Kirkland's, Inc.
Q3 2009 Earnings Call Transcript

Published: 20 Nov 2009

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Kirkland’s third quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Mr. Trip Sullivan, Corporation Communications. Please go ahead.

[Trip Sullivan:]

Thank you. Good morning and welcome to the Kirkland Incorporated conference call to review the company’s results for the third quarter of fiscal 2009. 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 risk and uncertainties are more fully described in Kirkland's filings with the Securities and Exchange Commission, including the company's Annual Report on Form 10K filed on April 20, 2009. With that said, I will turn the call over to you, Robert.

[Robert Alderson:]

Good morning. Thanks for joining us today. We are pleased to report yet another quarter of positive comparable store sales and strong earnings results. This was our best performance in a non-fourth quarter in memory and certainly since becoming a public company. Our results were driven by strong improvements in our merchandise and operating margins versus the prior year. We remain in a very solid financial position, ending the quarter with a cash balance of $37 million and no debt. Mike Madden, our CFO, will now walk you through the third quarter results and our financial position. Mike.

[Mike Madden:]

Thank you, Robert and good morning. I will start with a review of the third quarter financial statements and then finish with some high level guidance for the fourth quarter and fiscal 2010. Net sales for the third quarter were $92.4 million, a 7.6% increase over the prior year quarter despite operating 30 fewer stores on average during the quarter. Comparable store sales increased 11.3% for the quarter. Average sales per store were up 17% versus the prior year quarter. Comps increased 11.2% in our off mall stores and increased 11.7% in our mall stores. Average sales volume in our off-mall stores was 28% higher than our mall stores during the quarter. The comp gain was driven by a strong increase in the number of transactions, as well as the slightly higher average ticket. The increase in transaction count was due to a 4% increase in customer traffic count combined with a higher conversion rate. The increase in the average ticket was the result of a higher average retail selling price, partially offset by a decline in items per transaction. These results were consistent between our mall and our off-mall stores. Geographically, all states contributed with positive comp sales. All of our merchandise categories performed at or above plan with the strongest results coming from our wall decor, seasonal, and gift categories. In real estate at the end of the quarter, we operated 296 stores, 218 off-mall stores, and 78 mall stores, representing a 74% off-mall, 26% mall venue distribution. As planned, total square footage under lease decreased 5% from the end of Q3 2008 while total store units declined by 8% for the same period. Gross profit margin for the quarter increased 800 basis points to 41.3% of sales from 33.3% in the prior year. The components of the increase in reported gross profit margin were as follows

[Robert Alderson:]

Thanks, Mike. We had a great third quarter. We are very pleased and gratified -- double-digit increases in comp sales, an increase in earnings over the first and second quarters, and strong reversal of the third quarter 2008 earnings loss demonstrates the continued building of the positive momentum in our business. We have already earned more money in the first three quarters of 2009 than we did in all of 2008. More importantly, with a solid fourth quarter, Kirkland’s is positioned to have its best earnings year in its history, despite operating in continued difficult economic conditions. What has driven our continued success? As we noted last quarter, the combination of strong comp sales, stronger than planned results from new store openings, much improved merchandise margin, reduced occupancy expenses, and expense discipline was a winning combination. That’s been true again. With Kirkland’s, a merchandise driven retailer, success always starts with offering very compelling product -- that is, new and unique items of outstanding quality that have clearly discernible value to our customers, the attractiveness and value of the product leads to outstanding margins generated by sales with fewer markdowns. Our substantial margin increase for the third quarter reflects the early and strong sell-through across the overall product mix and the effect of much improved year over year results in our seasonal sales. Our 2009 Halloween and harvest merchandise has been a big success. We started somewhat slowly this year in the third quarter as we noted in our last report to the public, but as we predicted sales accelerated throughout the quarter and produced strong gross margin dollar gains over last year. We were able to exit Halloween and harvest merchandise on schedule and above both plan and last year in sales and margin. Also, throughout September and October, our Christmas seasonal merchandise landed in stores and immediately made a very positive and above plan sales and margin impact. We bought our Christmas seasonal product for this year somewhat conservatively on a per store basis, given our 2008 experience and our expectation of persistent adverse economic conditions that we thought would chill consumer confidence and seasonal spending, as well as again driving holiday related spending late into the season. Along with multiple changes in the seasonal mix and flow plan, we also hedged our seasonal bet with an increase in affordably priced gift items suitable for holiday giving, which have been very good sellers season to date. All seasonal product has not been shipped to stores and we expect continued strong results in a sell-through on time and above both plan and last year. While we are very gratified by the success of the seasonal product, it is of course hugely important that strong sales and margin trends continue throughout the fourth quarter for our core merchandise. Our business continues to be driven by wall decor, decorative accessories, furniture, candles and lighting, floral, textiles, and our other core categories. We continue to greatly benefit in merchandise margin results from the positive effect of on plan clean inventories. Beyond just being on plan, over the past several months our inventory mix has enjoyed its highest level of new fresh product in our history. When our product offering is new, fresh, and unique to the marketplace and is priced to reflect substantial value, it generally means very good things for our financial results. We are often asked about the possibility and likelihood of continued incremental gains and operating margin and whether we can return to the historic highs of 10% and above. With a solid fourth quarter, we may well accomplish that goal this year. Going forward, we will pursues incremental gains year over year by improving our merchandise process and offering that merchandise in better locations. Incremental improvement in merchandise margin remains key to realizing improved operating margin. Beyond merchandise margin, we continue to benefit from greatly reduced occupancy costs, as our multi-year plan to close underperforming stores reaches its final stages. As of year-end, our remaining mall stores as a group are good profit contributors but may be replaced over time as better opportunities off mall are available. Most stores in this group have remaining lease terms of three years or less. The move to off mall locations continues on plan and it is delivering the intended financial results in the form or lower rents and ancillary charges and concurrently we continue to get decidedly better sales and profit results from our new off mall replacement stores. We will continue to opportunistically close any unproductive store whether mall or non-mall. For this fiscal year, we are scheduled to close the remaining 17 stores of our 35 total closures in late January 2010. In subsequent years, we will be closing far fewer stores and actually managing terminations within our store base in what is a much more routine or normalized manner. A significant part of the operating margin opportunity going forward is our ability to drive top line revenue. Store unit and square footage growth is a key to that endeavour. We have watched traffic trends and other retail metrics in our business very carefully as we have tried to clearly understand whether to and how quickly to resume unit and square footage growth. As we have consistently advised over the past few quarters, our real estate rationalization plan will result in a slight decrease in store count by the end of fiscal 2009 as we close a total of 35 stores while opening 18 stores. However, that trend will change in fiscal 2010 due to the success of our 2009 store opening class and quarter over quarter increases in traffic, which accelerated nicely in the third quarter this year. Before ramping up store unit growth, we wanted to have a good sense that we were not only capitalizing on good real estate decisions with increased per unit sales for our new stores but also seeing improvement in the core business in sales, gross margin, and traffic. The sales and gross margin gains are significant and well-documented. Traffic, probably due to attendant economic conditions, has been more of a challenge. Modest traffic gains were apparent in our business in building by early third quarter 2008 before being adversely affected by the financial market meltdown that began in mid third quarter of 2008 and continued into 2009. After being flat to slightly positive on a comparable basis during the first and second quarter of this year, traffic began to improve strongly in both comparable and real terms during the third quarter of this year. Some improvement in consumer outlook may have contributed that result but we have also strongly ramped up communication to our existing customers and outreached to new customers by email blasts, our new efforts in social networking, and opening up our kirklands.com website to limited product sales. Our email campaign to customers has intensified as we link the effort to a series of full margin promotional events in our stores. We are gratified with customers that responded. We will continue to test new ways to cost efficiently reach customers with the Kirkland’s story by utilizing online capability both within and without the store. The convergence of traffic gains in new store success has given us renewed confidence that it is prudent to resume net store growth in 2010 with 30 to 40 plus new stores now anticipated along with 15 or so closings. As is always the case, the number of actual openings will depend on availability of locations in the dominant strip centers and target markets and the attractiveness of the financial deals. We are concerned with growth but we won’t sacrifice prudence. The five-year lease is like a marriage -- great if it is good but miserable and forever if it is not. Supply of suitable locations does not at this time appear to be a formidable issue in 2010 but we have noted increased landlord resistance to deals at rent levels available during the height of the financial crisis and its aftermath. New center development is still virtually non-existent and landlords had been slow to [re-demise] larger vacant spaces -- for example, Circuit City and Lennon’s, all of which affect the supply issue. The recent pattern of first replacing productive mall stores and filling in proven markets will again be central to the new store plan in 2010 and beyond. We expect average square footage of stores to increase as we open stores in the 8,000 to 10,000 square foot range based on availability. Please note that we do expect some contribution to revenue gain from the increase in new store openings in 2010. But the combination of late fiscal 2009 closings and the timing of 2010 openings may result in less of a gain than would be expected from a return to net positive store growth next year. Beyond 2010, assuming the business continues to progress steadily, we would expect more top line revenue impact from higher net new store growth. We expect our 2010 store class has the potential to perform very much like the very strong 2009 class. We are now fully engaged in another highly important fourth quarter. I am pleased to report that sales and other key trends in the business remain very good. With the momentum in the business at this point, we expect November and the early part of December comparable sales to be positive, given the somewhat easier comparisons produced by the uncertainty that customers face in the last few months of calendar 2008. Comparisons will be more difficult during the second half of the fourth quarter as we experienced a literal sales explosion from about December 16 through the midpoint of January last year. We are prepared for a promotional season with appropriate product scheduled for key sales days and periods both before and after Christmas day. However, we do not expect the season to be as promotionally driven by retailer panic as last year, given the control that retailers have exercised over their inventory levels during the year. Christmas 2008 was unpredictable, later, and therefore more exciting than we had hoped. I am quite sure that Christmas 2009 will have its moments and memories also. We feel like we are prepared for the season with both product and a plan. We will report sales to you as early as reasonably possible after the end of the quarter as we did last year. As we survey the results of the past three quarters and our early progress in the fourth quarter, we are pleased with our results year-to-date and feel strong momentum in the business. That’s a great place to be but we are ever mindful that the economy has yet to recover, and is not likely to return to any semblance of normalcy for a considerable period of time. Unemployment rates continue to rise and the real rate of joblessness may be nearer 20% than 10%. Until a real jobs recovery is in place and credit and housing markets are considerably more settled, we are no likely to see consistent quarter over quarter gains in gross national product at a magnitude that will signal a more vibrant and growing economy and give consumers the confidence and disposable cash to resume higher and more historically normal levels of spending. Our financial strength allows us to take advantage of the moment in many ways and we intend to do so but with a caution that all things are temporal and require [inaudible]. We appreciate your interest and confidence and look forward to seeing you in our busy and wonderful stores. Operator, Mike and I are prepared to take questions. Thank you.

[Operator:]

(Operator Instructions) Our first question comes from David Magee from SunTrust Robinson Humphrey.

[David Magee:]

Just a couple of questions, if I could -- with regard to the real estate and you sort of hinted at this already but Mike, could you just hit on what you plan to spend per store and what you might reasonably expect with regard to landlord incentives and what the pay-back period might be, or the pay-back rate in the first year might be.

[Mike Madden:]

Well, if you use kind of the last two years as the best guide, given we kind of zeroed in on the right, or the type of property we are going after. It’s typically to build out plus your inventory investment is about $200,000 to $250,000 and that is net. That includes the contribution from the landlord. And then the payback, we shoot for a payback that will be 100% in the first year of operation and that’s really what we have seen out of the class of 2009. We’re mindful of the goings on in the real estate markets and how that might impact it, but right now that is what I would say.

[David Magee:]

Thank you. Are there any parts of the country that might be emphasizing more than others as you look for new stores?

[Robert Alderson:]

David, I think we will continue to be very sunbelt oriented from Southern California to Southern Florida and then sort of north into maybe Pennsylvania, Maryland, Virginia and we still would be looking in the northern Midwest, Chicago area. But primarily in the sunbelt states, because we have a lot of replacement opportunities still left there for good mall stores that are in proven markets and we also have some in-fill that is still possible. We’d like to see new center development begin to pick up. I don’t think it’s possible to get much out of the ground, even if the markets began to turn in a different way within 2010 but hopefully by 2011, which would allow that to be more vigorous.

[David Magee:]

It seems like some other retailers are having bigger problems finding the real estate. Some of them are in smaller markets, I guess. Is it the fact that you are in mid to larger markets helping you out in that regard?

[Robert Alderson:]

I think it’s a combination of several things. I think we have been in the market and doing business in 2009 when a lot of people had been on the sidelines and so we have some momentum with developers that maybe some others don’t have. We have a very strong financial position to present, which is very helpful to them in financing or in looking at a solid center. We present a use, which is interesting to them and produces high traffic rates and so that is helpful. We also take stores in a variety of sizes from as low as sort of high five to 6,000 feet up to 10,000 to 12,000 square feet, which is helpful because we are able to fill a lot of slots that other retails that are much more static about their store size. We are also able to work in unusual configurations where some people are much more rigid about the shape of their store and their frontage and other things, so I think we have a great deal of flexibility to offer the landlords. And we have good relationships with landlords. We have been at work with them for a long time and we are constantly out there working with them, so I think we -- I don’t say that we are not going to have any problems because I noted in the script that we are seeing some resistance on the price side and I think the landlords are seeing the supply begin to work in their favor a little bit because of the lack of new development. And also there have not been as many shutterings and closings of stores as I think everyone widely predicted in the aftermath of the fall 2008 situation. So if conditions don’t get worse economically, we could see a continued tightening.

[David Magee:]

Thank you, Robert. And the last question, maybe for Mike, an operating margin of close to 10% would be very, very impressive. I am assuming that would be very, very impressive. I am assuming that would be net of any incentive compensation differences year to year?

[Mike Madden:]

Yes, it is. That takes all of that into account.

[David Magee:]

Great. Thanks a lot, guys, good luck.

[Operator:]

(Operator Instructions) Our next question comes from Maria Vizuete from Piper Jaffray.

[Maria Vizuete:]

I am wondering if you can talk a little bit, I know you guys touched on it a bit but just on some of the product categories that you are seeing that are working well currently and then how you see that going as we go further into the holiday season.

[Robert Alderson:]

Well, as we talked about in the script, obviously the seasonal category is doing extremely well this fall both in Halloween and harvest and in Christmas year to date or season to date. Mainly what is out there now is -- that’s been selling has been the decorative side of our Christmas offering and we changed that up quite a bit this year and I think we made some great changes that our merchants drove and it’s been extremely well-received and we will be sort of after next weekend and Black Friday, we will be shifting into the more giftable side of that as we sell the decorative piece of the mix down. But as I noted in the script, we’ve had really, really good sales and margin results across the entire mix and it’s kind of -- as Kirkland’s goes, as does wall decor, furniture, candles and lighting and textiles and decorative accessories -- those categories along with others like floral and garden and the typical things that you see in our store, they really represent who Kirkland’s is to the customer and we’ve continued to have very, very nice results and so we expect as we move into next year for that not to change very much. We will always tweak the open to buy money and direct money toward success. That’s a very typical thing to do and you may see some incremental changes in spend in certain categories or within certain classes within categories but I don’t think that you will see the Kirkland’s store change very much in terms of this offering. We will potentially try a few new things next year as we continue to test product but we will talk about that as it happens. It’s a little early yet.

[Maria Vizuete:]

And then just one follow-up -- are you guys comfortable with your current price point positioning longer term and into the holiday season?

[Robert Alderson:]

We are. We are always value-driven and we price extremely well to the marketplace and we think that we have great new product that is different and unique and it is offered at a great price and I think the margin results and the turn and the sales level speak for themselves in terms of how well that is being received. I think if we were off on the price point that the customer would be telling us, we’d be having more sales resistance than we are seeing right now.

[Operator:]

Speakers, there are no further questions at this time. Please continue with your presentation or closing remarks.

[Robert Alderson:]

Okay, guys. Thank you very much for your time and interest today. We appreciate you being on the call. We look forward to talking with you after the Christmas season.