Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended November 28, 2009

OR

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to              

Commission file number 001-07832

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.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

As of January 4, 2010, 115,588,500 shares of the registrant’s common stock, $0.001 par value, were outstanding.

Table of Contents

PIER 1 IMPORTS, INC.

INDEX TO QUARTERLY FORM 10-Q

2

Table of Contents

PART I

Item 1.        Financial Statements.

PIER I IMPORTS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands except per share amounts)

(unaudited)

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

3

Table of Contents

PIER 1 IMPORTS, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands except share amounts)

(unaudited)

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

4

Table of Contents

PIER 1 IMPORTS, INC

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

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

5

Table of Contents

PIER 1 IMPORTS, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED NOVEMBER 28, 2009

(in thousands)

(unaudited)

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

6

Table of Contents

PIER 1 IMPORTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED NOVEMBER 28, 2009

AND NOVEMBER 29, 2008

(unaudited)

Throughout this report, references to the “Company” include Pier 1 Imports, Inc. and all its consolidated subsidiaries.  The accompanying unaudited financial statements should be read in conjunction with the Form 10-K for the year ended February 28, 2009.  All adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position as of November 28, 2009, and the results of operations and cash flows for the three and nine months ended November 28, 2009 and November 29, 2008 have been made and consist only of normal recurring adjustments, except as otherwise described herein.  The results of operations for the three and nine months ended November 28, 2009 and November 29, 2008, are not indicative of results to be expected for the fiscal year because of, among other things, seasonality factors in the retail business.  Historically, the strongest sales of the Company’s products have occurred during the holiday season beginning in November and continuing through December.  The Company conducts business as one operating segment.  The classification of certain amounts previously reported in the consolidated balance sheets and consolidated statements of cash flows for the nine months ended November 29, 2008, has been modified to conform to the November 28, 2009 method of presentation.

Note 1 — Earnings (loss) per share

Basic earnings (loss) per share amounts were determined by dividing net income (loss) by the weighted average number of common shares outstanding for the period.  Diluted earnings (loss) per share amounts were similarly computed, but would have included the effect, if dilutive, of the Company’s weighted average number of stock options outstanding and shares of unvested restricted stock.  As the effect would have been antidilutive, all 12,048,869 and 12,933,535 stock options outstanding and shares of unvested restricted stock were excluded from the computation of the third quarter and year-to-date earnings (loss) per share for fiscal 2010 and fiscal 2009, respectively.  Additionally, the common stock issuable under the Company’s convertible notes prior to their conversion and the related interest expense were also excluded from the diluted earnings per share calculation as the effect would have been antidilutive.  Earnings (loss) per share for the three and nine months ended November 28, 2009 and November 29, 2008 was calculated as follows (in thousands except per share amounts):

7

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

Note 2 — Comprehensive income (loss)

The components of comprehensive income (loss) for the three and nine months ended November 28, 2009 and November 29, 2008 were as follows (in thousands):

Note 3 — Stock-based compensation

The Company accounts for share-based compensation transactions in accordance with the applicable accounting guidance which requires all companies to measure and recognize compensation expense at an amount equal to the fair value of share-based payments granted under compensation arrangements.  The fair values for options granted during the respective periods were estimated as of the date of grant using the Black-Scholes option-pricing model and are amortized on a straight-line basis as compensation expense over the vesting periods of the options.  For the three and nine months ended November 28, 2009, the Company recorded stock-based compensation expense related to stock options and restricted stock of $645,000, or less than $0.01 per share, and $2,861,000, or $0.03 per share, respectively.  For the three and nine months ended November 29, 2008, the Company recorded stock-based compensation expense (benefit) related to stock options and restricted stock of ($287,000), or less than ($0.01) per share, and $4,215,000, or $0.05 per share, respectively.  During the third quarter of fiscal 2009, the Company reversed $1,420,000 in stock-based compensation expense related to a performance stock option grant, which was no longer considered probable to vest.  The Company recognized no net tax benefit related to stock-based compensation during the first nine months of fiscal 2010 or fiscal 2009 as a result of the Company’s valuation allowance on all deferred tax assets in both years.

As of November 28, 2009, there was approximately $1,911,000 of total unrecognized compensation expense related to unvested stock option awards that is expected to be recognized over a weighted average period of 1.6 years and $1,515,000 of total unrecognized compensation expense related to restricted stock that is expected to be recognized over a weighted average period of 1.1 years.

Note 4 — Costs associated with exit activities

As part of the ordinary course of business, the Company terminates leases prior to their expiration when certain stores or distribution center facilities are closed or relocated as deemed necessary by the evaluation of its real estate portfolio.  These decisions are based on store profitability, lease renewal obligations, relocation space availability, local market conditions and prospects for future profitability. In connection with these lease terminations, the Company has recorded estimated liabilities in accordance with applicable accounting guidance.  At the time of closure, neither the write-off of fixed assets nor the write-down of inventory related to such stores was material.  Additionally, employee severance costs associated with these closures were not significant.  The estimated liabilities were recorded based upon the Company’s remaining lease obligations less estimated subtenant rental income.  Revisions during the periods presented related to changes in estimated buyout terms or subtenant receipts expected on closed facilities.  Expenses related to lease termination obligations are included in selling, general and administrative expenses in the Company’s

8

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

consolidated statements of operations.  The following table represents a rollforward of the liability balances for the nine months ended November 28, 2009 and November 29, 2008 related to these closures (in thousands):

Total costs of lease terminations related to store closures are currently anticipated to be approximately $8,000,000 for fiscal 2010.  Of this amount, the Company incurred $621,000 in lease termination costs in the third quarter of fiscal 2010 and $7,439,000 for the year-to-date period.

Note 5 — Long-term debt and available credit

Long-term debt is summarized as follows at November 28, 2009 and November 29, 2008 (in thousands):

During the first quarter of fiscal 2010, a foreign subsidiary of the Company purchased $78,941,000 of the Company’s outstanding 6.375% convertible senior notes due 2036 (the “6.375% Notes”) in privately negotiated transactions at a purchase price of $27,399,000, including accrued interest.  The Company recognized a gain of $47,811,000 in connection with this transaction.  During August 2009, the $78,941,000 in 6.375% Notes were retired by the Company.

During the second quarter of fiscal 2010, the Company entered into separate privately negotiated exchange agreements under which it retired $64,482,000 of the Company’s outstanding 6.375% Notes.  Under the exchange agreements, the exchanging holders received $61,255,000 in aggregate principal of the Company’s new 9% convertible senior notes due 2036 (the “9% Notes”).  In addition to this exchange, the Company also purchased $5,000,000 of the outstanding 6.375% Notes for $4,750,000 in cash.  The Company recognized a net gain of $1,843,000 related to these transactions during the second quarter of fiscal 2010. Currently $16,577,000 of the Company’s 6.375% Notes remain outstanding.  The fair value of the 6.375% Notes was $15,662,000 and $116,969,000 based on quoted market values as of November 28, 2009 and November 29, 2008, respectively.

During the third quarter of fiscal 2010, all $61,255,000 of the Company’s recently issued 9% Notes converted into shares of the Company’s common stock.  The 9% Notes were convertible into shares of

9

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

the Company’s common stock at a conversion rate of 399.2016 shares for each $1,000 principal amount, representing a conversion price of $2.5050 per share.  The Company issued 24,453,065 shares of common stock as a result of the complete conversion of the 9% Notes.  Interest on the outstanding balance of the 9% Notes was payable at a rate of 9% per year and all accrued interest was paid to the holders at the time of conversion.  During the quarter, the Company incurred non-operating charges of $18,308,000 to record amortization of the remaining debt issuance costs and debt discounts of $13,616,000, and a $4,692,000 derivative fair value adjustment, as discussed in more detail below.

The 9% Notes contained make-whole interest provisions.  During the third quarter of fiscal 2010, all of the holders voluntarily converted their 9% Notes into common stock and pursuant to the indenture, received additional make-whole interest at that time equal to 2.5 years of interest.  The cash payment of make-whole interest totaled $13,782,000. The Company separately accounted for the additional interest payment feature of the 9% Notes as an embedded derivative instrument.  For the purpose of accounting for the 9% Notes, the fair value of this embedded derivative upon issuance reduced the carrying value of the debt and was reflected as a debt discount.  This potential interest payout was initially recorded at its estimated fair value as both a $9,090,000 derivative liability and a $9,090,000 discount to the 9% Notes.  The potential interest payout fair value measurement fell within the Level 3 fair value hierarchy.  Level 3 measurements are model-driven valuations in which one or more significant inputs or value-drivers are unobservable.  The fair value of the potential interest payout was determined based on the probability of when holders of the 9% Notes would convert their notes into shares of the Company’s common stock and assumptions regarding the Company’s common stock price.  During the third quarter, the fair value of this derivative for the make-whole interest provision was adjusted to its current fair value of $13,782,000, which resulted in a $4,692,000 charge to other nonoperating expense during the period.

The 9% Notes also included a beneficial conversion feature because the price of the Company’s common stock on the issuance date of the notes exceeded the effective conversion price.  In accordance with applicable accounting guidance, the Company recorded a $3,343,000 discount to the 9% Notes and a $3,343,000 addition to paid-in-capital representing the intrinsic value of the beneficial conversion feature.

The two underlying features described above resulted in a total debt discount of $12,433,000 and an initial carrying amount of the 9% Notes on the Company’s balance sheet of $48,822,000 compared to a face amount of $61,255,000.  When the notes were converted into common stock during the third quarter, the remaining unamortized debt discount and debt issuance costs of $13,616,000 were charged to interest expense at that time.

Effective March 1, 2009, the Company adopted the new guidance on “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)”, which clarifies that issuers of convertible debt instruments that may be settled wholly or partially in cash upon conversion should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods.  The 6.375% Notes are convertible into cash and, if applicable, shares of the Company’s common stock.  In accordance with the new guidance, the Company estimated the fair value of the debt component of the 6.375% Notes as of the date of their issuance using an income approach by discounting the present value of future payments associated with the notes, assuming no conversion features.  The Company did not apply the provisions of the new guidance retrospectively on its 6.375% Notes as it determined that the effect on prior periods was not material.  The impact of adoption representing the remaining value of the equity component of the 6.375% Notes as of the beginning of the fiscal year was $2,818,000, recorded as a reduction in carrying value of the notes and an increase in additional paid-in capital.  This amount was to be amortized as interest expense over the remaining life of the 6.375% Notes, or through February 2011. However, as a result of the retirement and exchange of the majority of the 6.375% Notes as discussed above, the Company’s gain on the transactions included the write-off of a portion of this unamortized discount.  As of November 28, 2009, the remaining unamortized discount related to the 6.375% Notes totaled $177,000.

10

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

As a result of the put feature of the 6.375% Notes, the Company anticipates that the remainder of the 6.375% Notes will have to be repaid on or before February 15, 2011.  The Notes are included in fiscal 2011 long-term debt maturities in the table below.  Long-term debt matures as follows (in thousands):

Effective July 30, 2009, the Company amended its secured credit facility which matures in May 2012.  The amendment reduced the total commitment amount to $300,000,000, removed real estate from eligibility for inclusion in the calculation of the borrowing base, increased applicable interest rate spreads and redefined permitted uses, liens, indebtedness, acquisitions, and restricted payments.  In addition, the amendment updated certain provisions to allow for the refinance or repurchase of the balance of the Company’s 6.375% Notes and 9% Notes, as well as repurchases of the Company’s outstanding common stock.  As of November 28, 2009, the Company had no outstanding cash borrowings and had utilized $96,799,000 in letters of credit and bankers’ acceptances.  Should the availability under this facility be less than $30,000,000, the Company will be required to comply with a fixed charge coverage ratio as stated in the agreement.  As of November 28, 2009, the Company’s calculated borrowing base was $273,390,000.  After excluding the required minimum of $30,000,000 and the $96,799,000 in utilized letters of credit and bankers’ acceptances from the borrowing base, $146,591,000 remained available for cash borrowings.

Note 6 — Condensed financial statements

The Company’s 6.375% Notes are and the 9% Notes were both fully and unconditionally guaranteed, on a joint and several basis, by all of the Company’s material domestic consolidated subsidiaries (the “Guarantor Subsidiaries”).  The subsidiaries that do not guarantee such Notes are comprised of the Company’s foreign subsidiaries and certain other insignificant domestic consolidated subsidiaries (the “Non-Guarantor Subsidiaries”).  Each of the Guarantor Subsidiaries is wholly owned.  In lieu of providing separate audited financial statements for the Guarantor Subsidiaries, condensed consolidating financial information is presented below.

11

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS

Three Months Ended November 28, 2009

(in thousands)

(unaudited)

CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS

Three Months Ended November 29, 2008

(in thousands)

(unaudited)