Kirkland's (KIRK) CEO Robert Alderson on Q2 2014 Results - Earnings Call Transcript

Aug.21.14 | About: Kirkland's, Inc. (KIRK)

Kirkland's, Inc. (NASDAQ:KIRK)

Q2 2014 Results Earnings Conference Call

August 21, 2014, 11:00 AM ET


Tripp Sullivan - SCR Partners

Robert Alderson - CEO

Mike Madden - President and COO

Adam Holland - VP of Finance and CAO


Neely Tamminga - Piper Jaffray

Brad Thomas - KeyBanc Capital Markets

David Magee - SunTrust

Mark Montagna - Avondale Partners

Joan Storms - Wedbush Securities

Anthony Lebiedzinski - Sidoti & Company


Ladies and gentlemen, thank you for standing by and welcome to Kirkland's Inc. Second Quarter 2014 Conference Call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded today, Thursday, August 21, 2014.

It is now my pleasure to introduce Tripp Sullivan with SCR Partners. Please go ahead Mr. Sullivan.

Tripp Sullivan

Thank you, Fran. Good morning and welcome to the Kirkland's Incorporated conference call to review the company's results for the second quarter of fiscal 2014. On the call this morning are Robert Alderson, Chief Executive Officer; Mike Madden, President and Chief Operating Officer and Adam Holland, Vice President of Finance and Chief Accounting Officer.

The results, as well as the 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 17, 2014.

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

Mike Madden

Thanks Tripp and good morning everybody. For the second quarter net sales were $103.5 million, that's a 6.6% increase versus the prior year quarter. Comparable store sales including e-commerce sales increased 3.6%. Comparable brick-and-mortar sales were up 2.6%.

E-commerce revenue was $5.6 million for the quarter, a 27% increase over the prior year quarter. At the store level, the comp sales gain was driven by a 4% increase in transactions offset by a decrease in the average ticket. The increase in transaction resulted from a 3% lift in the convergent rate combined with the slight increase in traffic.

The decrease in the average ticket was the result of a decrease in the average unit retail price partially offset by an increase in items per transaction.

Traffic continued its positive trend going into the second quarter but slowed a bit during the month of June. It then rebounded in July, allowing us to finish with positive momentum going into the third quarter.

From a geographic standpoint, sales results were generally consistent across most of the country. Texas and Florida which combined represents over 90 stores in the chain, both performed slightly better than the company average.

Merchandise categories recording strong sales performance during the quarter were fragrances and accessories, textiles, arts, holiday, housewares and wall décor. These increases were partially offset by declines in furniture, decorative accessories and floral.

We opened six new stores and closed two stores during the second quarter. The timing of space availability from landlords during the second quarter delayed some new store openings during the second quarter and pushed two stores to open in the third quarter.

Of the 328 stores at the end of the quarter, 91% were in off-mall venue and 9% were located in enclosed malls. At the end of the quarter, we had 2.47 million square feet under lease with a 6% increase from the prior year. Average store size was up 2% at 7,532 square feet.

Gross profit margin for the second quarter decreased 10 basis points to 36.6%. The first component of gross profit merchandise margins increased 72 basis points to 54.2%.

Lower year-over-year inbound freight costs helped our merchandise margin during the second quarter, providing a benefit of approximately 20 basis points. Favorable results from our annual physical inventory counts, which took place during the second quarter also contributed 20 basis points of merchandise margin improvement over the prior year.

Aside from the freight and shrinkage benefit, merchandise margins also improved due to lower markdown to promotional discounts compared to the prior year quarter.

Store occupancy costs were flat as a percentage of sales versus the prior year. Outbound freight costs were up 46 basis points as a percentage of sales, primarily due to the increase in the e-commerce business.

Rate pressure on distribution center to store truck routes also contributed to the increase. Central distribution costs were up 37 basis points as a percentage of sales, reflecting an increase in labor costs associated with the expanding e-commerce business.

Operating expenses for the quarter were $35.3 million, or 34.1% of sales as compared to 33.7% of sales in the prior year quarter. Comp leverage provided declines in various categories of expenses as a percentage of sales, particularly store payroll, our largest operating expense, which declined 28 basis points as a percentage of sales versus the prior year.

We also continued to see positive trends in our self-insurance reserves, reflecting better claims experience. These benefits were offset by an increase in marketing expenses of about $300,000 versus the prior year quarter, higher utility cost and an increase in corporate payroll.

Operating expenses associated with e-commerce also increased approximately $400,000 versus the prior year quarter.

Depreciation and amortization increased 21 basis points as a percentage of sales reflecting the increase in capital expenditures in recent fiscal periods and the implementation of major technology upgrades.

Income tax benefit was $657,000 or 38.4% of pretax income versus a benefit of $516,000 or 47.2% of pretax income recorded in the prior year quarter. The prior year quarters rate include a discreet benefit related to our prior period item.

Turning to the balance sheet and the cash flow statement. At the end of the quarter, we had $68.5 million of cash on hand, as compared to $63.5 million at the end of the prior year period.

Inventories were $57.4 million reflecting an increase in total inventory of 6% over the prior year quarter. The increase primarily related to growth and store account as well as in the e-commerce business. Per retail stores inventories were flat.

At quarter end we had no long-term debt, no borrowings were outstanding under our revolving line of credit. For the second quarter cash used in operations was $4.5 million. Working capital shifts specifically increases in income tax payments and incentive bonus payouts, lead to the increase in cash used in operations.

Capital expenditures were $14.8 million for the quarter, due primarily to an increase in new store openings, 13 this year year-to-date versus seven last year, and the launch on our multi-channel order management system project.

In late May we announced the authorization of share repurchase plan, providing for purchase of up-to $30 million worth of our outstanding common stock over a two year period. During the quarter we purchased 68,000 shares of common stock for a total purchase price of approximately $1.2 million or an average share price of $18.20.

The purchases were accomplished to an open market trading plan subject to safe harbor guidelines and through the use of 10b5-1 trading plan. As of August 2, 2014, we had 17.3 million shares outstanding subsequent to quarter end through yesterday we had purchased an additional 14,000 shares of stock, resulting in a total of 82,000 shares purchased to-date in the authorization.

Moving on to our outlook for the third quarter, we expect total sales to be in the range of $113 million to $115 million, reflecting an increase in comparable store sales of 3% to 4.5% compared with net sales of $106.1 million and a comparable store sales increase to 4.9% in the prior quarter.

We anticipate opening 13 stores and closing two stores during the quarter. As mentioned in the press release, cost associated with the move to our replacement headquarters building are expected to have a negative impact on earnings of approximately $0.02 during the quarter.

Early in the third quarter comp sales trends continue to run positive for the 2.5 weeks in August. Conversion remains strong and traffic trends are essentially flat on a year-over-year basis. Merchandise margin trends have continued to show strength and are expected to gain on the prior year during the quarter.

We expect inbound freight to be neutral to merchandise margin for the remainder of fiscal 2014. Operating expenses are expected to increase on a dollar basis and as compared to last year due to an increase in store count, increase in corporate personnel and higher depreciation expense.

The approximate $0.02 impact to earnings due to one-time charges associated with our move to the new headquarters building will also be included in operating expenses for the quarter.

As a result we expect to report income of $0.02 to $0.04 per share as compared with earnings of $0.06 per share in the prior quarter.

We plan on opening 13 stores and closing two as I already said that. Inventories at the end of the third quarter are expected to be up versus the prior year in total due to a higher store count and e-commerce growth and that would result in per store inventory be slightly up on a year-over-year basis at the end of Q3.

For the full year fiscal 2014, as it relates to store count and store growth, we now expect to open approximately 35 new stores and close approximately 15 stores. The majority of the remaining new store openings will occur by Thanksgiving with the balance opening after the holiday period. Remaining store closings will occur primarily after the holiday period.

Based on our updated store openings and closing guidance, we expect total sales for fiscal 2014 to increase 7% to 8.5% over fiscal 2013. This level of sales growth will imply comparable store sales in the range of 3% to 4.5% for the full year.

We expect merchandise margins to improve year-over-year driven by an improved mix, coupled with controlled promotional activity. Sales leverage will help to offset increases in corporate overhead and e-commerce multi-channel capabilities.

We expect marketing expenses to increase slightly in total dollars for fiscal 2014 but remain flat as a percentage of sales. For the back half on year-over-year basis, we expect marketing expenses to be down in the range of $300,000 versus the prior period.

As mentioned in our sales release, we have recently begun to move, began to profit to move our people to a replacement of corporate headquarters building and expect to be completely moved by the end of Q3. We estimate that the relocation will have a total impact of approximately $0.04 during the back half of the year on operating expenses, $0.02 of which will hit in the third quarter as I previously mentioned.

Our 39% tax rate assumption still reflects the lack of certain job tax credits such as the work opportunity tax credit that is yet to be renewed by Congress. Should the renewals of those credits be addressed during fiscal 2014, we will record a credit to the tax rate in that quarter where they are reinstated.

From a cash flow standpoint, we expect to generate positive cash flow in 2014, excluding share repurchase activity. We do not anticipate any usage of our line of credit during the year and expect capital expenditures to range between $31 million and $34 million in fiscal 2014 before accounting for landlord construction allowances.

As I mentioned last quarter, these CapEx assumptions reflect the increase in store openings, the office relocation, multi-channel and information technology projects and distribution center enhancements. We currently estimate that approximately $14 million to $16 million of the total CapEx will relate to new store construction, $9 million to $10 million will relate to multi-channel capabilities and information technology, $2 million to $3 million will relate to the distribution center and supply chain, with the balance relating to the office relocation and just normal capital maintenance items.

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

Robert Alderson

Thanks Mike and good morning everyone. In addition to the second quarter results, big news announced by Kirkland's today was the promotion of our former CFO Mike Madden to President, Chief Operating Officer.

The investment community is been waiting for a while for an announcement signaling our direction in transitioning leadership of the company subsequent to my retirement. Our Board has engaged in a process for more than a year, designed very carefully address that transition, and we’re very pleased with the result.

Mike is highly qualified and very experienced, 14 years with Kirkland's and before that our audit manager while at PWC. He's a very disciplined and conservative planner and leader. Most of you know him very well from our Investor Relations interaction.

He's been an integral member of our executive management group since 2008 and heavily involved in our turnaround and all decision-making thereafter. I expect Mike to be a great success and we will team very closely or even closer in the next few months to make sure the handoff goes extremely smoothly and productively.

Mike will handoff the Chief Accounting Officer role to Adam Holland, the key member and leader of our financial group, he’s gained invaluable experience as a member of our management team leading numerous big projects from planning to execution such as the build up and implementation of our e-commerce channel.

We’re very excited about Adam’s demonstrated ability, skill set and his potential to lead our financial team. At the same time we announced some key elements of internal reorganization with our Senior Vice President and Director of Stores, Michelle Graul being named Executive Vice President of Stores and Merchandising.

Michelle brings an abundance of highly successful retail experience at Kirkland's and other sector retailers in store operations, human resources and visual merchandising to her expanded role. I'm highly confident that Michelle, Mike, and our Vice President’s group of merchandising, stores, finance, and marketing will form an even more formidable merchandising chain to execute the primary business of our company, as we look toward a period of accelerated top and bottom line growth and expanding the reach of our brand to that of a national player in the home décor sector and both brick-and-mortar stores and online.

I’m tremendously excited about the bright future of our company as we confront and embrace new challenges and opportunities with the new and highly capable, young and energetic leadership team.

Now I’ll tell you second quarter results. We experienced solid performance with comparable sales and earnings within the range of our guidance, despite continued pressures on home retail from a persistently sluggish economy. We were especially pleased at traffic per comp stores turn slightly positive after months of signs in our retail metrics suggesting that we were trending in that direction.

While not yet robust in Q2, positive traffic plus even stronger results in conversion, transactions and items per transaction, produced a positive comp sales results. As predicted, merchandise gross margins showed continued quarter-over-quarter improvement but not quite to the level expected about 30 basis points, due to the promotional nature of the second quarter and a somewhat tepid retail environment.

We were pleased to see the combination of gross margin, conversion and transaction results as validation in our merchandise mix continues to resonate with our customers and bring them to both our brick-and-mortar in web stores.

Early Q3 results had been positive based on August comparable sales and merchandise margin. While pleased with the quarterly sales results in both brick-and-mortar stores and online, we are reminded of the inconsistency of retail activity in a no or slow growth economy by the consumer spending low and mid to late June and a down trending results nationally in April through June.

Our guidance for the year has been trimmed by $0.03 primarily to account for timing issues with new store openings. But we would still prefer better jobs environment and a housing market to feel more comfortable with the state of consumer.

Sustained economic optimism and predictable growth are required to produce both in a world full of political discord and danger and in a country mired in political stalemate and totally lacking focus on economic growth.

It's exceedingly difficult to expect to return to historic levels of economic growth or return of sustain optimism to nurture our healthy job's market and a growing housing market anytime in the near term.

Despite environmental influence, we're still optimistic about the near term prospects for Kirkland's. First, we don't view the consumer as without resources and interest in shopping. While its been a historically limp and erratic recovery, there's been a recovery of sorts.

Importantly, our business continues to improve its consistency and produce solid result as our years of financial investment and foundational work in systems, process and people have yielded a capable and productive business platform on which to grow the top and bottom line and produce stored unit growth necessary to in time create a highly recognizable national retail brand.

Accelerated but prudent growth is presently moderately difficult. Not impossible, just challenging, with limited space available from existing or new centers at acceptable occupancy cost Kirkland's.

New retail developments are coming online very slowly as we previously noted. And it now appears it may be years before there is significant increase in new power strip center shopping space due to slow economic and housing growth, tougher lending underwriting for development loans, and the effect of environmental and other governmental regulation.

We’ll continue to compete for viable retail spaces and we will win our share. The viability to Kirkland's, means a half probability or profitability and a reasonable return on our investment, in addition to a good retail location in a desired market and development.

We are happy to announce that we’re augmenting our real estate effort. We have a new hire, at the Vice President level, who starts next month. And we expect to devote many more resources to building a larger universe of potential deals, and to augmenting or hire real estate team.

We opened six new stores during the second quarter and closed two mall stores, two fewer openings than projected. Space delivery delays have adversely affected our new store openings schedule as Mike noted. We will finish 2014 a tad shy of our goal of 10% annual square footage growth. But we should have 30 openings by Thanksgiving with the balance of the 2014 class, four to six stores probably, opening in January.

Therefore, the 2014 class we are not opened on a time schedule to provide full compliment of plan current year new store revenue to our 2014 fiscal plan. Closing are running close to or very slightly behind our projection of 15 at this time.

Delays notwithstanding our sales run rate for the 2014 class of new stores thus far is nicely above plan suggesting the possibility of additional revenue availability if the trend continues.

Thus we announced a slight adjustment to the back half guidance despite the sales opportunity that we have in the fourth quarter this year with more moderate weather during the critical weekend holiday shopping periods.

We still believe the 10% annual square footage growth plan we announced at the end of last year is both desirable and doable. But we will not unduly moderate our deal standards to hit an annual new store opening goal.

We know the results of ignoring and accepting high occupancy cost or accepting secondary locations in order to hit our store opening or store revenues goal. That said, our goal for brick-and-mortar stores remains largely unchanged for future period.

And vigorous growth of the online channel is expected to continue on several fronts as we seek to expand our side offering, improve side performance and accessibility, together with improved buying convenience for customers, communicate better with customers, better opportunities, drive store visits, and make the site rich in information about our product.

As we have said more than once, our brick-and-mortar unit growth will always be tempered by the effects of growth and e-commerce. Mike provided some earlier detail as for merchandise category performance for the quarter and our ended quarter inventory position which is very acceptable given the growth in e-commerce.

The biggest takeaway for our Q2 category performance is the very solid and consistent across-the-board comp performance in our major categories. Of these, only decorative accessories, among the major categories was down significantly to last year in plan as we continue to moderate our SKU offering and rebuild is very important category from core success.

During the second quarter, we had successful Mother's Day and big sale events, the two largest events on the promotional calendar for the first half. We were pleased with the trial of summer appropriate seasonal product in the second quarter which will influence our buying in the first half of 2015.

As I mentioned, retail was erratic in the second quarter, so we did experience a need to drive sales with more promotions during the middle of the quarter through a combination of limited time flash sales and promotional store flyers, that produced customer excitement and significant increases in traffic and sales without having to promote specific categories, classes or items.

These promotions were helpful to the quarterly sales results, but didn't affect our average unit retail and average ticket, the only two retail metrics not positive for the period.

We're reminded that the middle and back half of the second quarter and especially July, remain important to the customer as a period of promotional expectation. Our back to campus event continues to perform very well from the second quarter end of the third, with a different and more focused aim point than typical back to school.

As we look toward third quarter, we're experiencing above expectation early sales of our seasonal product and Halloween harvest. Christmas product will appear in the stores next month. Early seasonal sales are very important to enable us to deliver healthy product margins during the back half.

Based on the repetitive successes over the past several years with seasonally appropriate product and our anticipation about this years product selection, are the success of this years product selection. We expect to realize strong sell-throughs at nice gross margins on our Fall and holiday seasonal assortments in the back half of this year.

We're pleased with our positioning as we look forward to make positive changes in the next few months. We’ll continue to move forward with e-commerce platform changes such as order management and the functional enhancements to Oracle for allocation and planning, both of which we've discussed with you previously.

We’re excited to report that we’re partially moved into our new headquarters building with the remainder of national team set to move in on or about October 1. We see a bright future for Kirkland's as we consider the potential of a newly constituted, highly talented and focused management team, located in a new expanded and more efficient environment with state-of-the-art information systems and operating at highly additive store base. And we look forward to seeing you in our stores very soon and talking about Kirkland's.

Thank you for time and interest, and operator we're ready for questions.

Question-and-Answer Session


Thank you, Mr. Alderson. (Operator Instructions) And our first question is on the line of Neely Tamminga with Piper Jaffray. Please go ahead.

Neely Tamminga - Piper Jaffray

Great, good morning. I just want to offer up my congratulations to Mike up front. Very well deserved, as an opportunity and it's going to be fun to watch you rise to the occasion, as we know you can.

So I have about three questions I want to walk through if I may. First, I would love to talk a little bit more about that real estate dynamic. So as we kind of think about the three signs that you indicated that are impacting the full year, was that some of that reflected in the Q2? How much of that's Q2, Q3, Q4 in terms of the delay of those openings and the impact of having to account for rent, et cetera? That would be helpful.

And then I guess the bigger broader question is this do you think unique to the category in which you serve or the size of box that you're serving? Just kind of trying to get a little bit more sense of what's really kind of behind the situation and whether or not you think that it's contained or not contained?

Secondly too if I may, could you also talk through decorative accessories a little bit more, what are you guys doing to address that as a category and how much of that did it represent really in Q2 and how much should that typically represent kind of seasonal really amps up in the back half, but how much is decorative accessories in the back half? In the overall assortment and what are you doing there? And I will have a follow-up as well, thanks.

Mike Madden

Thanks, Neely. I’ll start nearly on the real estate timing that you asked about. We're essentially at the lower end of the pervious range we gave on new store openings and closings, they are 35 and 15.

The impact on Q2 was relatively minor, we're pushing two stores from Q2 into Q3, we had a couple of week or two delays on some of the stores we did open in Q2. So, I would put that less than $0.5 million on Q2.

The way to think about the back half, though is, let's say, you move five stores from the beginning of Q4 to the end of the year, and you still get them open by the end of the year, but you miss the fourth quarter. That's about $2 million worth of sales but maybe a little bit more.

And if you flow that through, let's say 40%, that's about a nickel just on the sales. Now, you do pick up some of that with that being lower and some other expenses up, try to account for that in the 40% when I explain it but that's the impact.

Now, Robert did allude to in his comments that the new stores that we've opened today have been opening pretty strong. So that offsets it a bit, but that’s how I would explain the impact – and as it has on the guidance, on the real estate.

Robert Alderson

I would just add that, we're not happy that the class this year got pushed again a little bit downstream, and we didn’t end up at 40 or 42 openings, instead of 35 - that's what we would like to happen.

But, sometimes you just can’t approve everything that is out there and the delays are just not within our ability to conquer.

So, I think the way we have approached, it is okay. We try to add for three years now and that's been the results, surely we can learn from that. And so we have hired a guy to come in who’s very experienced, he’ll be here next month as I mentioned. We’re going to build little bit bigger team and approach this with the idea that we need to have more deals in the pipeline.

We try to be very efficient with that and that’s always been the way Kirkland’s sales reacted because we would like to pay as little as we can in occupancy costs and the closer you are to the moment and the deal, the better chance you have to get a market or more favorable deal.

So, we just need a bigger universe to work with and we need to slide that universe further forward so that we can open an acceptable number prior to the 1st, November, and that’s the goal that we're working toward.

Neely Tamminga - Piper Jaffray

That's helpful.

Robert Alderson

The question on decorative, I’m sorry, getting a feedback here. On a annual basis, dec is 7% to 8% of our business annually. So, it’s an important category but it’s been a category that has been running at comp rates of let’s go back to say 2011 and 2012, we’ve been running down until this year and for a couple of years we were running down double digits on the comp.

And that has been a function of changes that the consumer does from time to time, we’ve been doing the best we could to adjust to that. When we see that we're not making quick progress in adjusting, our typical pattern as you know from following us for a while is that, we will repair category down and go back to core.

And we will get all we can out of core and then we’ll start very carefully looking for new directions and new skews and try to build that category back slowly to the productivity level that we previously enjoyed or finding a different level where we can produce comp sales and the margins that we want.

So, it’s looking for the balance of productivity. We’ve done that recently let's say over the past three or four years in our alternative wall décor and mirrors, in textiles. Whenever we have a problem pop up out of 13 categories, we deal with it. And so that’s what we’re doing right now and that was the reason for the call out.

We had a really nice recovery in furniture recently, where we went through about a year process, we're not quite where we want to be there but it looks pretty good.

Mike Madden

And Neely, the numbers on dec access, it’s about 8% of the business in Q2 and it’s planned to be about 6% in Q3. Reason why that goes down is primarily due to seasonal selling starting to creep-in and take more of the share.

Robert Alderson

And we won't see began to go the other way until probably mid December.

Neely Tamminga - Piper Jaffray

That's really helpful you guys and I just have one follow-up question and I'll pass it on to the next one. But on omnichannel we're really excited about all of the initiatives coming together for you guys in the back half and really flipping the switch to really see the full through of your omnichannel capabilities in the back half.

Just wondering it sounds like your expenses are embedded obviously in the guidance related to that and all of the build that goes into it. Have you included some revenue lift as well in your comp guidance or is that kind of a TBD?

Robert Alderson

I would say it's somewhat of TBD nearly the run rate we kind of projected on the e-commerce side is maybe slightly better that what we've experienced year-to-date. We are turning on this order management functionality in late September. And we will continue to add to that as we move forward into the season.

And especially as we go into next year when we can start really turning on some key capabilities there, that can drive the top line such as third-party selling, a better way to fulfill inside the store, as opposed to having to touch every item every time there's an order in the DC.

So there is a lot of opportunity. I wouldn't say that we've driven that projection up dramatically inside fiscal 2014 yet.

Neely Tamminga - Piper Jaffray

Okay. That's very helpful guys. Good luck out there.

Robert Alderson

Thank you.


Our next question from the line of Brad Thomas with KeyBanc Capital Markets. Please go ahead.

Brad Thomas - KeyBanc Capital Markets

Good morning, Robert and Mike and let me add my congratulations as well to Mike on the new opportunity. Very excited for you.

Mike Madden

Thanks Brad.

Brad Thomas - KeyBanc Capital Markets

I wanted to follow-up on that subject about the leadership team. And obviously, Michelle and Adam will be taking on additional responsibilities but as you look at the team, are there any holes that you believe you have to fill or areas that you need to add as you take on a bigger role within the company?

Robert Alderson

This is Robert. I'll answer a little bit for Mike, and then I'll, obviously let him - I think this is really the changes that we announced today of course about Mike, that speak for themselves and obviously with that change suggested that we needed something different to be happening in the financial side. So Adam is imminently capable and we’re excited about his potential as I said in my remarks.

The internal reorganization is really a continuation of an effort of a couple of years even going back when we first reorganized our stores in 2010. To unify the intent of buyers with the execution in stores and the presentation in stores, and the way that we set-up stores, and the way that we operate our marketing and our promotions and is an attempt to start to even close that, those gaps if we have an even closer.

And I think we are really putting some very, very capable people into a position to play off of each others talents and strengths and for us to work even closer as a merchandising group.

So there is a strategic design behind that and it doesn't have anything to do with the succession. I think we would have wanted to do this anyway. So, now Mike?

Mike Madden

Brad, I'm excited about the opportunity here, and I think that it's good to be going into it with the team that's not been working with for a long time and we’ve got good tenure across leadership group, we've got some new faces as well.

It’s a new start for us in a lot of ways. And new office and this transition is going to be important time for me to really dig into some of the areas of the business that haven’t had much exposure to even though I have great exposure in every area. But I'm feeling like to work with Michelle, Carla and some of the merchants is a big opportunity for me and we’ll see where that goes and I'm optimistic we’ll get to a good place.

Robert Alderson

Just to add about the new slots that you asked about any needs that we had. I just announced a moment ago, first time we said anything that, we were at a place where we could say, that we had a hire in real estate.

So we’re good to go there and recently we announced that we made a hire in logistics. We brought Gary Jordan into run our supply chain, former guy from Asics. And we’re looking – we’re at the beginning of a very deep dive into where do we go from $25 million, $30 million in the sales in e-com and how do we get to $50 million, $75 million or $100 million or whatever the water level tells us is the right number, as we also grow the brick-and-mortar base.

So, we’ll looking at that to see what additional talent that we need to bring in. We made a recent add in our IT group to help us with some of our capability online and otherwise. We brought Ken Buettner in as a Vice President, so - from Tractor Supply.

So we feel good about the moves we made with the team and Mike is going to be looking at that I know very carefully over the next few months to determine what he believes he needs in the go-forward period to be able to get the job done and we’re certainly speaking as a board member. We are very supportive of that because that's what we want to do, we want to do maximize our productivity and maximize value to our shareholders.

Brad Thomas - KeyBanc Capital Markets

Very helpful. If I could follow up with two questions: one on sales, and one on the new store performance. With respect to the third quarter, you all are going to be up against a much more difficult comparison; I think it sounds like comps are positive thus far in August.

Is it possible to give us a little bit more color around how things are trending? What the comparisons looked like last year in the third quarter? I think that was a quarter where trends actually improved through the quarter, if I'm not mistaken. And just your level of confidence that you could hit at a 3% to 4.5% comp that you're guiding to here?

Mike Madden

Right. Well first of all on the guidance - the cost guidance, we certainly - a big part of that is just a trend that we’re seeing in the business and I think it would be fair to say that we’re trending in the guidance range that we gave thus far in August.

We have a seasonal assortment that got off to a start and we're optimistic about. Yes last year was a better comp for us, a 4.9, we did pretty well with the seasonal, but we felt like we have more opportunity there this year. And a consistency in the business is been there for us so far this year.

So there are some factors there but I think lead to a comfort level with that guidance at this time and that's why we did up there.

Brad Thomas - KeyBanc Capital Markets

Great, and then just a housekeeping item on the new store performance; it sounds like they're doing very well. Any more clarity on how some of the new markets are doing versus the fill-in stores would be helpful.

Mike Madden

Looking at the stores we have opened so far this year, it’s somewhat of a mix between fill-in and new, I'm looking at the list right now, we've got certainly really strong performance in some of the fill-ins: markets like Jackson, Mississippi; Johnson City, Tennessee. But we also opened a store in Novi, Michigan, which is just off of kind of a suburb of the Detroit area - strong opening. We only have three stores in that state. So that’s definitely a new market in our - the way we look at it.

So good mix, good result so far and hopefully that will continue into the remainder of the class.

Brad Thomas - KeyBanc Capital Markets

Great to hear. Thanks so much.

Mike Madden

Thanks Brad.


Our next question from the line of David Magee with SunTrust. Please go ahead.

David Magee - SunTrust

Yes, hi, everybody, and congrats as well from me. Robert, congrats on being a step closer to nirvana, and Mike, Michelle, congrats as well.

A couple questions I have -- one is: You sound increasingly confident regarding the fourth quarter. Obviously that's by far the biggest quarter all year. Hopefully we won't have the same weather; we'll have a better calendar. And you mentioned something maybe about seasonal -- doing something different with that. I'm interested in what you might be doing differently there, or any other opportunities that help the visibility of the fourth quarter of this year versus last?

Robert Alderson

Well, without talking about specific merchandise initiatives right now, you know that’s a highly competitive sector. We bought – we felt like as strongly as we performed last year in the fourth quarter in seasonal, we felt like there is additional opportunity.

There is certainly no secret that Christmas art has been a growth area and that's something that we continue to be innovative in our merchandise offering. And it's something that we enjoy doing because we know a lot about selling art.

But there are numerous opportunities in the seasonal category. We are making it enter the stores differently this year, little bit timing difference, slightly earlier but the way that we’re flowing it to the stores will staff specific collections at a time rather than giving a little bit of everything that the store this time and next time, until it takes several trucks over several weeks to build the full collection in the stores.

So we’re trying to do some things that we think it will make that products sell even better than it did last year. And we have a good bit of experience in our system now that is helping us as we look at buyers that we actually can even in our seasonal contacts think about some core product that should be repeated. And that’s been very pleasant experience from our buyers as we look at the fourth quarter.

The fourth quarter is not all that seasonal and so you got to have reasonable success with the rest of your merchandise mix. And I think some of the emphasis that we switched over the past few quarters to building housewares and textiles and accessories and some of those categories that have lend themselves to gifting and to rapid turnover and to building of excitement with customers who want to see what’s new that rolls in on a fairly frequent basis. I think that’s been helpful to our fourth quarter business also.

It’s not been particularly helpful to our average unit retail because it does affect it some. But we will be over with that as we go into 2015.

David Magee - SunTrust

With regard to the success you're seeing with e-commerce, are you seeing any signs of cannibalization at this point with the stores? And then, as part of that, are you seeing a change in terms of the transaction size with e-commerce?

Mike Madden

Yeah I'll cover that. I think there's naturally going to be some cannibalization, it’s hard to measure but we feel like a lot of its incremental when you look at what we’re pursuing in the percentage of our business that’s coming through, paid search advertising, and there’s other ways - those ways that we look at it certainly suggest that we’re attracting customers.

But about 50% of what we sell online are items that we also sell in the store. About 40% of the revenue that we generate online and ship to store not 40% order but 40% of revenue.

So there is definitely a connection there and part of this is, we’re giving our customer more choice in how they shop with us. And that's a natural outflow of this, and reason we’re doing it.

So, there is some cannibalization but we feel like we need to be positioned to handle what the customer is asking for through the site.

We are selling more skews on the site. We’re up above 5,000 skews now and I think that’s naturally led to a little bit lower average item on the site which we, depending on the seasonal kind of ranges between say $25 and $45 on the site. And it's a little lower this year, we’re pushing more units and that’s a little taxing on the operation, but we’re working on that to better define what sells well online at a profit versus what doesn’t.

David Magee - SunTrust

Thank you, Mike. And lastly, are you seeing or have you talked about the sourcing costs from China -- any change there?

Robert Alderson

David, we aren't seeing anything that has been significant, the back half is of course dominated by seasonal which we bought in February, March and April. So, we'll be buying that again in a few months and we will see what happens there but structurally we haven’t seen significant changes, and our shipping costs have been largely static this year based on some deals that we did that’s on the inbound side.

So, so far not affected dramatically but we’ll see.

David Magee - SunTrust

Great. Thanks a lot and good luck here.

Robert Alderson

Thank you.


Our next question from the line of Mark Montagna with Avondale Partners. Please go ahead.

Mark Montagna - Avondale Partners

Hi, just a question about marketing. Hoping you could just give us an update in terms of your elimination of TV marketing in some markets, increased print ads, and what further changes do you think you're going to make? And does that result in cost savings or just keeping marketing flat? And what about a change in message? Is there any change?

Mike Madden

Okay. Well, to summarize where we are with the advertising right now, during the first half and second quarter we were in 25 markets, covered about 141 stores which is about 43% of the chain. We had five drops in Q2, they were combination of freestanding inserts in the newspaper, shared inserts in the newspapers, shared mail delivered to the mail box.

We are going to continue in most of those markets in the back half, I mentioned earlier that in terms of year-over-year on the marketing expense in the back half, we’re going to be slightly down. So, we are going to end the year with roughly the same marketing expense, maybe a little higher, not much though as we have last year and about the same as a percentage of sale.

What we’re learning and why we moved away from the TV for the moment was just the cost and the impact on the return that we saw, because we did that throughout last year, we ran television throughout last year, in fewer markets but enough certainly to get a read on the impact. And we shifted more to the print this year and the costs are lower and we’re seeing a better return on that.

What we’re doing right now though as we go into the back half, is analyzing each markets. Some markets are more efficient, more dense for us and more effective. So, we’re going to tweak that a little bit, and it will result in a little bit less being spent in the back half than in the first half.

But overall statement would be, we’re committed to continuing these forms of external advertising, we feel like we need to reach a new customer. We’re doing a pretty good job of reaching the existing customer through loyalty, through the website, through our email database and other tools. We got to start bringing on these new customers, and we’re seeing awareness kick-up.

We’re looking at the returns hard from a financial standpoint and trying to control the impact to the expense line. But we are seeing awareness lift in these markets. And down the road, that means a lot to us.

In terms of the creative, we're constantly tweaking that. We focused a little bit on this theme of home, the family aspect of home, the welcoming nature of the store, and you see our messaging hit on those, feel good topics. And we’ll continue to do that, but how it shows and looks, we’re always trying to tweak that and it evolves.

Mark Montagna - Avondale Partners

Okay, and then just a follow-up: Your comps are really pretty impressive this year, and the guidance going forward looks good. So, naturally you'd expect some additional leverage to flow to the bottom line. But is all that additional leverage just being eaten up by the e-commerce and nothing else, which would actually be a good thing if it's only just the e-commerce. And when did that e-commerce expense start to ramp up, and when should it level off?

Mike Madden

We started that site from scratch back in 2010. So, we’ve been investing pretty heavily since then and it comes in the form of the supply chain, corporate personnel that support all these efforts - technology, people in technology.

So, a lot of it is that Mark, and yes we’ve increased the marketing budget which has been part of it as well for the overall company. And then just the people, so we segregated into three buckets, the e-commerce expenses and the need we felt to invest so that we could support all the additional capabilities that brings the business. That overlaps into corporate personnel because lot of those ads that we made relate directly to that omnichannel approach that we’re taking.

And then on the marketing side, just the pure marketing, we really didn’t do much of that in the past and we had a big lifting in the bar there and we trying to manage that cost now that we got it built into the P&L as best we can, to our earlier discussion here.

So, stepping back from it, I think we haven’t had the growth on the top line combination of comps and new store activity catch-up with those investments yet. And that’s what we’re seeing in Q1, Q2 and in the Q3.

But as we get to Q4, there’s a better flow through in Q4 because we're going to have more stores open, we’re going to have more of a lift on that side. And as we go into 2015, the expense increases should drop and a lot of what we’ve done is in place.

So, the sales lift combined with a lower increase on the expense side is how I would look at 2015 here early on.

Mark Montagna - Avondale Partners

Okay. That's fantastic. Thank you.


Our next question from the line of Joan Storms with Wedbush Securities. Please go ahead.

Joan Storms - Wedbush Securities

Hi, good morning. Congratulations to Mike, Michelle and Adam. Most of my questions have been answered, but I guess just a couple quick ones. On the freight, we just got off the Dollar Tree call as well, and they were talking about freight expenses being higher due to driver shortages, and I believe you guys had mentioned that in the past. You talked a little bit about inbound was a little neutral, but can you comment on that at all?

Mike Madden

Sure. Inbound is neutral as container cost coming from overseas. And feel like that's not going to have much of the impact for the balance of the year. We’ve got fixed rates during the spring.

On the outbound side, as you alluded to, a lot of our – our e-commerce shipping flows through that line item on our P&L so that the lift in that business had an impact on that comparison.

But also as you mentioned the driver shortage issue, it is tougher for us to get the number of bids on routes and pricing that we had in the past. That’s become more difficult. And we try to manage around that as best we can but it's something that’s going on macro wise that everybody is having to react to and it did play a part in some of that deleverage we saw on that line item.

Joan Storms - Wedbush Securities

Okay, and then also, on the e-commerce, you said it was up 27% in the quarter. And just remind us what the growth rate had been in the past couple of quarters, and maybe -- I think you said you're expecting a little bit higher growth rate in the back -- ?

Mike Madden

It’s been around that range Joan that 30%, 35% range. So it was a little lower, the growth rate but the volume did pick up. I think about $600,000 or so from Q1 to Q2, so sequentially we're increasing the business even though Q2 for the company overall is probably our, it's our lowest quarter of the year. It’s the one that makes the least amount of impact on the overall year.

So, we did see that lift and we do have embedded in the guidance a little bit higher growth rate than 27% for the back half.

Joan Storms - Wedbush Securities

Okay, and then lastly -- so, the deviation from your guidance for the third quarter versus where we were on the street at the $0.08 over the $0.06, is primarily due to the $0.02 from the corporate headquarter relo, and then some e-commerce investments?

Mike Madden

More or less, yes. There’s $0.02 impact for the relocation. Keep in mind, a penny doesn’t take much whether it's 17 million share count. You can move that with a couple of hundred thousand dollars pretax profit or expense.

So, some of its just kind of where it ended up. But I would say that it's the relo but, and it’s also just higher cost to process e-commerce orders. With our ticket being a little lower this year, it’s more units, it’s more work, it’s more labor, it’s more packaging and as that grows, we’re trying to keep up with it as best we can and be efficient at the same time and right now we’re not at that point of optimal efficiency.

Joan Storms - Wedbush Securities

And also probably part of that, too, is your sales being -- the new stores being shifted to post-holiday, too, probably?

Mike Madden

Yes, there’s an impact there too as well.

Joan Storms - Wedbush Securities

Okay, great. Perfect. Okay, thank you very much and good luck going forward.

Mike Madden

Thank you, Joan.


Our next question from the line of Anthony Lebiedzinski with Sidoti & Company. Please go ahead.

Anthony Lebiedzinski - Sidoti & Company

Good morning. Congrats to Mike, Michelle, Adam and Robert. So, just to follow up on the e-commerce question -- looking at last year, e-commerce was about $20 million in revenue, and this year looks like it should be around $27 million-plus. So, just wondering like at what level of sales do you guys need to make this a contributor to the bottom line?

Mike Madden

That’s a toughie because it depends on what you include in there. And as we start to interact more with the store and actually fulfill orders inside the store, that’s going to help our overall profit picture because we’re not having to touch it and move it like we are today. But, it’s company wide sales, so, that will be a better profit scenario for us and we’re able to in store fulfill instead of ship to store as much even going forward.

And as we start to engage with third party, that’s very little impact on us in terms of cost because as we engage with third party vendors, they’re managing the inventory, they’re doing shipping, it’s kind of just a margin for us.

So, as those two dynamics start to play into the overall e-commerce scenario for Kirkland's, that's going to have a lot to say about profitability. As I sit here today looking at it, newer marginally profitable at this level and its taking a lot of energy to keep up with the volume as currently constructed. And if were to increase it, it’s actually costing us at the same, it increases based on the way we fulfill it today.

But again, we're working on two major things that will offset a lot of costs and lead to a better flow through for that business.

Anthony Lebiedzinski - Sidoti & Company

Okay. So, can you just remind us as to when do you expect third party fulfillment and as well as in store fulfillment?

Mike Madden

We are working on both initiatives, precursor to that is getting this order management system in and up and running which is going to be happening in September. That was a foundational investment so it’s the type of technology that you get in place and then you start turning features of it on.

We’ll get some immediate benefits in terms of how we communicate with customers about their order as it’s in process and how we chose, to have fulfill orders in a more effective way. So there's a immediate benefit but turning on the supplier direct fulfillment will be 2015, hopefully early in the year but we’ve got some work to do to finalize that.

And then on the in store fulfillment, again, we got to get past holidays because that’s a big training effort for the stores and we want to go out really ready to execute there.

So, that would be early next year as well.

Anthony Lebiedzinski - Sidoti & Company

Okay, that's helpful. And can you give us an update on your customer loyalty program -- how many members do you have in that? What's the average spending per customer? Any relevant metrics for that would be helpful

Mike Madden

Yes. We are up to, looks like little over 2.5 million enrolled and I would characterize or dig into that little further just to give you some color. Those that are really actively, we would say repeat high level loyalty people within that 2.5 million or around say 700,000 people. And if you look at that slice of it, we’re seeing and ADT, it's in the $45 range which is about 15%, 16% more than the average for the company.

And even those that are in the K-club program which is the full 2.5 million, that ticket is about 5% or 6% more. So, we’re encouraged by that. It’s about overall when you include the credit card program and the loyalty program business by itself. It's approaching two-thirds of the business.

So, we are starting to get to a point where we can segment better and speak to customers in a different way, we’re looking forward being able to report back more detail on that as we go forward.

Anthony Lebiedzinski - Sidoti & Company

Okay, and lastly, as far as new store openings for next year, I know you haven't given guidance for that, but any ballpark estimate as to what your expectations are, would be very helpful, thank you

Mike Madden

Well, we’ve said 10% square footage growth which for us I think next year just for now and just to think about, we will refine this later to be clear, but next 30 kind of number is probably what we're pushing for.

Anthony Lebiedzinski - Sidoti & Company

Thank you very much.


Mr. Alderson, there are no further questions at this time. I will turn the call back to you. You may continue with your closing remarks sir.

Robert Alderson

Well, thank you very much everyone for your interest and time. And we’ll see you later in the year to talk about Q3. Thank you.


Ladies and gentlemen, this does conclude the conference call for today. We thank you all for your participation today. Have a great day everyone.

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