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Kirkland's (NASDAQ:KIRK)

Q3 2013 Earnings Call

November 21, 2013 11:00 am ET

Executives

Tripp Sullivan

W. Michael Madden - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Secretary

Robert E. Alderson - Chief Executive Officer, President and Executive Director

Analysts

Jason Campbell - KeyBanc Capital Markets Inc., Research Division

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

Jeff Black - Avondale Partners, LLC, Research Division

Neely J.N. Tamminga - Piper Jaffray Companies, Research Division

Joan L. Bogucki-Storms - Wedbush Securities Inc., Research Division

Anthony C. Lebiedzinski - Sidoti & Company, LLC

David Berman - Berman Capital Management LP

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Kirkland's, Inc. Third Quarter 2013 Conference Call. [Operator Instructions] As a reminder, this call is being recorded, Thursday, November 21, 2013.

I would now like to turn the conference over to Mr. Tripp Sullivan of Corporate Communications. Please go ahead, sir.

Tripp Sullivan

Good morning, and welcome to this Kirkland's, Inc. conference call to review the company's results for the third quarter of fiscal 2013. 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 in 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 18, 2013.

With that said, I'll turn the call over to Mike for a review of the financial results. Mike?

W. Michael Madden

Thank you, Tripp, and good morning, everybody. Our third quarter results featured a return to positive comparable store sales and another strong year-over-year increase in our merchandise margin, leading to a better-than-expected earnings performance.

For the third quarter, net sales were $106.1 million, a 9.8% increase versus the prior year quarter. Comparable store sales, including e-commerce sales, increased 4.9%. Comparable brick-and-mortar sales were up 3.7%. And e-commerce sales were $5.1 million for the quarter, a 34% increase over the prior year quarter.

As a reminder, each quarter during fiscal '13 starts 1 week later than the same quarter of fiscal '12, due to the retail calendar for fiscal '12 having 53 weeks versus the typical 52 weeks. For the third quarter, this shift had a positive impact on the reported comparable store sales results by approximately 50 basis points.

The 3.7% comp sales increase in our brick-and-mortar stores was driven by an increase in the average ticket, combined with the slight increase in transactions. The average ticket was up 3%, driven by an increase in the average retail price per item, offset slightly by a small decline in items per transaction. The year-over-year transaction count was up nearly 1%, reflecting an increase in the conversion rate that almost overcame a 3% decline in traffic.

From a geographic standpoint, sales results were fairly consistent across the country, with particular strength in the State of Florida, where we have 31 stores. Strong performance from our fall seasonal assortment, along with a bit early results from our holiday seasonal product, helped to drive the overall sales increase from a merchandising standpoint.

Other significant merchandise categories showing strong positive comp performance were mirrors, wall decor, textiles and housewares. These increases were partially offset primarily by declines in art, frames and floral.

We opened 9 stores and closed 3 stores during the quarter, bringing us to 323 stores at quarter's end. 289 of the stores, or 89%, were in off-mall venues, and 34 stores or 11% were in -- were located in enclosed malls.

At the end of the quarter, we had 2.39 million square feet under lease, that's an 8% increase from the prior year. The average store size was up 3% at 7,393 square feet.

Gross profit margin for the third quarter increased 357 basis points to 38.8% of sales from 35.2% in the prior year. This increase was primarily due to a large improvement in our merchandise margin, which increased 310 basis points to 55.2% from 52.1% in the prior year quarter. The increase was primarily due to a year-over-year reduction in markdowns and promotional activity.

Additionally, and as expected, inbound freight costs were lower than the prior year quarter, accounting for approximately 30 basis points of the 310 basis point improvements.

Occupancy cost decreased 65 basis points, as a percentage of sales, versus the prior quarter, reflecting leverage from the increase in comparable store sales. Outbound freight costs were up 29 basis points, as a percentage of sales, primarily due to an increase in shipping costs for e-commerce. And central distribution costs were down 12 basis points, as a percentage of sales, due to leverage from the sales increase.

Operating expenses for the quarter were $35.4 million, or 33.3% of sales, as compared to $31.6 million, or 32.7% of sales for the prior year quarter. The increase in operating expenses, as a percentage of sales, is related to 2 items that we've mentioned in our previous calls.

First, marketing expenses increased approximately $1 million versus the prior year quarter, as we continue to invest and expand our branding activities. We are advertising in 10 media markets this fall and that's up from 7 test markets earlier in the year, and the early results have been encouraging. We are seeing increases in sales and traffic in these markets, when compared to the rest of the chain and are thus far, driving margin dollars that are incremental to the cost of the marketing activities.

Secondly, incentive bonus accruals increased approximately $700,000 versus the prior year quarter. In the prior year, there was no accrual for incentive bonuses due to the company's operating performance, while the current year is thus far, tracking closely internal plans. The remaining operating expenses decreased, as a percentage of sales, by approximately 90 basis points versus the prior year quarter, reflecting the impact of the sales increase.

Depreciation and amortization was $4 million versus $3.1 million in the prior year quarter, increasing 60 basis points, as a percentage of sales, and reflecting the increase in capital expenditures in recent fiscal years, and the implementation of major technology upgrades during fiscal 2012.

Operating income was $1.7 million, or 1.6% of sales for the third quarter, as compared to an operating loss of $0.7 million or 0.8% of sales in the prior year quarter.

Income tax expense was $674,000, or 40% of pretax income, versus a benefit of $349,000 or 45.6% of pretax loss reported in the prior year quarter.

Net income for the quarter was $1 million, or $0.06 per share, as compared to a net loss of $416,000 or $0.02 per share in the prior year quarter.

Turning to the balance sheet and the cash flow statement. At the end of the quarter, we had $54.6 million in cash on hand, as compared to $67.8 million at the end of fiscal 2012 and $34.3 million in the prior year quarter. The increase in cash reflects the improvement in our operating performance, along with the reduction in capital expenditures this year.

Inventories were $68.8 million, as compared to $64.2 million in the prior year. This reflects an increase in total inventory of 7% and an increase of 2% on a per store basis. The increase in total inventory, reflects the year-over-year increase in store count, as well as the increase in the average store size. On a per-square-foot basis, inventory levels were down slightly from the prior year.

Accounts payable decreased to $24.8 million from $27.8 million in the prior year quarter, due to the timing of our inventory receipt flow and the 1 week shift in the calendar. At quarter's end, we had no long-term debt and no borrowings were outstanding under our revolving line of credit.

For the first 3 quarters of the year, cash used in operations was $1.1 million versus $7.4 million in the prior year period, reflecting the improvement in our operating performance.

Capital expenditures were $13.1 million, and that's down from $25 million in the prior year period and reflective of the lighter store openings schedule and a reduction in major capital-intensive technology projects.

Now moving to the guidance. And before actually going through it, I'd like to point out a couple of things that will have an impact on the fourth quarter comparisons, both of which were already factored into our full year guidance.

First, as mentioned earlier, there was a shift in the retail calendar this year. And as a result of this shift, to the fourth quarter of last year contained 14 weeks, while the fourth quarter of this year contains 13 weeks. The extra week in last year's calendar represent sales of approximately $7.5 million, and estimated earnings of approximately $0.02 per share.

Secondly, for comparative purposes, it should be noted that in the prior year, we recorded a $0.03 benefit, resulting from a positive change in the actuarial estimates of our general liability and workers compensation self-insurance reserves.

For the fourth quarter ending February 1, 2014, we expect to open 8 stores and close 7 stores. 3 of the openings will occur in November, 2 of which have already opened, with the remaining 6 scheduled for late January. One of the closings has already occurred, and the remaining 5 closings will occur after the holiday season.

As a result, for the full year of fiscal '13, we will have 24 new stores and 23 closings. This activity will result in square footage growth of 3% for the year, due to the average size of the openings being greater than that of the closings.

We expect total sales to be in the range of $159 million to $162 million, reflecting a comparable store sales increase of 2% to 4%, based on a 13 week to 13 week comparison, compared with sales of $162.9 million and a comparable store sales decrease of 2.6 in the prior year quarter.

This will result in total sales for fiscal 2013 ranging between $464 million and $467 million and imply a full year comparable store sales increase of 1% to 2% on a 52 week to 52 week comparison.

Early in the fourth quarter, the positive comp sales trends have continued. Year-over-year increases in the average ticket and the conversion rate, combined with sequentially improving traffic trends, have driven the sales results thus far in the quarter.

Merchandise margin trends have continued to show strength and are expected to gain on the prior year during the fourth quarter, as a result of the improved seasonal mix -- merchandise mix, controlled promotional activity and positive inbound freight cost comparisons.

Operating expenses are expected to increase on a dollar basis, despite the extra week in last year's calendar, reflecting an increase in marketing expenses associated with our branding initiatives, an increase in the incentive accruals due to improved performance, and a prior year positive insurance adjustment, which equated to approximately $1 million.

With an effective tax rate assumption for the quarter between 38% and 38.5%, we would expect to report earnings of $0.77 to $0.82 per share for the quarter, as compared to $0.82 in the prior year. This brings full year guidance to $0.90 to $0.95 per share, which is an increase from the previous guidance of $0.80 to $0.90 per share.

Given the extensive technology investments we've made in the last few years and a comparative reduction in new store activity, capital expenditures are currently anticipated to range between $18 million and $19 million for fiscal 2013, before landlord construction allowances for new stores. We currently estimate that approximately $11 million of the capital expenditures will relate to new store construction, $5 million will relate to information technology, with the balance of our capital expenditures, relating to distribution center improvements and major store maintenance.

Given these levels of operating performance and capital expenditures, we expect to end the year with cash balances in the range of $86 million to $89 million. Thanks, and I'll now turn it over to Robert.

Robert E. Alderson

Thanks, Mike. We had a great quarter. Our merchandising momentum and store execution continues to drive strong and better-than-expected results. The strong 4.9% comparable sales increase was driven by low to mid-single digit increases in conversion, average ticket and item retail, which led to a small 1% gain in transactions.

Importantly, traffic improved sequentially to a 3% deficit to the prior year quarter, after running down mid-to high-single digits for the first half of 2013. The traffic trend improved as the third quarter progressed and has continued into the early portion of the fourth quarter.

The good news in product margin gains continued and helped drive our outperform earnings results for the subject quarter. Comparable quarterly product gross margin improved significantly and contributed to our year-to-date product gross margin gain of 210 basis points. We do expect such trends to continue in the fourth quarter, albeit, at a possibly slower rate of year-over-year increase, as most industry commentary suggests a highly promotional retail environment in the fourth quarter.

Better information provided to merchants and planners from our first stage merchandising system upgrade, helped us continue to generate a merchandise offering that is resonating well with our customers. Inventory levels continue in line, despite a diminished markdown rate and a more focused and less reactive promotional schedule.

As we enter the high sales period the fourth quarter, our promotional buyers should provide strong traffic and sales incentives and contribute to what we expect to be an improved Q4 performance. We don't anticipate major changes in the macroeconomic environment, although, some recent reports of improved consumer confidence polling are cautiously heartening, but understood to be temporal.

Collateral effects of the Obamacare rollout on consumer confidence and attitude towards the holiday season are yet to be determined.

If circumstances dictate, we will have the margin room to be promotionally reactive to adverse changes for whatever reason in the external environment. Our expanded media marketing test will continue through the fourth quarter, with significant, graduated changes in process and media spend first appearing in the first half of next year. We will be building that media spend very gradually, as test results are verified by performance. Such increased marketing efforts and the natural build of traffic we expect to continue from customer reaction to the merchandise mix should help sustain the recent improving trends and traffic.

The Q3 and partial Q4 results have featured very strong performance from our Halloween harvest and Christmas seasonal product, both highly important to reach our sales and product gross margin goes for the second half of the year.

Halloween harvest is effectively gone from the stores and finished the season nicely above plan in both sales and margin. As previously reported, we adjusted our mix of this year based on prior year trends to reduce Halloween and increase the buy for harvest, which produced an on time sell through with fewer markdowns and contributed nicely to the final result. Our early sales of margin results from Christmas seasonal product are encouraging, but we are pre-Black Friday and have a ways to go before conclusion of the season.

Our previously described plan to deliver Christmas items in the store in multiple ways and to begin store receipts slightly earlier year seems to be productive. Again, we have a strong promotional plan to the seasonal shopper in place. But based on early seasonal results, expect a full and on-time sell-through at a lower markdown rate for this merchandise throughout the season. We bought this segment of the mix slightly down to last year, but with an increased initial markup. We will report more specifically on seasonal product performance on the next quarterly call.

While seasonal products are certainly helpful to our Q3 results, major product categories must and did perform well in order to produce a mid-single digit comp for the quarter. We experienced comparable gains to the prior year quarter in all 3 of the major divisions of the business, that is wall decor, home decor and seasonal. Mike, mentioned the categories that exhibited strong performance during the quarter previously in his detailed remarks. And it's worthy to add that the very important categories of furniture and decorative accessories continued to show nice progress toward positive comp sales after months of focus and rehabilitative work from our merchandising team.

The base Oracle information system and core product strategy are clearly contributing to consistent performance gains. At the same time, we're progressing on our second phase installation of Oracle planning and allocation as we reported last quarter.

We will report more substantively on that rollout on the next call. Also, as discussed last quarter, our CRM loyalty program rolled out to all stores in the third quarter and our in-store sign-up process is well underway. While, it will likely take several quarters to realize appreciable sales benefits from more highly directed marketing to individuals, the acceptance indicated by the steady and above plan customer sign-up has been gratifying.

The e-commerce business continues to show momentum and gains versus the prior year period. Our newly designed website is more customer friendly and has been well-received and contributed to Web store performance metrics. Needless to say, we will continue to aggressively address opportunities on multiple fronts presented by this channel.

Our strong 34% comparable sales result and nearly 5% of total quarterly sales represent gains to plan. Increased conversion experienced in the prior quarter continued in Q3. As we said, constant change in scope of offering and improvement in process are the centerpieces of our e-commerce efforts.

As we suggested on our last call, our focus is not on external factors, largely out of our effective control that affect business. We continue to drive the rebuilding and recalibration of our company to prepare it for long-term and consistent results in a highly competent sector.

Information merchandising system implementations continue, and we will have more to say specifically about 2014 in the stores, and backroom in our next call, as final project plans evolve and commence implementation. Marketing enhancements for both stores and e-commerce will continue and implement more fully in the first half of next year, both online and in traditional media.

We will continue to accelerate the e-commerce business in 2014. Not unexpectedly, our real estate plan for 2014 will also be more aggressive, given the positive trends in our merchandise and unit profitability. We feel it's an opportune time to be in a more aggressive, extended real estate ramp. We expect at this time to reach at least 10% square footage growth in 2014.

Preliminarily, this would imply 45 to 50 new openings and 15 to 20 closings. But we will provide a more refined schedule in our March call. Next year should begin a period of pure closings, as we have reached the point of diminishing return for closing older mall locations, where a viable off-mall alternative is not yet presented.

In fact, we have began to extend the leases for some of these mall stores, as we recognize that such locations will represent the best retail opportunity for Kirkland's for the foreseeable future. Areas of growth opportunity have been discussed previously, but the West Coast, Northeast, mid-Atlantic and upper Midwest are areas, where we have a presence but insufficient market penetration and density. We intend to address those areas with a greater effort.

We also have a tested viable smaller market store location opportunity that can be layered into our plan in 2014 and beyond that is profitable and very feasible due to the flexibility of the Kirkland's store space needs and its attraction to the large middle income customer base in such markets.

We do expect increased openings to be accretive to earnings in the ensuing fiscal years. We will address more specifics of our real state effort over the next several communications to investors. We've been engrossed in a 3-year period of intense and reformative foundational work designed to totally recast and reposition the key elements of our company, including the balance sheet, store base, systems, marketing and to add a second and complementary online channel. We see progress, and it's now getting to be reflected in our results and outlook.

We remain cautious about the short and mid-term outlook for consumer metrics, but we also remain very positive about the progress and prospect for Kirkland's. The heavy lifting is, by no means, over, but the plan is well understood and well underway.

We believe we're at the right moment with our balance sheet and earnings momentum to invest even more strongly but prudently in our business. We look forward to reporting to you again on those efforts in a few months.

We wish everyone a wonderful holiday season and again, remind you that we sincerely appreciate your time and interest in Kirkland's. It's unclear at this moment, if this is the last or merely the close to the last time, I will report as the new CEO of Kirkland's. I would remind that the timing of the leadership transition is not important, only the result. As I am committed to and intend to be totally and actively engaged until the handoff is fully and satisfactorily implemented. I again express my appreciation to each of you for your interest in and support at Kirkland's. Operator, we're ready to take calls.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Mr. Brad Thomas with KeyBanc Capital Markets.

Jason Campbell - KeyBanc Capital Markets Inc., Research Division

This is actually Jason standing in for Brad. And Robert, if this is your last call, it's been nice working with you. First, I just wanted to touch on your new advertising. I think you said it's in 10 markets. I was wondering if you can give any more detail around, what some of the performance, deltas between the markets with that advertising? And then how much may have contributed to your comps?

W. Michael Madden

Yes, we're in '10 markets. It covers about 60 stores. So still a pretty small component of the chain. I think, we're focused on what's going on in those individual markets, the media we're using in those individual markets, which is a combination of cable and print. So we are, I guess, early on in this, and we've got a gradual approach to how we roll it out to the full chain. But I think, what we're saying at this moment is we're seeing enough of the sales lift to generate incremental margin dollars on top of the cost. And we believe and understand that as you get into this, it takes some time to mature. So we'll be monitoring, as we stay in some of these markets for an extended period of time, how much of an additional ramp-up we get. But I'm not ready to start quantifying the impact on the comps because it's still such a small slice of the chain, and we'll keep reporting on this as we go forward.

Jason Campbell - KeyBanc Capital Markets Inc., Research Division

And have you meant -- have you talked about anything on what you expect for advertising spending in '14? I know you said it was up $1 million this quarter.

W. Michael Madden

Yes, we said it was up $1 million this quarter. I think embedded in what we said related to Q4 would be a similar type of increase. We have not yet spoke about Q4 or 2014 other than to say, we will continue to monitor the success of what we're doing today and have a plan to gradually push it out to other markets in the chain.

Robert E. Alderson

Jason, I think it's clearly a crawl walk run plan. And I don't think we'll deviate from that, unless we see some out of bounds results, which I really don't expect. I think it will be incremental.

Jason Campbell - KeyBanc Capital Markets Inc., Research Division

Okay. And then on e-commerce, it was about 5% of sales this quarter. I mean, do you guys have kind of a target on where you think that could be next year, 3 years, 5 years out, what kind of mix you expect?

W. Michael Madden

We have internally talked about 10% goal over a period of a few years. And we have, I think, are tracking along toward that. It's becoming, as a lot of other retailers are saying, it's becoming increasingly difficult to carve it out that way because there's so many touch points and the multi channel nature of the company and where were headed. That's going to become even more cloudy as we go forward. It's all good, but it's hard to break it out in terms of the percent of the business. We will continue to do so as long as it's relevant.

Jason Campbell - KeyBanc Capital Markets Inc., Research Division

And then have you seen any differences in basket size, frequency or any sort of -- I know you talked about more multichannel, any of the halo or maybe markets where you are good in e-commerce? Does that spillover in the stores or any more details around that?

W. Michael Madden

Right now, the reach in e-commerce is mainly within our footprint. But you can see some good activity in markets like in the Pacific Northwest and New York City and other major metro areas, where we are starting to attract some customers, I think, as a result of our digital marketing that we're doing. Our basket size is increasing, as we've increased the skew selection on the site. And that's a key metric that we look at. The average order value is actually over $100 an order. So bigger ticket purchases online.

Jason Campbell - KeyBanc Capital Markets Inc., Research Division

And then how does that compare in terms of magnitude to the basket in-store?

W. Michael Madden

Basket in-store is kind of, depending on the season, between $35 and $40.

Operator

Our next question comes from the line of David Magee with SunTrust Robinson.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

You mentioned that the promotional environment, I guess, just are progressing as you would expect right now. Is that -- did I hear that correctly?

Robert E. Alderson

Yes, I think, so far, we've seen good results. We're still pre-Black Friday, and I think the season is yet to unfold. But there has been a bit of commentary from the whole -- from the general retail sector indicating an expectation of great promotion. We've seen a little bit of it, but not enough yet to say, "Hey, that's clearly a big trend. " I think the JCPenney factor is somewhat of an unknown, and there'll be some great promotions online. There is no question about that. But so far, our business seems to indicate that we're holding well to plan.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

The conversion rate right now and the transaction size, how close are those metrics to their historical high in the past? Do we have more upside there next year, or does next year, does traffic become the primary comp driver?

Robert E. Alderson

Well, I think, obviously, traffic will continue to be a focus, because we want to see that return to sequentially positive results. And we think there is upside there. And I believe there is upside on the conversion. And in the other metrics, I think our average unit retail has done rather nicely and our average ticket has done rather nicely, and you have to be a little bit careful about what you wish for on items per transaction, depending on what you're trying to do at the time. But I think there's upside across the board.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

And lastly, do you all have the ability to sell the items on the website directly from the store inventory?

W. Michael Madden

Not yet, David. But that is a -- that's an initiative that we are in the midst of. What we did...

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

Is that likely 2000...

W. Michael Madden

...2014. What we are doing now that is an improvement is we're showing more SKUs that are available in-store only on the site. We've also added a feature where you can check the inventory of those items online and determine if it's in quantity in your home store that you designate as a shopper for us. So big improvements there. We are pushing forward toward a shared inventory mix in the near future.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

And once you have that capability, I guess, you'd be able to sell clearance merchandise online perhaps more efficiently than maybe in the past?

W. Michael Madden

That would be an opportunity for us, yes.

Operator

Our next question comes from the line of Jeff Black with Avondale Partners.

Jeff Black - Avondale Partners, LLC, Research Division

When you look at the gross margin, we're just curious what really drove the improvement? Was this better in-stocks in core from what you've been working on, or was it better sell-throughs in some of the fashion product? And looking at where we are on merchandise margin, given your guidance, how far is there to go there in the next few years, and I guess, in '14, what do you see as the biggest opportunities on gross margin?

Robert E. Alderson

Well, let me start with the last and say that I don't expect us to sequentially deliver 200 to 300 basis points over the next 4 or 5 quarters. But we do expect and are working toward reasonable incremental gains, and we think that has been driven in some respects by a better-executed core item strategy. And we've mentioned or called out specifically the great performance of seasonal in the third and early fourth quarter, which is typically higher-margin product and has limited quantity, and there is some sense of urgency involved with it. So those are all positive things. But I think you also have to look across the board at your core merchandise offering, and with the possible exception of a little bit of dip that we've had in framed art in the last couple of quarters, the rest of the merchandise mix has performed very well. And I think, controlled inventories, very controlled promotions that are very focused and provide a very nice offering to the customer, as well as moving some things that we need to move, along with a good product have contributed to an overall better margin. So I think it's a very holistic effort on the merchandising side, and better information is certainly a part of it, but you have to have the execution piece in the store. I think we have gained a lot of traction with organizing our stores much better and to making them more plausible to be shopped by the customer and more focused, and we have a big visual effort that's been going on now for the last year to coordinate merchandise, visual and execution in the stores. So all of that really has to work together to deliver the kind of sell-through that you want. And when you get the sell-through, you get the margin.

W. Michael Madden

And Jeff, just to add to that. Historically speaking, that part of your question, with our guidance this year, I think, that would still imply that we're about a 100 basis points short of where we had been about 3 years ago on the merchandise margin. So that would suggest still some improvement to go from there with better tools in-house today than we had. So we think there is some upside to continue.

Jeff Black - Avondale Partners, LLC, Research Division

And then just a clarification. On the traffic, did you guys -- is it implied that the traffic is better in the test markets or the markets where you're using the advertising test?

W. Michael Madden

It is. We are measuring all metrics in those markets against the control group. And traffic is one of those metrics, and that would -- that shows that we are ahead of the control group by a good margin on traffic. Primarily, we want to look at ultimately, just the sales, because conversion comes into play with some of the advertising with the print. But traffic is up to answer your question, yes.

Operator

Our next question comes from the line of Neely Tamminga with Piper Jaffray.

Neely J.N. Tamminga - Piper Jaffray Companies, Research Division

Here is a variety of questions I have for you. On the shared inventory initiative, Mike, if you could talk us through some of the key metrics that we're interested in, that would be really helpful. I mean, it's great that you guys are moving in that direction. Is this a first half '14 or a second half '14 initiative? And will you go by category or kind of like site-wide? That's the first part of my question. And then, secondly, related to that, if you could talk to maybe how much of the sales online have you identified as being held back because of stock-outs. So what really is kind of the topline driver by fulfilling some of these orders will be helpful. I think of situations like, given your wall decor right now, you go to your new arrivals, you're largely stocked out of wall decor on that landing page. How much of this has been kind of then holding actually your overall topline back is just the perspective that we would love to have. Related to is your SKUs per store. So you've got SKUs in your store, how much -- how many of those SKUs are actually shown on your website and how many can you actually purchase on your website? So I'll just pause there and see if you could guide us a little bit on the shared initiative.

W. Michael Madden

We'll do the best I can on those. First of all, the -- what was the first part of your question, again, in shared initiatives.

Neely J.N. Tamminga - Piper Jaffray Companies, Research Division

The timing.

W. Michael Madden

Yes, we are working on that as we speak. The -- we need some technology to be added to our order management-type technology that we're going to leverage to be able to get to that. That's a next-year project. It's unclear as to in what phases that will roll out. And you mentioned kind of starting with certain categories that may very well be a direction we head down, because that could get it in potentially sooner. But it's a next-year initiative. I don't want to say which quarter yet without -- we're still working through the work plan on that project. But it's a top priority in e-commerce next year. The stock-outs component, I think that is really one of the things we're trying to address in going to a shared inventory. I don't think, overall, we have a terrible problem with stock-outs. I think, when we have an item that starts to sell really well as we do throughout our business, you know we have lead times and sometimes it's hard to fill those back in. So I think you see some of that online, just like you see it in the stores. But if we are able to leverage the store inventory to fulfill that order and allow the customer to get it however they want it, that's going to reduce those stock-outs quite a bit. As far as the stores SKUs that are available for sale online, we now have over 4,000 SKUs online because we've added out 1,300, as I mentioned earlier, that are only available in store. So we are now showing almost a full assortment, I would say, online, both what's being sold as web exclusive items through the website and what is also being sold in the stores. So we have a good mix of that. So we're over 4,000, if you include the in-store portion and we've added 1,300 of those to the site lately. And another thing we're doing next year, just to bolt on to those few things that you did mention is to go to, in connection with this Order Management technology, to go to some third parties and have drop-ship capability, so we're not having to fulfill the orders ourselves all the time.

Robert E. Alderson

I would also mention that, I think, we recognize the power of leveraging that store inventory for the web, and as Mike said, top priority, but we are also attacking in different ways, too. I mean, we're going to try to -- were testing some rapid-response replenishment that might be available if we can make this work and work with our systems. So we see the need and appreciate the urgency, and I promise you, we're on it.

Neely J.N. Tamminga - Piper Jaffray Companies, Research Division

Just one more follow-up. Could you, in theory, launch Buy Online, Pick up in Store since you've got the local store inventory already available as a bridge before you get to that, or is that not? Do you need that incremental tuck for the order management in order to do it?

Robert E. Alderson

I think to do it effectively, we would need to install Order Management. I don't think we're at a point where we can say, "Hey, you can order it, but pick it up in store. " Now we do have in-store pickup of online items that represent an opportunity where you're too bulky to ship or for some reason, shipping is not feasible, and we're leveraging that opportunity really well. But on the other side of that, I don't think we can short-circuit that yet.

W. Michael Madden

And Neely, one important thing and how we're thinking about it is, we've got feedback on our site we've launched, and you can see on our site where you can drop in your feedback. And we're going to react a lot to what the customer is really asking for. I mean, one of the things -- they want be able to decide how it's delivered. They want to be able to pick up an item in the store to save on their shipping. They want to use different varieties of payment, and we're getting that feedback constantly. And we're trying to pull that together into some initiatives that will facilitate a better experience.

Neely J.N. Tamminga - Piper Jaffray Companies, Research Division

Okay, great. And then just 2 brief questions. One would be, what other trends -- like how much are corporate sales relative to your total sales trends? And has that been an up-trending category and is that something that you guys are thinking at about possibly expanding? Does it makes sense? And then, secondly, this is really a financially sort of question. I don't think you covered this off specially, but you obviously took an increase in bonus accrual for Q3 because trends are better relative to last year. Just wondering, if you basically accounted for the trends continuing on with the guidance in place for Q4 also in that bonus accrual, or we also seeing a show bonus accruals in Q4. Did you kind take the second half in Q3?

W. Michael Madden

Yes, on the bonus accrual, the main reason for the call outs, because last year, it was -- there was not one, so we've got kind of a comparison issue that we're calling out. That would really the flow -- the accrual kind of flows in according to the sales contribution, the revenue contribution by quarter, and that is in our -- that's embedded in our plan all the time, and what we try to do is gauge the payout relative to the guidance that we give. So it should match up with sales in terms of contribution and it's always trying to keep pace with what the current guidance is or forecast is for the company. And your other question about corporate sales...

Robert E. Alderson

Are to talking about large-quantity sales like to hotel banners....

Neely J.N. Tamminga - Piper Jaffray Companies, Research Division

Yes, it was like the interior designer market, who obviously uses -- Kirkland's as a resource, I'm just wondering if that's been a source of potential upside for you guys of late too with the housing market kind of stabilizing and coming back?

Robert E. Alderson

We think there's some upside there. It's a couple percent of sales. And we have people who, in our group, that actively worked market. But that's been a little hard for us to gain really big traction in. And I don't, honestly, I don't know what the future holds for that. I think we'll continue to offer the opportunity. And we -- it's probably priority 6 or 7 in a list of things that we're trying to do now, because the Web Initiatives along with the improvements that we're trying to do in our merchandising systems. I think, all of those things are so hugely important to the overall that we just least haven't gotten to that one as a big project yet"

Operator

[Operator Instructions] Our next question comes from the line of Joan Bogucki-Storms with Wedbush Securities.

Joan L. Bogucki-Storms - Wedbush Securities Inc., Research Division

Mike, if you could just quickly go over sort of the modules that you -- since you implemented the merchandising, the foundation system last year, what have you turned on, module-wise year-to-date, what's left for this year, and what comes sort of the beginning of 2015? And then with that, what kind of, like, potentially the -- what sort of tools does that bring to the buying team?

W. Michael Madden

Okay. Yes, last year, we implemented the foundation of the Oracle system in the third quarter. And this year was all what we called internally our Phase II, which was really addressing the merchandise planning side of the capabilities of the overall suite of products in Oracle. That included merchandise financial planning, which is now in place, and we are starting to work with that and started that in the third quarter. We had previously gone live with a new allocation module and a new replenishment module. So kind of connecting that with the core strategy that we've been talking about in merchandising, you can imagine, you've got now core items that are being set up as replenishable in the system using the new technology. So allocation, replenishment, financial planning in place, location planning in place, what we have yet to implement and are working on that for the balance of the year is assortment planning and item planning, which is really the beginning part of the feed up through the entire plan. So that's really going to give the buyers and the planners that clear path from -- to build a bottoms-up plan to meet the financial plan targets for the company. There is a lot of benefit in the things we've already rolled in, because a lot of what we did in those areas of merchandise planning were very manual and are arduous. But we are happy to say we're going to be going in the next year with all those tools in place. So as we plan our seasons we're going to be much better equipped to do so.

Joan L. Bogucki-Storms - Wedbush Securities Inc., Research Division

Okay, excellent. And I apologize if this was already been asked. I had to step out for 1 second. On the whole traffic, so that, you had mentioned in the beginning of the call the transactions were slightly positive and so -- and that historically, if the conversion was working in the ticket, then traffic would follow. So how are you thinking about traffic for the fourth quarter and heading into 2015?

W. Michael Madden

Well, we -- I think, you summed it up pretty well. I mean, that's what we've said that we were happy to see, for the first part of the year, the ticket be up and be consistently up. The margin to go along with that had been a positive for us, particularly in Q2 and Q3, and then the conversion rate being positive. And those indicators typically lead to better foot traffic down the road. We were pleased to see the decline in traffic go down. We were showing 6% to 7% declines in the first half and we have just reported a 3% decline in the third quarter. And I would say it's fair to say that traffic got better as the quarter progressed, so we entered the fourth quarter with a little bit better trend. So hopefully, that continues. And I don't know if I'd say what '15 is going to look like, but if we keep performing on those other metrics, I would feel good about it, absent some macro effect that I can't know what it is yet. So...

Operator

Our next question comes from the line of Anthony Lebiedzinski with Sidoti & Co.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Just firstly, on just on e-commerce. So more and more online retailers are doing free shipping promotions or discounted shipping promotions that you have a goal to eventually expand that business to 10% of your overall sales. So will you need to do more of that in order to get there? And Just wanted to get better clarity as to how you're thinking about free shipping?

W. Michael Madden

Well, first of all, over 40% of our orders is Pick Up In Store, so --

that is free shipping for the customer, and they look at it that way. They enjoy that. They like to go to stores too, so we get the benefit of them coming in to pick it up and not have to pay shipping for it because it's riding along the truck with everything else. So that's a big point. And then, on the promotion side, we do run free-shipping promotions from time to time. But as we see what promotions really are effective online, you'd be surprised that when we run other style promotions, other category focuses or flash sale and things like that, we actually get a better response.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay. And that's helpful. And I think you mentioned at some point that you would look to do some third-party fulfillment. Would that be a lower margin business?

W. Michael Madden

Well, yes, it would be. I mean, it'd be a different model, and because we wouldn't be holding inventory, it would be structured much differently. So it'd be lower margin, but it'd be no expense. It's just the matter of how that works out with the vendors.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Got it. Okay. And just looking at the guidance for the fourth quarter, you expect same-store sales to be up 1% to 2%. The third quarter, you did 4.9%. So is that just because the third quarter comparison was easier, or was there anything else going on in terms of how you set about the guidance?

W. Michael Madden

Well, the 1% to 2% was a full year...

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Yes, you're right. It's 2% to 4%.

W. Michael Madden

It's 2% to 4%. And I think its just our reflection of what we have in our plan, in our forecast and what we were seeing coming into the quarter and our view of the calendar and how that's going to flow, and that's where we ended up. So I don't see it as any kind of comparison issue or anything like that. Third quarter, actually, on paper was an easier comparison based on last year's down 5%.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

I understand, okay. And lastly, it sounds like you will be pursuing the branding initiatives going forward. It is leading to incrementally higher sales, better margins for you. So with that in mind, so as you look to continue with your branding initiatives and keeping in mind maybe perhaps other costs as well for next year, what kind of same-store sales gain would you need in order to leverage your operating expenses?

W. Michael Madden

Yes, I would continue to say in a 3% to 4% range, it's hard to -- like we called out today, it's 1 quarter, so it's a little more difficult to apply that to a full year, because if you looked at other quarters, you see different results. But in the one we just gave, if you excluded the marketing investment, if you kind of carved out the incentive year-over-year comparison issue, we did leverage the rest of the SG&A by about 90 basis points. And with some more growth next year, I think that would maybe help us to leverage those expenses overall even better. But there will be the investment in marketing, and we will continue to push forward with that slowly, as Robert mentioned, and smartly. And we'll talk about the impact on the SG&A. But, I think, in general, I would say about 3%.

Operator

And our final question comes from the line of David Berman with Berman Capital.

David Berman - Berman Capital Management LP

I think I've got the perfect question to ask you being the very -- the best [ph] one right at the end. There was a study recently that showed that when a CEO leaves a company, generally speaking, he leaves at the top, when the stocks are at the top and the business is at top, because he works damn hard to make he's leaving the business in a good way, et cetera, et cetera. So the question, Robert, is what do you think of that study, and how do you think Kirkland's is going to do going forward without you? And by the way, congratulations on an absolutely remarkable job. This company was almost out of business many years ago, and you've done one of the most incredible turns in retail history.

Robert E. Alderson

Well, thank you for all of that. I think Kirkland's is going to do very well. I think the collaborative efforts of a lot of good people over the last 3 to 4 years have been aimed toward putting a great foundation and putting a lot of capability in the hands of some very capable people, so that we could compete efficiently and productively in this sector. And I think that's where we are. And I don't know about everybody leaving at the top. I hope that, as I continue to see what happens with Kirkland's that this is the beginning rather than the peak of something, and I think that it can be and will be, and I have confidence that our Board will make the transition and hand off work really well this time. It hasn't in the past, but that doesn't mean we won't have a good one this time. So I look forward to the future, and I think everyone is poised and prepared for that. And with that said, David, thank you always for provocative questions. It's always a pleasure to get your questions.

David Berman - Berman Capital Management LP

Yeah, we had to end it up in a very positive note. I think that is terrific. Well done. Absolutely well done. And you've done a great job, and let's hope that these guys can carry on doing what you did.

Operator

Thank you. Mr. Alderson, you now may proceed with the conference.

Robert E. Alderson

Okay, thank you. Well, thanks for your time today and for your interest in Kirkland's, as we previously said, and we'll speak to you in March about what happens in the fourth quarter. So thanks again. Have a great holiday.

Operator

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

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