Kirkland's - 10-Q quarterly report FY2019 Q3

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q



x	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended November 2, 2019



¨	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ______to ______.

Commission file number: 000-49885

Kirkland’s, Inc.

(Exact name of registrant as specified in its charter)



Tennessee	62-1287151
(State or other jurisdiction of	(IRS Employer Identification No.)
incorporation or organization)

5310 Maryland Way
Brentwood, Tennessee	37027
(Address of principal executive offices)	(Zip Code)

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

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



Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	KIRK	NASDAQ Global Select Market

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 x 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 x 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.



Large accelerated filer	¨	Accelerated filer	x
Non-accelerated filer	¨	Smaller reporting company	x
		Emerging growth company	¨

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 x

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 - 13,897,530 shares outstanding as of November 26, 2019.

KIRKLAND’S, INC.

TABLE OF CONTENTS



		Page

PART I	FINANCIAL INFORMATION	3
Item 1.	Financial Statements	3
	Condensed Consolidated Balance Sheets (Unaudited) as of November 2, 2019, February 2, 2019 and November 3, 2018	3
	Condensed Consolidated Statements of Operations (Unaudited) for the 13-week and 39-week periods ended November 2, 2019 and November 3, 2018	4
	Condensed Consolidated Statement of Shareholders’ Equity (Unaudited) for the 13-week and 39-week periods ended November 2, 2019 and November 3, 2018	5
	Condensed Consolidated Statements of Cash Flows (Unaudited) for the 39-week periods ended November 2, 2019 and November 3, 2018	7
	Notes to Condensed Consolidated Financial Statements (Unaudited)	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23
Item 4.	Controls and Procedures	23

PART II	OTHER INFORMATION	24
Item 1.	Legal Proceedings	24
Item 1A.	Risk Factors	24
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	24
Item 6.	Exhibits	25

SIGNATURES		26

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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)



	November 2,			February 2,			November 3,
	2019			2019			2018
ASSETS
Current assets:
Cash and cash equivalents	$	4,202		$	57,946		$	23,837
Inventories, net	140,222			84,434			113,759
Prepaid expenses and other current assets	8,417			15,561			23,314
Total current assets	152,841			157,941			160,910
Property and equipment:
Equipment	21,524			21,425			21,878
Furniture and fixtures	80,869			81,523			82,361
Leasehold improvements	125,294			126,784			126,843
Computer software and hardware	73,311			69,444			67,911
Projects in progress	11,815			8,344			8,899
Property and equipment, gross	312,813			307,520			307,892
Accumulated depreciation	(216,717		)	(196,697		)	(192,617		)
Property and equipment, net	96,096			110,823			115,275
Operating lease right-of-use assets	210,213			—			—
Deferred income taxes	944			1,703			1,255
Other assets	6,283			6,681			7,201
Total assets	$	466,377		$	277,148		$	284,641
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	68,395		$	40,004		$	55,001
Accounts payable to related party vendor	—			8,166			11,261
Income taxes payable	—			701			—
Accrued expenses	23,527			37,665			34,466
Operating lease liabilities	53,210			—			—
Total current liabilities	145,132			86,536			100,728
Deferred rent	—			51,871			53,944
Operating lease liabilities	206,789			—			—
Revolving line of credit	25,000			—			—
Deferred income taxes	—			—			27
Other liabilities	8,883			7,941			8,692
Total liabilities	385,804			146,348			163,391
Shareholders’ equity:
Preferred stock, no par value, 10,000,000 shares authorized; no shares issued or outstanding at November 2, 2019, February 2, 2019, or November 3, 2018, respectively	—			—			—
Common stock, no par value; 100,000,000 shares authorized; 13,897,530; 14,504,824; and 15,063,439 shares issued and outstanding at November 2, 2019, February 2, 2019, and November 3, 2018, respectively	171,585			169,477			168,725
Accumulated deficit	(91,012		)	(38,677		)	(47,475		)
Total shareholders’ equity	80,573			130,800			121,250
Total liabilities and shareholders’ equity	$	466,377		$	277,148		$	284,641

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)



	13 Weeks Ended						39 Weeks Ended
	November 2,			November 3,			November 2,			November 3,
	2019			2018			2019			2018
Net sales	$	144,936		$	154,571		$	394,469		$	430,924
Cost of sales	104,800			95,289			276,792			267,619
Cost of sales related to merchandise purchased from related party vendor	—			12,629			14,749			34,542
Cost of sales	104,800			107,918			291,541			302,161
Gross profit	40,136			46,653			102,928			128,763
Operating expenses:
Compensation and benefits	29,115			29,621			83,333			83,490
Other operating expenses	20,208			18,783			54,998			54,067
Depreciation (exclusive of depreciation included in cost of sales)	1,602			1,867			5,177			5,405
Asset impairment	3,392			—			7,251			—
Total operating expenses	54,317			50,271			150,759			142,962
Operating loss	(14,181		)	(3,618		)	(47,831		)	(14,199		)
Interest expense	169			69			307			200
Other income	(158		)	(224		)	(712		)	(825		)
Loss before income taxes	(14,192		)	(3,463		)	(47,426		)	(13,574		)
Income tax expense (benefit)	8,114			(683		)	921			(3,197		)
Net loss	$	(22,306	)	$	(2,780	)	$	(48,347	)	$	(10,377	)

Loss per share:
Basic	$	(1.61	)	$	(0.18	)	$	(3.42	)	$	(0.66	)
Diluted	$	(1.61	)	$	(0.18	)	$	(3.42	)	$	(0.66	)
Weighted average shares outstanding:
Basic	13,867			15,486			14,116			15,673
Diluted	13,867			15,486			14,116			15,673

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)



	Common Stock					Accumulated Deficit			Total Shareholders’ Equity
	Shares		Amount			Accumulated Deficit			Total Shareholders’ Equity
Balance at February 2, 2019	14,504,824		$	169,477		$	(38,677	)	$	130,800
Cumulative effect of change in accounting principle	—		—			(331		)	(331		)
Employee stock purchases	6,880		68			—			68
Stock-based compensation expense	—		560			—			560
Repurchase and retirement of common stock	(287,056	)	—			(2,368		)	(2,368		)
Net loss	—		—			(8,921		)	(8,921		)
Balance at May 4, 2019	14,224,648		170,105			(50,297		)	119,808
Employee stock purchases	22,354		77			—			77
Restricted stock issued	70,725		—			—			—
Net share settlement of restricted stock	(10,792	)	(44		)	—			(44		)
Stock-based compensation expense	—		731			—			731
Repurchase and retirement of common stock	(345,906	)	—			(1,046		)	(1,046		)
Net loss	—		—			(17,120		)	(17,120		)
Balance at August 3, 2019	13,961,029		170,869			(68,463		)	102,406
Employee stock purchases	36,453		45			—			45
Restricted stock issued	98,298		—			—			—
Net share settlement of restricted stock	(23,937	)	(33		)	—			(33		)
Stock-based compensation expense	—		704			—			704
Repurchase and retirement of common stock	(174,313	)	—			(243		)	(243		)
Net loss	—		—			(22,306		)	(22,306		)
Balance at November 2, 2019	13,897,530		$	171,585		$	(91,012	)	$	80,573

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KIRKLAND’S, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

(in thousands, except share data)



	Common Stock					Accumulated Deficit			Total Shareholders’ Equity
	Shares		Amount			Accumulated Deficit			Total Shareholders’ Equity
Balance at February 3, 2018	15,977,239		$	167,501		$	(26,740	)	$	140,761
Employee stock purchases	10,969		82			—			82
Exercise of stock options	20,834		23			—			23
Stock-based compensation expense	—		393			—			393
Repurchase and retirement of common stock	(315,548	)	—			(2,972		)	(2,972		)
Net loss	—		—			(882		)	(882		)
Balance at May 5, 2018	15,693,494		167,999			(30,594		)	137,405
Employee stock purchases	7,306		79			—			79
Exercise of stock options	146,692		—			—			—
Restricted stock issued	108,900		—			—			—
Net share settlement of stock options and restricted stock	(137,478	)	(378		)	—			(378		)
Stock-based compensation expense	—		498			—			498
Repurchase and retirement of common stock	(77,096	)	—			(832		)	(832		)
Net loss	—		—			(6,715		)	(6,715		)
Balance at August 4, 2018	15,741,818		168,198			(38,141		)	130,057
Employee stock purchases	9,971		77			—			77
Exercise of stock options	10,000		—			—			—
Net share settlement of stock options	(8,877	)	—			—			—
Stock-based compensation expense	—		450			—			450
Repurchase and retirement of common stock	(689,473	)	—			(6,554		)	(6,554		)
Net loss	—		—			(2,780		)	(2,780		)
Balance at November 3, 2018	15,063,439		$	168,725		$	(47,475	)	$	121,250

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)



	39 Weeks Ended
	November 2,			November 3,
	2019			2018
Cash flows from operating activities:
Net loss	$	(48,347	)	$	(10,377	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation of property and equipment	21,156			21,992
Amortization of debt issue costs	41			41
Asset impairment	7,251			—
Cumulative effect of change in accounting principle	(331		)	—
Loss on disposal of property and equipment	150			340
Stock-based compensation expense	1,995			1,341
Deferred income taxes	759			988
Changes in assets and liabilities:
Inventories, net	(55,788		)	(32,504		)
Prepaid expenses and other current assets	2,443			(2,318		)
Accounts payable	27,845			9,856
Accounts payable to related party vendor	(8,166		)	3,738
Accrued expenses	(3,547		)	(5,007		)
Income taxes refundable	(1,041		)	(9,951		)
Operating lease assets and liabilities	(7,161		)	1,242
Other assets and liabilities	300			(200		)
Net cash used in operating activities	(62,441		)	(20,819		)

Cash flows from investing activities:
Capital expenditures	(12,759		)	(25,025		)
Net cash used in investing activities	(12,759		)	(25,025		)

Cash flows from financing activities:
Borrowings on revolving line of credit	25,000			—
Cash used in net share settlement of stock options and restricted stock	(77		)	(378		)
Proceeds received from employee stock option exercises	—			23
Employee stock purchases	190			238
Repurchase and retirement of common stock	(3,657		)	(10,358		)
Net cash provided by (used in) financing activities	21,456			(10,475		)

Cash and cash equivalents:
Net decrease	(53,744		)	(56,319		)
Beginning of the period	57,946			80,156
End of the period	$	4,202		$	23,837

Supplemental schedule of non-cash activities:
Non-cash accruals for purchases of property and equipment	$	1,818		$	1,970
Operating lease assets and liabilities recognized upon adoption of ASC 842	295,240			—
Increase of operating lease liabilities from new or modified leases	17,840			—

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

Kirkland’s, Inc. (the “Company”) is a specialty retailer of home décor in the United States operating 432 stores in 37 states as of November 2, 2019, as well as an e-commerce enabled website, www.kirklands.com. 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.

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 Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required for complete financial statements. 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 Securities and Exchange Commission on March 29, 2019.

It should be understood that accounting measurements at interim dates inherently involve greater reliance on estimates than those at fiscal year-end. In addition, because of seasonality factors, the results of the Company’s operations for the 13-week and 39-week periods ended November 2, 2019 are not indicative of the results to be expected for any other interim period or for the entire fiscal year. The Company’s fiscal year ends on the Saturday closest to January 31, resulting in years of either 52 or 53 weeks.

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.

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 on long-lived assets, inventory reserves and self-insurance reserves.

For the 13-week and 39-week periods ended November 3, 2018, the Company recorded an unfavorable $0.7 million one-time out-of-period adjustment related to revised straight-line rent calculations to cost of sales from deferred rent.

In the beginning of fiscal 2019, the Company adopted new lease accounting guidance. The adoption of the new lease accounting guidance had a material impact to the Company’s condensed consolidated balance sheets and related disclosures, and resulted in the recording of additional right-of-use assets and lease liabilities of approximately $295.2 million as of the date of adoption. This guidance was applied using the optional transition method, which allowed the Company to not recast comparative financial information but rather recognize a cumulative-effect adjustment to retained earnings as of the effective date in the period of adoption. An adjustment of $0.3 million was made to retained earnings as a result of right-of-use assets that were impaired upon the adoption of this guidance. See Note 11 to the condensed consolidated financial statements for further discussion. Consistent with the optional transition method, the financial information in the condensed consolidated balance sheets prior to the adoption of this new lease accounting guidance has not been adjusted and is therefore not comparable to the current period presented. The standard did not materially impact the Company’s condensed consolidated statements of operations or cash flows. For additional information, including the required disclosures, related to the impact of adopting this standard, see Note 10 and Note 12 to the condensed consolidated financial statements.

Certain other amounts in the fiscal 2018 operating activities section of the condensed consolidated statement of cash flows have been reclassified to conform to the fiscal 2019 presentation. These reclassifications had no effect on reported net loss.

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 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:



	November 2, 2019		February 2, 2019		November 3, 2018
Gift card liability, net of estimated breakage	$	11,187	$	13,032	$	10,308

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



	13-Week Period Ended				39-Week Period Ended
	November 2, 2019		November 3, 2018		November 2, 2019		November 3, 2018
Gift card breakage revenue	$	243	$	257	$	774	$	809
Gift card redemptions recognized in the current period related to amounts included in the gift card contract liability balance as of the prior period	1,814		2,110		5,349		5,012

Note 2 - Income Taxes

An estimate of the annual effective tax rate is used at each interim period based on the facts and circumstances available at that time, while the actual effective tax rate is calculated at year-end. For the 13-week periods ended November 2, 2019 and November 3, 2018, the Company recorded income tax expense of 57.2% of the loss before income taxes and recorded an income tax benefit of 19.7% of the loss before income taxes, respectively. For the 39-week periods ended November 2, 2019 and November 3, 2018, the Company recorded income tax expense of 1.9% of the loss before income taxes and an income tax benefit of 23.6% of the loss before income taxes, respectively. The change in the tax rate for the 13-week and 39-week periods ended November 2, 2019 was primarily due to establishing a valuation allowance against deferred tax assets of $11.3 million as of November 2, 2019, as the Company is estimated to have a three year cumulative pretax loss, and by the realization of discrete shortfall tax expense related to stock forfeitures and vesting of restricted stock units.

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 carryforwards. 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. For the period ended November 2, 2019, the Company established a full valuation allowance against its federal and consolidated state deferred tax assets, primarily net operating loss carryforwards, due to uncertainty regarding their realization. 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 decrease 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.

Note 3 - Loss Per Share

Basic loss per share is computed by dividing net loss by the weighted average number of shares outstanding during each period presented. Diluted loss per share is computed by dividing net 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 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 loss per share, because to do so would have been antidilutive, were approximately 1.6 million and 1.2 million shares for the 13-week periods ended November 2, 2019 and November 3, 2018, respectively, and 1.6 million and 1.3 million shares for the 39-week periods ended November 2, 2019 and November 3, 2018, respectively.

Note 4 - 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.

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The Company maintains The Executive Non-Qualified Excess Plan (the “Deferred Compensation Plan”). The Deferred Compensation Plan is funded, and the Company invests participant deferrals into trust assets, which are invested in a variety of mutual funds that are Level 1 inputs. The plan assets and plan liabilities are adjusted to fair value on a recurring basis. The Board of Directors approved the termination of the Deferred Compensation Plan effective September 6, 2019. Any remaining balances in the Deferred Compensation Plan will be paid out one year from the effective date. Deferred Compensation Plan assets and liabilities were approximately $1.8 million, $1.9 million and $2.1 million as of November 2, 2019, February 2, 2019 and November 3, 2018, respectively, and were recorded in other assets and other liabilities 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 which would fall within Level 3 of the fair value hierarchy. The Company uses market participant rents 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 to quantify fair value for other long-lived assets. See Note 11 to the condensed consolidated financial statements for further discussion.

Note 5 - 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. 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 not yet set. 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. To date, the parties have exchanged the court mandated initial disclosures. 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 the Company’s consolidated financial condition, operating results or cash flows.

Note 6 - 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:



	13-Week Period Ended				39-Week Period Ended
	November 2, 2019		November 3, 2018		November 2, 2019		November 3, 2018
Stock-based compensation expense (included in compensation and benefits on the condensed consolidated statements of operations)	$	704	$	450	$	1,995	$	1,341
Stock options granted	74,468		—		504,961		157,700
Restricted stock units granted	42,424		132,834		501,141		243,734

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Note 7 - Related Party Transactions

The Company had an agreement with a related party vendor to purchase merchandise inventory. The vendor was considered a related party for financial reporting purposes because its principal owner is the spouse of the Company’s former Vice President of Product Development and Trend. As of June 14, 2019, the vendor is no longer a related party. The table below sets forth selected results related to this vendor, for the time period that the vendor was a related party, in dollars (in thousands) and percentages for the periods indicated:



	13-Week Period Ended						39-Week Period Ended
	November 2, 2019			November 3, 2018			November 2, 2019			November 3, 2018
Related Party Vendor:
Purchases	$	—		$	17,444		$	19,577		$	41,966
Purchases as a percent of total merchandise purchases	—		%	22.5		%	9.4		%	21.1		%

Note 8 - Stock Repurchase Plan

On August 22, 2017, the Company announced that its Board of Directors authorized a stock repurchase plan providing for the purchase in the aggregate of up to $10 million of the Company’s outstanding common stock. This stock repurchase plan was completed during the third quarter of fiscal 2018. On September 24, 2018, the Company announced that its Board of Directors authorized a new stock repurchase plan providing for the purchase in the aggregate of up to $10 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 acquisition price, regulatory limitations and other market and economic factors. The stock 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 November 2, 2019, the Company had approximately $21,000 remaining under the current stock repurchase plan. The table below sets forth selected stock repurchase plan information (in thousands, except share amounts) for the periods indicated:



	13-Week Period Ended				39-Week Period Ended
	November 2, 2019		November 3, 2018		November 2, 2019		November 3, 2018
Shares repurchased and retired	174,313		689,473		807,275		1,082,117
Share repurchase cost	$	243	$	6,554	$	3,657	$	10,358

Note 9 - Senior Credit Facility

The Company is party to a Joinder and First Amendment to Amended and Restated Credit Agreement (the “Credit Agreement”) with Bank of America, N.A. as administrative agent and collateral agent, and the lenders named therein (the “Lenders”). The Credit Agreement includes a senior secured revolving credit facility of $75 million, a swingline availability of $10 million, a $25 million incremental accordion feature and a maturity date of February 2021. Borrowings 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 Lenders 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 contain 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 ERISA events. 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 facility 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 an Amended and Restated Security Agreement (the “Security Agreement”) with its Lenders. 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 November 2, 2019, the Company was in compliance with the covenants in the Credit Agreement, and there were $25 million of outstanding borrowings under the revolving credit facility, with $50 million available for borrowing.

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Note 10 - Leases

The Company leases retail store facilities, corporate office space, warehouse facilities and certain vehicles and equipment under operating leases with terms generally ranging up to 10 years and expiring at various dates through fiscal 2029. Most of the retail store lease agreements include an initial term with renewal options and provide for minimum fixed rental payments. The Company does not include lease renewal options in the lease term for calculations of its right-of-use assets and liabilities until it is reasonably certain that the Company plans to renew these leases. A few retail store lease agreements have only variable lease payments based on a percentage of sales, while other store leases contain contingent rentals based on sales performance in excess of specified minimums in addition to minimum fixed rentals.

The majority of the Company’s leases have monthly fixed rent with variable components (e.g., real estate taxes and insurance costs) and variable non-lease components (e.g., common area maintenance). These variable payments are excluded from the calculation of the lease liability and right-of-use asset. For leases where the lease and non-lease components are fixed, the Company has elected an accounting policy to account for lease and non-lease components as a single component. The Company’s leases do not provide an implicit rate, so the incremental borrowing rate, based on the information available at commencement or modification date, is used in determining the present value of lease payments. For operating leases that commenced prior to the date of adoption of the new lease accounting guidance, the Company used the incremental borrowing rate that corresponded to the remaining lease term as of the date of adoption.

The Company’s classification of lease cost on the Company’s condensed consolidated statements of operations is as follows (in thousands):



	13 Week Period Ended ⁽¹⁾		39-Week Period Ended ⁽¹⁾
	November 2, 2019		November 2, 2019
Cost of sales ⁽²⁾
Operating lease cost	$	13,855	$	40,917
Short-term lease cost	362		1,070
Variable lease cost	315		832
Total lease cost in cost of sales	$	14,532	$	42,819
Other operating expenses
Operating lease cost	$	713	$	2,173
Short-term lease cost	136		224
Total lease cost in other operating expenses	$	849	$	2,397


⁽¹⁾	Total lease cost for the 13-week and 39-week periods ended November 2, 2019 excludes expense for variable non-lease components including common area maintenance and excludes costs that are not a component of the lease including real estate taxes, insurance, sales taxes and utilities for the Company’s leases.


⁽²⁾	Cost of sales includes all distribution center lease costs and store occupancy-related lease cost.

As of November 2, 2019, future minimum payments, by year and in the aggregate, under all operating leases with initial terms of one year or more consist of the following (in thousands):



	Operating Leases
2019 (excluding the 39 weeks ended November 2, 2019)	$	11,315
2020	65,526
2021	56,759
2022	47,015
2023	38,416
After 2023	86,826
Total lease payments ⁽¹⁾	305,857
Less: Interest	(45,858		)
Present value of lease liabilities	$	259,999

⁽¹⁾ Operating lease payments exclude $6.0 million of legally binding minimum lease payments for leases signed but not yet commenced for three new store leases.

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The Company’s lease term and discount rate is as follows:



	November 2, 2019
Weighted-average remaining lease term (years)	6.0
Weighted-average discount rate	5.7	%

Cash paid for amounts included in the measurement of lease liabilities is as follows (in thousands):



	13-Week Period Ended		39-Week Period Ended
	November 2, 2019		November 2, 2019
Operating cash flows from operating leases	$	16,048	$	48,965

The Company adopted new lease accounting guidance as of the beginning of fiscal 2019 as discussed in Note 1 and Note 12, and as required, the following disclosure is provided for periods prior to adoption. As of February 2, 2019, future minimum payments, by year and in the aggregate, under all operating leases with initial terms of one year or more consist of the following (in thousands):



	Operating Leases
2019	$	67,354
2020	62,102
2021	53,164
2022	44,087
2023	35,606
Thereafter	91,629
Total minimum lease payments	$	353,942

Note 11 - Impairments

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.

In connection with the adoption of the new lease accounting standard, the Company reviewed its store portfolio for possible impairment, as right-of-use assets are now included as part of the long-lived asset group that is evaluated for impairment. As a result of this review, eight stores were identified for which the carrying amounts of the store assets were not expected to be recoverable. In the first 13 weeks of fiscal 2019, the Company recorded an adjustment to increase the opening balance of accumulated deficit by approximately $0.3 million for the cumulative effect of the adoption of ASC 842 for right-of-use assets at six of the impaired stores.

During the 13-week and 39-week periods ended November 2, 2019, the Company recorded an impairment charge of approximately $41,000 for right-of-use asset impairment at one store and $525,000 for right-of-use asset impairment at three stores, respectively. The Company also recorded an impairment charge totaling approximately $3.4 million and $6.7 million for the 13-week and 39-week periods ended November 2, 2019, respectively, for leasehold improvements, fixtures and equipment at 17 stores and 22 stores, respectively, for which the carrying value exceed the fair value of these assets. The total impairment charge, net of tax, for the 13-week and 39-week periods ended November 2, 2019 was $2.5 million and $5.5 million, respectively.

In the first quarter of fiscal 2019, the Company shifted to estimating the fair value of long-lived fixed assets based on orderly liquidation value as the Company believes this method better reflects the fair value of the assets. The Company previously used the age-life method for calculating the fair value of long-lived fixed assets.

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Note 12 - New Accounting Pronouncements

New Accounting Pronouncements Recently Adopted

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, “Leases (Topic 842)”, which supersedes the existing guidance for lease accounting, Leases (Topic 840) (“ASU 2016-02”). ASU 2016-02 requires lessees to recognize a lease liability and a right-of-use asset for both operating leases and finance leases on the balance sheet at the lease commencement date. For operating leases, the lessee would recognize a straight-line total lease expense, while for finance leases, the lessee would recognize interest expense and amortization of the right-of-use asset. The Company currently only has operating leases. Lessor accounting remains largely unchanged, and the Company is not a lessor in any lease agreements. The guidance also requires certain qualitative and quantitative disclosures about the amount, timing and uncertainty of cash flows arising from leases.

There have been multiple standard updates amending this guidance or providing corrections or improvements on issues in the guidance. In July 2018, the FASB issued ASU 2018-11, “Leases (Topic 842): Targeted Improvements,” which provides an optional transition method in addition to the existing modified retrospective transition method by allowing a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. Under this transition method, companies may continue to report comparative periods under ASC 840, although they must also provide the required disclosures under ASC 840 for all periods presented under ASC 840. In January 2018, the FASB issued ASU 2018-01, “Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842.” This update permits an entity to elect an optional transition practical expedient to not evaluate land easements that exist or expired before the entity’s adoption of ASU 2016-02 and that were not accounted for as leases under previous lease guidance.

The Company adopted this guidance as of the beginning of the first 13 weeks of fiscal 2019, and as a part of that process, made the following elections:


•	The Company elected the optional transition method, which allows for the lessee to not recast comparative financial information but rather recognize a cumulative-effect adjustment to retained earnings as of the effective date in the period of adoption.


•	The Company elected the package of practical expedients permitted under the transition guidance within the new standard, which, among other things, allowed the Company to carry forward its prior lease classification under ASC 840, not reassess whether expired or existing contracts contain leases and not reevaluate initial direct costs for existing leases.


•	The Company did not elect the hindsight practical expedient for all leases.


•	The Company elected to make the accounting policy election for short-term leases, for which the Company does not recognize right-of-use assets or lease liabilities, resulting in lease payments being recorded as an expense on a straight-line basis over the lease term.


•	The majority of the Company’s leases have variable non-lease components. For leases where the non-lease components are fixed, the Company has elected an accounting policy to account for lease and non-lease components as a single component.


•	The Company elected the land easement practical expedient.

Adoption of the new standard had a material impact on the Company’s condensed consolidated balance sheets, statement of shareholders’ equity and related disclosures, and resulted in the recording of additional right-of-use assets and lease liabilities of approximately $295.2 million as of the date of adoption. Right-of-use assets are recorded based upon the present value of remaining operating lease liabilities adjusted for prepaid and deferred rent, including deferred construction allowances from landlords and initial direct costs. The Company also recorded an adjustment to increase the opening balance of accumulated deficit by approximately $0.3 million for the cumulative effect of the adoption of ASC 842 for right-of-use assets for stores with impairment indicators at adoption. The standard did not materially impact the Company’s condensed consolidated statements of operations or cash flows.

In August 2018, the FASB issued ASU 2018-15, “Intangibles–Goodwill and Other–Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is A Service Contract” (“ASU 2018-15”). This update clarifies the accounting treatment for fees paid by a customer in a cloud computing arrangement (hosting arrangement) by providing guidance for determining when the arrangement includes a software license. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2019, with early adoption permitted. The amendments may be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company adopted this guidance in the first 13 weeks of fiscal 2019 using the prospective adoption method. This guidance could have a material effect on future financial results depending on whether or not the Company implements

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new software as a service solutions with significant implementation costs, as they would be deferred and expensed over the term of the agreement. The adoption of this guidance did not have a material effect on the Company’s current consolidated financial statements and related disclosures.

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 February 2, 2019, filed with the Securities and Exchange Commission on March 29, 2019 (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”.

General

We are a specialty retailer of home décor in the United States, operating 432 stores in 37 states as of November 2, 2019, as well as an e-commerce enabled website, www.kirklands.com. Our stores present a broad selection of distinctive merchandise, including holiday décor, furniture, art, fragrance and accessories, ornamental wall décor, decorative accessories, mirrors, lamps, textiles, artificial floral products, gifts, housewares, outdoor living items, frames and clocks. Our stores offer an extensive assortment of holiday merchandise during seasonal periods as well as items carried throughout the year suitable for gift-giving. We provide our customers an engaging shopping experience characterized by a diverse, ever-changing merchandise selection reflecting current styles at prices which provide discernible value. This combination of ever-changing and stylish merchandise, value pricing and a stimulating online and store experience has led to our emergence as a key player in home décor and enabled us to develop a loyal customer base.

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, and gift card breakage revenue and excludes sales taxes. We use comparable store sales to measure sales increases or decreases from stores that have been open for at least 13 full fiscal months. Stores closed during the year are included in the comparable store sales calculation only for the full fiscal months of the year the stores were open. Relocated stores are removed from the comparable store base when the existing store closes, and the new replacement store is added into the comparable store sales calculation after 13 full fiscal months of activity. E-commerce store sales, including shipping revenue, are included in consolidated comparable store sales. Increases in comparable store sales are an important factor in maintaining or increasing the profitability of existing stores.

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 (including e-commerce shipping) 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 Growth

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



	13-Week Period Ended		39-Week Period Ended
	November 2, 2019	November 3, 2018	November 2, 2019	November 3, 2018
New stores opened during the period	1	6	5	22
Stores closed during the period	—	—	1	8

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The following table summarizes our stores and square footage under lease:



	November 2, 2019	November 3, 2018
Number of stores	432	432
Square footage	3,437,072	3,420,097
Average square footage per store	7,956	7,917

13-Week Period Ended November 2, 2019 Compared to the 13-Week Period Ended November 3, 2018

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:



	13-Week Period Ended
	November 2, 2019					November 3, 2018					Change
	$			%		$			%		$			%
Net sales	$	144,936		100.0	%	$	154,571		100.0	%	$	(9,635	)	(6.2	)%
Cost of sales	104,800			72.3		107,918			69.8		(3,118		)	(2.9	)
Gross profit	40,136			27.7		46,653			30.2		(6,517		)	(14.0	)
Operating expenses:
Compensation and benefits	29,115			20.1		29,621			19.2		(506		)	(1.7	)
Other operating expenses	20,208			14.0		18,783			12.1		1,425			7.6
Depreciation (exclusive of depreciation included in cost of sales)	1,602			1.1		1,867			1.2		(265		)	(14.2	)
Asset impairment	3,392			2.3		—			—		3,392			100.0
Total operating expenses	54,317			37.5		50,271			32.5		4,046			8.0
Operating loss	(14,181		)	(9.8	)	(3,618		)	(2.3	)	(10,563		)	292.0
Interest expense	169			0.1		69			—		100			144.9
Other income	(158		)	(0.1	)	(224		)	(0.1	)	66			(29.5	)
Loss before income taxes	(14,192		)	(9.8	)	(3,463		)	(2.2	)	(10,729		)	309.8
Income tax expense (benefit)	8,114			5.6		(683		)	(0.4	)	8,797			(1,288.0	)
Net loss	$	(22,306	)	(15.4	)%	$	(2,780	)	(1.8	)%	$	(19,526	)	702.4	%

Net sales. Net sales decreased 6.2% to $144.9 million for the third 13 weeks of fiscal 2019 compared to $154.6 million for the prior year period. Comparable store sales, including e-commerce sales, decreased 6.4%, or $9.7 million for the third 13 weeks of fiscal 2019 compared to the prior year period. This was partially offset by the impact of net new store growth, which contributed an increase in net sales of $0.1 million. Comparable store sales, including e-commerce sales, increased 1.4% in the prior year period. For the third 13 weeks of fiscal 2019, e-commerce comparable sales increased 25.9%, while comparable store sales at brick-and-mortar stores decreased 11.0%. For brick-and-mortar stores, the comparable store sales decrease was primarily due to a decrease in store traffic, which was partially offset by an improvement in conversion. For e-commerce, comparable sales benefited from an increase in website traffic and conversion, partially offset by a decrease in average ticket due to decreases in both average retail price and items per transaction. The merchandise categories contributing most to the comparable store sales decrease for the third 13 weeks of fiscal 2019 were ornamental wall décor, lamps, gift, decorative accessories and holiday, which were partially offset by increases in textiles and furniture.

Gross profit. Gross profit as a percentage of net sales decreased 250 basis points from 30.2% in the third 13 weeks of fiscal 2018 to 27.7% in the third 13 weeks of fiscal 2019. The overall decrease in gross profit margin was due to a decline in merchandise margin and higher store occupancy costs, partially offset by favorable outbound freight costs and lower central distribution expenses. Merchandise margin decreased approximately 360 basis points from 55.4% in the third 13 weeks of fiscal 2018 to 51.8% in the third 13 weeks of fiscal 2019 because of unfavorable product margin due to both product mix and increased promotions and unfavorable inbound freight expenses due to rate increases and product mix shifts. Store occupancy costs increased approximately 25 basis points as a percentage of net sales, primarily due to sales deleverage. Outbound freight costs, which include e-commerce shipping, decreased approximately 80 basis points as a percentage of net sales, which was driven by favorable distribution center to store shipping costs as we started using a third-party retail distribution center in Texas reducing the overall miles to deliver

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product to stores and lower shipping costs for ship-to-home customer orders due to the increase in store-fulfilled online sales and savings from a new shipping provider contract. Central distribution costs decreased 55 basis points as a percentage of net sales, primarily due to a change in the process of estimating when warehousing costs are expensed, as well as reduced labor costs.

Compensation and benefits. Compensation and benefits as a percentage of net sales increased approximately 90 basis points from 19.2% in the third 13 weeks of fiscal 2018 to 20.1% in the third 13 weeks of fiscal 2019, primarily due to sales deleverage of both store and corporate payroll expenses, as well as corporate severance agreements and higher executive stock compensation expense, partially offset by lower corporate bonus expense.

Other operating expenses. Other operating expenses as a percentage of net sales increased approximately 190 basis points from 12.1% in the third 13 weeks of fiscal 2018 to 14.0% in the third 13 weeks of fiscal 2019. The increase as a percentage of net sales was primarily due to higher advertising expenses and sales deleverage.

Asset impairment. For the third 13 weeks of fiscal 2019, we recorded a right-of-use asset impairment charge of approximately $41,000 at one store and an impairment charge of approximately $3.4 million for leasehold improvements, fixtures and equipment at 17 stores, for which the carrying value exceeded the fair value of these assets.

Income tax benefit. We recorded income tax expense of approximately $8.1 million, or 57.2% of the loss before income taxes during the third 13 weeks of fiscal 2019, compared to an income tax benefit of approximately $0.7 million, or 19.7% of the loss before income taxes during the prior year period. The change in the tax rate for the third 13 weeks of fiscal 2019 compared to the prior year period was primarily due to establishing a valuation allowance against deferred tax assets of $11.3 million as of November 2, 2019, as the Company is estimated to have a three year cumulative pretax loss, and by the realization of discrete shortfall tax expense related to stock forfeitures and vesting of restricted stock units. See Note 2 to the condensed consolidated financial statements for further discussion.

Net loss and loss per share. We reported a net loss of $22.3 million, or $1.61 per diluted share, for the third 13 weeks of fiscal 2019 as compared to a net loss of $2.8 million, or $0.18 per diluted share, for the third 13 weeks of fiscal 2018.

39-Week Period Ended November 2, 2019 Compared to the 39-Week Period Ended November 3, 2018

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:



	39-Week Period Ended
	November 2, 2019					November 3, 2018					Change
	$			%		$			%		$			%
Net sales	$	394,469		100.0	%	$	430,924		100.0	%	$	(36,455	)	(8.5	)%
Cost of sales	291,541			73.9		302,161			70.1		(10,620		)	(3.5	)
Gross profit	102,928			26.1		128,763			29.9		(25,835		)	(20.1	)
Operating expenses:
Compensation and benefits	83,333			21.1		83,490			19.4		(157		)	(0.2	)
Other operating expenses	54,998			14.0		54,067			12.5		931			1.7
Depreciation (exclusive of depreciation included in cost of sales)	5,177			1.3		5,405			1.3		(228		)	(4.2	)
Asset impairment	7,251			1.8		—			—		7,251			100.0
Total operating expenses	150,759			38.2		142,962			33.2		7,797			5.5
Operating loss	(47,831		)	(12.1	)	(14,199		)	(3.3	)	(33,632		)	236.9
Interest expense	307			0.1		200			—		107			53.5
Other income	(712		)	(0.2	)	(825		)	(0.2	)	113			(13.7	)
Loss before income taxes	(47,426		)	(12.0	)	(13,574		)	(3.1	)	(33,852		)	249.4
Income tax expense (benefit)	921			0.3		(3,197		)	(0.7	)	4,118			(128.8	)
Net loss	$	(48,347	)	(12.3	)%	$	(10,377	)	(2.4	)%	$	(37,970	)	365.9	%

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Net sales. Net sales decreased 8.5% to $394.5 million for the first 39 weeks of fiscal 2019 compared to $430.9 million for the prior year period. Comparable store sales, including e-commerce sales, decreased 9.3%, or $38.9 million for the first 39 weeks of fiscal 2019 compared to the prior year period. This was partially offset by the impact of net new store growth, which contributed an increase in net sales of $2.5 million. Comparable store sales, including e-commerce sales, decreased 0.3% in the prior year period. For the first 39 weeks of fiscal 2019, e-commerce comparable sales increased 19.4%, while comparable store sales at brick-and-mortar stores decreased 13.5%. For brick-and-mortar stores, the comparable store sales decrease was primarily due to a decrease in store traffic and a decline in the average ticket, which was partially offset by an improvement in conversion. For e-commerce, comparable sales benefited from an increase in website traffic and conversion, partially offset by a decrease in average ticket due to decreases in both average retail price and items per transaction. The merchandise categories contributing most to the comparable store sales decrease for the first 39 weeks of fiscal 2019 were ornamental wall décor, art, decorative accessories and lamps, which were partially offset by increases in textiles, floral and furniture.

Gross profit. Gross profit as a percentage of net sales decreased 380 basis points from 29.9% in the first 39 weeks of fiscal 2018 to 26.1% in the first 39 weeks of fiscal 2019. The overall decrease in gross profit margin was due to lower merchandise margin and the deleverage of store occupancy costs and central distribution expenses, partially offset by a slight decrease in outbound freight costs. Merchandise margin decreased approximately 210 basis points from 54.9% in the first 39 weeks of fiscal 2018 to 52.8% in the first 39 weeks of fiscal 2019 due to unfavorable product margin because of increased promotions and higher inbound freight costs partially offset by favorable damages. Store occupancy costs increased approximately 140 basis points as a percentage of net sales and central distribution costs increased 35 basis points as a percentage of net sales, both primarily due to sales deleverage. Outbound freight costs, which include e-commerce shipping, decreased approximately 5 basis points as a percentage of net sales, which was driven by lower shipping costs for ship-to-home customer orders.

Compensation and benefits. Compensation and benefits as a percentage of net sales increased approximately 170 basis points from 19.4% in the first 39 weeks of fiscal 2018 to 21.1% in the first 39 weeks of fiscal 2019, primarily due to sales deleverage of both store and corporate payroll expenses.

Other operating expenses. Other operating expenses as a percentage of net sales increased approximately 150 basis points from 12.5% in the first 39 weeks of fiscal 2018 to 14.0% in the first 39 weeks of fiscal 2019. The increase as a percentage of net sales was primarily due to sales deleverage and increased advertising expenses.

Asset impairment. For the first 39 weeks of fiscal 2019, we recorded an impairment charge of approximately $525,000 for right-of-use assets at three impaired stores and an impairment charge of approximately $6.7 million at 22 stores for the first 39 weeks of fiscal 2019 for leasehold improvements, fixtures and equipment, for which the carrying value exceeded the fair value of these assets.

Income tax benefit. We recorded income tax expense of approximately $0.9 million, or 1.9% of the loss before income taxes during the first 39 weeks of fiscal 2019, compared to an income tax benefit of approximately $3.2 million, or 23.6% of the loss before income taxes during the prior year period. The change in the tax rate for the first 39 weeks of fiscal 2019 compared to the prior year period was primarily due to establishing a valuation allowance against deferred tax assets of $11.3 million as of November 2, 2019, as the Company is estimated to have a three year cumulative pretax loss, and by the realization of discrete shortfall tax expense related to stock forfeitures and vesting of restricted stock units. See Note 2 to the condensed consolidated financial statements for further discussion.

Net loss and loss per share. We reported a net loss of $48.3 million, or $3.42 per diluted share, for the first 39 weeks of fiscal 2019 as compared to a net loss of $10.4 million, or $0.66 per diluted share, for the first 39 weeks of fiscal 2018.

Non-GAAP Financial Measures

Adjusted net loss and adjusted loss per share. To supplement our unaudited consolidated condensed financial statements presented in accordance with generally accepted accounting principles, or GAAP, we provide certain non-GAAP financial measures, including adjusted loss and adjusted diluted loss per share. These measures are not in accordance with, and are not intended as alternatives to, GAAP. 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 measures, in evaluating our operational performance.

We define adjusted net loss and adjusted diluted loss per share by adjusting the applicable GAAP measure to remove the impact of special items.

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Non-GAAP 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 measure has its limitations as an analytical tool, and you should not consider them in isolation or as a substitute for analysis of the Company’s results as reported under GAAP.

The following table shows a reconciliation net loss and diluted loss per share to adjusted net loss and adjusted diluted loss per share for the 13 weeks and 39 weeks ended November 2, 2019 and November 3, 2018:



	13-Week Period Ended						39-Week Period Ended
	November 2, 2019			November 3, 2018			November 2, 2019			November 3, 2018
Net loss	$	(22,306	)	$	(2,780	)	$	(48,347	)	$	(10,377	)
Special Items:
CEO transition costs, net of tax	—			755			—			1,909
Severance charges, net of tax	329			72			1,142			72
Tax valuation allowance	11,336			—			11,336			—
Asset impairment, net of tax	2,548			—			5,526			—
Total special items, net of tax	14,213			827			$	18,004		1,981
Adjusted net loss	$	(8,093	)	$	(1,953	)	$	(30,343	)	$	(8,396	)

Diluted loss per share	$	(1.61	)	$	(0.18	)	$	(3.42	)	$	(0.66	)
Adjusted diluted loss per share	$	(0.58	)	$	(0.13	)	$	(2.15	)	$	(0.54	)

Diluted weighted average shares outstanding	13,867			15,486			14,116			15,673

Included in the reported net loss for the third 13 weeks of fiscal 2019 are asset impairment charges of approximately $2.5 million, net of tax, the establishment of a tax valuation allowance on deferred tax assets of $11.3 million and severance charges of approximately $0.3 million, net of tax, which increased the net loss by approximately $1.03 per diluted share. Included in the reported net loss for the third 13 weeks of fiscal 2018 are severance and transition charges of approximately $0.8 million, net of tax, associated with our Chief Executive Officer transition and other severance charges of approximately $0.1 million, net of tax, which increased the net loss by approximately $0.05 per diluted share.

Included in the reported net loss for the first 39 weeks of fiscal 2019 are asset impairment charges of approximately $5.5 million, net of tax, the establishment of a tax valuation allowance on deferred tax assets of $11.3 million and severance charges of approximately $1.1 million, net of tax, which increased the net loss by approximately $1.27 per diluted share. Included in the reported net loss for the first 39 weeks of fiscal 2018 are severance and transition charges of approximately $1.9 million, net of tax, associated with our Chief Executive Officer transition and other severance charges of approximately $0.1 million, net of tax, which increased the net loss by approximately $0.12 per diluted share.

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 purchases of equipment or information technology assets for our stores (including e-commerce), distribution facilities and corporate headquarters; new store openings; and existing store expansions, remodels or relocations. Historically, we have funded our working capital and capital expenditure requirements with internally-generated cash or borrowings under our revolving credit facility.

Cash flows from operating activities. Net cash used in operating activities was approximately $62.4 million during the first 39 weeks of fiscal 2019 as compared to approximately $20.8 million for the first 39 weeks of fiscal 2018. Cash flows from operating activities depend heavily on operating performance and changes in working capital. The change in the amount of cash from operations as compared to the prior year period was primarily due to a decline in operating performance and an increase in inventories, partially offset by an increase in accounts payable.

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Cash flows from investing activities. Net cash used in investing activities for the first 39 weeks of fiscal 2019 consisted of $12.8 million in capital expenditures as compared to $25.0 million in capital expenditures for the prior year period. The table below sets forth capital expenditures by category (in thousands) for the periods indicated:



	39-Week Period Ended
	November 2, 2019		November 3, 2018
Distribution center and supply chain enhancements	$	4,057	$	1,564
Existing stores	2,869		3,260
New stores	2,726		11,885
Technology and omni-channel projects	2,986		5,400
Corporate	121		2,916
Total capital expenditures	$	12,759	$	25,025

The capital expenditures in the current year period related primarily to distribution center and supply chain enhancements, improvements to existing stores, the opening of five new stores during the period and information technology system investments. Capital expenditures in the prior year period related primarily to the opening of 22 new stores during the period, information technology system investments, corporate hardware lease buyouts, investments in our existing stores and improvements to our supply-chain.

Cash flows from financing activities. Net cash provided by financing activities was approximately $21.5 million for the first 39 weeks of fiscal 2019 compared to net cash used in financing activities of $10.5 million for the first 39 weeks of fiscal 2018. In the first 39 weeks of fiscal 2019, we borrowed $25 million under our revolving credit facility which was partially offset by share repurchases of $3.7 million. In the first 39 weeks of fiscal 2018, net cash used in financing activities was primarily related to the repurchase and retirement of common stock pursuant to our stock repurchase plan.

Senior credit facility. We are party to the Credit Agreement with Bank of America, N.A. as administrative agent and collateral agent, and the Lenders. The Credit Agreement includes a senior secured revolving credit facility of $75 million, a swingline availability of $10 million, a $25 million incremental accordion feature and a maturity date of February 2021. Borrowings 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 Lenders on the unused portion of the credit facility is 25 basis points per annum.

We are subject to a Security Agreement with our Lenders. 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 November 2, 2019, we were in compliance with the covenants in the Credit Agreement, and there were $25 million of outstanding borrowings under the credit facility, with $50 million available for borrowing.

At November 2, 2019, our balance of cash and cash equivalents was approximately $4.2 million. We believe that the combination of our cash balances, availability under our Credit Agreement and cash flow from operations will be sufficient to fund our planned capital expenditures and working capital requirements for at least the next twelve months.

Stock repurchase plan. On August 22, 2017, we announced that our Board of Directors authorized a stock repurchase plan providing for the purchase in the aggregate of up to $10 million of our outstanding common stock. This stock repurchase plan was completed during the third quarter of fiscal 2018. On September 24, 2018, the Company announced that its Board of Directors authorized a new stock repurchase plan providing for the purchase in the aggregate of up to $10 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 acquisition price, regulatory limitations and other market and economic factors. The stock repurchase plan does not require us to repurchase any specific number of shares, and we may terminate the repurchase plan at any

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time. As of November 2, 2019, we had approximately $21,000 remaining under our current stock repurchase plan. The table below sets forth selected stock repurchase plan information (in thousands, except share amounts) for the periods indicated:



	13-Week Period Ended				39-Week Period Ended
	November 2, 2019		November 3, 2018		November 2, 2019		November 3, 2018
Shares repurchased and retired	174,313		689,473		807,275		1,082,117
Share repurchase cost	$	243	$	6,554	$	3,657	$	10,358

Related Party Transactions

We had an agreement with a related party vendor to purchase merchandise inventory. The vendor was considered a related party for financial reporting purposes because its principal owner was the spouse of our former Vice President of Product Development and Trend. As of June 14, 2019, the vendor is no longer a related party. The table below sets forth selected results related to this vendor, for the time period that the vendor was a related party, in dollars (in thousands) and percentages for the periods indicated:



	13-Week Period Ended						39-Week Period Ended
	November 2, 2019			November 3, 2018			November 2, 2019			November 3, 2018
Related Party Vendor:
Purchases	$	—		$	17,444		$	19,577		$	41,966
Purchases as a percent of total merchandise purchases	—		%	22.5		%	9.4		%	21.1		%
Cost of sales	$	—		$	12,629		$	14,749		$	34,542
Payable amounts outstanding at fiscal period-end	—			11,261			—			11,261

Significant Contractual Obligations and Commercial Commitments

Construction Commitments. As of November 2, 2019, the Company had no material commitments related to construction projects extending greater than 12 months.

Critical Accounting Policies and Estimates

There have been no significant changes to our critical accounting policies during fiscal 2019 other than the change in calculation of the fair value of long-lived assets as discussed in Note 11 to the condensed consolidated financial statements. Refer to the Annual Report for a summary of our critical accounting policies.

New Accounting Pronouncements

See Note 12, New Accounting Pronouncements, to the condensed consolidated financial statements for recently adopted accounting pronouncements.

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 which could cause actual results to differ materially from the results projected in such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.

The factors listed below under the heading “Risk Factors” and in the other sections of this Form 10-Q provide examples of risks, uncertainties and events that could cause our actual results to differ materially from the expectations expressed in our forward-looking statements.

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These forward-looking statements speak only as of the date of this report, and, except as required by law, we undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this report.

We caution readers that the following important factors, among others, have in the past, in some cases, affected and could in the future affect our actual results of operations and cause our actual results to differ materially from the results expressed in any forward-looking statements made by us or on our behalf.


•	If we do not generate sufficient cash flow, we may not be able to implement our growth strategy.


•	If we are unable to profitably open and operate new stores at a rate that exceeds planned store closings, we may not be able to adequately execute our growth strategy, resulting in a decrease in net sales and net income.


•	Our success depends upon our marketing, advertising and promotional efforts. If we are unable to implement them successfully, or if our competitors market, advertise or promote more effectively than we do, our revenue may be adversely affected.


•	We may not be able to successfully anticipate consumer trends, and our failure to do so may lead to loss of consumer acceptance of our products resulting in reduced net sales.


•	We may not be able to successfully respond to technological change, our website could become obsolete and our financial results and conditions could be adversely affected.


•	Inventory loss and theft and the inability to anticipate inventory needs may result in reduced net sales.


•	Inability to successfully develop and maintain a relevant and reliable omni-channel experience for our customers could adversely affect our sales, results of operations and reputation.


•	Our results could be negatively impacted if our merchandise offering suffers a substantial impediment to its reputation due to real or perceived quality issues.


•	We face an extremely competitive specialty retail business market, and such competition could result in a reduction of our prices and a loss of our market share.


•	Weather conditions could adversely affect our sales and/or profitability by affecting consumer shopping patterns.


•	We are exposed to the risk of natural disasters, pandemic outbreaks, global political events, war and terrorism that could disrupt our business and result in lower sales, increased operating costs and capital expenditures.


•	Our performance may be affected by general economic conditions.


•	Our profitability is vulnerable to inflation and cost increases.


•	Our business is highly seasonal and our fourth quarter contributes a disproportionate amount of our net sales, net income and cash flow, and any factors negatively impacting us during our fourth quarter could reduce our net sales, net income and cash flow, leaving us with excess inventory and making it more difficult for us to finance our capital requirements.


•	Failure to control merchandise returns could negatively impact the business.


•	We may experience significant variations in our quarterly results.


•	Our comparable store net sales fluctuate due to a variety of factors.


•	Our freight costs and thus our cost of goods sold are impacted by changes in fuel prices.


•	New legal requirements could adversely affect our operating results.


•	Litigation may adversely affect our business, financial condition, results of operations or liquidity.


•	Product liability claims could adversely affect our reputation.


•	If we fail to protect our brand name, competitors may adopt trade names that dilute the value of our brand name.


•	Failure to protect the integrity and security of individually identifiable data of our customers and employees could expose us to litigation and damage our reputation; the expansion of our e-commerce Business has inherent cybersecurity risks that may result in business disruptions.


•	Our hardware and software systems are vulnerable to damage that could harm our business.


•	We depend on a number of vendors to supply our merchandise, and any delay in merchandise deliveries from certain vendors may lead to a decline in inventory which could result in a loss of net sales.

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•	We are dependent on foreign imports for a significant portion of our merchandise, and any changes in the trading relations and conditions between the United States and the relevant foreign countries may lead to a decline in inventory resulting in a decline in net sales, or an increase in the cost of sales resulting in reduced gross profit.


•	Our success is highly dependent on our planning and control processes and our supply chain, and any disruption in or failure to continue to improve these processes may result in a loss of net sales and net income.


•	We depend on key personnel, and, if we lose the services of any member of our senior management team, we may not be able to run our business effectively.


•	Our charter and bylaw provisions and certain provisions of Tennessee law may make it difficult in some respects to cause a change in control of Kirkland’s and replace incumbent management.


•	If we fail to maintain an effective system of internal control, we may not be able to accurately report our financial results.


•	The market price for our common stock might be volatile and could result in a decline in the value of your investment.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company does not utilize financial instruments for trading or other speculative purposes, nor does it utilize leveraged financial instruments. There have been no material changes in the market risk factors from those disclosed in the Company’s Form 10-K for the year ended February 2, 2019.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. Both our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15(d)-(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) have concluded that as of November 2, 2019 our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by the Company in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

(b) Change in internal controls over financial reporting. There have been no changes in internal controls over financial reporting identified in connection with the foregoing evaluation that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

ITEM 1A. RISK FACTORS

In addition to factors set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Cautionary Statement for Purposes of the ‘Safe Harbor’ Provisions of the Private Securities Litigation Reform Act of 1995,” in Part I - Item 2 of this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in the Annual Report on Form 10-K for the fiscal year ended February 2, 2019, 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. 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 weeks ended November 2, 2019 were as follows:



Period	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Program	Maximum Dollar Value of Shares that May Yet be Purchased Under the Program (in 000s)
August 4, 2019 to August 31, 2019	109,311	$	1.40	109,331	$	112
September 1, 2019 to October 5, 2019	65,002	1.40		65,002	21
October 6, 2019 to November 2, 2019	—	—		—	21
Total	174,313	$	1.40	174,333	$	21

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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


(a)	Exhibits.



Exhibit No.		Description of Document
31.1		Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)
31.2		Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a)
32.1		Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350
32.2		Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
10.1		Employment Agreement, effective September 18, 2019 by and between Nicole A. Strain and the Company (Exhibit 10.1 to the Company’s Current Report on From 8-K dated September 19, 2019)*+
101		Interactive Data File (Quarterly Report on Form 10-Q, for the quarter ended November 2, 2019, furnished in XBRL (eXtensible Business Reporting Language))

* Incorporated by reference.

+ Management contract of compensatory plan or arrangement.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.



	KIRKLAND’S, INC.
Date: December 5, 2019	/s/ Steve C. Woodward
	Steve C. Woodward Chief Executive Officer
Date: December 5, 2019	/s/ Nicole A. Strain
	Nicole A. Strain Chief Financial Officer

Kirkland's - 10-Q quarterly report FY2019 Q3

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