KIRKLANDS INC (Form: 10-K, Received: 04/14/2005 17:15:25)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K


(Mark One)
þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

		For the fiscal year ended January 29, 2005

or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND 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)		(I.R.S. Employer Identification No.)

805 North Parkway, Jackson, Tennessee (Address of principal executive offices)		38305 (Zip Code)

Registrant’s telephone number, including area code:

(731) 668-2444

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


(Title of each class)		(Name of Each Exchange on Which Registered)

None		None

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

Common Stock, no par value per share

(Title of class)

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 þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ No o

The aggregate market value of the common stock held by non-affiliates of the registrant as of July 31, 2004, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $96,178,198 based on the last sale price of the common stock as reported by The Nasdaq Stock Market. This calculation excludes 10,144,825 shares held by directors, executive officers and one holder of more than 10% of the registrant’s common stock.

As of April 8, 2005, there were 19,295,938 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for the Annual Meeting of Shareholders of Kirkland’s, Inc. to be held June 6, 2005, are incorporated by reference into Part III of this Form 10-K.

TABLE OF CONTENTS

FORM 10-K


		Page

Forward-Looking Statements			2
PART I
Item 1.	Business		3
Item 2.	Properties		19
Item 3.	Legal Proceedings		20
Item 4.	Submission of Matters to a Vote of Security Holders		20
PART II
Item 5.	Market for Registrant’s Common Equity and Related Shareholder Matters		21
Item 6.	Selected Financial Data		21
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		23
Item 7A.	Quantitative and Qualitative Disclosure About Market Risk		36
Item 8.	Financial Statements and Supplementary Data		36
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		36
Item 9A.	Controls and Procedures		36
Item 9B.	Other Information		37
PART III
Item 10.	Directors and Executive Officers of the Registrant		38
Item 11.	Executive Compensation		38
Item 12.	Security Ownership of Certain Beneficial Owners and Management		38
Item 13.	Certain Relationships and Related Transactions		38
Item 14.	Principal Accounting Fees and Services		38
PART IV
Item 15.	Exhibits, Financial Statements, Schedules and Reports on Form 8-K		39
	Report of Independent Registered Public Accounting Firm		40
	Consolidated Balance Sheets as of January 29, 2005, and January 31, 2004		42
	Consolidated Statements of Operations for the 52 weeks ended January 29, 2005, January 31, 2004, and February 1, 2003		43
	Consolidated Statements of Changes in Shareholders’ Equity (Deficit) for the 52 weeks ended January 29, 2005, January 31, 2004, and February 1, 2003		44
	Consolidated Statements of Cash Flows for the 52 weeks ended January 29, 2005, January 31, 2004, and February 1, 2003		45
	Notes to Consolidated Financial Statements		46
	Exhibits		60
Signatures			62
Index of Exhibits Filed with this Annual Report on Form 10-K

FORWARD-LOOKING STATEMENTS

This Form 10-K contains forward-looking statements within the meaning of the federal securities laws and the Private Securities Litigation Reform Act of 1995. These statements may be found throughout this Form 10-K, particularly under the headings “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” among others. Forward-looking statements typically are identified by the use of terms such as “may,” “will,” “should,” “expect,” “anticipate,” “believe,” “estimate,” “intend” and similar words, although some forward-looking statements are expressed differently. You should consider statements that contain these words carefully because they describe our expectations, plans, strategies and goals and our beliefs concerning future business conditions, our results of operations, financial position and our business outlook or state other “forward-looking” information based on currently available information. The factors listed below under the heading “Risk Factors” and in the other sections of this Form 10-K 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.

The forward-looking statements made in this Form 10-K relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

The terms “Kirkland’s,” “we,” “us,” and “our” as used in this Form 10-K refer to Kirkland’s, Inc.

PART I


Item 1.	*Business*

General

We are a leading specialty retailer of home decor in the United States, operating 320 stores in 37 states as of January 29, 2005. Our stores present a broad selection of distinctive merchandise, including framed art, mirrors, candles, lamps, accent furniture, accent rugs, garden accessories and artificial floral products. Our stores also offer an extensive assortment of holiday merchandise as well as items carried throughout the year suitable for giving as gifts. In addition, we use innovative design and packaging to market home decor items as gifts. We provide our predominantly female customers an engaging shopping experience characterized by a diverse, ever-changing merchandise selection at surprisingly attractive prices. Our stores offer a unique combination of style and value that has led to our emergence as a leader in home decor and has enabled us to develop a strong customer franchise. As a result, we have achieved substantial growth and have expanded our store base into different regions of the country.

During the past seven fiscal years, we have more than doubled our store base, principally through new store openings. We intend to continue opening new stores both in existing markets and in new markets, including major metropolitan markets, middle markets and selected smaller communities. Although we anticipate that our growth will include both mall and non-mall locations, we expect that substantially all of the new stores opened in fiscal 2005 will be located in non-mall venues. During the 52 weeks ended January 29, 2005 (“fiscal 2004”), we opened 54 new stores and closed 14 stores. We believe there are currently more than 650 additional locations in the United States that could support a Kirkland’s store.

Business Strategy

Our goal is to be the leading specialty retailer of home decor in each of our markets. We believe the following elements of our business strategy differentiate us from our competitors and position us for profitable growth:

Item-focused merchandising. While our stores contain items covering a broad range of complementary product categories, we emphasize key items within our targeted categories rather than merchandising complete product classifications. Although we do not attempt to be a fashion leader, our experienced buyers work closely with our vendors to identify and develop stylish merchandise reflecting the latest trends. We take a disciplined approach to test-marketing products and monitoring individual item sales, which enables us to identify and quickly reorder appropriate items in order to maximize sales of popular products. We also evaluate market trends and merchandise sales data to help us develop additional products to be made by our vendors and marketed in our stores, frequently on an exclusive basis. In most cases, this exclusive merchandise is the result of our buying team’s experience in interpreting market and merchandise trends in a way that appeals to our customer. We estimate that over 60% of our merchandise is designed or packaged exclusively for Kirkland’s, which distinguishes us in the marketplace and enhances our margins.

Ever-changing merchandise mix. We believe our ever-changing merchandise mix creates an exciting “treasure hunt” environment, encouraging strong customer loyalty and frequent return visits to our stores. The merchandise in our stores is typically traditionally styled for broad market appeal, yet it reflects an understanding of our customer’s desire for newness and freshness. Our information systems permit close tracking of individual item sales, enabling us to react quickly to both fast-selling and slow-moving items. Accordingly, we actively change our merchandise throughout the year in response to market trends, sales results and changes in seasons. We also strategically increase selling space devoted to gifts and seasonal merchandise in advance of holidays.

Stimulating visual presentation. Our stores have a distinctive, “interior design” look that helps customers visualize the merchandise in their own homes and inspires decorating and gift-giving ideas. Using multiple merchandise arrangements to simulate home settings, we group complementary

merchandise creatively throughout the store, rather than displaying products strictly by category or product type. We believe this cross-category merchandising strategy encourages customers to browse for longer periods of time, promoting add-on sales.

Strong value proposition. Our customers regularly experience the satisfaction of paying noticeably less for items similar or identical to those sold by other retail stores or through catalogs. This strategy of providing a unique combination of style and value is an important element in making Kirkland’s a destination store. While we carry items in our stores that sell for several hundred dollars, most items sell for under $50 and are perceived by our customers as affordable luxuries. Our longstanding relationships with vendors and our ability to place large orders of a single item enhance our ability to attain favorable product pricing from vendors.

Broad market appeal. Our stores operate successfully across a wide spectrum of different regions, market sizes and real estate venues. We operate our stores in 37 states, and although originally focused in the Southeast, approximately 50% of our stores are now located outside that region. We operate successfully in major metropolitan markets such as Houston, Texas, and Atlanta, Georgia, middle markets such as Birmingham, Alabama, and Buffalo, New York, and smaller markets such as Appleton, Wisconsin, and Panama City, Florida. In addition, although our stores are predominantly located in enclosed malls, we also operate successfully in non-mall venues, including selected “lifestyle” and “power” strip centers. The flexibility of our concept enables us to select the most promising real estate opportunities that meet requisite economic and demographic criteria within our target markets. Our current plan is to emphasize non-mall locations, and a majority of the new stores opened in fiscal 2004 have been located in non-mall venues.

Growth Strategy

Our growth strategy is to continue to build on our position as a leading specialty retailer of home decor in the United States by:

Opening new stores. Over the past seven years, we have more than doubled our store base, principally through new store openings. We intend to continue opening new stores both in existing and new markets. We anticipate that we will open most of our new stores in non-mall locations in major metropolitan markets, middle markets and in selected smaller communities. We believe there are currently more than 650 additional locations in the United States that could support a Kirkland’s store. Assuming the continued availability of adequate capital, we expect a net increase of approximately 30 stores during the 52 weeks ending January 28, 2006 (“fiscal 2005”).

Our proven store model produces strong store-level cash flow and provides an attractive store-level return on investment. In fiscal 2004, our average store generated net sales of approximately $1.3 million. Our stores typically generate a positive store contribution in their first full year of operation. Since fiscal 2003, when we began to focus our growth on non-mall opportunities, we have experienced better sales and store contribution from our non-mall stores as compared to mall stores.

We use store contribution, which consists of store gross profit minus store operating expenses, as our primary measure of operating profitability for a single store or group of stores. Store contribution specifically excludes the allocation of corporate overhead and distribution costs, and therefore should not be considered comparable to operating income or other GAAP profit measures that are appropriate for assessing overall corporate financial performance. Store contribution also excludes depreciation and amortization charges. We track these non-cash charges for each store and for Kirkland’s as a whole. However, we exclude these charges from store contribution in order to more closely measure the cash flow produced by each store in relation to the cash invested in that store in the form of capital assets and inventory.

Increasing store productivity. We plan to increase our sales per square foot and store profitability by leveraging recent investments in information systems and central distribution. We believe that the sales productivity of our stores will benefit from our strong existing customer franchise and our continuing

efforts to enhance the Kirkland’s brand. Our distinctive and often proprietary merchandise offering, together with carefully coordinated in-store marketing, visual presentation and product packaging, enable us to establish a distinct brand identity and to solidify our bond with customers, further enhancing our store-level productivity.

Merchandising

Merchandising strategy. Our merchandising strategy is to (i) offer distinctive and often exclusive, high quality home decor at affordable prices, (ii) maintain a breadth of product categories, (iii) provide a carefully edited selection of key items within targeted categories, rather than merchandising complete product classifications, (iv) emphasize new and fresh merchandise by continually updating our merchandise mix and (v) present merchandise in a visually appealing manner to create an inviting atmosphere which inspires decorating and gift-giving ideas.

Our information systems permit close tracking of individual item sales, which enables us to react quickly to market trends and best sellers. As a result, we minimize the accumulation of slow-moving inventory and resulting markdowns. Regional differences in home decor are addressed by tailoring inventories to geographic considerations and store sales results.

We continuously introduce new and often exclusive products to our merchandise assortment in order to (i) maintain customer interest due to the freshness of our product selections, encouraging frequent return visits to our stores, (ii) enhance our reputation as a leader in identifying or developing high quality, fashionable products and (iii) allow merchandise which has peaked in sales to be quickly discontinued and replaced by new items. In addition, we strategically increase selling space devoted to gifts and holiday merchandise during the third and fourth quarters of the calendar year. Our flexible store design and layout allow for selling space changes as needed to capitalize on selling trends.

Our average store generally carries approximately 2,500-3,000 SKUs. We regularly monitor the sell-through on each item, and the number and make-up of our active SKUs is likewise constantly changing based on changes in selling trends. New and different SKUs are introduced to our stores on a weekly or more frequent basis, and a substantial portion of the inventory carried in our stores is replaced with new SKUs every few months. Over the past several quarters, we have undertaken efforts to reduce the number of SKU’s offered in our stores. At January 29, 2005, our average SKU count per store had declined 15% compared to January 31, 2004. Our strategy is to enhance sales and gross margin performance by presenting a more focused assortment.

We purchase merchandise from approximately 200 vendors, and our buying team works closely with many of these vendors to differentiate Kirkland’s merchandise from that of our competitors. We estimate that over 60% of our merchandise assortment is designed or packaged exclusively for Kirkland’s, generally based on our buyers’ experience in modifying certain merchandise characteristics or interpreting market trends into a product and price point that will appeal to our customer. For products that are not manufactured specifically for Kirkland’s, we may create custom packaging as a way to differentiate our merchandise offering and reinforce our brand names. Exclusive or proprietary products distinguish us from our competition, enhance the value of our merchandise and improve our net sales and gross margin. We market a substantial portion of our exclusive or custom-packaged merchandise assortment under the Kirkland’s private label brand and other proprietary names. Our strategy is to continue to grow our exclusive and proprietary products and custom-packaged products within our merchandise mix.

Product assortment. Our major merchandise categories include wall decor (framed art, mirrors, and other wall ornaments), lamps, decorative accessories, candles and various holders, textiles, garden accessories and floral products. Our stores also offer an extensive assortment of holiday merchandise, as well as items carried throughout the year suitable for giving as gifts. Consistent with our item-focused strategy, a vital part of the product mix is a variety of home decor and other assorted merchandise that does not necessarily fit into a specific product category. Decorative accessories consist of such varied products as sconces, vases and clocks. Other merchandise includes accent furniture, housewares and picture frames. Throughout the year and especially in the fourth quarter of the calendar year, our buying

team uses its experience in home decor to develop products that are as appropriate for gift-giving as they are for personal purchase. Innovative product design and packaging are important elements of this effort.

The following table presents the percentage of fiscal 2004 and fiscal 2003 net sales contributed by our major merchandise categories:


	% of Net Sales

Merchandise Category	Fiscal 2004			Fiscal 2003

Wall Décor (including framed art, mirrors, and other wall ornaments)		27	%		28	%
Lamps		11			10
Decorative Accessories		9			11
Holiday		9			8
Gifts		9			5
Garden		8			8
Candles		8			8
Textiles		7			6
Accent Furniture		4			4
Floral		3			4
Other (including housewares, picture frames and other miscellaneous items)		5			8

Total		100	%		100	%

Value to customer. Through our distinctive merchandising, together with carefully coordinated in-store marketing, visual presentation and product packaging, we continually strive to increase the perceived value of our products to our customers. Our shoppers regularly experience the satisfaction of paying noticeably less for items similar or identical to those sold by other retail stores or through catalogs. Our stores typically have two semi-annual clearance events, one in January and one in July. We also run category promotions periodically throughout the year. We believe our value-oriented pricing strategy, coupled with an adherence to high quality standards, is an important element in establishing our distinct brand identity and solidifying our connection with our customers.

Store Operations

General. As of January 29, 2005, we operated 320 stores in 37 states, all but one of which are open seven days a week. In addition to corporate management, six Regional Managers and 33 District Managers (who generally have responsibility for eight to 10 stores within a geographic district) manage store operations. A Store Manager and one or two Assistant Store Managers manage individual stores. The Store Manager is responsible for the day-to-day operation of the store, including sales, customer service, merchandise display and control, human resource functions and store security. A typical store operates with an average of eight to ten associates including a full-time stock person and a combination of full and part-time sales associates, depending on the volume of the store and the season. Additional part-time sales associates are typically hired to assist with increased traffic and sales volume in the fourth quarter of the calendar year.

Format. The average Kirkland’s store has approximately 4,700 square feet of which approximately 70% typically represents selling space. As of January 29, 2005, the average size of our mall stores was 4,602 square feet, while our non-mall stores averaged 4,986 square feet. Non-mall stores tend to be larger than mall stores, primarily due to the lower occupancy cost per square foot that is typically available for these stores. Merchandise is generally displayed according to display guidelines and directives given to each store from the Visual Merchandising team with input from Merchandising and Store Operations personnel. This procedure ensures uniform display standards throughout the chain. Using multiple types of fixtures, we group complementary merchandise creatively throughout the store, rather than displaying products strictly by category or product type.

During fiscal 2004, we opened 54 new stores and closed 14 stores. Of the 54 new stores, 44 are located in non-mall venues and 10 are located in enclosed malls. All of the 14 closings in fiscal 2004 were mall stores. As of January 29, 2005, we operated 79 of our 320 stores in a variety of non-mall venues including “lifestyle” strip centers, “power” centers and outlet centers. We currently anticipate that substantially all of the new stores opened in fiscal 2005 will be located in non-mall venues.

Visual merchandising. Because of the nature of our merchandise and our focus on identifying and developing best-selling items, we believe adherence to our visual merchandising standards is an important responsibility of our store and field supervisory management. We emphasize visual merchandising in our training efforts, and our dedicated team of visual merchants provides valuable leadership and support to this aspect of Store Operations. The Visual Merchandising team provides Store Managers with recommended display directives such as photographs and drawings, weekly placement guides and display manuals. In addition, each Store Manager has some flexibility to creatively highlight those products that are expected to have the greatest appeal to local shoppers. The Visual Merchandising team also assists Regional Managers and District Managers in opening new stores. We believe effective and consistent visual merchandising enhances a store’s ability to reach its full sales potential.

Personnel recruitment and training. We believe our continued success is dependent in part on our ability to attract, retain and motivate quality employees. In particular, the success of our expansion program depends on our ability to promote and/or recruit qualified District and Store Managers and maintain quality sales associates. To date, the majority of our District Managers previously have been Kirkland’s Store Managers. An intensive nine-week training program is provided for new District Managers. Store Managers and Assistant Managers, many of whom begin their Kirkland’s career as sales associates, currently complete a formal training program before taking responsibility for a store. This training program includes five to 10 days in a designated “training store,” working directly with a qualified Training Store Manager. District Managers are primarily responsible for recruiting new Store Managers. Store Managers are responsible for the hiring and training of new sales associates, assisted where appropriate by a full-time recruiter. We constantly look for motivated and talented people to promote from within Kirkland’s, in addition to recruiting from outside Kirkland’s.

Compensation and incentives. We compensate our Regional, District and Store Managers with a base salary plus a quarterly performance bonus based on store sales and store-level profit contribution. Sales associates are compensated on an hourly basis. In addition, we regularly run a variety of contests that reward associates for outstanding sales achievement.

Real Estate

Strategy. Our real estate strategy is to identify retail properties that are convenient and attractive to our target female customer. The flexibility and broad appeal of our stores and our merchandise allow us to operate successfully in major metropolitan markets such as Houston, Texas, and Atlanta, Georgia, middle markets such as Birmingham, Alabama, and Buffalo, New York, and smaller markets such as Appleton, Wisconsin, and Panama City, Florida.

Site selection. We locate our stores in enclosed malls or non-mall venues which are destinations for large numbers of shoppers and which reinforce our quality image and brand. To assess potential new locations, we review financial and demographic criteria and analyze the quality of tenants and competitive factors, square footage availability, frontage space and other relevant criteria to determine the overall acceptability of a property and the optimal locations within it.

Until recent years, we preferred to locate stores in regional or super-regional malls with a history of high sales per square foot and multiple national department stores as anchors. Beginning in fiscal 2003, we began to explore more non-mall real estate alternatives. During fiscal 2004, we intensified our emphasis on non-mall locations as we opened 54 new stores and closed 14 stores. Of the 54 new stores, 44 are located in non-mall venues and 10 are located in enclosed malls. All of the 14 closings in fiscal 2004 were mall stores. Of our 320 stores as of January 29, 2005, 79 were in a variety of non-mall venues including “lifestyle” strip centers, “power” centers and outlet centers. Non-mall stores tend to be slightly larger than

mall stores, primarily due to the lower occupancy cost per square foot that is typically available for these stores. We currently anticipate that substantially all of the new stores opened in fiscal 2005 will be located in non-mall venues.

We believe we are a desirable tenant to developers because of our long and successful operating history, sales productivity, ability to attract customers and our strong position in the home decor category. The following table provides a history of our store openings and closings since the beginning of our fiscal year ended December 31, 2000 (“fiscal 2000”).


	Fiscal			Fiscal			Fiscal			Fiscal			Fiscal
	2004			2003			2002			2001(1)			2000

Stores open at beginning of period		280			249			234			240			226
New stores opened(2)		54			42			16			5			17
Stores closed		(14	)		(11	)		(1	)		(11	)		(3	)

Stores open at end of period		320			280			249			234			240


(1)	Also includes the period beginning on January 1, 2001 and ending on February 3, 2001.

(2)	Excludes our warehouse outlet store located in Jackson, Tennessee.

Purchasing and Inventory Management

Merchandise sourcing and product development. Our merchandise team purchases inventory on a centralized basis to take advantage of our technology and our consolidated buying power and to closely control the merchandise mix in our stores. Our buying team selects all of our products, negotiates with all of our vendors and works closely with our planning and allocation team to optimize store-level merchandise mix by category, classification and item. We believe the level of experience of our buying team gives us a competitive advantage in understanding our customer and identifying or developing merchandise suitable to her tastes and budget. We estimate that over 60% of our merchandise assortment is designed or packaged exclusively for Kirkland’s, generally based on our buyers’ experience in modifying certain merchandise characteristics or interpreting market trends into a product and price point that will appeal to our customer. The amount of exclusively designed or packaged merchandise continues to grow annually. Non-exclusive merchandise is often boxed or packaged exclusively for Kirkland’s utilizing Kirkland’s proprietary brands.

We purchase merchandise from approximately 200 vendors. Approximately 75% of our total purchases are from importers of merchandise manufactured primarily in the Far East and India, with the balance purchased from domestic manufacturers and wholesalers. For our purchases of merchandise manufactured abroad, we have historically bought from importers or U.S.-based representatives of foreign manufacturers rather than dealing directly with foreign manufacturers. This process has enabled us to maximize flexibility and minimize product liability and credit risks. This allows our executive management and buyers to focus on managing the retail business and allows the importers to handle the procurement and shipment of foreign-manufactured merchandise for our stores. As we execute our growth strategy, we are continually evaluating the best ways to source and differentiate our merchandise while attaining our sales and gross margin objectives. For certain categories and items, the strategic use of domestic manufacturers and wholesalers enables us to reduce the lead times between ordering products and offering them in our stores.

Planning and allocation. Our merchandise planning and allocation team works closely with our buying team, field management and store personnel to meet the requirements of individual stores for appropriate merchandise in sufficient quantities. This team also manages inventory levels, allocates merchandise to stores and replenishes inventory based upon information generated by our information systems. Our inventory control systems monitor current inventory levels at each store and our operations as a whole. If necessary, we can shift slow-moving inventory to other stores for sell-through prior to instituting corporate-wide markdowns. We also continually monitor recent selling history within each store

by category, classification and item to properly allocate further purchases to maximize sales and gross margin.

Each of our stores is internally classified for merchandising purposes based on certain criteria including store sales, size, location and historical performance. Although all of our stores carry similar merchandise, the variety and depth of products in a given store may vary depending on the store’s rank and classification. Inventory purchases and allocation are also tailored based on regional or demographic differences between stores.

In April 2001, we installed a state-of-the-art merchandise management system, improving the efficiency of our planning and allocation process. This system provides our buyers and planners with daily information on sales, gross margin and inventory by category, classification and item. This information is available for each store, permitting our planners to assess merchandise trends and manage inventory levels and flow at the individual store level.

Distribution and Logistics

Prior to the 12 months ended December 31, 2000 (“fiscal 2000”), we distributed our products primarily through direct shipments from our vendors to each of our individual stores. Inventory backstock was held both in the store’s stockroom and in local storage facilities managed by each Store Manager. We maintained a modest central distribution capability in Jackson, Tennessee through a collection of low-cost warehouses to process certain merchandise shipments and to hold inventory for new store openings. As our store base grew, this legacy distribution system became cumbersome and inefficient, and we recognized the need to develop a more scalable central distribution strategy to permit greater inventory control and to control freight costs. Between fiscal 2000 and fiscal 2003, we expanded our central distribution operations in order to support store growth and to begin capturing the financial benefits of centralized distribution and freight management.

During this period, we recognized the need for a more comprehensive approach to the management of our merchandise supply chain. This approach entails the thorough evaluation of all parts of the supply chain, from merchandise vendor to the store selling floor, and the development of strategies that incorporate the needs and expertise of many different parts of the Company including logistics, merchandising, store operations, information technology and finance. To support our effort to build a modern, efficient supply chain, during fiscal 2003 we reached an agreement to lease a new, 771,000-square-foot distribution center in Jackson, Tennessee. This building was built to our specifications and opened in June 2004.

The commencement of operations in the new distribution center was accompanied by the implementation of a new warehouse management system as well as investments in material handling equipment designed to streamline the flow of goods within the distribution center. In fiscal 2005 and beyond, our goal is to achieve better labor productivity, better transportation efficiency, leaner store-level inventories and reduced store-level storage costs.

In addition to making improvements to our distribution center operation, we have taken important steps to improve our efficiency in transporting merchandise to stores. We currently utilize third-party carriers to transport merchandise from our Jackson distribution center to our stores. Until fiscal 2004, the majority of our merchandise deliveries had been handled by less-than-truckload (LTL) carriers, which had provided a cost-effective means of distribution for stores in reasonable proximity to our central distribution facilities. In an attempt to improve store service levels and cost efficiencies, during fiscal 2004 we expanded our use of full truckload deliveries to regional “pool points”, with local delivery agents handling the actual store delivery function. As of January 29, 2005, a majority of our stores received their shipments using this “pool” transportation method. For certain stores located farther from our distribution center, we have now introduced a third alternative whereby we use less frequent, full truckload deliveries. The optimal delivery method for a given store depends on the store’s sales volume, square footage, geographic location and other factors.

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.

E-Commerce

We believe the Internet offers opportunities to complement our “brick-and-mortar” stores, increase sales and increase consumer brand awareness of our products. We maintain a web site at www.kirklands.com, which provides our customers with a resource to locate a store, preview our merchandise and purchase a limited array of products online. We currently sell a modest amount of merchandise through our web site and maintain a small customer service department to handle e-mail and phone inquiries from our store and e-commerce customers. The information contained or incorporated in our web site is not a part of this annual report on Form 10-K.

Information Systems

We have invested significant resources developing an information systems infrastructure to support our business. Since fiscal 1999 we have completed projects including the installation of new point-of-sale (POS) software in all stores and integrated retail management software at our home office, an upgrade of the POS hardware in all of our stores, and the implementation of additional POS applications such as debit and gift card processing.

Our store information systems include a server in each store that runs our automated POS application on multiple POS registers. The server provides managers with convenient access to detailed sales and inventory information for the store. Our POS registers provide price look-up (all merchandise is bar-coded), time and attendance and automated check, credit card, debit card and gift card processing. Through automated nightly two-way electronic communication with each store, we upload SKU-level sales, gross margin information and payroll hours to our home office system and download new merchandise pricing, price changes for existing merchandise, purchase orders and system maintenance tasks to the store server. Based upon the evaluation of information obtained through daily polling, our planning and allocation team implements merchandising decisions regarding inventory levels, reorders, price changes and allocation of merchandise to our stores.

The core of our home office information system is the integrated GERS retail management software installed in April 2001. This system integrates all merchandising and financial applications, including category, classification and SKU inventory tracking, purchase order management, automated ticket making, general ledger, sales audit and accounts payable. We moved into a new distribution center during the second quarter of 2004. Concurrent with this move, we implemented a new warehouse management system (WMS) designed by HighJump Software, a 3M Company. The WMS was tailored to our specifications and provides us with a fully automated solution for all operations within the distribution center. We utilize a Lawson Software package for our payroll and human resources functions.

Marketing

Our marketing efforts emphasize in-store signage, store and window banners and displays and other techniques to attract customers and provide an exciting shopping experience. Historically, we have not engaged in extensive media advertising because we believe that we have benefited from our strategic locations in high-traffic shopping centers and valuable “word-of-mouth” advertising by our customers. We supplement our in-store marketing efforts with periodic local newspaper advertisements to promote specific events in our stores, including our semi-annual clearance events. We are actively evaluating ways to enhance our marketing to customers through direct mail and e-mail communications.

As part of our effort to reach out to customers, we offer our Kirkland’s private-label credit card. We introduced the card during the third quarter of fiscal 2004. This program is administered by a third-party,

who bears the credit risk associated with the card program without recourse to us. Cardholders are automatically enrolled in a loyalty program whereby they earn loyalty points by making purchases in our stores. Customers attaining specified levels of loyalty points are eligible for special discounts on future purchases in our stores. We believe that customers using the card visit our stores and purchase merchandise more frequently and spend more per visit than our customers not using the card. As of January 29, 2005, there were approximately 85,000 Kirkland’s private-label credit card holders.

Trademarks

All of our stores operate under the name “Kirkland’s” other than 18 stores, which operate under the name “Briar Patch by Kirkland’s.” We acquired these stores in 1998. As these stores are remodeled or relocated, we intend to change the name of these stores to the “Kirkland’s” name.

We have registered several trademarks with the United States Patent and Trademark Office on the Principal Register that are used in connection with the Kirkland’s stores, including KIRKLAND’S® logo design, THE KIRKLAND COLLECTION®, HOME COLLECTION BY KIRKLAND’S®, KIRKLAND’S OUTLET®, KIRKLAND’S HOME®, as well as several trademark registrations for Kirkland’s private label brand, the CEDAR CREEK COLLECTION®. In addition to the registrations, Kirkland’s also is the common law owner of the trademark BRIAR PATCH ^tm. These marks have historically been very important components in our merchandising and marketing strategy. We are not aware of any claims of infringement or other challenges to our right to use our marks in the United States.

Competition

The retail market for home decor is highly competitive. Accordingly, we compete with a variety of specialty stores, department stores, discount stores and catalog retailers that carry merchandise in one or more categories also carried by our stores. 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, Michael’s Stores, Pier 1 Imports and Williams-Sonoma. Department stores typically have higher prices than our stores for similar merchandise. Specialty retailers tend to have higher prices and a narrower assortment of products than our stores. Wholesale clubs may have lower prices than our stores, but the product assortment is generally considerably more limited. We believe that the principal competitive factors influencing our business are merchandise quality and selection, price, customer service, visual appeal of the merchandise and the store and the convenience of location.

The number of companies offering a selection of home decor products that overlaps generally with our product assortment has increased over the last five years. However, we believe that our stores still occupy a distinct niche in the marketplace: traditionally styled merchandise, reflective of current market trends typically offered at a discount to catalog and department store prices. We believe we compete effectively with other retailers due to our experience in identifying a broad collection of distinctive merchandise, pricing it to be attractive to the target Kirkland’s customer, presenting it in a visually appealing manner and providing quality customer service.

In addition to competing for customers, we compete with other retailers for suitable store locations and qualified management personnel. Many of our competitors are larger and have substantially greater financial, marketing and other resources than we do. See “Risk Factors — 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.”

Employees

We employed approximately 3,877 employees at April 2, 2005. The number of employees fluctuates with seasonal needs. None of our employees is covered by a collective bargaining agreement. We believe our employee relations are good.

Availability of SEC Reports

We file annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and other information with the SEC. Members of the public may read and copy materials that we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Members of the public may also obtain information on the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet web site that contains reports, proxy and information statements and other information regarding issuers, including Kirkland’s, that file electronically with the SEC. The address of that site is http://www.sec.gov. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and other information filed by us with the SEC are available, without charge, on our Internet web site, http://www.kirklands.com, as soon as reasonably practicable after they are filed electronically with the SEC. Copies are also available, without charge, by written request to: Secretary, Kirkland’s, Inc., 805 North Parkway, Jackson, TN 38305.

Executive Officers of Kirkland’s

The name, age as of April 14, 2005, and position of each of our executive officers are as follows:

Robert E. Alderson, 58, has been a Director of Kirkland’s since September 1986, President of Kirkland’s since November 1997, Chief Executive Officer of Kirkland’s since March 2001, and Chairman of the Board since December 2004. He served as Chief Operating Officer of Kirkland’s from November 1997 through March 2001 and as Senior Vice President of Kirkland’s since joining in 1986 through November 1997. He also served as Chief Administrative Officer of Kirkland’s from 1986 to 1997. Prior to joining Kirkland’s, he was a senior partner at the law firm of Menzies, Rainey, Kizer & Alderson.

Reynolds C. Faulkner, 41, has been a Director of Kirkland’s since September 1996 and joined Kirkland’s as Senior Vice President and Chief Financial Officer in February 1998. He was promoted to Executive Vice President in February 2002. Prior to joining Kirkland’s, from July 1989 to January 1998, Mr. Faulkner was an investment banker in the corporate finance department of The Robinson-Humphrey Company, LLC, most recently serving as a Managing Director and head of the retail practice group. In this capacity, Mr. Faulkner was involved in numerous public and private financings and mergers and acquisitions of companies in the retail industry.

Dwayne F. Cochran, 43, has been Executive Vice President and Director of Stores since November 2004. Prior to joining Kirkland’s, Mr. Cochran was East Zone Vice President for Pier 1 Imports from 1997 to 2004 and a regional manager for Pier 1 Imports from 1995 to 1997. Prior to that, Mr. Cochran held various supervisory positions at Brookstone for 5 years and Johnston and Murphy for 7 years.

No family relationships exist among any of the above-listed officers, and there are no arrangements or understandings between any of the above-listed officers and any other person pursuant to which they serve as an officer. All officers are elected to hold office for one year or until their successors are elected and qualified.

Risk Factors


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

One of our strategies is to open new stores by focusing on both existing markets and by targeting new geographic markets. During fiscal 2004, we opened 54 new stores, and our future operating results will depend to a substantial extent upon our ability to open and operate new stores successfully. We plan to open approximately 55-60 new stores and close approximately 30 stores in fiscal 2005. We also have an ongoing expansion, remodeling and relocation program. We expanded, remodeled or relocated seven stores in fiscal 2004 and may expand, remodel or relocate additional stores during fiscal 2005.

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 compared to stores operated in existing markets. Also, stores opened in non-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 managers, 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 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. There is also no assurance that consumers will continue to focus on their homes or on home-oriented products or that trends in favor of “cocooning” and new home purchases will continue.


	*Reduced Consumer Spending in the Southeastern Part of the United States Where Approximately Half of Our Stores Are Concentrated Could Reduce Our Net Sales.*

Approximately 50% 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.


	*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 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 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 200 vendors with which we have no long-term purchase commitments or exclusive contracts. None of our vendors supplied more than 10% of our merchandise purchases during fiscal 2004. Historically, we have retained our vendors and we have generally not experienced difficulty in obtaining desired merchandise from vendors on acceptable terms. 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 have from time to time experienced delays of this nature. 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. While we believe that buying from importers instead of directly from manufacturers reduces or eliminates the risks involved with relying on products manufactured abroad, our vendors are subject to those risks, 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 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.

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.


	*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.*

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 with a mall concentration 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 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.


	*We May Experience Significant Variations in Our Quarterly Results.*

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 $3 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.


	*Our Comparable Store Net Sales Fluctuate Due to a Variety of Factors and May Not Be a Meaningful Indicator of Future Performance.*

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 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 29, 2005, approximately 75% 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.


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

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 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 80% 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 80% 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 80% 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 42% 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 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.


Item 2.	*Properties*

We lease all of our store locations and expect to continue our policy of leasing rather than owning. Our leases for mall stores typically provide for 10-year terms, many with the ability for us (or the landlord) to terminate the lease at specified points during the term if net sales at the leased premises do not reach a certain annual level. Our leases for non-mall stores typically provide for terms ranging from 5 to 10 years. Many of our leases provide for payment of percentage rent (i.e., a percentage of net sales in excess of a specified level) and the rate of increase in key ancillary charges is generally capped.

As current leases expire, we believe we will be able either to obtain lease renewals if desired for present store locations or to obtain leases for equivalent or better locations in the same general area. To date, we have not experienced unusual difficulty in either renewing leases for existing locations or securing

leases for suitable locations for new stores. A majority of our store leases contain provisions permitting the landlord to terminate the lease upon a change in control of Kirkland’s.

We own our corporate headquarters in Jackson, Tennessee, which currently consists of approximately 40,000 square feet of office space. We currently lease one central distribution facility, consisting of 771,000 square feet, also located in Jackson, Tennessee. This lease has a 15-year initial term, with two five-year options.

The following table indicates the states where our stores are located and the number of stores within each state as of January 29, 2005:


Alabama		18
Arizona		5
Arkansas		6
California		2
Colorado		3
Connecticut		2
Delaware		1
Florida		42
Georgia		21
Illinois		8
Indiana		8
Iowa		4
Kansas		4
Kentucky		9
Louisiana		10
Maryland		5
Massachusetts		3
Michigan		6
Minnesota		1
Mississippi		9
Missouri		4
Nebraska		1
Nevada		3
New Jersey		3
New Mexico		1
New York		7
North Carolina		18
Ohio		11
Oklahoma		3
Pennsylvania		12
South Carolina		13
Tennessee		16
Texas		39
Utah		1
Virginia		15
West Virginia		3
Wisconsin		3


Item 3.	*Legal Proceedings*

We are involved in various routine legal proceedings incidental to the conduct of our business. We believe any resulting liability from existing legal proceedings, individually or in the aggregate, will not have a material adverse effect on our operations, cash flows or financial condition.


Item 4.	*Submission of Matters to a Vote of Security Holders*

We did not submit any matters to a vote of security holders in the fourth quarter of fiscal 2004.

PART II


Item 5.	*Market for Registrant’s Common Equity and Related Shareholder Matters*

Our common stock is listed on The Nasdaq Stock Market under the symbol “KIRK”. We commenced trading on The Nasdaq Stock Market on July 11, 2002. On April 8, 2005, there were approximately 84 holders of record, and 3,050 beneficial owners, of our common stock. The following table sets forth the high and low last sale prices of our common stock for the periods indicated.


	Fiscal 2004				Fiscal 2003

	High		Low		High		Low

First Quarter	$	18.05	$	13.88	$	15.40	$	10.45
Second Quarter	$	18.57	$	10.20	$	18.16	$	14.25
Third Quarter	$	10.50	$	7.55	$	22.01	$	14.96
Fourth Quarter	$	12.56	$	8.69	$	22.15	$	14.41

Dividend Policy

We intend to retain all future earnings to finance the continued growth and development of our business, and do not, therefore, anticipate paying any cash dividends on our common stock in the foreseeable future. In addition, our senior credit facility restricts the payment of cash dividends. No dividends have been paid on our common stock subsequent to 1995. Future cash dividends, if any, will be determined by our Board of Directors and will be based upon our earnings, capital requirements, financial condition, debt covenants and other factors deemed relevant by our Board of Directors.


Item 6.	*Selected Financial Data*

The selected “Statement of Operations Data” and “Balance Sheet Data” have been derived from our consolidated financial statements for the periods indicated. The “Store and Other Data” for all periods presented below have been derived from internal records of our operations. This selected financial data should be read in conjunction with our consolidated financial statements and related notes, and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K.

The selected financial data below have been revised to reflect a restatement of the financial statements with respect to certain lease-related accounting adjustments. Refer to Note 2 to the consolidated financial statements for additional information regarding the restatement.


		52 Weeks Ended									34 Days
											Ended			Year Ended
		January 29,		January 31,		February 1,		February 2,			February 3,			December 31,
		2005		2004		2003		2002(6)			2001(1)(6)			2000(6)

		(In thousands, except per share data)
				(restated)		(restated)		(restated)			(restated)			(restated)
Statement of Operations Data:
Net sales		$	394,429	$	369,158	$	341,504	$	307,213		$	23,875		$	259,240
Gross profit (excluding depreciation and amortization)			126,791		127,313		122,497		109,037			4,901			88,760
Operating income (loss)			11,481		30,169		32,722		27,753			(3,004	)		13,247
Income (loss) before accretion of redeemable preferred stock and dividends accrued			6,589		18,041		15,897		1,896			(2,646	)		(1,208	)
Net income (loss) allocable to common shareholders			6,589		18,041		10,271		(4,543	)		(3,424	)		(7,763	)
Earnings (loss) per common share:
	Basic	$	0.34	$	0.95	$	0.73	$	(0.60	)	$	(0.46	)	$	(1.28	)
	Diluted	$	0.34	$	0.92	$	0.70	$	(0.60	)	$	(0.46	)	$	(1.28	)
Weighted average number of common shares outstanding:
	Basic		19,231		19,048		13,979		7,521			7,519			6,053
	Diluted		19,541		19,545		14,657		7,521			7,519			6,053


	52 Weeks Ended
													Year Ended
	January 29,			January 31,			February 1,			February 2,			December 31,
	2005			2004			2003			2002			2000

Store and Other Data:
Comparable store sales increase (decrease)(2)		(5.2	)%		(0.2	)%		8.4	%		13.3	%		0.6	%
Number of stores at year end(3)		320			280			249			234			240
Average net sales per store (in thousands)(4)	$	1,322		$	1,423		$	1,417		$	1,307		$	1,112
Average net sales per square foot(4)(5)	$	286		$	311		$	313		$	289		$	248
Average gross square footage per store(5)		4,616			4,576			4,526			4,528			4,486


	January 29,		January 31,		February 1,		February 2,			December 31,
	2005		2004		2003(7)		2002(7)			2000(7)

	(In thousands)
			(restated)		(restated)		(restated)			(restated)
Balance Sheet Data:
Total assets	$	130,137	$	116,814	$	87,814	$	104,600		$	121,266
Total debt, including mandatorily redeemable preferred stock (Class C)		—		—		—		75,239			104,360
Common stock warrants		—		—		—		11,315			—
Redeemable convertible preferred stock (Class A, Class B and Class D)		—		—		—		85,294			81,909
Shareholders’ equity (deficit)		65,120		58,072		38,100		(113,167	)		(108,947	)


(1)	Effective January 1, 2001, we changed our fiscal reporting year from a calendar year to a 52/53-week retail calendar ending on the Saturday closest to January 31, resulting in a 34-day stub period as presented.

(2)	We include new stores in comparable store net sales calculations after the store has been in operation one full fiscal year. We exclude from comparable store net sales calculations each store that was expanded, remodeled or relocated during the applicable period. Each expanded, remodeled or relocated store is returned to the comparable store base after it has been excluded from the comparable store base for one full fiscal year. The comparable store net sales increase for fiscal 2001 reflects the increase in comparable store net sales for the 52-week period ended February 2, 2002, compared to the 53-week period ended February 3, 2001.

(3)	Our store count excludes our warehouse outlet store located in Jackson, Tennessee.

(4)	Calculated using net sales of all stores open at both the beginning and the end of the period.

(5)	Calculated using gross square footage of all stores open at both the beginning and the end of the period. Gross square footage includes the storage, receiving and office space that generally occupies approximately 30% of total store space.

(6)	As a result of the restatement described in note 2 to the consolidated financial statements, net loss allocable to common shareholders was reduced by $113,000, or $0.02 per diluted share for fiscal 2001; $10,000, with no impact on earnings per share for the 34-day period ended February 3, 2001; and $107,000, or $0.02 per diluted share for fiscal 2000.

(7)	As a result of the restatement described in note 2 to the consolidated financial statements, shareholders’ equity (deficit) was reduced by $1,057,000 as of February 1, 2003; $1,072,000 as of February 2, 2002; and $1,088,000 as of December 31, 2000.


Item 7.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations*

The following discussion should be read with our consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K. A number of the matters and subject areas discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and elsewhere in this annual report on Form 10-K are not limited to historical or current facts and deal with potential future circumstances and developments and are accordingly “forward-looking statements.” You are cautioned that such forward-looking statements, which may be identified by words such as “anticipate,” “believe,” “expect,” “estimate,” “intend,” “plan” and similar expressions, are only predictions and that actual events or results may differ materially.

Our fiscal year is comprised of the 52 or 53-week period ending on the Saturday closest to January 31. Accordingly, fiscal 2004 represented 52 weeks ended on January 29, 2005. Fiscal 2003 represented 52 weeks ended on January 31, 2004. Fiscal 2002 represented 52 weeks ended on February 2, 2002.

Restatement of Financial Statements

We have restated our financial statements including our consolidated balance sheet as of January 31, 2004 and our consolidated statements of operations, changes in shareholders’ equity and cash flows for the years ended January 31, 2004 and February 1, 2003, which are included in this Annual Report on Form 10-K. See Note 2 to the consolidated financial statements. We have also restated our quarterly financial information for fiscal 2003 and the first three quarters of fiscal 2004. The restatement also affects periods prior to fiscal 2002. The impact of the restatement on such prior periods has been reflected as an adjustment of $1.1 million to retained earnings as of February 2, 2002 in the consolidated statement of changes in shareholders’ equity. We have also restated the financial information for fiscal 2001, the 34-day period ended February 3, 2001, and fiscal 2000 included in “Item 6. Selected Financial Data.” The restatement concerns changes made to two of our lease-related accounting practices.

In the fourth quarter of fiscal 2004, we initiated a review of certain of our lease accounting practices. As a result of this review, we changed two of our lease-related accounting practices and restated certain

historical financial information for prior periods to correct these errors. The restatement adjustments do not affect cash and had no impact on revenues or comparable store net sales.

Historically, we had recognized rent expense for leases on a straight-line basis beginning on the earlier of the store opening date or the lease commencement date. This had the effect of excluding the store construction period, or build-out period, from the term over which rent is expensed. Based on a re-examination of the applicable accounting literature, including SFAS No. 13, Accounting for Leases, FASB Technical Bulletin No. 88-1 (“FTB 88-1”), Issues Relating to Accounting for Leases, and FASB Technical Bulletin 85-3 (“FTB 85-3”), Accounting for Operating Leases With Scheduled Rent Increases, we determined that the proper accounting practice is to include the build-out period in the lease term for determining straight-line rent expense on all operating leases. Previously, we also recorded tenant construction allowances received from landlords as a reduction of the cost of the related leasehold improvements. Based on a re-examination of the same accounting literature, we determined that the proper accounting was to record such landlord incentives as a deferred rent liability amortized as a reduction of rent expense over the lease term.

The restatement includes adjustments to cost of sales, gross profit, other operating expenses, depreciation and amortization, operating income, income taxes, net income and earnings per share. The restatement adjustments decreased our net income and earnings per share by $0.1 million, or $0.01 per diluted share, in fiscal 2003, and increased net income by $15,000 in fiscal 2002 with no impact on earnings per share. For additional information related to the restatement adjustments, see Note 2 to the consolidated financial statements.

The financial statements included in our previously filed Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q do not reflect the restatement described above, and therefore such financial statements should no longer be relied upon.

All financial information included in this section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” has been changed to reflect the restatement.

Introduction

Our stores offer a unique combination of style and value that has led to our emergence as a leader in home decor and has enabled us to develop a strong customer franchise. As a result, we have achieved substantial growth and have expanded our store base into different regions of the country. During the past seven years, we have more than doubled our store base, principally through new store openings. We intend to continue opening new stores both in existing and new markets. We anticipate our growth will include mall and non-mall locations in major metropolitan markets, middle markets and selected smaller communities. We believe there are currently more than 650 additional locations in the United States that could support a Kirkland’s store. We plan on opening 55-60 new stores and estimate closing 30 stores in fiscal 2005.

Overview of Key Financial Measures

Net sales and gross profit are the most significant drivers to our operating performance. Net sales consists of all merchandise sales to customers, net of returns and exclusive of sales taxes. Our net sales for fiscal 2004 increased by 6.8% to $394.4 million from $369.2 million in fiscal 2003, reflecting sales from the 54 new stores we opened in fiscal 2004 as well as sales increases from the 42 stores we opened in fiscal 2003. Comparable store sales declined 5.2% for fiscal 2004. We use comparable store sales to measure our

ability to achieve sales increases from stores that have been open at least one full fiscal year. 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 three distinct components: product cost (including freight cost), store occupancy cost and central distribution cost. Product cost comprises the majority of cost of sales, while central distribution cost is the least significant of these three elements. Product cost is variable, while occupancy and distribution costs are largely fixed. Accordingly, gross margin (gross profit expressed as a percentage of net sales) can be influenced by many factors including overall sales performance. For fiscal 2004, gross profit decreased 0.4% to $126.8 million from $127.3 million for fiscal 2003. Gross margin for fiscal 2004 decreased to 32.1% of net sales from 34.5% of net sales for fiscal 2003, primarily due to heavier than anticipated markdown activity that resulted in higher product cost as a percentage of net sales.

Operating expenses, including the costs of operating our stores and corporate headquarters, are also an important component of our operating performance. Compensation and benefits comprise the majority of our operating expenses. Operating expenses contain fixed and variable costs, and managing the operating expense ratio (operating expenses expressed as a percentage of net sales) is an important focus of management as we seek to maintain or increase our overall profitability. Operating expenses include cash costs as well as non-cash costs such as depreciation and amortization. Due to the significant fixed cost component of operating expenses, as well as the tendency of many operating costs to rise over time, increases in comparable store sales are typically necessary in order to prevent meaningful increases in the operating expense ratio. Operating expenses can also include certain costs that are of a one-time or non-recurring nature. While these costs must be considered to understand fully our operating performance, we typically identify such costs separately on the consolidated statement of operations so that we can evaluate comparable expense data across different periods.

A complete evaluation of our financial performance incorporates not only operating results, but also an assessment of how effectively we are deploying our capital. We believe that a high return on capital is an indicator of a financially productive business. Accordingly, we evaluate our earnings in relation to inventories and total assets in order to determine if we are achieving acceptable levels of return on our capital. Inventory yield (gross profit divided by average inventories) and return on assets (net income divided by total assets) are two of the measures we use.

We use a number of key performance measures to evaluate our financial performance, including the following:


	Fiscal Year

	2004			2003			2002

Net sales growth		6.8	%		8.1	%		11.2	%
Comparable store sales growth		(5.2	)%		(0.2	)%		8.4	%
Average net sales per store(1)	$	1,322		$	1,423		$	1,417
Average net sales per square foot(2)	$	286		$	311		$	313
Gross profit %		32.1	%		34.5	%		35.9	%
Compensation and benefits as a % of sales		16.8	%		15.6	%		15.8	%
Other operating expenses as a % of sales		9.3	%		7.8	%		7.3	%
Inventory yield(3)		279.8	%		287.7	%		286.8	%
Return on assets (ROA)(4)		5.1	%		15.4	%		11.7	%


(1)	Calculated using net sales of all stores open at both the beginning and the end of the period indicated.

(2)	Calculated using the gross square footage of all stores open at both the beginning and the end of the period. Gross square footage includes the storage, receiving and office space that generally occupies approximately 30% of total store space.


(3)	Inventory yield is defined as gross profit divided by average inventory for each of the preceding four quarters.

(4)	Return on assets equals net income allocable to common shareholders divided by total assets.

Strategic Areas of Emphasis

The increase in our store base during fiscal 2004 reflected a continued commitment to growth following the growth in fiscal 2003 and our initial public offering in July 2002. That transaction enabled us to reduce our debt significantly, which led to a significant reduction in interest expense and the ability to allocate more of our cash toward capital expenditures and working capital for new stores. Capital expenditures for fiscal 2004 were $30.0 million, of which $18.4 million was related to leasehold improvements, equipment and fixtures for new stores. We also spent $4.8 million on new information technology systems and related material handling equipment as part of our relocation to a new distribution center during the second quarter of fiscal 2004.

The construction of new stores will continue to be an important part of our strategy in fiscal 2005. We plan on opening 55-60 new stores and closing 30 stores during the upcoming year. Our stores historically have operated primarily in enclosed malls, but in fiscal 2003 we opened 17 of our 42 new stores in a variety of non-mall venues including “lifestyle” centers, “power” centers and outlet centers. We continued this trend in fiscal 2004, opening 44 of our 54 new stores in these non-mall venues. At January 29, 2005, we operated 79 of our 320 stores in non-mall venues, and we anticipate that substantially all of our new store openings in fiscal 2005 will be in non-mall venues. Although our sample of non-mall stores is still relatively small, typically these stores have been able to achieve equivalent sales volumes with lower total occupancy costs than our mall stores.

The following table summarizes our stores and square footage under lease in mall and non-mall locations as of January 29, 2005 and January 31, 2004:


	Stores				Square Footage				Average Store Size

	1/29/05		1/31/04		1/29/05		1/31/04		1/29/05		1/31/04

Mall		241		245		1,108,964		1,116,332		4,602		4,556
Non-Mall		79		35		393,923		165,605		4,986		4,732

Total		320		280		1,502,887		1,281,937		4,697		4,578

Another important area of emphasis will be improving the effectiveness of our supply chain. We commenced operations in a newly built distribution center in the second quarter of fiscal 2004. This new facility replaced the three buildings that previously supported our central distribution effort. The commencement of operations in the new distribution center was accompanied by the implementation of a new warehouse management system as well as investments in material handling equipment designed to streamline the flow of goods within the distribution center. In fiscal 2005 and beyond, our goal is to achieve better labor productivity, better transportation efficiency, leaner store-level inventories and reduced store-level storage costs as a result of this move and our continued improvement in distribution practices.

Our objective is to finance all of our operating and investing activities with cash provided by operations and borrowings under our revolving credit line. Our cash balances increased to $17.9 million at January 29, 2005 from $17.4 million at January 31, 2004. We expect that capital expenditures for fiscal 2005 will range from $28 million to $30 million, primarily to fund the construction of 55-60 new stores and maintain our information technology infrastructure.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and the results of our operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles. The preparation of these financial statements requires us to make estimates that affect the reported amounts contained in the financial statements and related disclosures. We base our

estimates on historical experience and on various other assumptions which are believed to be reasonable under the circumstances. Actual results may differ from these estimates. Our critical accounting policies are discussed in the notes to our consolidated financial statements. Certain judgments and estimates utilized in implementing these accounting policies are likewise discussed in each of the notes to our consolidated financial statements. The following discussion aggregates the various critical accounting policies addressed throughout the financial statements, the judgments and uncertainties affecting the application of these policies and the likelihood that materially different amounts would be reported under varying conditions and assumptions.

Cost of sales and inventory valuation — Our inventory is stated at the lower of cost or market, net of reserves and allowances, with cost determined using the average cost method with average cost approximating current cost. We estimate the amount of shrinkage that has occurred through theft or damage and adjust that to actual at the time of our physical inventory counts which occur near our fiscal year end. We also evaluate the cost of our inventory in relation to the estimated sales price. This evaluation is performed to ensure that we do not carry inventory at a value in excess of the amount we expect to realize upon the sale of the merchandise. We believe we have the appropriate merchandise valuation and pricing controls in place to minimize the risk that our inventory values would be materially misstated.

Depreciation and recoverability of long-lived assets — Approximately 49% of our assets at January 29, 2005, represent investments in property and equipment. Determining appropriate depreciable lives and reasonable assumptions in evaluating the carrying value of capital assets requires judgments and estimates.


	•	We utilize the straight-line method of depreciation and a variety of depreciable lives. Land is not depreciated. Buildings are depreciated over 40 years. Furniture, fixtures and equipment are generally depreciated over 5 years. Computer software and equipment is depreciated over 3-5 years. Leasehold improvements are amortized over the shorter of the useful lives of the asset or the original non-cancelable lease term. Our lease terms typically range from 5 to 10 years.

	•	To the extent we replace or dispose of fixtures or equipment prior to the end of its assigned depreciable life, we could realize a loss or gain on the disposition. To the extent our assets are used beyond their assigned depreciable life, no depreciation expense is being realized. We reassess the depreciable lives in an effort to reduce the risk of significant losses or gains arising from either the disposition of our assets or the utilization of assets with no depreciation charges.

	•	Recoverability of the carrying value of store assets is assessed annually and upon the occurrence of certain events or changes in circumstances such as anticipated store closings or upcoming lease renewals. The assessment requires judgment and estimates for future store-generated cash flows. The review includes a comparison of the carrying value of the store assets to the future undiscounted cash flows expected to be generated by the store. The underlying estimates for cash flows include estimates for future net sales, gross profit and store expense increases and decreases. To the extent our estimates for net sales, gross profit and store expenses are not realized, future assessments of recoverability could result in additional impairment charges.

Goodwill — We account for our goodwill in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Accordingly, goodwill is not amortized but reviewed for impairment on an annual basis or more frequently when events and circumstances indicate that an impairment may have occurred. We have not recorded an impairment to our goodwill since adopting SFAS No. 142.

Insurance reserves — Workers’ compensation, general liability and employee medical insurance programs are partially self-insured. It is our policy to record a self-insurance liability using estimates of claims incurred but not yet reported or paid, based on historical claims experience and trends. Actual results can vary from estimates for many reasons, including, among others, inflation rates, claim settlement patterns, litigation trends and legal interpretations. We monitor our claims experience in light of these factors and revise our estimates of insurance reserves accordingly. The level of our insurance reserves may increase or decrease as a result of these changing circumstances or trends.

Income taxes — We record income tax liabilities utilizing known obligations and estimates of potential obligations. A deferred tax asset or liability is recognized whenever there are future tax effects from existing temporary differences and operating loss and tax credit carryforwards. We record a valuation allowance to reduce deferred tax assets to the balance that is more likely than not to be realized. We must make estimates and judgments on future taxable income, considering feasible tax planning strategies and taking into account existing facts and circumstances, to determine the proper valuation allowance. When we determine that deferred tax assets could be realized in greater or lesser amounts than recorded, the asset balance and income statement reflects the change in the period such determination is made. Due to changes in facts and circumstances and the estimates and judgments that are involved in determining the proper valuation allowance, differences between actual future events and prior estimates and judgments could result in adjustments to this valuation allowance. We use an estimate of our annual effective tax rate 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.

Stock options and warrants — Certain of our stock options require us to record a non-cash stock compensation charge in our financial statements. The amount of the charge is determined based upon the excess of the fair value of our common stock at the date of grant over the exercise price of the stock options. Other options have been granted to employees or directors with an exercise price that is equal to or greater than the fair value of our common stock on the date of grant. Stock options which have been granted to persons other than employees or directors in exchange for services are valued using an option-pricing model. The fair value of our common stock is a significant element of determining the value of the stock option or the amount of the non-cash stock compensation charge to be recorded for our stock option awards or for non-employee stock option grants. Prior to our initial public offering in July 2002, our common stock was not traded on a stock exchange. To determine the value of our common stock prior to the initial public offering we first considered the amount paid to us for our common stock in recent transactions. Absent a recent sale of our common stock, we obtained a valuation from an independent appraiser. In each case, the determination of the fair value of our common stock requires judgment and the valuation has a direct impact on our financial statements. We believe that reasonable methods and assumptions have been used for determining the fair value of our common stock.

Fiscal 2004 Compared to Fiscal 2003

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):


			Fiscal 2004						Fiscal 2003						Change

			$			%			$			%			$			%

			(restated)
Net sales			$	394,429			100.0	%	$	369,158			100.0	%	$	25,271			6.8	%
Cost of sales				267,638			67.9	%		241,845			65.5	%		25,793			10.7	%

		Gross profit		126,791			32.1	%		127,313			34.5	%		(522	)		(0.4	)%
Operating expenses:
	Compensation and benefits			66,180			16.8	%		57,574			15.6	%		8,606			14.9	%
	Other operating expenses			36,866			9.3	%		28,923			7.8	%		7,943			27.5	%
	Lease termination charge			—			0.0	%		1,053			0.3	%		(1,053	)		(100.0	)%
	Depreciation and amortization			12,055			3.1	%		9,325			2.5	%		2,730			29.3	%
	Non-cash stock compensation charge			209			0.0	%		269			0.1	%		(60	)		(22.3	)%

		Operating income		11,481			2.9	%		30,169			8.2	%		(18,688	)		(61.9	)%
Interest expense, net				827			0.2	%		661			0.2	%		166			25.1	%
Other income, net				(233	)		(0.1	)%		(174	)		(0.0	)%		(59	)		33.9	%

Income before income taxes				10,887			2.8	%		29,682			8.0	%		(18,795	)		(63.3	)%
Income tax provision				4,298			1.1	%		11,641			3.1	%		(7,343	)		(63.1	)%

Net income			$	6,589			1.7	%	$	18,041			4.9	%	$	(11,452	)		(63.5	)%

Net sales. Net sales increased by 6.8% to $394.4 million for fiscal 2004 from $369.2 million for fiscal 2003. The net sales increase in fiscal 2004 resulted primarily from the opening of new stores. We opened 54 new stores in fiscal 2004 and 42 new stores in fiscal 2003, and we closed 14 stores in fiscal 2004 and 11 stores in fiscal 2003. Our net sales also benefited from sales increases from expanded, remodeled or relocated stores, which are excluded from our comparable store base. The impact of these changes in the store base was offset by a decline of 5.2% in comparable store net sales for fiscal 2004. During fiscal 2003, comparable store net sales decreased 0.2%. The comparable store net sales decline resulted from several factors, including a difficult sales environment in the home décor sector. Additionally, our merchandise assortments were not sufficiently compelling to customers, particularly in several of our home décor categories where our inventory mix became overly broad during the second and third quarters of the year. Key categories that outperformed the prior year included novelty/gift items and textiles. These increases were offset by declines in decorative accessories, floral, housewares, frames, and garden. The growth in the store base along with sales from expanded, remodeled or relocated stores accounted for an increase of $41.2 million over the prior year. This increase was partially offset by the negative comparable store sales performance, which accounted for a $15.9 million decrease from the prior year. The comparable store sales performance was characterized by higher average retail prices offset by lower transaction volumes.

Gross profit. Gross profit decreased $0.5 million, or 0.4%, to $126.8 million for fiscal 2004 from $127.3 million for fiscal 2003. Gross profit expressed as a percentage of net sales decreased to 32.1% for fiscal 2004, from 34.5% for fiscal 2003. The decrease in gross profit as a percentage of net sales resulted from higher product cost of sales, which includes freight expenses. Product cost of sales, including freight expenses, increased during fiscal 2004 as a percentage of sales, primarily due to heavier markdown activity in response to a difficult sales environment and to correct uneven merchandise assortments and inventory positions. Store occupancy costs also increased as a percentage of sales as the comparable store net sales decline negatively affected the occupancy ratio, offsetting the benefits we began to achieve from our shift to more non-mall real estate, the occupancy rates for which tend to be lower than those for enclosed mall properties. Central distribution costs increased slightly as a percentage of net sales due to the transition

costs incurred during the second quarter of 2004 in connection with our move into a new distribution center.

Compensation and benefits. Compensation and benefits, including both store and corporate personnel, was $66.2 million, or 16.8% of net sales, for fiscal 2004 as compared to $57.6 million, or 15.6% for fiscal 2003. The increase in the compensation and benefits ratio was primarily due to the negative comparable store net sales performance. In particular, we were not able to reduce hours sufficiently in stores to maintain the ratio at the prior year level. Furthermore, we made several additions to corporate management during 2004 in order to strengthen key departments such as merchandising, marketing and store operations. Finally, and to a lesser extent, we experienced increases in health care costs related to our employee health insurance coverage.

Other operating expenses. Other operating expenses, including both store and corporate costs, were $36.9 million, or 9.3% of net sales, for fiscal 2004 as compared to $28.9 million, or 7.8% of net sales, for fiscal 2003. The increase in these operating expenses as a percentage of net sales was primarily the result of the negative comparable store sales performance and the lack of a positive leveraging effect on the relatively fixed components of store and corporate operating expenses. Additionally, we increased spending on advertising and promotion by approximately $1.8 million during fiscal 2004 as we experimented with various forms of media advertising and other marketing programs in order to drive customer traffic to our stores. Furthermore, corporate professional fees increased due to the costs associated with our efforts to comply with the Sarbanes-Oxley Act. These costs totaled approximately $1.0 million for fiscal 2004. We expect these costs to decrease in fiscal 2005.

Lease termination charge. During the fourth quarter of fiscal 2003, we provided notice to our landlords of our intent to terminate the leases on our existing central distribution facilities. Consequently, upon providing that notice, we recorded a charge of $1.1 million related to the penalties associated with those early terminations. No such charge was recorded during fiscal 2004.

Depreciation and amortization. Depreciation and amortization expense was $12.1 million, or 3.1% of net sales, for fiscal 2004 as compared to $9.3 million, or 2.5% of net sales, for fiscal 2003. The increase in depreciation and amortization was the result of the growth of the store base and the increased capital costs associated with our move to a new distribution center during the second quarter of 2004.

Non-cash stock compensation charge. During fiscal 2004 and fiscal 2003, we incurred non-cash stock compensation charges related to stock options granted to certain employees in November 2001. The charge related to these stock option arrangements amounted to $0.2 million for fiscal 2004, a decrease from $0.3 million for fiscal 2003. See Note 9 to our consolidated financial statements. This charge was taken ratably over the vesting period of the November 2001 options. These options are now fully vested; therefore, there will be no additional charge related to these options in future periods.

Interest expense, net. Net interest expense was $0.8 million, or 0.2% of net sales, for fiscal 2004 as compared to $0.7 million, or 0.2% of net sales, for fiscal 2003. The increase was the result of the October 2004 refinancing of our line of credit facility. As a result of this refinancing, we recorded a charge upon early retirement of our previous facility of $0.3 million. There was no such charge in the prior year.

Income taxes. Income tax provision was $4.3 million, or 39.5% of income before income taxes, for fiscal 2004 compared to $11.6 million, or 39.2% of income before income taxes, for fiscal 2003.

Net income. As a result of the foregoing, net income $6.6 million, or 1.7% of net sales, for fiscal 2004 compared to $18.0 million, or 4.9% of net sales, for fiscal 2003. Diluted earnings per share was $0.34 for fiscal 2004 as compared to $0.92 for fiscal 2003.

Fiscal 2003 Compared to Fiscal 2002

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):


			Fiscal 2003						Fiscal 2002						Change

			$			%			$			%			$			%

			(restated)						(restated)
Net sales			$	369,158			100.0	%	$	341,504			100.0	%	$	27,654			8.1	%
Cost of sales				241,845			65.5	%		219,007			64.1	%		22,838			10.4	%

		Gross profit		127,313			34.5	%		122,497			35.9	%		4,816			3.9	%
Operating expenses:
	Compensation and benefits			57,574			15.6	%		53,887			15.8	%		3,687			6.8	%
	Other operating expenses			28,923			7.8	%		25,097			7.3	%		3,826			15.2	%
	Lease termination charge			1,053			0.3	%		—			0.0	%		1,053			100.0	%
	Depreciation and amortization			9,325			2.5	%		8,212			2.4	%		1,113			13.6	%
	Non-cash stock compensation charge			269			0.1	%		2,579			0.8	%		(2,310	)		(89.6	)%

		Operating income		30,169			8.2	%		32,722			9.6	%		(2,553	)		(7.8	)%
Interest expense, net				661			0.2	%		6,232			1.8	%		(5,571	)		(89.4	)%
Other income, net				(174	)		(0.0	)%		(128	)		(0.0	)%		(46	)		35.9	%

Income before income taxes				29,682			8.0	%		26,618			7.8	%		3,064			11.5	%
Income tax provision				11,641			3.1	%		10,721			3.1	%		920			8.6	%

Income before accretion of preferred stock and dividends accrued				18,041			4.9	%		15,897			4.7	%		2,144			13.5	%
Accretion of redeemable preferred stock and dividends accrued				—			0.0	%		5,626			1.7	%		(5,626	)		(100.0	)%

Net income allocable to common stock			$	18,041			4.9	%	$	10,271			3.0	%	$	7,770			75.6	%

Net sales. Net sales increased by 8.1% to $369.2 million for fiscal 2003 from $341.5 million for fiscal 2002. The net sales increase in fiscal 2003 resulted primarily from the opening of new stores. We opened 42 new stores in fiscal 2003 and 16 new stores in fiscal 2002, and we closed 11 stores in fiscal 2003 and one store in fiscal 2002. Our net sales also benefited from sales increases from expanded, remodeled or relocated stores, which are excluded from our comparable store base. The impact of these changes in the store base was offset somewhat by a decline of 0.2% in comparable store net sales for fiscal 2003. During fiscal 2002, comparable store net sales increased 8.4%. The comparable store net sales decline was primarily the result of a weak fourth quarter, during which comparable store net sales declined 4.7%. Key categories that outperformed the prior year included wall decor, candles, textiles and housewares. These increases were offset by declines in lamps, garden, decorative accessories and holiday. In response to weak sales in the holiday category in the fourth quarter of fiscal 2002, we purchased less holiday merchandise for the fourth quarter of fiscal 2003. However, sales in our non-holiday categories were not sufficient to make up for the lower sales of holiday merchandise. The growth in the store base along with sales from expanded, remodeled or relocated stores accounted for an increase of $28.5 million over the prior year. This increase was partially offset by the negative comparable store sales performance, which accounted for an $0.8 million decrease from the prior year. The comparable store sales performance was characterized by relatively flat unit sales along with a slight decrease in the average retail price per item.

Gross profit. Gross profit increased $4.8 million, or 3.9%, to $127.3 million for fiscal 2003 from $122.5 million for fiscal 2002. Gross profit expressed as a percentage of net sales decreased to 34.5% for fiscal 2003, from 35.9% for fiscal 2002. The decrease in gross profit as a percentage of net sales resulted from higher product cost of sales, which includes freight expenses. Product cost of sales, including freight expenses, increased during fiscal 2003 as a percentage of sales, primarily due to heavier markdown activity

in response to a sluggish sales environment and the underperformance of certain merchandise categories, particularly in the first and second quarters. Store occupancy costs also increased as a percentage of sales due to the comparable store net sales decline. Consistent with our strategic plans, central distribution costs increased slightly as a percentage of net sales as we continued to build the infrastructure to support a higher level of activity in our central distribution centers.

Compensation and benefits. Compensation and benefits, including both store and corporate personnel, was $57.6 million, or 15.6% of net sales, for fiscal 2003 as compared to $53.9 million, or 15.8% for fiscal 2002. The decline in these expenses as a percentage of net sales was primarily the result of lower levels of incentive compensation this year as compared to the prior year due to underperformance versus our plan during fiscal 2003. Tight payroll management at the store-level in response to a difficult sales environment also helped us to produce a reduction in payroll as a percentage of net sales despite the negative comparable store net sales performance.

Other operating expenses. Other operating expenses, including both store and corporate costs, were $28.9 million, or 7.8% of net sales, for fiscal 2003 as compared to $25.1 million, or 7.3% of net sales, for fiscal 2002. The increase in these operating expenses as a percentage of net sales was primarily the result of the negative comparable store sales performance and the lack of a positive leveraging effect on the relatively fixed components of store and corporate operating expenses. In addition, the increase in these expenses as a percentage of net sales was partially due to expenses incurred in connection with our accelerated store expansion plan. Furthermore, corporate insurance costs increased as we experienced a full year of impact from the enhancements in directors and officers coverage that were made upon completion of the initial public offering in July 2002.

Lease termination charge. During the fourth quarter of fiscal 2003, we provided notice to our landlords of our intent to terminate the leases on our existing central distribution facilities. Consequently, upon providing that notice, we recorded a charge of $1.1 million related to the penalties associated with these early terminations. No such charge was recorded during fiscal 2002.

Depreciation and amortization. Depreciation and amortization expense was $9.3 million, or 2.5% of net sales, for fiscal 2003 as compared to $8.2 million, or 2.4% of net sales, for fiscal 2002. The increase in depreciation and amortization was the result of the growth of the store base and the completion of various information technology projects.

Non-cash stock compensation charge. During fiscal 2003, we incurred non-cash stock compensation charges related to stock options granted to certain employees in November 2001. During fiscal 2002, we incurred non-cash stock compensation charges related to these options as well as certain stock options granted to a consultant in July 2001, and certain re-priced employee stock options for which variable accounting methods were required. Charges related to these stock option arrangements amounting to $0.3 million, or 0.1% of net sales, were recorded for fiscal 2003, a decrease from $2.6 million, or 0.8% of net sales, for fiscal 2002. See Note 9 of the notes to our consolidated financial statements.

Interest expense, net. Net interest expense was $0.7 million, or 0.2% of net sales, for fiscal 2003 as compared to $6.2 million, or 1.8% of net sales, for fiscal 2002. The decrease was the result of a combination of factors including our May 2002 debt refinancing, our July 2002 initial public offering, strong cash flow from operations and low interest rates. During fiscal 2002, we recorded interest expense associated with our mandatorily redeemable Class C Preferred Stock of $1.1 million, or 0.3% of net sales. No interest was recorded related to the Class C Preferred Stock during 2003 due to its repayment in connection with the initial public offering. Amortization of debt issue costs was $0.2 million, or 0.1% of net sales, for fiscal 2003 as compared to $0.9 million, or 0.3% of net sales, for fiscal 2002. The decrease was the result of our May 2002 refinancing and the related reduction of issue costs in comparison to our previous financing arrangements. Additionally, during fiscal 2002, we recorded a loss on the early extinguishment of long-term debt in the amount of $0.3 million, or 0.1% of net sales, upon repayment in full of our term loan. No such charge was recorded during fiscal 2003.

Income taxes. Income tax provision was $11.6 million, or 39.2% of income before income taxes, for fiscal 2003 compared to $10.7 million, or 40.3% of income before income taxes, for fiscal 2002. The decrease in the effective tax rate for fiscal 2003 was primarily the result of fewer non-deductible stock compensation charges during 2003 as compared to fiscal 2002.

Net income. As a result of the foregoing, income before accretion of preferred stock and dividends accrued was $18.0 million, or 4.9% of net sales, for fiscal 2003 compared to $15.9 million, or 4.7% of net sales, for fiscal 2002 During fiscal 2002, preferred stock accretion and dividends of $5.6 million were recorded, resulting in net income allocable to common shareholders of $10.3 million.

Liquidity and Capital Resources

Our principal capital requirements are for working capital and capital expenditures. Working capital consists mainly of merchandise inventories, 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 or corporate headquarters. Historically, we have funded our working capital and capital expenditure requirements with internally generated cash, borrowings under our credit facilities and proceeds from the sale of equity securities.

Cash flows from operating activities. Net cash provided by operating activities was $30.3 million, $35.9 million and $21.5 million for fiscal 2004, fiscal 2003 and fiscal 2002, respectively. The primary sources of our cash flow typically are net income, adjusted for non-cash charges, and construction allowances received from landlords. The changes in net cash provided by operating activities depend heavily on changes in working capital, the timing and amount of payments for income taxes, and the timing of interest payments on indebtedness. During fiscal 2002, non-cash working capital increased $7.2 million as we began to increase our growth rate. Additionally, during 2002, we refinanced our existing indebtedness and completed an initial public offering. Through these two financing events, we repaid $13.4 million in previously accrued interest. During fiscal 2003, net cash provided by operating activities increased as a result of higher net income, greater construction allowances due to an increase in new store growth, and the lack of large payments of accrued interest due to the retirement of all outstanding long-term debt during fiscal 2002. Non-cash working capital increased $2.1 million during fiscal 2003 as we continued to increase our growth rate and required incremental inventory investment for our new stores. Offsetting this incremental use of cash, we received a benefit from the new bonus depreciation tax laws that were in effect for fiscal 2003, resulting in a favorable impact on operating cash flow. Operating cash flow decreased during fiscal 2004, as our financial performance declined. Net income declined to $6.6 million from $18.0 million in fiscal 2003. This decline was offset by a decline in inventory of $4.5 million as we attempted to manage working capital tightly in a challenging sales environment. We again received a tax benefit from the bonus depreciation laws in effect during fiscal 2004. This benefit will not be available for fiscal 2005 capital expenditures due to the expiration of the applicable tax law.

Cash flows from investing activities. Net cash used in investing activities was $30.0 million, $22.8 million and $11.2 million for fiscal 2004, fiscal 2003 and fiscal 2002, respectively. These amounts consisted entirely of capital expenditures offset slightly by proceeds received from the sale of certain assets. These capital expenditures primarily included investments in new store construction; existing store remodels; information technology assets for stores, the distribution center, and the corporate headquarters; and materials handling equipment for our new distribution facility. The increase in this amount over the last three fiscal years is due to the growth in our store base and the related infrastructure investments we have made to prepare us for our growth and expansion plans. During fiscal 2004, we opened 54 new stores and remodeled 7 stores. We expect that capital expenditures for fiscal 2005 will range from $28 to $30 million, primarily to fund the construction of 55-60 new stores and the maintenance of our information technology infrastructure. We anticipate that capital expenditures, including leasehold improvements, furniture and fixtures, and equipment for our fiscal 2005 new stores will average approximately $350,000-$375,000 per store. We anticipate that we will continue to receive landlord allowances, which help to

defray a portion of the cost of our leasehold improvements. These allowances are reflected as a component of cash flows from operating activities within our consolidated statement of cash flows.

Cash flows from financing activities. Net cash provided by financing activities was $0.2 million in fiscal 2004. Net cash used in financing activities was $1,000 and $35.8 million for fiscal 2003 and fiscal 2002, respectively. Cash flows from financing activities for fiscal 2004 were primarily comprised of borrowings and repayments under our revolving credit facility. The facility was drawn to a peak of $18.7 million and paid down to zero by the end of the fiscal year. During fiscal 2003, cash flows from financing activities also primarily related to bank revolver activity. We borrowed to a peak of $13 million and paid down to zero by the end of the year. During fiscal 2002, two significant financing events took place — our senior debt refinancing and our initial public offering of common stock. The net use of cash for fiscal 2002 reflected the retirement of approximately $101.4 million in long-term obligations and certain shares of common stock. These retirements and repurchases were funded with a combination of existing cash balances and the proceeds of these two financing events. Additionally, using availability from our revolving line of credit we were able to complete the full repayment of our $15 million term loan during the third quarter of fiscal 2002.

Revolving credit facility. On October 4, 2004, we completed a refinancing of our revolving credit facility and entered into a new, five-year senior secured credit facility with a revolving loan limit of $45 million. The new facility includes a letter of credit subfacility for up to $15 million of the total loan limit. Amounts borrowed under the facility bear interest at a floating rate equal to the 60-day LIBOR rate plus 1.25% to 1.50% (depending on the amount of excess availability under the borrowing base) per annum. We also pay an unused line fee of 0.2% per annum based on the excess of the loan limit over our actual borrowings. The maximum availability under the facility is limited by a borrowing base that consists of a percentage of eligible inventory and credit card receivables less reserves. Our credit lender may from time to time reduce the lending formula with respect to the eligible inventory to the extent our lender determines that the liquidation value of the eligible inventory has decreased. Our lender also may from time to time decrease the borrowing base by adding reserves with respect to matters such as inventory shrinkage. The facility also contains provisions that could result in changes to the presented terms of the facility or the acceleration of maturity. Circumstances that could lead to such changes in terms or acceleration include, but are not limited to, a material adverse change in our business or an event of default under the credit agreement. The facility has one financial covenant that requires us to maintain excess availability under the borrowing base of $3 million at all times. The facility matures in October 2009. As of January 29, 2005, we were in compliance with the covenants in the facility and there were no borrowings outstanding under the facility.

At January 29, 2005, our balance of cash and cash equivalents was $17.9 million and the borrowing availability under our facility was $20.3 million. We believe that these sources of cash, together with cash provided by our operations, will be adequate to carry out our fiscal 2005 plans in full and fund our planned capital expenditures and working capital requirements for at least the next twelve months.

Contractual obligations. The following table identifies payment obligations for the periods indicated under our current contractual arrangements. The amounts set forth below reflect contractual obligations as of January 29, 2005, and do not reflect our expectations as to expenditures for the categories of obligations described below. The timing and/or the amount of the payments may be changed in accordance with the terms of the contracts or new contractual obligations may be added.


	Payments Due By Period

Contractual Obligations	Total		Less than 1 Year		2-3 Years		4-5 Years		More than 5 Years

	(Dollars in millions)
Operating lease obligations(1)	$	206.7	$	33.0	$	60.4	$	47.1	$	66.2
Purchase obligations(2)	$	63.1	$	63.1		—		—		—

Total	$	269.8	$	96.1	$	60.4	$	47.1	$	66.2


(1)	Operating leases consist of future minimum rental payments required under non-cancelable operating leases and does not include future minimum sublease rentals. The amounts included above primarily consist of operating leases for our store locations and distribution facilities, but also include operating leases for certain equipment and vehicles.

(2)	Purchase obligations consist entirely of open purchase orders of merchandise inventory as of January 29, 2005.

Seasonality and Quarterly Results

We have historically experienced and expect to continue to experience substantial seasonal fluctuations in our net sales and operating income. We believe this is the general pattern typical of our segment of the retail industry and, as a result, expect that this pattern will continue in the future. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of new store openings, net sales contributed by new stores, shifts in the timing of certain holidays and competition. Consequently, comparisons between quarters are not necessarily meaningful and the results for any quarter are not necessarily indicative of future results.

Our strongest sales period is the winter holiday season. Consequently, we generally realize a disproportionate amount of our net sales and a substantial majority of our operating and net income during the fourth quarter of our fiscal year. In anticipation of the increased sales activity during the fourth quarter of our fiscal year, we purchase large amounts of inventory and hire temporary staffing help for our stores. Our operating performance could suffer if net sales were below seasonal norms during the fourth quarter of our fiscal year. Our net sales, operating income and net income are typically lowest in the first quarter of our fiscal year. We expect this trend to continue.

The following table sets forth certain unaudited financial and operating data for Kirkland’s in each fiscal quarter during fiscal 2004 and fiscal 2003. The unaudited quarterly information includes all normal recurring adjustments that we consider necessary for a fair presentation of the information shown. The quarterly information below has been revised to reflect the restatement of the financial statements with respect to certain lease-related accounting adjustments. Refer to Note 2 to the consolidated financial statements.


		Fiscal 2004 Quarter Ended(1)

		May 1,			July 31,			October 30,			January 29,
		2004			2004			2004			2005

		(restated)			(restated)			(restated)
Net sales		$	82,611		$	84,701		$	82,815		$	144,302
Gross profit			26,334			21,923			24,584			53,950
Operating income (loss)			1,319			(4,427	)		(4,434	)		19,023
Net income (loss)			765			(2,745	)		(2,992	)		11,561
Earnings (loss) per common share:
	Basic		0.04			(0.14	)		(0.16	)		0.60
	Diluted		0.04			(0.14	)		(0.16	)		0.59
Stores open at end of period			278			289			305			320
Comparable store net sales increase (decrease)			1.5	%		(3.4	)%		(13.8	)%		(4.9	)%


		Fiscal 2003 Quarter Ended(2)

		May 3,			August 2,			November 1,			January 31,
		2003			2003			2003			2004

		(restated)			(restated)			(restated)			(restated)
Net sales		$	73,437		$	78,951		$	84,052		$	132,718
Gross profit			23,941			23,899			28,196			51,277
Operating income			1,945			1,359			3,196			23,669
Net income			1,113			738			1,835			14,355
Earnings per common share:
	Basic		0.06			0.04			0.10			0.75
	Diluted		0.06			0.04			0.09			0.73
Stores open at end of period			251			258			279			280
Comparable store net sales increase (decrease)			5.1	%		(0.9	)%		2.7	%		(4.7	)%


(1)	Net income (loss) previously reported in our Quarterly Reports on Form 10-Q was $850,000 for the 13 weeks ended May 1, 2004; $(2,661,000) for the 13 weeks ended July 31, 2004; and $(2,908,000) for the 13 weeks ended October 30, 2004. Diluted earnings per share was not affected for the 13 weeks ended May 1, 2004. Diluted earnings per share was reduced by $0.01 for each of the 13 week periods ended July 31, 2004 and October 30, 2004. See Note 2 to the consolidated financial statements.

(2)	Net income (loss) previously reported in our Quarterly Reports on Form 10-Q and our Annual Report on Form 10-K was $1,138,000 for the 13 weeks ended May 3, 2003; $764,000 for the 13 weeks ended August 2, 2003; $1,861,000 for the 13 weeks ended November 1, 2003; and $14,380,000 for the 13 weeks ended January 31, 2004. Diluted earnings per share was not affected for the 13 week periods ended May 3, 2003, August 2, 2003 and January 31, 2004. Diluted earnings per share was reduced by $0.01 for the 13 weeks ended November 1, 2003. See Note 2 to the consolidated financial statements.

Inflation

We do not believe that our operating results have been materially affected by inflation during the preceding three fiscal years. There can be no assurance, however, that our operating results will not be adversely affected by inflation in the future.

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, a revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123R requires the fair-value measurement of all stock-based awards to employees, including stock option grants, and the recognition of the resulting expense in our consolidated financial statements. The provisions of SFAS No. 123R are effective for reporting periods beginning after June 15, 2005. Accordingly, we will be required to adopt SFAS No. 123R in the third quarter of fiscal 2005. We will continue to account for stock-based compensation using the intrinsic value approach until adoption of SFAS No. 123R on July 31, 2005. We are currently evaluating the provisions of SFAS No. 123R and have not yet determined the method of adoption, its impact on our financial statements, or its impact in relation to the pro forma disclosures historically disclosed in the notes to the financial statements.

In November 2004, the FASB issued SFAS No. 151, Inventory Costs, which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. The statement is effective for fiscal years beginning after June 15, 2005. We do not believe that the adoption of SFAS No. 151 will have a material impact on our financial statements.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Non-Monetary Assets, which eliminates the exception for non-monetary exchanges of similar productive assets and replaces it with a

general exception for exchanges of non-monetary assets that do not have commercial substance. SFAS No. 153 will be effective for fiscal periods beginning after June 15, 2005. We do not believe that the adoption of SFAS No. 153 will have a material impact on our financial statements.


Item 7A.	*Quantitative and Qualitative Disclosure About Market Risk*

Market risks related to our operations result primarily from changes in short-term London Interbank Offered Rates, or LIBOR, as our senior credit facility utilizes short-term LIBOR rates and/or contracts. The base interest rate used in our senior credit facility is the 60-day LIBOR; however, from time to time, we may enter into one or more LIBOR contracts. These LIBOR contracts vary in length and interest rate, such that adverse changes in short-term interest rates could affect our overall borrowing rate when such contracts are renewed.

As of January 29, 2005, we had no outstanding borrowings under our revolving credit facility. All amounts borrowed throughout the year under our revolving credit facility were entered into for other than trading purposes.

We were not engaged in any foreign exchange contracts, hedges, interest rate swaps, derivatives or other financial instruments with significant market risk as of January 29, 2005.


Item 8.	*Financial Statements and Supplementary Data*

The financial statements and schedules are listed under Item 15(a) and filed as part of this annual report on Form 10-K.

The supplementary financial data is set forth under Item 7 of this annual report on Form 10-K.


Item 9.	*Changes in and Disagreements with Accountants on Accounting and Financial Disclosure*

None


Item 9A.	*Controls and Procedures*

Evaluation of Disclosure Controls and Procedures

We have established and maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended (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 that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the date of such evaluation.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of January 29, 2005 based on the Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of January 29, 2005.

PricewaterhouseCoopers LLP, the independent registered public accounting firm that audited our financial statements included in this Annual Report on Form 10-K, has audited our management’s assessment of the effectiveness of our internal control over financial reporting as of January 29, 2005, as stated in their report which is included herein.

Management’s Consideration of the Restatement

In coming to the conclusion that our internal control over financial reporting was effective as of January 29, 2005, our management considered, among other things, the control deficiency related to our accounting for leases, which resulted in the need to restate our previously filed financial statements as disclosed in footnote 2 to our consolidated financial statements included in this Form 10-K. After reviewing and analyzing the Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) No. 99, Materiality, Accounting Principles Board Opinion No. 28, Interim Financial Reporting, paragraph 29 and SAB Topic 5-F, Accounting Changes Not Retroactively Applied Due to Immateriality, and taking into consideration (i) that the restatement adjustments did not have a material impact on the financial statements of prior interim or annual periods taken as a whole; (ii) that the cumulative impact of the restatement adjustments on shareholders’ equity was not material on the financial statements of prior interim or annual periods; and (iii) that we were required to restate our previously issued financial statements solely because the cumulative impact of the error, if recorded in the current period, would have been material to the current year’s reported net income, our management concluded that the control deficiency that resulted in the restatement of the prior period financial statements was not in itself a material weakness. Furthermore, the control deficiency that resulted in the restatement when aggregated with other deficiencies did not constitute a material weakness.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control 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.


Item 9B.	*Other Information*

None.

PART III


Item 10.	*Directors and Executive Officers of the Registrant*

Information concerning directors, appearing under the caption “Board of Directors” in our Proxy Statement (the “Proxy Statement”) to be filed with the SEC in connection with our Annual Meeting of Shareholders scheduled to be held on June 6, 2005, information concerning executive officers, appearing under the caption “Item 1. Business — Executive Officers of Kirkland’s” in Part I of this annual report on Form 10-K, and information under the caption “Other Matters — Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement are incorporated herein by reference in response to this Item 10.

The Board of Directors has adopted a Code of Business Conduct and Ethics applicable to our directors, officers and employees, including our President and Chief Executive Officer, our Executive Vice President and Chief Financial Officer and our Vice President of Finance and Treasurer/Controller, which has been posted on the “Investor Relations” section of our web site. We intend to satisfy the amendment and waiver disclosure requirements under applicable securities regulations by posting any amendments of, or waivers to, the Code of Business Conduct and Ethics on our web site.


Item 11.	*Executive Compensation*

The information contained in the sections titled “Executive Compensation” and “Information About the Board of Directors — Board of Directors Compensation” in the Proxy Statement is incorporated herein by reference in response to this Item 11.


Item 12.	*Security Ownership of Certain Beneficial Owners and Management*

The information contained in the section titled “Security Ownership of Kirkland’s — Ownership of Management and Certain Beneficial Owners” in the Proxy Statement, with respect to security ownership of certain beneficial owners and management, is incorporated herein by reference in response to this Item 12.

Equity Compensation Plan Information

(c)

(a)

(b)

Number of securities

remaining available for

to be issued upon

Weighted-average

future issuance under equity

exercise of outstanding

exercise price of

compensation plans

options, warrants and

outstanding options,

(excluding securities

Plan category

rights

warrants and rights

reflected in column (a))

Equity compensation plans approved by security holders

637,855

7.24

2,625,572

Equity compensation plans not approved by security holders

—

Total

635,855

7.24

2,625,572


Item 13.	*Certain Relationships and Related Transactions*

The information contained in the section titled “Related Party Transactions” in the Proxy Statement is incorporated herein by reference in response to this Item 13.


Item 14.	*Principal Accounting Fees and Services*

The information contained in the section titled “Other Matters — Audit Fees” in the Proxy Statement is incorporated herein by reference in response to this Item 14.

PART IV


Item 15.	*Exhibits, Financial Statements, Schedules and Reports on Form 8-K*

(a) 1. Financial Statements

The financial statements and schedules set forth below are filed on the indicated pages as part of this annual report on Form 10-K.


		Report of Independent Registered Public Accounting Firm			41
		Consolidated Balance Sheets as of January 29, 2005 and January 31, 2004			43
		Consolidated Statements of Operations for the 52 Weeks Ended January 29, 2005, January 31, 2004 and February 1, 2003			44
		Consolidated Statements of Shareholders’ Equity (Deficit) for the 52 Weeks Ended January 29, 2005, January 31, 2004 and February 1, 2003			45
		Consolidated Statements of Cash Flows for the 52 Weeks Ended January 29, 2005, January 31, 2004, and February 1, 2003			46
		Notes to Consolidated Financial Statements			47
		2. Schedules
		None.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Kirkland’s, Inc.:

We have completed an integrated audit of Kirkland’s, Inc.’s fiscal 2004 consolidated financial statements and of its internal control over financial reporting as of January 29, 2005 and audits of its fiscal 2003 and fiscal 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Consolidated Financial Statements

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Kirkland’s, Inc. and its subsidiaries at January 29, 2005 and January 31, 2004, and the results of their operations and their cash flows for each of the three years in the period ended January 29, 2005 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As described in Note 2, the consolidated financial statements for the years ended January 31, 2004 and February 1, 2003 have been restated.

Internal Control over Financial Reporting

Also, in our opinion, management’s assessment, included in “Management’s Report on Internal Control Over Financial Reporting,” appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of January 29, 2005 based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 29, 2005, based on criteria established in Internal Control — Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the

assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.


	PricewaterhouseCoopers LLP

Memphis, Tennessee

April 12, 2005

KIRKLAND’S, INC.

CONSOLIDATED BALANCE SHEETS


		January 29, 2005			January 31, 2004

		(In thousands, except share data)
					(restated)
ASSETS
Current assets:
Cash and cash equivalents		$	17,912		$	17,423
Inventories, net			37,073			41,574
Income taxes receivable			2,124			—
Prepaid expenses and other current assets			6,278			7,570
Deferred income taxes			1,265			1,813

	Total current assets		64,652			68,380
Property and equipment, net			64,020			46,246
Deferred income taxes			—			526
Debt issue costs, net			83			280
Goodwill			1,382			1,382

	Total assets	$	130,137		$	116,814


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	22,199		$	19,995
Income taxes payable			—			6,487
Accrued expenses			14,936			14,085

	Total current liabilities		37,135			40,567
Deferred income taxes			2,376			—
Deferred rent			25,506			18,175

	Total liabilities		65,017			58,742

Commitments and contingencies (Note 12)			—			—
Shareholders’ equity:
Preferred stock, no par value, 10,000,000 shares authorized; no shares issued or outstanding at January 29, 2005 and January 31, 2004			—			—
Common stock, no par value, 100,000,000 shares authorized; 19,264,412 and 19,166,022 shares issued and outstanding at January 29, 2005 and January 31, 2004, respectively			138,607			138,149
Loan to shareholder			(619	)		(620	)
Accumulated deficit			(72,868	)		(79,457	)

	Total shareholders’ equity		65,120			58,072

	Total liabilities and shareholders’ equity	$	130,137		$	116,814

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

KIRKLAND’S, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS


			52 Week Period Ended

			January 29,			January 31,			February 1,
			2005			2004			2003

			(In thousands, except per share data)
						(restated)			(restated)
Net sales			$	394,429		$	369,158		$	341,504
Cost of sales (exclusive of depreciation and amortization as shown below)				267,638			241,845			219,007

		Gross profit		126,791			127,313			122,497
Operating expenses:
	Compensation and benefits			66,180			57,574			53,887
	Other operating expenses			36,866			28,923			25,097
	Lease termination charge			—			1,053			—
	Depreciation and amortization			12,055			9,325			8,212
	Non-cash stock compensation charge			209			269			2,579

		Total operating expenses		115,310			97,144			89,775
		Operating income		11,481			30,169			32,722
Interest expense:
	Senior, subordinated and other indebtedness			412			485			3,362
	Class C Preferred Stock			—			—			1,134
	Amortization of debt issue costs			147			210			944
	Loss on early extinguishment of long-term debt			364			—			325
	Inducement charge on exchange of Class C Preferred Stock			—			—			554

		Total interest expense		923			695			6,319
Interest income				(96	)		(34	)		(87	)
Other income				(233	)		(174	)		(172	)
Other expenses				—			—			44

Income before income taxes				10,887			29,682			26,618
Income tax provision				4,298			11,641			10,721

		Income before accretion of preferred stock and dividends accrued		6,589			18,041			15,897
Accretion of redeemable preferred stock and dividends accrued				—			—			(5,626	)

Net income allocable to common shareholders			$	6,589		$	18,041		$	10,271

Earnings per share:
	Basic		$	0.34		$	0.95		$	0.73

	Diluted		$	0.34		$	0.92		$	0.70

Weighted average number of shares outstanding:
	Basic			19,231			19,048			13,979

	Diluted			19,541			19,545			14,657

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

KIRKLAND’S, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (DEFICIT)


	Common Stock
							Loan to			Accumulated			Total Equity
	Shares			Amount			Shareholder			Deficit			(Deficit)

				(In thousands, except share data)
Balance at February 2, 2002 (restated)		7,531,585		$	229		$	—		$	(113,395	)	$	(113,166	)
Reclassification of common stock warrants to equity due to termination of put feature					7,020									7,020
Accretion of redeemable preferred stock and dividends accrued					(5,626	)								(5,626	)
Exercise of stock options and employee stock purchases		169,997			2,210			(217	)					1,993
Initial public offering of common stock, net of offering expenses		4,925,000			66,543									66,543
Exercise of common stock warrants		2,096,135
Conversion of Class A, Class B and Class D Preferred Stock		4,209,906			63,149									63,149
Conversion of Class C Preferred Stock		567,526			8,471									8,471
Repurchase of common stock		(589,798	)		(8,228	)								(8,228	)
Difference in repurchase of preferred stock and carrying value					1,945									1,945
Tax benefit from exercise of stock options					111									111
Accrued interest on shareholder loan, net of interest paid								(8	)					(8	)
Income before accretion of preferred stock and dividends accrued (restated)											15,897			15,897

Balance at February 1, 2003 (restated)		18,910,351			135,824			(225	)		(97,498	)		38,101
Exercise of stock options and employee stock purchases		255,671			2,166									2,166
Tax benefit from exercise of stock options					159									159
Accrued interest on shareholder loan, net of interest paid								(14	)					(14	)
Shareholder loan advance								(381	)					(381	)
Net income (restated)											18,041			18,041

Balance at January 31, 2004 (restated)		19,166,022			138,149			(620	)		(79,457	)		58,072
Exercise of stock options and employee stock purchases		98,390			349									349
Tax benefit from exercise of stock options					109									109
Net interest paid on shareholder loan								1						1
Net income											6,589			6,589

Balance at January 29, 2005		19,264,412		$	138,607		$	(619	)	$	(72,868	)	$	65,120

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

KIRKLAND’S, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS


			52 Week Period Ended

			January 29,			January 31,			February 1,
			2005			2004			2003

			(In thousands)
						(restated)			(restated)
Cash flows from operating activities:
Income before accretion of redeemable preferred stock and dividends accrued			$	6,589		$	18,041		$	15,897
Adjustments to reconcile income before accretion of preferred stock and dividends accrued to net cash provided by operating activities:
Depreciation of property and equipment				12,055			9,325			8,212
Loss on early extinguishment of long-term debt				139			—			325
Amortization of debt issue costs and debt discount				147			210			1,004
Non-cash stock compensation charge				209			269			2,579
Inducement charge associated with exchange of Class C Preferred Stock				—			—			554
Loss on disposal of property and equipment				192			457			132
Deferred income taxes				3,450			1,965			(1,220	)
Changes in assets and liabilities:
	Inventories, net			4,501			(2,102	)		(6,709	)
	Prepaid expenses and other current assets			1,292			(2,892	)		(2,721	)
	Other noncurrent assets			—			4			91
	Accounts payable			2,204			2,401			5,064
	Income taxes payable			(8,502	)		(181	)		7,006
	Accrued expenses and other noncurrent liabilities			8,063			8,442			(8,727	)

		Net cash provided by operating activities		30,339			35,939			21,487

Cash flows from investing activities:
Proceeds from sale of property and equipment				4			25			15
Capital expenditures				(30,025	)		(22,784	)		(11,184	)

	Net cash used in investing activities			(30,021	)		(22,759	)		(11,169	)

Cash flows from financing activities:
Borrowings on revolving line of credit				80,283			20,551			36,194
Repayments on revolving line of credit				(80,283	)		(20,551	)		(36,194	)
Proceeds from term loan				—			—			15,000
Principal payments on long-term debt, including Class C Preferred Stock				—			—			(82,382	)
Net proceeds from initial public offering				—			—			66,543
Redemption of Class A, Class B and Class D Preferred Stock				—			—			(25,826	)
Repurchase of common stock				—			—			(8,228	)
Exercise of stock options and employee stock purchases				259			394			78
Debt issue costs				(89	)		—			(1,002	)
Advance on shareholder loan and net interest paid (accrued)				1			(395	)		(8	)

	Net cash provided by (used in) financing activities			171			(1	)		(35,825	)

Cash and cash equivalents:
	Net increase (decrease)		$	489		$	13,179		$	(25,507	)
	Beginning of the year			17,423			4,244			29,751

	End of the year		$	17,912		$	17,423		$	4,244

Supplemental cash flow information:
	Interest paid		$	405		$	485		$	15,875

	Income taxes paid		$	9,349		$	9,856		$	4,998

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

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 1 —	Description of Business and Significant Accounting Policies

Kirkland’s, Inc. (the “Company”) is a leading specialty retailer of home decor with 320 stores in 37 states as of January 29, 2005. The consolidated financial statements of the Company include the accounts of Kirkland’s, Inc. and its wholly-owned subsidiaries Kirkland’s Stores, Inc. and kirklands.com, inc. Significant intercompany accounts and transactions have been eliminated.

Fiscal year — The Company’s fiscal year is comprised of the 52 or 53-week period ending on the Saturday closest to January 31. Accordingly, fiscal 2004 represented 52 weeks ended on January 29, 2005; fiscal 2003 represented 52 weeks ended on January 31, 2004; and fiscal 2002 represented 52 weeks ended on February 1, 2003.

Cash and cash equivalents — Cash and cash equivalents consist of cash on deposit in banks and investments with maturities of 90 days or less at the date of purchase.

Inventories — Inventories are stated at the lower of cost or market, net of allowances, with cost being determined using the average cost method which approximates current cost.

Prepaid expenses and other current assets — Prepaid expenses and other current assets consist primarily of prepaid rent, prepaid insurance and receivables from landlords for tenant allowances. Tenant allowance receivables were $2,487,000 and $3,582,000 at January 29, 2005, and January 31, 2004, respectively.

Property and equipment — Property and equipment are stated at cost. Depreciation is computed on a straight-line basis over the estimated useful lives of the respective assets. Furniture, fixtures and equipment are generally depreciated over 5 years. Buildings are depreciated over 40 years. Leasehold improvements are amortized over the shorter of the useful life of the asset or the expected lease term. Maintenance and repairs are expensed as incurred and improvements are capitalized. Gains or losses on the disposition of fixed assets are recorded upon disposal. As of January 29, 2005, and January 31, 2004, the Company had property and equipment with aggregated original acquisition costs of $26.9 million and $23.2 million that were fully-depreciated.

Debt issue costs — Debt issue costs are amortized using the straight-line method, which approximates the interest method, over the life of the debt and are shown net of accumulated amortization of $6,000 at January 29, 2005, and $351,000 at January 31, 2004. Amortization of debt issue costs is included as a separate component of interest expense in the consolidated statements of operations.

Long-lived assets — The Company periodically reviews the recoverability of property and equipment and other long-lived assets whenever an event or change in circumstances indicates the carrying amount of an asset or group of store-level assets may not be recoverable. The impairment review includes comparison of future cash flows expected to be generated by the asset or group of store-level assets with their associated carrying value. If the carrying value of the asset or group of store-level assets exceeds the expected cash flows (undiscounted and without interest charges), an impairment loss is recognized to the extent the carrying amount of the asset exceeds its fair value. The Company recorded an impairment of $401,000 and $223,000 during fiscal 2004 and fiscal 2003, respectively, which represents the impairment of the leasehold improvements of stores anticipated to be closed. These impairment charges are included in depreciation and amortization on the consolidated statements of operations. No impairment charge was recorded during fiscal 2002. These stores also had other long-lived assets, consisting of computer equipment, furniture and fixtures, and other equipment with carrying values of $542,000 and $409,000 in fiscal 2004 and 2003, respectively, that were not considered to be impaired due to the transfer of such assets for use in other store locations or the corporate office.

Goodwill — The Company accounts for its goodwill in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. Accordingly, goodwill is not amortized but reviewed for impairment on an annual

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

basis during each fourth quarter or more frequently when events and circumstances indicate that an impairment may have occurred. Upon adoption of SFAS No. 142 in fiscal 2002, there was accumulated amortization on goodwill of $285,000. The Company has not recorded an impairment to its goodwill since adopting SFAS No. 142.

Insurance reserves — Workers’ compensation, general liability and employee medical insurance programs are self-insured up to certain stop-loss limits. It is the Company’s policy to record its self-insurance liability using estimates of claims incurred but not yet reported or paid, based on historical trends. Actual results can vary from estimates for many reasons, including, among others, inflation rates, claim settlement patterns, litigation trends and legal interpretations.

Customer loyalty program — During fiscal 2004, the Company established a private-label credit card program for its customers. The card program is operated and managed by a third-party bank that assumes all credit risk with no recourse to the Company. All cardholders are automatically enrolled in a loyalty program whereby they earn loyalty points by making purchases in the Company’s stores. Attaining specified loyalty point levels results in the issuance of discount certificates to the cardholder. The Company accrues for the expected liability, based on estimated redemption rates associated with the discount certificates issued as well as the accumulated points that have not yet resulted in the issuance of a certificate.

Deferred rent — Many of the Company’s operating leases contain predetermined fixed escalations of minimum rentals during the lease term, as defined by SFAS No. 13, Accounting for Leases , as amended. Additionally, the Company may not pay rent during the build-out period for its new stores. For these leases, the Company recognizes the related rental expense on a straight-line basis over the lease term commencing with the date of entry to the leased space, and records the difference between amounts charged to operations and amounts paid as a noncurrent liability. The cumulative net excess of recorded rent expense over lease payments made of $6.2 million and $5.0 million is reflected in deferred rent in the consolidated balance sheets as of January 29, 2005, and January 31, 2004, respectively.

The Company also receives incentives from landlords in the form of construction allowances. These construction allowances are recorded as a noncurrent liability and amortized as a reduction to rent expense over the lease term. The unamortized amount of construction allowances of $19.3 million and $13.2 million is also reflected in deferred rent in the consolidated balance sheets as of January 29, 2005, and January 31, 2004, respectively.

Revenue recognition — The Company recognizes revenue at the time of sale of merchandise to customers. Net sales include the sale of merchandise, net of returns and exclusive of sales taxes. Revenues from gift cards, gift certificates and store credits are recognized when redeemed.

Cost of sales — Cost of sales includes the cost of product sold (including freight costs), store occupancy costs and central distribution costs.

Compensation and benefits — Compensation and benefits includes all store and corporate office salaries and wages and incentive pay as well as employee health benefits, 401(k) plan benefits, social security and unemployment taxes.

Other operating expenses — Other operating expenses consist of such items as insurance, advertising, property taxes, supplies, losses on disposal of assets and various other store and corporate expenses.

Preopening expenses — Preopening expenses, which consist primarily of payroll and occupancy costs, are expensed as incurred.

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Advertising expenses — Advertising costs are expensed in the period in which the advertising first takes place. Advertising expense was $4,192,000, $2,456,000, and $2,447,000 for fiscal years 2004, 2003 and 2002, respectively.

Other income — Other income consists of sales tax rebates of $170,000, $144,000, and $149,000 for fiscal years 2004, 2003 and 2002, respectively, and other miscellaneous income of $64,000, $30,000, and $23,000 for fiscal years 2004, 2003 and 2002, respectively.

Income taxes — Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

Stock options — The Company applies Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related Interpretations, in accounting for its stock compensation plans. These plans are more fully described in Note 9 to these financial statements. Compensation cost on stock options is measured as the excess, if any, of the fair value of the Company’s common stock at the date of the grant over the exercise price. The following table illustrates the effect on net income allocable to common shareholders and earnings per share had the Company applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure — an Amendment of FASB Statement No. 123.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, Share-Based Payment, a revision of SFAS No. 123. Pursuant to SFAS No. 123R, the pro forma disclosures permitted under SFAS No. 123 will no longer be an alternative to recognition within the financial statements. The Company is required to adopt SFAS No. 123R in the third quarter of fiscal 2005.


		52 Weeks Ended

		January 29,			January 31,			February 1,
		2005			2004			2003

					(Restated)			(Restated)
Net income allocable to common shareholders, as reported		$	6,589		$	18,041		$	10,271
Add: Stock-based compensation costs, net of taxes, included in determination of net income allocable to common shareholders			209			269			1,973
Deduct: Stock-based compensation costs, net of taxes, determined under the fair value based method for all awards			(648	)		(621	)		(2,064	)

Pro forma net income allocable to common shareholders		$	6,150		$	17,689		$	10,180

Earnings per share:
	Basic, as reported	$	0.34		$	0.95		$	0.73

	Basic, pro forma	$	0.32		$	0.93		$	0.73

	Diluted, as reported	$	0.34		$	0.92		$	0.70

	Diluted, pro forma	$	0.31		$	0.91		$	0.69

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model based upon the following assumptions: expected volatility ranging from 41.9% to 47.3% for fiscal 2004, 51.4% to 55.0% for fiscal 2003, and 55.0% for 2002; risk-free interest rates ranging from 3.4%

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

to 3.9% in fiscal 2004, 2.4% to 3.4% in fiscal 2003 and 2.9% in fiscal 2002; expected lives of 5 years; and no expected dividend payments.

Use of estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingencies at the date of the financial statements and the related reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Fair value of financial instruments — SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosure of the fair values of most on and off balance sheet financial instruments for which it is practicable to estimate that value. The scope of SFAS No. 107 excludes certain financial instruments such as trade receivables and payables, lease contracts and all non-financial instruments such as buildings and equipment. As of January 29, 2005, the book value approximated fair value for all of the Company’s assets and liabilities that fall under the scope of SFAS No. 107.

Non-cash supplemental disclosure — Accretion of redeemable preferred stock and dividends accrued for each of the periods presented have been excluded from the statements of cash flows. Certain non-cash equity transactions related to the Company’s initial public offering and the exercise of stock options were also excluded from the statements of cash flows. These transactions are reported separately on the face of the Company’s consolidated statement of shareholders’ equity (deficit). Additionally, during fiscal 2002, the Company exchanged certain computer equipment in return for credits provided by a vendor amounting to $149,000.

Earnings per share — Basic earnings per share is computed by dividing net income allocable to common shareholders by the weighted average number of common shares outstanding during each period presented. Diluted earnings per share is computed by dividing net income allocable to common shareholders by the weighted average number of common shares outstanding plus the dilutive effect of common stock equivalents outstanding during the applicable periods.

Comprehensive income — Comprehensive income is reported in accordance with SFAS No. 130, Reporting Comprehensive Income. Comprehensive income does not differ from the consolidated net income allocable to common shareholders presented in the consolidated statements of operations.

Operating segments — An operating segment is defined as a component of an enterprise that engages in business activities from which it may earn revenues and incur expenses and about which separate financial information is regularly evaluated by the chief operating decision maker in deciding how to allocate resources. Due to the similar economic characteristics of the Company’s stores, the Company operates as one business segment and does not disclose separate segment information.

Recent accounting pronouncements — In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, a revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123R requires the fair-value measurement of all stock-based awards to employees, including stock option grants, and the recognition of the resulting expense in the Company’s consolidated financial statements. The provisions of SFAS No. 123R are effective for reporting periods beginning after June 15, 2005. Accordingly, the Company will be required to adopt SFAS No. 123R in the third quarter of fiscal 2005. The Company will continue to account for stock-based compensation using the intrinsic value approach until adoption of SFAS No. 123R on July 31, 2005. The Company is currently evaluating the provisions of SFAS No. 123R and has not yet determined the method of adoption, its impact on the Company’s financial statements, or its impact in relation to the pro forma disclosures historically disclosed in the notes to the financial statements.

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In November 2004, the FASB issued SFAS No. 151, Inventory Costs, which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. The statement is effective for fiscal years beginning after June 15, 2005. The Company does not believe that the adoption of SFAS No. 151 will have a material impact on the Company’s financial statements.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Non-Monetary Assets, which eliminates the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. SFAS No. 153 will be effective for fiscal periods beginning after June 15, 2005. The Company does not believe that the adoption of SFAS No. 153 will have a material impact on the Company’s financial statements.


Note 2 —	Restatement of Financial Statements

In December 2004, the Company initiated a review of certain aspects of its lease-related accounting practices. As a result of this review, the Company changed two of these practices and restated certain historical financial information for prior periods to correct these errors in lease accounting.

Historically, the Company has recognized rent expense for leases on a straight-line basis beginning on the earlier of the store opening date or the lease commencement date. This had the effect of excluding the store construction period, or build-out period, from the term over which rent is expensed. Based on a re-examination of the applicable accounting literature, including SFAS No. 13, Accounting for Leases, FASB Technical Bulletin No. 88-1 (“FTB 88-1”), Issues Relating to Accounting for Leases, and FASB Technical Bulletin 85-3 (“FTB 85-3”), Accounting for Operating Leases With Scheduled Rent Increases, the Company determined that the proper accounting practice is to include the build-out period in the lease term for determining straight-line rent expense on all operating leases. Previously, the Company also recorded tenant construction allowances received from landlords against the related leasehold improvements on a “net” basis. Based on a re-examination of the same accounting literature, the Company determined that the proper accounting was to record such landlord incentives as a deferred rent liability that is amortized as a reduction of rent expense over the lease term.

The Company restated its balance sheet as of January 31, 2004, and its consolidated statements of operations, changes in shareholders’ equity and cash flows for the years ended January 31, 2004 and February 1, 2003 to reflect these corrections. The Company also restated its quarterly financial information for fiscal 2003 and the first three quarters of fiscal 2004. The restatement also affected periods prior to fiscal 2002. The impact of the restatement on such prior periods has been reflected as an adjustment of $1,071,000 to retained earnings as of February 2, 2002 in the consolidated statement of changes in shareholders’ equity. As a result of this restatement, the Company’s financial results have been adjusted as follows (in thousands, except per share data):


	As Previously
	Reported						As Restated

	January 31,						January 31,
	2004			Adjustments			2004

Property and equipment, net	$	33,087		$	13,159		$	46,246
Deferred rent		3,102			15,073			18,175
Noncurrent deferred income taxes		(230	)		756			526
Retained earnings		(78,299	)		(1,158	)		(79,457	)
Total shareholders’ equity		59,230			(1,158	)		58,072

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


		As Previously
		Reported						As Restated

		Year Ended						Year Ended
		January 31,						January 31,
		2004			Adjustments			2004

Net sales		$	369,158		$	—		$	369,158
Cost of sales			243,581			(1,736	)		241,845

	Gross profit		125,577			(1,736	)		127,313
Total other operating expenses			87,763			56			87,819
Depreciation and amortization			7,478			1,847			9,325

	Operating income		30,336			(167	)		30,169
Total interest expense			695			—			695
Other income, net			(208	)		—			(208	)

	Income before income taxes		29,849			(167	)		29,682
Income tax provision			11,706			(65	)		11,641

	Net income	$	18,143		$	(102	)	$	18,041

Earnings per share:
Basic		$	0.95					$	0.95

Diluted		$	0.93					$	0.92


		As Previously
		Reported						As Restated

		Year Ended						Year Ended
		February 1,						February 1,
		2003			Adjustments			2003

Net sales		$	341,504		$	—		$	341,504
Cost of sales			220,561			(1,554	)		219,007

	Gross profit		120,943			(1,554	)		122,497
Total other operating expenses			81,563			—			81,563
Depreciation and amortization			6,683			1,529			8,212

	Operating income		32,697			25			32,722
Total interest expense			6,319			—			6,319
Other income, net			(215	)		—			(215	)

	Income before income taxes		26,593			25			26,618
Income tax provision			10,711			10			10,721

	Net income before accretion of preferred stock and dividends accrued		15,882			15			15,897
Accretion of preferred stock and dividends accrued			(5,626	)		—			(5,626	)

	Net income	$	10,256		$	15		$	10,271

Earnings per share:
Basic		$	0.73					$	0.73

Diluted		$	0.70					$	0.70

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	As Previously
	Reported						As Restated

	Year Ended						Year Ended
	January 31,						January 31,
	2004			Adjustments			2004

Cash flows from operating activities	$	28,971		$	6,968		$	35,939
Cash flows from investing activities		(15,791	)		(6,968	)		(22,759	)
Cash flows from financing activities		(1	)		—			(1	)

Net increase in cash	$	13,179		$	—		$	13,179


	As Previously
	Reported						As Restated

	Year Ended						Year Ended
	February 1,						February 1,
	2003			Adjustments			2003

Cash flows from operating activities	$	18,709		$	2,778		$	21,487
Cash flows from investing activities		(8,391	)		(2,778	)		(11,169	)
Cash flows from financing activities		(35,825	)		—			(35,825	)

Net decrease in cash	$	(25,507	)	$	—		$	(25,507	)


Note 3 —	Initial Public Offering

On July 10, 2002, the Company completed an initial public offering of 6.0 million shares of common stock, of which 1.075 million shares were sold by selling shareholders, at a price of $15.00 per share. The net proceeds to the Company from the offering, after underwriting discounts and transaction expenses, were approximately $66.5 million. The net proceeds were used to repay all of the Company’s outstanding subordinated debt and accrued interest thereon and to purchase a portion of the outstanding shares of the Company’s Class A Preferred Stock, Class B Preferred Stock, Class C Preferred Stock, Class D Preferred Stock and common stock.

Immediately prior to the offering, the Company effected a 54.9827-for-1 stock split. Accordingly, all references in the consolidated financial statements to the number of shares outstanding, price per share and other share and per share amounts have been retroactively restated to reflect the stock split for all periods presented. Concurrent with the offering, all of the Company’s outstanding common stock warrants were exercised resulting in the issuance of 2,096,135 shares of common stock. Additionally, all outstanding shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock that were not redeemed with the proceeds of the offering were converted into 4,209,906 shares of common stock. All outstanding shares of Class C Preferred Stock that were not redeemed with proceeds of the offering were exchanged for 567,526 shares of common stock, which shares were sold in the offering (see Note 11).

As a result of the initial public offering, the Company’s charter was amended, authorizing 100,000,000 shares of no par value common stock and 10,000,000 shares of no par value preferred stock.

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Note 4 —	Property and Equipment

Property and equipment is comprised of the following (in thousands):


	January 29,		January 31,
	2005		2004

			(Restated)
Land	$	402	$	402
Buildings		3,481		3,481
Equipment		29,711		18,960
Furniture and fixtures		40,863		35,896
Leasehold improvements		43,838		32,787
Projects in progress		793		1,924

		119,088		93,450
Less: accumulated depreciation		55,068		47,204

	$	64,020	$	46,246


Note 5 —	Accrued Expenses

Accrued expenses are comprised of the following (in thousands):


	January 29,		January 31,
	2005		2004

Salaries and wages	$	2,018	$	1,768
Stock compensation		481		380
Gift certificates and store credits		6,654		5,182
Lease termination accrual		—		1,263
Self-insurance		1,536		1,877
Sales taxes		1,751		1,568
Other		2,496		2,047

	$	14,936	$	14,085


Note 6 —	Income Taxes

The provision (benefit) for income taxes consists of the following (in thousands):


		52 Weeks Ended

		January 29,		January 31,		February 1,
		2005		2004		2003

				(Restated)		(Restated)
Current
	Federal	$	730	$	8,013	$	10,085
	State		118		1,663		1,856

		$	848	$	9,676	$	11,941

Deferred
	Federal	$	2,847	$	1,894	$	(820	)
	State		603		71		(400	)

			3,450		1,965		(1,220	)

		$	4,298	$	11,641	$	10,721

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Significant components of the Company’s deferred tax assets (liabilities) are as follows (in thousands):


		January 29,			January 31,
		2005			2004

					(Restated)
Current deferred tax assets:
	Inventory valuation methods	$	422		$	582
	Accruals		843			1,231

			1,265			1,813

Noncurrent deferred tax assets (liabilities):
	Deferred rent and other		2,797			1,973
	Net operating loss and credit carryforwards		260			296
	Property and equipment		(5,433	)		(1,743	)

			(2,376	)		526

Total deferred tax assets (liabilities)		$	(1,111	)	$	2,339

A reconciliation of the provision for income taxes to the amount computed by applying the federal statutory tax rate of 35.0% to income before income taxes for the periods indicated below, respectively, is as follows:


	52 Weeks Ended

	January 29,			January 31,			February 1,
	2005			2004			2003

				(Restated)			(Restated)
Statutory federal income tax rate		35.0	%		35.0	%		35.0	%
State income taxes, net of federal benefit		4.3	%		3.8	%		4.0	%
Non-deductible stock compensation		0.6	%		0.3	%		1.4	%
Other		(0.4	)%		0.1	%		(0.1	)%

		39.5	%		39.2	%		40.3	%

At January 29, 2005, and January 31, 2004, the Company was in a net operating loss carryforward position in certain states. The Company had an aggregate of $4.0 million and $4.6 million in certain states at January 29, 2005, and January 31, 2004, respectively. These carryforwards will expire, if unused in 2014 through 2018. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. Due to the likelihood of full utilization of the remaining state net operating loss carryforwards, no valuation allowance has been provided as of January 29, 2005.


Note 7 —	Senior Credit Facility

Effective October 4, 2004, the Company entered into a new, five-year senior secured revolving credit facility with a revolving loan limit of up to $45 million. The revolving credit facility bears interest at a floating rate equal to the 60-day LIBOR rate (2.6% at January 29, 2005) plus 1.25% to 1.50% (depending on the amount of excess availability under the borrowing base). Additionally, the Company pays a fee to the bank equal to a rate of 0.2% per annum on the unused portion of the revolving line of credit. Borrowings under the facility are collateralized by substantially all of the Company’s assets and guaranteed by the Company’s subsidiaries. The maximum availability under the credit facility is limited by a borrowing base formula, which consists of a percentage of eligible inventory less reserves. The facility also contains provisions that could result in changes to the presented terms or the acceleration of maturity. Circumstances that could lead to such changes or acceleration include a material adverse change in the

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

business or an event of default under the credit agreement. The facility has one financial covenant that requires the Company to maintain excess availability under the borrowing base, as defined in the credit agreement, of $3 million at all times. The facility matures in October 2009. As of January 29, 2005, there were no outstanding borrowings under the credit facility, with approximately $20.3 million available for borrowing.

The proceeds from this new credit facility were used to repay existing indebtedness, consisting of amounts outstanding under the Company’s previous $45 million secured revolving credit facility dated May 22, 2002, which was thereupon terminated. As a result of this early termination, during the third quarter of fiscal 2004, the Company incurred a pre-tax charge of $364,000 consisting of a prepayment penalty of $225,000 and a write-off of unamortized debt issue costs of $139,000.

In fiscal 2002, the Company repaid a $15 million term loan that had been a component of the credit facility dated May 22, 2002. As a result of this early extinguishment, the Company recorded a loss of $325,000 relating to the unamortized issue costs associated with the term loan.


Note 8 —	Long-Term Leases (restated)

The Company leases retail store facilities, warehouse facilities and certain equipment under operating leases with terms ranging up to 15 years and expiring at various dates through 2019. Most of the retail store lease agreements include renewal options and provide for minimum rentals and contingent rentals based on sales performance in excess of specified minimums. Rent expense under operating leases was $31,349,000, $27,712,000, and $25,402,000 in fiscal years 2004, 2003 and 2002, respectively. Contingent rental expense was $564,000, $1,146,000, and $1,399,000, for fiscal years 2004, 2003 and 2002, respectively.

Future minimum lease payments under all operating leases with initial terms of one year or more are as follows: $33,016,000 in 2005; $31,432,000 in 2006; $28,970,000 in 2007; $25,875,000 in 2008; and $21,185,000 in 2009; and $66,228,000 thereafter.

The Company occupied a new distribution center during the second quarter of fiscal 2004 under a lease with an initial term of 15 years with two five-year renewal options. The new facility replaced the three leased buildings that previously supported the Company’s central distribution effort. Consequently, after providing notice to the landlords of its intent to terminate the leases, the Company recorded a one-time charge of $1.1 million related to the penalty associated with these early terminations. This charge was recorded in the fourth quarter of fiscal 2003.


Note 9 —	Employee Benefit Plans

Stock awards — On June 12, 1996, the Company adopted the “1996 Executive Incentive and Non-Qualified Stock Option Plan” (the “1996 Plan”), which provides employees and officers with opportunities to purchase shares of the Company’s common stock. The 1996 Plan authorized the grant of incentive and non-qualified stock options and required that the exercise price of incentive stock options be at least 100% of the fair market value of the stock at the date of the grant. As of January 29, 2005, options to purchase 337,855 shares of common stock were outstanding under the 1996 Plan at exercise prices ranging from $1.29 to $1.73. No additional options may be granted under the 1996 Plan.

On September 28, 1999, the Company’s Board of Directors re-priced certain employee options granted in 1998 to $1.73 per share, which was not less than the fair value of the Company’s stock at the date of the repricing, as determined by the Company’s Board of Directors. The repricing resulted in variable accounting under the provisions of APB 25. The compensation charge was based on the excess of the fair value of the Company’s common stock over the $1.73 exercise price of the stock options. The Company recognized a non-cash stock compensation charge of $742,000 for the 2002 fiscal year. The holder exercised these options on May 4, 2002.

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

On November 27, 2001, the Company granted options to purchase 505,841 shares of common stock to certain employees at an exercise price of $1.29 per share. The estimated fair value of the Company’s common stock was greater than the exercise price of the stock options on the date of grant. Accordingly, the Company has recognized compensation expense in accordance with the vesting provisions of the grant of approximately $209,000 for fiscal 2004, $269,000 for fiscal 2003, and $280,000 for fiscal 2002.

In July 2002, the Company adopted the Kirkland’s, Inc. 2002 Equity Incentive Plan (the “2002 Plan”). The 2002 Plan provides for the award of restricted stock, incentive stock options, non-qualified stock options and stock appreciation rights with respect to shares of common stock to employees, directors, consultants and other individuals who perform services for the Company. The 2002 Plan is authorized to provide awards for up to a maximum of 2,500,000 shares of common stock. Options issued under the 2002 Plan have maximum contractual terms of 10 years and generally vest ratably over 3 years. As of January 29, 2005, options to purchase 300,000 shares of common stock were outstanding under the 2002 Plan at exercise prices ranging from $8.84 to $18.55 per share.

The following table summarizes information about employee stock options outstanding and exercisable at January 29, 2005:


	Options Outstanding

			Weighted Average
	Number		Remaining Contractual		Weighted Average
Range of Exercise Prices	of Shares		Life (In Years)		Exercise Price

$1.29		289,880		6.8	$	1.29
$1.73		47,975		2.4	$	1.73
$8.84 - $11.75		135,000		9.7	$	9.47
$14.58 - $18.55		165,000		8.5	$	17.46

Total		637,855		7.5	$	7.24


	Options Exercisable

	Number		Weighted Average
Range of Exercise Prices	of Shares		Exercise Price

$1.29		289,880	$	1.29
$1.73		47,975	$	1.73
$8.84 - $11.75		25,000	$	11.61
$14.58 - $18.55		97,490	$	17.01

Total		460,345	$	5.22

Transactions under the Company’s stock option plans in each of the periods indicated are as follows:


					Weighted		Weighted Average
		Number of			Average		Fair Value of Stock
		Shares			Exercise Price		at Grant Date

Balance at February 2, 2002			1,186,637		$	0.91
Options granted:
	Exercise price less than fair market value		103,807		$	0.01	$	15.00
	Exercise price greater than fair market value		25,000		$	15.00	$	11.06
Options exercised			(166,700	)	$	1.69
Options forfeited			(434,904	)	$	0.01

Balance at February 1, 2003			713,840		$	1.64

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


					Weighted		Weighted Average
		Number of			Average		Fair Value of Stock
		Shares			Exercise Price		at Grant Date

Options granted:
	Exercise price equal to fair market value		148,000		$	17.98	$	17.98
Options exercised			(231,288	)	$	0.74
Options forfeited			(29,309	)	$	3.69

Balance at January 31, 2004			601,243		$	5.91
Options granted:
	Exercise price equal to fair market value		145,000		$	9.90	$	9.90
Options exercised			(82,763	)	$	1.44
Options forfeited			(25,625	)	$	9.85

Balance at January 29, 2005			637,855		$	7.24

Options Exercisable As of:
January 29, 2005			460,345		$	5.22

January 31, 2004			314,635		$	3.11

February 1, 2003			376,615		$	1.96

The weighted average remaining contractual life of the options was 7.5 years, 7.7 years, and 7.3 years for the fiscal years ended 2004, 2003, and 2002, respectively.

Employee Stock Purchase Plan — In July 2002, upon completion of the initial public offering, the Company adopted an Employee Stock Purchase Plan (“ESPP”). Under the ESPP, full-time employees who have completed twelve consecutive months of service are allowed to purchase shares of the Company’s common stock, subject to certain limitations, through payroll deduction, at 85% of the fair market value. The Company’s ESPP is authorized to issue up to 500,000 shares of common stock. During fiscal 2004, fiscal 2003, and fiscal 2002, there were 21,175, 27,936 and 7,417 shares of common stock, respectively, issued to participants under the ESPP.

401(k) Savings Plan — The Company maintains a defined contribution 401(k) employee benefit plan, which covers all employees meeting certain age and service requirements. Up to 6% of the employee’s compensation may be matched at the Company’s discretion. This discretionary percentage was 50% of an employee’s contribution subject to Plan maximums in fiscal 2004. The Company’s matching contributions were approximately $283,000, $285,000, and $299,000 in fiscal 2004, 2003 and 2002, respectively. The Company has the option to make additional contributions to the Plan on behalf of covered employees; however, no such contributions were made in fiscal 2004, 2003 or 2002.

Deferred compensation plan — Effective March 1, 2005, the Company adopted The Executive Non-Qualified Excess Plan (the “Deferred Compensation Plan”). The Deferred Compensation Plan is available for certain employees whose benefits under the 401(k) Savings Plan are limited due to provisions of the Internal Revenue Code. No expenses were incurred in fiscal 2004, 2003, or 2002 relating to this plan as it was adopted subsequent to January 29, 2005.


Note 10 —	Earnings Per Share

Basic earnings per share are based upon the weighted average number of shares outstanding during each of the periods presented. Diluted earnings per share is based upon the weighted average number of shares outstanding plus the shares that would be outstanding assuming exercise of dilutive common stock equivalents.

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The computations for basic and diluted earnings per share are as follows (in thousands, except for per share amounts):


		52 Weeks Ended

		January 29,		January 31,		February 1,
		2005		2004		2003

				(Restated)		(Restated)
Numerator:
	Net income allocable to common shareholders	$	6,589	$	18,041	$	10,271

Denominator:
	Denominator for basic earnings per share, weighted-average shares outstanding		19,231		19,048		13,979
	Effect of dilutive stock options		310		497		678

	Denominator for diluted earnings per share, adjusted weighted-average shares outstanding		19,541		19,545		14,657

Basic earnings per share		$	0.34	$	0.95	$	0.73

Diluted earnings per share		$	0.34	$	0.92	$	0.70

The calculations of diluted earnings per share for fiscal 2004, 2003 and 2002 exclude stock options and warrants outstanding of 128,055, 28,915, and 1,449,967, respectively, as the effect of their inclusion would be anti-dilutive.


Note 11 —	Related Parties


	*Aircraft rental*

The Company rents aircraft from an entity owned by a member of its Board of Directors. Rental expense approximated $15,000, $97,000, and $130,000, in fiscal 2004, 2003 and 2002, respectively.


	*Operating lease*

The Company leases retail space for its store in Jackson, Tennessee from a landlord in which the Company’s Chairman of the Board of Directors, President and Chief Executive Officer and another member of the Company’s Board of Directors maintain a minority interest. The lease was entered into during fiscal 2004. During fiscal 2004, the Company paid approximately $116,000 for rent and related ancillary charges pursuant to this lease. The Audit Committee of our Board of Directors approved this relationship.


	*Shareholder Agreements*

In contemplation of the initial public offering, in May 2002, the Company entered into a stock repurchase agreement with certain of its shareholders. The agreement was amended on July 10, 2002, upon completion of the offering. The agreement specifies the class and number of shares of capital stock that were to be repurchased in the offering. The purchase price of each share of Class A, Class B and Class D Preferred Stock was to be equal to 93% of the sum of (i) the stated value of such share plus (ii) all dividends with respect to such share accrued and unpaid through the completion of the offering. The purchase price for a share of Class C Preferred Stock was to be equal to 100% of the stated value of such share. The purchase price for each share of common stock was to be equal to 93% of the offering price of $15.00. The aggregate difference between the purchase price and the carrying values of the

KIRKLAND’S, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Class A, Class B and Class D Preferred Stock of $1,945,000 was recorded as common equity upon completion of the offering.

Also in contemplation of the initial public offering, in May 2002, the Company entered into an agreement with its founder and then Chairman under which he agreed to exchange all of his outstanding shares of Class C Preferred Stock, having an aggregate stated value of $7.9 million, for shares of the Company’s common stock. The number of shares to be issued under this agreement was to be equal to the stated value of the shares of Class C Preferred Stock divided by 93% of the initial public offering price. This 7% discount related to the inducement associated with this exchange agreement was recorded as a $554,000 charge to interest expense, and accordingly reflected as a component of the Company’s earnings per share, upon the occurrence of the offering. All of the shares acquired by the then Chairman under this exchange agreement were subsequently sold in the offering.


	*Shareholder Loan*

On May 4, 2002, the Company loaned $217,000 to its Executive Vice President and Chief Financial Officer. The note bears interest at the rate of 4.75% per year, and is payable over the term of the note. The note matures in May 2005 and is due and payable in full at that time. On April 10, 2003, the Company advanced an additional $381,401 to the borrower in accordance with the original terms of the note. This additional principal amount is subject to the same interest rate and principal repayment as the original principal amount. The loan is collateralized by marketable securities having a value of no less than the original principal amount of the loan together with 125,526 shares of the Company’s common stock owned by the borrower. The pledge agreement between the Company and the borrower requires the borrower to supply additional collateral at any time the value of existing collateral falls below 125% of the then principal amount of the loan. The loan was approved by the Company’s Board of Directors and Audit Committee.


Note 12 —	Commitments and Contingencies

Financial instruments that potentially subject the Company to concentration of risk are primarily cash and cash equivalents. The Company places its cash and cash equivalents in insured depository institutions and attempts to limit the amount of credit exposure to any one institution within the covenant restrictions imposed by the Company’s debt agreements.

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 will have a material effect on the financial condition, operating results or cash flows of the Company.


Note 13 —	Consulting Contract

In July 2001, the Company entered into a contract with a consultant to provide services to the Company for $16,667 per month. Under the terms of the agreement, the consultant was also granted a warrant to purchase 103,807 shares of the Company’s common stock for $0.01 per share. The warrant became exercisable upon the consummation of the initial public offering in July 2002. At that time, the Company recorded a charge of $1.6 million upon completion of the initial public offering representing the expense related to this arrangement based upon the fair value of the warrant at that date. On June 20, 2003, the warrant was exercised by the consultant.


	3.	Exhibits: (see (b) below)

(b) Exhibits.

The following is a list of exhibits filed as part of this annual report on Form 10-K. For exhibits incorporated by reference, the location of the exhibit in our previous filing is indicated in parentheses.


Exhibit
Number				Description

	3	.1*	—	Amended and Restated Charter of Kirkland’s, Inc. (Exhibit 3.1 to the Company’s Annual Report on Form 10-K filed on May 1, 2003) (the “2002 Form 10-K”)
	3	.2*	—	Amended and Restated Bylaws of Kirkland’s, Inc. (Exhibit 3.2 to the 2002 Form 10-K)
	4	.1*	—	Form of Specimen Stock Certificate (Exhibit 4.1 to Amendment No. 1 to the Company’s registration statement on Form S-1 of Kirkland’s filed on June 5, 2002, Registration No. 333-86746 (“Amendment No. 1 to 2002 Form S-1”))
	10	.1*	—	Loan and Security Agreement, dated as of October 4, 2004, by and among Kirkland’s, Inc., Kirkland’s Stores, Inc. and kirklands.com, inc., Fleet Retail Group, Inc., as Agent, and the Financial Institutions Party Thereto From Time to Time as Lenders (Exhibit 10.1 to the Company’s Form 8-K dated October 8, 2004)
	10	.2*	—	Amended and Restated Registration Rights Agreement dated as of April 15, 2002, by and among Kirkland Holdings L.L.C., Kirkland’s, Inc., SSM Venture Partners, L.P., Joseph R. Hyde III, Johnston C. Adams, Jr., John H. Pontius, CT/Kirkland Equity Partners, L.P., R-H Capital Partners, L.P., TCW/Kirkland Equity Partners, L.P., Capital Resource Lenders II, L.P., Allied Capital Corporation, The Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., Global Private Equity II Limited Partnership, Advent Direct Investment Program Limited Partnership, Advent Partners Limited Partnership, Carl Kirkland, Robert E. Kirkland, Robert E. Alderson, The Amy Katherine Alderson Trust, The Allison Leigh Alderson Trust, The Carl T. Kirkland Grantor Retained Annuity Trust 2001-1 and Steven Collins (Exhibit 10.2 to Amendment No. 1 to 2002 Form S-1)
	10	.3+*	—	Employment Agreement by and between Kirkland’s and Carl Kirkland dated June 1, 2002, (Exhibit No. 10.5 to Amendment No. 1 to 2002 Form S-1)
	10	.4+*	—	Employment Agreement by and between Kirkland’s and Robert E. Alderson dated June 1, 2002, (Exhibit No. 10.6 to Amendment No. 1 to 2002 Form S-1)
	10	.5+*	—	Employment Agreement by and between Kirkland’s and Reynolds C. Faulkner dated June 1, 2002, (Exhibit 10.7 to Amendment No. 2 to the registration statement on Form S-1 of Kirkland’s filed on June 14, 2002, Registration No. 333-86746 (“Amendment No. 2 to 2002 Form S-1”))
	10	.6+*	—	Amendment to Employment Agreement by and between Kirkland’s, Inc. and Carl Kirkland dated March 31, 2004 (Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended May 1, 2004 (“May 2004 Form 10-Q”))
	10	.7+*	—	Amendment to Employment Agreement by and between Kirkland’s, Inc. and Robert E. Alderson dated March 31, 2004 (Exhibit 10.2 to the May 2004 Form 10-Q)
	10	.8+*	—	Amendment to Employment Agreement by and between Kirkland’s, Inc. and Reynolds C. Faulkner dated March 31, 2004 (Exhibit 10.3 to the May 2004 Form 10-Q)
	10	.9+*	—	1996 Executive Incentive and Non-Qualified Stock Option Plan, as amended through April 17, 2002 (Exhibit 10.10 to the 2002 Form S-1)
	10	.10+*	—	2002 Equity Incentive Plan (Exhibit 10.11 to Amendment No. 1 to 2002 Form S-1)
	10	.11*	—	Employee Stock Purchase Plan (Exhibit 10.12 to Amendment No. 4 to the Company’s registration statement on Form S-1 of Kirkland’s filed on July 10, 2002, Registration No. 333-86746)
	10	.12*	—	Sublease Agreement by and between Southwind Properties and Kirkland’s dated March 5, 2001 (Exhibit 10.16 to the Company’s registration statement on Form S-1 of Kirkland’s filed on April 23, 2002, Registration No. 333-86746 (the “2002 Form S-1”))
	10	.13*	—	Sublease Agreement by and between Phoenician Properties and Kirkland’s dated February 1, 2002, (Exhibit 10.17 to Amendment No. 1 to 2002 Form S-1)


Exhibit
Number				Description

	10	.14*	—	Letter Agreement by and between Kirkland’s and Robert E. Kirkland dated June 3, 2002 (Exhibit 10.19 to Amendment No. 1 to 2002 Form S-1)
	10	.15*	—	Promissory Note for up to $717,000 by Reynolds C. Faulkner in favor of Kirkland’s dated May 4, 2002 (Exhibit 10.23 to Amendment No. 1 to 2002 Form S-1)
	10	.16*	—	Security Agreement by Reynolds C. Faulkner and Mary Ruth Faulkner in favor of Kirkland’s effective as of May 4, 2002 (Exhibit 10.24 to Amendment No. 3 to the Company’s registration statement on Form S-1 of Kirkland’s filed on June 24, 2002, Registration No. 333-86746)
	10	.17+*	—	Form of Non-Qualified Stock Option Award Agreement for Director Grants (Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended October 30, 2004 (“October 2004 Form 10-Q”))
	10	.18+*	—	Form of Incentive Stock Option Agreement (Exhibit 10.2 to the October 2004 Form 10-Q)
	10	.19+	—	Executive Non-Qualified Excess Plan
	21	.1*	—	Subsidiaries of Kirkland’s (Exhibit 21 to 2002 Form S-1)
	23	.1	—	Consent of PricewaterhouseCoopers LLP
	31	.1	—	Certification of the President and Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31	.2	—	Certification of the Executive Vice President and Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32	.1	—	Certification of the President and Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32	.2	—	Certification of the Executive Vice President and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


*	Incorporated by reference.

+ Management contract or compensatory plan or arrangement.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


	Kirkland’s, Inc.


	By:	/s/ Robert E. Alderson



	Robert E. Alderson
	Chairman of the Board, President and Chief Executive Officer

Date: April 14, 2005

Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.


Signature	Title	Date


/s/ Robert E. Alderson Robert E. Alderson	President, Chief Executive Officer and Director (Principal Executive Officer)	April 14, 2005

/s/ Reynolds C. Faulkner Reynolds C. Faulkner	Executive Vice President, Chief Financial Officer and Director (Principal Financial Officer)	April 14, 2005

/s/ Connie L. Scoggins Connie L. Scoggins	Vice President of Finance and Treasurer/Controller (Principal Accounting Officer)	April 14, 2005

/s/ Carl Kirkland Carl Kirkland	Director	April 14, 2005

/s/ Steven J. Collins Steven J. Collins	Director	April 14, 2005

/s/ David M. Mussafer David M. Mussafer	Director	April 14, 2005

/s/ R. Wilson Orr, III R. Wilson Orr, III	Director	April 14, 2005

/s/ John P. Oswald John P. Oswald	Director	April 14, 2005


Signature	Title	Date


/s/ Ralph T. Parks Ralph T. Parks	Director	April 14, 2005

/s/ Murray M. Spain Murray M. Spain	Director	April 14, 2005

KIRKLANDS, INC.

INDEX OF EXHIBITS FILED WITH THIS ANNUAL REPORT ON 10-K


Exhibit
Number			Description

	10	.19	Executive Non-Qualified Excess Plan
	23	.1	Consent of PricewaterhouseCoopers LLP
	31	.1	Certification of the President and Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a)
	31	.2	Certification of the Executive Vice President and Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a)
	32	.1	Certification of the President and Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
	32	.2	Certification of the Executive Vice President and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

EXHIBIT 10.19

THE EXECUTIVE NONQUALIFIED EXCESS PLAN(SM)
PLAN DOCUMENT

.
.

TABLE OF CONTENTS

THE EXECUTIVE NONQUALIFIED EXCESS PLAN(SM)

                                                                                Page
                                                                                ----
Section 1.       Purpose ................................................        1

Section 2.       Definitions ............................................        1

   2.1           "Active Participant" ...................................        1
   2.2           "Adoption Agreement" ...................................        1
   2.3           "Beneficiary" ..........................................        2
   2.4           "Board" ................................................        2
   2.5           "Change in Control" ....................................        2
   2.6           "Committee" ............................................        2
   2.7           "Compensation" .........................................        2
   2.8           "Crediting Date" .......................................        2
   2.9           "Deferred Compensation Account" ........................        2
   2.10          "Disabled" .............................................        3
   2.11          "Education Account" ....................................        3
   2.12          "Effective Date" .......................................        3
   2.13          "Employee" .............................................        3
   2.14          "Employer" .............................................        4
   2.15          "Employer Credits" .....................................        4
   2.16          "Independent Contractor" ...............................        4
   2.17          "In-Service Account" ...................................        4
   2.18          "Normal Retirement Age" ................................        4
   2.19          "Participant" ..........................................        4
   2.20          "Participating Employer" ...............................        5
   2.21          "Performance-Based Compensation" .......................        5
   2.22          "Plan" .................................................        5
   2.23          "Plan Administrator" ...................................        5
   2.24          "Plan Year" ............................................        5
   2.25          "Provider" .............................................        5
   2.26          "Qualifying Distribution Event" ........................        5
   2.27          "Salary Deferral Agreement" ............................        5
   2.28          "Salary Deferral Credits" ..............................        5
   2.29          "Service" ..............................................        6
   2.30          "Service Bonus" ........................................        6
   2.31          "Spouse" or "Surviving Spouse" .........................        6
   2.32          "Student" ..............................................        6
   2.33          "Trust" ................................................        6
   2.34          "Trustee" ..............................................        6
   2.35          "Unforeseeable Emergency" ..............................        6
   2.36          "Years of Service" .....................................        7

Section 3.       Participation ..........................................         7

Section 4.       Credits to Deferred Compensation Account ...............         7

   4.1           Salary Deferral Credits ................................         7
   4.2           Employer Credits .......................................         8
   4.3           Deferred Compensation Account ..........................         8

Section 5.       Qualifying Distribution Events .........................         9

   5.1           Separation from Service ................................         9
   5.2           Disability .............................................         9
   5.3           Death ..................................................         9
   5.4           In-Service Withdrawals .................................         9
   5.5           Education Withdrawals ..................................        10
   5.6           Change in Control ......................................        11
   5.7           Unforeseeable Emergency ................................        11

Section 6.       Qualifying Distribution Events Payment Options .........        12

   6.1           Payment Options ........................................        12
   6.2           Subsequent Elections ...................................        13
   6.3           Acceleration Prohibited                                         13

Section 7.       Vesting ................................................        13

Section 8.       Accounts; Deemed Investment; Adjustments to Account ....        14

   8.1           Accounts ...............................................        14
   8.2           Deemed Investments .....................................        14
   8.3           Adjustments to Deferred Compensation Account ...........        14

Section 9.       Administration by Committee ............................        15

   9.1           Membership of Committee ................................        15
   9.2           Committee Officers; Subcommittee .......................        15
   9.3           Committee Meetings .....................................        15
   9.4           Transaction of Business ................................        15
   9.5           Committee Records ......................................        16
   9.6           Establishment of Rules .................................        16
   9.7           Conflicts of Interest ..................................        16
   9.8           Correction of Errors ...................................        16
   9.9           Authority to Interpret Plan ............................        16
   9.10          Third Party Advisors ...................................        17
   9.11          Compensation of Members ................................        17
   9.12          Expense Reimbursement ..................................        17
   9.13          Indemnification ........................................        17

Section 10.      Contractual Liability; Trust ...........................        18

   10.1          Contractual Liability ..................................        18
   10.2          Trust ..................................................        18

Section 11.      Allocation of Responsibilities .........................        18

   11.1          Board ..................................................        19
   11.2          Committee ..............................................        19
   11.3          Plan Administrator .....................................        19

Section 12.      Benefits Not Assignable; Facility of Payments ..........        19

   12.1          Benefits not Assignable ................................        19
   12.2          Payments to Minors and Others ..........................        20

Section 13.      Beneficiary ............................................        20

Section 14.      Amendment and Termination of Plan ......................        21

Section 15.      Communication to Participants ..........................        21

Section 16.      Claims Procedure .......................................        21

   16.1          Filing of a Claim for Benefits .........................        21
   16.2          Notification to Claimant of Decision ...................        22
   16.3          Procedure for Review ...................................        22
   16.4          Decision on Review .....................................        23
   16.5          Action by Authorized Representative of Claimant ........        23

Section 17.      Miscellaneous Provisions ...............................        23

   17.1          Set off ................................................        23
   17.2          Notices ................................................        24
   17.3          Lost Distributes .......................................        24
   17.4          Reliance on Data .......................................        24
   17.5          Receipt and Release for Payments .......................        25
   17.6          Headings ...............................................        25
   17.7          Continuation of Employment .............................        25
   17.8          Merger or Consolidation; Assumption of Plan ............        25
   17.9          Construction ...........................................        26

iii

THE EXECUTIVE NONQUALIFIED EXCESS PLAN(SM)

SECTION 1. PURPOSE:

By execution of the Adoption Agreement, the Employer has adopted the Plan set forth herein to provide a means by which certain management Employees and Independent Contractors of the Employer may elect to defer receipt of current Compensation from the Employer in order to provide retirement and other benefits on behalf of such Employees and Independent Contractors of the Employer, as selected in the Adoption Agreement. The Plan is intended to be a nonqualified deferred compensation plan that complies with the provisions of
Section 409A of the Internal Revenue Code (the "Code"). The Plan is intended to be an unfunded plan maintained primarily for the purpose of providing deferred compensation benefits for a select group of management or highly compensated employees under Sections 201(2), 301(a)(3) and 401(a)(1) of the Employee Retirement Income Security Act of 1974 and independent contractors.

SECTION 2. DEFINITIONS:

As used in the Plan, including this Section 2, references to one gender shall include the other and, unless otherwise indicated by the context:

2.1 "ACTIVE PARTICIPANT" means, with respect to any day or date, a Participant who is in Service on such day or date; provided, that a Participant shall cease to be an Active Participant immediately upon a determination by the Committee that the Participant has ceased to be an Employee or Independent Contractor, or that the Participant no longer meets the eligibility requirements of the Plan.

2.2 "ADOPTION AGREEMENT" means the written agreement pursuant to which the Employer adopts the Plan. The Adoption Agreement is a part of the Plan as applied to the Employer.

2.3 "BENEFICIARY" means the person, persons, entity or entities designated or determined pursuant to the provisions of Section 13 of the Plan.

2.4 "BOARD" means the Board of Directors of the Employer, if the Employer is a corporation. If the Employer is not a corporation, "Board" shall mean the Employer.

2.5 "CHANGE IN CONTROL" means a change in ownership or effective control of the Employer, or in the ownership of a substantial portion of the assets of the Employer, as provided in regulations promulgated under Section 409A of the Code.

2.6 "COMMITTEE" means the person designated in the Adoption Agreement. If the Committee designated in the Adoption Agreement is unable to serve, the Employer shall satisfy the duties of the Committee provided for in
Section 9.

2.7 "COMPENSATION" shall have the meaning designated in the Adoption Agreement.

2.8 "CREDITING DATE" means the date designated in the Adoption Agreement for crediting the amount of any Salary Deferral Credits to the Deferred Compensation Account of a Participant. Employer Credits may be credited to the Deferred Compensation Account of a Participant on any day that securities are traded on a national securities exchange.

2.9 "DEFERRED COMPENSATION ACCOUNT" means the account maintained with respect to each Participant under the Plan. The Deferred Compensation Account shall be credited with Salary Deferral Credits and Employer Credits, credited or debited for deemed investment gains or losses, and adjusted for payments in accordance with the rules and elections in effect under Section 8. The Deferred Compensation Account of a Participant shall include any In-Service Account or Education Account of the Participant, if applicable.

2.10 "DISABLED" means a Participant who is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, or is, by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, receiving income replacement benefits for a period of not less than three months under an accident and health plan covering Employees of the Employer.

2.11 "EDUCATION ACCOUNT" means a separate account to be kept for each Participant that has elected to make education withdrawals as described in
Section 5.5. The Education Account shall be adjusted in the same manner and at the same time as the Deferred Compensation Account under Section 8 and in accordance with the rules and elections in effect under Section 8.

2.12 "EFFECTIVE DATE" shall be the date designated in the Adoption Agreement as of which the Plan first becomes effective. Notwithstanding the foregoing, any amounts credited to the account of a Participant pursuant to the terms of a predecessor plan of the Employer which are not earned and vested before January 1, 2005, shall be subject to the terms of this Plan.

2.13 "EMPLOYEE" means an individual in the Service of the Employer if the relationship between the individual and the Employer is the legal relationship of employer and employee and if the individual is a highly compensated or management employee of the Employer. An individual shall cease to be an Employee upon the Employee's termination of Service.

2.14 "EMPLOYER" means the Employer identified in the Adoption Agreement, and any Participating Employer which adopts this Plan. The Employer may be a corporation, a limited liability company, a partnership or sole proprietorship. All references herein to the Employer shall be applied separately to each such Employer as if the Plan were solely the Plan of that Employer.

2.15 "EMPLOYER CREDITS" means the amounts credited to the Participant's Deferred Compensation Account by the Employer pursuant to the provisions of Section 4.2.

2.16 "INDEPENDENT CONTRACTOR" means an individual in the Service of the Employer if the relationship between the individual and the Employer is not the legal relationship of employer and employee. An individual shall cease to be an Independent Contractor upon the termination of the Independent Contractor's Service. An Independent Contractor shall include a director of the Employer who is not an Employee.

2.17 "IN-SERVICE ACCOUNT" means a separate account to be kept for each Participant that has elected to make in-service withdrawals as described in
Section 5.4. The In-Service Account shall be adjusted in the same manner and at the same time as the Deferred Compensation Account under Section 8 and in accordance with the rules and elections in effect under Section 8.

2.18 "NORMAL RETIREMENT AGE" of a Participant means the age designated in the Adoption Agreement.

2.19 "PARTICIPANT" means with respect to any Plan Year an Employee or Independent Contractor who has been designated by the Committee as a Participant and who has entered the Plan or who has a Deferred Compensation Account under the Plan.

2.20 "PARTICIPATING EMPLOYER" means any trade or business (whether or not incorporated) which adopts this Plan with the consent of the Employer identified in the Adoption Agreement.

2.21 "PERFORMANCE-BASED COMPENSATION" means any compensation based on services performed over a period of at least twelve months as provided in regulations promulgated under Section 409A of the Code.

2.22 "PLAN" means The Executive Nonqualified Excess Plan(SM), as herein set out or as duly amended. The name of the Plan as applied to the Employer shall be designated in the Adoption Agreement.

2.23 "PLAN ADMINISTRATOR" means the person designated in the Adoption Agreement. If the Plan Administrator designated in the Adoption Agreement is unable to serve, the Employer shall be the Plan Administrator.

2.24 "PLAN YEAR" means the twelve-month period ending on the last day of the month designated in the Adoption Agreement; provided, that the initial Plan Year may have fewer than twelve months.

2.25 "PROVIDER" means Executive Benefit Services, Inc.

2.26 "QUALIFYING DISTRIBUTION EVENT" means an event described in
Section 5.

2.27 "SALARY DEFERRAL AGREEMENT" means a written agreement entered into between a Participant and the Employer pursuant to the provisions of
Section 4.1

2.28 "SALARY DEFERRAL CREDITS" means the amounts credited to the Participant's Deferred Compensation Account by the Employer pursuant to the provisions of Section 4.1.

2.29 "SERVICE" means employment by the Employer as an Employee. If the Participant is an Independent Contractor, "Service" shall mean the period during which the contractual relationship exists between the Employer and the Participant.

2.30 "SERVICE BONUS" means any bonus paid to a Participant by the Employer which is not Performance-Based Compensation.

2.31 "SPOUSE" or "SURVIVING SPOUSE" means, except as otherwise provided in the Plan, a person of the opposite sex who is the legally married spouse or surviving spouse of a Participant.

2.32 "STUDENT" means the individual designated by the Participant in the Salary Deferral Agreement with respect to whom the Participant will create an Education Account.

2.33 "TRUST" means the trust fund established pursuant to Section 10.2, if designated by the Employer in the Adoption Agreement.

2.34 "TRUSTEE" means the trustee, if any, named in the agreement establishing the Trust and such successor or additional trustee as may be named pursuant to the terms of the agreement establishing the Trust.

2.35 "UNFORESEEABLE EMERGENCY" means a severe financial hardship to the Participant resulting from a sudden or unexpected illness or accident of the Participant, the Participant's Spouse or dependent (as defined in Section 152(a) of the Code), loss of the Participant's property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant.

2.36 "YEARS OF SERVICE" means each Plan Year of Service completed by the Participant. For vesting purposes, Years of Service shall be calculated from the date designated in the Adoption Agreement.

SECTION 3. PARTICIPATION:

The Committee in its discretion shall designate each Employee or Independent Contractor who is eligible to participate in the Plan. An Employee or Independent Contractor designated by the Committee as a Participant who has not otherwise entered the Plan shall enter the Plan and become a Participant as of the date determined by the Committee. A Participant who separates from Service with the Employer and who later returns to Service will not be an Active Participant under the Plan except upon satisfaction of such terms and conditions as the Committee shall establish upon the Participant's return to Service, whether or not the Participant shall have a balance remaining in the Deferred Compensation Account under the Plan on the date of the return to Service.

SECTION 4. CREDITS TO DEFERRED COMPENSATION ACCOUNT:

4.1 SALARY DEFERRAL CREDITS. To the extent provided in the Adoption Agreement, each Active Participant may elect, by entering into a Salary Deferral Agreement with the Employer, to defer the receipt of Compensation from the Employer by a dollar amount or percentage specified in the Salary Deferral Agreement. The amount of the Participant's Salary Deferral Credit shall be credited by the Employer to the Deferred Compensation Account maintained for the Participant pursuant to Section 8. The following special provisions shall apply with respect to the Salary Deferral Credits of a Participant:

4.1.1 The Employer shall credit to the Participant's Deferred Compensation Account on each Crediting Date an amount equal to the total Salary Deferral Credit for the period ending on such Crediting Date.

4.1.2 An election pursuant to Section 4.1 shall be made by the Participant by executing and delivering a Salary Deferral Agreement to the Committee. The Salary Deferral Agreement shall become effective with respect to such Participant as of the first day of January following the date such Salary Deferral Agreement is received by the Committee; provided, that in the case of the first year in which the Participant becomes eligible to participate in the Plan, the Participant may execute and deliver a Salary Deferral Agreement to the Committee within 30 days after the date the Participant enters the Plan to be effective as of the first payroll period next following the date the Salary Deferral Agreement is received by the Committee. A Participant's election shall continue in effect, unless earlier modified by the Participant, until the Participant separates from Service, or, if earlier, until the Participant ceases to be an Active Participant under the Plan.

4.1.3 A Participant may unilaterally modify a Salary Deferral Agreement (either to terminate, increase or decrease the portion of his future Compensation which is subject to salary deferral within the percentage limits set forth in Section 4.1 of the Adoption Agreement) by providing a written modification of the Salary Deferral Agreement to the Employer. The modification shall become effective as of the first day of January following the date such written modification is received by the Committee.

4.1.4 Notwithstanding Sections 4.1.2 and 4.1.3, a Salary Deferral Agreement relating to the deferral of Performance-Based Compensation must be executed and delivered to the Committee no later than the date which is 6 months prior to the end of the performance period, and may not be modified after such date.

4.1.5 The Committee may from time to time establish policies or rules governing the manner in which Salary Deferral Credits may be made.

4.2 EMPLOYER CREDITS. If designated by the Employer in the Adoption Agreement, the Employer shall cause the Committee to credit to the Deferred Compensation Account of each Active Participant an Employer Credit as determined in accordance with the Adoption Agreement.

4.3 DEFERRED COMPENSATION ACCOUNT. All Salary Deferral Credits and Employer Credits shall be credited to the Deferred Compensation Account of the Participant.

SECTION 5. QUALIFYING DISTRIBUTION EVENTS:

5.1 SEPARATION FROM SERVICE. If the Participant separates from Service with the Employer, the vested balance in the Deferred Compensation Account shall be paid to the Participant by the Employer as provided in Section
6. Notwithstanding the foregoing, no distribution shall be made earlier than six months after the date of separation from Service (or, if earlier, the date of death) with respect to a Participant who is a key employee (as defined in
Section 416(i) of the Code without regard to paragraph (5) thereof) of a corporation the stock in which is traded on an established securities market or otherwise.

5.2 DISABILITY. If the Participant becomes Disabled while in Service, the vested balance in the Deferred Compensation Account shall be paid to the Participant by the Employer as provided in Section 6.

5.3 DEATH. If the Participant dies while in Service, the Employer shall pay a benefit to the Participant's Beneficiary in the amount designated in the Adoption Agreement. Payment of such benefit shall be made by the Employer as provided in Section 6. If a Participant dies following his separation from Service for any reason, and before all payments under the Plan have been made, the vested balance in the Deferred Compensation Account shall be paid by the Employer to the Participant's Beneficiary pursuant to Section 6.

5.4 IN-SERVICE WITHDRAWALS. If the Employer designates in the Adoption Agreement that in-service withdrawals are permitted under the Plan, a Participant may elect in the Salary Deferral Agreement to withdraw a designated amount from the Deferred Compensation Account at the specified time or times designated by the Participant in the Salary Deferral Agreement, and the Participant's In-Service Account shall be credited with the amount designated for in-service withdrawals. In no event may an in-service withdrawal be made prior to two years following the establishment of the In-Service Account of the Participant.

Notwithstanding the foregoing, if a Participant incurs a Qualifying Distribution Event prior to the date on which the entire balance in the In-Service Account has been distributed, then the balance in the In-Service Account on the date of the Qualifying Distribution Event shall be distributed to the Participant in the same manner and at the same time as the balance in the Deferred Compensation Account is distributed under Section 6 and in accordance with the rules and elections in effect under Section 6.

5.5 EDUCATION WITHDRAWALS. If the Employer designates in the Adoption Agreement that education withdrawals are permitted under the Plan, a Participant may elect in the Salary Deferral Agreement to withdraw a designated amount from the Deferred Compensation Account at the specified time or times designated by the Participant in the Salary Deferral Agreement, and the Participant's Education Account shall be credited with the amount designated for in-service withdrawals. If the Participant designates more than one Student, the Education Account will be divided into a separate Education Account for each Student, and the Participant may designate in the Salary Deferral Agreement the percentage or dollar amount of the Deferred Compensation Account to be credited to each Education Account. In the absence of a clear designation, all credits made to the Education Account shall be equally allocated to each Education Account. The Employer shall pay to the Participant the balance in the Education Account with respect to the Student at the time and in the manner designated by the Participant in the Salary Deferral Agreement. Notwithstanding the foregoing, if the Participant incurs a Qualifying Distribution Event prior to the date on which the entire balance of the Education Account has been distributed, then the balance in the Education Account on the date of the Qualifying Distribution Event shall be distributed to the Participant in the same manner and at

the same time as the Deferred Compensation Account is distributed under Section 6 and in accordance with the rules and elections in effect under Section 6.

5.6 CHANGE IN CONTROL. If the Employer designates in the Adoption Agreement that distributions are permitted under the Plan due to a Change in Control, the vested balance in the Deferred Compensation Account shall be paid to the Participant by the Employer as provided in Section 6 as soon as practicable following a Change in Control regardless of whether the Participant has separated from Service with the Employer.

5.7 UNFORESEEABLE EMERGENCY. A distribution of the Deferred Compensation Account may be made to a Participant in the event of an Unforeseeable Emergency, subject to the following provisions:

5.7.1 A Participant may, at any time prior to his separation from Service for any reason, make application to the Committee to receive a distribution in a lump sum of all or a portion of the vested balance in the Deferred Compensation Account (determined as of the date the distribution, if any, is made under this Section 5.7) because of an Unforeseeable Emergency. A distribution because of an Unforeseeable Emergency shall not exceed the amount required to satisfy the Unforeseeable Emergency plus amounts necessary to pay taxes reasonably anticipated as a result of such distribution, after taking into account the extent to which the Unforeseeable Emergency may be relieved through reimbursement or compensation by insurance or otherwise or by liquidation of the Participant's assets (to the extend the liquidation of such assets would not itself cause severe financial hardship).

5.7.2 The Participant's request for a distribution on account of Unforeseeable Emergency must be made in writing to the Committee. The request must specify the nature of the financial hardship, the total amount requested to be distributed from the Deferred Compensation Account, and the total amount of the actual expense incurred or to be incurred on account of financial hardship.

5.7.3 If a distribution under this Section 5.7 is approved by the Committee, such distribution will be made as soon as practicable following the date it is approved. The processing of the request shall be completed as soon as practicable from the date on which the Committee receives the properly completed written request for a distribution on account of an Unforeseeable Emergency. A distribution due to Unforeseeable Emergency shall not affect any deferral election previously made by the Participant. If a Participant's separation

from Service occurs after a request is approved in accordance with this
Section 5.7.3, but prior to distribution of the full amount approved, the approval of the request shall be automatically null and void and the benefits which the Participant is entitled to receive under the Plan shall be distributed in accordance with the applicable distribution provisions of the Plan.

5.7.4 The Committee may from time to time adopt additional policies or rules governing the manner in which such distributions may be made so that the Plan may be conveniently administered.

SECTION 6. QUALIFYING DISTRIBUTION EVENTS PAYMENT OPTIONS:

6.1 PAYMENT OPTIONS. The Employer shall designate in the Adoption Agreement the payment options available upon a Qualifying Distribution Event. The Participant shall elect in the Salary Deferral Agreement the method under which the vested balance in the Deferred Compensation Account shall be distributed from among the designated payment options. Payment shall be made in the manner elected by the Participant and shall commence as soon as practicable following the Qualifying Distribution Event. If the Participant elects the installment payment option, the payment of each annual installment shall be made on the anniversary of the date of the first installment payment, and the amount of the annual installment shall be adjusted on such anniversary for credits or debits to the Participant's account pursuant to Section 8 of the Plan. Such adjustment shall be made by dividing the balance in the Deferred Compensation Account on such date by the number of annual installments remaining to be paid hereunder; provided that the last annual installment due under the Plan shall be the entire amount credited to the Participant's account on the date of payment. In the event the Participant fails to make a valid election of the payment method, the distribution will be made in a single lump sum payment upon the Qualifying Distribution Event. Notwithstanding any election made by the Participant, the vested balance in the Deferred Compensation Account of the Participant will be distributed in a single lump sum payment if the amount of such benefit on the date that payment

is to commence does not exceed the maximum amount permitted to be automatically distributed under the regulations promulgated under Section 409A of the Code.

6.2 SUBSEQUENT ELECTIONS. With the consent of the Committee, a Participant may delay or change the method of payment of the Deferred Compensation Account subject to the following requirements:

6.2.1 The new election may not take effect until at least 12 months after the date on which the new election is made.

6.2.2 If the new election relates to a payment for a Qualifying Distribution Event other than the death of the Participant, the Participant becoming Disabled, or an Unforeseeable Emergency, the new election must provide for the deferral of the first payment for a period of at least five years from the date such payment would otherwise have been made.

6.2.3 If the new election relates to a payment from the In-Service Account or Education Account, the new election must be made at least 12 months prior to the date of the first scheduled payment from such account.

6.3 ACCELERATION PROHIBITED. The acceleration of the time or schedule of any payment due under the Plan is prohibited except as provided in regulations promulgated under Section 409A of the Code.

SECTION 7. VESTING:

A Participant shall be fully vested in the portion of his Deferred Compensation Account attributable to Salary Deferral Credits, and all income, gains and losses attributable thereto. A Participant shall become fully vested in the portion of his Deferred Compensation Account attributable to Employer Credits, and income, gains and losses attributable thereto, in accordance with the vesting schedule and provisions designated by the Employer in the Adoption Agreement. If a Participant's Deferred Compensation Account is not fully vested upon separation from Service, the portion of the Deferred Compensation Account that is not fully vested shall thereupon be forfeited.

SECTION 8. ACCOUNTS; DEEMED INVESTMENT; ADJUSTMENTS TO ACCOUNT:

8.1 ACCOUNTS. The Committee shall establish a book reserve account, entitled the "Deferred Compensation Account," on behalf of each Participant. The Committee shall also establish an In-Service Account and Education Account as a part of the Deferred Compensation Account of each Participant, if applicable. The amount credited to the Deferred Compensation Account shall be adjusted pursuant to the provisions of Section 8.3.

8.2 DEEMED INVESTMENTS. The Deferred Compensation Account of a Participant shall be credited with an investment return determined as if the account were invested in one or more investment funds made available by the Committee. The Participant shall elect the investment funds in which his Deferred Compensation Account shall be deemed to be invested. Such election shall be made in the manner prescribed by the Committee and shall take effect upon the entry of the Participant into the Plan. The investment election of the Participant shall remain in effect until a new election is made by the Participant. In the event the Participant fails for any reason to make an effective election of the investment return to be credited to his account, the investment return shall be determined by the Committee.

8.3 ADJUSTMENTS TO DEFERRED COMPENSATION ACCOUNT. With respect to each Participant who has a Deferred Compensation Account under the Plan, the amount credited to such account shall be adjusted by the following debits and credits, at the times and in the order stated:

8.3.1 The Deferred Compensation Account shall be debited each business day with the total amount of any payments made from such account since the last preceding business day to him or for his benefit.

8.3.2 The Deferred Compensation Account shall be credited on each Crediting Date with the total amount of any Salary Deferral Credits and Employer Credits to such account since the last preceding Crediting Date.

8.3.3 The Deferred Compensation Account shall be credited or debited on each day securities are traded on a national stock exchange with the amount of deemed investment gain or loss resulting from the performance of the investment funds elected by the Participant in accordance with Section
8.2. The amount of such deemed investment gain or loss shall be determined by the Committee and such determination shall be final and conclusive upon all concerned.

SECTION 9. ADMINISTRATION BY COMMITTEE:

9.1 MEMBERSHIP OF COMMITTEE. If elected in the Adoption Agreement, the Committee shall consist of at least three individuals who shall be appointed by the Board to serve at the pleasure of the Board. Any member of the Committee may resign, and his successor, if any, shall be appointed by the Board. The Committee shall be responsible for the general administration and interpretation of the Plan and for carrying out its provisions, except to the extent all or any of such obligations are specifically imposed on the Board.

9.2 COMMITTEE OFFICERS; SUBCOMMITTEE. The members of the Committee may elect Chairman and may elect an acting Chairman. They may also elect a Secretary and may elect an acting Secretary, either of whom may be but need not be a member of the Committee. The Committee may appoint from its membership such subcommittees with such powers as the Committee shall determine, and may authorize one or more of its members or any agent to execute or deliver any instruments or to make any payment on behalf of the Committee.

9.3 COMMITTEE MEETINGS. The Committee shall hold such meetings upon such notice, at such places and at such intervals as it may from time to time determine. Notice of meetings shall not be required if notice is waived in writing by all the members of the Committee at the time in office, or if all such members are present at the meeting.

9.4 TRANSACTION OF BUSINESS. A majority of the members of the Committee at the time in office shall constitute a quorum for the transaction of business. All resolutions or other actions taken by the Committee at any meeting shall be by vote of a majority of those

present at any such meeting and entitled to vote. Resolutions may be adopted or other action taken without a meeting upon written consent thereto signed by all of the members of the Committee.

9.5 COMMITTEE RECORDS. The Committee shall maintain full and complete records of its deliberations and decisions. The minutes of its proceedings shall be conclusive proof of the facts of the operation of the Plan.

9.6 ESTABLISHMENT OF RULES. Subject to the limitations of the Plan, the Committee may from time to time establish rules or by-laws for the administration of the Plan and the transaction of its business.

9.7 CONFLICTS OF INTEREST. No individual member of the Committee shall have any right to vote or decide upon any matter relating solely to himself or to any of his rights or benefits under the Plan (except that such member may sign unanimous written consent to resolutions adopted or other action taken without a meeting), except relating to the terms of his Salary Deferral Agreement.

9.8 CORRECTION OF ERRORS. The Committee may correct errors and, so far as practicable, may adjust any benefit or credit or payment accordingly. The Committee may in its discretion waive any notice requirements in the Plan; provided, that a waiver of notice in one or more cases shall not be deemed to constitute a waiver of notice in any other case. With respect to any power or authority which the Committee has discretion to exercise under the Plan, such discretion shall be exercised in a nondiscriminatory manner.

9.9 AUTHORITY TO INTERPRET PLAN. Subject to the claims procedure set forth in Section 16 the Plan Administrator and the Committee shall have the duty and discretionary authority to interpret and construe the provisions of the Plan and to decide any dispute which

may arise regarding the rights of Participants hereunder, including the discretionary authority to construe the Plan and to make determinations as to eligibility and benefits under the Plan. Determinations by the Plan Administrator and the Committee shall apply uniformly to all persons similarly situated and shall be binding and conclusive upon all interested persons.

9.10 THIRD PARTY ADVISORS. The Committee may engage an attorney, accountant, actuary or any other technical advisor on matters regarding the operation of the Plan and to perform such other duties as shall be required in connection therewith, and may employ such clerical and related personnel as the Committee shall deem requisite or desirable in carrying out the provisions of the Plan. The Committee shall from time to time, but no less frequently than annually, review the financial condition of the Plan and determine the financial and liquidity needs of the Plan. The Committee shall communicate such needs to the Employer so that its policies may be appropriately coordinated to meet such needs.

9.11 COMPENSATION OF MEMBERS. No fee or compensation shall be paid to any member of the Committee for his Service as such.

9.12 EXPENSE REIMBURSEMENT. The Committee shall be entitled to reimbursement by the Employer for its reasonable expenses properly and actually incurred in the performance of its duties in the administration of the Plan.

9.13 INDEMNIFICATION. No member of the Committee shall be personally liable by reason of any contract or other instrument executed by him or on his behalf as a member of the Committee nor for any mistake of judgment made in good faith, and the Employer shall indemnify and hold harmless, directly from its own assets (including the proceeds of any insurance policy the premiums for which are paid from the Employer's own assets), each member of the Committee and each other officer, employee, or director of the Employer to

whom any duty or power relating to the administration or interpretation of the Plan may be delegated or allocated, against any unreimbursed or uninsured cost or expense (including any sum paid in settlement of a claim with the prior written approval of the Board) arising out of any act or omission to act in connection with the Plan unless arising out of such person's own fraud, bad faith, willful misconduct or gross negligence.

SECTION 10. CONTRACTUAL LIABILITY; TRUST:

10.1 CONTRACTUAL LIABILITY. The obligation of the Employer to make payments hereunder shall constitute a contractual liability of the Employer to the Participant. Such payments shall be made from the general funds of the Employer, and the Employer shall not be required to establish or maintain any special or separate fund, or otherwise to segregate assets to assure that such payments shall be made, and the Participant shall not have any interest in any particular assets of the Employer by reason of its obligations hereunder. To the extent that any person acquires a right to receive payment from the Employer, such right shall be no greater than the right of an unsecured creditor of the Employer.

10.2 TRUST. If so designated in Section 2.33 of the Adoption Agreement, the Employer may establish a Trust with the Trustee, pursuant to such terms and conditions as are set forth in the Trust Agreement. The Trust, if and when established, is intended to be treated as a grantor trust for purposes of the Code and all assets of the Trust shall be held in the United States. The establishment of the Trust is not intended to cause Participants to realize current income on amounts contributed thereto, and the Trust shall be so interpreted and administered.

SECTION 11. ALLOCATION OF RESPONSIBILITIES:

The persons responsible for the Plan and the duties and responsibilities allocated to each are as follows:

11.1 BOARD.

(i) To amend the Plan;

(ii) To appoint and remove members of the Committee; and

(iii) To terminate the Plan.

11.2 COMMITTEE.

(i) To designate Participants;

(ii) To interpret the provisions of the Plan and to determine the rights of the Participants under the Plan, except to the extent otherwise provided in Section 16 relating to claims procedure;

(iii) To administer the Plan in accordance with its terms, except to the extent powers to administer the Plan are specifically delegated to another person or persons as provided in the Plan;

(iv) To account for the amount credited to the Deferred Compensation Account of a Participant; and

(v) To direct the Employer in the payment of benefits.

11.3 PLAN ADMINISTRATOR.

(i) To file such reports as may be required with the United States Department of Labor, the Internal Revenue Service and any other government agency to which reports may be required to be submitted from time to time; and

(ii) To administer the claims procedure to the extent provided in Section 16.

SECTION 12. BENEFITS NOT ASSIGNABLE; FACILITY OF PAYMENTS:

12.1 BENEFITS NOT ASSIGNABLE. No portion of any benefit credited or paid under the Plan with respect to any Participant shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance or charge, and any attempt so to anticipate, alienate, sell, transfer, assign, pledge, encumber or charge the same shall be void, nor shall any portion of such benefit be in any manner payable to any assignee, receiver or any one trustee, or be liable for his debts, contracts, liabilities, engagements or torts. Notwithstanding the

foregoing, in the event that all or any portion of the benefit of a Participant is transferred to the former spouse of the Participant incident to a divorce, the Committee shall maintain such amount for the benefit of the former spouse until distributed in the manner required by an order of any court having jurisdiction over the divorce, and the former spouse shall be entitled to the same rights as the Participant with respect to such benefit.

12.2 PAYMENTS TO MINORS AND OTHERS. If any individual entitled to receive a payment under the Plan shall be physically, mentally or legally incapable of receiving or acknowledging receipt of such payment, the Committee, upon the receipt of satisfactory evidence of his incapacity and satisfactory evidence that another person or institution is maintaining him and that no guardian or committee has been appointed for him, may cause any payment otherwise payable to him to be made to such person or institution so maintaining him. Payment to such person or institution shall be in full satisfaction of all claims by or through the Participant to the extent of the amount thereof.

SECTION 13. BENEFICIARY:

The Participant's beneficiary shall be the person or persons designated by the Participant on the beneficiary designation form provided by and filed with the Committee or its designee. If the Participant does not designate a beneficiary, the beneficiary shall be his Surviving Spouse. If the Participant does not designate a beneficiary and has no Surviving Spouse, the beneficiary shall be the Participant's estate. The designation of a beneficiary may be changed or revoked only by filing a new beneficiary designation form with the Committee or its designee. If a beneficiary (the "primary beneficiary") is receiving or is entitled to receive payments under the Plan and dies before receiving all of the payments due him, the balance to which he is entitled shall be paid to the contingent beneficiary, if any, named in the Participant's current beneficiary designation form. If there is no contingent beneficiary, the balance shall be

paid to the estate of the primary beneficiary. Any beneficiary may disclaim all or any part of any benefit to which such beneficiary shall be entitled hereunder by filing a written disclaimer with the Committee before payment of such benefit is to be made. Such a disclaimer shall be made in a form satisfactory to the Committee and shall be irrevocable when filed. Any benefit disclaimed shall be payable from the Plan in the same manner as if the beneficiary who filed the disclaimer had died on the date of such filing.

SECTION 14. AMENDMENT AND TERMINATION OF PLAN:

The Board may amend any provision of the Plan or terminate the Plan at any time; provided, that in no event shall such amendment or termination reduce the balance in any Participant's Deferred Compensation Account as of the date of such amendment or termination, nor shall any such amendment affect the terms of the Plan relating to the payment of such Deferred Compensation Account.

SECTION 15. COMMUNICATION TO PARTICIPANTS:

The Employer shall make a copy of the Plan available for inspection by Participants and their beneficiaries during reasonable hours at the principal office of the Employer.

SECTION 16. CLAIMS PROCEDURE:

The following claims procedure shall apply with respect to the Plan:

16.1 FILING OF A CLAIM FOR BENEFITS. If a Participant or beneficiary (the "claimant") believes that he is entitled to benefits under the Plan which are not being paid to him or which are not being accrued for his benefit, he shall file a written claim therefor with the Plan Administrator. In the event the Plan Administrator shall be the claimant, all actions which are required to be taken by the Plan Administrator pursuant to this Section 16 shall be taken instead by another member of the Committee designated by the Committee.

16.2 NOTIFICATION TO CLAIMANT OF DECISION. Within 90 days after receipt of a claim by the Plan Administrator (or within 180 days if special circumstances require an extension of time), the Plan Administrator shall notify the claimant of the decision with regard to the claim. In the event of such special circumstances requiring an extension of time, there shall be furnished to the claimant prior to expiration of the initial 90-day period written notice of the extension, which notice shall set forth the special circumstances and the date by which the decision shall be furnished. If such claim shall be wholly or partially denied, notice thereof shall be in writing and worded in a manner calculated to be understood by the claimant, and shall set forth: (i) the specific reason or reasons for the denial; (ii) specific reference to pertinent provisions of the Plan on which the denial is based; (iii) a description of any additional material or information necessary for the claimant to perfect the claim and an explanation of why such material or information is necessary; and
(iv) an explanation of the procedure for review of the denial and the time limits applicable to such procedures, including a statement of the claimant's right to bring a civil action under ERISA following an adverse benefit determination on review. Notwithstanding the forgoing, if the claim relates to a Participant who is Disabled, the Plan Administrator shall notify the claimant of the decision within 45 days (which may be extended for an additional 30 days if required by special circumstances).

16.3 PROCEDURE FOR REVIEW. Within 60 days following receipt by the claimant of notice denying his claim, in whole or in part, or, if such notice shall not be given, within 60 days following the latest date on which such notice could have been timely given, the claimant shall appeal denial of the claim by filing a written application for review with the Committee. Following such request for review, the Committee shall fully and fairly review the decision

denying the claim. Prior to the decision of the Committee, the claimant shall be given an opportunity to review pertinent documents and to submit issues and comments in writing.

16.4 DECISION ON REVIEW. The decision on review of a claim denied in whole or in part by the Plan Administrator shall be made in the following manner:

16.4.1 Within 60 days following receipt by the Committee of the request for review (or within 120 days if special circumstances require an extension of time), the Committee shall notify the claimant in writing of its decision with regard to the claim. In the event of such special circumstances requiring an extension of time, written notice of the extension shall be furnished to the claimant prior to the commencement of the extension. If the decision on review is not furnished in a timely manner, the claim shall be deemed denied as of the close of the initial 60-day period (or the close of the extension period, if applicable). Notwithstanding the forgoing, if the claim relates to a Participant who is Disabled, the Committee shall notify the claimant of the decision within 45 days (which may be extended for an additional 45 days if required by special circumstances).

16.4.2 With respect to a claim that is denied in whole or in part, the decision on review shall set forth specific reasons for the decision, shall be written in a manner calculated to be understood by the claimant, and shall cite specific references to the pertinent Plan provisions on which the decision is based.

16.4.3 The decision of the Committee shall be final and conclusive.

16.5 ACTION BY AUTHORIZED REPRESENTATIVE OF CLAIMANT. All actions set forth in this Section 16 to be taken by the claimant may likewise be taken by a representative of the claimant duly authorized by him to act in his behalf on such matters. The Plan Administrator and the Committee may require such evidence as either may reasonably deem necessary or advisable of the authority to act of any such representative.

SECTION 17. MISCELLANEOUS PROVISIONS:

17.1 SET OFF. Notwithstanding any other provision of this Plan, the Employer may reduce the amount of any payment otherwise payable to or on behalf of a Participant hereunder by the amount of any loan, cash advance, extension of credit or other obligation of the

Participant to the Employer that is then due and payable, and the Participant shall be deemed to have consented to such reduction.

17.2 NOTICES. Each Participant who is not in Service and each Beneficiary shall be responsible for furnishing the Committee or its designee with his current address for the mailing of notices and benefit payments. Any notice required or permitted to be given to such Participant or Beneficiary shall be deemed given if directed to such address and mailed by regular United States mail, first class, postage prepaid. If any check mailed to such address is returned as undeliverable to the addressee, mailing of checks will be suspended until the Participant or beneficiary furnishes the proper address. This provision shall not be construed as requiring the mailing of any notice or notification otherwise permitted to be given by posting or by other publication.

17.3 LOST DISTRIBUTES. A benefit shall be deemed forfeited if the Plan Administrator is unable to locate the Participant or Beneficiary to whom payment is due on or before the fifth anniversary of the date payment is to be made or commence; provided, that the deemed investment rate of return pursuant to Section 8.2 shall cease to be applied to the Participant's account following the first anniversary of such date; provided further, however, that such benefit shall be reinstated if a valid claim is made by or on behalf of the Participant or Beneficiary for all or part of the forfeited benefit.

17.4 RELIANCE ON DATA. The Employer, the Committee and the Plan Administrator shall have the right to rely on any data provided by the Participant or by any Beneficiary. Representations of such data shall be binding upon any party seeking to claim a benefit through a Participant, and the Employer, the Committee and the Plan Administrator shall

have no obligation to inquire into the accuracy of any representation made at any time by a Participant or beneficiary.

17.5 RECEIPT AND RELEASE FOR PAYMENTS. Subject to the provisions of
Section 17.1, any payment made from the Plan to or with respect to any Participant or Beneficiary, or pursuant to a disclaimer by a Beneficiary, shall, to the extent thereof, be in full satisfaction of all claims hereunder against the Plan and the Employer with respect to the Plan. The recipient of any payment from the Plan may be required by the Committee, as a condition precedent to such payment, to execute a receipt and release with respect thereto in such form as shall be acceptable to the Committee.

17.6 HEADINGS. The headings and subheadings of the Plan have been inserted for convenience of reference and are to be ignored in any construction of the provisions hereof.

17.7 CONTINUATION OF EMPLOYMENT. The establishment of the Plan shall not be construed as conferring any legal or other rights upon any Employee or any persons for continuation of employment, nor shall it interfere with the right of the Employer to discharge any Employee or to deal with him without regard to the effect thereof under the Plan.

17.8 MERGER OR CONSOLIDATION; ASSUMPTION OF PLAN. No employer-party to the Plan shall consolidate or merge into or with another corporation or entity, or transfer all or substantially all of its assets to another corporation, partnership, trust or other entity (a "Successor Entity") unless such Successor Entity shall assume the rights, obligations and liabilities of the employer-party under the Plan and upon such assumption, the Successor Entity shall become obligated to perform the terms and conditions of the Plan. Nothing herein shall prohibit the assumption of the obligations and liabilities of the Employer under the Plan by any Successor Entity.

17.9 CONSTRUCTION. The Employer shall designate in the Adoption Agreement the state according to whose laws the provisions of the Plan shall be construed and enforced, except to the extent that such laws are superseded by ERISA.

EXHIBIT 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-100157) and Form S-3 (No. 333-111245) of Kirkland's, Inc. of our report dated April 12, 2005 relating to the financial statements, management's assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting, which appears in this Form 10-K.

                                        /s/ PricewaterhouseCoopers LLP

Memphis, Tennessee


April 12, 2005

EXHIBIT 31.1

CERTIFICATION OF PRESIDENT AND CHIEF EXECUTIVE OFFICER

I, Robert E. Alderson, certify that:

1. I have reviewed this annual report on Form 10-K of Kirkland's, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of and for the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and

(d) disclosed in this annual report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors:

(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

                                                /s/ ROBERT E. ALDERSON
                                          --------------------------------------
                                                    Robert E. Alderson
                                          President and Chief Executive Officer



Date: April 14, 2005

EXHIBIT 31.2

CERTIFICATION OF EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER

I, Reynolds C. Faulkner, certify that:

1. I have reviewed this annual report on Form 10-K of Kirkland's, Inc.;

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

                                               /s/ REYNOLDS C. FAULKNER
                                          --------------------------------------
                                                   Reynolds C. Faulkner
                                               Executive Vice President and
                                                 Chief Financial Officer



Date: April 14, 2005

EXHIBIT 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350

In connection with the Annual Report of Kirkland's, Inc. (the "Company") on Form 10-K for the year ending January 29, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Robert E. Alderson, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

                                                /s/ ROBERT E. ALDERSON
                                          --------------------------------------
                                                    Robert E. Alderson
                                          President and Chief Executive Officer



April 14, 2005

EXHIBIT 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350

In connection with the Annual Report of Kirkland's, Inc. (the "Company") on Form 10-K for the year ending January 29, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Reynolds C. Faulkner, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

                                               /s/ REYNOLDS C. FAULKNER
                                          --------------------------------------
                                                   Reynolds C. Faulkner
                                            Executive Vice President and Chief
                                                    Financial Officer



April 14, 2005