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KIRKLAND'S, INC - Quarter Report: 2010 October (Form 10-Q)

Form 10-Q
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
     
þ   Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended October 30, 2010,
or
     
o   Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     .
Commission file number: 000-49885
KIRKLAND’S, INC.
(Exact name of registrant as specified in its charter)
     
Tennessee   62-1287151
(State or other jurisdiction of   (IRS Employer Identification No.)
incorporation or organization)    
     
2501 McGavock Pike, Suite 1000    
Nashville, Tennessee   37214
(Address of principal executive offices)   (Zip Code)
Registrant’s telephone number, including area code: (615) 872-4800
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, no par value — 19,899,139 shares outstanding as of December, 7, 2010.
 
 

 

 


 

KIRKLAND’S, INC.
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 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 

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KIRKLAND’S, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except share data)
                         
    October 30,     January 30,     October 31,  
    2010     2010     2009  
ASSETS
                       
Current assets:
                       
Cash and cash equivalents
  $ 58,831     $ 76,412     $ 37,017  
Inventories, net
    56,851       39,355       53,701  
Income taxes receivable
    3,332             2,081  
Prepaid expenses and other current assets
    12,334       7,883       8,062  
 
                 
Total current assets
    131,348       123,650       100,861  
Property and equipment, net
    45,125       36,856       38,505  
Non-current deferred income taxes
    3,656       4,395       2,963  
Other assets
    684       640       641  
 
                 
Total assets
  $ 180,813     $ 165,541     $ 142,970  
 
                 
 
                       
LIABILITIES AND SHAREHOLDERS’ EQUITY
                       
Current liabilities:
                       
Accounts payable
  $ 25,923     $ 15,589     $ 24,899  
Income taxes payable
          7,087        
Accrued expenses and other
    21,625       25,402       22,619  
 
                 
Total current liabilities
    47,548       48,078       47,518  
Deferred rent
    27,001       25,399       26,590  
Other liabilities
    3,331       3,579       2,891  
 
                 
Total liabilities
    77,880       77,056       76,999  
 
                 
Shareholders’ equity:
                       
Common stock, no par value; 100,000,000 shares authorized; 19,891,346, 19,749,148 and 19,709,563 shares issued and outstanding at October 30, 2010, January 30, 2010 and October 31, 2009, respectively
    145,773       143,374       142,938  
Accumulated deficit
    (42,840 )     (54,889 )     (76,967 )
 
                 
Total shareholders’ equity
    102,933       88,485       65,971  
 
                 
 
                       
Total liabilities and shareholders’ equity
  $ 180,813     $ 165,541     $ 142,970  
 
                 
The accompanying notes are an integral part of these financial statements.

 

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KIRKLAND’S, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in thousands, except per share data)
                                 
    13-Week Period Ended     39-Week Period Ended  
    October 30,     October 31,     October 30,     October 31,  
    2010     2009     2010     2009  
Net sales
  $ 92,725     $ 92,389     $ 275,694     $ 263,397  
Cost of sales (exclusive of depreciation as shown below)
    56,732       54,458       164,243       159,885  
 
                       
 
                               
Gross profit
    35,993       37,931       111,451       103,512  
Operating expenses:
                               
Compensation and benefits
    18,337       17,427       53,228       50,519  
Other operating expenses
    10,744       9,330       29,146       25,529  
Depreciation
    3,146       3,531       9,294       11,017  
 
                       
Total operating expenses
    32,227       30,288       91,668       87,065  
 
                               
Operating income
    3,766       7,643       19,783       16,447  
 
                               
Interest expense, net
    33       43       101       111  
Other income, net
    (62 )     (50 )     (249 )     (184 )
 
                       
 
                               
Income before income taxes
    3,795       7,650       19,931       16,520  
Income tax expense
    1,516       2,080       7,882       4,028  
 
                       
 
                               
Net income
  $ 2,279     $ 5,570     $ 12,049     $ 12,492  
 
                       
 
                               
Earnings per share:
                               
Basic
  $ 0.11     $ 0.28     $ 0.61     $ 0.63  
 
                       
Diluted
  $ 0.11     $ 0.27     $ 0.59     $ 0.62  
 
                       
 
                               
Weighted average shares for basic earnings per share
    19,889       19,708       19,839       19,684  
Effect of dilutive stock equivalents
    633       625       749       497  
 
                       
Adjusted weighted average shares for diluted earnings per share
    20,522       20,333       20,588       20,181  
 
                       
The accompanying notes are an integral part of these financial statements.

 

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KIRKLAND’S, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)
(in thousands, except share data)
                                 
                            Total  
    Common Stock     Accumulated     Shareholders’  
    Shares     Amount     Deficit     Equity  
Balance at January 30, 2010
    19,749,148     $ 143,374     $ (54,889 )   $ 88,485  
Exercise of employee stock options and employee stock purchases
    142,198       328               328  
Tax benefit from exercise of stock options
            460               460  
Net share settlement of options
            (239 )             (239 )
Stock-based compensation expense
            1,850               1,850  
Net income
                    12,049       12,049  
 
                       
 
                               
Balance at October 30, 2010
    19,891,346     $ 145.773     $ (42,840 )   $ 102,933  
 
                       
The accompanying notes are an integral part of these financial statements.

 

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KIRKLAND’S, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
                 
    39-Week Period Ended  
    October 30,     October 31,  
    2010     2009  
Cash flows from operating activities:
               
Net income
  $ 12,049     $ 12,492  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Depreciation
    9,294       11,017  
Amortization of landlord construction allowances
    (4,727 )     (5,654 )
Amortization of debt issue costs
    20       21  
Loss on disposal of property and equipment
    247       250  
Stock-based compensation expense
    1,850       942  
Excess tax benefits from exercise of stock options
    (460 )      
Deferred income taxes
    278       50  
Changes in assets and liabilities:
               
Inventories, net
    (17,496 )     (15,015 )
Prepaid expenses and other current assets
    (3,990 )     (1,886 )
Other noncurrent assets
    (64 )     (44 )
Accounts payable
    10,334       11,398  
Income taxes payable
    (9,959 )     (7,430 )
Accrued expenses and other current and noncurrent liabilities
    2,304       2,191  
 
           
 
               
Net cash provided by (used in) operating activities
    (320 )     8,332  
 
           
 
               
Cash flows from investing activities:
               
Proceeds from sale of property and equipment
    (37 )     67  
Capital expenditures
    (17,773 )     (8,013 )
 
           
 
               
Net cash used in investing activities
    (17,810 )     (7,946 )
 
           
 
               
Cash flows from financing activities:
               
Borrowings on revolving line of credit
           
Repayments on revolving line of credit
           
Excess tax benefits from exercise of stock options
    460        
Cash used to net share settle options
    (239 )      
Exercise of stock options and employee stock purchases
    328       186  
 
           
 
               
Net cash provided by financing activities
    549       186  
 
           
 
               
Cash and cash equivalents:
               
Net increase (decrease)
    (17,581 )     572  
Beginning of the period
    76,412       36,445  
 
           
 
               
End of the period
  $ 58,831     $ 37,017  
 
           
The accompanying notes are an integral part of these financial statements.

 

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KIRKLAND’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1 — Basis of Presentation
Kirkland’s, Inc. (the “Company”) is a specialty retailer of home décor with 296 stores in 29 states as of October 30, 2010. The consolidated financial statements of the Company include the accounts of Kirkland’s, Inc. and its wholly-owned subsidiaries, Kirkland’s Stores, Inc. and Kirklands.com, Inc. Significant intercompany accounts and transactions have been eliminated.
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, including normal recurring adjustments, considered necessary for a fair presentation have been included. These financial statements should be read in conjunction with the audited financial statements included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 15, 2010.
It should be understood that accounting measurements at interim dates inherently involve greater reliance on estimates than those at fiscal year end. In addition, because of seasonality factors, the results of the Company’s operations for the 13-week and 39-week periods ended October 30, 2010 may not be indicative of the results to be expected for any other interim period or for the entire fiscal year. The Company’s fiscal year ends on the Saturday closest to January 31, resulting in years of either 52 or 53 weeks. All references to a fiscal year refer to the fiscal year ending on the Saturday closest to January 31 of the following year.
The preparation of the unaudited consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from the estimates and assumptions used.
Changes in estimates are recognized in the period when new information becomes available to management. Areas where the nature of the estimate makes it reasonably possible that actual results could materially differ from amounts estimated include: impairment assessments on long-lived assets, inventory reserves, self-insurance reserves, income tax liabilities, stock-based compensation, gift certificate and gift card breakage, customer loyalty program accruals and contingent liabilities.
Certain prior period balances have been reclassified to conform to the current period presentation. The expenses associated with the Company’s customer loyalty program were reclassified during the fourth quarter of fiscal 2009 to cost of sales from other operating expenses. This reclassification on the statements of income was made in all prior periods presented for comparability purposes. The amounts reclassified for the 13-week and 39-week periods ended October 31, 2009 were $212,000, and $373,000, respectively. These reclassifications had no effect on net income, shareholders’ equity, total assets and total liabilities, or the major categories of the cash flow statement.
Note 2 — Income Taxes
An estimate of the annual effective tax rate is used at each interim period based on the facts and circumstances available at that time, while the actual effective tax rate is calculated at year-end. For the 13-week period ended October 30, 2010, the Company recorded income tax expense of 40.0% of income before income taxes. In the prior year period, the Company recorded income tax expense of 27.2% of income before income taxes as a result of a reduction in the Company’s valuation allowance against deferred tax assets which resulted in a reduction of income tax expense of approximately $1.0 million, or $0.04 per diluted share. For the 39-week period ended October 30, 2010, the Company recorded income tax expense of 39.5% of income before income taxes. In the prior year period, the Company recorded income tax expense of 24.4% of income before income taxes as a result of a reduction in the Company’s valuation allowance against deferred tax assets which resulted in a reduction of income expense by approximately $2.6 million, or $0.13 per diluted share.

 

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The Company provides for uncertain tax positions and the related interest and penalties, if any, based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. The Company recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. To the extent the Company prevails in matters for which a liability for an unrecognized tax benefit is established or is required to pay amounts in excess of the liability, the Company’s effective tax rate in a given financial statement period may be affected.
Note 3 — Earnings Per Share
Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during each period presented, which excludes non-vested restricted stock. Diluted earnings per share is computed by dividing net income by the weighted average number of shares outstanding plus the dilutive effect of stock equivalents outstanding during the applicable periods using the treasury stock method. Diluted earnings per share reflects the potential dilution that could occur if options to purchase stock were exercised into common stock or restricted stock units became vested. Stock options and restricted stock units that were not included in the computation of diluted earnings per share because to do so would have been antidilutive were 368,000 and 67,500 shares for the 13-week periods ended October 30, 2010 and October 31, 2009, and 568,000 and 1,102,000 for the 39-week periods ended October 30, 2010 and October 31, 2009, respectively.
Note 4 — Commitments and Contingencies
The Company is party to pending legal proceedings and claims. Although the outcome of such proceedings and claims cannot be determined with certainty, the Company’s management is of the opinion that it is unlikely that these proceedings and claims in excess of insurance coverage will have a material effect on the financial condition, operating results or cash flows of the Company.
Note 5 — Stock-Based Compensation
The Company maintains equity incentive plans under which it may grant non-qualified stock options, incentive stock options, restricted stock units, or stock appreciation rights to employees, non-employee directors and consultants.
The Company granted 225,000 stock options and 114,000 restricted stock units during the 39-week period ended October 30, 2010. This compares to 630,000 stock options granted in the 39-week period ended October 31, 2009. Total stock-based compensation expense (a component of compensation and benefits) was $798,000 for the 13-week period ended October 30, 2010 and $1.9 million for the 39-week period ended October 30, 2010 compared to $378,000 and $942,000, respectively, for the comparable prior year periods.
As of October 30, 2010, there was approximately $3.9 million of total unrecognized compensation expense related to unvested stock option awards that is expected to be recognized over a weighted average period of 1.7 years and $2.0 million of total unrecognized compensation expense related to unvested restricted stock that is expected to be recognized over a weighted average period of one year.
Note 6 — Related Party Transactions
In July 2009, the Company entered into a Vendor Agreement with a related party vendor to purchase merchandise inventory. The vendor is considered a related party because one of its principals is the spouse of the Company’s Vice President of Merchandising. During the 13-week and 39-week periods ended October 30, 2010, purchases from this vendor totaled approximately $6.0 million and $15.4 million, or 11% of total merchandise purchases during both periods. Payable amounts outstanding to this vendor were approximately $1.0 million as of October 30, 2010. The Company’s payable terms with this vendor are consistent with the terms offered by other vendors in the ordinary course of business.

 

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ITEM 2.  
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward Looking Statements
This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (MD&A) is intended to provide an understanding of our financial condition, change in financial condition, cash flow, liquidity and results of operations. The following MD&A discussion should be read in conjunction with the condensed consolidated financial statements and notes to those statements that appear elsewhere in this Form 10-Q and in the Company’s Annual Report on Form 10-K. The following discussion contains forward-looking statements that reflect the Company’s plans, estimates and beliefs. The Company’s actual results could differ materially from those discussed or referred to in the forward-looking statements. Factors that could cause or contribute to any differences include, but are not limited to, those discussed under the caption, “Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995” and under Part II, Item 1A — “Risk Factors”.
General
We are a specialty retailer of home décor in the United States, operating 296 stores in 29 states as of October 30, 2010. Our stores present a broad selection of distinctive merchandise, including framed art, mirrors, wall décor, candles and related items, lamps, decorative accessories, accent furniture, textiles, garden-related accessories and artificial floral products. Our stores also offer an extensive assortment of holiday merchandise during seasonal periods as well as items carried throughout the year suitable for gift-giving. In addition, we sometimes use innovative design and packaging to market home décor items as gifts. We provide our predominantly female customers an engaging shopping experience characterized by a diverse, ever-changing merchandise selection at prices which provide the customer discernable value. Our stores offer a unique combination of style and value that has led to our emergence as a recognized name in home décor and has enabled us to develop a strong customer franchise.
During the 13-week period ended October 30, 2010, we opened 15 new stores and closed five stores. The following table summarizes our stores and square footage under lease by venue type:
                                                                 
    Stores             Square Footage     Average Store Size  
    10/30/10             10/31/09             10/30/10     10/31/09     10/30/10     10/31/09  
Mall
    61       21 %     78       26 %     292,000       368,314       4,787       4,722  
Off-Mall
    235       79 %     218       74 %     1,582,524       1,403,010       6,734       6,436  
 
                                               
Total
    296       100 %     296       100 %     1,874,524       1,771,324       6,333       5,984  
 
                                               
13-Week Period Ended October 30, 2010 Compared to the 13-Week Period Ended October 31, 2009
Results of operations. The table below sets forth selected results of our operations in dollars and expressed as a percentage of net sales for the periods indicated (dollars in thousands):
                                                 
    13-Week Period Ended        
    October 30, 2010     October 31, 2009     Change  
    $     %     $     %     $     %  
Net sales
  $ 92,725       100.0 %   $ 92,389       100.0 %   $ 336       0.4 %
Cost of sales
    56,732       61.2 %     54,458       58.9 %     2,274       4.2 %
 
                                   
Gross profit
    35,993       38.8 %     37,931       41.1 %     (1,938 )     (5.1 %)
 
                                               
Operating expenses:
                                               
Compensation and benefits
    18,337       19.8 %     17,427       18.9 %     910       5.2 %
Other operating expenses
    10,744       11.6 %     9,330       10.1 %     1,414       15.2 %
Depreciation
    3,146       3.4 %     3,531       3.8 %     (385 )     (10.9 %)
 
                                   
Total operating expenses
    32,227       34.8 %     30,288       32.8 %     1,939       6.4 %
 
                                               
Operating income
    3,766       4.1 %     7,643       8.3 %     (3,877 )     (50.7 %)
 
                                               
Interest expense, net
    33       0.0 %     43       0.0 %     (10 )     (23.3 %)
Other income, net
    (62 )     (0.1 %)     (50 )     (0.1 %)     (12 )     24.0 %
 
                                   
 
                                               
Income before income taxes
    3,795       4.1 %     7,650       8.3 %     (3,855 )     (50.4 %)
Income tax expense
    1,516       1.6 %     2,080       2.3 %     (564 )     (27.1 %)
 
                                   
 
                                               
Net income
  $ 2,279       2.5 %   $ 5,570       6.0 %   $ (3,291 )     (59.1 %)
 
                                   

 

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Net sales. Net sales increased 0.4% to $92.7 million for the third fiscal quarter of 2010 compared to $92.4 million for the prior year period. The increase in net sales was the result of new store growth of $2.3 million, partially offset by a $2.0 million decrease in comparable store sales. During the third quarter of fiscal 2010, comparable store sales decreased 2.4% as compared to an 11.3% increase in the prior year period. The comparable store sales decrease was primarily due to a decrease in the average ticket, offset partially by an increase in transactions. The decrease in the average ticket was the result of a lower average retail selling price and a decrease in items per transaction. The increase in transactions was due to an increase in customer traffic count, partially offset by a decline in the conversion rate. Conversion rate is calculated as total transactions divided by total customer traffic. The strongest performing merchandise categories were seasonal, floral and wall décor. The weakest performing merchandise categories were art, lamps, and candles and accessories.
Gross profit. Gross profit as a percentage of net sales decreased from 41.1% in the third quarter of 2009 to 38.8% in the third quarter of 2010. Merchandise margins decreased from 56.6% in the third quarter of fiscal 2009 to 53.7% in the third quarter of fiscal 2010. Merchandise margin is calculated as net sales minus product cost of sales, inventory shrinkage, and loyalty reward program expense. Merchandise margin excludes outbound freight, store occupancy and central distribution costs. The decrease in merchandise margin in the third quarter of 2010 was due to higher ocean freight costs and an increase in markdowns versus the prior year period. Store occupancy costs as a percentage of net sales decreased 77 basis points versus the prior year quarter. This decline resulted primarily from favorable lease renewal and extension terms, the closure of underperforming stores, and our continued shift to less-costly off-mall real estate locations. Outbound freight costs and central distribution expenses increased 10 basis points as a percentage of sales due to sales deleverage and initial freight costs associated with new store openings.
Compensation and benefits. At the store level, the compensation and benefits expense ratio increased for the third quarter of fiscal 2010 as compared to the third quarter of 2009 primarily due to sales deleverage, partially offset by lower store bonus accruals. At the corporate level, the compensation and benefits ratio increased slightly for the third quarter of 2010 as compared to the third quarter of 2009, primarily due to an increase in stock compensation expense.
Other operating expenses. Other operating expenses increased as a percentage of net sales for the third quarter of fiscal 2010. This was primarily the result of increases in marketing expenses, travel expenses, credit and debit card charges, and deleverage caused by the decrease in comparable store sales in the third quarter of fiscal 2010 as compared to the prior year period. We also held a full store managers’ meeting in August 2010 for the first time in several years. The cost of this meeting accounted for approximately 49 basis points of the total year-over-year increase in operating expenses as a percentage of sales.
Depreciation. The decrease in depreciation as a percentage of sales reflects the reduction in capital expenditures during 2008 and 2009 relative to prior periods, and the decline in store count during those periods, and the impact of lease extensions for store locations in which the majority of the fixed assets are fully depreciated.
Income tax expense. We recorded income tax expense of approximately $1.5 million, or 40.0% of pre-tax income during the third quarter of fiscal 2010, versus approximately $2.1 million, or 27.2% of pre-tax income, in the prior year quarter. The most significant reconciling item between our effective tax rate and the federal statutory rate of 35% during the prior year period was the reversal of $1.0 million of the valuation allowance previously established against deferred tax assets primarily related to net operating losses generated in fiscal 2007. We were able to reverse the remaining valuation allowance by the end of fiscal 2009 as we achieved positive operating performance. At January 30, 2010, there was no remaining valuation allowance against our deferred tax assets.

 

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Net income and earnings per share. As a result of the foregoing, we reported net income of $2.3 million, or $0.11 per diluted share, for the third quarter of fiscal 2010 as compared to net income of $5.6 million, or $0.27 per diluted share, for the third quarter of fiscal 2009.
We believe that expressing net income and earnings per share for the prior year period results using a normalized tax rate is instrumental in judging our performance for current and future periods when we expect to incur more normalized tax rates. Excluding adjustments to our valuation allowance on deferred taxes, adjusted net income and adjusted earnings per share were $4.6 million, or $0.23 per diluted share for the 13-week period ended October 31, 2009. A reconciliation of these non-GAAP financial measures is presented under “Reconciliation of Non-GAAP Measures” within this Item 2.
39-Week Period Ended October 30, 2010 Compared to the 39-Week Period Ended October 31, 2009
Results of operations. The table below sets forth selected results of our operations in dollars and expressed as a percentage of net sales for the periods indicated (dollars in thousands):
                                                 
    39-Week Period Ended        
    October 30, 2010     October 31, 2009     Change  
    $     %     $     %     $     %  
Net sales
  $ 275,694       100.0 %   $ 263,397       100.0 %     12,297       4.7 %
Cost of sales
    164,243       59.6 %     159,885       60.7 %     4,358       2.7 %
 
                                   
Gross profit
    111,451       40.4 %     103,512       39.3 %     7,939       7.7 %
 
                                               
Operating expenses:
                                               
Compensation and benefits
    53,228       19.3 %     50,519       19.2 %     2,709       5.4 %
Other operating expenses
    29,146       10.6 %     25,529       9.7 %     3,617       14.2 %
Depreciation
    9,294       3.4 %     11,017       4.2 %     (1,723 )     (15.6 %)
 
                                   
Total operating expenses
    91,668       33.2 %     87,065       33.1 %     4,603       5.3 %
 
                                               
Operating income
    19,783       7.2 %     16,447       6.2 %     3,336       20.3 %
 
                                               
Interest expense, net
    101       0.0 %     111       0.0 %     (10 )     (9.0 %)
Other income, net
    (249 )     (0.1 %)     (184 )     (0.1 %)     (65 )     35.3 %
 
                                   
 
                                               
Income before income taxes
    19,931       7.2 %     16,520       6.3 %     3,411       20.6 %
Income tax expense
    7,882       2.9 %     4,028       1.5 %     3,854       95.7 %
 
                                   
 
                                               
Net income
  $ 12,049       4.4 %   $ 12,492       4.7 %   $ (443 )     (3.5 %)
 
                                   
Net sales. Net sales increased 4.7% to $275.7 million for the first three quarters of fiscal 2010 from $263.4 million for the prior year period. During the first three quarters of fiscal 2010, comparable store sales increased 3.5% on top of a 7.6% increase in the prior year period. The comparable store sales increase accounted for an $8.2 million increase in overall sales for the period. The balance of the overall increase of $4.1 million was the result of strong sales performance from new store openings partially offset by store closings. The comparable store sales increase was primarily due to a 7% increase in the number of transactions, offset partially by a lower average ticket. The increase in transactions was driven by an increase in customer traffic count. The decrease in the average ticket was the result of a lower average retail selling price, partially offset by a slight increase in items per transaction. The strongest performing merchandise categories were wall décor, mirrors, candles, and accessories. The weakest performing merchandise categories were art, lamps, and candles and accessories.

 

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Gross profit. Gross profit as a percentage of net sales increased from 39.3% in the first three quarters of fiscal 2009 to 40.4% in the first three quarters of fiscal 2010. Merchandise margins decreased from 55.0% in the first three quarters of fiscal 2009 to 54.6% in the first three quarters of fiscal 2010. The decrease in merchandise margin was the result of increased ocean freight costs and increased markdowns during the third quarter of fiscal 2010. Store occupancy costs as a percentage of net sales decreased 1.4%. This decline resulted from favorable lease renewal and extension terms, the closure of underperforming stores, and our continued shift to less-costly off-mall real estate locations. Outbound freight costs and central distribution expenses decreased slightly as a percentage of sales primarily due to comparable store sales leverage.
Other operating expenses. Other operating expenses increased as a percentage of net sales for the first three quarters of fiscal 2010. This was primarily the result of increases in marketing expenses. travel expenses, meeting expenses and information technology maintenance expenses as compared to the prior year period.
Depreciation. The decrease in depreciation as a percentage of sales reflects the reduction in capital expenditures during 2008 and 2009 relative to prior periods and the related decline in store count during those periods, and the impact of lease extensions for store locations in which the majority of the fixed assets are fully depreciated.
Income tax expense. We recorded income tax expense of approximately $7.9 million, or 39.5% of pre-tax income during the first three quarters of fiscal 2010, versus approximately $4.0 million, or 24.4% of pre-tax income during the prior year period. The most significant reconciling items between our effective tax rate and the federal statutory rate of 35% during the prior year period was the reversal of $2.6 million of the valuation allowance previously established against deferred tax assets primarily related to net operating losses generated in fiscal 2007. We were able to reverse the remaining valuation allowance by the end of fiscal 2009 as we achieved positive operating performance. At January 30, 2010, there was no remaining valuation allowance against our deferred tax assets.
Net income and earnings per share. As a result of the foregoing, we reported net income of $12.0 million, or $0.59 per diluted share, for the first three quarters of fiscal 2010 as compared to net income of $12.5 million, or $0.62 per share, for the first three quarters of fiscal 2009.
We believe that expressing net income and earnings per share for the prior year period using a normalized tax rate is instrumental in judging our performance for current and future periods when we expect to incur more normalized tax rates. Excluding adjustments to our valuation allowance on deferred taxes, adjusted net income and adjusted earnings per share were $9.9 million or $0.49 per diluted share for the 39-week period ended October 31, 2009. A reconciliation of these non-GAAP financial measures is presented under “Reconciliation of Non-GAAP Measures” within this Item 2.
Liquidity and Capital Resources
Our principal capital requirements are for working capital and capital expenditures. Working capital consists mainly of merchandise inventories offset by accounts payable, which typically reach their peak by the end of the third quarter of each fiscal year. Capital expenditures primarily relate to new store openings; existing store expansions, remodels or relocations; and purchases of equipment or information technology assets for our stores, distribution facilities and corporate headquarters. Historically, we have funded our working capital and capital expenditure requirements with internally generated cash and borrowings under our credit facility.
Cash flows from operating activities. Net cash provided by (used in) operating activities was ($320,000) and $8.3 million for the first three quarters of fiscal 2010 and fiscal 2009, respectively. Cash flows from operating activities depend heavily on operating performance, changes in working capital and the timing and amount of payments for income taxes. The change in the amount of cash from operations as compared to the prior year period was primarily the result of an increase in inventories, prepaid expenses and an increase in income taxes paid. The change in cash flows from operations was primarily the result of an increase in inventories combined with an increase in income taxes paid.

 

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Cash flows from investing activities. Net cash used in investing activities for the first three quarters of fiscal 2010 consisted principally of $17.8 million in capital expenditures as compared to $7.9 million for the prior year period. The capital expenditures primarily related to new store construction and information technology assets. During the first three quarters of fiscal 2010, we opened 28 stores. We expect that capital expenditures for all of fiscal 2010 will be approximately $24 to $26 million, primarily to fund the construction of approximately 38 new stores, make improvements in our information technology infrastructure, and maintain our investments in existing stores and our distribution center.
Cash flows from financing activities. Net cash provided by financing activities was approximately $549,000 and $186,000 for the first three quarters of fiscal 2010 and fiscal 2009, respectively, and was related to the exercise of employee stock options as well as employee stock purchases and the related tax benefits.
Revolving credit facility. Effective October 4, 2004, we entered into a five-year senior secured revolving credit facility with a revolving loan limit of up to $45 million. On August 6, 2007, we entered into the First Amendment to Loan and Security Agreement (the “Amendment”) which provided the Company with additional availability under our borrowing base through higher advance rates on eligible inventory. As a result of the Amendment, the aggregate size of the overall credit facility remained unchanged at $45 million, but the term of the facility was extended two years making the new expiration date October 4, 2011. Amounts outstanding under the amended facility, other than First In Last Out (“FILO”) loans, bear interest at a floating rate equal to the 60-day LIBOR rate (0.27% at October 30, 2010) plus 1.25% to 1.50% (depending on the amount of excess availability under the borrowing base). FILO loans, which apply to the first approximately $2 million borrowed at any given time, bear interest at a floating rate equal to the 60-day LIBOR rate plus 2.25% to 2.50% (depending on the amount of excess availability under the borrowing base). Additionally, we pay a quarterly fee to the bank equal to a rate of 0.2% per annum on the unused portion of the revolving line of credit. Borrowings under the facility are collateralized by substantially all of our assets and guaranteed by our subsidiaries. The maximum availability under the credit facility is limited by a borrowing base formula, which consists of a percentage of eligible inventory and receivables less reserves. The facility also contains provisions that could result in changes to the presented terms or the acceleration of maturity. Circumstances that could lead to such changes or acceleration include a material adverse change in the business or an event of default under the credit agreement. The facility has one financial covenant that requires the Company to maintain excess availability under the borrowing base, as defined in the credit agreement, of at least $3.0 to $4.5 million depending on the size of the borrowing base, at all times.
As of October 30, 2010, we were in compliance with the covenants in the facility and there were no outstanding borrowings under the credit facility, with approximately $42.0 million available for borrowing (net of the availability block as described above).
At October 30, 2010, our balance of cash and cash equivalents was approximately $58.8 million and the borrowing availability under our facility was $42.0 million (net of the availability block as described above). We believe that the combination of our cash balances, line of credit availability and cash flow from operations will be sufficient to fund our planned capital expenditures and working capital requirements for at least the next twelve months.
Reconciliation of Non-GAAP Measures
“Management’s Discussion and Analysis of Financial Condition and Results of Operations” includes certain financial measures not derived in accordance with generally accepted accounting principles (non-GAAP measures). The non-GAAP measures are “adjusted net income” and “adjusted earnings per share” and are equal to net income, and earnings per share, in each case excluding adjustments to the Company’s valuation allowance for deferred tax assets. Management uses these measures to focus on normalized operations, and believes that it is useful to investors because it enables them to perform more meaningful comparisons of past, present and future operating results. Non-GAAP measures should not be used as a substitute for GAAP financial measures, or considered in isolation, for the purpose of analyzing our financial performance, financial position, or cash flows. However, the Company believes that using this information, along with the corresponding GAAP measures, provides for a more complete analysis of the results of operations by quarter. Net income and earnings per share are the most directly comparable GAAP measures. Below is a reconciliation of the non-GAAP measures to their most comparable GAAP measures.

 

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Reconciliation of Non-GAAP Financial Information
                 
    13 Weeks Ended     39 Weeks Ended  
(dollars in thousands, except per share amounts)   October 31, 2009     October 31, 2009  
Net income
               
 
               
Net income in accordance with GAAP
  $ 5,570     $ 12,492  
 
               
Adjustments to the valuation allowance for deferred tax assets
  $ (954 )   $ (2,562 )
 
           
 
               
Adjusted net income
  $ 4,616     $ 9,930  
 
           
 
               
Diluted earnings per share
               
 
               
Diluted EPS in accordance with GAAP
  $ 0.27     $ 0.62  
 
               
Adjustments to the valuation allowance for deferred tax assets
  $ (0.04 )   $ (0.13 )
 
           
 
               
Adjusted diluted earnings per share
  $ 0.23     $ 0.49  
 
           
Off-Balance Sheet Arrangements
None.
Significant Contractual Obligations and Commercial Commitments
Construction commitments
The Company had commitments for new store construction projects totaling approximately $2.2 million at October 30, 2010.
Critical Accounting Policies and Estimates
There have been no significant changes to our critical accounting policies during fiscal 2010. Refer to our Annual Report on Form 10-K for the fiscal year ended January 30, 2010, for a summary of our critical accounting policies.
Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995
The following information is provided pursuant to the “Safe Harbor” provisions of the Private Securities Litigation Reform Act of 1995. Certain statements under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-Q are “forward-looking statements” made pursuant to these provisions. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Words such as “should,” “likely to,” “forecasts,” “strategy,” “goal,” “anticipates,” “believes,” “expects,” “estimates,” “intends,” “plans,” “projects,” and similar expressions, may identify such forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially from the results projected in such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.
The factors listed below under the heading “Risk Factors” and in the other sections of this Form 10-Q provide examples of risks, uncertainties and events that could cause our actual results to differ materially from the expectations expressed in our forward-looking statements.

 

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These forward-looking statements speak only as of the date of this report and, except as required by law, we undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this report.
We caution readers that the following important factors, among others, have in the past, in some cases, affected and could in the future affect our actual results of operations and cause our actual results to differ materially from the results expressed in any forward-looking statements made by us or on our behalf.
   
If We Do Not Generate Sufficient Cash Flow, We May Not Be Able to Implement Our Growth Strategy.
   
If We Are Unable to Profitably Open and Operate New Stores, We May Not Be Able to Adequately Execute Our Growth Strategy, Resulting in a Decrease in Net Sales and Net Income.
   
Our Performance May Be Affected by General Economic Conditions and the Recent Global Financial Crisis.
   
We May Not Be Able to Successfully Anticipate Consumer Trends and Our Failure to Do So May Lead to Loss of Consumer Acceptance of Our Products Resulting in Reduced Net Sales.
   
The Market Price for Our Common Stock Might Be Volatile and Could Result in a Decline in the Value of Your Investment.
   
Our Comparable Store Net Sales Fluctuate Due to a Variety of Factors.
   
Failure to Protect the Integrity and Security of Individually Identifiable Data of Our Customers and Employees Could Expose Us to Litigation and Damage Our Reputation.
   
We Face an Extremely Competitive Specialty Retail Business Market, and Such Competition Could Result in a Reduction of Our Prices and a Loss of Our Market Share.
   
We Depend on a Number of Vendors to Supply Our Merchandise, and Any Delay in Merchandise Deliveries from Certain Vendors May Lead to a Decline in Inventory Which Could Result in a Loss of Net Sales.
   
We Are Dependent on Foreign Imports for a Significant Portion of Our Merchandise, and Any Changes in the Trading Relations and Conditions Between the United States and the Relevant Foreign Countries May Lead to a Decline in Inventory Resulting in a Decline in Net Sales, or an Increase in the Cost of Sales Resulting in Reduced Gross Profit.
   
Our Success Is Highly Dependent on Our Planning and Control Processes and Our Supply Chain, and Any Disruption in or Failure to Continue to Improve These Processes May Result in a Loss of Net Sales and Net Income.
   
Our Business Is Highly Seasonal and Our Fourth Quarter Contributes a Disproportionate Amount of Our Net Sales, Net Income and Cash Flow, and Any Factors Negatively Impacting Us During Our Fourth Quarter Could Reduce Our Net Sales, Net Income and Cash Flow, Leaving Us with Excess Inventory and Making It More Difficult for Us to Finance Our Capital Requirements.
   
We May Experience Significant Variations in Our Quarterly Results.
   
Our Hardware and Software Systems Are Vulnerable to Damage that Could Harm Our Business.
   
We Depend on Key Personnel, and if We Lose the Services of Any Member of Our Senior Management Team, We May Not Be Able to Run Our Business Effectively.

 

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Our Charter and Bylaw Provisions and Certain Provisions of Tennessee Law May Make It Difficult in Some Respects to Cause a Change in Control of Kirkland’s and Replace Incumbent Management.
   
Concentration of Ownership among Our Existing Directors, Executive Officers, and Their Affiliates May Prevent New Investors from Influencing Significant Corporate Decisions.
   
If We Fail to Maintain an Effective System of Internal Control, We May Not Be Able to Accurately Report Our Financial Results.
ITEM 3.  
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not utilize financial instruments for trading or other speculative purposes, nor does it utilize leveraged financial instruments. There have been no material changes in the market risk factors from those disclosed in the Company’s Form 10-K for the year ended January 30, 2010.
ITEM 4.  
CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15(d)-(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) have concluded that as of October 30, 2010 our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by the Company in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
(b) Change in internal controls over financial reporting. There have been no changes in internal controls over financial reporting identified in connection with the foregoing evaluation that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II OTHER INFORMATION
ITEM 1.  
LEGAL PROCEEDINGS
We are involved in various routine legal proceedings incidental to the conduct of our business. We believe any resulting liability from existing legal proceedings, individually or in the aggregate, will not have a material adverse effect on our operations or financial condition.
ITEM 1A.  
RISK FACTORS
In addition to factors set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Cautionary Statement for Purposes of the ‘Safe Harbor’ Provisions of the Private Securities Litigation Reform Act of 1995,” in Part I — Item 2 of this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 30, 2010, which could materially affect our business, financial condition or future results. The risks described in this report and in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
As of the date of this filing, there have been no material changes in our risk factors from those disclosed in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended January 30, 2010.

 

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ITEM 2.  
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3.  
DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4.  
RESERVED
Reserved.
ITEM 5.  
OTHER INFORMATION
None.
ITEM 6.  
EXHIBITS
  (a)  
Exhibits.
         
Exhibit No.   Description of Document
       
 
  31.1    
Certification of the President and Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a)
       
 
  31.2    
Certification of the Senior Vice President and Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a)
       
 
  32.1    
Certification of the President and Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
       
 
  32.2    
Certification of the Senior Vice President and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

 

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
         
  KIRKLAND’S, INC.
 
 
Date: December 9, 2010  /s/ Robert E. Alderson    
  Robert E. Alderson   
  President and Chief Executive Officer
(Principal Executive Officer) 
 
     
Date: December 9, 2010  /s/ W. Michael Madden    
  W. Michael Madden   
  Senior Vice President and
Chief Financial Officer (Principal Financial Officer and Accounting Officer) 
 

 

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