KIRKLAND’S THIRD QUARTER 2012 CONFERENCE CALL

Moderator: Robert Alderson
November 20, 2012
11:00 am CT

The results as well as notice of the accessibility in this conference call on a listen-only basis over the Internet were released earlier this morning and is my belief that it 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 risk and uncertainties which may cause Kirkland’s actual results in future periods to differ materially from forecast 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 10K filed on April 12, 2012.

With that said, I’ll turn the call over to (Mike) for review of the financial results. (Mike).

For the third quarter, net sales were 96.7 million a 0.4% decrease versus the prior year quarter. Comparable store sales, including ecommerce decreased 4.7%. Ecommerce sales were 3.8 million for the quarter, a 76% increase over the prior year. Comparable (brick and mortar) sales were down 6.6% with average sales per (brick and mortar) store down 4%. The store (comp) sales decline was driven by 7% decrease in transactions partially offset by slight increase in the average ticket.

The decrease in transactions resulted from equal declines in the conversion rate and the traffic count. The increase in the average ticket was the result of an increase in items per transaction offset partially by a decline in the average retail selling price. Sales performance by geographic area was relatively consistent across the chain. Merchandise categories primarily contributing to the (comp) decline were decorative accessories, wall décor and furniture. In real estate, we opened ten stores and closed four stores during the quarter, bringing us to 308 stores at quarter end.

Eighty-six percent of the total stores at quarter end were off mall and 14% were located in malls. At the end of the quarter we had 2.2 million square feet under lease an 8% increase over the prior year. Average store size was up 6% to just over 7100 square feet. Gross profit margin for the third quarter decreased approximately 200 basis points to 35.2% of sales from 37.2 in the prior year. The components of gross profit margins were as follows: First, merchandise margin decreased approximately 120 basis points as a percentage of sales.

An increase in promotional activity as well the markdown rate as compared to the prior year lead to the majority of the merchandise margin decline. Inbound freight container rates also increased relative to the prior year, contributing approximately 50 basis points to the merchandise margin decline. Second, store occupancy costs increased approximately 30 basis points as a percentage of sales, reflecting the (comp) sales decline.

Third, outbound freight costs increased 20 basis points, reflecting an increase in ecommerce sales, which carry higher shipping costs. And fourth, central distribution costs increased 30 basis points versus the prior year quarter, reflecting the comparable store sales decline combined with the increase in ecommerce sales.

Operating expenses for the quarter were 31.6 million or 32.7% of sales as compared to 31.3 million or 32.2% of sales for the prior year quarter. The increase in operating expenses as a percentage of sales related primarily to (d-leverage) on fixed costs due to the comparable store sales decline. Depreciation and amortization increased 20 basis points as a percentage of sales, reflecting an increase in capital expenditures combined with a slight increase — or decrease in total sales.

Operating loss for the second quarter — or third quarter was $746,000 dollars or 0.8% of sales as compared to operating income of 1.9 million or 2% of sales for the prior year quarter. We reported an income tax benefit of $349,000 dollars or 45.6% at a pre-tax loss versus an expense of $673,000 dollars or 35.1% of pre-tax income for the prior year quarter. Net loss for the quarter was $416,000 dollars or 2 cents per share, compared to earning of 1.2 million or 6 cents per share in the prior year quarter.

At the end of the quarter, there were 17,070,553 shares outstanding. Turning over to the balance sheet and the cash close statement, at the end of the third quarter — which is typically our low point during the year —we had $34.3 million dollars in cash on hand, as compared to 60.3 million at the end of the prior year quarter and 83.1 million at year-end 2011.

Notably impacting these comparisons, during the trailing 12-month period, we repurchased $32 million dollars of our common stock as part of our stock repurchase program, in addition to investing heavily in several strategic information technology and infrastructure projects. Inventories at the end of the quarter were 64.2 million, compared to 59.9 million in the prior year. Including ecommerce, this represents a 7% increase in total inventory versus the prior year.

As the business continues to grow and mature, ecommerce inventories have increased almost two-fold over last year. At the store level we ended the third quarter up 2% versus the prior year on a per store basis and down 3% on a per square foot basis. We ended the quarter on the higher end of our range of expectations but we are nonetheless comfortable with the levels of inventory we are carrying into the fourth quarter.

We expect to end the fiscal year with inventories in the range of 48 to 50 million, the mid-point of which reflects a 3-1/2% increase in inventories over the prior year, supporting a 4-1/2% increase in the store base and a 10% increase in square footage. We continue to operate the business without any long-term debt and no (barrings) were outstanding on our revolving line of credit at the end of the quarter.

Capital expenditures were 10.2 million for the quarter and included the following, 6.8 million for new store construction, 1.9 million for information technology projects, primarily our (oracle) merchandising system which went live during November — or October, $500,000 dollars for store improvements including the introduction of new more flexible merchandise fixtures that allow for better clarity and presentation as well as the reset and refreshing of many of our older, smaller locations.

Five hundred thousand dollars for improvement in our distribution center to better support workflow and additional space for ecommerce fulfillment and lastly the remaining $500,000 dollars spent during the quarter, related to various routine maintenance capital expenditures. The final item I’ll cover before turning the call over to (Robert), is to provide our guidance for the fourth quarter in the full fiscal year.

For the fourth quarter ending February 2, 2013, we expect to open 17 stores and close two stores. As a result, for the full year of fiscal 2012, we will have 42 new stores and 28 closings. This overall store activity equates to unit growth of approximately 4-1/2% and square footage growth of approximately 10%. We expect total sales for the 14-week fourth quarter to be in the range of 160 to 163 million, reflecting a comparable store sales decrease of 2% to 5% on a 13-week to 13-week comparative basis.

Compared with sales of 149.1 million and a comparable store sales increase of 1.4% in the prior year quarter. This would result in total sales for the full year to range between 445-1/2 million to 448-1/2 million and apply comparable store sales decline of 3 to 4% on a 52-week to 52-week comparative basis. We expect gross profit margin to be down in the range of 200 basis points versus the prior year quarter, reflecting a decrease in merchandising margin due in part to higher inbound freight costs as well as an expected promotional sales environment, combined with smaller increases in outbound freight, occupancy and central distribution costs as a percentage of sales.

Operating expenses for the fourth quarter should be above the prior year quarter by 9 to 12%, the majority of this increase reflects the extra week in the retail calendar this year, as well as an increase in the number of stores in operation and an increase in new store activity during the quarter as compared to last year. Based on these assumptions, we expect our full year operating margin to be 250 to 290 basis points below fiscal 2011. We expect to report earnings of 71 to 76 cents per share in the fourth quarter, which would result in earnings of 67 to 72 cents per share for the full fiscal year.

The earnings impact of the extra week in this year’s retail calendar is not material. The full year tax rate is expected to range between 38 and 38-1/2%. From a cash flow standpoint, for the full year we expect capital expenditures totaling 30 to 32 million before (landlord) construction allowances for new stores. And based on our fourth quarter forecast, cash and equivalents are expected to be between 61 and 64 million at the end of the year.

Thank you and I’ll now turn the call over to (Robert).

We’ve been looking for improvement in decorative accessories and I think we’re seeing the beginnings of better business in this important category. Somewhat new emphasis impulse, ladies accessories continue to show promise. These positive results were offset by decline in furniture productivity and our continue to struggle with wall décor. Both are a work in progress with significant attention. (Owing Harvest) delivered a nice comparable sales support for the very modest increase in the buy for the season.

(Harvest) performed better than Halloween and we will adjust a mix and content and amount of spend in subsequent seasons to account for the abnormal amount of vacant temporary retail space, both primary and secondary that is being leased for and devoted to selling Halloween products. During the quarter on schedule, we quietly and successfully implemented our new (oracle) retail management system. After an intense two-year installation process and a three-year total project timeline.

That was a great accomplishment for our company and I’d like to thank our entire staff for their tireless work on this implementation. Installation of the second phase, the planning allocation module, is in process and we’ll provide updates on our progress on subsequent calls. We’re now in position with our technology additions and replacements to turn even more attention and resources to opportunities like driving our ecommerce platform and capability, installing (CRM) and other applications that will help us leverage our foundational investments and drive sales.

It’s much to early to describe the multiple benefits that are possible from the (oracle) driven information but we’ve coupled the technology upgrade with a strong effort of instilling best practices in our merchandise buying process, along with additions to our merchandising talent to take advantage of (oracle’s) benefits to generate more data driven decision making in buying, planning and allocation.

(Mike) gave you information on our store openings for the quarter. We replaced numerous stores in the past several years and we’ll continue to target opportunities. The quarter produced a number of stores in new markets, which should be a consistent and evident trend over the next few years. Although we strive to avoid late-in-the-year openings, we will again open 17 stores in the fourth quarter but only one store will open after Christmas this year.

Our new California stores continue to have strong openings and perform well. We will carefully continue our expansion in the (Central Valley) and Sacramento areas and begin to look north along the West Coast. New store in strip center locations in New Jersey during the fourth quarter will be carefully watched for customer reaction in this new market for Kirkland’s. As we approach 2013, we will continue to be cautious and conservative on store expansion for a couple of reasons.

First, we’re very involved with efforts to improve the productivity of our box and implementing change in technology and process. Second, we remain very concerned about a fragile economy that faces some distinct challenges in the coming months, as it faces the pending fiscal cliff at year-end and prepares to absorb multiple shocks with healthcare and other regulatory changes. Despite these challenges, we still expect year-over-year net store growth in fiscal 2013 and at this moment expect square footage growth to approximate that of fiscal 2012.

Concurrent with store expansion, our management team’s very involved in an accelerated process aimed at developing a multi-phased major branding and selling effort as we move ever closer to repositioning our store base from regional and closed malls into major strip centers. We recognize we are essentially moving into a new neighborhood that requires us to effectively gain the attention of old as well as new customers, many of whom have long-term loyalty to our new retail neighbors.

And to effectively invite interest and entice such customers to make the overt choice to stop their vehicle and come into our store. While email and social network efforts are well developed at Kirkland’s, our customer inboxes and social network sites are crowded with retail opportunities both promotional and lifestyle oriented. We recognize the need to intercept with more customers in more ways to garner their interest and motivate store and online visits.

Developing our ecommerce capability is one way to help the effort, by providing an expanded offering in the context of the seamless customer retail experience. Developing and productively deploying a more effective description of who we are and what we do very well is of paramount importance. We’re developing methods to sing louder and more beautifully to gain customer attention and develop a major national brand that means something to the customer who hasn’t learned about us during our 40 plus years in regional malls.

We expect to begin to test the effectiveness of different media opportunities as well as our early first quarter of next year. That being said, all of our intentions and efforts are geared toward maximizing the holiday season in the fourth quarter. Early November traffic and conversion trends have been about the same as the prior quarter. We’ve shown some improvement since national election week is behind us. As we said in our press release earlier today, it’s early in the quarter and there’s limited visibility.

So we remain cautious and conservative as to the results. We are well prepared for the holiday with what we believe is a strong, well priced assortment featuring a substantial amount of new products, attractive, bought-for-the-event promotions and a floor set that features great values on holiday and gift items and in practical settings. We have the merchandise messaging and margin to drive the results. Holiday spending is likely to again be cautious, bill-driven and more than likely late in the season.

We also have a strong plan to capture post Christmas business as well. On a personal note, we announced today that I would take a short absence after Thanksgiving to accomplish a non-emergency medical procedure and that (Mike Madden) would assume the interim President/Chief Executive Officer role. No time is ever perfect in retail but over the next several weeks our primary focus will be on execution. (Mike) is very capable, highly experienced and very respected. I’m totally confident he will lead the company very well in my absence.

Operator we’re prepared to accept questions.

So, I think we’ll be very conservative and prudent about the deals and not be particularly worried about hitting a number and we’ll take it as it comes. And one of the things that I didn’t mention that we’re very concerned about is the consistent drift of deals into the late year caused by a variety of reasons and we’re going to be a little bit more careful about opening late and we’ll black out some periods and let those deals roll over to the next year if we need to.

I don’t think the overall affect of cannibalization has been that great, except for in some select markets whereas I said we’re filling out and there’s a natural transfer in some of those locations.

But I think it’s more about going forward to productivity, those units and not as much about the advantage we get by moving from one location to another.

We’ve got more to offer online and we’re starting to learn a lot more about what promotions work best online, that’s been a big part of the last 12 months is measuring the different promotions that we run and how successful they are and then learning from that and applying it going forward. That’s been a big improvement and it’s a way we can kind of drive sales when we want to drive sales. There’s some back-end things that we’re working on, expanding the navigation on the site, there’s a lot of opportunity there to allow our customers to navigate easier.

Especially when you look at our art category with so many different themes and varieties to choose from and we launched our mobile site in August — or back in August which opened up the site, you know, in a more workable way to smartphone users and they can buy online. So we still got a lot to do, we’re not where we want to be, we’ve got a huge project list that we’re having to prioritize and choose from going into next year but it’s all good — it’s great stuff and we’re excited about the business.

And so we’ve learned, you know, sort of timing, you know, what hours are the high sales activities, be able to time our activities and scheduling and all those other things that contribute to sales to those — to the time. So we’ve also learned that, you know, you’ve got to offer a deal that really looks good in comparison to what’s going on in the world because there’re a lot of very extravagant percentage off opportunities being offered and sometimes those are real prices and sometimes they’re not. And we try to make sure that the customer understands the value involved in that.

So it’s a constant — (Nealy) as you know, it’s a constant learning process and no season is ever the same and no black Friday weekend is ever the same but we feel like we’ve got a great array of merchandise for the weekend and we hope we get our share.

Just wondering how you guys might be attacking that, it sounds like you might just going to be (halting) those promotions through your email function which is something you have today versus even where you were the last time we saw this calendar but just kind of curious how you’re going to be (flowing) those promos for a bit longer, kind of extended (traffic)?

I hope we get a lot of extra bounce from it and we’ll see, we’ve certainly tried to prepare for it.

So we’re working with some people who do this for retail companies and we’re deep into the process, we’ll start next year to test some of the things that we’ve worked on and we’ll do some media tests and I think the opportunity for us is to make many more customers aware of Kirkland’s so that we become an attractive alternative when they make a trip to the shopping center. They may not know us from our mall years but we like to position our real estate with those tenants and so now it’s our responsibility to make our message equally as good or if not better.

So we’re not expecting to change the world with that (Anthony) in the first year, it’s a building process. You don’t build a brand over night and we had an opportunity to do that for more than 40 years and regionally (close) malls but really wasn’t necessary. We had 1000 plus people come by our storefront everyday and walk in our doors simply because we were there and our money was used by the mall developer to advertise shopping centers. So that’s not something that we have a great deal of history with or are very accomplished with at this point. But we intend to get better at it very quickly.

You know, third party delivery of products is on the schedule in ecom and more ability for the customer to find the product they’re looking for and getting it however they’d like and we want shipping to store, we do a lot of that now but we want the customer to have a choice in how they buy online. And there’s a lot of technology that goes into making that happen.
And then (Robert) mentioned (CRM), customer relationship management software at the store level allowing us to collect more information about our customers and apply it, you know, to our buying decisions and our promotional, you know, strategy going forward with that richer, deeper information at the customer level. And those are the priorities for 2013.

One is that we’ve been trying to develop and add a plan for adding talent to the group and we’re underway with that and when we have an opportunity to or the need to make an announcement, that we will. The second part of that is about installing best practices if you will, better process and looking at our inventory mix and what we sell from a much more data driven view point, Kirkland’s for many years has really been focused on finding constant new product offerings.

And sometimes in a — when an economic environment that is a little bit more rich, that’s a great thing to do. Sometimes when it’s in a little bit more restricted environment, it makes sense to use data extremely well, moderate the amount of new that represents risk and continue to bring items in that represent great selling opportunities that still have punch going forward. And that’s really about building a better core assortment and that’s what we’re involved in right now.

And I think when you see the world as core and then several other layers to that, it can soon modify how you spend your money. And it tends to constantly remind you to allocate risk in that inventory spend and the most advantageous way and with the most amount of information that you possibly can as to history and the probability of success. So I think the process part for us over the next six months to a year is going to be the most important part of that and we’ll blend the new talent and the new information in as that become available to us.

One of the big opportunities for us in combining process and information from (oracle) and one that I think it will help categories where we tend to occasionally find struggles is that when we are able to build store specific inventory — store specific inventory mix for each of our stores with better information and present product with a greater propensity to be sold in that store, I think we’re going to profit immeasurably.

I don’t think that’s a long way away and it’s something that we’re putting a lot of focus, effort and energy into. On the deck side, I think it’s a lot about the core business, modifying or controlling our risk and really understanding the level of spend that we need to make in that category relative to the whole. So I think we’re seeing progress there. I think we’re actually seeing progress in a wall decor, especially in large wall décor pieces. So it’s a constant effort to make all 13 categories go in the right direction.

And I think we’re seeing improvement. I hope we’ll be able to report that to you shortly.

When we look at realtor information, I think what we’re seeing right now, (Bill) more than new stuff is a change or an increase in the sales rate of older homes. In other words, people flipping those homes. It’s a little bit difficult right now to tell how much of that is bank activity, your bank sellers and how much of that represents an across the board change in the economy. So I think that will become more transparent over the next several months. We certainly hope there’s an improvement and look forward to seeing that in our stores.

The one thing that we always say is that we offer a great opportunity to customers to improve their existing home at a great value in terms of price and the impact that they can make relative to redecorating or improving their home for a relatively small amount of money.

I mean it’s — I don’t know how far back it goes but there seems to be an effort to try to get in front of other retailers with opportunities. That’s kind of what we’ve seen. I don’t think the season overall will be dramatically more promotional than it has been for the last two or three because it’s been very promotional.

END