KIRKLAND'S, INC - Quarter Report: 2021 July (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended July 31, 2021

or

For the transition period from ______to ______.

Commission file number: 000-49885

Kirkland’s, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (615) 872-4800

Securities registered pursuant to Section 12(b) of the Act:

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☒

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 – 13,476,733 shares outstanding as of August 27, 2021.

KIRKLAND’S, INC.

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PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

KIRKLAND’S, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands, except share data)

The accompanying notes are an integral part of these financial statements.

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KIRKLAND’S, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share data)

The accompanying notes are an integral part of these financial statements.

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KIRKLAND’S, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

(in thousands, except share data)

The accompanying notes are an integral part of these financial statements.

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KIRKLAND’S, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)

The accompanying notes are an integral part of these financial statements.

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KIRKLAND’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 – Description of Business and Basis of Presentation

Nature of Business — Kirkland’s, Inc. (the “Company”) is a specialty retailer of home décor in the United States operating 369 stores in 35 states as of July 31, 2021, as well as an e-commerce website, www.kirklands.com.

Principles of consolidation — The condensed consolidated financial statements of the Company include the accounts of Kirkland’s, Inc. and its wholly-owned subsidiaries, Kirkland’s Stores, Inc., Kirkland’s DC, Inc., and Kirkland’s Texas, LLC. Significant intercompany accounts and transactions have been eliminated.

Basis of presentation — The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and are presented in accordance with the requirements of Form 10-Q and pursuant to the reporting and disclosure rules and regulations of the United States Securities and Exchange Commission (“SEC”). In the opinion of management, all adjustments, including normal recurring accruals, 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 SEC on March 26, 2021.

Impact of the novel coronavirus (“COVID-19”) pandemic — The COVID-19 pandemic has created significant public health concerns as well as economic disruption, uncertainty and volatility which has affected the Company’s business operations in fiscal 2020 and fiscal 2021. The Company continues to closely monitor the impact of the COVID-19 pandemic on all facets of its business, which includes the impact on its employees, customers, suppliers, vendors, business partners and supply chain networks. While the duration and extent of the COVID-19 pandemic and its impact on the global economy remains uncertain, the Company expects that its business operations and results of operations, including its net sales, earnings and cash flows will continue to be materially impacted.

Currently, the COVID-19 pandemic is impacting the Company’s supply chain and staffing strategies. While inventory levels improved through the 26-week period ended July 31, 2021, the Company continues to run under its budgeted inventory levels with shortages in specific inventory categories due to global supply chain constrains and shipping delays. The Company is prioritizing the shipment of harvest and Christmas merchandise to try to protect this important upcoming selling season. As of August 1, 2020, inventory levels were significantly lower than normal due to the Company cancelling purchase orders and having lower inventory receipts due to the temporary store closures in the prior year period, while experiencing an increase in demand for home furnishings. The Company is also implementing new incentive programs and recruiting practices to hire and retain qualified workers at its stores and distribution centers for the harvest and Christmas selling seasons.

Seasonality — The results of the Company’s operations for the 13 and 26-week periods ended July 31, 2021 are not indicative of the results to be expected for any other interim period or for the entire fiscal year due to seasonality factors.

Fiscal year — The Company’s fiscal year ends on the Saturday closest to January 31, resulting in years of either 52 or 53 weeks. Accordingly, fiscal 2021 represents the 52 weeks ending on January 29, 2022 and fiscal 2020 represents the 52 weeks ended on January 30, 2021.

Use of estimates — The preparation of the condensed 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 condensed consolidated financial statements and accompanying notes. Actual results could differ from the estimates and assumptions used. It should be understood that accounting measurements at interim dates inherently involve greater reliance on estimates than those at fiscal year-end.

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, but are not limited to, impairment assessments of long-lived assets, inventory reserves, self-insurance reserves and deferred tax asset valuation allowances.

Note 2 – Revenue Recognition

Net sales — Net sales includes the sale of merchandise, net of returns, shipping revenue, gift card breakage revenue and revenue earned from our private label credit card program and excludes sales taxes.

Sales returns reserve — The Company had a liability of approximately $1.5 million, $2.0 million and $1.3 million reserved for sales returns at July 31, 2021, January 30, 2021 and August 1, 2020, respectively, included in accrued expenses on the condensed

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consolidated balance sheets. The related sales return reserve product recovery asset included in prepaid expenses and other current assets on the condensed consolidated balance sheets was approximately $666,000, $850,000 and $542,000 at July 31, 2021, January 30, 2021 and August 1, 2020, respectively.

Deferred e-commerce revenue — Deferred revenue related to e-commerce orders that have been shipped but not estimated to be received by customers included in accrued expenses on the condensed consolidated balance sheets was approximately $1.0 million, $1.2 million and $1.8 million at July 31, 2021, January 30, 2021 and August 1, 2020, respectively. The related contract assets, reflected in inventory on the condensed consolidated balance sheets, totaled approximately $448,000, $530,000 and $871,000 at July 31, 2021, January 30, 2021 and August 1, 2020, respectively.

Gift cards — The Company uses the redemption recognition method to account for breakage for unused gift card amounts where breakage is recognized as gift cards are redeemed for the purchase of goods based upon a historical breakage rate. In these circumstances, to the extent the Company determines there is no requirement for remitting card balances to government agencies under unclaimed property laws, such amounts are recognized in the condensed consolidated statements of operations as a component of net sales.

The table below sets forth selected gift card liability information (in thousands) for the periods indicated:

The table below sets forth selected gift card breakage and redemption information (in thousands) for the periods indicated:

Customer loyalty program — The Company has a loyalty program called the K-club that was redesigned in fiscal 2020 to allow members to receive points based on qualifying purchases that are converted into certificates that may be redeemed on future purchases. This customer option is a material right and, accordingly, represents a separate performance obligation to the customer under ASC 606 Revenue from Contracts with Customers. The related loyalty program deferred revenue included in accrued expenses on the condensed consolidated balance sheets was approximately $825,000 and $922,000 at July 31, 2021 and January 30, 2021, respectively, compared to none at August 1, 2020.

Note 3 – Income Taxes

For the 13-week periods ended July 31, 2021 and August 1, 2020, the Company recorded an income tax benefit of 182.0% of income before income taxes and an income tax expense of 71.9% of the loss before income taxes, respectively. The change in income taxes for the 13-week period ended July 31, 2021, compared to the prior year period, was primarily due to the realization of a discrete tax benefit related to the vesting of restricted stock units for the current year period compared to a true up in the prior year period due to calculating the tax provision under the discrete method for the 13-week period ended May 2, 2020 based on no annual forecast due to COVID-19 compared to using the annual effective tax rate method for the 26-week period ended August 1, 2020.

For the 26-week periods ended July 31, 2021 and August 1, 2020, the Company recorded an income tax benefit of 3.3% of income before income taxes and an income tax benefit of 49.3% of the loss before income taxes, respectively. The change in income taxes for the 26-week period ended July 31, 2021, compared to the prior year period, was primarily due to recording a $12.3 million income tax benefit during the prior year period related to the carryback of the 2019 federal net operating loss to prior periods pursuant to the CARES Act and recording an additional income tax benefit of $2.3 million related to the carry back of the projected fiscal 2020 loss to years with a 35% statutory tax rate.

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The Company recognizes deferred tax assets and liabilities using estimated future tax rates for the effect of temporary differences between the book and tax basis of recorded assets and liabilities, including net operating loss carry forwards. Management assesses the realizability of deferred tax assets and records a valuation allowance if it is more likely than not that all or a portion of the deferred tax assets will not be realized. The Company considers the probability of future taxable income and our historical profitability, among other factors, in assessing the amount of the valuation allowance. Adjustments could be required in the future if the Company estimates that the amount of deferred tax assets to be realized is more than the net amount recorded. Any change in the valuation allowance could have the effect of increasing or decreasing the income tax provision in the statement of operations based on the nature of the deferred tax asset deemed realizable in the period in which such determination is made. As of July 31, 2021, January 30, 2021 and August 1, 2020, the Company recorded a full valuation allowance against deferred tax assets.

Note 4 – Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares outstanding during each period presented. Diluted earnings (loss) per share is computed by dividing net income (loss) 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 (loss) per share reflects the potential dilution that could occur if options to purchase stock were exercised into common stock and if outstanding grants of restricted stock were vested. Stock options and restricted stock units that were not included in the computation of diluted earnings (loss) per share, because to do so would have been antidilutive, were approximately 83,000 shares and 1.5 million shares for the 13-week periods ended July 31, 2021 and August 1, 2020, respectively, and 123,000 shares and 1.4 million shares for the 26-week periods ended July 31, 2021 and August 1, 2020, respectively.

Note 5 – Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The Company uses a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value.  These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. The carrying amounts of cash and cash equivalents, accounts receivable, other current assets and accounts payable approximate fair value because of their short maturities.

The Company maintained The Executive Non-Qualified Excess Plan (the “Deferred Compensation Plan”). The Deferred Compensation Plan was funded, and the Company invested participant deferrals into trust assets, which were invested in a variety of mutual funds that were Level 1 inputs. The plan assets and plan liabilities were adjusted to fair value on a recurring basis. The Board of Directors approved the termination of the Deferred Compensation Plan effective September 6, 2019, and all remaining balances in the Deferred Compensation Plan were paid out during fiscal 2020. Deferred Compensation Plan assets and liabilities were zero as of July 31, 2021 and January 30, 2021, and approximately $1.7 million as of August 1, 2020 and were recorded in prepaid expenses and other current assets and accrued expenses in the condensed consolidated balance sheets.

The Company measures certain assets at fair value on a non-recurring basis, including the evaluation of long-lived assets for impairment using Company-specific assumptions including forecasts of projected financial information that would fall within Level 3 of the fair value hierarchy. The Company uses market participant rents (Level 2 input) to calculate the fair value of right-of-use assets and discounted future cash flows of the asset or asset group using a discount rate that approximates the cost of capital of a market participant (Level 2 input) to quantify fair value for other long-lived assets. See Note 10 – Impairment for further discussion.

Note 6 – Commitments and Contingencies

The Company was named as a defendant in a putative class action filed in April 2017 in the United States District Court for the Western District of Pennsylvania, Gennock v. Kirkland’s, Inc. The complaint alleged that the Company, in violation of federal law, published more than the last five digits of a credit or debit card number on customers’ receipts. On October 21, 2019, the District Court dismissed the matter and ruled that the Plaintiffs did not have standing based on the Third Circuit’s recent decision in Kamal v. J. Crew Group, Inc., 918 F.3d 102 (3d. Cir. 2019). Following the dismissal in federal court, on October 25, 2019, the Plaintiffs filed a Praecipe to Transfer the case to Pennsylvania state court, and on August 20, 2020, the court ruled that the Plaintiffs have standing. However, the court also certified the standing issue for an interlocutory appeal, and the Company has filed a petition for allowance of appeal with the Pennsylvania Supreme Court. The Company continues to believe that the case is without merit and intends to continue to vigorously defend itself against the allegations. The matter is covered by insurance, and the Company does not believe that the case will have a material adverse effect on its consolidated financial condition, operating results or cash flows.

The Company has been named as a defendant in a putative class action filed in May 2018 in the Superior Court of California, Miles v. Kirkland’s Stores, Inc. The case has been removed to Federal Court, Central District of California, and trial is currently set for January 24, 2022. The complaint alleges, on behalf of Miles and all other hourly Kirkland’s employees in California, various wage

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and hour violations. Kirkland’s denies the material allegations in the complaint and believes that its employment policies are generally compliant with California law. The parties have agreed to a non-binding mediation of this matter which is scheduled for November 3, 2021, and to stay discovery and any other proceedings until after this mediation. The Company continues to believe the case is without merit and intends to vigorously defend itself against the allegations.

The Company is also party to other pending legal proceedings and claims that arise in the normal course of business. 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 such proceedings and any claims in excess of insurance coverage will have a material effect on its consolidated financial condition, operating results or cash flows.

Note 7 – Stock-Based Compensation

The Company maintains equity incentive plans under which it may grant non-qualified stock options, incentive stock options, restricted stock, restricted stock units, or stock appreciation rights to employees, non-employee directors and consultants. Compensation expense is recognized on a straight-line basis over the vesting periods of each grant. There have been no material changes in the assumptions used to compute compensation expense during the current year. The table below sets forth selected stock-based compensation information (in thousands, except share amounts) for the periods indicated:

^(a)Assumes 100% target level achievement of the relative performance targets.

During the 13-week and 26-week periods ended July 31, 2021, the Company granted performance-based restricted stock units (“PSUs”) that are subject to the achievement of specified performance goals. The performance metrics for the PSUs are earnings before interest, taxes, depreciation and amortization (“EBITDA”) compared to budgeted EBITDA and also include a relative shareholder return modifier. The number of PSUs presented in the foregoing table represent the shares that can be achieved at the target-level of achievement of the applicable performance metrics. The actual number of shares that will be issued under the performance awards, which may be higher or lower than target, will be determined by the level of achievement of the performance goals and the total shareholder return modifier. As of July 31, 2021, the Company has recorded compensation expense related to the PSUs at their target value, as the Company currently estimates that the performance metric based on EBITDA for fiscal 2021 will be achieved at target level. If the performance targets are achieved, the PSUs will be issued based on the achievement level, including the relative shareholder return modifier, and will cliff vest in full on February 3, 2024.

Note 8 – Share Repurchase Plan

On September 24, 2018, the Company announced that its Board of Directors authorized a share repurchase plan providing for the purchase in the aggregate of up to $10 million of the Company’s outstanding common stock. This share repurchase plan was completed during the fourth quarter of fiscal 2020. On December 3, 2020, the Company announced that its Board of Directors authorized a new share repurchase plan providing for the purchase in the aggregate of up to $20 million of the Company’s outstanding common stock. Repurchases of shares are made in accordance with applicable securities laws and may be made from time to time in the open market or by negotiated transactions. The amount and timing of repurchases are based on a variety of factors, including stock price, regulatory limitations and other market and economic factors. The share repurchase plan does not require the Company to repurchase any specific number of shares, and the Company may terminate the repurchase plan at any time. As of July 31, 2021, the Company had approximately $6.5 million remaining under the current share repurchase plan. The table below sets forth selected share repurchase plan information (in thousands, except share amounts) for the periods indicated:

Note 9 – Senior Credit Facility

On December 6, 2019, the Company entered into a Second Amended and Restated Credit Agreement (the “Credit Agreement”) with Bank of America, N.A. as administrative agent, collateral agent and lender. The Credit Agreement contains a $75 million senior secured revolving credit facility, a swingline availability of $10 million, a $25 million incremental accordion feature and maturity date

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of December 2024. Advances under the Credit Agreement bear interest at an annual rate equal to the London Interbank Offered Rate (“LIBOR”) plus a margin ranging from 125 to 175 basis points with no LIBOR floor, and the fee paid to the lender on the unused portion of the credit facility is 25 basis points per annum.

Borrowings under the Credit Agreement are subject to certain conditions, and the Credit Agreement contains customary events of default, including, without limitation, failure to make payments, a cross-default to certain other debt, breaches of covenants, breaches of representations and warranties, a change in control, certain monetary judgments and bankruptcy and certain events under the Employee Retirement Income Security Act of 1974 (“ERISA”). Upon any such event of default, the principal amount of any unpaid loans and all other obligations under the Credit Agreement may be declared immediately due and payable. The maximum availability under the Credit Agreement is limited by a borrowing base formula, which consists of a percentage of eligible inventory and eligible credit card receivables, less reserves.

The Company is subject to a Second Amended and Restated Security Agreement (the “Security Agreement”) with its lender. Pursuant to the Security Agreement, the Company pledged and granted to the administrative agent, for the benefit of itself and the secured parties specified therein, a lien on and security interest in all of the rights, title and interest in substantially all of the Company’s assets to secure the payment and performance of the obligations under the Credit Agreement.

As of July 31, 2021, the Company was in compliance with the covenants in the Credit Agreement. Under the Credit Agreement, there were no outstanding borrowings and a $600,000 letter of credit outstanding with approximately $65.0 million available for borrowing as of July 31, 2021.

Note 10 – Impairment

The Company evaluates the recoverability of the carrying amounts of long-lived assets when events or changes in circumstances dictate that their carrying values may not be recoverable. This review includes the evaluation of individual under-performing retail stores and assessing the recoverability of the carrying value of the assets related to the stores. Future cash flows are projected for the remaining lease life. If the estimated future cash flows are less than the carrying value of the assets, the Company records an impairment charge equal to the difference between the assets’ fair value and carrying value. The fair value is estimated using a discounted cash flow approach considering such factors as future sales levels, gross margins, changes in rent and other expenses as well as the overall operating environment specific to that store. The amount of the impairment charge is allocated proportionately to all assets in the asset group with no asset written down below its individual fair value.

The table below sets forth impairment information (in thousands, except store counts) for the periods indicated:    

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Note 11 – New Accounting Pronouncements

New Accounting Pronouncements Not Yet Adopted

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which amends the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology, which will result in more timely recognition of losses. The new guidance applies to financial assets measured at amortized cost basis, including receivables that result from revenue transactions and held-to-maturity debt securities. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022 for non-accelerated filers, and early adoption is permitted for fiscal years beginning after December 15, 2018. The Company anticipates adopting this guidance in the fourth quarter of fiscal 2021 and does not expect the adoption of this guidance to have a material impact on its condensed consolidated financial statements and related disclosures.

In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” This guidance is in response to accounting concerns regarding contract modifications and hedge accounting because of impending rate reform associated with structural risks of interbank offered rates (IBORs), and, particularly, the risk of cessation of the LIBOR related to regulators in several jurisdictions around the world having undertaken reference rate reform initiatives to identify alternative reference rates. The guidance provides optional expedients and exceptions for applying U.S. generally accepted accounting principles (“GAAP”) to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The adoption of this guidance is effective for all entities as of March 12, 2020 through December 31, 2022. The Company does not expect the adoption of this guidance to have a material impact on its condensed consolidated financial statements and related disclosures.

Note 12 – Subsequent Events

Subsequent to July 31, 2021, the Company substantially completed its December 3, 2020 authorized $20 million share repurchase plan by repurchasing 336,420 shares at a cost of approximately $6.5 million.

On September 2, 2021, the Company announced that its Board of Directors authorized a new share repurchase plan providing for the purchase in the aggregate of $20 million of the Company’s outstanding common stock. Repurchases of shares will be made in accordance with applicable securities laws and may be made from time to time in the open market or by negotiated transactions.  The amount and timing of repurchases will be based on a variety of factors, including stock price, regulatory limitations and other market and economic factors. The share repurchase plan does not require the Company to repurchase any specific number of shares, and the Company may terminate the repurchase plan at any time.

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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 Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended January 30, 2021, filed with the SEC on March 26, 2021 (the “Annual Report”). The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our 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.”

Introduction

We are a specialty retailer of home décor in the United States, operating 369 stores in 35 states as of July 31, 2021, as well as an e-commerce website, www.kirklands.com. Our stores present a curated selection of distinctive merchandise, including holiday décor, furniture, textiles, wall décor, decorative accessories, art, mirrors, fragrances and other home decorating items. Our stores offer an extensive assortment of holiday merchandise during seasonal periods. We provide our customers an engaging shopping experience characterized by affordable home décor and inspirational design ideas. We believe that this combination of quality and stylish merchandise, value pricing and a stimulating online and store experience allows our customer to furnish their home on a budget.

Impact of the COVID-19 Pandemic on Our Business

The COVID-19 pandemic has created significant public health concerns as well as economic disruption, uncertainty and volatility which has affected our business operations in fiscal 2020 and fiscal 2021. We continue to closely monitor the impact of the COVID-19 pandemic on all facets of our business, which includes the impact on our employees, customers, suppliers, vendors, business partners and supply chain networks. All of our stores and distribution centers are currently open with enhanced safety measures. The health and safety of our employees and customers are the primary concerns of our management team. We have taken numerous actions to promote health and safety, including providing personal protective equipment to our employees, establishing mask protocols in our facilities, rolling out additional functionality to support contactless shopping experiences, implementing additional cleaning and sanitation procedures and promoting social distancing. While the duration and extent of the COVID-19 pandemic and its impact on the global economy remains uncertain, we expect that our business operations and results of operations, including our net sales, earnings and cash flows will continue to be materially impacted.

Currently, the COVID-19 pandemic is impacting our supply chain and staffing strategies. While inventory levels improved through the 26-week period ended July 31, 2021, we continue to run under our budgeted inventory levels with shortages in specific inventory categories due to global supply chain constrains and shipping delays. We are prioritizing the shipment of harvest and Christmas merchandise to try to protect this important upcoming selling season. As of August 1, 2020, inventory levels were significantly lower than normal due to the cancelling of purchase orders and having lower inventory receipts due to the temporary store closures in the prior year period, while experiencing an increase in demand for home furnishings. We are also implementing new incentive programs and recruiting practices to hire and retain qualified workers at our stores and distribution centers for the harvest and Christmas selling seasons.

OVERVIEW OF KEY FINANCIAL MEASURES

Net sales and gross profit are the most significant drivers of our operating performance. Net sales consists of all merchandise sales to customers, net of returns, shipping revenue associated with e-commerce sales, gift card breakage revenue and excludes sales taxes. We use comparable sales to measure sales increases or decreases from stores that have been open for at least 13 full fiscal months including our e-commerce sales. Closed stores are removed from the calculation the day after the store closes. Relocated stores remain in our comparable sales calculation. E-commerce store sales, including shipping revenue, are included in comparable sales. Increases in comparable sales are an important factor in maintaining or increasing our profitability.

Gross profit is the difference between net sales and cost of sales. Cost of sales has various distinct components including: product cost of sales (including inbound freight, damages and inventory shrinkage), store occupancy costs (including rent and depreciation of leasehold improvements and other property and equipment), outbound freight costs to stores, e-commerce shipping expenses and central distribution costs (including operational costs and depreciation of leasehold improvements and other property and equipment). Product and outbound freight costs are variable, while occupancy and central distribution costs are largely fixed.

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Accordingly, gross profit expressed as a percentage of net sales can be influenced by many factors, including overall sales performance.

Store Optimization

As part of our store optimization strategy, which includes exiting unprofitable stores and continuing to reduce the store base over the next several years, we permanently closed six store locations and opened two new store locations during the 26-week period ended July 31, 2021. We are prioritizing sustained improvement in overall profitability and developing a future state plan for infrastructure that complements our omni-channel concept and improves the customer experience. We anticipate additional store closures and limited store openings as we continue to execute our store optimization strategy. We believe our ideal store count should be approximately 350 stores with additional opportunities for more favorable rent terms during ongoing lease renewals.

The following table summarizes our store openings and closings during the periods indicated:

The following table summarizes our open stores and square footage under lease as of the dates indicated:

13-Week Period Ended July 31, 2021 Compared to the 13-Week Period Ended August 1, 2020

Results of operations. The table below sets forth selected results of our operations both in dollars (in thousands) and as a percentage of net sales for the periods indicated:

Net sales. Net sales decreased 8.0% to $114.8 million for the second 13 weeks of fiscal 2021 compared to $124.7 million for the prior year period driven by 5% fewer stores and a decline in e-commerce traffic and a decline in store traffic and conversion, partially due to inventory shortages, offset by an increase in order value due to increased sales of larger ticket items including furniture. Comparable sales, including e-commerce sales, decreased 5.2%, or $6.2 million for the second 13 weeks of fiscal 2021 compared to the prior year period. Comparable sales, including e-commerce sales, increased 10.2% in the prior year period. For the second 13

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weeks of fiscal 2021, e-commerce comparable sales decreased 12.6% because of the high e-commerce demand in the prior year period due to the COVID-19 pandemic.

Gross profit. Gross profit as a percentage of net sales increased 600 basis points from 28.6% in the second 13 weeks of fiscal 2020 to 34.6% in the second 13 weeks of fiscal 2021. The overall increase in gross profit margin was due to favorable landed product margin, store occupancy costs and distribution center costs, partially offset by unfavorable e-commerce shipping expenses, store outbound freight costs and other costs. Landed product margin improved approximately 380 basis points from 56.0% in the second 13 weeks of fiscal 2020 to 59.8% in the second 13 weeks of fiscal 2021 mainly due to the continued benefit from direct sourcing and a disciplined approach to our discount strategy. Store occupancy and depreciation costs decreased approximately 140 basis points as a percentage of net sales in the second 13 weeks of fiscal 2021 due to store closures and negotiated rent reductions. Distribution center costs decreased approximately 140 basis points in the second 13 weeks of fiscal 2021 due to a favorable warehouse expense capitalization adjustment because of the increase in inventory. E-commerce shipping costs increased approximately 50 basis points as a percentage of net sales in the second 13 weeks of fiscal 2021 due to a lower percentage of e-commerce orders being fulfilled in store compared to the prior year period. Outbound freight costs increased approximately 10 basis points as a percentage of net sales due to more freight moved due to improved inventory levels in the second 13 weeks of fiscal 2021. Other costs, which includes damages and shrink, were approximately flat as a percentage of net sales in the second 13 weeks of fiscal 2021 as favorable shrink results offset increased product damages.

Compensation and benefits. Compensation and benefits as a percentage of net sales increased approximately 270 basis points from 16.2% in the second 13 weeks of fiscal 2020 to 18.9% in the second 13 weeks of fiscal 2021 primarily due to increased store labor costs, as some stores were still temporarily closed in the prior year period due to the COVID-19 pandemic, increased corporate labor costs and sales deleverage.

Other operating expenses. Other operating expenses as a percentage of net sales increased approximately 320 basis points from 10.9% in the second 13 weeks of fiscal 2020 to 14.1% in the second 13 weeks of fiscal 2021. The increase as a percentage of net sales was primarily related to an increase in advertising expenses due to intentional funding of incremental advertising in the current year period compared to a reduction in expense in 2020 when natural demand was higher. Also, professional fees and travel have increased due to the temporary cost reductions in the prior year period due to the COVID-19 pandemic.

Asset impairment. During the second 13 weeks of fiscal 2021, we recorded no impairment charges compared to an impairment charge of approximately $5.7 million in the prior year period. See Note 10 – Impairment in the condensed consolidated financial statements for discussion of impairment.

Income tax (benefit) expense. We recorded an income tax benefit of approximately $404,000, or 182.0% of income before income taxes, during the second 13 weeks of fiscal 2021 compared to income tax expense of $3.9 million, or 71.9% of the loss before income taxes, during the prior year period. The change in income taxes for the 13-week period ended July 31, 2021, compared to the prior year period, was primarily due to the realization of a discrete tax benefit related to the vesting of restricted stock units for the current year period compared to a true up in the prior year period due to calculating the tax provision under the discrete method for the 13-week period ended May 2, 2020 based on no annual forecast due to COVID-19 compared to using the annual effective tax rate method for the 26-week period ended August 1, 2020.

Net income (loss) and earnings (loss) per share. We reported net income of $0.6 million, or $0.04 per diluted share, for the second 13 weeks of fiscal 2021 as compared to a net loss of $9.4 million, or $0.66 per diluted share, for the second 13 weeks of fiscal 2020.

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26-Week Period Ended July 31, 2021 Compared to the 26-Week Period Ended August 1, 2020

Results of operations. The table below sets forth selected results of our operations both in dollars (in thousands) and as a percentage of net sales for the periods indicated:

Net sales. Net sales increased 18.0% to $238.4 million for the first 26 weeks of fiscal 2021 compared to $202.0 million for the prior year period. Comparable sales, including e-commerce sales, increased 24.6%, or $46.7 million for the first 26 weeks of fiscal 2021 compared to the prior year period, which was partly offset by a $10.3 million decrease in sales due to permanently closed stores. Comparable sales, including e-commerce sales, decreased 15.5% in the prior year period. For the first 26 weeks of fiscal 2021, e-commerce comparable sales increased 10.3%. For stores, the comparable sales mainly improved due to significant temporary store closures due to the COVID-19 pandemic in the prior year period.

Gross profit. Gross profit as a percentage of net sales increased 1,070 basis points from 22.8% in the first 26 weeks of fiscal 2020 to 33.5% in the first 26 weeks of fiscal 2021. The overall increase in gross profit margin was due to favorable store occupancy costs, merchandise margin, distribution center costs, store outbound freight costs, and other costs, partially offset by unfavorable e-commerce shipping expenses. Store occupancy and depreciation costs decreased approximately 540 basis points as a percentage of net sales due to the leverage of increased sales, in addition to store closures and negotiated rent reductions. Landed product margin increased approximately 410 basis points from 54.5% in the first 26 weeks of fiscal 2020 to 58.6% in the first 26 weeks of fiscal 2021 mainly due to the continued benefit from direct sourcing and a disciplined approach to our discount strategy. Distribution center costs decreased approximately 80 basis points in the first 26 weeks of fiscal 2021 due to sales leverage and a favorable warehouse expense capitalization adjustment driven by higher inventory levels compared to the prior year period. Outbound freight costs decreased approximately 40 basis points as a percentage of net sales in the first 26 weeks of fiscal 2021 due to sales leverage. Other costs, which includes damages and shrink, were favorable 10 bps as a percentage of net sales in the second 26 weeks of fiscal 2021, as favorable shrink results offset increased product damages. E-commerce shipping costs increased approximately 10 basis points as a percentage of sales due to a lower percentage of e-commerce orders being fulfilled in store compared to the prior year period, partially offset by sales leverage.

Compensation and benefits. Compensation and benefits as a percentage of net sales decreased approximately 210 basis points from 19.2% in the first 26 weeks of fiscal 2020 to 17.1% in the first 26 weeks of fiscal 2021 primarily due to sales leverage of both store and corporate payroll expenses because of the temporary COVID-19 store closures, which reduced sales in the prior year period. The approximately $2.0 million increase in compensation and benefits over the prior year period is mainly due to a $1.4 million expense reduction due to employee retention payroll tax credits provided for in the CARES Act in the prior year period.

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Other operating expenses. Other operating expenses as a percentage of net sales remained consistent at 14.0% for the first 26 weeks of fiscal 2020 and 2021.

Asset impairment. During the first 26 weeks of fiscal 2021, we recorded an impairment charge of approximately $310,000 compared to an impairment charge of approximately $8.9 million in the prior year period. See Note 10 – Impairment in the condensed consolidated financial statements for discussion of impairment.

Income tax benefit. We recorded income tax benefit of approximately $74,000, or 3.3% of income before income taxes, during the first 26 weeks of fiscal 2021 compared to income tax benefit of $16.3 million, or 49.3% of the loss before income taxes, during the prior year period. The change in income taxes for the 26-week period ended July 31, 2021, compared to the prior year period, was primarily due to recording a $12.3 million income tax benefit during the prior year period related to the carryback of the 2019 federal net operating loss to prior periods pursuant to the CARES Act and recording an additional income tax benefit of $2.3 million related to the carry back of the projected fiscal 2020 loss to years with a 35% statutory tax rate.

Net income (loss) and earnings (loss) per share. We reported net income of $2.3 million, or $0.15 per diluted share, for the first 26 weeks of fiscal 2021 as compared to a net loss of $16.8 million, or $1.20 per diluted share, for the first 26 weeks of fiscal 2020.

Non-GAAP Financial Measures

To supplement our unaudited consolidated condensed financial statements presented in accordance with GAAP, we provide certain non-GAAP financial measures, including EBITDA, adjusted EBITDA, adjusted operating (loss) income, adjusted net (loss) income and adjusted diluted (loss) earnings per share. These measures are not in accordance with, and are not intended as alternatives to, GAAP financial measures. We use these non-GAAP financial measures internally in analyzing our financial results and believe that they provide useful information to analysts and investors, as a supplement to GAAP financial measures, in evaluating our operational performance.

We define EBITDA as net income or loss before interest, provision for income tax, and depreciation and amortization, adjusted EBITDA as EBITDA with non-GAAP adjustments and adjusted operating (loss) income as operating income (loss) with non-GAAP adjustments. We define adjusted net (loss) income and adjusted diluted (loss) earnings per share by adjusting the applicable GAAP financial measures for non-GAAP adjustments.

Non-GAAP financial measures are intended to provide additional information only and do not have any standard meanings prescribed by GAAP. Use of these terms may differ from similar measures reported by other companies. Each non-GAAP financial measure has its limitations as an analytical tool, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP.

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The following table shows a reconciliation of operating income (loss) to EBITDA, adjusted EBITDA and adjusted operating (loss) income for the 13-week and 26-week periods ended July 31, 2021 and August 1, 2020 and a reconciliation of net income (loss) and diluted earnings (loss) per share to adjusted net (loss) income and adjusted diluted (loss) earnings per share for the 13-week and 26-week periods ended July 31, 2021 and August 1, 2020: