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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended        February 1, 2003

OR

For the transition period from __________________________ to __________________________

Commission file number        000-49885

Registrant’s telephone number, including area code        (731)668-2444       

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

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

Common Stock, no par value per share

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

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     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 o No x

     The aggregate market value of the common stock held by non-affiliates of the registrant as of August 2, 2002, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $70,474,207 based on the last sale price of the common stock as reported by The Nasdaq Stock Market. This calculation excludes 11,826,092 shares held by directors, executive officers and one holder of more than 10% of the registrant’s common stock.

     As of April 1, 2003, there were 18,912,004 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 May 27, 2003, are incorporated by reference into Part III of this Form 10-K.

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FORM 10-K

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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.

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PART I

Item 1. Business

General

     We are a leading specialty retailer of home décor in the United States, operating 249 stores in 30 states as of February 1, 2003. Our stores present a broad selection of distinctive merchandise, including framed art, mirrors, candles, lamps, picture frames, 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 décor 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 décor and has enabled us to develop a strong customer franchise. As a result, we have achieved substantial growth over the last six fiscal years. Since the beginning of 1997, our net sales have grown at a compounded annual growth rate of 18%. For the 52 weeks ended February 1, 2003 (“fiscal 2002”), we recorded net sales of $341.5 million.

Key Operating Strengths

     Our goal is to be the leading specialty retailer of home décor 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 of over 5,000 SKUs 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.

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     Flexible approach to real estate. Our stores operate successfully across a wide spectrum of different regions, market sizes and real estate venues. We operate our stores in 30 states, and although originally focused in the Southeast, over 40% 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 community 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.

Growth Strategy

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

     Opening new stores using our proven store model. Over the past six 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 in selected smaller communities. We believe there are currently more than 800 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 ended January 31, 2004 (“fiscal 2003”) and approximately 40 stores during the 52 weeks ended January 29, 2005 (“fiscal 2004”).

     Our proven store model produces strong store-level cash flow and provides an attractive store-level return on investment. In fiscal 2002, our average store generated net sales of approximately $1.4 million. These results were relatively consistent across a wide spectrum of different market sizes and real estate venues. Our stores typically generate a positive store contribution in their first full year of operation. From January 1, 1997 through the end of fiscal 2001, we opened 98 new stores and all but six produced a positive store contribution in their first full fiscal year.

     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 our recent investments in information systems and central distribution, which together contributed to our 11.2% increase in net sales and our 8.3% increase in average net sales per square foot in fiscal 2002. 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. We believe our comparable store sales will continue to benefit from the discretionary income available to consumers in their prime earning years as well as other consumer and demographic trends favoring home-oriented purchases.

Merchandising

     Merchandising strategy. Our merchandising strategy is to (i) offer distinctive and often exclusive, high quality home décor 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. We believe that this strategy creates a shopping experience that appeals to shoppers, both style-conscious and price-

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conscious. Although we do not attempt to be a fashion leader, we identify and capitalize on existing or emerging trends when identifying or developing merchandise for sale.

     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 décor 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.

     While our stores generally carry over 5,000 SKUs, we are constantly monitoring the sell-through on each item and are typically reordering approximately 2,500 active SKUs at any point in time. The 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.

     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 Cedar Creek 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 décor (framed art and mirrors), lamps, candles and various holders, photo frames, textiles, garden accessories, floral products and decorative accessories. 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 décor 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, novelty items and housewares. Throughout the year and especially in the fourth quarter of the calendar year, our buying team uses its experience in home décor 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.

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     The following table presents the percentage of fiscal 2002 net sales contributed by our major merchandise categories:

     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 February 1, 2003, we operated 249 stores in 30 states, all of which are open seven days a week. In addition to corporate management, five Regional Managers and 28 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, merchandise display and control, personnel 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 prototype Kirkland’s store is between 4,200 and 4,800 square feet, of which approximately 70% typically represents selling space. 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.

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     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.

     Briar Patch. We operate 25 stores under the name “Briar Patch by Kirkland’s.” These stores are operated and merchandised in the same fashion as our stores operated under the “Kirkland’s” name and generate store-level operating results comparable to our “Kirkland’s” stores. In 1998, we acquired the 35-store Briar Patch operation, and we have since converted six of those stores to “Kirkland’s” stores and have closed four of them. As the remaining stores are remodeled or relocated, we intend to change the name of these stores to “Kirkland’s.”

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 allows 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, and generally, we sought approximate store frontage of 35 to 40 feet on average. As of February 1, 2003, we operated 231 of our 249 stores in enclosed malls, with the remainder in a variety of off-mall venues such as “lifestyle” strip centers and community strip centers.

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     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 décor category. The following table provides a history of our store openings and closing since the beginning of our fiscal year ended December 31, 1998 (“fiscal 1998”).

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. The six members of our buying team have an average of 14 years of retail experience. We believe this level of experience 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 believe buying from importers or U.S.-based representatives of foreign manufacturers rather than directly from foreign manufacturers enables us to maximize flexibility and minimize product liability and credit risks. Further, we believe our executive management and buyers are more effective by focusing on managing the retail business and allowing importers to handle the procurement and shipment of foreign-manufactured merchandise for our stores. 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

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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

     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.

     During fiscal 2000, we began working with a leading supply chain consulting firm to improve our distribution practices and to formulate a long-term distribution strategy. In March 2001, we consolidated our central distribution operations into one modern, 303,000-square-foot facility in Jackson, Tennessee (the “DC”), which allowed us to increase our dollar volume of centrally distributed merchandise by 25% from fiscal 2000 to the 52 weeks ended February 2, 2002 (“fiscal 2001”). In fiscal 2001, we distributed approximately 62% of our merchandise purchases centrally while the remaining 38% of our purchases were shipped directly from vendors to our stores. In May 2002, we expanded our distribution capacity through the lease of a 168,000-square-foot warehouse in close proximity to our DC. By increasing our central distribution capacity and hiring additional staff, we were able to raise our percentage of centrally distributed merchandise to 75% in fiscal 2002 from 62% in fiscal 2001.

     Central distribution offers a number of important benefits. In addition to allowing us to manage freight costs and the flow of merchandise to our stores more efficiently, central distribution allows us to increase the percentage of our purchases that are pre-ticketed by vendors (approximately 95% as of February 1, 2003). Increased use of central distribution has enabled us to significantly reduce the use of costly local storage facilities and has also reduced truck rental costs. Between fiscal 2000 and fiscal 2002, we reduced our total combined costs for local storage and truck rentals by 44%, or $1.8 million.

     We expect to continue to expand our proportion of centrally distributed merchandise. During the third quarter of fiscal 2002, in anticipation of our peak inventory needs during fiscal 2003, we leased an additional 187,000 square feet of warehouse space in Jackson, Tennessee, for one year at an annual cost of approximately $345,000. In September 2002, we hired a Vice President of Logistics and have been evaluating numerous alternatives for enhancing our distribution effort. Our evaluation encompasses a range of potential improvements in distribution facilities, as well as possible introduction of advanced information systems and automation to enhance distribution efficiencies. We believe that our existing distribution facilities provide us with adequate capacity at least until fiscal 2004. As we continue to capitalize on the benefits of central distribution, we will continue to take advantage of the benefits that direct shipment capability offers, such as maximizing sales during the late fall season.

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

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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. These investments include $6.5 million of software and hardware replacements or upgrades since late 1999. Recent projects include new point-of-sale (POS) software and servers in all stores (fiscal 1999), integrated retail management software at our home office (fiscal 2001) and an upgrade of POS hardware in approximately two-thirds of our stores (fiscal 2001/fiscal 2002). We believe these newly enhanced systems provide our key decision makers, both in stores and at our home office, with the timely information needed to drive our sales and profitability. We also made incremental investments during 2002 by upgrading our POS software to allow for debit processing capability and the introduction of our new Kirkland’s gift card.

     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. Our distribution center also employs certain elements of the GERS software package. We utilize a Lawson Software package for our payroll and human resource 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 malls and valuable “word-of-mouth” advertising by our customers. Many shopping mall leases historically required some advertising, although an industry shift to “media funds” has largely been implemented, whereby a retailer contributes at agreed levels to the shopping mall’s advertising fund based on the square footage of the store. 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.

Trademarks

     All of our stores operate under the name “Kirkland’s” other than 25 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 registered our “Kirkland’s” logo with the United States Patent and Trademark Office on the Principal Register. In addition, we hold several trademark registrations in connection with our Cedar Creek private label brand as well as a registration of “the Kirkland Collection.” We believe the “Kirkland’s” logo, “the Kirkland Collection” and the Cedar Creek private label brand have become important components in our merchandising and marketing strategy. We also claim common law trademark rights in Briar Patch, Kirkland’s Outlet, Kirkland’s Home and other marks. We are exploring the possibility of federal registration of several of these marks. We are not aware of any claims of infringement or other challenges to our right to use our marks in the United States.

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Competition

     The retail market for home décor 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, Michaels Stores, Pier 1 Imports and Williams-Sonoma. We believe that the principal competitive factors influencing our business are merchandise quality and selection, price, visual appeal of the merchandise and the store and the convenience of location. Although we face competition from a broad range of retailers, we believe that few competitors focus exclusively on home décor, primarily in a mall environment. Specialty retailers tend to have higher prices and a narrower assortment of products than our stores. Department stores typically have higher prices than our stores for similar merchandise. Wholesale clubs may have lower prices than our stores, but the product assortment is generally considerably more limited.

     The number of companies offering a selection of home décor 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 and presenting it in a visually appealing manner.

     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 3,346 employees at April 22, 2003. 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. Our SEC filings became available on our Internet web site beginning on March 13, 2003. Copies are also available, without charge, from Secretary, Kirkland’s, Inc., 805 North Parkway, Jackson, TN 38305.

     Consistent with our ongoing commitment to corporate governance, our Board of Directors is currently updating our Code of Business Conduct and Ethics that applies to our directors, officers and employees, including our President and Chief Executive Officer, our Chief Financial Officer and our Controller. The Code of Business Conduct and Ethics will reflect and reinforce our commitment to integrity in the conduct of our business. We will post the Code of Business Conduct and Ethics in the “Investors Relations” section of our website. 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.

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Executive Officers of Kirkland’s

     The name, age as of April 15, 2003, and position of each of our executive officers are as follows:

     Carl Kirkland, 62, has been Chairman of the Board since June 1996. Mr. Kirkland co-founded Kirkland’s in 1966 and served as Chief Executive Officer from 1966 through March 2001 and President from 1966 through November 1997. He has over 30 years of experience in the retail industry. Mr. Kirkland also serves on the board of directors of Hibbett Sporting Goods, Inc.

     Robert E. Alderson, 56, has been a Director of Kirkland’s since September 1986, President of Kirkland’s since November 1997 and Chief Executive Officer of Kirkland’s since March 2001. 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, 39, 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.

     Chris T. LaFont, 42, has been Senior Vice President of Merchandising and General Merchandise Manager since February 2003. He served as Vice President of Merchandising – Product Development from September 1997 through February 2003. From 1988 to September 1997, he served as Vice President of Visual Merchandising for Kirkland’s. Mr. LaFont started his career with Kirkland’s in 1981 as a management trainee.

     C. Edmond Wise, Jr., 52, has been Senior Vice President of Store Operations since joining Kirkland’s in December 2000. Prior to joining Kirkland’s, Mr. Wise was a Director of Retail Operations for Payless ShoeSource from October 1998 to November 2000. Prior to that, Mr. Wise had 26 years of retail operations experience, including eight years with Edison Brothers Stores and 16 years with J. Riggings, a division of U. S. Shoe Corporation.

Risk Factors

     If any of the risks described below occur, our business, financial condition or results of operations could be adversely affected in a material way. This could cause the value of our common stock to decline, perhaps significantly, and you may lose all or part of your investment.

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 implement 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. We have opened 122 new stores since January 1, 1997. We intend to open approximately 37-40 new stores in fiscal 2003, and our future operating results will depend to a substantial extent upon our ability to open and operate new stores successfully. To date we have signed leases for 13 new stores in fiscal 2003, eight of which have already opened. We also have an ongoing expansion, remodeling and relocation program and intend to expand, remodel or relocate 8-10 stores in fiscal 2003.

     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;

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	•		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 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, much less store-level profitability comparable to that of existing stores. 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 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 décor items may decline during recessionary periods or 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.

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Reduced consumer spending in the southeastern part of the United States where a majority of our stores are concentrated could reduce our net sales.

     Approximately 53% 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 décor 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 15% of our merchandise purchases during fiscal 2002. 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 vendors 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.

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     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 recent 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. In addition, the recent outbreak of Severe Acute Respiratory Syndrome in China may disrupt the manufacturing of our products and/or our vendors’ ability to purchase products from suppliers in China. 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.

     We are also subject to the risk that the manufacturers abroad who ultimately manufacture our products may employ labor practices that are not consistent with acceptable practices in the United States. In any such event we could be hurt by negative publicity with respect to those practices and, in some cases, face liability for those practices.

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

     An important part of our efforts to achieve efficiencies, cost reductions and net sales growth is the continued identification and implementation of improvements to our planning, logistical and distribution infrastructure and our supply chain, including merchandise ordering, transportation and receipt processing. We also need to ensure that our distribution infrastructure and supply chain keep pace with our anticipated growth and increased number of stores. In particular, we may need to expand our existing infrastructure to the extent we open new stores in regions of the United States where we presently do not have 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 facilities in Jackson, Tennessee. Any significant disruption in the operations of these facilities 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 malls 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.

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

     We have experienced, and expect to continue to experience, substantial seasonal fluctuations in our net sales and operating results, which are typical of many mall-based specialty retailers and common to most retailers generally. Due to the importance of the fall selling season, which includes Thanksgiving and Christmas, the last quarter of our fiscal year, has historically contributed and is expected to continue to contribute a disproportionate amount of our net sales, net income and cash flow for the entire fiscal year. We expect 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 accord with our business and growth strategy.

     We entered into a new senior credit facility in May 2002. 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.

     Our senior credit facility has two financial covenants. One covenant requires us to maintain trailing twelve months earnings before interest, taxes, depreciation and amortization (“EBITDA”), net of capital expenditures, at levels varying between $17.2 million and $26.7 million each fiscal quarter based upon our projections taking into account the seasonality of our business. The other covenant requires us to keep our senior debt within a specified ratio of our trailing twelve months EBITDA ranging from 1.0:1.0 to 1.8:1.0 each fiscal quarter based upon our projections taking into account the seasonality of our business and our anticipated utilization of the revolving credit facility. Any failure to comply with these or other covenants would allow the lenders to accelerate repayment of

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their debt, prohibit further borrowing under the revolving portion of the credit 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. Our comparable store net sales increased 0.6% in fiscal 2000 over the 12 months ended December 31, 1999, increased 13.3% in fiscal 2001 over the 53-week period ended February 3, 2001, and increased 8.4% in fiscal 2002 over fiscal 2001. 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.

     Substantially all of our existing stores are located in enclosed malls. As a result, we largely rely 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.

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We depend on key personnel, and if we lose the services of any of our principal executive officers, including Carl Kirkland, our Chairman, and Robert E. Alderson, our President and Chief Executive Officer, we may not be able to run our business effectively.

     We have benefited substantially from the leadership and performance of our senior management, especially Carl Kirkland, our Chairman, and Robert E. Alderson, our President and Chief Executive Officer. Our success will depend on our ability to retain our current management 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. Although we maintain key man insurance in the amount of $3 million on each of Messrs. Kirkland and Alderson, the loss of the services of either of these individuals for any reason could have a material adverse effect on our business, financial condition and results of operations. In addition, the loss of certain of our other principal executive officers could affect our ability to run our business effectively. Our employment agreements with Messrs. Kirkland and Alderson expire in June 2006 and continue on successive one-year renewal terms unless terminated by either party. 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 will 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 in 2003, 2004 and 2005) 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 will be 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.

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

     The market price of our common stock could be subject to significant fluctuations in response to our operating results, general trends in 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 investors from influencing significant corporate decisions.

     As of March 31, 2003, our current directors, executive officers and their affiliates, in the aggregate, beneficially own approximately 42.8% 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 typically provide for 10-year terms, many with the ability for us (or the landlord) to terminate the lease in the middle of the term if net sales at the leased premises do not reach a certain annual level. The leases typically 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 lease three central distribution facilities, consisting of a combined 658,000-square-feet, also located in Jackson, Tennessee.

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     The following table indicates the states and cities where our stores are located and the number of stores within each state as of February 1, 2003:

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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 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 2002.

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 25, 2003, there were approximately 45 holders of record of our common stock. On April 28, 2003, the last reported sale price of our common stock on The Nasdaq Stock Market was $14.75. The following table sets forth the high and low last sale prices of our common stock for the periods indicated.

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.

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Item 6. Selected Consolidated Financial Data

     The selected “Statement of Operations Data” for the fiscal year ended December 31, 2000, the 34-day period ended February 3, 2001, the fiscal year ended February 2, 2002, and the fiscal year ended February 1, 2003, and the selected “Balance Sheet Data” as of February 2, 2002, and February 1, 2003, have been derived from our audited consolidated financial statements included in this annual report on Form 10-K. The selected “Balance Sheet Data” as of December 31, 1998, 1999 and 2000 and the selected “Statement of Operations Data” for the years ended December 31, 1998 and 1999 have been derived from our audited consolidated financial statements not included in this annual report on Form 10-K. The “Store and Other Data” for all periods presented below have been derived from internal records of our operations. The selected consolidated financial data should be read in conjunction with our consolidated financial statements and notes thereto, and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this annual report on Form 10-K.

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

     The following discussion should be read in conjunction with our consolidated financial statements and notes thereto 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.

Overview

     We are a leading specialty retailer of home décor in the United States, operating 249 stores in 30 states as of February 1, 2003. Our stores present a broad selection of distinctive merchandise, including framed art, mirrors, candles, lamps, picture frames, 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. For the fiscal year ended February 1, 2003, we recorded net sales of $341.5 million.

     Our stores offer a unique combination of style and value that has led to our emergence as a leader in home décor and has enabled us to develop a strong customer franchise. As a result, we have achieved substantial growth over the last six fiscal years. During this period, 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 800 additional locations in the United States that could support a Kirkland’s store. We plan on opening 37-40 new stores and estimate closing 7-10 stores in fiscal 2003.

     On July 10, 2002, we completed an initial public offering of our common stock, receiving net proceeds of approximately $66.5 million. We used the proceeds of the offering to repay existing subordinated debt, redeem our mandatorily redeemable Class C Preferred Stock and redeem certain shares of our Class A Preferred Stock, Class B Preferred Stock, Class D Preferred Stock and common stock.

Results of Operations

     On January 1, 2001, we elected to change our fiscal reporting year from a calendar year basis to a 52/53-week year ending on the Saturday closest to January 31. Consequently, the results of operations table and discussion below compare the 52 weeks ended February 1, 2003, 52 weeks ended February 2, 2002 and the twelve months ended December 31, 2000. The results for the 34-day “stub period” ended February 3, 2001 are included separately in our consolidated financial statements.

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     The table below sets forth selected results of our operations expressed as a percentage of net sales for the periods indicated.

Fiscal Year Ended February 1, 2003, Compared to Fiscal Year Ended February 2, 2002

     Net sales. Net sales increased by 11.2% to $341.5 million for fiscal 2002 from $307.2 million for fiscal 2001. The net sales increase in fiscal 2002 resulted primarily from an 8.4% increase in comparable store net sales. We also opened 16 new stores in fiscal 2002 and five new stores in fiscal 2001, and we closed one store in fiscal 2002 and nine stores in fiscal 2001. Our net sales benefited from this increase in our store base as well as sales increases from expanded, remodeled or relocated stores, which are excluded from our comparable store base. The increase in comparable store net sales accounted for approximately $24.2 million of the total net sales increase, or 70.6%, and the net increase in the store base over the last two fiscal years along with sales increases from expanded, remodeled or relocated stores accounted for approximately $10.1 million, or 29.4%, of the total net sales increase. The comparable store net sales increase was primarily the result of an improved inventory position and fresher merchandise mix as compared to the prior year, as we continued to benefit from the investments in distribution and information systems that we made in fiscal 2000 and 2001. Key categories contributing to the improvement in comparable store net sales included wall décor, lamps and decorative accessories. The comparable store net sales increase resulted entirely from an increase in unit sales. Through the first three quarters of fiscal 2002, we

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experienced increases in both unit sales and the average retail price per item. However, significant markdown activity negatively impacted retail prices during the fourth quarter, resulting in an average retail price per item that was relatively unchanged for fiscal 2002 compared to fiscal 2001.

     Gross profit. Gross profit increased $13.8 million, or 12.9%, to $120.9 million for fiscal 2002 from $107.1 million for fiscal 2001. Gross profit expressed as a percentage of net sales increased to 35.4% for fiscal 2002, from 34.9% for fiscal 2001. The increase in gross profit as a percentage of net sales resulted primarily from the leveraging of store occupancy costs through higher net sales. Product cost of sales, including freight expenses, was relatively flat for fiscal 2002 as a percentage of sales, primarily due to the significant markdown activity that took place in the fourth quarter in response to a heavily promotional retail environment and comparatively weak sales trends in the holiday merchandise category compared to the prior year. Consistent with our strategic plans, central distribution costs increased slightly as a percentage of net sales as we leased additional space and hired additional staff to support a higher level of activity in our central distribution centers. We expect to continue to experience cost increases in central distribution as we process a greater percentage of merchandise purchases through our central distribution facilities.

     Other operating expenses. Other operating expenses, including both store and corporate costs, were $79.0 million, or 23.1% of net sales, for fiscal 2002 as compared to $72.0 million, or 23.4% of net sales, for fiscal 2001. The decline in these operating expenses as a percentage of net sales was primarily the result of strong net sales that leveraged store payroll costs and other relatively fixed components of store operating expenses. In addition, by continuing to improve our inventory management and distribution practices, we were able to save over $750,000 in costs related to local storage facilities and related truck rentals. Offsetting these expense reductions and the leveraging impact were increases in insurance costs due to rising premiums and coverage enhancements, an increase in corporate salaries and an increase in professional fees related to costs incurred on supply chain enhancement projects.

     Depreciation and amortization. Depreciation and amortization expense was $6.7 million, or 2.0% of net sales, for fiscal 2002 as compared to $6.4 million, or 2.1% of net sales, for fiscal 2001. The decline as a percentage of net sales was the result of the strong net sales performance as well as a decline in capital expenditures in recent fiscal years.

     Non-cash stock compensation charge. During fiscal 2002, we incurred non-cash stock compensation charges related to certain stock options granted to a consultant in July 2001, stock options granted to certain employees in November 2001, and certain re-priced employee stock options for which variable accounting methods were required. Charges related to these stock option arrangements amounting to $2.6 million, or 0.7% of net sales, were recorded for fiscal 2002, an increase from $1.2 million, or 0.4% of net sales, for fiscal 2001. See Note 8 of the notes to our consolidated financial statements. We will continue to incur a $70,000 charge related to the November 2001 grant of certain employee stock options each quarter through the third quarter of fiscal 2004.

     Interest expense. Interest expense on senior, subordinated and other notes payable was $3.4 million, or 1.0% of net sales, for fiscal 2002 as compared to $9.8 million, or 3.2% of net sales, for fiscal 2001. The decrease was the result of our May 2002 debt refinancing, our July 2002 initial public offering, strong cash flow from operations and low interest rates. Interest expense associated with the mandatorily redeemable Class C Preferred Stock was $1.1 million, or 0.3% of net sales, for fiscal 2002 as compared to $2.0 million, or 0.7% of net sales, for fiscal 2001. Amortization of debt issue costs was $0.9 million, or 0.3% of net sales, for fiscal 2002 as compared to $1.3 million, or 0.4% of net sales, for fiscal 2001. We recorded no accretion of common stock warrants in fiscal 2002 compared to $11.3 million, or 3.7% of net sales, in fiscal 2001. The accretion of common stock warrants reflects the accretion to fair value of detachable put warrants issued by us in connection with our issuance of subordinated debt in 1996. All of these warrants were exercised in connection with our July 2002 initial public offering.

     Income taxes. Income tax provision was $10.8 million, or 40.3% of income before income taxes, for fiscal 2002 compared to $1.8 million, or 50.0% of income before income taxes, for fiscal 2001. The decrease in the effective tax rate for fiscal 2002 was primarily the result of the higher level of income before income taxes in fiscal 2002 as compared to fiscal 2001, which reduced the tax rate impact of non-deductible stock compensation charges.

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     Income before extraordinary item and accretion of preferred stock and dividends accrued. As a result of the foregoing, income before extraordinary item and accretion of preferred stock and dividends accrued was $16.1 million, or 4.7% of net sales, for fiscal 2002 compared to $1.8 million, or 0.6% of net sales, for fiscal 2001.

     Extraordinary item. During the third quarter of fiscal 2002, we repaid our $15 million term loan in its entirety. The term loan originally was due in May of 2005. As a result of this early repayment, we recorded an extraordinary loss on the early extinguishment of this debt in the amount of $192,000, net of income tax effects. No such charge was incurred during fiscal 2001. As a result of the implementation of SFAS No. 145, this extraordinary item will be reclassified to non-operating expense in fiscal 2003.

Fiscal Year Ended February 2, 2002, Compared to Fiscal Year Ended December 31, 2000

     Net sales. Net sales increased by 18.5% to $307.2 million for fiscal 2001 from $259.2 million for fiscal 2000. The net sales increase in fiscal 2001 resulted primarily from an increase in comparable store net sales. We also opened five new stores in fiscal 2001 and 17 new stores in fiscal 2000, and we closed 11 stores in fiscal 2001 and the 34-day stub period ended February 3, 2001. We also closed three stores in fiscal 2000. Our net sales benefited from this increase in our store base, as well as sales increases from expanded, remodeled or relocated stores, which are excluded from our comparable store base. The increase in comparable store net sales accounted for approximately $37.2 million of the total net sales increase, or 77.5%, and the net increase in the store base over the last two fiscal years along with sales increases from expanded, remodeled or relocated stores accounted for approximately $10.8 million, or 22.5%, of the total net sales increase. One of our key operating initiatives during 2001 was a concerted effort to reduce inventory levels and SKU counts to offer a better, sharper array of merchandise without changing the core categories of merchandise that we offer. Much of this inventory reduction was accomplished from January through April 2001 through markdowns and promotional activities. As a result of this effort, merchandise flow improved during the balance of the year, allowing our customers to experience a steady flow of fresh product. In addition, the installation of a fully integrated retail information management system at our home office in April 2001 significantly increased our ability to maintain a fresh merchandise mix and appropriate inventory levels in our stores. The comparable store net sales increase was primarily the result of increased unit sales and customer traffic, although we did experience favorable trends in our average retail price per item sold.

     Gross profit. Gross profit increased $20.1 million, or 23.1%, to $107.1 million for fiscal 2001 from $87.0 million for fiscal 2000. Gross profit expressed as a percentage of net sales increased to 34.9% for fiscal 2001, from 33.6% for fiscal 2000. The increase in gross profit as a percentage of net sales resulted primarily from the leveraging of store occupancy costs through higher net sales. Additionally, as a result of our aggressive inventory reduction in the first quarter of fiscal 2001, product cost of sales, including freight expenses, declined as a percentage of net sales particularly in the second half of fiscal 2001, due to the strong sell-through and fresher merchandise mix. These factors were partially offset by an increase in central distribution costs as a percentage of net sales as we leased additional distribution center space and increased staffing levels to support a higher level of activity during fiscal 2001.

     Other operating expenses. Other operating expenses, including both store and corporate costs, were $72.0 million, or 23.4% of net sales, for fiscal 2001 as compared to $67.4 million, or 26.0% of net sales, for fiscal 2000. The decline in these operating expenses as a percentage of net sales was primarily the result of strong net sales that leveraged the fixed component of operating expenses. The percentage decrease in operating expenses also benefited from several expense control initiatives at the store and corporate levels. Two of the most significant initiatives were directly related to our fiscal 2001 plan to improve store-level operating performance. First, we initiated a concerted effort to restrain growth in store payroll expense. By operating stores with lower inventory levels and improving merchandise distribution and allocation, we were able to reduce store payroll expense to 12.2% of net sales for fiscal 2001 as compared to 13.6% of net sales for fiscal 2000. This improvement was partially the result of our completion of a planned reduction in the number of store assistant manager positions. Second, we were able to save over $1 million by reducing our stores’ use of local storage facilities and related truck rentals.

     Depreciation and amortization. Depreciation and amortization expense was $6.4 million, or 2.1% of net sales, for fiscal 2001 as compared to $6.5 million, or 2.5% of net sales, for fiscal 2000. The decline as a percentage of net sales was the result of the strong sales performance as well as a decline in capital expenditures over the last two fiscal years in relation to previous fiscal years.

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     Non-cash stock compensation charge. In fiscal 2001, we incurred a non-cash stock compensation charge related to certain outstanding stock options of $1.2 million, or 0.4% of net sales. No such charge was incurred in fiscal 2000. See Note 8 of the notes to our consolidated financial statements.

     Interest expense. Interest expense on senior, subordinated and other notes payable was $9.8 million, or 3.2% of net sales, for fiscal 2001 as compared to $11.2 million, or 4.3% of net sales, for fiscal 2000. The decrease was the result of significantly improved operating cash flow that led to lower average debt balances in fiscal 2001 in comparison to fiscal 2000 combined with lower interest rates. Interest expense associated with the mandatorily redeemable Class C Preferred Stock was $2.0 million, or 0.7% of net sales, for fiscal 2001 as compared to $1.9 million, or 0.7% of net sales, for fiscal 2000. Amortization of debt issue costs was $1.3 million, or 0.4% of net sales, for fiscal 2001 as compared to $1.3 million, or 0.5% of net sales, for fiscal 2000. The accretion of common stock warrants of $11.3 million, or 3.7% of net sales, reflects the accretion to fair value of detachable put warrants issued by us in connection with our issuance of subordinated debt in 1996. No such charge was recorded in fiscal 2000.

     Income taxes. Income tax provision was $1.8 million, or 50.0% of income before income taxes, for fiscal 2001 as compared to a benefit of $0.6 million, or 30.3% of loss before income taxes, for fiscal 2000. The increase in the effective tax rate for fiscal 2001 is primarily the result of non-deductible stock compensation charges associated with certain employee stock options.

     Income (loss) before accretion of preferred stock and dividends accrued. As a result of the foregoing, income before accretion of preferred stock and dividends accrued was $1.8 million, or 0.6% of net sales, for fiscal 2001 compared to a loss of $1.3 million, or 0.5% of net sales, for fiscal 2000.

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.

     Net cash provided by operating activities for fiscal 2002 was $18.7 million compared to $37.5 million for fiscal 2001. Income after extraordinary item and before preferred stock dividends and accretion for fiscal 2002 increased to $15.9 million from $1.8 million for fiscal 2001. Depreciation was $6.7 million, modestly higher than the prior year’s $6.3 million, and non-cash stock compensation charge was $2.6 million, higher than the prior year’s $1.2 million. These cash sources were offset primarily by a reduction in accrued expenses and other noncurrent liabilities due to the payment to our debtholders of $13.4 million in accrued interest with the proceeds of our May 2002 refinancing and July 2002 initial public offering. An increase in inventories of $6.7 million was financed largely by an increase in accounts payable of $5.1 million during the period.

     Net cash used in investing activities for fiscal 2002 consisted almost entirely of $8.4 million in capital expenditures. These expenditures primarily included investments in existing store remodels, new store construction and information technology assets for stores and the corporate headquarters. During fiscal 2002, we opened 16 new stores and remodeled 4 stores. We expect that capital expenditures for fiscal 2003 will range from $14.5 to $15.5 million, primarily to fund the construction of 37-40 new stores and to complete several ongoing information technology projects. We anticipate that capital expenditures, including leasehold improvements and furniture and fixtures, for our fiscal 2003 new stores will average approximately $155,000 – $165,000 per store (net of landlord allowances).

     Net cash used in financing activities for fiscal 2002 was $35.8 million. Two significant financing events, our May 2002 senior debt refinancing and our July 2002 initial public offering of common stock, took place during the second fiscal quarter. 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 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.

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     With the completion of our initial public offering and the application of the net proceeds toward debt reduction along with the repayment of our term loan, our only remaining debt consists of our $45 million revolving credit facility. The revolving credit facility bears interest at a floating rate equal to the prime rate or LIBOR plus 2.25%, at our election. The maximum availability under the revolving credit facility is limited by a borrowing base that consists of a percentage of eligible inventory less reserves. Our revolving 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 from time to time may decrease the borrowing base by adding reserves with respect to matters such as inventory shrinkage. The revolving credit facility terminates in May 2005. As of February 1, 2003, we had no borrowings outstanding under our revolving credit facility.

     Our senior credit facility contains provisions that could result in changes in 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 senior credit facility has two financial covenants, both of which are tested quarterly on a latest-twelve-months basis. The first covenant establishes a minimum level of earnings before interest, taxes, depreciation and amortization excluding certain non-recurring items, or EBITDA, less capital expenditures, and the second covenant establishes a maximum senior debt to EBITDA ratio. As of February 1, 2003, we were in compliance with all covenants under our senior credit facility.

     At February 1, 2003, our balance of cash and cash equivalents was $4.2 million and the borrowing availability under our revolving credit facility was $21.4 million. We believe that these sources of cash, together with cash provided by our operations, will be adequate to carry out our fiscal 2003 growth plans in full and fund our planned capital expenditures, interest payments and working capital requirements for at least the next twelve months.

The following table summarizes our known material contractual obligations specified in the table in effect at February 1, 2003: