Edgar Filing: KIRKLAND'S, INC

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Form 10-Q

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 October 27, 2012,

¨	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 incorporation or organization)		(IRS Employer Identification No.)

2501 McGavock Pike, Suite 1000 Nashville, Tennessee		37214
(Address of principal executive offices)		(Zip Code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x NO ¨

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

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 — 17,070,553 shares outstanding as of November 20, 2012.

KIRKLAND’S, INC.

TABLE OF CONTENTS


	Page
PART I — FINANCIAL INFORMATION:

Item 1. Financial Statements

Condensed Consolidated Balance Sheets as of October 27, 2012 (unaudited), January 28, 2012, and October 29, 2011 (unaudited)		3

Condensed Consolidated Statements of Operations for the 13-week and 39-week periods ended October 27, 2012, and October 29, 2011 (unaudited)		4

Condensed Consolidated Statement of Shareholders’ Equity for the 39-week period ended October 27, 2012 (unaudited)		5

Condensed Consolidated Statements of Cash Flows for the 39-week periods ended October 27, 2012, and October 29, 2011 (unaudited)		6

Notes to Condensed Consolidated Financial Statements (unaudited)		7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		9

Item 3. Quantitative and Qualitative Disclosures About Market Risk		14

Item 4. Controls and Procedures		14

PART II — OTHER INFORMATION:

Item 1. Legal Proceedings		15

Item 1A. Risk Factors		15

Item 6. Exhibits		16

SIGNATURES		17

EXHIBIT 31.1

EXHIBIT 32.1

EXHIBIT 101

KIRKLAND’S, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)


	October 27, 2012 (Unaudited)			January 28, 2012			October 29, 2011 (Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	34,339		$	83,123		$	60,343
Inventories, net		64,191			47,306			59,940
Income taxes receivable		4,479			—			2,664
Deferred income taxes		1,497			1,657			2,174
Prepaid expenses and other current assets		9,917			7,784			11,176

Total current assets		114,423			139,870			136,297
Property and equipment, net		76,004			60,315			58,366
Non-current deferred income taxes		803			1,108			2,412
Other assets		1,457			1,296			1,176

Total assets	$	192,687		$	202,589		$	198,251

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	27,793		$	21,592		$	24,975
Income taxes payable		—			3,146			—
Accrued expenses		19,874			21,805			21,145

Total current liabilities		47,667			46,543			46,120
Deferred rent		37,490			34,311			30,578
Other liabilities		4,593			4,073			4,445

Total liabilities		89,750			84,927			81,143

Shareholders’ equity:
Common stock, no par value; 100,000,000 shares authorized; 17,070,553; 18,360,739; and 19,542,449 shares issued and outstanding at October 27, 2012, January 28, 2012, and October 29, 2011, respectively		152,684			150,352			149,256
Accumulated deficit		(49,747	)		(32,690	)		(32,148	)

Total shareholders’ equity		102,937			117,662			117,108

Total liabilities and shareholders’ equity	$	192,687		$	202,589		$	198,251

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

KIRKLAND’S, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share data)


	13-Week Period Ended						39-Week Period Ended
	October 27, 2012			October 29, 2011			October 27, 2012			October 29, 2011
Net sales	$	96,688		$	97,071		$	285,480		$	281,175
Cost of sales (exclusive of depreciation as shown below)		62,669			60,938			182,998			176,109

Gross profit		34,019			36,133			102,482			105,066
Operating expenses:
Compensation and benefits		19,152			18,828			57,181			55,187
Other operating expenses		12,491			12,467			37,487			34,541
Depreciation		3,122			2,914			9,342			8,888

Total operating expenses		34,765			34,209			104,010			98,616

Operating income (loss)		(746	)		1,924			(1,528	)		6,450
Interest expense, net		70			55			217			125
Other income, net		(51	)		(51	)		(179	)		(126	)

Income (loss) before income taxes		(765	)		1,920			(1,566	)		6,451
Income tax expense (benefit)		(349	)		673			(1,108	)		2,514

Net income (loss)	$	(416	)	$	1,247		$	(458	)	$	3,937

Earnings (loss) per share:
Basic	$	(0.02	)	$	0.06		$	(0.03	)	$	0.20

Diluted	$	(0.02	)	$	0.06		$	(0.03	)	$	0.19

Weighted average shares for basic earnings (loss) per share:		17,067			19,918			17,602			19,930
Effect of dilutive stock equivalents		—			286			—			568

Adjusted weighted average shares for diluted earnings (loss) per share		17,067			20,204			17,602			20,498

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

KIRKLAND’S, INC.

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)

(in thousands, except share data)


	Common Stock						Accumulated			Total Shareholders’
	Shares			Amount			Deficit			Equity
Balance at January 28, 2012		18,360,739		$	150,352		$	(32,690	)	$	117,662
Exercise of employee stock options and employee stock purchases		99,114			224			—			224
Tax benefit from exercise of stock options		—			46			—			46
Net share settlement of stock options		(27,402	)		—			—			—
Stock-based compensation expense		—			2,085			—			2,085
Repurchase and retirement of common stock		(1,361,898	)		(23	)		(16,599	)		(16,622	)
Net loss		—			—			(458	)		(458	)

Balance at October 27, 2012		17,070,553		$	152,684		$	(49,747	)	$	102,937

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

KIRKLAND’S, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)


	39-week Period Ended
	October 27, 2012			October 29, 2011
Cash flows from operating activities:
Net income (loss)	$	(458	)	$	3,937
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation of property and equipment		9,342			8,888
Amortization of landlord construction allowances		(2,993	)		(3,530	)
Amortization of debt issue costs		57			33
Loss (gain) on disposal of property and equipment		(35	)		152
Cash received for landlord construction allowances		5,393			6,849
Stock-based compensation expense		2,085			2,382
Excess tax benefits from exercise of stock options and restricted stock		(46	)		(1,177	)
Deferred income taxes		465			382
Changes in assets and liabilities:
Inventories, net		(16,885	)		(15,488	)
Prepaid expenses and other current assets		(852	)		(3,708	)
Other noncurrent assets		(212	)		(186	)
Accounts payable		6,201			4,739
Income taxes refundable / payable		(7,579	)		(2,776	)
Accrued expenses and other current and noncurrent liabilities		(1,913	)		(2,414	)

Net cash used in operating activities		(7,430	)		(1,917	)

Cash flows from investing activities:
Capital expenditures		(24,996	)		(21,175	)

Net cash used in investing activities		(24,996	)		(21,175	)

Cash flows from financing activities:
Refinancing costs		(6	)		(287	)
Excess tax benefits from exercise of stock options and restricted stock		46			1,177
Cash used in net share settlement of stock options and restricted stock		—			(1,142	)
Exercise of stock options and employee stock purchases		224			422
Repurchase and retirement of common stock		(16,622	)		(7,957	)

Net cash used in financing activities		(16,358	)		(7,787	)

Cash and cash equivalents:
Net decrease		(48,784	)		(30,879	)
Beginning of the period		83,123			91,222

End of the period	$	34,339		$	60,343

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

KIRKLAND’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 — Basis of Presentation

Kirkland’s, Inc. (the “Company”) is a specialty retailer of home décor and gifts with 308 stores in 32 states as of October 27, 2012. 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., Kirkland’s Texas, LLC, and Kirklands.com, 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 with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required 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 April 12, 2012.

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 period ended October 27, 2012 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. All references to a fiscal year refer to the fiscal year ending on the Saturday closest to January 31 of the following year.

The preparation of the 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 possible that actual results could materially differ from amounts estimated include: impairment assessments on long-lived assets, inventory reserves, self-insurance reserves, income tax liabilities, stock-based compensation, gift card breakage, customer loyalty program accruals and contingent liabilities.

Note 2 — Income Taxes

An estimate of the annual effective tax rate is used at each interim period based on the facts and circumstances available at that time, while the actual effective tax rate is calculated at year-end. For the 13-week period ended October 27, 2012, the Company recorded an income tax benefit of 45.6% of the loss before income taxes. In the prior year period, the Company recorded income tax expense of 35.1% of pre-tax income. During the 13-week period ended October 27, 2012, the Company reversed a portion of its reserve for uncertain income tax positions for which the statute of limitations expired. This adjustment resulted in an income tax benefit of approximately $205,000. This benefit was partially offset by $87,000 in tax expense related to a prior year item. For the 39-week period ended October 27, 2012, the Company recorded an income tax benefit of 70.8% of the pre-tax loss. In the prior year period, the Company recorded income tax expense of 39.0% of pre-tax income. In addition to the activity noted in the current period, during the 13-week period ended July 28, 2012, the Company recorded state and federal employment tax credits totaling approximately $400,000 that related to prior year periods and in excess of previous estimates.

Note 3 — Earnings Per Share

Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during each period presented, which excludes non-vested restricted stock units. Diluted earnings per share is computed by dividing net income by the weighted average number of shares outstanding plus the dilutive effect of stock equivalents outstanding during the applicable periods using the treasury stock method. Diluted earnings per share reflects the potential dilution that could occur if options to purchase stock were exercised into common stock. Stock options that were not included in the computation of diluted earnings per share because to do so would have been antidilutive were 1.7 million and 955,000 shares for the 13-week periods ended October 27, 2012, and October 29, 2011, and 1.7 million and 545,000 for the 39-week periods ended October 27, 2012, and October 29, 2011, respectively.

Note 4 — Commitments and Contingencies

The Company is party to pending legal proceedings and claims. Although the outcome of such proceedings and claims cannot be determined with certainty, the Company’s management is of the opinion that it is unlikely that these proceedings and any claims in excess of insurance coverage will have a material effect on the financial condition, operating results or cash flows of the Company.

Note 5 — Stock-Based Compensation

The Company maintains equity incentive plans under which it may grant non-qualified stock options, incentive stock options, restricted stock, restricted stock units, or stock appreciation rights to employees, non-employee directors and consultants.

The Company granted 175,000 stock options and 94,000 restricted stock units during the 39-week period ended October 27, 2012. This compares to 172,500 stock options and 89,000 restricted stock units granted in the 39-week period ended October 29, 2011. Total stock-based compensation expense (a component of compensation and benefits) was $630,000 for the 13-week period ended October 27, 2012, and $2.1 million for the 39-week period ended October 27, 2012, compared to $733,000 and $2.4 million, respectively, for the comparable prior year periods. 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 quarter.

Note 6 — Stock Repurchase Program

On August 19, 2011, the Company announced that its Board of Directors authorized a stock repurchase plan providing for the purchase in the aggregate of up to $40 million of the Company’s outstanding common stock from time to time until February 2013. The Company repurchased and retired a total of approximately 3.4 million shares at an aggregate cost of $40 million, completing the repurchase authorization in July, 2012.

Note 7 — Related Party Transactions

In July 2009, the Company entered into an agreement with a related party vendor to purchase merchandise inventory. The vendor is considered a related party for financial reporting purposes because its principal is the spouse of the Company’s Vice President of Merchandising. During the 13-week periods ended October 27, 2012, and October 29, 2011, purchases from this vendor totaled approximately $8.3 million, or 13.5% of total merchandise purchases, and $7.1 million, or 12.2% of merchandise purchases, respectively. During the 39-week periods ended October 27, 2012, and October 29, 2011, purchases from this vendor totaled approximately $19.7 million, or 12.4% of total merchandise purchases, and $17.0 million, or 11.2% of total merchandise purchases, respectively. Included in cost of sales for the 13-week periods ended October 27, 2012, and October 29, 2011 were $5.3 million and $4.8 million, respectively, related to this vendor. Included in cost of sales for the 39-week periods ended October 27, 2012, and October 29, 2011 were $16.9 million and $14.2 million, respectively related to this vendor. Payable amounts outstanding to this vendor were approximately $3.7 million and $2.2 million as of October 27, 2012 and October 29, 2011, respectively. The Company’s payable terms with this vendor are consistent with the terms offered by other vendors in the ordinary course of business.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (MD&A) is intended to provide an understanding of our financial condition, change in financial condition, cash flow, liquidity and results of operations. The following MD&A discussion should be read in conjunction with the condensed consolidated financial statements and notes to those statements that appear elsewhere in this Form 10-Q and in the Company’s Annual Report on Form 10-K, filed April 12, 2012. The following discussion contains forward-looking statements that reflect the Company’s plans, estimates and beliefs. The Company’s actual results could differ materially from those discussed or referred to in the forward-looking statements. Factors that could cause or contribute to any differences include, but are not limited to, those discussed under the caption “Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995” and under Part II, Item 1A — “Risk Factors”.

General

We are a specialty retailer of home décor and gifts in the United States, operating 308 stores in 32 states as of October 27, 2012. Our stores present a broad selection of distinctive merchandise, including framed art, mirrors, wall décor, candles and related items, lamps, decorative accessories, accent furniture, textiles, garden-related accessories and artificial floral products. Our stores also offer an extensive assortment of holiday merchandise during seasonal periods as well as items carried throughout the year suitable for gift-giving. In addition, we use innovative design and packaging to market home décor items as gifts. We provide our predominantly female customers an engaging shopping experience characterized by a diverse, ever-changing merchandise selection at prices which provide discernible value to the customer. Our stores offer a unique combination of style and value that has led to our emergence as a leader in home décor and has enabled us to develop a strong customer franchise.

During the 13-week period ended October 27, 2012, we opened 10 new stores and closed 4 stores. The following table summarizes our stores and square footage under lease:


	As of October 27, 2012		As of October 29, 2011
Number of stores		308		301
Square footage		2,201,060		2,038,952
Average square footage per store		7,146		6,774

13-Week Period Ended October 27, 2012 Compared to the 13-Week Period Ended October 29, 2011

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
	October 27, 2012						October 29, 2011						Change
	$			%			$			%			$			%
Net sales	$	96,688			100.0	%	$	97,071			100.0	%	$	(383	)		(0.4	%)
Cost of sales		62,669			64.8	%		60,938			62.8	%		1,731			2.8	%

Gross profit		34,019			35.2	%		36,133			37.2	%		(2,114	)		(5.9	%)
Operating expenses:
Compensation and benefits		19,152			19.8	%		18,828			19.4	%		324			1.7	%
Other operating expenses		12,491			12.9	%		12,467			12.8	%		24			0.2	%
Depreciation		3,122			3.2	%		2,914			3.0	%		208			7.1	%

Total operating expenses		34,765			36.0	%		34,209			35.2	%		556			1.6	%
Operating income (loss)		(746	)		(0.8	%)		1,924			2.0	%		(2,670	)		(138.8	%)
Interest expense, net		70			0.1	%		55			0.1	%		15			27.3	%
Other income, net		(51	)		(0.1	%)		(51	)		(0.1	%)		—			0.0	%

Income (loss) before income taxes		(765	)		(0.8	%)		1,920			2.0	%		(2,685	)		(139.8	%)
Income tax expense (benefit)		(349	)		(0.4	%)		673			0.7	%		(1,022	)		(151.9	%)

Net income (loss)	$	(416	)		(0.4	%)	$	1,247			1.3	%	$	(1,663	)		(133.4	%)

Net sales. Net sales decreased 0.4% to $96.7 million for the third fiscal quarter of 2012 compared to $97.1 million for the prior year period. The impact of net new store growth contributed an increase to net sales of $3.6 million. This increase in net sales was offset by a decline in comparable store sales, including E-commerce sales, of 4.7%, accounting for a $4.0 million decline versus the prior year quarter. Comparable store sales decreased 3.6% in the prior year period. The E-commerce business was up 76% versus the prior year period, while comparable store sales at brick-and-mortar stores were down 6.6%. For brick-and-mortar stores, the comparable store sales decrease for the third quarter of 2012 was primarily due to a decrease in number of transactions, partially offset by a slight increase in the average ticket. The decrease in transactions resulted from a decline in the conversion rate and a decrease in traffic. The increase in the average ticket reflected an increase in items sold per transaction, offset partially by a decline in average retail selling price. The merchandise categories contributing most to the comparable store sales decline were decorative accessories, wall décor, and furniture.

Gross profit. Gross profit as a percentage of net sales decreased from 37.2% in the third quarter of 2011 to 35.2% in the third quarter of 2012. Merchandise margins decreased from 53.4% in the third quarter of fiscal 2011 to 52.1% in the third quarter of fiscal 2012. Merchandise margin is calculated as net sales minus product cost of sales (including inbound freight), inventory shrinkage, and loyalty reward program discounts. Merchandise margin excludes outbound freight, store occupancy and central distribution costs. The decrease in merchandise margin was primarily the result of higher promotional activity and increased markdowns. Higher inbound freight container rates also contributed approximately 0.5% to the merchandise margin decline. Store occupancy costs as a percentage of net sales increased 0.3%. This increase resulted from the decline in comparable store sales. Outbound freight costs and central distribution expenses increased as a percentage of sales primarily due to an increase in shipping and packaging costs associated with E-commerce, as well as comparable store sales deleverage.

Compensation and benefits. Compensation and benefits expenses for both stores and the corporate level increased for the third quarter of fiscal 2012 as compared to the third quarter of 2011 primarily due to the impact of wage and headcount increases, combined with the slight decrease in total sales. This increase was partially offset at the corporate level by a decrease in stock compensation expense in the third quarter of 2012. Increases in health insurance expense at both stores and corporate also helped to contribute to the overall increase in compensation and benefits expense versus the prior year quarter.

Other operating expenses. Other operating expenses were relatively flat on a dollar basis, but increased slightly as a percentage of net sales versus the prior year period due to increases in utilities, professional fees, as well as deleverage due to the decline in comparable store sales.

Depreciation. The increase in depreciation as a percentage of sales reflects an increase in capital expenditures during the last two fiscal years.

Income tax expense. We recorded an income tax benefit of approximately $349,000, or 45.6% of pre-tax loss during the third quarter of fiscal 2012, versus expense of approximately $673,000, or 35.1% of pre-tax income, in the prior year quarter. During the third quarter of 2012, the Company reversed a portion of its reserve for uncertain income tax positions for which the statute of limitations expired. This adjustment resulted in an income tax benefit of approximately $205,000. This benefit was partially offset by $87,000 in tax expense related to a prior year item.

Net income and earnings per share. As a result of the foregoing, we reported a net loss of $416,000, or ($0.02) per diluted share, for the third quarter of fiscal 2012 as compared to net income of $1.2 million, or $0.06 per diluted share, for the third quarter of fiscal 2011.

39-week Period Ended October 27, 2012 Compared to the 39-week Period Ended October 29, 2011

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


	39-Week Period Ended
	October 27, 2012						October 29, 2011						Change
	$			%			$			%			$			%
Net sales	$	285,480			100.0	%	$	281,175			100.0	%	$	4,305			1.5	%
Cost of sales		182,998			64.1	%		176,109			62.6	%		6,889			3.9	%

Gross profit		102,482			35.9	%		105,066			37.4	%		(2,584	)		(2.5	%)
Operating expenses:
Compensation and benefits		57,181			20.0	%		55,187			19.6	%		1,994			3.6	%
Other operating expenses		37,487			13.1	%		34,541			12.3	%		2,946			8.5	%
Depreciation		9,342			3.3	%		8,888			3.2	%		454			5.1	%

Total operating expenses		104,010			36.4	%		98,616			35.1	%		5,394			5.5	%
Operating income (loss)		(1,528	)		(0.5	%)		6,450			2.3	%		(7,978	)		(123.7	%)
Interest expense, net		217			0.1	%		125			0.0	%		92			73.6	%
Other income, net		(179	)		(0.1	%)		(126	)		(0.0	%)		(53	)		42.1	%

Income (loss) before income taxes		(1,566	)		(0.5	%)		6,451			2.3	%		(8,017	)		(124.3	%)
Income tax expense (benefit)		(1,108	)		(0.4	%)		2,514			0.9	%		(3,622	)		(144.1	%)

Net income (loss)	$	(458	)		(0.2	%)	$	3,937			1.4	%	$	(4,395	)		(111.6	%)

Net sales. Net sales increased 1.5% to $285.5 million for the first three quarters of fiscal 2012 from $281.2 million for the prior year period. The impact of net new store growth contributed an increase to net sales of $12.3 million. This increase was partially offset by a decline in comparable store sales, including E-commerce sales, of 3.2%, accounting for an $8.0 million decline versus the prior year period. Comparable store sales decreased 6.7% in the prior year period. The E-commerce business was up 94% versus the prior year period, while comparable store sales at brick-and-mortar stores were down 5.2%. For brick-and-mortar stores, the comparable store sales decrease was primarily due to a decline in number of transactions, offset by a slight increase in the average ticket. The decline in transactions resulted from a decline in the conversion rate and slightly lower traffic. The slight increase in average ticket was the result of an increase in items per transaction offset partially by a slight decline in average retail selling price. Categories contributing most to the comparable store sales decline were wall décor and decorative accessories.

Gross profit. Gross profit as a percentage of net sales decreased from 37.4% in the first three quarters of fiscal 2011 to 35.9% in the first three quarters of fiscal 2012. Merchandise margins were 52.5% in the first three quarters of fiscal 2012, compared to 52.9% in the first three quarters of fiscal 2011. Store occupancy costs as a percentage of net sales increased 0.5%. This increase resulted primarily from the decline in comparable stores sales. Outbound freight costs and central distribution expenses also increased as a percentage of sales primarily due to deleverage, an increase in diesel fuel costs, and shipping and packaging costs associated with E-commerce.

Compensation and benefits. At the store-level and corporate level, the compensation and benefits expense ratio increased for the first three quarters of fiscal 2012 as compared to the first three quarters of 2011 primarily due to the impact of rising wage rates and headcount increases against a narrow increase in total sales. Increases in health insurance expense at both stores and corporate also contributed to the increase in compensation and benefits expense, particularly in the third quarter of fiscal 2012.

Other operating expenses. Other operating expenses increased as a percentage of net sales for the first three quarters of fiscal 2012 due to increases in marketing and information technology expenses, as well as deleverage due to the decline in comparable store sales.

Depreciation. The increase in depreciation as a percentage of sales versus the prior year period reflects an increase in capital expenditures over the last two fiscal years.

Income tax expense. We recorded income tax benefit of $1.1 million, or 70.8% of pre-tax loss during the first three quarters of fiscal 2012, versus an expense of approximately $2.5 million, or 39.0% of pre-tax income, during the prior year period. During the second quarter of 2012, we recorded state and federal employment tax credits totaling approximately $400,000 that related to prior year periods and in excess of our previous estimates. During the third quarter of 2012, the Company reversed a portion of its reserve for uncertain income tax positions for which the statute of limitations expired. This adjustment resulted in an income tax benefit of approximately $205,000. This benefit was partially offset by $87,000 in tax expense related to a prior year item.

Net income and earnings per share. As a result of the foregoing, we reported a net loss of $458,000, or ($0.03) per diluted share, for the first three quarters of fiscal 2012 as compared to net income of $3.9 million, or $0.19 per share, for the first three quarters of fiscal 2011.

Liquidity and Capital Resources

Our principal capital requirements are for working capital and capital expenditures. Working capital consists mainly of merchandise inventories offset by accounts payable, which typically reach their peak by the end of the third quarter of each fiscal year. Capital expenditures primarily relate to new store openings; existing store expansions, remodels or relocations; and purchases of equipment or information technology assets for our stores, distribution facilities and corporate headquarters. Historically, we have funded our working capital and capital expenditure requirements with internally generated cash and borrowings under our credit facility.

Cash flows from operating activities. Net cash used in operating activities was approximately $7.4 million and $1.9 million for the first three quarters of fiscal 2012 and fiscal 2011, respectively. Cash flows from operating activities depend heavily on operating performance, changes in working capital and the timing and amount of payments for income taxes. The change in the amount of cash used in operations as compared to the prior year period was primarily the result of the decline in operating performance, an increase in inventories due to retail square footage growth and an increase in the E-Commerce business, as well as an increase in taxes paid to $7.6 million for the first three quarters of fiscal 2012 versus $6.1 million in the prior year period.

Inventory levels at the end of the third quarter of fiscal 2012 were $64.2 million, an increase of $4.3 million from the third quarter of fiscal 2011. The increase in inventory resulted from E-commerce inventory growth in support of sales expected for the fourth quarter of the year, as well as to support an 8% increase in retail square footage. Inventory levels at brick-and-mortar stores at the end of the third quarter 2012 were up 2% versus the prior year. At the end of the third quarter of 2012, brick-and-mortar inventory per retail square foot was 3% lower than the end of the same period last year.

Cash flows from investing activities. Net cash used in investing activities for the first three quarters of fiscal 2012 consisted of $25.0 million in capital expenditures as compared to $21.2 million in capital expenditures for the prior year period. The capital expenditures primarily related to new store construction, information technology projects, and store improvements. During the first three quarters of fiscal 2012, we opened 25 stores compared to 23 stores during the first three quarters of fiscal 2011. We expect that capital expenditures for fiscal 2012 will be approximately $30 to $32 million, primarily to fund the leasehold improvements of new stores, make improvements in our information technology infrastructure, and maintain our investments in existing stores and our distribution center.

Cash flows from financing activities. Net cash used in financing activities was approximately $16.4 million for the first three quarters of fiscal 2012, and was primarily related to the repurchase and retirement of common stock. Net cash used in financing activities was approximately $7.8 million for the first three quarters of fiscal 2011, and primarily related to the repurchase and retirement of common stock, partially offset by the exercise of employee stock options, employee stock purchases, and the related tax benefits.

Revolving credit facility. On August 19, 2011, we entered into an Amended and Restated Credit Agreement, dated as of August 19, 2011 (the “Credit Agreement”), with Bank of America, N.A. as administrative agent and collateral agent, and the lenders named therein (the “Lenders”), replacing our prior credit agreement entered into in 2004. The Credit Agreement increased our senior secured revolving credit facility from $45 million to $50 million and extended the maturity date to August 2016. Borrowings under the facility bear interest at an annual rate equal to LIBOR plus a margin ranging from 175 to 225 basis points with no LIBOR floor. Additionally, a fee of 0.375% per annum is assessed on the unused portion of the facility.

Pursuant to the Credit Agreement, borrowings are subject to certain customary 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.

Also on August 19, 2011, we entered into an Amended and Restated Security Agreement, dated as of August 19, 2011 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 October 27, 2012, we were in compliance with the covenants in the facility and there were no outstanding borrowings under the credit facility, with approximately $50 million available for borrowing. We do not anticipate any borrowings under the credit facility during fiscal 2012.

At October 27, 2012, our balance of cash and cash equivalents was approximately $34 million and the borrowing availability under our facility was $50 million. We believe that the combination of our cash balances, line of credit availability and cash flow from operations will be sufficient to fund our planned capital expenditures and working capital requirements for at least the next twelve months.

Share repurchase authorization. On August 19, 2011, the Company announced that its Board of Directors authorized a stock repurchase plan providing for the purchase in the aggregate of up to $40 million of the Company’s outstanding common stock from time to time until February 2013. The Company repurchased and retired a total of approximately 3.4 million shares at an aggregate cost of $40 million, completing the repurchase authorization in July, 2012.

Related Party Transactions

In July 2009, the Company entered into an agreement with a related party vendor to purchase merchandise inventory. The vendor is considered a related party for financial reporting purposes because its principal is the spouse of the Company’s Vice President of Merchandising. During the third quarter of fiscal 2012 and 2011, purchases from this vendor totaled approximately $8.3 million, or 13.5% of total merchandise purchases, and $7.1 million, or 12.2% of merchandise purchases, respectively. During the first three quarters of 2012 and 2011, purchases from this vendor totaled approximately $19.7 million, or 12.4% of total merchandise purchases, and $17.0 million, or 11.2% of total merchandise purchases, respectively. Included in cost of sales for the third quarter of fiscal 2012 and 2011 were $5.3 million and $4.8 million, respectively, related to this vendor. Included in cost of sales for the first three quarters of 2012 and 2011 were $16.9 million and $14.2 million, respectively related to this vendor. Payable amounts outstanding to this vendor were approximately $3.7 million and $2.2 million as of October 27, 2012 and October 29, 2011, respectively. The Company’s payable terms with this vendor are consistent with the terms offered by other vendors in the ordinary course of business.

Significant Contractual Obligations and Commercial Commitments

Construction commitments

The Company had commitments for new store construction projects totaling approximately $4.0 million at October 27, 2012.

Critical Accounting Policies and Estimates

There have been no significant changes to our critical accounting policies during fiscal 2012. Refer to our Annual Report on Form 10-K for the fiscal year ended January 28, 2012, for a summary of our critical accounting policies.

Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995

The following information is provided pursuant to the “Safe Harbor” provisions of the Private Securities Litigation Reform Act of 1995. Certain statements under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-Q are “forward-looking statements” made pursuant to these provisions. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Words such as “should,” “likely to,” “forecasts,” “strategy,” “goal,” “anticipates,” “believes,” “expects,” “estimates,” “intends,” “plans,” “projects,” and similar expressions, may identify such forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially from the results projected in such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.

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

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.

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If We Are Unable to Profitably Open and Operate New Stores, We May Not Be Able to Adequately Execute Our Growth Strategy, Resulting in a Decrease in Net Sales and Net Income.

•

Our Success Depends Upon our Marketing, Advertising and Promotional Efforts. If We are Unable to Implement Them Successfully, or if Our Competitors are More Effective Than We are, Our Revenue May Be Adversely Affected.

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Our Results Could be Negatively Impacted if any of our Primary Brands Suffers a Substantial Impediment to its Reputation Due to Real or Perceived Quality Issues.

•

Product Liability Claims Could Adversely Affect Our Reputation.

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Weather Conditions Could Adversely Affect Our Sales and/or Profitability by Affecting Consumer Shopping Patterns.

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Our Performance May Be Affected by General Economic Conditions.

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Changes in Accounting and Tax Rules and Regulations May Adversely Affect our Operating Results.

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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.

•

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.

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The Market Price for Our Common Stock Might Be Volatile and Could Result in a Decline in the Value of Your Investment.

•

Our Comparable Store Net Sales Fluctuate Due to a Variety of Factors.

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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.

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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.

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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.

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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.

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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.

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We May Experience Significant Variations in Our Quarterly Results.

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Our Hardware and Software Systems Are Vulnerable to Damage that Could Harm Our Business.

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We Depend on Key Personnel, and if We Lose the Services of Any Member of Our Senior Management Team, We May Not Be Able to Run Our Business Effectively.

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Our Charter and Bylaw Provisions and Certain Provisions of Tennessee Law May Make It Difficult in Some Respects to Cause a Change in Control of Kirkland’s and Replace Incumbent Management.

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Concentration of Ownership among Our Existing Directors, Executive Officers, and Their Affiliates May Prevent New Investors from Influencing Significant Corporate Decisions.

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If We Fail to Maintain an Effective System of Internal Control, We May Not Be Able to Accurately Report Our Financial Results.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company does not utilize financial instruments for trading or other speculative purposes, nor does it utilize leveraged financial instruments. There have been no material changes in the market risk factors from those disclosed in the Company’s Form 10-K for the year ended January 28, 2012.

ITEM 4.

CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. Our Interim 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”) has concluded that as of October 27, 2012 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. During the quarter ended October 27, 2012, the Company completed the implementation of a new Oracle ERP software system. This implementation was subject to various testing and review procedures prior to execution. In connection with the ERP system implementation, the Company has updated its internal controls over financial reporting, as necessary, to accommodate modifications to our business processes and accounting procedures. Management does not believe the ERP system implementation will have an adverse effect on our internal controls over financial reporting. Other than the change described above, there have been no changes in internal controls over financial reporting identified in connection with the foregoing evaluation that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

The Company is party to pending legal proceedings and claims. Although the outcome of such proceedings and claims cannot be determined with certainty, the Company’s management is of the opinion that it is unlikely that these proceedings and claims in excess of insurance coverage will have a material effect on the financial condition, operating results or cash flows of the Company.

ITEM 1A.

RISK FACTORS

In addition to factors set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Cautionary Statement for Purposes of the ‘Safe Harbor’ Provisions of the Private Securities Litigation Reform Act of 1995,” in Part I — Item 2 of this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 28, 2012, which could materially affect our business, financial condition or future results. The risks described in this report and in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

ITEM 6.

EXHIBITS

(a) Exhibits.


Exhibit No.		Description of Document

31.1		Certification of the Interim President and Chief Executive Officer and the Senior Vice President and Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)

32.1		Certification of the Interim President and Chief Executive Officer and the Senior Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

101		Interactive Data File (Quarterly Report on Form 10-Q, for the quarter ended October 27, 2012, furnished in XBRL (eXtensible Business Reporting Language))

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.

EXHIBIT INDEX


Exhibit No.		Description of Document

31.1		Certification of the Interim President and Chief Executive Officer and the Senior Vice President and Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)

32.1		Certification of the Interim President and Chief Executive Officer and the Senior Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

101		Interactive Data File (Quarterly Report on Form 10-Q, for the quarter ended October 27, 2012, furnished in XBRL (eXtensible Business Reporting Language))

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company