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

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended May 1, 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 – 14,252,579 shares outstanding as of May 21, 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 370 stores in 35 states as of May 1, 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.

Company response to 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. All of the Company’s stores and distribution centers are currently open with enhanced safety measures. The health and safety of the Company’s employees and customers are the primary concerns of the Company’s management team. The Company has taken numerous actions to promote health and safety, including providing personal protective equipment to its employees, establishing mask protocols in its facilities, rolling out additional functionality to support contactless shopping experiences, implementing additional cleaning and sanitation procedures and promoting social distancing.

During the 13-week period ended May 2, 2020, as a proactive and cautionary measure, the Company elected to borrow $40 million from its revolving credit facility, which was later repaid during the 13-week period ended August 1, 2020. The Company also temporarily closed all of its stores during the 13-week period ended May 2, 2020 and reopened stores during the 13-week period ended August 1, 2020. In an effort to further strengthen the Company’s financial flexibility and efficiently manage through the pandemic during the 13-week period ended May 2, 2020, the Company permanently reduced store and corporate payroll, temporarily furloughed store employees, cancelled inventory purchases, reduced capital expenditures and cut advertising, outbound freight and other expenses.

The Coronavirus Aid, Relief and Economic Security (“CARES”) Act was also signed into law during the 13-week period ended May 2, 2020. The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferral of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. The CARES Act allowed the Company’s net operating losses incurred in fiscal 2019 to be carried back to preceding taxable years to generate a refund of previously paid income taxes of approximately $12.3 million that was received during the 13-week period ended August 1, 2020. As of May 1, 2021 and May 2, 2020, the Company had an income tax receivable of approximately $107,000 and $22.0 million, respectively. At both May 1, 2021 and May 2, 2020, the Company had a $1.4 million employer payroll tax credit receivable from the Internal Revenue Service (“IRS”) recorded in prepaid and other current assets. The Company also had deferred employer social security payroll taxes payable of $3.3 million recorded in accrued expenses as of May 1, 2021 and $201,000 recorded in other liabilities as of May 2, 2020.

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As of May 1, 2021 and May 2, 2020, the Company had $76.3 million and $99.1 million, respectively, in inventory. While the lower inventory levels are partially due to a lower store count, it also reflects ongoing supply chain disruptions, port constraints and increased inbound freight costs due to the COVID-19 pandemic, which has slowed the flow of inventory receipts to the Company.  

Seasonality — The results of the Company’s operations for the 13-week period ended May 1, 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 $1.6 million and $481,000 reserved for sales returns at May 1, 2021 and May 2, 2020, respectively, included in accrued expenses on the condensed 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 $709,000 and $218,000 at May 1, 2021 and May 2, 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 $1.5 million and $1.9 million at May 1, 2021 and May 2, 2020, respectively. The related contract assets, reflected in inventory on the condensed consolidated balance sheets, totaled approximately $715,000 and $882,000 at May 1, 2021 and May 2, 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 $1.2 million at May 1, 2021 compared to none at May 2, 2020.

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Note 3 – 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 May 2, 2020, the Company was not able to use the estimated annual effective tax rate due to an inability to reliably estimate the annual effective tax rate; therefore, the actual effective tax rate for the period was used. For the 13-week period ended May 1, 2021, the Company was able to use the estimated annual effective tax rate.

For the 13-week periods ended May 1, 2021 and May 2, 2020, the Company recorded income tax expense of 16.1% of income before income taxes and an income tax benefit of 73.1% of the loss before income taxes, respectively. The change in income taxes for the 13-week period ended May 1, 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 $3.8 million related to the carry back of the projected fiscal 2020 loss to years with a 35% statutory tax rate.

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 May 1, 2021 and May 2, 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 50,000 shares and 1.2 million shares for the 13-week periods ended May 1, 2021 and May 2, 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 and approximately $1.6 million as of May 1, 2021 and May 2, 2020, respectively, 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.

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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 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 are currently engaging in discovery, and the Plaintiff has until June 9, 2021 to file for class certification. The Company believes 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 period ended May 1, 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. During the 13-week period ended May 1, 2021, the Company recorded no compensation expense related to the performance-based units because actual EBITDA was lower than minimum target EBITDA under the award agreement. If the performance targets are achieved, the PSUs will be issued based on the achievement level and will cliff vest in full on February 3, 2024.

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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 May 1, 2021, the Company had approximately $18.5 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 and 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 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 May 1, 2021, the Company was in compliance with the covenants in the Credit Agreement. Under the Credit Agreement, there were no outstanding borrowings and $600,000 in letters of credit outstanding with approximately $48.7 million available for borrowing as of May 1, 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.

During the 13-week periods ended May 1, 2021 and May 2, 2020, the Company recorded an impairment charge of approximately $310,000 and $2.2 million for leasehold improvements, fixtures and equipment at two stores and 16 stores, respectively, for which the carrying values exceed the respective fair value for these assets. The Company also recorded an impairment charge totaling $1.0 million for right-of-use assets at six stores for the 13-week period ended May 2, 2020. No impairment charge was recorded for right-of-use assets for the 13-week period ended May 1, 2021. The total impairment charge, net of tax, for the 13-week periods ended May 1, 2021 and May 2, 2020 was approximately $234,000 and $2.4 million, respectively.

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Note 11 – New Accounting Pronouncements

New Accounting Pronouncements Not Yet Adopted

In June 2016, the 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 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.

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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 370 stores in 35 states as of May 1, 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 its employees, establishing mask protocols in its facilities, rolling out additional functionality to support contactless shopping experiences, implementing additional cleaning and sanitation procedures and promoting social distancing.

We temporarily closed all of our stores during the 13-week period ended May 2, 2020 and reopened stores during the 13-week period ended August 1, 2020. In an effort to further strengthen our financial flexibility and efficiently manage through the pandemic during the 13-week period ended May 2, 2020, we borrowed $40 million on our revolving credit facility, permanently reduced store and corporate payroll, temporarily furloughed store employees, cancelled inventory purchases, reduced capital expenditures and cut advertising, outbound freight and other expenses.

The CARES Act was also signed into law during the 13-week period ended May 2, 2020, which allowed our net operating losses incurred in fiscal 2019 to be carried back to preceding taxable years to generate a refund of previously paid income taxes of approximately $12.3 million. We also recorded a $1.4 million employer payroll tax credit receivable from the IRS during the 13-week period ended May 2, 2020, and we deferred employer social security payroll taxes payable of $3.3 million as of May 1, 2021 and $201,000 as of May 2, 2020.

During the 13-week period ended May 1, 2021, we had lower than anticipated inventory levels, which negatively impacted net sales. While the lower inventory levels are partially due to a lower store count, it also reflects ongoing supply chain disruptions, port constraints and increased inbound freight costs due to the COVID-19 pandemic, which has slowed the flow of our inventory receipts. We have also experienced difficulty retaining and hiring qualified workers at our distribution centers and store locations, due to the COVID-19 pandemic. 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.

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

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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. 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 five store locations and opened two new store locations in the 13-week period ended May 1, 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 in the range of 300 to 350 stores and expect to achieve that range in the next two to three years.

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:

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13-Week Period Ended May 1, 2021 Compared to the 13-Week Period Ended May 2, 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 60.0% to $123.6 million for the first 13 weeks of fiscal 2021 compared to $77.2 million for the prior year period. Comparable sales, including e-commerce sales, increased 75.3%, or $52.9 million for the first 13 weeks of fiscal 2021 compared to the prior year period. Comparable sales, including e-commerce sales, decreased 38.8% in the prior year period. For the first 13 weeks of fiscal 2021, e-commerce comparable sales increased 42.0%. For e-commerce, comparable sales benefited from an increase in average ticket. 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 1930 basis points from 13.3% in the first 13 weeks of fiscal 2020 to 32.6% in the first 13 weeks of fiscal 2021. The overall increase in gross profit margin was due to favorable store occupancy costs, merchandise margin, store outbound freight costs, e-commerce shipping expenses and distribution center costs. Store occupancy and depreciation costs decreased approximately 1,170 basis points as a percentage of net sales due to the leverage of increased sales, store closures and negotiated rent reductions. Merchandise margin increased approximately 580 basis points from 51.4% in the first 13 weeks of fiscal 2020 to 57.3% in the first 13 weeks of fiscal 2021 mainly due to lower promotional activity and increased direct sourcing. Outbound freight costs were approximately 170 basis points favorable as a percentage of net sales due to sales leverage. Distribution center costs were approximately 10 basis points favorable due to sales leverage partially offset by an unfavorable warehouse expense capitalization adjustment driven by lower inventory levels compared to the prior year period.

Compensation and benefits. Compensation and benefits as a percentage of net sales decreased approximately 860 basis points from 24.1% in the first 13 weeks of fiscal 2020 to 15.5% in the first 13 weeks of fiscal 2021 primarily due to sales leverage of both store and corporate payroll expenses. The approximately $535,000 increase in compensation and benefits over the prior year period is mainly due to COVID-19 related temporary store closures in the prior year period which led to all store team members being paid during the first two weeks of temporary store closures and then furloughing all part-time store employees and temporarily reducing the pay of full-time managers and key employees as well as a $1.4 million expense reduction due to employee retention payroll tax credits provided for in the CARES Act, which was partially offset by the implementation of our revised store labor model with reduced store operating hours, lower employees during non-peak hours and a lower store count.

Other operating expenses. Other operating expenses as a percentage of net sales decreased approximately 500 basis points from 18.9% in the first 13 weeks of fiscal 2020 to 13.9% in the first 13 weeks of fiscal 2021. The decrease as a percentage of net sales was primarily due to sales leverage as a result of the prior year temporary store closures. The $2.6 million increase in other operating expenses was primarily related to increased advertising expenses and credit card processing fees due to the sales volume increase.

Asset impairment. During the first 13 weeks of fiscal 2021, we recorded an impairment charge of approximately $310,000 for property and equipment impairment charges at two stores compared to an impairment charge of approximately $1.0 million for right-of-use asset impairment at six stores and $2.2 million for property and equipment impairment charges at 16 stores in the prior year period.

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Income tax expense (benefit). We recorded income tax expense of approximately $330,000, or 16.1% of income before income taxes, during the first 13 weeks of fiscal 2021 compared to income tax benefit of $20.3 million, or 73.1% of the loss before income taxes, during the prior year period. The change in the tax rate for the first 13 weeks of fiscal 2021 compared to the prior period was primarily due to recording a $12.3 million income tax benefit during the prior year period related to the carry back of fiscal 2019 federal net operating losses to prior periods pursuant to the CARES Act and recording an additional income tax benefit of $3.8 million related to the carry back of 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 $1.7 million, or $0.11 per diluted share, for the first 13 weeks of fiscal 2021 as compared to a net loss of $7.4 million, or $0.53 per diluted share, for the first 13 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 income (loss), adjusted net income (loss) and adjusted diluted earnings (loss) 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 income (loss) as operating income (loss) with non-GAAP adjustments. We define adjusted net income (loss) and adjusted diluted earnings (loss) 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 income (loss) for the 13-week periods ended May 1, 2021 and May 2, 2020 and a reconciliation of net income (loss) and diluted earnings (loss) per share to adjusted net income (loss) and adjusted diluted earnings (loss) per share for the 13-week periods ended May 1, 2021 and May 2, 2020:

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 early portion of the fourth quarter of each fiscal year. Capital expenditures primarily relate to technology and omni-channel projects, distribution center and supply chain

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enhancements, new stores and existing store remodels. Historically, we have funded our working capital and capital expenditure requirements with internally-generated cash and borrowings under our revolving credit facility.

Cash flows from operating activities. Net cash used in operating activities was approximately $25.0 million during the first 13 weeks of fiscal 2021 compared to approximately $37.7 million for the first 13 weeks of fiscal 2020. Cash flows from operating activities depend heavily on operating performance and changes in working capital and the timing and amount of payments for income taxes. The decrease in the amount of cash used in operations as compared to the prior year period was due to an improvement in operating performance.

Cash flows from investing activities. Net cash used in investing activities for the first 13 weeks of fiscal 2021 consisted mainly of $1.6 million in capital expenditures as compared to $2.5 million in capital expenditures for the prior year period. The table below sets forth capital expenditures by category (in thousands) for the periods indicated:

The capital expenditures in the current year period related primarily to technology and omni-channel projects, as well as the opening of two new stores during the period. Capital expenditures in the prior year period related primarily to distribution center and supply chain enhancements and technology and omni-channel projects.

Cash flows from financing activities. In the first 13 weeks of fiscal 2021, net cash used in financing activities of $1.6 million was primarily related to the repurchase and retirement of common stock pursuant to our share repurchase plan of $1.4 million. In the first 13 weeks of fiscal 2020, net cash provided by financing activities primarily related to $40.0 million of borrowings under our revolving credit facility as a preemptive measure related to the COVID-19 pandemic and temporary store closures.

Senior credit facility. On December 6, 2019, we entered into the Credit Agreement with Bank of America, N.A. as administrative agent and 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 a maturity date of December 2024. Advances under the Credit Agreement bear interest at an annual rate equal to 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 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.

We are subject to a Security Agreement with our lender. Pursuant to the Security Agreement, we 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 our assets to secure the payment and performance of the obligations under the Credit Agreement.

As of May 1, 2021, we were in compliance with the covenants in the Credit Agreement. Under the Credit Agreement, there were no outstanding borrowings and $600,000 in letters of credit outstanding with approximately $48.7 million available for borrowing as of May 1, 2021.

As of May 1, 2021, our balance of cash and cash equivalents was approximately $72.3 million. We believe that the combination of our cash balances, cash flow from operations and availability under our Credit Agreement will be sufficient to fund our planned capital expenditures and working capital requirements for at least the next twelve months.

Share repurchase plan. On September 24, 2018, we announced that our Board of Directors authorized a share repurchase plan providing for the purchase in the aggregate of up to $10 million of our outstanding common shares. On December 3, 2020, we announced that our Board of Directors authorized a new share repurchase plan providing for the purchase in the aggregate of $20

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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 us to repurchase any specific number of shares, and we may terminate the repurchase plan at any time. As of May 1, 2021, we had approximately $18.5 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:

Contractual Obligations

Not applicable to smaller reporting companies.

Critical Accounting Policies and Estimates

There have been no significant changes to our critical accounting policies during the 13-weeks ended May 1, 2021. Refer to our Annual Report for a summary of our critical accounting policies.

New Accounting Pronouncements

See Note 11 – New Accounting Pronouncements in the condensed consolidated financial statements for accounting pronouncements net yet adopted.

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 Quarterly Report on 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, including, without limitation, the impact of public health issues, such as the current global pandemic of COVID-19, 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 risk factors listed below 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. 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 risk 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.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of May 1, 2021 and May 2, 2020, we had no outstanding borrowings and $40 million in outstanding borrowings under our Credit Agreement, respectively. We are exposed to interest rate changes, primarily as a result of borrowings under our revolving credit facility as discussed in Note 9 — Senior Credit Facility in the notes to the condensed consolidated financial statements, which bear interest based on variable rates. A 1% increase or decrease in the interest rate on borrowings under our revolving credit facility at our recent borrowing levels would not have a material impact to our results of operations.

We manage cash and cash equivalents in various institutions at levels beyond federally insured limits per institution, and we may purchase investments not guaranteed by the Federal Deposit Insurance Company. Accordingly, there is a risk that we will not recover the full principal of our investments or that their liquidity may be diminished.

We were not engaged in any foreign exchange contracts, hedges, interest rate swaps, derivatives or other financial instruments with significant market risk as of May 1, 2021.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures. Both our Chief Executive Officer (our principal executive officer) and Chief Financial Officer (our principal financial officer), after the evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended,) was performed by management with the participation of our Chief Executive Officer and Chief Financial Officer, have concluded that, as of May 1, 2021, our disclosure controls and procedures were effective as of the end of the period covered by this report.

Change in internal controls over financial reporting. There have been no changes in internal control over financial reporting that have occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

For a description of the Company’s legal proceedings, refer to Note 6 — Commitments and Contingencies in the notes to the condensed consolidated financial statements.

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 risk factors discussed in Part I, “Item 1A. Risk Factors” in the Annual Report on Form 10-K for the fiscal year ended January 30, 2021, which could materially affect our business, financial condition or future results. The risks described in this report and in our Annual Report are not the only risks facing our Company. There have been no material changes to our risk factors as previously disclosed in the Annual Report. 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.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Issuer Repurchases of Equity Securities

Shares of common stock repurchased by the Company during the 13-week period ended May 1, 2021 were as follows:

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 $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 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.

ITEM 6. EXHIBITS

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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.

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