| You should carefully consider the following risks, as well as the other information contained in this 10-K, including our consolidated financial statements and the related notes, before investing in our common stock |
| During fiscal 2005, we opened 59 new stores, and our future operating results will depend to a substantial extent upon our ability to open and operate new stores successfully |
| We also have an ongoing expansion, remodeling and relocation program |
| We remodeled one store in fiscal 2005 and may expand, remodel or relocate additional stores during fiscal 2006 |
| There can be no assurance that we will be able to open, expand, remodel and relocate stores at this rate, or at all |
| Our ability to open new stores and to expand, remodel and relocate existing stores depends on a number of factors, including our ability to: • obtain adequate capital resources for leasehold improvements, fixtures and inventory on acceptable terms, or at all; • locate and obtain favorable store sites and negotiate acceptable lease terms; • construct or refurbish store sites; • obtain and distribute adequate product supplies to our stores; • maintain adequate warehousing and distribution capability at acceptable costs; • hire, train and retain skilled managers and personnel; and • continue to upgrade our information and other operating systems to control the anticipated growth and expanded operations |
| The rate of our expansion will also depend on the availability of adequate capital, which in turn will depend in large part on cash flow generated by our business and the availability of equity and debt capital |
| There can be no assurance that we will have adequate cash flow generated by our business or that we will be able to obtain equity or debt capital on acceptable terms, or at all |
| Moreover, our senior credit facility contains provisions that restrict the amount of debt we may incur in the future |
| In addition, the cost of opening, expanding, remodeling and relocating new or existing stores may increase in the future compared to historical costs |
| The increased cost could be material |
| If we are not successful in obtaining sufficient capital, we may be unable to open additional stores or expand, remodel and relocate existing stores as planned, which may adversely affect our growth strategy resulting in a decrease in net sales |
| As a result, there can be no assurances that we will be able to achieve our current plans for the opening of new stores and the expansion, remodeling or relocation of existing stores |
| There also can be no assurance that our existing stores will maintain their current levels of net sales and store-level profitability or that new stores will generate net sales levels necessary to achieve store-level profitability |
| New stores that we open in our existing markets may draw customers from our existing stores and may have lower net sales growth relative to stores opened in new markets |
| New stores also may face greater competition and have lower anticipated net sales volumes relative to previously opened stores during their comparable years of operations |
| New stores opened in new markets, where we are less familiar with the target customer and less well known, may face different or additional risks and increased costs 13 _________________________________________________________________ [73]Table of Contents compared to stores operated in existing markets |
| Also, stores opened in off-mall locations may require greater marketing costs in order to attract customer traffic |
| These factors, together with increased pre-opening expenses at our new stores, may reduce our average store contribution and operating margins |
| If we are unable to profitably open and operate new stores and maintain the profitability of our existing stores, our net income could suffer |
| The success of our growth plan will be dependent on our ability to promote and/or recruit enough qualified regional directors, district managers, store managers and sales associates to support the expected growth in the number of our stores, and the time and effort required to train and supervise a large number of new managers and associates may divert resources from our existing stores and adversely affect our operating and financial performance |
| Our operating expenses would also increase as a result of any increase in the minimum wage or other factors that would require increases in the compensation paid to our employees |
| A Prolonged Economic Downturn Could Result in Reduced Net Sales and Profitability |
| Our net sales are also subject to a number of factors relating to consumer spending, including general economic conditions affecting disposable consumer income such as unemployment rates, business conditions, interest rates, levels of consumer confidence, energy prices, mortgage rates, the level of consumer debt and taxation |
| A weak retail environment could impact customer traffic in our stores and also adversely affect our net sales |
| Purchases of home decor items may decline during recessionary periods, and a prolonged recession may have a material adverse effect on our business, financial condition and results of operations |
| In addition, economic downturns during the last quarter of our fiscal year could adversely affect us to a greater extent than if such downturns occurred at other times of the year |
| Approximately 56prca of our stores are located in the southeastern region of the United States |
| Consequently, economic conditions, weather conditions, demographic and population changes and other factors specific to this region may have a greater impact on our results of operations than on the operations of our more geographically diversified competitors |
| In addition, changes in regional factors that reduce the appeal of our stores and merchandise to local consumers could reduce our net sales |
| Our success depends on our ability to anticipate and respond to changing merchandise trends and consumer demands in a timely manner |
| If we fail to identify and respond to emerging trends, consumer acceptance of the merchandise in our stores and our image with our customers may be harmed, which could reduce customer traffic in our stores and materially adversely affect our net sales |
| Additionally, if we misjudge market trends, we may significantly overstock unpopular products and be forced to take significant inventory markdowns, which would have a negative impact on our gross profit and cash flow |
| Conversely, shortages of items that prove popular could reduce our net sales |
| In addition, a major shift in consumer demand away from home decor could also have a material adverse effect on our business, results of operations and financial condition |
| We Depend on a Number of Vendors to Supply Our Merchandise, and Any Delay in Merchandise Deliveries from Certain Vendors May Lead to a Decline in Inventory Which Could Result in a Loss of Net Sales |
| We purchase our products from approximately 260 vendors with which we have no long-term purchase commitments or exclusive contracts |
| None of our vendors supplied more than 10prca of our merchandise purchases during fiscal 2005 |
| Historically, we have retained our vendors and we have generally not experienced difficulty in obtaining desired merchandise from vendors on acceptable terms |
| 14 _________________________________________________________________ [74]Table of Contents However, our arrangements with these vendors do not guarantee the availability of merchandise, establish guaranteed prices or provide for the continuation of particular pricing practices |
| Our current vendors may not continue to sell products to us on current terms or at all, and we may not be able to establish relationships with new vendors to ensure delivery of products in a timely manner or on terms acceptable to us |
| We may not be able to acquire desired merchandise in sufficient quantities on terms acceptable to us in the future |
| Also, our business would be adversely affected if there were delays in product shipments to us due to freight difficulties, strikes or other difficulties at our principal transport providers or otherwise |
| We are also dependent on vendors for assuring the quality of merchandise supplied to us |
| Our inability to acquire suitable merchandise in the future or the loss of one or more of our vendors and our failure to replace any one or more of them may harm our relationship with our customers resulting in a loss of net sales |
| We Are Dependent on Foreign Imports for a Significant Portion of Our Merchandise, and Any Changes in the Trading Relations and Conditions Between the United States and the Relevant Foreign Countries May Lead to a Decline in Inventory Resulting in a Decline in Net Sales, or an Increase in the Cost of Sales Resulting in Reduced Gross Profit |
| Many of our vendors are importers of merchandise manufactured in the Far East and India |
| Our vendors are subject to the risks involved with relying on products manufactured abroad, and we remain subject to those risks to the extent that their effects are passed through to us by our vendors or cause disruptions in supply |
| These risks include changes in import duties, quotas, loss of “most favored nation” (“MFN”) trading status with the United States for a particular foreign country, work stoppages, delays in shipments, freight cost increases, terrorism, war, economic uncertainties (including inflation, foreign government regulations and political unrest) and trade restrictions (including the United States imposing antidumping or countervailing duty orders, safeguards, remedies or compensation and retaliation due to illegal foreign trade practices) |
| If any of these or other factors were to cause a disruption of trade from the countries in which the suppliers of our vendors are located, our inventory levels may be reduced or the cost of our products may increase |
| We currently purchase a majority of our merchandise from importers of goods manufactured in China |
| China has been granted permanent normal trade relations by the United States effective January 1, 2002, based on its entry into the World Trade Organization (“WTO”), and now enjoys MFN trading status |
| China’s entry into the WTO potentially stabilizes the trading relationship between it and the United States, but the possibility of trade disputes concerning merchandise currently imported from China continues to create risks |
| These risks could result in sanctions against China, and the imposition of new duties on certain imports from China, including products supplied to us |
| Any significant increase in duties or any other increase in the cost of the products imported for us from China could result in an increase in the cost of our products to our customers which may correspondingly cause a decrease in net sales or could cause a reduction in our gross profit |
| Historically, instability in the political and economic environments of the countries in which our vendors obtain our products has not had a material adverse effect on our operations |
| However, we cannot predict the effect that future changes in economic or political conditions in such foreign countries may have on our operations |
| Although we believe that we could access alternative sources in the event of disruptions or delays in supply due to economic, political or health conditions in foreign countries on our vendors, such disruptions or delays may adversely affect our results of operations unless and until alternative supply arrangements could be made |
| In addition, merchandise purchased from alternative sources may be of lesser quality or more expensive than the merchandise we currently purchase abroad |
| Countries from which our vendors obtain these products may, from time to time, impose new or adjust prevailing quotas or other restrictions on exported products, and the United States may impose new duties, quotas and other restrictions on imported products |
| This could disrupt the supply of such products to us and adversely affect our operations |
| The United States Congress periodically considers other 15 _________________________________________________________________ [75]Table of Contents restrictions on the importation of products obtained for us by vendors |
| The cost of such products may increase for us if applicable duties are raised or import quotas with respect to such products are imposed or made more restrictive |
| We are also subject to the risk that the manufacturers abroad who ultimately manufacture our products may employ labor practices that are not consistent with acceptable practices in the United States |
| In any such event we could be hurt by negative publicity with respect to those practices and, in some cases, face liability for those practices |
| 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 |
| An important part of our efforts to achieve efficiencies, cost reductions and net sales growth is the continued identification and implementation of improvements to our planning, logistical and distribution infrastructure and our supply chain, including merchandise ordering, transportation and receipt processing |
| We also need to ensure that our distribution infrastructure and supply chain keep pace with our anticipated growth and increased number of stores |
| In particular, we may need to expand our existing infrastructure to the extent we open new stores in regions of the United States where we presently do not have significant concentrations of stores |
| The cost of this enhanced infrastructure could be significant |
| In addition, a significant portion of the distribution to our stores is coordinated through our distribution facility in Jackson, Tennessee |
| Any significant disruption in the operations of this facility would have a material adverse effect on our ability to maintain proper inventory levels in our stores which could result in a loss of net sales and net income |
| The retail market is highly competitive |
| We compete against a diverse group of retailers, including specialty stores, department stores, discount stores and catalog retailers, which carry merchandise in one or more categories also carried by us |
| Our product offerings also compete with a variety of national, regional and local retailers, including such specialty retailers as Bed, Bath & Beyond, Cost Plus World Market, Linens ’n Things, Michaels Stores, Pier 1 Imports and Williams-Sonoma |
| We also compete with these and other retailers for suitable retail locations, suppliers, qualified employees and management personnel |
| One or more of our competitors are present in substantially all of the markets in which we have stores |
| Many of our competitors are larger and have significantly greater financial, marketing and other resources than we do |
| This competition could result in the reduction of our prices and a loss of our market share |
| Our net sales are also impacted by store liquidations of our competitors |
| We believe that our stores compete primarily on the basis of merchandise quality and selection, price, visual appeal of the merchandise and the store and convenience of location |
| There can be no assurance that we will continue to be able to compete successfully against existing or future competition |
| Our expansion into the markets served by our competitors and the entry of new competitors or expansion of existing competitors into our markets may have a material adverse effect on our market share and could result in a reduction in our prices in order for us to remain competitive |
| Our Business Is Highly Seasonal and Our Fourth Quarter Contributes a Disproportionate Amount of Our Net Sales, Net Income and Cash Flow, and Any Factors Negatively Impacting Us During Our Fourth Quarter Could Reduce Our Net Sales, Net Income and Cash Flow, Leaving Us with Excess Inventory and Making It More Difficult for Us to Finance Our Capital Requirements |
| We have experienced, and expect to continue to experience, substantial seasonal fluctuations in our net sales and operating results, which are typical of many specialty retailers and common to most retailers generally |
| Due to the importance of the fall selling season, which includes Thanksgiving and Christmas, the last quarter of our fiscal year has historically contributed, and is expected to continue to contribute, a disproportionate amount of our net sales, net income and cash flow for the entire fiscal year |
| We expect 16 _________________________________________________________________ [76]Table of Contents this pattern to continue during the current fiscal year and anticipate that in subsequent fiscal years, the last quarter of our fiscal year will continue to contribute disproportionately to our operating results and cash flow |
| Any factors negatively affecting us during the last quarter of our fiscal year, including unfavorable economic or weather conditions, could have a material adverse effect on our financial condition and results of operations, reducing our cash flow, leaving us with excess inventory and making it more difficult for us to finance our capital requirements |
| Our quarterly results of operations may also fluctuate significantly based upon such factors as the timing of new store openings, pre-opening expenses associated with new stores, the relative proportion of new stores to mature stores, net sales contributed by new stores, increases or decreases in comparable store net sales, adverse weather conditions, shifts in the timing of holidays, the timing and level of markdowns, changes in fuel and other shipping costs, changes in our product mix and actions taken by our competitors |
| The Agreement Governing Our Debt Places Certain Reporting and Consent Requirements on Us Which May Affect Our Ability to Operate Our Business in Accordance with Our Business and Growth Strategy |
| Our senior credit facility contains a number of covenants requiring us to report to our lender or to obtain our lender’s consent in connection with certain activities we may wish to pursue in the operation of our business |
| These requirements may affect our ability to operate our business and consummate our business and growth strategy and may limit our ability to take advantage of potential business opportunities as they arise |
| These requirements affect our ability to, among other things: • incur additional indebtedness; • create liens; • pay dividends or make other distributions; • make investments; • sell assets; • enter into transactions with affiliates; • repurchase capital stock; and • enter into certain mergers and consolidations |
| The senior credit facility has one financial covenant |
| This covenant requires us to maintain “excess availability,” as defined in our credit agreement, of at least dlra3 million |
| Any failure to comply with this or other covenants would allow the lenders to accelerate repayment of their debt, prohibit further borrowing under the facility, declare an event of default, take possession of their collateral or take other actions available to a secured senior creditor |
| If compliance with our debt obligations materially hinders our ability to operate our business and adapt to changing industry conditions, we may lose market share, our revenue may decline and our operating results may suffer |
| This could have a material adverse effect on the market value and marketability of our common stock |
| Numerous factors affect our comparable store net sales results, including among others, weather conditions, retail trends, the retail sales environment, economic conditions, the impact of competition and our ability to execute our business strategy efficiently |
| Our comparable store net sales results have experienced fluctuations in the past |
| In addition, we anticipate that opening new stores in existing markets may result in decreases in comparable store net sales for existing stores in such markets |
| Past comparable 17 _________________________________________________________________ [77]Table of Contents store net sales results may not be indicative of future results |
| Our comparable store net sales may not increase from quarter to quarter and may decline |
| As a result, the unpredictability of our comparable store net sales may cause our revenues and operating results to vary quarter to quarter, and an unanticipated decline in revenues or comparable store net sales may cause the price of our common stock to fluctuate significantly |
| We Are Highly Dependent on Customer Traffic in Malls, and Any Reduction in the Overall Level of Mall Traffic Could Reduce Our Net Sales and Increase Our Sales and Marketing Expenses |
| As of January 28, 2006, approximately 60prca of our existing stores were located in enclosed malls |
| As a result, we rely heavily on the ability of mall anchor tenants and other tenants to generate customer traffic in the vicinity of our stores |
| Historically, we have not relied on extensive media advertising and promotion in order to attract customers to our stores |
| Our future operating results will also depend on many other factors that are beyond our control, including the overall level of mall traffic and general economic conditions affecting consumer confidence and spending |
| Any significant reduction in the overall level of mall traffic could reduce our net sales |
| We rely upon our existing information systems for operating and monitoring all major aspects of our business, including sales, warehousing, distribution, purchasing, inventory control, merchandise planning and replenishment, as well as various financial functions |
| These systems and our operations are vulnerable to damage or interruption from: • fire, flood and other natural disasters; • power loss, computer systems failures, internet and telecommunications or data network failure, operator negligence, improper operation by or supervision of employees, physical and electronic loss of data or security breaches, misappropriation and similar events; and • computer viruses |
| Any disruption in the operation of our information systems, the loss of employees knowledgeable about such systems or our failure to continue to effectively modify such systems could interrupt our operations or interfere with our ability to monitor inventory, which could result in reduced net sales and affect our operations and financial performance |
| We also need to ensure that our systems are consistently adequate to handle our anticipated store growth and are upgraded as necessary to meet our needs |
| The cost of any such system upgrades or enhancements would be significant |
| 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 |
| We have benefited substantially from the leadership and performance of our senior management team |
| Our success will depend on our ability to retain our current senior management members and to attract and retain qualified personnel in the future |
| Competition for senior management personnel is intense and there can be no assurances that we will be able to retain our personnel |
| The loss of a member of senior management would require the remaining executive officers to divert immediate and substantial attention to seeking a replacement |
| 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 |
| Our charter authorizes the issuance of “blank check” preferred stock with such designations, rights and preferences as may be determined from time to time by our Board of Directors |
| Accordingly, the Board of Directors is empowered, without shareholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights that could materially adversely affect the voting power or other rights of the holders of our common stock |
| Holders of the common stock do not have preemptive 18 _________________________________________________________________ [78]Table of Contents rights to subscribe for a pro rata portion of any capital stock which may be issued by us |
| In the event of issuance, such preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of Kirkland’s |
| Although we have no present intention to issue any new shares of preferred stock, we may do so in the future |
| Our charter and bylaws contain certain corporate governance provisions that may make it more difficult to challenge management, may deter and inhibit unsolicited changes in control of Kirkland’s and may have the effect of depriving our shareholders of an opportunity to receive a premium over the prevailing market price of our common stock in the event of an attempted hostile takeover |
| First, the charter provides for a classified Board of Directors, with directors (after the expiration of the terms of the initial classified board of directors) serving three year terms from the year of their respective elections and being subject to removal only for cause and upon the vote of 80prca of the voting power of all outstanding capital stock entitled to vote (the “Voting Power”) |
| Second, our charter and bylaws do not generally permit shareholders to call, or require that the Board of Directors call, a special meeting of shareholders |
| The charter and bylaws also limit the business permitted to be conducted at any such special meeting |
| In addition, Tennessee law permits action to be taken by the shareholders by written consent only if the action is consented to by holders of the number of shares required to authorize shareholder action and if all shareholders entitled to vote are parties to the written consent |
| Third, the bylaws establish an advance notice procedure for shareholders to nominate candidates for election as directors or to bring other business before meetings of the shareholders |
| Only those shareholder nominees who are nominated in accordance with this procedure are eligible for election as directors of Kirkland’s, and only such shareholder proposals may be considered at a meeting of shareholders as have been presented to Kirkland’s in accordance with the procedure |
| Finally, the charter provides that the amendment or repeal of any of the foregoing provisions of the charter mentioned previously in this paragraph requires the affirmative vote of at least 80prca of the Voting Power |
| In addition, the bylaws provide that the amendment or repeal by shareholders of any bylaws made by our Board of Directors requires the affirmative vote of at least 80prca of the Voting Power |
| Furthermore, Kirkland’s is subject to certain provisions of Tennessee law, including certain Tennessee corporate takeover acts that are, or may be, applicable to us |
| These acts include the Investor Protection Act, the Business Combination Act and the Tennessee Greenmail Act, and these acts seek to limit the parameters in which certain business combinations and share exchanges occur |
| The charter, bylaws and Tennessee law provisions may have an anti-takeover effect, including possibly discouraging takeover attempts that might result in a premium over the market price for our common stock |
| The Market Price for Our Common Stock Might Be Volatile and Could Result in a Decline in the Value of Your Investment |
| The price at which our common stock trades may be volatile |
| The market price of our common stock could be subject to significant fluctuations in response to our operating results, general trends and prospects for the retail industry, announcements by our competitors, analyst recommendations, our ability to meet or exceed analysts’ or investors’ expectations, the condition of the financial markets and other factors |
| In addition, the stock market in recent years has experienced extreme price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of companies |
| These fluctuations, as well as general economic and market conditions, may adversely affect the market price of our common stock notwithstanding our actual operating performance |
| Concentration of Ownership among Our Existing Directors, Executive Officers, and Their Affiliates May Prevent New Investors from Influencing Significant Corporate Decisions |
| As of the date of this filing, our current directors, executive officers and their affiliates, in the aggregate, beneficially own approximately 45prca of our outstanding common stock |
| As a result, these shareholders are able to exercise a controlling influence over matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions, and will have 19 _________________________________________________________________ [79]Table of Contents significant control over our management and policies |
| These shareholders may support proposals and actions with which you may disagree or which are not in your interests |