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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended July 31, 2010

OR

For the transition period from              to             

Commission file number 0-14970

COST PLUS, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code (510) 893-7300

(Former name, former address and former fiscal year, if changed since last report)

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  ¨

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

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 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  ¨    No  x

As of August 27, 2010, the number of shares of the registrant’s Common Stock, $0.01 par value, outstanding was 22,087,113.

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COST PLUS, INC.

FORM 10-Q

For the Quarter Ended July 31, 2010

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PART I. FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

COST PLUS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts, unaudited)

See notes to condensed consolidated financial statements.

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COST PLUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts, unaudited)

See notes to condensed consolidated financial statements.

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COST PLUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands, unaudited)

See notes to condensed consolidated financial statements.

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COST PLUS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three and Six Months Ended July 31, 2010 and August 1, 2009

(Unaudited)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared from the records of Cost Plus, Inc. (“Cost Plus World Market” or “the Company”) and, in the opinion of management, include all adjustments that are normal and recurring in nature necessary to present fairly the Company’s financial position at July 31, 2010 and August 1, 2009, and the interim results of operations for the three and six months ended July 31, 2010 and August 1, 2009, and cash flows for the six months ended July 31, 2010 and August 1, 2009. The balance sheet at January 30, 2010, presented herein, has been derived from the audited financial statements of the Company for the fiscal year then ended. Unless otherwise indicated, information presented in the notes to the financial statements relates only to the Company’s continuing operations.

Accounting policies followed by the Company are described in Note 1 to the audited consolidated financial statements for the fiscal year ended January 30, 2010 in the Company’s Annual Report on Form 10-K. Certain information and disclosures normally included in the notes to the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted for purposes of presenting the interim condensed consolidated financial statements. Such statements should be read in conjunction with the audited consolidated financial statements, including notes thereto, for the fiscal year ended January 30, 2010.

During fiscal 2009, the Company determined that the borrowings and payments under its revolving line of credit should be presented on a gross basis, not a net basis, within the financing activities section of the consolidated statement of cash flows. The presentation for the six months ended August 1, 2009 has been corrected in the accompanying condensed consolidated financial statements.

The Company has experienced net losses each annual period since fiscal 2006. As of July 31, 2010, the Company had an accumulated deficit of $114.8 million. For fiscal 2009 and fiscal 2008, the Company did not generate positive cash flows from its operating activities. There can be no assurance that the business will be profitable or will generate sufficient cash to fund operations in the future or that additional losses and negative cash flows from operations will not be incurred, which could have a material adverse affect on the Company’s financial condition. However, the Company believes that its existing cash balance, combined with fiscal 2010 cash flows from operations and borrowings under its asset-based credit facility, will be sufficient to enable it to meet planned expenditures through the next 12 months. The Company is dependent upon its asset-based credit facility to fund operating losses and seasonal inventory purchases. The Company does not plan on fully paying off its asset-based credit facility during fiscal 2010. Access to the Company’s asset-based credit facility is dependent upon meeting its debt covenants and not exceeding the borrowing limit of the asset-based credit facility. As of July 31, 2010, the Company was in compliance with its debt covenant requirements. There can be no assurance that the Company will achieve or sustain positive cash flows from operations or profitability. If the Company is unable to maintain adequate liquidity, future operations may need to be scaled back.

The results of operations for the three-month and six-month periods ended July 31, 2010, presented herein, are not indicative of the results to be expected for the full year because of, among other things, seasonal factors in the retail business.

2. CONTINUING OPERATIONS STORE CLOSURE ACTIVITIES

In January 2009, the Board of Directors of the Company approved a plan for the Company to close 26 of its stores; eight of these stores are classified within continuing operations. All eight stores classified within continuing operations were closed during the first quarter of fiscal 2009 and, with the exception of the finalization of any lease settlement activities, all store closure activities were completed during the first quarter of fiscal 2009. Additionally, in January 2010, the Board of Directors approved a plan for the Company to close five of its stores, all of which are classified within continuing operations. All five stores were closed during the first quarter of fiscal 2010.

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The costs associated with closing the stores were accounted for in accordance with ASC 420-10, “Exit or Disposal Cost Obligations,” in which the liability for the costs associated with an exit or disposal activity is recognized when the liability is incurred. During the second quarter of fiscal 2010, there was a gain of $62,000 related to closing stores classified within continuing operations as a result of favorable lease buy-out settlements, compared to costs of $329,000 in the second quarter of fiscal 2009, consisting primarily of estimated lease exit costs, net of estimated sublease income.

Additional charges or recoveries related to the planned disposition of stores may be incurred as a result of changes to management’s current estimates and assumptions. The timing of future transactions and charges related to these store closures are subject to significant uncertainty, including the variability in future vacancy periods, sublease income or negotiations with landlords regarding buy-out payments on leases.

Following is a year-to-date summary of the reserve for store closures in continuing operations, which is included in accrued store closure and lease exit costs of $7.4 million and $16.1 million on the Company’s condensed consolidated balance sheet as of July 31, 2010 and August 1, 2009, respectively (in thousands):

3. DISCONTINUED OPERATIONS

In January 2009, the Board of Directors of the Company approved a plan for the Company to close 26 of its stores; 18 of these stores are classified within discontinued operations as they were in eight underperforming media markets that the Company exited. All 18 stores classified within discontinued operations were closed during the first quarter of fiscal 2009 and, with the exception of the finalization of any lease settlement activities, all store closure activities were completed during the first quarter of fiscal 2009. The loss from discontinued operations also includes the adjustment of estimated lease exit costs net of estimated sublease income resulting from the settlement of lease buy-out costs related to the 13 stores that were closed in the first quarter of fiscal 2008.

The stores closed are reported as discontinued operations in accordance with ASC 205-20, “Presentation of Financial Statements – Discontinued Operations,” which requires the Company to report the results of operations of a component of an entity that either has been disposed of or is classified as held for sale, in discontinued operations. As such, both current and prior year results for these stores are classified as discontinued operations on the Company’s condensed consolidated statements of operations.

Also included in discontinued operations are the costs associated with closing the stores reported as discontinued operations. These costs were accounted for in accordance with ASC 420-10, “Exit or Disposal Cost Obligations” and were approximately $440,000 for the six-month period ended July 31, 2010 and $16.5 million for the six-month period ended August 1, 2009. The recognition of the costs associated with closing the stores requires the Company to make judgments and estimates regarding the nature, timing, and amount of costs, including estimated lease exit costs net of estimated sublease income, employee severance and various other costs related to the closure of stores. At the end of each quarter, the Company evaluates the remaining accrual balance.

Additional charges or recoveries related to the planned disposition of stores may be incurred as a result of changes to management’s current estimates and assumptions. The timing of future transactions and charges related to these store closures are subject to significant uncertainty, including the variability in future vacancy periods, sublease income or negotiations with landlords regarding buy-out payments on leases.

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Results from discontinued operations were as follows:

Following is a year-to-date summary of the reserve for store closures in discontinued operations, which is included in accrued store closure and lease exit costs of $7.4 million and $16.1 million on the Company’s condensed consolidated balance sheet as of July 31, 2010 and August 1, 2009, respectively (in thousands):

4. SHARE-BASED COMPENSATION

The Company accounts for share-based compensation arrangements in accordance with ASC 718-10, “Share-Based Payment.” Under the provisions of ASC 718-10, the Company is required to measure the cost of services received in exchange for an award of equity instruments based on the fair value of the award. For employees and directors, the award is measured on the grant date and then recognized over the period during which services are required to be provided, usually the vesting period. The Company had share-based compensation expense of $338,000 for the three months ended July 31, 2010 compared to $367,200 for the three months ended August 1, 2009. Share-based compensation expense for the six months ended July 31, 2010 was $696,000 compared to $830,600 for the six months ended August 1, 2009. Share-based compensation is recorded as a component of selling, general and administrative expenses. As of July 31, 2010, there was $2.4 million of total unrecognized compensation cost related to unvested share-based compensation that is expected to be recognized over a weighted average period of approximately 1.7 years.

During the second quarter of fiscal 2010, the Company granted options to purchase 821,500 shares of common stock to its employees and non-employee directors. During the second quarter of fiscal 2009, the Company granted options to purchase 10,000 shares of common stock to its employees and non-employee directors. The weighted average fair value per option granted was $3.38 during the three-month and six-month periods ended July 31, 2010, and $0.88 and $0.57 for the three-month and six-month periods ended August 1, 2009, respectively. The following table presents the weighted average assumptions used in the Black-Scholes-Merton option pricing model to value the stock options granted during the three-month and six-month periods ended July 31, 2010 and August 1, 2009:

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5. RECONCILIATION OF BASIC SHARES TO DILUTED SHARES

Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS is computed by dividing net income by the weighted average number of common shares and dilutive common stock equivalents outstanding during the period. Diluted EPS reflects the potential dilution that could occur if options to purchase common stock were exercised into common stock.

The following is a reconciliation of the weighted average number of shares (in thousands) used in the Company’s basic and diluted earnings per share computations:

Certain options to purchase common stock were outstanding but were not included in the computation of diluted earnings per share because the effect would be anti-dilutive. For the three-month and six-month periods ended July 31, 2010 and August 1, 2009, there were 3,764,365 and 3,652,461 anti-dilutive options, respectively.

6. LONG-TERM DEBT AND REVOLVING LINE OF CREDIT

The Company’s long-term debt as of July 31, 2010, January 30, 2010, and August 1, 2009 is summarized as follows:

The Company’s long-term debt includes financing obligations related to the sale-leaseback of its distribution centers in Stockton, California and Windsor, Virginia. The Company has accounted for the sale-leaseback transactions as financings whereby the net book value of the assets remain on the Company’s consolidated balance sheet. The Company also recorded a financing obligation which is being amortized over the period of the leases (including option periods) and approximates the discounted value of minimum lease payments under the leases. The monthly lease payments are accounted for as principal and

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interest payments on the recorded obligations. For further details on the Company’s long-term debt, see Note 7 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended January 30, 2010.

On June 25, 2007, the Company entered into a secured five-year revolving credit agreement (the “Credit Agreement”) with a group of banks that terminated and replaced its existing credit agreements. The Credit Agreement allows for cash borrowings and letters of credit under a secured asset-based credit facility of up to $200.0 million. The amount available for borrowing at any time is limited by a stated percentage of the aggregate amount of the liquidated value of eligible inventory and the face amount of eligible credit card receivables. The Credit Agreement includes three options to increase the size of the asset-based credit facility by up to $50.0 million in the aggregate. All borrowings and letters of credit under the Credit Agreement are collateralized by all assets presently owned and hereafter-acquired by the Company. Interest is paid in arrears monthly, quarterly, or over the applicable interest period as selected by the Company, with the entire balance payable on June 25, 2012. Borrowings pursuant to its asset-based credit facility bear interest, at the Company’s election, at a rate equal to either (i) the higher of Bank of America’s prime rate or the federal funds effective rate plus an applicable margin; or (ii) the LIBOR rate plus an applicable margin. The applicable margin is based on the Company’s Average Excess Availability, as defined in the Credit Agreement. In addition, the Company pays a commitment fee on the unused portion of the amount available for borrowing as described in the Credit Agreement. The Credit Agreement includes limitations on the ability of the Company to, among other things, incur debt, grant liens, make investments, enter into mergers and acquisitions, pay dividends, repurchase its outstanding common stock, change its business, enter into transactions with affiliates, and dispose of assets including closing stores. The events of default under the Credit Agreement include, among others, payment defaults, cross defaults with certain other indebtedness, breaches of covenants, loss of collateral, judgments, changes in control, and bankruptcy events. In the event of a default, the Credit Agreement requires the Company to pay incremental interest at the rate of 2.0% and the lenders may, among other remedies, foreclose on the security (which could include the sale of the Company’s inventory), eliminate their commitments to make credit available, declare due all unpaid principal amounts outstanding, and require cash collateral for any letter of credit obligations. In addition, in the event of a default or if the Company’s Average Excess Availability is 15% or less of the borrowing capacity under the asset-based credit facility, the Company will be subject to additional restrictions, including specific restrictions with respect to its cash management procedures.

The Company uses the borrowings under the Credit Agreement for working capital, issuance of commercial and standby letters of credit, capital expenditures, and other general corporate purposes. As of July 31, 2010, the Company was in compliance with its loan covenant requirements, had $68.0 million in borrowings and $9.9 million in issued and outstanding letters of credit, and had remaining credit available under the Credit Agreement of $54.5 million. Based on current projections, the Company expects to be in compliance throughout fiscal 2010. The Company’s business is highly seasonal, reflecting the general pattern associated with the retail industry of peak sales and earnings during the fourth quarter (Holiday) season, therefore borrowings under the line of credit often peak early in the fourth quarter of each fiscal year.

The borrowing base, based on inventory and accounts receivable value less certain reserves, at July 31, 2010, at January 30, 2010 and at August 1, 2009 consisted of the following (in millions):

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7. INCOME TAXES

The Company’s effective tax rate from continuing operations was a provision of 1.6%, before discrete items, in the second quarter of fiscal 2010 compared to a provision of 0.7%, before discrete items, in the second quarter of fiscal 2009. The effective tax rate increase is due to an increase in state tax expense as a result of increased revenue. Because the Company has recorded a full valuation allowance on its net deferred tax asset, no federal or state tax benefit has been recorded on its operating loss in the second quarter of fiscal 2010 or is expected for the fiscal 2010 annual period.

The Company accounts for income taxes in accordance with the provisions of ASC 740-10, “Income Taxes,” which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amount and the tax bases of the assets and liabilities. The recording of the net deferred tax asset assumes the realization of such asset in the future; otherwise, a valuation allowance must be recorded to reduce the asset to its net realizable value. The Company considers future pre-tax income and, if necessary, ongoing prudent and feasible tax planning strategies in assessing the need for such a valuation allowance. The Company has recorded a full valuation allowance as of July 31, 2010 and August 1, 2009.

At both January 30, 2010 and at July 31, 2010, the Company had $1.9 million in unrecognized tax benefits; the recognition of which would have an impact of $316,000 on the Company’s income tax provision. At the end of the second quarter of fiscal 2010, it is reasonably possible that the total amounts of unrecognized tax benefits could decrease by $559,000 within the next 12 months due to the expiration of the statute of limitations.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. At July 31, 2010 and at August 1, 2009, the Company had accrued $196,000 and $185,000, respectively, for the potential payment of interest and penalties.

As of July 31, 2010, the Company is subject to U.S. federal income tax examinations for tax years 2004 and forward, and is subject to state and local tax examinations for tax years 2004 and forward.

8. FAIR VALUE MEASUREMENTS

The Company adopted ASC 820-10, “Fair Value Measurements,” for financial assets and financial liabilities beginning in fiscal 2008 and for nonfinancial assets and liabilities beginning in fiscal 2009.

ASC 820-10 establishes a three-tier fair value hierarchy, which prioritizes inputs used in measuring fair value. The tiers include:

The fair value of impaired long-lived assets and the initial estimates of store lease exit costs were measured at fair value on a nonrecurring basis using Level 3 inputs as defined in the fair value hierarchy. Fair value of long-lived assets and store lease exit costs are determined by estimating the amount and timing of net future cash flows (including rental expense for leased properties, sublease rental income, common area maintenance costs and real estate taxes) and discounting them using a risk-

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adjusted rate of interest. The Company estimates future cash flows based on its experience and knowledge of the market where the store is located and, when necessary, uses real estate brokers. There were no impairment charges for the write-down of store assets or impairments related to financial assets during the first six months of fiscal 2010 or the first six months of fiscal 2009.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of financial condition, results of operations, liquidity and capital resources should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and notes thereto for the three-month and six-month periods ended July 31, 2010 and with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the year ended January 30, 2010. The results of operations for the three-month and six-month periods ended July 31, 2010, presented herein, are not indicative of the results to be expected for the full year because of, among other things, seasonal factors in the retail business.

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements reflect the Company’s current beliefs and estimates with respect to future events and the Company’s future financial performance, operations and competitive position and may be identified, without limitation, by use of the words “may,” “should,” “expects,” “anticipates,” “estimates,” “believes,” “looking ahead,” “forecast,” “projects,” “continues,” “intends,” “likely,” “plans” and similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance or achievements to differ materially from those expressed or implied by such forward-looking statements, including those set forth in the Annual Report on Form 10-K for the fiscal year ended January 30, 2010 and elsewhere in this Quarterly Report on Form 10-Q. The reader should carefully consider, together with the other matters referred to herein, the risk factors set forth in the Annual Report on Form 10-K for the fiscal year ended January 30, 2010 as well as in other documents the Company files with the Securities and Exchange Commission (the “SEC”). The Company may from time to time make additional written and oral forward-looking statements, including statements contained in the Company’s filings with the SEC. The Company does not undertake to update any forward-looking statement that may be made from time to time by or on behalf of the Company.

Overview

Cost Plus, Inc. and its subsidiaries (“Cost Plus World Market” or “the Company”) is a leading specialty retailer of casual home furnishings and entertaining products. The stores feature an ever-changing selection of casual home furnishings, housewares, gifts, decorative accessories, gourmet foods and beverages offered at competitive prices and imported from more than 50 countries. Many items are unique and exclusive to Cost Plus World Market. The value, breadth and continual refreshment of products invite customers to come back throughout a lifetime of changing home furnishings and entertaining needs.

Net sales for the second quarter of fiscal 2010 were $192.4 million, a 4.9% increase compared to $183.4 million for the second quarter of last year. Comparable store sales for the quarter increased 6.5% compared to a decrease of 10.9% for the second quarter of last year. The increase in same store sales was attributable to a 5.8% increase in customer count and a 0.7% increase in the average ticket per customer.

The Company reported a net loss of $7.0 million in the second quarter of fiscal 2010, or $0.32 per diluted share, compared to a net loss of $20.8 million, or $0.94 per diluted share, for the second quarter of last year. The decrease in the net loss was primarily due to a $12.8 million increase in gross profit. The gross profit rate was 31.6% for the second quarter of 2010 versus 26.2% for the second quarter of last year. The increase in gross profit is due to higher same store sales, improved merchandise margin, and to a lesser extent, decreased occupancy costs. The improvement in merchandise margin for both the second quarter and year-to-date periods are the result of strong performance in non-furniture home categories as well as significantly lower markdowns and higher initial mark-ups across most categories of the business compared with the same periods a year ago.

In the second quarter of fiscal 2010, the Company did not open or close any stores and ended the quarter with 263 stores in 30 states.

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Results of Operations

The three months and six months ended July 31, 2010 as compared to the three months and six months ended August 1, 2009

Net Sales Net sales consists almost entirely of retail sales, but also includes direct-to-consumer sales and shipping revenue. Net sales increased $9.0 million, or 4.9%, to $192.4 million for the second quarter of fiscal 2010 from $183.4 million for the second quarter of fiscal 2009. Year-to-date, net sales were $381.6 million, a 3.8% increase from the same period last year. Comparable store sales increased 6.5% in the second quarter of fiscal 2010, compared to a decrease of 10.9% in the second quarter of fiscal 2009. Year-to-date, comparable store sales increased 6.1% compared to a decrease of 9.9% for the same period last year. The increase in comparable store sales in the second quarter of fiscal 2010 was attributable to a 5.8% increase in customer count and a 0.7% increase in the average ticket per customer. As of July 31, 2010, the calculation of comparable store sales included a base of 261 stores. A store is included as comparable at the beginning of the fourteenth full fiscal month of sales with the exception of relocated stores which remain comparable upon opening. At the end of the second quarter of fiscal 2010, the Company operated 263 stores in 30 states versus 269 stores in 30 states at the end of the second quarter of fiscal 2009.

The Company classifies its sales into home and consumables product lines. For the second quarter of fiscal 2010, home accounted for 66% of total sales versus 65% for the second quarter of last year, and consumables accounted for 34% of total sales versus 35% for the second quarter of last year.

Cost of Sales and Occupancy Cost of sales and occupancy, which consists of costs to acquire merchandise inventory and costs of freight and distribution, as well as certain facilities costs, decreased $3.8 million, or 2.8%, to $131.6 million in the second quarter of fiscal 2010 as compared to the second quarter of last year. As a percentage of net sales, total cost of sales and occupancy decreased 540 basis points to 68.4% in the second quarter of fiscal 2010 compared to 73.8% in the second quarter of fiscal 2009. The 540 basis point decrease was primarily due to improvement in merchandise margin, as well as lower occupancy expenses compared to the second quarter of last year and the leveraging of those expenses on higher same store sales. Year-to-date, total costs of sales and occupancy were $263.1 million and decreased $8.6 million, or 3.2%, compared to the same period in fiscal 2009. As a percentage of net sales, total cost of sales and occupancy for the year decreased 490 basis points to 69.0% from 73.9% last year.

Selling, General and Administrative (“SG&A”) Expenses SG&A expenses for the second quarter of fiscal 2010 were $64.6 million and were relatively flat compared to the second quarter last year. As a percentage of net sales, SG&A expenses decreased 160 basis points to 33.6% for the second quarter of fiscal 2010 from 35.2% for the second quarter last year. The decrease in SG&A expenses as a percentage of net sales is largely due to increased leverage on higher same store sales. Year-to-date, as a percentage of net sales, SG&A expenses decreased 190 basis points to 33.2% from 35.1% for the same period last year.

Store Closure Costs Costs related to closing the stores classified within continuing operations were a gain of $62,000 for the second quarter of fiscal 2010 as a result of favorable lease buy-out settlements compared with costs of $329,000 for the second quarter of fiscal 2009. Year-to-date, costs related to closing the stores classified within continuing operations were $2.7 million compared to $6.1 million for the same period last year. Store closure costs were primarily related to lease exit costs from the five stores that closed during the first quarter of fiscal 2010 and from the eight stores that closed during the first quarter of fiscal 2009.

Store Preopening Expenses Store preopening expenses typically include rent expense incurred prior to opening as well as grand opening advertising and preopening merchandise setup expenses. There were no preopening expenses for the second quarter of fiscal 2010 or for the second quarter of fiscal 2009. The Company did not open any stores during the second quarter of fiscal 2010 or during the second quarter of fiscal 2009. Year-to-date, preopening expenses for fiscal 2010 were $106,000 compared to no preopening expenses for the same period last year, with one new store opening for fiscal 2010 year-to-date compared to no new store openings for the same period last year. Store preopening expenses vary depending on the amount of time between the possession date and the store opening, the particular store site and whether it is located in a new or existing market.

Net interest expense Net interest expense, which includes interest on capital leases and debt, net of interest earned on investments, was $2.7 million for the second quarter of fiscal 2010 compared to $2.9 million for the second quarter of fiscal 2009. Included in net interest expense is interest related to the distribution center lease obligations of $2.1 million for both the second quarter of fiscal 2010 and for the second quarter of fiscal 2009. Year-to-date, net interest expense was $5.4 million

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compared to $5.7 million for the same period last year. The decrease in interest expense for the quarter and year-to-date was due to a lower interest rate on relatively flat borrowings under the Company’s asset-based credit facility.

Income Taxes The Company’s effective tax rate from continuing operations was a provision of 1.6%, before discrete items, in the second quarter of fiscal 2010 compared to a provision of 0.7%, before discrete items, in the second quarter of fiscal 2009. The effective tax rate increase is due to an increase in state tax expense as a result of increased revenue. Because the Company has recorded a full valuation allowance on its net deferred tax asset, no federal or state tax benefit has been recorded on its operating loss in the second quarter of fiscal 2010 or is expected for the fiscal 2010 annual period.

Liquidity and Capital Resources

The Company’s cash and cash equivalents balance was $2.9 million at July 31, 2010 and $2.5 million at August 1, 2009. The Company met its short-term liquidity needs and its capital requirements for the six-month period ended July 31, 2010 with existing cash and cash provided from financing activities. The Company believes that the combination of its cash and cash equivalents, cash generated from operations and available borrowings under its asset-based credit facility will be sufficient to finance its working capital and other capital projects for the next 12 months.

The Company has experienced net losses each annual period since fiscal 2006. As of July 31, 2010, the Company had an accumulated deficit of $114.8 million. For fiscal 2009 and fiscal 2008, the Company did not generate positive cash flows from its operating activities. There can be no assurance that the business will be profitable or will generate sufficient cash to fund operations in the future or that additional losses and negative cash flows from operations will not be incurred, which could have a material adverse affect on the Company’s financial condition. However, the Company believes that its existing cash balance, combined with fiscal 2010 cash flows from operations and borrowings under its asset-based credit facility, will be sufficient to enable it to meet planned expenditures through the next 12 months. The Company is dependent upon its asset-based credit facility to fund operating losses and seasonal inventory purchases. The Company does not plan on fully paying off its asset-based credit facility during fiscal 2010. Access to the Company’s asset-based credit facility is dependent upon meeting its debt covenants and not exceeding the borrowing limit of the asset-based credit facility. As of July 31, 2010, the Company was in compliance with its debt covenant requirements. There can be no assurance that the Company will achieve or sustain positive cash flows from operations or profitability. If the Company is unable to maintain adequate liquidity, future operations may need to be scaled back.

Cash Flows From Operating Activities Net cash used in operating activities totaled $16.7 million year-to-date compared to $25.3 million in the same period last year, a decrease of $8.6 million. The decrease in net cash used in operations compared to last year was primarily due to a lower net loss for the first six months of fiscal 2010 compared to the same period last year, the receipt of a $13.0 million tax refund, as well as a decrease in the change in accounts payable year over year. This decrease was partially offset by increases in merchandise inventories and other liabilities compared to decreases in those items for the first six months of last year.

Cash Flows From Investing Activities Net cash used in investing activities totaled $1.6 million year-to-date as compared to $1.5 million for the same period last year.

The Company estimates that fiscal 2010 capital expenditures will be approximately $4.1 million; including approximately $1.9 million for management information systems and distribution center projects and $2.2 million allocated to investments in existing stores and various other corporate projects. The Company intends to open one new store and close one store for the remainder of fiscal 2010.

Cash Flows From Financing Activities Net cash provided by financing activities was $18.6 million year-to-date compared to $25.6 million for the same period last year. Borrowings under the Company’s asset-based credit facility increased $19.5 million as of July 31, 2010 from $48.5 million at January 30, 2010, compared to an increase of $26.8 million for the same period last year. Principal payments on long-term debt in the first six months of fiscal 2010 were $433,000 compared to $404,000 in the first six months of fiscal 2009 and principal payments on capital lease obligations in the first six months of fiscal 2010 were $435,000 compared to $781,000 in the first six months of fiscal 2009.

Revolving Line of Credit On June 25, 2007, the Company entered into a secured five-year revolving credit agreement (the “Credit Agreement”) with a group of banks that terminated and replaced its existing credit agreements. The Credit Agreement allows for cash borrowings and letters of credit under a secured asset-based credit facility of up to $200.0 million. The amount available for borrowing at any time is limited by a stated percentage of the aggregate amount of the liquidated value of eligible

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inventory and the face amount of eligible credit card receivables. The Credit Agreement includes three options to increase the size of the asset-based credit facility by up to $50.0 million in the aggregate. All borrowings and letters of credit under the Credit Agreement are collateralized by all assets presently owned and hereafter-acquired by the Company. Interest is paid in arrears monthly, quarterly, or over the applicable interest period as selected by the Company, with the entire balance payable on June 25, 2012. Borrowings pursuant to its asset-based credit facility bear interest, at the Company’s election, at a rate equal to either (i) the higher of Bank of America’s prime rate or the federal funds effective rate plus an applicable margin; or (ii) the LIBOR rate plus an applicable margin. The applicable margin is based on the Company’s Average Excess Availability, as defined in the Credit Agreement. In addition, the Company pays a commitment fee on the unused portion of the amount available for borrowing as described in the Credit Agreement. The Credit Agreement includes limitations on the ability of the Company to, among other things, incur debt, grant liens, make investments, enter into mergers and acquisitions, pay dividends, repurchase its outstanding common stock, change its business, enter into transactions with affiliates, and dispose of assets including closing stores. The events of default under the Credit Agreement include, among others, payment defaults, cross defaults with certain other indebtedness, breaches of covenants, loss of collateral, judgments, changes in control, and bankruptcy events. In the event of a default, the Credit Agreement requires the Company to pay incremental interest at the rate of 2.0% and the lenders may, among other remedies, foreclose on the security (which could include the sale of the Company’s inventory), eliminate their commitments to make credit available, declare due all unpaid principal amounts outstanding, and require cash collateral for any letter of credit obligations. In addition, in the event of a default or if the Company’s Average Excess Availability is 15% or less of the borrowing capacity under the asset-based credit facility, the Company will be subject to additional restrictions, including specific restrictions with respect to its cash management procedures.

The Company uses the borrowings under the Credit Agreement for working capital, issuance of commercial and standby letters of credit, capital expenditures, and other general corporate purposes. As of July 31, 2010, the Company was in compliance with its loan covenant requirements, had $68.0 million in borrowings and $9.9 million in issued and outstanding letters of credit, and had remaining credit available under the Credit Agreement of $54.5 million. Based on current projections, the Company expects to be in compliance throughout fiscal 2010. The Company’s business is highly seasonal, reflecting the general pattern associated with the retail industry of peak sales and earnings during the fourth quarter (Holiday) season, therefore borrowings under the line of credit often peak early in the fourth quarter of each fiscal year.

Summary Disclosure about Contractual Obligations and Commercial Commitments

The Company does not believe there were any other significant changes to its contractual obligations that were not in of the ordinary course of business, from those reported on its Annual Report on Form 10-K for the fiscal year ended January 30, 2010.

Critical Accounting Policies

The Company’s condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of these statements requires management to make judgments and estimates. Some accounting policies have a significant impact on amounts reported in these financial statements. A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in our Annual Report on Form 10-K for the fiscal year ended January 30, 2010, in the Notes to the Consolidated Financial Statements (Note 1) and the Critical Accounting Policies and Estimates section.

Seasonality

The Company’s business is highly seasonal, reflecting the general pattern associated with the retail industry of peak sales and earnings during the fourth quarter (Holiday) selling season. Due to the importance of the Holiday selling season, the fourth quarter of each fiscal year has historically contributed, and the Company expects it will continue to contribute, a disproportionate percentage of its net sales and most of its net income, if any, for the entire fiscal year. The Company believes this is the general pattern associated with the retail industry.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes to the Company’s market risk from those disclosed in the Company’s Form 10-K filed for the fiscal year ended January 30, 2010.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management evaluated, with the participation of its principal executive officer and its principal financial officer, the effectiveness of its disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. The Company maintains disclosure controls and procedures that are designed to ensure that the information disclosed in the reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

As of July 31, 2010, the Company’s management, including its principal executive officer and principal financial officer, concluded that its disclosure controls and procedures are effective. This conclusion is based on management’s evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures.

Changes in Internal Control Over Financial Reporting

There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended July 31, 2010 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1A. RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A, “Risk Factors,” in our Annual Report on Form 10-K for the year ended January 30, 2010, which could materially affect our business, financial condition or operating results and cause the market price of our stock to decline, perhaps significantly. The risks described in our Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

ITEM 6. EXHIBITS

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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INDEX TO EXHIBITS

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