Yesterday, my Foolish colleague Jeremy MacNealy gave a rundown on Cost Plus' (NASDAQ:CPWM) earnings release with a focus on the income statement. I'm going to add a bit to his take today, but with a focus on the balance sheet, because I see some concerns there that warrant a mention.

My main concerns with Cost Plus center around its inventory and its debt, which were both up substantially in the last quarter. While the company forecasted higher inventory levels, the continued increase of inventory in relation to sales should give an investor pause, since before this quarter, inventories were already high. The numbers for this quarter show inventory gains coming in at 21.5% versus sales gains of just 7%.

The inventory gains are a real problem for the company, because they tie up a large portion of the company's cash. And while the cash balance is strong enough for now, it isn't particularly robust.

At present, Cost Plus' debt may be a larger concern for investors than its inventory is. The company's proportion of long-term debt to cash is a touch concerning, but the company's free cash flow has historically made this manageable. Glancing at the company's income statement -- no statement of cash flows was provided in the earnings release -- the situation appears to be changing for the worse. Last year at this time, Cost Plus had earnings before interest and taxes (EBIT) of $12.1 million and net interest expense of $1.6 million, which gave the company a fairly healthy interest coverage ratio of 7.6 times EBIT (interest coverage ratio = EBIT/net interest expense).

This quarter, the company's EBIT is $4.3 million and its interest expense is $2.1 million for an interest coverage ratio of approximately 2. At the very least, that's a troubling sign.

Wares similar to what Cost Plus sells can be found at Pier 1 Imports (NYSE:PIR), Williams-Sonoma (NYSE:WSM), Crate & Barrel, and a number of department stores such as Dillards (NYSE:DDS), which leads me to believe that getting its inventory under control is not going to be easy without a fair amount of discounting. Given the company's need for cash and relatively long cash conversion cycle, this is also not a good sign.

The beauty of working at The Motley Fool is that we are allowed -- nay, encouraged -- to do our own research and to have our own opinions. Cost Plus initially garnered a Motley Fool Hidden Gems Watch List mention, because despite its recent poor performance, the underlying company does have potential and the shares are not expensive. However, inventory was cited as an area of Cost Plus' business that would need to improve before the company warranted a more serious look. With the company's inventory position having further deteriorated this quarter, caution is still warranted. But the shares are still inexpensive and the company does have potential. I say, just give the balance sheet a little time to show some improvement.

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Nathan Parmelee has no financial interest in any of the companies mentioned. The Motley Fool has an ironclad disclosure policy.