level performance goals for the full year of fiscal 2011.

For the first quarter ending April 30, 2011, we expect total sales to be in the range of $94 million to $96 million, reflecting a comparable store sales decline in the high-single-digit range, compared with net sales of $93.5 million and a comparable store sales increase of 12.6% in the prior-year quarter.

We expect some continued pressure from inbound freight costs during the first quarter, but not to the level we experienced in the back half of 2010. Excluding the freight impact, merchandise margins have been relatively strong for the first quarter to date. Operating expenses in the first quarter are expected to increase year-over-year at a rate slightly higher than the rate of store growth.

Earnings per share expected to be in the range of $0.10 to $0.14 per diluted share as compared with $0.32 per share in the prior-year quarter.

We expect to open approximately three stores and close six to eight stores during the quarter. For the full year fiscal 2011, as it relates to store count and store growth, we expect to open approximately 40 to 45 stores and close approximately 15 to 20 stores. We will update our progress on this growth plan each quarter.

The store openings will be weighted toward the back half of the year and the closings will be relatively evenly spread across the quarters.

The real estate market showed signs of tightening due to the lack of new development. We are still confident in our ability to secure locations and open stores, but the process for securing deals in existing centers is a bit more laborious than with new development. The opportunity for growth in store count remains, but our primary focus is to be very selective in location and the economics of each deal.

Our topline expectations are for total sales in fiscal 2011 to be above fiscal 2010 in the range of 9% to 12%. This level of sales increase takes into account the store growth expectations, combined with a flat to slightly negative comparable store sales decrease.

Given prior-year comparisons and the current trends in the business, we would expect comparable store sales trends to improve as the year progresses.

Based on our current conservative outlook, we would expect operating margin for fiscal '11, to decline slightly from the 10.1% recorded in fiscal 2010. We expect sourcing cost pressures and transportation costs to increase due to rising oil prices, particularly impacting the back half of the fiscal year.

Additionally, the flat to slightly negative comparable store sales expectation would result in some deleverage of occupancy costs and other operating expenses. However, we are encouraged by our merchandise margin results thus far in 2011. And we are also optimistic about our new store activity continuing to be a contributor to topline growth and earnings.

With a tax rate assumption of approximately 38.5% for fiscal 2011, at this time we would expect earnings per share to be at or slightly below adjusted earnings per share for fiscal 2010.

From a cash flow standpoint we anticipate again generating positive cash flow in 2011 and fully funding our new store growth and technology improvements through internally generated cash flow. We do not anticipate any uses of our line of credit in 2011.

Capital expenditures are currently anticipated to range between $25 million and $28 million in 2011, before landlord construction allowances for new stores. We currently estimate that approximately $16 million to $18 million of the total capital expenditures will relate to new store construction, and $5 million to $7 million will relate to information technology investments, with the balance of our capital expenditures relating to maintenance and store merchandise fixture enhancements.

We plan to update these annual performance goals and outlook each quarter during 2011. Thank you, and I will now turn it back over to Robert.

Thanks, Mike. As expected, given tough multiple-year comparisons and a year-over-year difference in sales momentum entering the quarter, both our annual and fourth-quarter earnings results met the lower end of our expectations in terms of guidance, but were not what we had hoped.

Yet I would note that of the $0.18 delta on year-over-year adjusted earnings, $0.13 can be attributed solely to increased inbound freight cost that affected our merchandise margin. The fourth quarter was strongly affected by such adverse cost.

Quarterly sales were also affected in store by flat traffic after experiencing nice gains throughout the year. Transactions, conversion and average ticket were all down low- to mid-single digits for the quarter, largely attributable to a less robust season and less productive sales in our core categories.

Seasonal Christmas merchandise performed well and consistent with the prior year. The performance lag in our important wall category, specifically in framed images, continued throughout the quarter, and impacted quarterly sales performance.

As we indicated in previous public comments, we recognized the weaker back-half art trends and started evaluation and remedial steps in this category by the midpoint of the third quarter. In our opinion the downturn in art sales was partially attributable to our actions and execution and partially to a downtrend in the category nationally, probably driven by an extended period of dislocations in the housing market.

We can and expect to repair our process and offering in the category, but we don't expect the housing market to recover significantly in this fiscal year. Thus we expect to see some continued headwind in the wall categories, which for Kirkland's includes framed images, alternative wall decor, mirrors, large clocks and wall frames.

Six weeks into fiscal 2011 we are encouraged that our framed image business, which is our largest wall component at 14% of total revenue, is already stronger than last year in terms of sales, gross margin percentage and average retail. That is a nice and significant accomplishment.

However, during the same time period we have not yet seen a comparable lift in the other components of the wall category, which were collectively 22% of our total revenues in 2010, and expect our work on improving results there to continue well into the second and third quarters.

2010 was marked by a return to net store growth for the first time since stopping store growth entirely in 2008 as part of our recovery plan. We continue to close mall stores when we have a replacement opportunity that fits our expectations to selectively backfill existing markets, and very consistent selectively consider new markets.

Our 2010 class of 38 new stores exceeded our early expectations in number, as we experienced good availability of locations and economic deals throughout the year. This class has less than a full year of actual sales results, but even with the sales downturn in the back-half of the year, we expect it to perform moderately behind the class of 2009, but still significantly better than our new store model.

The class of 2010 is larger, more geographically dispersed than the prior-year class and averages 8,481 square feet, which fairly represents the preferred footprint of 8,000 to 10,000 square feet in dominant strip centers going forward.

We successfully restarted our direct sales to customer piece of the e-commerce business in November 2010. Our focus in this phase of the project was on carefully ramping up our SKU offering as we tested our new software platform and oriented our new e-comm merchant and management team.

We largely met our 2010 goals, as we focused on anticipating and meeting customer problems and expectations, as well as vetting our business process and model. In 2011 we expect to add a third-party dropship to customer capability, and carefully built a partner vendor base for this important element of the business.

We issued sales and earnings per share guidance earlier today for the first quarter of 2011 and provided performance goals for the year. We were reminded that only being five weeks into the year, while at the same time facing outlier prior-year sales and earnings comparisons, is not the most ideal moment in time to frame 2011 expectations.

We do not have good visibility into the trends in the landed cost of products sourced from Asia at the moment. We are very aware of the pressure on product costs arising from persistent inflation in China, deriving from rising costs of raw materials, and especially labor costs.

The extent of such rise depends largely on continued strong demand, as was demonstrated by the strong price pressure throughout 2008, which was negated almost instantly by the drop in demand occasioned by the fall market crash.

Also, we can only speculate on the year-long effect of more than a minimal appreciation of the Chinese currency versus US dollar, as we have no special knowledge of how well and for how long China will balance competing interest in managing the currency markets.

We had anticipated lower and more historically normal inbound freight costs for containers and relatively stable outbound fuel costs for merchandise deliveries in 2011, especially in the first-half. But the recent sharp spikes in oil prices quickly generated surcharges in both areas last week, with a clear prospect of more increases if the political unrest in the oil-producing world continues to affect expectations on production and delivery.

The US consumer is affected by all such matters. Kirkland's has some product price elasticity, which we will carefully exercise, but we have no control of many external factors that determine consumer confidence and spending.

We believe that consumer spending was affected during the period April through December 2010 by consumer perceptions related to US domestic and financial issues. And that may be the case again this year, albeit for different reasons.

That said, we have seen strong merchandise margin performance for the short year-to-date. We expect to improve our [framed] wall business, which is well underway with the framed image component.

We expect to carefully adjust our allocation of dollars to tweak the productivity of our product mix. For example, we expect to sell more accent furniture and seating this year, which should have an impact on some of our transactional metrics.

We continue to work on additional product lines that are accretive to our overall business. We expect to react appropriately to the pressure on product prices through a variety of means, and not by just increasing prices, although some of that will be necessary.

The heart of the Kirkland's 45-year appeal to customers, and the basis of our connection to our loyal customer base, is to consistently deliver clearly discernible value, which to us is a combination of price, quality and style.

We continue to believe that our merchandising philosophy well-executed provides us with continued strength and relevance in our sector of the marketplace.

Thank you for your time and interest. We are prepared to answer questions.

(Operator Instructions). David Berman, Berman Capital.

Outstanding results. I was just curious about the store growth. Given that the business is a little bit weaker than one would expect, to what extent you considered reducing the store growth.

Also, the capital expenditures from that comes to almost close to $1 a share, which is nice cash to have.

On the growth issue, first of all, we are really -- we are not in a growth at all cost mode. I think we said in the release that we are going to be very cautious. We have said this since 2008. Right deal, right location, we will do it.

I would point out that we don't think the box is broken. We don't think the business is broken. We would have loved to have had better fourth-quarter results, but we don't think that is a reason to pull back.

We still have historically great deals out there, although the deal market for real estate may be firming slightly, and we may see some tightening on space availability throughout the year. So there is still a great opportunity to set up deals that will do extremely well financially for Kirkland's over the next 10 years.

Then I think the last thing I would say is that when you look at our store openings and store closings, and then you look at the 57 or so stores that we still have left that are in mall stores, we are not going to be growing a whole lot. If we drop those -- continue to replace those stores effectively over the next two to three years, we are really maintaining the store base critical mass and the revenue of the Company, as opposed to being on some really high trajectory growth rate.

Right. So you're not finding it is taking away from your management skills in terms of trying to turn the ship?

We don't think so. I think, as always, there is a cost related to growth. You have to have the right number of people to be able to open and close stores, and you have to generate the management. All of that requires some investment in people, but I think it is manageable, and I think that is something that we pay a lot of attention to.

The main thing that I think you should remember is -- this is -- we are very conservative and we look at every deal very, very carefully.

In terms of your (multiple speakers).

I was going to say, Dave, the new stores are outperforming our model that we have put out there when we talk about growth and that is encouraging as well.

That's good. You also -- part of your capital expenditures were also for a POS upgrade, which I think cost quite a bit of money. Aren't you [running] that up now or some point soon? And that kind of benefit should we see from that on the bottom line?

It is not only point-of-sale. We have been working on various technology projects. One was our e-comm platform, which we finished and rolled out last year. One was a financial reporting package that we went live with at the beginning of this year. And then that left POS and merchandising, our back-office system that we are working on replacing.

So both the POS and the merchandising project are scheduled for a 2011 implementation. And I think it will take most of the year on both of those to get them implemented.

And the benefits -- we are with two systems right now that are about 10 years old; they need refreshing. We need to get updated with the partners that are going to be investing in our systems over the next 10, 15 years. So that, and then especially on the merchandising side, we have a lot of opportunities to improve our store level assortment and allocations, and with the new system gives us new capabilities to do that.

Well, good luck with that. So when can we start to hear from you on that?

I think we will continue to update that throughout the year. I think the benefits really are going to be 2012 and going forward from there.

Okay, good. Thank you very much. And despite the poor sales, the operating margins are still healthy and cash looks good, so thank you.

Anthony Lebiedzinski, Sidoti & Company.

You mentioned that your new stores are outperforming the model. What would you say are the main reasons for that?

Well, I think first and foremost, better real estate. We have, as we have discussed a lot, been moving out of the enclosed mall, the enclosed regional mall, which we felt, as it relates to our customer base, those locations have changed over the years and aren't as shopped by our customer as they used to be.

So the new real estate in the strip center with the co-tenancy that our customers frequents is probably the most relevant item there. So that is topline.

Then on the occupancy costs, the rates we are paying in rent are a lot lower than historically in the malls or in the lifestyle centers. So the combination of those two continues to be the reason that we are outperforming now.

And in what markets are you looking to open stores this year?

We will continue to backfill existing markets and replace mall stores. I think that is the first consideration that we give when we are looking at location, and the first priority.

The second is we try to backfill existing markets. We always love to do those in the Southeast, Texas and places where we have large name recognition and a large customer base, and we can identify a market that we are under-serving.

But we will add some stores in California in 2011, where we are doing extremely well. The upper Midwest, the new stores we are doing there are doing extremely well.

Mid-Atlantic will be an area of focus for us this year. It is an area where we have been somewhat lightly represented but have had very productive stores, even in malls.

So I think we have plenty of opportunity without getting too far afield. The one thing that we do have, there are a number of companies that are trying -- beginning to ramp up growth. But we have some momentum in that market, and we have a fairly large group of deals that have been worked for some period of time. So we feel pretty -- it is a reason we said we feel pretty good about being able to obtain what we need in 2011, even without new development being a big factor.

You also mentioned you expect some tightening of the commercial real estate markets. With that in mind, would you perhaps look to accelerate the store openings for the year?

I think we have a plan that we think is manageable, given the resources that we have, the number of deals that we have in play that can actually be executed within the year. So I don't think that would particularly drive any measurable increase. I think we pretty well know what we can do.

It is very difficult -- Mike mentioned this in his remarks earlier -- it is very difficult to get a deal done and get the space when you want it, and be able to get the store open within a timeframe that you would love to have it open. So if we said today, gosh, we would like to do 20% more, I'm not sure we could do that, to be frank. I think we have some deals that we could do, but the question would be when would we get the space?

A lot of it, Anthony, has to do with the spaces that are available are big-box spaces that sometimes require the landlord to go in and develop out into smaller units of a 30,000 foot space, and there is a lot of work to do in those instances.

Those guys are very reluctant to do those deals. It represents a large upfront cost. They've got to do some serious remodel to break it up with utilities and demising walls and a redo of the storefront. And it really changes their expectations with respect to the property financially. And they would love to find a single user replacement if they could to quickly replace their cash flow. So those deals take a while.

And, lastly, you have a great balance sheet. The cash flow here is good. Other than new store openings, some technology improvements, do you foresee any other uses of cash flow?

We haven't announced anything else. If there is anything that happens that we feel like we need to talk to you about, we certainly will.

Okay, it sounds good. Thank you.

Chris Rapalje, SunTrust Robinson Humphrey.

Just a few questions. First, with the merchandise right now, I guess just big picture when you look at the spring offering, and then maybe some of what you have coming beyond that, do you feel like there is any opportunities for adjustments there or are you feeling good with the right cadence with your customer, etc.?

Yes, I feel pretty good about our first-half offering. Our spring, and then as we go into the summer, I think we -- as always, we make a really strong effort to make it new, fresh, different, to flow it rapidly in terms of new ideas.

And I think we are trying to do a much, much better job of communicating with the customer about it through various Internet vehicles. So I feel pretty good about it.

Our merchandise cycles run sort of 90, to the topside 120, 150 days when you get into textiles and some other things. So when you are in March you pretty well have made your bed. So we will play this out. I think it is going to do reasonably well, as we said. I don't know that that is going to change.

Then with the guidance, I am just wondering what your thoughts are versus traffic trends versus ticket going forward?

I think that we said in the fourth quarter traffic was more flat, and so I think that you can assume that we thought about it that way going into 2011. We are working on it. We look at the ticket and we try and manage that. We realize we have got some opportunity there.

Then my last question was just whether you have been seeing anything different on the competitive front, any new sources of competition there, anybody being more aggressive?

Not so different. I think there obviously has been some nice recovery by peer and cost plus world markets. And we are glad to see that. They are big factors in the co-tenancy that we are looking for in dominant strip centers, along with the usual players.

But the Kirkland's way of doing things well-executed is -- and the way that our product mix shakes out makes us significantly different, and I think we are happy with that.

Okay, well, thanks very much. And good luck.

Jennifer Milan, Sterne Agee.

I am just wondering back to the cost environment, if you could give us any more color where you are in terms of your receipts and forward buys? And then any particular areas of pressure that you are seeing?

And you talked about prices being a potential offset. I was wondering if you could quantify that at all and talk about maybe other potential offsets?

Jennifer, I don't think we are in a position. I think we have said we didn't have a lot of vision into some of this. We have not been greatly affected at this point in time with respect to buys that we have in the system and that we are currently negotiating that would take us into the fall.

I think we are seeing in some places some increases being suggested. I think we are doing a pretty good job of managing that based on how we reported our early margin trends to you.

Some of the apparel people have reported expectations of mid-single-digit up to mid-double-digit increases in costs in the cotton and some of those areas. We are not terribly affected by that. But we do expect maybe sort of mid-single-digit pressure later in the year.

I think that is probably about as far as I would speculate. A lot of it depends on demand, as I said in my remarks. And I think the labor cost in China are the biggest piece of that, if that was what you were asking about in the first part of your question. I don't think it is as much raw materials as the pressure on labor costs.

Yes, that is very helpful actually. Also, I was wondering if you could comment on any changes or plans for changes in terms of visual merchandising, and what response has been to the new signage in terms of less of a focus on blaring price points?

I think what we were trying to achieve is a better balance between talking to the customer in store about price and also doing things around branding and about lifestyle opportunities and showing ideas.

I think the idea of the new effort in visual merchandising is about presenting still a treasure hunt, but a more manageable and more understandable store for both the employees who work in the store and who are responsible for replenishing the floor and talking to customers and providing help, and also for the customers.

We are not going to compartmentalize or decompartmentalize. That was tried in our stores back in the 2006 and 2007 timeframe, and it really wasn't -- it didn't prove to be very helpful.

But I think we are seeking that balance. We have added some capability there, and are trying to build that team, and drive the information and ability and training down into the store so that we do a more consistent job. So I think consistency is one of the things that we are also looking for, in addition to balance and more manageability.

And nothing major in terms of the overall visual presentation within the stores?

I don't think you're going to see anything that is really a huge change that you're going to walk in and go -- oh, my gosh, they have really changed the store. I think it is going to be -- it is going to be a bit more subtle than that.

The wall is a big, big category for us. We talked about that a little bit earlier in our remarks. And we are working really hard on getting those things interspersed with other merchandise and more widely shown on the floor with other items. We're working really hard on showing ideas. And so the customer takes away more than the fact that they can get well-priced product, they can also do some things that are really effective in their store for a really good price.

I think we are overall -- too, we are upgrading the merchandise offering. It is very subtle, but I think we are offering better quality and better looks. And we are very much, I think, in the right color tones and on style. So I think we should see improvement in the floor over the year -- over the course of the year.

Okay, thank you. One last thing. I did notice a lot of changes or new merchandise in the art category that I thought looked great. And I'm excited to hear about the dropship direct to customers. I was just wondering where you are in terms of maybe other categories, such as larger rugs or furniture pieces for e-comm?

Working on it, actually. I think the dropship will be -- we're working on it right now. It is sort of our number-one e-comm priority. And hopefully by sometime late second quarter or early third quarter you'll see that at least in the early stages of being available.

I think it represents a great growth opportunity, especially on the SKU side and on the revenue side for our e-commerce business properly executed, and if we get the right partner base, and we make sure that we meet customer expectations.

I'm excited about that. And that certainly is an opportunity to do a lot of testing. And it gives us an opportunity to sell larger scale items and some -- that would be true in rugs and furniture and art and other things.

I appreciate your comment on the art. We really have made an effort beginning last year to make that a much more interesting and vibrant category, and I appreciate you recognizing that.

Thank you. Good luck.

Alex Fuhrman, Piper Jaffray.

So it sounds like if you strip out the freight costs, merchandise margins really weren't that bad in Q4, so can you talk a little bit about what you're seeing in terms of new customers' proclivity to convert at full price?

And when you say the decline in AUR we saw in the fourth quarter, is that primarily due to markdowns or is there also a merchandise mix shift element involved there as well?

I will cover some of that. You are right. The fourth-quarter freight was a big impact, by far the largest impact. We said going into the quarter we thought it would be more promotional; it was. We had to react to some of that, given our sales trend. But all in all, pretty strong first cost margins that we thought in the fourth quarter, and that continued into the early part of this year.

As for the AUR, that has been pretty much the case throughout last year. I think certainly part of it is markdown, particularly in the back-half. But I think more of that issue was mix related. And we are -- Robert mentioned we are going to sell a bit more furniture this year. We are doing some things to try and drive the ticket, and as a result the average retail price is going to be the driver there.

I think we used a lot of our better and more revenue-rich categories to drive business last year. And I think we learned something from that. I think we will have a better balance of how we do that this year as we do promotions.

And some of those shipping dislocations that we had last year affected our promotions. Things that we would have -- that we bought for promotional activity, but which didn't get here. Those typically, when we do that are at full margin, and we had to replace those. And we are backing up a little bit in the whole process so that we are able to ensure that things get here on time. And that was something that was maybe peculiar to 2010, but we don't want to see it repeated in 2011. So I think we have adjusted our process.

Right. Then just getting to the -- back to the real estate strategy a little bit. Can you remind us of the productivity differential between the mall and the off-mall stores? And are there any of your mall-based stores that are currently cash flow negative on a four wall basis?

We currently have very few stores, whether they are mall or off-mall that our four wall negative. It is probably less than 10, or around 10. It is probably -- it is a mix between mall and off-mall.

The productivity difference over the years has narrowed, at least as a percentage of revenue, because we have adjusted some rents in the mall stores, and we have closed the unproductive ones.

So it is not a problem in terms of they are unproductive; they are productive. It is a matter of finding a better location that can drive more topline volume. The mall stores still do quite a bit less in topline volume than the off-mall stores do. And they're smaller, and they limit us in terms of the things that we just talked about that we are trying to do in merchandising.

Then thinking beyond even the next two or three years, longer-term, you're still growing your topline at a pretty good healthy high-single-digit, low-double-digit rate, hopefully. As you approach and eventually surpass $0.5 billion in sales, what kind of options does that scale give you in terms of tweaking your supply chain and mitigating sourcing costs down the road?

I don't think we are still near the size of Target or Bed Bath & Beyond or some of the larger box guys who have 600 or 700 stores and significantly higher sales, and therefore buys. I don't know that another -- moving from mid-$400 million's to over $500 million is going to change that that much.

I think we are significant to our vendor base, and I think we get very good prices. And we have a very stripped-down model that we work with import vendors and factories where we [work] more direct.

So I think there are a lot of things that we do that are calculated to deliver the best price. And that has been consistently something that I think we have been able to do over the years. So I think it is going to be a while before scale gives us some larger advantage. Would you agree with that, Mike?

Yes, I would.

That is helpful, and that certainly sounds fair. Then I guess just real quick before I sign off here. You mentioned that color was pretty strong in the fourth quarter, that you guys had some good color tones and that you're seeing that. I am just kind of curious to which colors have really been the top performers here into the spring season?

Well, I was really referring to the currencies into the first-half or the spring half of the year. We are always using the bright primary colors in spring, which the reds and yellows and that group. But we have also done some purples and browns and some of the lighter tones and colors and worked those in nicely into the color palette.

So pretty happy with what we are doing there, because I think it reacts well, or it has been -- the customers reacted well to it.

That all sounds great, and thanks a lot, and good luck guys.

Bill Dezellem, Tieton Capital Management.

We have a group of questions. First of all, would you please discuss fuel prices in terms of the impact on your customers, given that part of their budget is now going to be going to pay for higher fuel?

Well, I think I said earlier in my remarks, I think the US consumer is always affected when anything affects their disposable income. So we have sort of mid $3 to high $3 gas on average right now. I don't know that that is a shock to anybody anymore given where we were a year or two ago when oil spiked up in the close to $150 a barrel range.

If we get $5 gas, that might be a shock. What has happened is that the trucking industry has reacted rather rapidly with feel surcharges. And we will see that in some expenses -- for our supply chain expense. And we've gotten a fairly small bunker fuel surcharge on inbound already. That will affect our business in terms of landed cost -- actual landed cost.

As yet I don't think that has translatable into higher prices for the consumer in our store. It might be down the line if it becomes more significant.

So you have not yet seen an impact on the consumer in terms of their buying behavior here just in the last month? (multiple speakers).

I don't know that we can make that attribution yet. I think it is too early.

Thank you. Next question is what do you feel is not correct or is the problem with the non-frame part of your wall business? And with that in mind, how are you addressing that?

I think we probably got a bit -- we probably drove the promotional side of alternative wall decor and the frame business -- the wall frame business a bit in the last three quarters of 2010. I think we blurred the lines between our everyday business and our promotional business. And I think it was a bit maybe disorienting to both our stores and to the customer, and probably resulted in less revenue being derived from the everyday business.

I think anytime we have a category that is not working, the process that we take here is that we step back, take a look, try to understand why we are not performing as well as we hoped. And we develop a plan to address that. If it involves selling the category down some in order to get a new start, we will do that. If it involves selling what we don't love about what we own down over a more protracted period of time, we will do that. But we will certainly try to adjust the dollars in the open to buy for those categories to make them as productive as possible.

We always give a lot of attention to new ideas and bringing new designs and things that are not found elsewhere in the marketplace as part of any recovery for a category. But it is much more -- it is a very holistic process, and requires the coordination and best thoughts of all the best people that we have inside the Company.

Would you anticipate selling down this category so you can bring some fresh things in or do not feel as though that is necessarily going to be required for this category?

I think at this moment in time I don't want to say very much about it because we're in the midst of evaluating a lot of things. We are always buying and looking toward new product and new designs. I think what the big decision for us to make as we go forward is can we more productively use dollars in other categories, or some percentage of those dollars in other categories, and when we benefit by some lesser amount of the offering. And that is the process that we go through constantly -- monthly literally in our open to buy discussions and evaluations of product performance.

Thank you. Then one additional question. The e-commerce side, what is the timeframe to get your full SKU count that you are targeting on the Web, to get all those SKUs there?

I don't think we know what the optimal SKU count is for our business right now. It is right around 1,000 SKUs at the moment. That is certainly on the very low side. Dropship with vendors where we don't touch the product, when it is fully implemented will almost give us infinite opportunity there on the SKU side.

But in terms of what we actually own and fulfill through our facilities in Jackson, Tennessee, I am not sure we really know that. I think that is something that we are walk carefully into. And that would be, I think, a process that will play out over the next six to eight quarters actually.

Thank you.

Brad Thomas, KeyBanc Capital Markets.

I just wanted to follow up on the performance of the 2010 class of stores and the 2009 class of stores. I was wondering if you could provide any more quantification around the annualized run rate that 2010 was coming in at? And how does the 2009 class perform as it started to enter the comp base?

Well, I will take the end of that first. It is still very fresh, Brad, because a lot of those stores were open late in 2009, so you don't have a lot of time there. But what I would say is they are comping better than the average of the Company -- they are doing better than the Company's comp, but still negative in the fourth quarter.

So that is -- but again, caveat that that is very earlier and we don't have many months of that in on the class because it was so back-ended.

What we have said about the annualized volumes, 2009 was -- their first year was about $1.9 million. As many of those out there know, what we have plan or what we shoot for in a new store class is $1.5 million. That is what we put out there.

The class of '10, again, early and we're using run rate techniques to get the number, but I would say it is right in between what we put out as a model and what that '09 class did.

The '09 class was heavily focused on relocations, and a lot of those stores matured faster -- or that class on average would mature faster than the class of '10.

Then the class of '10 obviously has been affected by the overall business not being as robust as '09. So there is a lot of factors in there, but generally that is what we are seeing, and I hope that helps answer the question.

That is helpful, Mike. So as we think about 2011 class that is ahead of us, would you think that 1.7 run rate would seem realistic? And does the balance of relocation versus new markets seem similar to what we had seen in 2010?

Well, it hasn't played out yet, so -- we have only opened one store, I think, at this moment in time. I think we will know what the class is going to look like largely by the time we talk to you guys next on a call. And we can give you a little bit more color on geographic dispersion, how many percentage that are replacement or not replacements. And then segment it into markets for you a little bit better. I think maybe we can try to do that.

But I think it will look more -- I think it will look a lot like the 2010 class. We have approved a lot of deals and are in lease negotiations and early stage of preparing to start construction. And I am encouraged by the composition, the class and the way the deals look.

We know there is going to be some -- or we think there's going to be some tightening in the market. And space is going to be a little tighter, as we move into looking at 2012 deals, but right now it is pretty good for us.

I think on a productivity side, we have been very consistent since we started opening stores again in 2009 -- we have been very consistent in picking the right deal and getting some better than modeled results from that group.

Thanks. Just to follow up on that, Robert, given that store openings is, I think, one of the key stories for the Company in 2011, can you just talk about some of the steps that you have put into place to ensure that you execute on this higher level of openings? I'm thinking in particular on the real estate front, the training of employees and in the recruitment of employees.

Well, I think we are -- that is always the question. It is a process to lease. You have to do it well. But, first of all, you have to pick the right place, and that is both art and science. End of the day it is a five or ten year marriage and it takes a while to get away from mistakes -- and you love the great ones.

As you try to make sure that every one of those are good, you have to really make sure that you vet the deal very, very carefully. And we spend a lot of time with that, with a group of people who are very experienced working with it and with a really outstanding broker group.

The second thing that we do is we get out and see the locations. That is another thing that this management team makes a real effort to do. So that we take responsibility for it and learn a lot about it. And it helps us determine whether or not we have made the right decision.

On being able to run the store effectively over a five to ten year period, depending on the term of the lease and whether you have any options in it or not, we are trying really hard to improve our store group.

We inserted a new leadership a year ago. We have since added to that leadership group. We just put a new Visual Director in place. We intend to bump up the ability of our store development team to allow them to do visual training and store analytical training for our store managers.

I think the training effort is something that is a real focus for us. And we will add some additional capability in that this year as we go downstream.

We are looking for a better store experience. And that is sort of the rallying cry around the efforts of our store leadership and Company leadership. We believe that we can add to the sales line, the top line, and the productivity on the margin side of each and every store by how well we display product and how well we treat customers that come in the store.

Customers cost a lot to get, and we are spending a bit more money, as you will notice, trying to communicate with them and convince them to come to our store, and largely through Internet and in-store activity. We will continue to try to get better at that. And we have added some capability already to make our creative effort better in 2011.

Brad, I think we're making some investments and we are focused on the right things. We just have to execute that. And we can have a better store experience in our stores, if we are committed to it and have the will to do it.

Great, thanks very much.

Rob Wilson, Tiburon Research.

Thanks for taking my call. Robert, you mentioned the freight surcharges that you saw a pickup last week. And I was wondering if this thought process was possibly incorporated into your guidance that you have given for the year?

Well, I think all the facts that we accumulate certainly are part of that overall consciousness that we bring to the process of trying to be fair, forthcoming. And yet at the same time -- you have known us for a long time -- we are a fairly conservative management team. We don't try to over or understate anything. We try to give you the best information we can.

So, yes. The answer is yes. This part of all of that overall consciousness that goes into those decisions.

On that, just a little bit more on that. Those surcharges where fuel related, and so you can take from that that they are not as significant as what we saw last year when the issue on the inbound freight was more supply and demand driven, and we saw major increases in container costs.

These are maybe a little earlier than we had thought we would see fuel surcharges, but it is not comparable to what we saw last year.

I will say that the industry did begin to adjust surcharges to drop some of them as they got through the calendar year 2010. So we saw the year, the calendar year, beginning with more normalized and more historically normal rates. And that is -- a little bit of what -- that is the way we expect the year to go, assuming that we don't have something really unusual happen in the oil-producing world.

Well, that's very helpful. Mike, are you going to include the Web sales in your comp sales or are you going to make that out separately?

We are going to break it out separately.

Okay, and then, finally, did you go into any new markets in 2010 or are you planning on going into any new markets in 2011?

I don't think we -- when you talk about a market I don't think we really opened some -- we reentered in mid-Atlantic, and then we went back into Denver. We did a store in Lake Havasu out in Arizona, which we have not been in that market before. That is sort of a one-store market.

We opened in Fresno in California, which is really an extension of the nucleus of that store base out there, which is largely Southern California. And the significance of that is that I think we will expand into the Central Valley out there very carefully up to Sacramento. And that will give us plenty of California growth for a while. We will be very content with that.

We will do some more upper Midwest stores in the new format. And I think we do extremely well in Pennsylvania, and by extension down into the mid-Atlantic. I would really like to see us exploit a great opportunity that we have there for Kirkland's. So I don't think it is going to be anything extraordinary that you're going to be very surprised about.

Okay, final question. When you go into a new market, let's just call Fresno a new market, how does that store perform relative to the other stores in your, let's say, your 2010 class?

Welcome in that particular situation, very well. That store had a very strong opening. Now it has only been open for, what, three or four months, but it was really strong and it is comparable to the rest of the class.

So no material divergence between Pennsylvania or Fresno versus the rest of the class?

No.

Not really. What you're looking for is staying power and sometimes that is about management and other things. But so far so good on those. I think that is one of the things as we look at classes and try to draw circles around things and try to understand what is happening in a real estate class, that is one of the pleasant surprises that we have had about 2010.

All right, well, thanks for taking my call. Good luck.

Chuck Griege, Blue Lion Capital.

Just a couple of questions. First, could you break down for us your OpEx in the quarter?

In what way?

Just how you would in your Q, comp and benefits versus other.

Oh, I don't have that. We will put that out in the Q or in the K. I don't have that right with me today. There was nothing unique in the trends in the split between comps and benefits and other that I would call out, in response to your question.

Okay. And can you talk a little bit about how you see the inbound freight impact lessening as we move through the year? And are there ways you can mitigate that?

Well, I think we are certainly working really hard to fill every container, trying to drive the percentage of fill on every container we bring from Asia to its maximum. It is very difficult to fill 100% all the time, but that is what we are working toward.

In some cases we change materials on items -- how we make it. I think you will see some substitutions for resin-based product began to flow in to our store and others over the course of the year, if the price of oil stays any appreciable time at an extraordinary level historically.

We sometimes just don't buy something, if we think that it can't be sold at a price that would be attractive to the customer and represent value. There are a lot of ideas out there. And to say no on a particular item if we don't think we can get the margin spread we need is not unusual.

We ask vendors sometimes to help us. The factories help us sometimes. But I think you will -- I think we will see less factory help on pricing as we go through 2011, given the pressure on wages that we are seeing in China.

I think the unknown out there in terms of all that will be the relationship between the Chinese currency and the dollar, how much that changes over the course of 2011. So far the Chinese have done a very good job of keeping that in line. But I think if it appreciated 5% over the course of the year, I don't think anybody would be surprised. That would certainly -- that will certainly be a bit of a difference maker.

On the question about how that would play out, the inbound freight, right now as we sit here today looking ahead, it looks better than it did last year. We have seen rates come down. I think some of the issues in the industry have settled out. They got -- they had good years last year, and things are a little bit more normalized, and we have seen those come down.

I think the variable here is likely fuel costs and where those go. But setting that aside, I think the outlook there is better for inbound costs as it relates to containers for 2011 versus 2010.

Okay, and then back to the OpEx. I think you said in your opening remarks that you deleveraged 64 bips on the store labor side, and then marketing expenses were up 32 bips.

Yes.

That is just under 100 bips. And it looks like your OpEx as a percent of revenue was up 200 bips. Is there any other meaningful items (multiple speakers)?

Well, there was 32 related to stock compensation valuations being higher, so that is part of it. Then I think the balance of it is -- there is a lot of individual line items that we could look at, but I think more or less you can group that up as when you are (multiple speakers).

Just a bunch of cats and dogs?

Yes, when your comp is down 8%, you're going to delever.

Your new stores that you are opening, can you just talk a little bit about -- I think you said earlier you had about ten stores, both mall and off-mall, that were losers. Can you give us a sense as to how many of those you expect to close in 2011?

I don't know, it depends on the lease. And I think that there is a handful of those that are scheduled to close. But obviously when a store is unproductive we want to get out of it as soon as we can, but we are limited to some degree by the lease term. Those are -- most of those are borderline negative too. They are not any that are really bleeding really badly.

The last time I looked at this it was seven. And if you aggregated the negative four wall contribution it was really pretty insignificant.

It is probably like $0.5 million to $700,000 or something like that altogether.

It is really not material. And I think we will --.

That is combined for the ten stores?

Yes.

Yes. A lot of those where just, as I say, borderline zero to negative $50,000. And there is a couple in there that are in the $100,000 to $200,000 range, but those are very much outliers.

Okay. Someone else mentioned the use of your cash. You are self-funding at this point. Can you talk a little bit more about shareholder-friendly uses of that cash, either a dividend or a stock buyback at this point?

We really haven't commented any further.

I was just hoping to ask the question. You are self-funding. You got good margins. You are approaching your store openings in a very deliberate and measured manner. And you've got $4.50 a share or thereabouts in cash.

It is becoming pretty common in the industry that a lot of retailers who historically hadn't been paid a dividend or hadn't done much of a stock buyback have begun that. I just wanted to get your sense as to how you felt about that.

We understand all that and we watch all that. We are very happy that our balance sheet is as strong as it is, given where we have been. And our priorities and use of cash are growth, and we want to be able to exploit opportunities as they arise in that regard.

But we get it. We've got a credit facility we need to work through this year that has a play here in all of this.

Does it restrict you?

It does somewhat, yes.

Can you just let us know what those restrictions are?

Well, dividends and levels of any repurchases. So we are working through that because the deal expires in October of this year. So beyond that I think you just got to wait for us to comment further. We don't have anything further to say about it right now.

Can you tell me who the lead bank is on that facility?

It is Bank of America.

Okay, thanks a lot. I appreciate it.

Mr. Alderson, there are no further questions at this time. I will now turn the call back over to you. Please continue with your presentation and/or closing remarks.

Well, thank you very much everyone for your interest and time. And we look forward to talking with you in a few months. Thanks.

Thank you.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.