The calculation of diluted earnings per share for the 26-week period ended August 2, 2003, excludes stock options of 45,000 as their effect would be anti-dilutive. The calculations of diluted earnings per share for the 13-week and 26-week periods ended August 3, 2002, exclude stock options and warrants of 2,270,606 and 2,610,721, respectively, as their effect would be anti-dilutive.

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Note 6 – Stock Options

          We apply APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations, in accounting for our stock compensation plans. Compensation cost on stock options is measured as the excess, if any, of the fair value of our common stock at the date of the grant over the exercise price. The following table illustrates the effect on net income (loss) allocable to common shareholders and earnings per share had we applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.”

          During the 13 week period ended August 2, 2003, options to purchase 103,807 shares of our stock that were granted to a consultant as part of a 2001 contract were exercised.

Note 7 – Loan to Shareholder

          In May 2002, we loaned $217,000 to our Executive Vice President and Chief Financial Officer (the “Borrower”). The note bears interest at the rate of 4.75% per year which is payable over the term of the note. The note matures in May 2005 and is due and payable in full at that time. The loan is collateralized by marketable securities having a value of no less than the principal amount of the loan together with 125,526 shares of our common stock owned by the Borrower. The security agreement between the Borrower and us requires the Borrower to supply additional collateral at any time the value of existing collateral falls below 125% of the then principal amount of the loan. In addition, in accordance with the requirements of the note, in April 2003 we advanced an additional $381,401 of principal to the Borrower subject to the same interest rate, principal repayment and collateral provisions as the original principal amount. The total amount outstanding under the note as of August 2, 2003, was approximately $605,000, including accrued interest. Our Board of Directors and our Audit Committee approved the loan.

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

General

          We are a leading specialty retailer of home décor in the United States, operating 258 stores in 31 states as of August 2, 2003. Our stores present a broad selection of distinctive merchandise, including framed art, mirrors, candles, lamps, picture frames, accent rugs, garden accessories and artificial floral products. Our stores also offer an extensive assortment of holiday merchandise, as well as items carried throughout the year suitable for giving as gifts.

          Our stores offer a unique combination of style and value that has led to our emergence as a leader in home décor and has enabled us to develop a strong customer franchise. As a result, we have achieved substantial growth over the last five fiscal years. During this period, we have almost doubled our store base, principally through new store openings. We intend to continue opening new stores both in existing and new markets. We anticipate our growth will include mall and non-mall locations in major metropolitan markets, middle markets and selected smaller communities. We believe there are currently more than 800 additional locations in the United States that could support a Kirkland’s store. We plan on opening 40 new stores and estimate closing 10 stores in fiscal 2003. As of August 2, 2003, we have opened 18 new stores and closed 9 stores this fiscal year. We anticipate unit growth in the range of 15-18% in fiscal 2004.

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Results of Operations

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

13 Weeks Ended August 2, 2003, Compared to 13 Weeks Ended August 3, 2002

          Net sales. Net sales increased 5.7% to $79.0 million for the second quarter of fiscal 2003 from $74.7 million for the second quarter of fiscal 2002 as we began to experience the positive top-line impact from our new store openings. We opened 18 new stores during the first half of fiscal 2003 and 16 new stores during fiscal 2002, and we closed 9 stores during the first half of fiscal 2003 and 1 store during fiscal 2002. The overall increase in net sales was the result of this increase in our store base as well as sales increases from expanded, remodeled or relocated stores, which are excluded from our comparable store base. Comparable store sales decreased 0.9% for the quarter against a 16.7% increase in comparable store sales for the second quarter of fiscal 2002. Continued softness in the retail environment and weaker than expected performance in merchandise categories such as lamps, garden and decorative accessories led to the comparable store sales decline for the quarter. Efforts to drive sales through heavier markdowns and promotional activities were not enough to offset these factors. Sales throughout the second quarter of fiscal 2003 were driven by unit volume, as the average retail price per item decreased from the second quarter of fiscal 2002. The popularity of lower-priced categories combined with the heavier markdown activity led to the lower average retail price per item. Key categories contributing to the overall net sales increase were wall décor, candles, textiles, housewares, and novelty.

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          Gross profit. Gross profit decreased $2.2 million, or 8.7%, to $23.5 million for the second quarter of fiscal 2003 from $25.7 million for the second quarter of fiscal 2002. Gross profit expressed as a percentage of net sales decreased to 29.7% for the second quarter of fiscal 2003 from 34.4% for the second quarter of fiscal 2002. The decrease in gross profit as a percentage of net sales was primarily the result of heavy markdown activity undertaken in an attempt to drive sales and position inventories for the second half of the year. Product cost of sales, including freight expenses, increased approximately 430 basis points as a percentage of net sales as compared to the prior year quarter as a result of the increase in markdown activity. Consistent with our strategic plans, central distribution costs increased slightly as a percentage of net sales as we continued to increase the activity level in our central distribution facilities. We expect to continue to experience cost increases in central distribution as we process a greater percentage of our merchandise purchases through our central distribution facilities. Furthermore, store occupancy costs increased slightly as a percentage of net sales as compared to the prior year quarter due to the negative leverage resulting from the comparable store sales decrease.

          Other operating expenses. Other operating expenses, including both store and corporate costs, were $20.2 million, or 25.6% of net sales, for the second quarter of fiscal 2003 compared with $18.6 million, or 24.9% of net sales, for the second quarter of fiscal 2002. The increase in these operating expenses as a percentage of net sales was primarily the result of the negative leverage resulting from the comparable store sales decrease. In addition, insurance costs were higher as compared to the prior year due to enhancements in our corporate insurance coverage that were made when we completed our initial public offering late in the second quarter of fiscal 2002. Good payroll expense management at the store-level helped to offset these negative pressures on operating expenses.

          Depreciation and amortization. Depreciation and amortization expense was $1.8 million, or 2.2% of net sales, for the second quarter of fiscal 2003 compared to $1.6 million, or 2.2% of net sales, for the second quarter of fiscal 2002. We anticipate that depreciation and amortization will begin growing at a higher rate as capital investment rises along with new store growth.

          Non-cash stock compensation charge. During the second quarter of fiscal 2003, we incurred a non-cash stock compensation charge of $67,000, or 0.1% of net sales, related to certain stock options granted to employees in November 2001 that had an exercise price that was less than the fair value of the underlying common stock on the date of the grant. During the second quarter of fiscal 2002, we incurred non-cash stock compensation charges related to the aforementioned November 2001 employee option grant, certain re-priced employee stock options for which variable accounting methods were required, and certain options granted to a consultant. Combined non-cash charges related to these options of $1.6 million, or 2.2% of net sales, were recorded during the second quarter of fiscal 2002.

          Interest expense. Interest expense on indebtedness during the second quarter of fiscal 2003 was $132,000, or 0.2% of net sales, compared with $1.2 million, or 1.7% of net sales, for the second quarter of fiscal 2002. The decrease was the result of our May 2002 refinancing, our July 2002 initial public offering, strong cash flows and lower interest rates. Amortization of debt issue costs declined to $52,000, or 0.1% of net sales, for the second quarter of fiscal 2003 as compared to $441,000, or 0.6% of net sales, for the prior year quarter due to the repayment of our prior indebtedness in connection with the May 2002 refinancing and the July 2002 initial public offering. Interest expense associated with the mandatorily redeemable Class C Preferred Stock was $590,000 for the second quarter of fiscal 2002. No such interest was recorded during the second quarter of fiscal 2003 due to the repayment of this debt in connection with our initial public offering. During the second quarter of fiscal 2002, an inducement charge of $554,000 was recorded associated with the exchange of shares of Class C Preferred Stock for common stock in connection with our initial public offering. No such charge was recorded during fiscal 2003.

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          Income taxes. Income tax provision was $499,000, or 39.5% of income before income taxes, for the second quarter of fiscal 2003 compared with $424,000, or 41.1% of income before income taxes for the second quarter of fiscal 2002. The reduction in the effective tax rate is the result of fewer non-deductible stock compensation charges associated with certain stock options this year as compared to the prior year.

          Income before accretion of preferred stock and dividends accrued. As a result of the foregoing, income before accretion of preferred stock and dividends accrued was $764,000, or 1.0% of net sales, for the second quarter of fiscal 2003 as compared to $608,000, or 0.8% of net sales, for the second quarter of fiscal 2002.

26 Weeks Ended August 2, 2003, Compared to 26 Weeks Ended August 3, 2002

          Net sales. Net sales increased 8.2% to $152.4 million for the first half of fiscal 2003 from $140.9 million for the first half of fiscal 2002 primarily due to the growth in our store base. We opened 18 new stores during the first half of fiscal 2003 and 16 new stores during fiscal 2002, and we closed 9 stores during the first half of fiscal 2003 and 1 store during fiscal 2002. This growth in the store base along with sales increases from expanded, remodeled or relocated stores, which are excluded from our comparable store base, contributed to the overall sales increase. Comparable store sales increased 1.9% for the first half of fiscal 2003 against a 17.3% increase for the first half of fiscal 2002. Sales from new stores and other non-comparable stores accounted for $8.9 million, or 78%, of the overall sales increase while comparable store sales increases accounted for $2.6 million, or 22%, of the overall sales increase. Sales increases throughout the first half of fiscal 2003 were driven by unit volume, as the average retail price per item decreased from the first half of the prior year. The popularity of lower-priced merchandise in addition to enhanced markdown activity as compared to the prior year led to the lower average retail selling price. Key categories contributing to the overall sales increase were wall décor, candles, textiles and housewares.

          Gross profit. Gross profit decreased $0.9 million, or 1.9%, to $47.0 million for the first half of fiscal 2003 from $47.9 million for the first half of fiscal 2002. Gross profit expressed as a percentage of sales decreased to 30.9% from 34.0% for the prior-year period. The decrease in gross profit percentage was the result of heavier promotional and markdown activity undertaken this year to drive sales and position inventories for the second half of the year. Product cost of sales, including freight expenses, increased approximately 320 basis points as a percentage of net sales as compared to the prior-year period as a result of these actions. Additionally, and consistent with our plans, central distribution costs increased slightly as a percentage of sales as we continued to increase the activity level in our central distribution facilities. Offsetting these factors, store occupancy costs declined slightly as a percentage of sales as compared to the prior-year period.

          Other operating expenses. Other operating expenses, including both store and corporate costs, were $40.0 million, or 26.2% of net sales, for the first half of fiscal 2003 compared with $35.8 million, or 25.4% of net sales, for the first half of fiscal 2002. As expected, the increase in these expenses as a percentage of net sales was partially due to expenses incurred in connection with our accelerated store expansion plan. The relatively modest comparable store sales increase also contributed to the increase in the operating expense ratio. Furthermore, insurance costs increased over the prior-year period due to higher premiums and enhancements in our corporate directors and officers coverage that occurred upon completion of our initial public offering in July 2002.

          Depreciation and amortization. Depreciation and amortization expense was $3.5 million, or 2.3% of net sales, for the first half of fiscal 2003 compared to $3.3 million, or 2.3% of net sales, for the first half of fiscal 2002. We anticipate that depreciation and amortization will begin growing at a higher rate as capital investment rises along with new store growth.

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          Non-cash stock compensation charge. During the first half of fiscal 2003, we incurred a non-cash stock compensation charge of $134,000, or 0.1% of net sales, related to certain stock options granted to employees in November 2001 that had an exercise price that was less than the fair value of the underlying common stock on the date of the grant. During the first half of fiscal 2002, we incurred non-cash stock compensation charges related to the aforementioned November 2001 employee option grant, certain re-priced employee stock options for which variable accounting methods were required, and certain options granted to a consultant. Combined non-cash charges related to these options of $2.4 million, or 1.7% of net sales, were recorded during the first half of fiscal 2002.

          Interest expense. Interest expense on indebtedness during the first half of fiscal 2003 was $224,000, or 0.2% of net sales, compared with $2.7 million, or 1.9% of net sales, for the first half of fiscal 2002. The decrease was the result of our May 2002 refinancing, our July 2002 initial public offering, strong cash flows and lower interest rates. Amortization of debt issue costs declined to $105,000, or 0.1% of net sales, for the first half of fiscal 2003 as compared to $807,000, or 0.6% of net sales, for the prior-year period due to the repayment of our prior indebtedness in connection with the May 2002 refinancing and the July 2002 initial public offering. Interest expense associated with the mandatorily redeemable Class C Preferred Stock was $1.1 million for the first half of fiscal 2002. No such interest was recorded during the first half of fiscal 2003 due to the repayment of this debt in connection with our initial public offering. During the second quarter of fiscal 2002, an inducement charge of $554,000 was recorded associated with the exchange of shares of Class C Preferred Stock for common stock in connection with our initial public offering. No such charge was recorded during fiscal 2003.

          Income taxes. Income tax provision was $1.2 million, or 39.5% of income before income taxes, for the first half of fiscal 2003 compared with $524,000, or 41.1% of income before income taxes for the first half of fiscal 2002. The reduction in the effective tax rate is the result of fewer non-deductible stock compensation charges associated with certain stock options this year as compared to the prior year.

          Income before accretion of preferred stock and dividends accrued. As a result of the foregoing, income before accretion of preferred stock and dividends accrued was $1.9 million, or 1.3% of net sales, for the first half of fiscal 2003 as compared to $751,000, or 0.5% of net sales, for the first half of fiscal 2002.

Liquidity and Capital Resources

          Our principal capital requirements are for working capital and capital expenditures. Working capital consists mainly of merchandise inventories, which typically reach their peak by the end of the third quarter of each fiscal year. Capital expenditures primarily relate to new store openings; existing store expansions, remodels or relocations; and purchases of equipment or information technology assets for our stores, distribution facilities or corporate headquarters. Historically, we have funded our working capital and capital expenditure requirements with internally generated cash, borrowings under our credit facilities and proceeds from the sale of equity securities.

          Net cash used in operating activities for the first half of fiscal 2003 was $9.6 million compared to $10.5 million for the first half of fiscal 2002. Income before preferred stock dividends increased to $1.9 million from $751,000 in the prior-year period. During the first half of fiscal 2003, non-cash charges including depreciation and amortization, losses on disposals of assets, stock compensation and inducement charges totaled $4.0 million as compared to $7.2 million in the prior-year period, principally due to the significant non-cash stock compensation charges that were incurred at the time of our July 2002 initial public offering. The primary use of cash during the first half of fiscal 2003 was to reduce income taxes payable by $7.7 million, mostly due to our final April 2003 payment of federal income tax for fiscal 2002. This

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reduction in income taxes payable was larger than the $1.8 million reduction in income taxes payable during the first half of fiscal 2002. Other changes in assets and liabilities resulted in an additional $8.4 million in cash uses for the first half of fiscal 2003 compared to $16.7 million in cash uses for the first half of fiscal 2002. Increases in inventories and decreases in accrued expenses required less cash during the first half of fiscal 2003 than in the prior-year period. During the first half of fiscal 2002, we paid $13.4 million in accrued interest to our debtholders in connection with our May 2002 refinancing and our July 2002 initial public offering, which is reflected in the change in accrued expenses and other noncurrent liabilities on the statement of cash flows. These factors that contributed to lower cash requirements during the first half of fiscal 2003 were partially offset by the use of $2.1 million to reduce accounts payable, compared to the prior-year period when accounts payable increased by $5.1 million.

          Net cash used in investing activities for the first half of fiscal 2003 consisted principally of $6.1 million in capital expenditures. These expenditures primarily included investments in existing store remodels, new store construction and information technology assets for stores. During the first half of fiscal 2003, we opened 18 new stores and remodeled 3 stores. We expect that capital expenditures for fiscal 2003 will range from $14.5 million to $15.5 million, primarily to fund the construction of 40 new stores, 10 remodels and to complete several information technology projects. We anticipate that capital expenditures, including leasehold improvements and furniture and fixtures, for new stores in fiscal 2003 will average approximately $155,000 to $165,000 per store (net of landlord allowances). In connection with our plans to lease a new distribution center beginning in the second quarter of fiscal 2004, we are still formulating our plans for the timing of certain purchases of capital equipment for this new facility. As we evaluate the potential benefits of making these capital investments, including the current federal tax incentives associated with the purchase of certain capital equipment, we may decide to accelerate the acquisition of certain capital equipment into fiscal 2003. If we purchase this equipment in fiscal 2003, we estimate that these investments would add approximately $2.0 million to our total capital expenditures for fiscal 2003.

          Net cash provided by financing activities for the first half of fiscal 2003 was $13.6 million compared to a use of cash of $10.6 million in the prior-year period. Net cash provided by financing activities during the first half of fiscal 2003 was principally the result of borrowings under our revolving line of credit in the amount of $12.1 million. The use of cash in the prior-year period primarily represents the net effect of two financing events which occurred during the second quarter – our May 2002 refinancing and our July 2002 initial public offering.

          With the completion of our initial public offering and the application of the net proceeds toward debt reduction along with the repayment of our term loan, our only remaining debt consists of our $45 million revolving credit facility. The revolving credit facility bears interest at a floating rate equal to the prime rate or LIBOR plus 2.25%, at our election. The maximum availability under the revolving credit facility is limited by a borrowing base which consists of a percentage of eligible inventory less reserves. Our revolving credit lender may from time to time reduce the lending formula with respect to the eligible inventory to the extent our lender determines that the liquidation value of the eligible inventory has decreased. Our lender also from time to time may decrease the borrowing base by adding reserves with respect to matters such as inventory shrinkage. The revolving credit facility terminates in May 2005.

          Our revolving credit facility contains provisions that could result in changes in the presented terms of the facility or the acceleration of maturity. Circumstances that could lead to such changes in terms or acceleration include, but are not limited to, a material adverse change in our business or an event of default under the credit agreement. The revolving credit facility has two financial covenants, both of which are tested quarterly on a latest-twelve-months basis. The first covenant establishes a minimum level of earnings before interest, taxes, depreciation and amortization excluding certain non-recurring items, or EBITDA, less capital expenditures, and the second covenant establishes a maximum senior debt to EBITDA ratio. As of August 2, 2003, we were in compliance with all covenants under our revolving credit facility.

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          At August 2, 2003, our balance of cash and cash equivalents was $2.2 million and the borrowing availability under our revolving credit facility was $14.9 million. We believe that these sources of cash, together with cash provided by our operations, will be adequate to carry out our fiscal 2003 growth plans in full and fund our planned capital expenditures, interest payments and working capital requirements for at least the next twelve months.

Critical Accounting Policies

          Our critical accounting policies are discussed in the notes to our audited consolidated financial statements included in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on May 1, 2003. The following discussion aggregates the various critical accounting policies addressed throughout the financial statements, the judgments and uncertainties affecting the application of these policies and the likelihood that materially different amounts would be reported under varying conditions and assumptions.

          Cost of sales and inventory valuation. Our inventory is stated at the lower of cost or market with cost determined using the average cost method with average cost approximating current cost. We estimate the amount of shrinkage that has occurred through theft or damage and adjust that to actual at the time of our physical inventory counts which occur near our fiscal year end. We also evaluate the cost of our inventory in relation to the estimated sales price giving consideration to markdowns that will occur prior to or at the point of sale. This evaluation is performed to ensure that we do not carry inventory at a value in excess of the amount we expect to realize upon the sale of the merchandise. We believe we have the appropriate merchandising valuation and pricing controls in place to minimize the risk that our inventory values would be materially misstated.

          Depreciation and recoverability of long-lived assets. Approximately 33% of our assets at August 2, 2003 represent investments in property and equipment. Determining appropriate depreciable lives and reasonable assumptions in evaluating the carrying value of capital assets requires judgments and estimates.

	•		We utilize the straight-line method of depreciation and a variety of depreciable lives. Land is not depreciated. Buildings are depreciated over 40 years. Furniture, fixtures and equipment are depreciated over 5 to 7 years. Leasehold improvements are amortized over the shorter of the useful lives of the asset or the lease term. Our typical lease term is 10 years.
	•		To the extent we replace or dispose of fixtures or equipment prior to the end of its assigned depreciable life, we could realize a loss or gain on the disposition. To the extent our assets are used beyond their assigned depreciable life, no depreciation expense is realized. We periodically reassess the depreciable lives in an effort to reduce the risk of significant losses or gains arising from either the disposition of our assets or the utilization of assets with no depreciation charges.
	•		Recoverability of the carrying value of store assets is assessed annually and upon the occurrence of certain events or changes in circumstances such as store closings or upcoming lease renewals. The assessment requires judgment and estimates for future store generated cash flows. The review includes a comparison of the carrying value of the store assets to the future cash flows expected to be generated by the store. The underlying estimates for cash flows include estimates for future net sales, gross profit, and store expense increases and

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decreases. To the extent our estimates for net sales, gross profit and store expenses are not realized, future assessments of recoverability could result in additional impairment charges.

          Goodwill. We account for our goodwill in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Accordingly, goodwill is not amortized but reviewed for impairment on an annual basis or more frequently when events and circumstances indicate that an impairment may have occurred. We have not recorded an impairment related to our goodwill since adopting SFAS No. 142.

          Insurance reserves. Workers’ compensation, general liability and employee medical insurance programs are partially self-insured. It is our policy to record a self-insurance liability using estimates of claims incurred but not yet reported or paid, based on historical claims experience and trends. Actual results can vary from estimates for many reasons, including, among others, inflation, claims settlement patterns, litigation trends and legal interpretations. We monitor our claims experience in light of these factors and revise our estimates of insurance reserves accordingly. The level of our insurance reserves may increase or decrease as a result of these changing circumstances or trends.

          Stock options and warrants. Certain of our stock options require us to record a non-cash stock compensation charge in our financial statements. The amount of the charge is determined based upon the fair value of our common stock. Other options have been granted to employees and directors with an exercise price that is equal to or greater than the fair value of our common stock on the date of grant. Stock options which have been granted to third parties in exchange for services are valued using an option-pricing model. In each of these cases, the fair value of our common stock is a significant element of determining the value of the stock option, or the amount of the non-cash stock compensation charge to be recorded for our stock option awards. Since our initial public offering, the market value of our stock has been determined by its current price in the publicly traded market. Prior to the offering, the market value of our stock was not easily determinable. In determining the value of our common stock prior to the offering, we considered any amount paid to us for our common stock in recent transactions for the sale of our common stock. Absent a recent sale of common stock, we obtained a valuation from an independent appraiser. We believe that reasonable methods and assumptions have been used for determining the fair value of our common stock.

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Recent Accounting Pronouncements

          In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical Corrections as of April 2002,” which is effective for fiscal years beginning after May 15, 2002. SFAS No. 145 rescinds SFAS No. 4 which required that all gains and losses from extinguishments of indebtedness be aggregated, and if material, classified as an extraordinary item. As a result, gains and losses from debt extinguishments are to be classified as extraordinary only if they meet the criteria set forth in APB Opinion No. 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS No. 145 also requires that sale-leaseback accounting be used for capital lease modifications with economic effects similar to sale-leaseback transactions. As a result of the implementation of SFAS No. 145, the extraordinary loss recorded in the third quarter of fiscal 2002 pertaining to the early extinguishment of term debt will be reclassified to non-operating expense in the third quarter of fiscal 2003. Other than this reclassification, the implementation of SFAS No. 145 did not have a material impact on the results of our operations or financial position.

          In June 2002, the FASB issued SFAS No. 146, “Accounting for Restructuring Costs.” SFAS No. 146 applies to costs associated with an exit activity (including a restructuring) or with a disposal of long-lived assets, such as eliminating or reducing product lines, terminating employees and contracts, and relocating facilities or personnel. Under SFAS No. 146, a company will record a liability for costs associated with an exit or disclose information about its exit and disposal activities, the related costs and changes in those costs in the notes to the financial statements for the period in which the activity is initiated and in any subsequent period until the activity is completed. SFAS No. 146 is effective prospectively for exit and disposal activities initiated after December 31, 2002, with earlier adoption encouraged. Under SFAS No. 146, a company may not restate its previously issued financial statements, and it grandfathers the accounting for liabilities recorded under Emerging Issues Task Force (“EITF”) Issue 94-3. The implementation of SFAS No. 146 did not have a material impact on the results of our operations or our financial position.

          During 2002, the EITF released EITF Issue 02-16, “Accounting by a Customer (Including a Reseller) for Cash Consideration Received From a Vendor.” The issue addresses the accounting treatment of vendor allowances. The application of EITF Issue 02-16 did not have a material impact on our financial statements.

          In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”) “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others,” to clarify accounting and disclosure requirements relating to a guarantor’s issuance of certain types of guarantees, or groups of similar guarantees, even if the likelihood of the guarantor’s having to make any payments under the guarantee is remote. The disclosure provisions are effective for financial statements for fiscal years ended after December 15, 2002. For certain guarantees, FIN 45 also requires that guarantors recognize a liability equal to the fair value of the guarantee upon its issuance. This initial recognition and measurement provision is to be applied only on a prospective basis to guarantees issued or modified after December 31, 2002. The application of FIN 45 did not have a material impact on our financial statements.

          In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities (VIEs), an interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements,” to improve financial reporting of special purpose and other entities. In accordance with FIN 46, business enterprises that represent the primary beneficiary of another entity by retaining a controlling financial interest in that entity’s assets, liabilities and results of operating activities must consolidate the entity in their financial statements. Prior to the issuance of FIN 46, consolidation generally occurred when an enterprise controlled another entity through voting interests. Certain VIEs that are qualifying special

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purpose entities (“QSPEs”) subject to the reporting requirements of SFAS No. 140, “Accounting for Transfer and Servicing of Financial Assets and Extinguishment of Liabilities,” will not be required to be consolidated under the provisions of FIN 46. The consolidation provisions of FIN 46 apply to VIEs created or entered into after January 31, 2003, and for pre-existing VIEs in the first reporting period beginning after June 15, 2003. If applicable, transition rules allow the restatement of financial statements or prospective application with a cumulative effect adjustment. In addition, FIN 46 expands the disclosure requirements for the beneficiary of a significant or a majority of the variable interests to provide information regarding the nature, purpose and financial characteristics of the entities. The application of FIN 46 did not have a material impact on our financial statements.

          In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for how a company classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that a company classify a financial instrument that is within its scope as a liability (or an asset in some instances). This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The implementation of SFAS No. 150 did not have a material impact on the results of our operations or our financial position.

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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 profitably open and operate new stores and maintain the profitability of our existing stores, we may not be able to adequately implement our growth strategy, resulting in a decrease in net sales and net income.
	•		A prolonged economic downturn could result in reduced net sales and profitability.
	•		Reduced consumer spending in the southeastern part of the United States where a majority of our stores are concentrated could reduce our net sales.
	•		We may not be able to successfully anticipate consumer trends, and our failure to do so may lead to loss of consumer acceptance of our products, resulting in reduced net sales.
	•		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.
	•		Our success is highly dependent on our planning and control processes and our supply chain, and any disruption in or failure to continue to improve these processes may result in a loss of net sales and net income.
	•		We face an extremely competitive specialty retail business market, and such competition could result in a reduction of our prices and/or a loss of our market share.
	•		Our business is highly seasonal and our fourth quarter contributes a disproportionate amount of our operating income and net income, and any factors negatively impacting us during our fourth quarter

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			could reduce our net sales, net income and cash flow, leaving us with excess inventory and making it more difficult for us to finance our capital requirements.
	•		We may experience significant variations in our quarterly results.
	•		The agreement covering our debt places certain reporting and consent requirements on us which may affect our ability to operate our business in accord with our business and growth strategy.
	•		We are highly dependent on customer traffic in malls, and any reduction in the overall level of mall traffic could reduce our net sales and increase our sales and marketing expenses.
	•		Our hardware and software systems are vulnerable to damage that could harm our business.
	•		We depend on key personnel, and if we lose the services of any of our principal executive officers, including Carl Kirkland, our Chairman, and Robert E. Alderson, our President and Chief Executive Officer, we may not be able to run our business effectively.

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