FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

(Mark One)

For the quarterly period ended May 29, 2004

OR

Commission File Number 1-7832

PIER 1 IMPORTS, INC.

301 Commerce Street, Suite 600, Fort Worth, Texas 76102

(817) 252-8000

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Table of Contents

PART I

Item 1. Financial Statements.

PIER 1 IMPORTS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

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

PIER 1 IMPORTS, INC.

CONSOLIDATED BALANCE SHEETS
(in thousands except share amounts)
(unaudited)

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

PIER 1 IMPORTS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

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

PIER 1 IMPORTS, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
FOR THE THREE MONTHS ENDED MAY 29, 2004
(in thousands except per share amounts)
(unaudited)

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

PIER 1 IMPORTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MAY 29, 2004 AND MAY 31, 2003
(unaudited)

The accompanying unaudited financial statements should be read in conjunction with the Form 10-K for the year ended February 28, 2004. All adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position as of May 29, 2004, and the results of operations and cash flows for the three months ended May 29, 2004 and May 31, 2003 have been made and consist only of normal recurring adjustments. The results of operations for the three months ended May 29, 2004 and May 31, 2003 are not indicative of results to be expected for the fiscal year because of, among other things, seasonality factors in the retail business. The classifications of certain amounts previously reported in the balance sheets as of February 28, 2004 and May 31, 2003, and the statement of cash flows for the three months ended May 31, 2003, have been modified to conform to the May 29, 2004 method of presentation.

Note 1 — Earnings per share

Basic earnings per share amounts were determined by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per share amounts were similarly computed, but included the effect, when dilutive, of the Company’s weighted average number of stock options outstanding. Stock options for which the exercise price was greater than the average market price of common shares were not included in the computation of diluted earnings per share as the effect would be antidilutive. As of May 29, 2004 and May 31, 2003, there were 5,461,625 and 2,755,500 stock options outstanding, respectively, with exercise prices greater than the average market price of the Company’s common shares. Earnings per share for the three months ended May 29, 2004 and May 31, 2003 were calculated as follows (in thousands except per share amounts):

Note 2 — Comprehensive income

The components of comprehensive income for the three months ended May 29, 2004 and May 31, 2003 were as follows (in thousands):

Note 3 — Stock-based compensation

The Company grants stock options for a fixed number of shares to employees with stock option exercise prices equal to the fair market value of the shares on the date of grant. The Company accounts for stock option grants under the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and, accordingly, recognizes no compensation expense for the stock option grants.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation for the three months ended May 29, 2004 and May 31, 2003 (in thousands except per share amounts):

Note 4 — Store closing provision

Although the Company’s stores typically are not closed before the end of their primary lease terms, periodically certain stores with relatively short terms remaining on their respective leases are closed or relocated to more favorable locations within the same market. These decisions are based on lease

renewal obligations, relocation space availability, general economic conditions and prospects for future profitability. In connection with these store closings, the Company recorded estimated liabilities in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The estimated liabilities were recorded based upon the Company’s remaining lease obligations less estimated subtenant rental income for the closed stores. Revisions during the quarter related to changes in estimated subtenant receipts expected on closed facilities. Expenses related to store closings are included in selling, general and administrative expenses in the Company’s consolidated statements of operations. The write-off of fixed assets has not been material and there has been no write-down of inventory or employee severance costs associated with these closed stores. The following table represents a reconciliation of the liability balances from February 28, 2004 to May 29, 2004 (in thousands):

Note 5 — Benefit plans

The Company maintains supplemental retirement plans (“the Plans”) for certain of its executive officers. The Plans provide that upon death, disability or reaching retirement age, a participant will receive benefits based on highest compensation and years of service. Pension expense is determined using various actuarial cost methods to estimate the total benefits ultimately payable to executive officers and allocates this cost to service periods. The Plans are not funded and thus have no plan assets. However, a trust has been established for the purpose of setting aside funds to be used to settle the pension obligations upon retirement or death of certain participants. The Company made no contributions to the trust during the first quarter of fiscal 2005, but expects to contribute to the trust prior to the end of the fiscal year. The actuarial assumptions used to calculate pension costs are reviewed annually. The components of net periodic benefit costs for the three months ended May 29, 2004 and May 31, 2003 were as follows (in thousands):

Note 6 — Adoption of new accounting standard

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). This interpretation requires certain variable interest entities (“VIEs”), commonly referred to as special purpose entities, to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 was effective for all new VIEs created or acquired after January 31, 2003. During December 2003, the FASB issued a revision to FIN 46 (“FIN 46R”). Under the new provisions, public entities were required to apply the guidance if the entity has interests in VIEs for the periods ending after December 15, 2003. Application of this guidance by public companies was required for all other types of entities for periods ending after March 15, 2004. The adoption of FIN 46R did not have a material effect on the Company’s consolidated balance sheets or its statements of operations, shareholders’ equity and cash flows.

PART I

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

Management Overview

Pier 1 Imports, Inc. (together with its consolidated subsidiaries, the “Company”) is one of North America’s largest specialty retailers of unique decorative home furnishings, gifts and related items. The Company directly imports proprietary merchandise from over 40 countries, and sells a wide variety of furniture collections, decorative accessories, bed and bath products, housewares and other seasonal assortments in its stores. The Company operates stores in the United States and Canada under the names Pier 1 Imports (“Pier 1”) and “Cargokids”. Cargokids operates stores that sell children’s home furnishings and decorative accessories. Retail locations operating under the name “The Pier” are located primarily in the United Kingdom. As of May 29, 2004, the Company operated 1,201 stores in the United States, Canada, Puerto Rico, the United Kingdom and Mexico.

Management reviews a number of key indicators to evaluate the Company’s financial performance. The following table summarizes those key performance indicators for the three months ended May 29, 2004 and May 31, 2003:

After a good start early in the first quarter of fiscal 2005, sales slowed in April after the Easter weekend and average customer traffic was below last year’s levels for the rest of the quarter. As a result, comparable store sales during the quarter declined 1.8%. Compared to last year’s first quarter, gross profit as a percentage of sales declined 200 basis points and net income decreased 38.4%. Diluted earnings per share were $.13 for the first quarter of fiscal 2005 compared to $.21 for the year ago period. The new television advertising campaign featuring Thom Filicia that was launched in March and promotional events throughout the first quarter did not have the positive impact on sales the Company expected. Sales were further deflated by the shift of part of the Memorial Day weekend into the second fiscal quarter. Also, in light of rising fuel prices and other uncertain economic factors, the Company believes that the retail environment was not as strong as anticipated, and customers may have become more cautious with discretionary spending. Economic challenges have resulted in weaker demand and customers may be delaying purchases for the home and shifting spending to apparel. However, there are certain issues that are Pier 1 specific and in response, the Company has evaluated aspects of the business and plans to implement the following

marketing, merchandising and store operational strategies in an effort to increase customer traffic and improve customer conversion:

	•		The Company will reassess its advertising expenditures in an effort to increase local market awareness and improve the timing and placement of its printed and broadcast media. Promotional efforts will be focusing on the value, style and uniqueness of the Company’s merchandise.
	•		The Company is in the process of improving quality control procedures with vendors, agents and buyers.
	•		Certain items in the Company’s merchandise assortment that are subject to price competition from discount retailers or items where sales have slowed from the prior year will either be eliminated or prices will be reduced.
	•		Each Pier 1 store currently carries approximately 4,500 individual items and management now believes this may be too many. In an effort to edit the merchandise assortment, the Company plans to reduce its SKU count to approximately 3,500, while retaining new, unique merchandise.
	•		The Company’s store operations group will focus on increasing customer conversion by simplifying visual displays and by implementing better sales associate and manager training to build customer engagement and increase add-on sales.
	•		The Company plans to test market the name “Pier 1 kids” as a replacement of the name “Cargokids” at certain existing Cargokids stores during fiscal 2005.

The Company believes that implementation of these strategies will improve its competitive advantage over other retailers and increase the potential for positive sales results, especially during the second half of the fiscal year. Despite the disappointing first quarter results, the Company’s balance sheet remains sound.

Results of Operations

Net Sales — Net sales consisted almost entirely of sales to retail customers net of discounts and returns, but also included delivery service revenues and wholesale sales and royalties received from franchise stores and Sears de Mexico, S.A. Sales by retail concept during the period were as follows (in thousands):

(1)

Other sales consisted of wholesale sales and royalties received from franchise stores and from Sears de Mexico S.A., and Cargokids’ contract sales. As of August 30, 2003, Cargokids no longer sells merchandise under wholesale contracts.

Net sales for the first quarter of fiscal 2005 were $432.0 million, up 7.3% or $29.3 million from last year’s first quarter net sales of $402.7 million. Comparable store sales for the quarter declined 1.8%. The Company’s new television advertising campaign that debuted in March and promotional events during the first quarter of fiscal 2005 did not generate expected comparable store sales increases, and both average traffic counts per store and conversion rates were down during the first quarter compared to the same period last year. The Company currently expects soft sales results to continue into the second quarter and projects comparable stores sales in the negative low single digit range for the second quarter.

Contributing to total net sales growth during the quarter were the Company’s continued efforts to expand by opening new stores. During the first three months of fiscal 2005, the Company opened 20 and closed or relocated six North American Pier 1 stores, opened eight and closed one Cargokids stores and opened one store at The Pier. As a result of new store openings, total retail square footage increased 1.8% during the first quarter and 11.5% over the same quarter last year. The North American Pier 1 store count totaled 1,097 at the end of the first quarter compared to 1,007 stores a year ago. Including Cargokids and all other worldwide locations, the Company’s store count totaled 1,201 at the end of the first quarter of fiscal 2005.

A summary reconciliation of the Company’s stores open at the beginning of fiscal 2005 to the number open at the end of the first quarter follows (openings and closings include relocated stores):

(1)

International stores were located in Puerto Rico, the United Kingdom and Mexico.

The Company’s proprietary credit card generated net sales of $121.1 million during the first quarter of fiscal 2005, representing an increase of $14.5 million or 13.6% over proprietary credit card sales of $106.6 million for the same period last year. As a percentage of U.S. store sales, proprietary credit card sales increased to 30.9% compared to 28.9% during the same period a year ago. Average ticket on the proprietary credit card improved to $171 during the first quarter of fiscal 2005 compared to $168 during last year’s first quarter. These increases were partially attributable to a 15% discount offered on first time purchases made by new cardholders, an increase from the 10% discount previously offered. The Company continues to try to increase total sales on its proprietary credit card by developing customer loyalty through marketing promotions targeted to cardholders, including deferred payment options on larger purchases. Although the proprietary credit card generates modest income, it primarily serves as a tool for marketing and communication to the Company’s most loyal customers.

Gross Profit — Gross profit after related buying and store occupancy costs, expressed as a percentage of sales, decreased 200 basis points to 39.8% for the first quarter of fiscal 2005 from 41.8% last year. Merchandise margins for the quarter were 55.3% of sales, 110 basis points below last year’s 56.4%, primarily as a result of increased promotional discounts. Merchandise margins as a percentage of sales may decline in the second quarter compared to the same period a year ago as increased promotional activity is expected to continue to be used to stimulate sales. Store occupancy costs for the quarter increased 90 basis points as a percentage of sales to 15.5% from 14.6% last year as a result of relatively fixed rental costs spread over a lower sales base and from an increase in the percentage of total sales from newer stores, for which occupancy costs as a percentage of sales tend to be higher until the stores reach sales maturity.

Operating Expenses and Depreciation — For the first quarter of fiscal 2005, selling, general and administrative expenses totaled $139.9 million, an increase of $14.1 million over the same quarter last year or 120 basis points as a percentage of sales. Expenses that normally grow proportionately with sales and number of stores, such as marketing, store payroll, store supplies and equipment rental, increased 170 basis poin