General
We are a specialty retailer of home décor in the United States, operating 321 stores in 34 states as of November 1, 2008. Our stores present a broad selection of distinctive merchandise, including framed art, mirrors, wall décor, candles, lamps, decorative accessories, accent furniture, textiles, 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 recognized name in home décor and has enabled us to develop a strong customer franchise.
During the 13 week period ended November 1, 2008, we did not open any new stores and closed three stores. The following table summarizes our stores and square footage under lease by venue type:

                             Stores                              Square Footage               Average Store Size
            11/1/08                 11/3/07                  11/1/08         11/3/07        11/1/08        11/3/07
Mall             108        34 %         147        42 %       511,353         710,287          4,735         4,832
Off-Mall         213        66 %         207        58 %     1,342,012       1,285,787          6,301         6,212

Total            321       100 %         354       100 %     1,853,365       1,996,074          5,774         5,639

13-Week Period Ended November 1, 2008 Compared to the 13-Week Period Ended
November 3, 2007
   Results of operations. The table below sets forth selected results of our
operations in dollars and expressed as a percentage of net sales for the periods
indicated (dollars in thousands):

                                              13-Week Period Ended
                               November 1, 2008                 November 3, 2007                       Change
                               $               %                $                %                $               %
Net sales                  $  85,878          100.0 %       $   88,743          100.0 %         ($2,865 )          (3.2 %)
Cost of sales                 57,253           66.7 %           63,980           72.1 %          (6,727 )         (10.5 %)

Gross profit                  28,625           33.3 %           24,763           27.9 %           3,862            15.6 %

Operating expenses:
Compensation and
benefits                      16,651           19.4 %           17,171           19.3 %            (520 )          (3.0 %)
Other operating
expenses                       8,810           10.3 %           10,396           11.7 %          (1,586 )         (15.3 %)
Severance charge                   -            0.0 %              965            1.1 %            (965 )        (100.0 %)
Depreciation and
amortization                   4,685            5.5 %            4,862            5.5 %            (177 )          (3.6 %)

Total operating
expenses                      30,146           35.1 %           33,394           37.6 %          (3,248 )          (9.7 %)

Operating loss                (1,521 )         (1.8 %)          (8,631 )         (9.7 %)          7,110           (82.4 %)

Interest expense, net             18            0.0 %              210            0.2 %            (192 )         (91.4 %)
Other
(income) expense, net             45            0.1 %              (34 )          0.0 %              79          (232.4 %)


Loss before income
taxes                         (1,584 )         (1.8 %)          (8,807 )         (9.9 %)          7,223           (82.0 %)
Income tax provision
(benefit)                       (113 )         (0.1 %)           1,843            2.1 %          (1,956 )        (106.1 %)


Net loss                     ($1,471 )         (1.7 %)        ($10,650 )        (12.0 %)      $   9,179           (86.2 %)

Net sales. The overall decrease in net sales was primarily due to a decrease in average store count during the quarter, slightly offset by an increase in comparable store sales of 1.2% for the period. Comparable store sales in our mall store locations were up 2.2% for the third quarter, while comparable store sales for our off-mall store locations were up 0.8%. The comparable store sales increase was primarily due to an increase in the average ticket partially offset by a decline in the number of transactions. The average ticket was up during the quarter reflecting an increase in items per transactions. Transactions decreased during the quarter reflecting a slight decrease in traffic counts and customer conversion rates. The strongest performing categories were art, lamps, furniture, and floral.
We did not open any new stores during the third quarter of fiscal 2008 and opened 35 stores in fiscal 2007, and we closed three stores during the third quarter of fiscal 2008 and 49 stores in fiscal 2007. We ended the third quarter of fiscal 2008 with 321 stores in operation compared to 354 stores as of the end of the third quarter of fiscal 2007, representing a 9.3% decrease in the store base and a 7.1% decrease in total square footage under lease.

Gross profit. The increase in gross profit as a percentage of net sales resulted from a combination of factors. The merchandise margin increased from 48.9% in the third quarter of fiscal 2007 to 52.9% in the third quarter of fiscal 2008. Merchandise margin is calculated as net sales minus product cost of sales, excluding outbound freight, store occupancy, and central distribution costs. Merchandise markdowns were lower in the current year due to better sell through and a more compelling product offering. Additionally, the level of promotional activity was reduced compared to the heavy use of coupons in the prior year quarter. The occupancy ratio decreased versus the prior year period primarily due to closing underperforming stores as well as favorable lease renewals and extensions. The continued shift of the store base to less costly, off-mall locations also helped improve the ratio. Freight costs as a percentage of sales were flat as compared to the prior year period. Central distribution costs as a percentage of sales were slightly higher than the prior year as a result of a decreased revenue base.
Compensation and benefits. At the store-level, the compensation and benefits expense ratio was slightly higher during the third quarter of fiscal 2008 as compared to the third quarter of 2007. We experienced an increase in average hourly wages at the store level which was somewhat offset by higher comparable store sales during the third quarter of fiscal 2008. At the corporate level, the compensation and benefits ratio remained flat for the third quarter of 2008 as compared to the third quarter of 2007.
Other operating expenses. The decrease in these operating expenses as a percentage of net sales was primarily due to the positive comparable store sales performance and the effect of large reductions in marketing activities as compared to the prior year period. Corporate level operating expenses decreased as a percentage of net sales due to the positive comparable store sales performance coupled with lower professional fees and travel expenses. During the third quarter of fiscal 2007, the Company incurred a charge related to separation costs associated with a restructuring of corporate personnel that occurred during the quarter. This charge totaled approximately $965,000, or $0.04 per share. The Company eliminated 74 positions, including field multi-unit management and corporate positions at its Jackson and Nashville offices.
Depreciation and amortization. Depreciation and amortization remained flat as a percentage of sales as a result of a reduction in capital expenditures in recent quarters offset by the acceleration of depreciation on planned store closings and a smaller average store base.
Income tax provision (benefit). No income tax benefit has been recorded in the current year quarter due to our provision of a full valuation allowance against deferred tax assets because of our cumulative losses in recent years. In the prior year quarter, we incurred tax expense of $1.8 million due to the limited ability to carryback losses for two tax years.
Net loss and loss per share. As a result of the foregoing, we reported a net loss of $1.5 million, or $0.07 per share, for the third quarter of fiscal 2008 as compared to a net loss of $10.7 million, or $0.55 per share, for the third quarter of fiscal 2007.
39-Week Period Ended November 1, 2008 Compared to the 39-Week Period Ended November 3, 2007
Results of operations. The table below sets forth selected results of our operations in dollars and expressed as a percentage of net sales for the periods indicated (dollars in thousands):

                                                 39-Week Period Ended
                                   November 1, 2008                November 3, 2007                     Change
                                   $               %               $               %               $               %
Net sales                      $ 257,639          100.0 %      $ 258,416          100.0 %          ($777 )         (0.3 %)
Cost of sales                    174,237           67.7 %        187,611           72.6 %        (13,374 )         (7.1 %)

Gross profit                      83,402           32.4 %         70,805           27.4 %         12,597           17.8 %

Operating expenses:
Compensation and benefits         49,489           19.2 %         53,355           20.6 %         (3,866 )         (7.2 %)
Other operating expenses          25,803           10.0 %         32,057           12.4 %         (6,254 )        (19.5 %)

                                              39-Week Period Ended
                               November 1, 2008                 November 3, 2007                       Change
                               $               %                $                %                $               %
Impairment charges                352           0.1 %              813            0.3 %            (461 )         (56.7 %)
Severance charge                    -           0.0 %              965            0.4 %            (965 )        (100.0 %)
Depreciation and
amortization                   13,840           5.4 %           14,744            5.7 %            (904 )          (6.1 %)

Total operating
expenses                       89,484          34.7 %          101,934           39.4 %         (12,450 )         (12.2 %)

Operating loss                 (6,082 )        (2.4 %)         (31,129 )        (12.0 %)         25,047           (80.5 %)

Interest expense, net              30           0.0 %              214            0.1 %            (184 )         (86.0 %)
Other income, net                (291 )        (0.1 %)             (65 )          0.0 %            (226 )         347.7 %


Loss before income
taxes                          (5,821 )        (2.3 %)         (31,278 )        (12.1 %)         25,457           (81.4 %)
Income tax benefit               (104 )         0.0 %           (3,882 )         (1.5 %)          3,778           (97.3 %)


Net loss                      ($5,717 )        -2.2 %         ($27,396 )        -10.6 %       $  21,679           -79.1 %

Net sales. The overall decrease in net sales was primarily due to a decrease in the average store count offset by an increase in comparable store sales of 2.7% for the period. Comparable store sales in our mall store locations were up 6.2% for the first three quarters, while comparable store sales for our off-mall store locations were up 1.1%. The comparable store sales increase was primarily due to an increase in transaction volume driven by higher customer conversion rates coupled with a slight increase in the average ticket. The average ticket reflected an increase in items per transaction offset by a decrease in the average retail selling price.
We opened 3 new stores during the first three quarters of fiscal 2008 and 35 stores in fiscal 2007, and we closed 17 stores during the first three quarters of fiscal 2008 and 49 stores in fiscal 2007. We ended the third quarter of fiscal 2008 with 321 stores in operation compared to 354 stores as of the end of the third quarter of fiscal 2007, representing a 9.3% decrease in the store base and a 7.1% decrease in total square footage under lease.
Gross profit. The increase in gross profit as a percentage of net sales resulted from a combination of factors. The merchandise margin increased from 48.9% in the first three quarters of fiscal 2007 to 51.8% in the first three quarters of fiscal 2008. Merchandise margin is calculated as net sales minus product cost of sales, excluding outbound freight, store occupancy, and central distribution costs. Merchandise markdowns were lower in the current year due to better sell through and a more compelling product offering. Additionally, the level of promotional activity was reduced compared to the heavy use of coupons in the prior year period. The occupancy ratio decreased versus the prior year period primarily due to the leveraging effect of the positive comparable store sales. Additionally, rent reductions achieved in certain lease renewals and the closing of underperforming stores also benefited the comparison. Freight costs and central distribution costs were flat as a percentage of net sales as compared to the prior year period.
Compensation and benefits. At the store-level, the compensation and benefits expense ratio decreased for the first three quarters of fiscal 2008 as compared to the first three quarters of 2007 primarily due to the positive comparable store sales performance offset slightly by a higher average wage during the third quarter of fiscal 2008. At the corporate level, the compensation and benefits ratio decreased for the first three quarters of 2008 as compared to the first three quarters of 2007 primarily due to the reductions in corporate salaries and benefits as a result of personnel reductions in late fiscal 2007.
Other operating expenses. The decrease in these operating expenses as a percentage of net sales at the store level was primarily due to the positive comparable store sales performance and the effect of large reductions in marketing activities as compared to the prior year period. Corporate level operating expenses decreased as a percentage of net sales due to the positive comparable store sales performance coupled with lower professional fees and travel expenses. Also, in the prior year period, we incurred expenses of approximately $1.2 million, or $0.05 per diluted share, related to the opening of a satellite office in Nashville, Tennessee. These expenses were associated with personnel relocation costs and moving expenses.

Impairment charges. During the first three quarters of fiscal 2008, we incurred a charge related to the impairment of fixed assets related to certain underperforming stores in the pre-tax amount of approximately $352,000, or $0.02 per diluted share compared to impairment charges of $813,000 in the prior year period.
Severance charge. During the third quarter of fiscal 2007, we incurred a charge related to separation costs associated with a restructuring of corporate personnel that occurred during the quarter. This charge totaled approximately $965,000, or $0.04 per share.
Depreciation and amortization. The decrease in depreciation and amortization as a percentage of sales was primarily the result of the positive comparable store sales performance combined with a reduction in capital spending in recent periods and a smaller store base.
Income tax provision (benefit). No income tax benefit has been recorded in the current year due to our provision of a full valuation allowance against deferred tax assets because of our cumulative losses in recent years. During the second quart of fiscal 2007, we established a valuation allowance on our net deferred tax assets in the amount of $2.8 million.
Net loss and loss per share. As a result of the foregoing, we reported a net loss of $5.7 million, or $0.29 per share, for the first three quarters of fiscal 2008 as compared to a net loss of $27.4 million, or $1.40 per share, for the first three quarters of fiscal 2007.
Liquidity and Capital Resources
Our principal capital requirements are for working capital and capital expenditures. Working capital consists mainly of merchandise inventories offset by accounts payable, which typically reach their peak by the end of the third quarter of each fiscal year. Capital expenditures primarily relate to new store openings; existing store expansions, remodels or relocations; and purchases of equipment or information technology assets for our stores, distribution facilities or corporate headquarters. Historically, we have funded our working capital and capital expenditure requirements with internally generated cash and borrowings under our credit facility.
Cash flows from operating activities. Net cash used in operating activities was $5.4 million and $34.1 million for the first three quarters of fiscal 2008 and fiscal 2007, respectively. Net cash used in operating activities depends heavily on operating performance, changes in working capital and the timing and amount of payments for income taxes. The change in the amount of cash used in operating activities as compared to the prior year period was significantly impacted by the improvement in our operating performance resulting from the 2.7% increase in our year-to-date comparable store sales, the increase in profit margin and the reduction in operating expenses. Inventories increased approximately $17.5 million during the first three quarters of fiscal 2008 as compared to an increase of $18.0 million during the prior year period. Inventories averaged approximately $183,000 per store at November 1, 2008, as compared to $177,000 per store at November 3, 2007. Accounts payable increased $6.0 million during the first three quarters of fiscal 2008 as compared to an increase of $3.6 million for the prior year period. The change in accounts payable is primarily due to the timing and amount of merchandise receipt flow. We also received an income tax refund of approximately $2.9 million during the first three quarters of fiscal 2008 whereas we made cash tax payments of approximately $2.5 million in the prior-year period.
Cash flows from investing activities. Net cash provided by investing activities for the first three quarters of fiscal 2008 consisted principally of the sale of our corporate aircraft and former corporate headquarters building and land in Jackson, Tennessee resulting in net proceeds of approximately $816,000 and $2.8 million, respectively. These cash inflows were offset by capital expenditures for the period of approximately $2.1 million as compared to $11.8 million for the prior year period. These expenditures primarily related to new store construction. During the first three quarters of fiscal 2008, we opened three stores compared to 18 stores in the prior year period. We expect that capital expenditures for all of fiscal 2008 will be approximately $3 million, primarily to fund the maintenance of our existing investments in stores, information technology, and the distribution center, as well as the openings of the three new stores. As of November 1, 2008, we had no new lease commitments for new stores. Capital

expenditures, including leasehold improvements and furniture and fixtures, and equipment for our new stores in fiscal 2008 average approximately $400,000 to $430,000 per store. We received landlord allowances in connection with the construction of our three new stores in fiscal 2008 which are reflected as a component of cash flows from operating activities within our consolidated statement of cash flows.
Cash flows from financing activities. Net cash provided by financing activities was $69,000 and $20.9 million for the first three quarters of fiscal 2008 and fiscal 2007, respectively. Cash flows from financing activities for the first three quarters of fiscal 2008 were related to employee stock purchases. During the first three quarters of fiscal 2007, cash flows from financing activities primarily related to bank revolver borrowings.
Revolving credit facility. Effective October 4, 2004, we entered into a five-year senior secured revolving credit facility with a revolving loan limit of up to $45 million. On August 6, 2007, we entered into the First Amendment to Loan and Security Agreement (the "Amendment") which provided the Company with additional availability under our borrowing base through higher advance rates on eligible inventory. As a result of the amendment, the aggregate size of the overall credit facility remained unchanged at $45 million, but the term of the facility was extended two years making the new expiration date October 4, 2011. Amounts outstanding under the amended facility, other than First In Last Out ("FILO") loans, bear interest at a floating rate equal to the 60-day LIBOR rate (2.97% at November 1, 2008) plus 1.25% to 1.50% (depending on the amount of excess availability under the borrowing base). FILO loans, which apply to the first approximate $2 million borrowed at any given time, bear interest at a floating rate equal to the 60-day LIBOR rate plus 2.25% to 2.50% (depending on the amount of excess availability under the borrowing base). Additionally, we pay a quarterly fee to the bank equal to a rate of 0.2% per annum on the unused portion of the revolving line of credit. Borrowings under the facility are collateralized by substantially all of our assets and guaranteed by our subsidiaries. The maximum availability under the credit facility is limited by a borrowing base formula, which consists of a percentage of eligible inventory and receivables less reserves. The facility also contains provisions that could result in changes to the presented terms or the acceleration of maturity. Circumstances that could lead to such changes or acceleration include a material adverse change in the business or an event of default under the credit agreement. The facility has one financial covenant that requires the Company to maintain excess availability under the borrowing base, as defined in the credit agreement, of at least $3.0 million to $4.5 million depending on the size of the borrowing base, at all times.
As of November 1, 2008, we were in compliance with the covenants in the facility and there were no outstanding borrowings under the credit facility, with approximately $41 million available for borrowing (net of the availability block as described above).
At November 1, 2008, our balance of cash and cash equivalents was approximately $2.0 million and the borrowing availability under our facility was $41 million (net of the availability block as described above). During fiscal 2007, we undertook a number of measures to reduce expenses and improve liquidity, including corporate headcount reductions, slowing store growth, closing underperforming stores, commencing the sale of non-essential assets, enhancing and maximizing our existing credit facility, and reducing our planned inventory needs. We also received approximately $2.9 million in federal tax refunds during the first half of fiscal 2008. We believe that cash flow from operations, including the impact of the aforementioned initiatives, coupled with funds received from the sale of assets will result in peak borrowings that are lower than the prior year and will be sufficient to fund our planned capital expenditures and working capital requirements for at least the next twelve months.
Off-Balance Sheet Arrangements
None.
Significant Contractual Obligations and Commercial Commitments None.
Critical Accounting Policies and Estimates There have been no significant changes to our critical accounting policies during fiscal 2008. Refer to our Annual Report on Form 10-K for the fiscal year ended February 2, 2008, for a summary of our critical accounting policies.

Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995 The following information is provided pursuant to the "Safe Harbor" provisions of the Private Securities Litigation Reform Act of 1995. Certain statements under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-Q are "forward-looking statements" made pursuant to these provisions. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Words such as "should," "likely to," "forecasts," "strategy," "goal," "anticipates," "believes," "expects," "estimates," "intends," "plans," "projects," and similar expressions, may identify such forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially from the results projected in such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
We caution readers that the following important factors, among others, have in the past, in some cases, affected and could in the future affect our actual results of operations and cause our actual results to differ materially from the results expressed in any forward-looking statements made by us or on our behalf.
• If We Are Unable to Successfully Execute Our Turnaround Strategy, Our Results of Operations Will Not Improve.

• A Prolonged Economic Downturn Could Result in Reduced Net Sales and Profitability.

• 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.

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

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

• 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.

• 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 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.

. . .