##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended July 31, 2004 Commission File No. 1-6695   JO-ANN STORES, INC.  Ohio
    
    34-0720629(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)5555 Darrow Road, Hudson, Ohio
    
    44236(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (330) 656-2600 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 is an accelerated filer
(as defined in Rule 12b-2 of the Exchange
Act).Yes  x No  o Indicate the number of shares outstanding of each of the issuers
classes of common stock, as of the latest practicable date: Common Shares,
without par value, as of September 3, 2004: 22,605,211




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Jo-Ann Stores, Inc.
Form 10-Q Index
For the Quarter Ended July 31, 2004  
 Page NumbersPart I. Financial InformationItem 1. Financial StatementsConsolidated Balance Sheets  July 31, 2004 (Unaudited),
January 31, 2004 and August 2, 2003 (Unaudited)
    
    
    1Unaudited Consolidated Statements of Operations for the Thirteen and
Twenty-Six Weeks Ended July 31, 2004 and August 2, 2003
    
    
    2Unaudited Consolidated Statements of Cash Flows for the
Twenty-Six Weeks Ended July 31, 2004 and August 2, 2003
    
    
    3Notes to Unaudited Consolidated Financial Statements
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    13Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    20Item 4. Controls and Procedures
    
    
    20Part II. Other InformationItem 1. Legal Proceedings
    
    
    21Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    21Item 3. Defaults Upon Senior Securities
    
    
    21Item 4. Submission of Matters to a Vote of Security Holders
    
    
    21Item 5. Other Information
    
    
    22Item 6. Exhibits
    
    
    22Signatures
    
    
    23EX-31.1 Certification by CEOEX-31.2 Certification by CFOEX-32.1 Certification of PEO and PFO




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##### Table of Contents



PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements Jo-Ann Stores, Inc. 
 Consolidated Balance Sheets
 (Unaudited)
    
    
    
    
    
    (Unaudited)July 31,
    
    January 31,
    
    August 2,2004
    
    2004
    
    2003(Dollars in millions, except share and per share data)AssetsCurrent assets:Cash and cash equivalents
    
    $
    17.7
    
    
    $
    17.4
    
    
    $
    16.1Inventories
    
    
    508.4
    
    
    
    404.6
    
    
    
    471.6Deferred income taxes
    
    
    24.6
    
    
    
    25.0
    
    
    
    27.9Prepaid expenses and other current assets
    
    
    19.9
    
    
    
    23.5
    
    
    
    18.7Total current assets
    
    
    570.6
    
    
    
    470.5
    
    
    
    534.3Property, equipment and leasehold improvements, net
    
    
    204.5
    
    
    
    203.2
    
    
    
    190.4Goodwill, net
    
    
    26.5
    
    
    
    26.5
    
    
    
    26.5Other assets
    
    
    10.4
    
    
    
    7.5
    
    
    
    14.1Total assets
    
    $
    812.0
    
    
    $
    707.7
    
    
    $
    765.3Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    176.0
    
    
    $
    122.0
    
    
    $
    172.3Accrued expenses
    
    
    55.2
    
    
    
    76.1
    
    
    
    56.1Total current liabilities
    
    
    231.2
    
    
    
    198.1
    
    
    
    228.4Long-term debt
    
    
    161.7
    
    
    
    113.7
    
    
    
    190.5Deferred income taxes
    
    
    39.4
    
    
    
    39.4
    
    
    
    37.2Other long-term liabilities
    
    
    12.3
    
    
    
    10.3
    
    
    
    9.8Shareholders equity:Preferred stock, no par value, 5,000,000 shares authorized, none issued
    
    
    
    
    
    
    
    
    
    
    Common stock, stated value $0.05 per share; 150,000,000 authorized,
issued 26,136,822; 25,603,035 and 25,339,295 shares, respectively
    
    
    1.3
    
    
    
    1.3
    
    
    
    1.3Additional paid-in capital
    
    
    144.1
    
    
    
    129.0
    
    
    
    121.3Retained earnings
    
    
    266.0
    
    
    
    258.8
    
    
    
    219.7Accumulated other comprehensive loss
    
    
    (0.8
    )
    
    
    (1.6
    )
    
    
    (2.1
    )410.6
    
    
    
    387.5
    
    
    
    340.2Treasury stock, at cost, 3,743,330; 3,774,800 and 3,768,168
shares, respectively
    
    
    (43.2
    )
    
    
    (41.3
    )
    
    
    (40.8
    )Total shareholders equity
    
    
    367.4
    
    
    
    346.2
    
    
    
    299.4Total liabilities and shareholders equity
    
    $
    812.0
    
    
    $
    707.7
    
    
    $
    765.3
 See notes to unaudited consolidated financial statements 1




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##### Table of Contents



Jo-Ann Stores, Inc. 
 Consolidated Statements of Operations
 (Unaudited)
 Thirteen Weeks Ended
    
    Twenty-Six Weeks EndedJuly 31,
    
    August 2,
    
    July 31,
    
    August 2,2004
    
    2003
    
    2004
    
    2003(Dollars in millions, except share and per share data)Net sales
    
    $
    371.0
    
    
    $
    359.2
    
    
    $
    775.9
    
    
    $
    734.0Cost of sales
    
    
    189.1
    
    
    
    186.6
    
    
    
    395.0
    
    
    
    380.9Gross margin
    
    
    181.9
    
    
    
    172.6
    
    
    
    380.9
    
    
    
    353.1Selling, general and administrative expenses
    
    
    160.8
    
    
    
    158.8
    
    
    
    326.0
    
    
    
    311.9Store pre-opening and closing costs
    
    
    4.6
    
    
    
    2.6
    
    
    
    7.5
    
    
    
    4.7Depreciation and amortization
    
    
    9.9
    
    
    
    8.9
    
    
    
    19.6
    
    
    
    17.9Stock-based compensation expense
    
    
    2.0
    
    
    
    1.6
    
    
    
    4.0
    
    
    
    2.9Debt repurchase expenses
    
    
    
    
    
    
    
    
    
    
    4.2
    
    
    
    3.4Operating profit
    
    
    4.6
    
    
    
    0.7
    
    
    
    19.6
    
    
    
    12.3Interest expense, net
    
    
    3.8
    
    
    
    4.2
    
    
    
    7.9
    
    
    
    9.2Income (loss) before income taxes
    
    
    0.8
    
    
    
    (3.5
    )
    
    
    11.7
    
    
    
    3.1Income tax provision (benefit)
    
    
    0.3
    
    
    
    (1.3
    )
    
    
    4.5
    
    
    
    1.2Net income (loss)
    
    $
    0.5
    
    
    $
    (2.2
    )
    
    $
    7.2
    
    
    $
    1.9Net income (loss) per common share  basic
    
    $
    0.02
    
    
    $
    (0.10
    )
    
    $
    0.33
    
    
    $
    0.09Net income (loss) per common share  diluted
    
    $
    0.02
    
    
    $
    (0.10
    )
    
    $
    0.32
    
    
    $
    0.09Weighted average shares outstanding (in thousands):Basic
    
    
    22,149
    
    
    
    21,552
    
    
    
    21,976
    
    
    
    21,400Diluted
    
    
    22,877
    
    
    
    21,552
    
    
    
    22,771
    
    
    
    21,856
 See notes to unaudited consolidated financial statements 2




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Jo-Ann Stores, Inc. 
 Consolidated Statements of Cash Flows
(Unaudited)
 Twenty-Six Weeks EndedJuly 31,
    
    August 2,2004
    
    2003(Dollars in millions)Net cash flows used for operating activities:Net income
    
    $
    7.2
    
    
    $
    1.9Adjustments to reconcile net income to net cash
used for operating activities:Depreciation and amortization
    
    
    19.6
    
    
    
    17.9Stock-based compensation expense
    
    
    4.0
    
    
    
    2.9Tax benefit on stock benefit plan awards
    
    
    4.2
    
    
    
    1.3Amortization of deferred financing costs
    
    
    0.9
    
    
    
    0.8Loss on disposal of fixed assets
    
    
    0.8
    
    
    
    0.2Loss associated with purchase of senior subordinated notes
    
    
    4.2
    
    
    
    3.4Changes in operating assets and liabilities:Increase in inventories
    
    
    (103.8
    )
    
    
    (108.5
    )Increase in accounts payable
    
    
    54.0
    
    
    
    42.4Decrease in accrued expenses
    
    
    (20.9
    )
    
    
    (19.8
    )Other, net
    
    
    5.7
    
    
    
    0.5Net cash used for operating activities
    
    
    (24.1
    )
    
    
    (57.0
    )Net cash flows used for investing activities:Capital expenditures
    
    
    (21.6
    )
    
    
    (18.5
    )Net cash used for investing activities
    
    
    (21.6
    )
    
    
    (18.5
    )Net cash flows provided by financing activities:Proceeds from issuance of 7.5% senior subordinated notes, net
    
    
    97.0
    
    
    
    Purchase of 10 3/8% senior subordinated notes
    
    
    (66.6
    )
    
    
    (48.4
    )Net change in revolving credit facility
    
    
    12.4
    
    
    
    73.5Proceeds from stock benefit plans
    
    
    7.1
    
    
    
    3.7Other, net
    
    
    (3.9
    )
    
    
    (0.4
    )Net cash provided by financing activities
    
    
    46.0
    
    
    
    28.4Net increase (decrease) in cash and cash equivalents
    
    
    0.3
    
    
    
    (47.1
    )Cash and cash equivalents at beginning of period
    
    
    17.4
    
    
    
    63.2Cash and cash equivalents at end of period
    
    $
    17.7
    
    
    $
    16.1Supplemental disclosures of cash flow information:Cash paid during the period for:Interest
    
    $
    4.8
    
    
    $
    10.8Income taxes, net of refunds
    
    
    19.6
    
    
    
    4.3
 See notes to unaudited consolidated financial statements 3




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Notes to Consolidated Financial Statements (Unaudited)
Jo-Ann Stores, Inc. Note 1    Basis of Presentation Jo-Ann Stores, Inc. (the Company), an Ohio corporation, is a fabric and
craft retailer operating 863 retail stores in 47 states at July 31, 2004. The
766 traditional stores and 97 superstores feature a variety of competitively
priced merchandise used in sewing, crafting and home decorating projects,
including fabrics, notions, crafts, frames, scrapbooking material, artificial
and dried flowers, home accents, finished seasonal and home décor merchandise. The Companys fiscal year ends on the Saturday closest to January 31.
Fiscal years consist of 52 weeks, unless noted otherwise. The fiscal year
refers to the year in which the period ends (e.g., fiscal 2005 refers to the
year ended January 29, 2005). The consolidated interim financial statements include the accounts of the
Company and its subsidiaries and have been prepared without audit, pursuant to
the rules of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to those rules and regulations,
although the Company believes that the disclosures herein are adequate to make
the information not misleading. Certain amounts in the fiscal 2004 year-end
and interim financial statements have been reclassified in order to conform to
the current year presentation. The statements should be read in conjunction
with the consolidated financial statements and notes thereto included in the
Companys Annual Report on Form 10-K for the fiscal year ended January 31,
2004. Typical of most retail companies, the Companys business is highly
seasonal with the majority of revenues and operating profits generated in the
second half of the fiscal year. Accordingly, earnings or losses for a
particular interim period are not indicative of full year results. Due to the
seasonal nature of the Companys business, a comparable balance sheet as of
August 2, 2003 has been provided. In the opinion of management, the
consolidated financial statements contain all adjustments (consisting only of
normal recurring accruals) necessary for a fair statement of results for the
interim periods presented. Note 2   Debt Refinancing On February 26, 2004, the Company completed the placement of $100 million
of 7.5% senior subordinated notes due 2012. Net proceeds from the offering of
$97.0 million were used to repurchase $39.2 million of 10 3/8% senior
subordinated notes due 2007 that were tendered as part of the refinancing, as
well as the remaining $25.2 million in 10 3/8% senior subordinated notes that
remained outstanding on May 1, 2004, the date when their call premium was
reduced, and for general corporate purposes. As a result of the repurchase,
the Company incurred a $4.2 million charge primarily for the premium paid to
repurchase the 10 3/8% senior subordinated notes and to write-off the
remaining deferred debt costs. On April 16, 2004, the Company amended and extended the expiration date of
its senior credit facility originally entered into in April 2001 and led by
Fleet Retail Group, Inc. The senior credit facility, as amended, is a $350.0
million revolver that expires April 30, 2009. The prior credit facility
provided for a $325.0 million revolver and a $40.0 million term loan, and would
have expired on April 30, 2005. The amended credit facility is secured by a
first priority perfected security interest in inventory, accounts receivable,
property and other assets and is fully and unconditionally guaranteed by each
of the Companys wholly-owned subsidiaries. Interest on borrowings under the
amended credit facility is calculated at the banks base rate or London
Interbank Offered Rate (LIBOR) plus 1.25% to 2.00%, depending on the level 4




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of excess availability (as defined in the amended credit facility) that is
maintained. At July 31, 2004, interest on borrowings under the amended credit
facility was calculated at LIBOR plus 1.25%. The credit facility, as amended,
contains a sub-limit for letters of credit of $200.0 million. Note 3    Earnings Per Share Basic earnings per common share are computed by dividing net income by
the weighted average number of shares outstanding during the period. Diluted
earnings per share include the effect of the assumed exercise of dilutive
stock awards under the treasury stock method. The following table presents information necessary to calculate basic and
diluted earnings per common share for the periods presented (shares in
thousands). Thirteen Weeks Ended
    
    Twenty-Six Weeks EndedJuly 31,
    
    August 2,
    
    July 31,
    
    August 2,2004
    
    2003
    
    2004
    
    2003Weighted average shares outstanding:Basic commmon shares
    
    
    22,149
    
    
    
    21,552
    
    
    
    21,976
    
    
    
    21,400Incremental shares from assumed
exercise of stock options
    
    
    627
    
    
    
    
    
    
    
    698
    
    
    
    456Incremental restricted shares
    
    
    101
    
    
    
    
    
    
    
    97
    
    
    
    Diluted basic common shares
    
    
    22,877
    
    
    
    21,552
    
    
    
    22,771
    
    
    
    21,856
 Not included in the computation of diluted earnings per share were
certain stock options that would have been anti-dilutive to the earnings per
share calculation. For the second quarter of fiscal 2005 and fiscal 2004,
51,266 and 3,250,131 stock awards, respectively, were excluded. For the
fiscal 2005 and 2004 year-to-date periods, 28,766 and 281,308 stock awards,
respectively, were excluded. Note 4  Store Closing Charges The Company is pursuing a growth strategy that is driven by the
replacement of its traditional stores with superstores. In addition, the
Company continually reviews the productivity of its store base, actively
manages its real estate to preserve maximum flexibility in lease terms, and
closes locations that do not meet certain financial performance thresholds.
Through the first half of the fiscal year, the Company opened 11 new
superstores and one traditional store, and it closed 41 traditional stores. 5




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The charges to the statement of operations for the year-to-date period
ending July 31, 2004 related to store closings and a roll-forward of the store
closing reserve balances from January 31, 2004 is summarized in the following
table. Non-cancelable lease
    
    Asset
    
    OtherDollars in millions
    
    obligations
    
    Impairments
    
    Costs
    
    TotalBalance at January 31, 2004
    
    $
    1.8
    
    
    $
    
    
    
    $
    1.0
    
    
    $
    2.8Amounts charged to income
    
    
    0.7
    
    
    
    0.7
    
    
    
    2.9
    
    
    
    4.3Utilization:Cash
    
    
    (1.4
    )
    
    
    
    
    
    
    (2.7
    )
    
    
    (4.1
    )Non-Cash
    
    
    
    
    
    
    (0.7
    )
    
    
    
    
    
    
    (0.7
    )Balance at July 31, 2004
    
    $
    1.1
    
    
    $
    
    
    
    $
    1.2
    
    
    $
    2.3
 Store closing costs, as well as the pre-opening costs of new store
activity, are reported in the statement of operations in the line item
Store pre-opening and closing costs. Note 5  Fair Value of Derivative Financial Instruments The Company is subject to risk resulting from interest rate fluctuations,
as interest on the Companys credit facility is based on variable rates. The
Companys objective in managing its interest rate exposure is to limit the
impact of interest rate changes on earnings and cash flows. Interest rate
swaps are primarily utilized to achieve this objective, effectively converting
a portion of its variable-rate exposures to fixed interest rates. The Company
does not enter into financial instruments for trading purposes. At July 31, 2004, the Company had a $40.0 million interest rate swap with
a fixed LIBOR rate of 6.72% that expires on April 30, 2005. The interest rate
swap agreement requires the Company to pay a fixed interest rate while
receiving a floating interest rate based on LIBOR. In accordance with
Statement of Financial Accounting Standard (SFAS)
No. 133, Accounting for Derivative Instruments and Hedging Activities, as
amended, the Company has reviewed and designated its interest rate swap
agreement as a cash flow hedge and recognizes the fair value of its interest
rate swap agreement on the balance sheet. Changes in the fair value of this
agreement are recorded in other comprehensive income and reclassified into
earnings as the underlying hedged item affects earnings. Other comprehensive income includes the effects of derivative
transactions accounted for under SFAS No. 133, net of related tax.
Comprehensive income consists of the following: Thirteen Weeks Ended
    
    Twenty-Six Weeks EndedJuly 31,
    
    August 2,
    
    July 31,
    
    August 2,Dollars in millions
    
    2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    0.5
    
    
    $
    (2.2
    )
    
    $
    7.2
    
    
    $
    1.9Other comprehensive income, net of tax
    
    
    0.4
    
    
    
    0.4
    
    
    
    0.8
    
    
    
    0.5Comprehensive income (loss)
    
    $
    0.9
    
    
    $
    (1.8
    )
    
    $
    8.0
    
    
    $
    2.4
 Note 6   Shareholders Equity The Company has various stock-based compensation plans that it utilizes
as long-term compensation for its Board of Directors, executive officers,
senior management and other key employees. The Company 6




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issues stock under these various stock-award compensation plans and uses
treasury shares to fund the Companys match under the 401(k) savings plan. In fiscal 2005, the Company implemented changes in its long-term
compensation for employees, which it believes will help the Company continue to
attract and retain the best employees, and better align employee interests with
those of its shareholders. Annual grants to employees are now being made in
restricted stock awards instead of stock options. The award of restricted
stock offers employees the opportunity to earn shares of the Companys stock
over time, rather than options that provide employees the right to purchase stock
at a set price. Stock options continue to be awarded to new employees and
employees who are promoted into certain management positions. Early this year, the Compensation Committee of the Board of Directors
approved an annual base award of restricted stock to certain of the Companys
employees that serves as both a retention vehicle and is coupled with
performance awards. The base and performance awards vest 50% at the end of
three years, with the remaining 50% vesting at the end of the fourth year. The
base award consisted of approximately 187,000 restricted shares. The
performance-based award provides the potential to receive up to three-times
that amount in additional shares. The number of performance award shares
ultimately received, if any, will depend on achieving certain performance
criteria that are measured at the end of the third year. During the first half of fiscal 2005, shares outstanding increased by
565,000 as follows: CommonNet
    
    
    
    
    
    Stock
    
    AdditionalCommon
    
    Treasury
    
    Stated
    
    Paid-In
    
    TreasuryShares
    
    Shares
    
    Value
    
    Capital
    
    Stock(Shares in thousands)
    
    (Dollars in millions)Balance, January 31, 2004
    
    
    21,828
    
    
    
    3,775
    
    
    $
    1.3
    
    
    $
    129.0
    
    
    $
    (41.3
    )Exercise of stock options
    
    
    608
    
    
    
    (105
    )
    
    
    
    
    
    
    5.3
    
    
    
    0.6Purchase of common stock
    
    
    (91
    )
    
    
    91
    
    
    
    
    
    
    
    
    
    
    
    (2.5
    )Issuance of treasury shares
    
    
    18
    
    
    
    (18
    )
    
    
    
    
    
    
    0.4
    
    
    
    Associate stock ownership plan
    
    
    59
    
    
    
    
    
    
    
    
    
    
    
    1.2
    
    
    
    Tax benefit on equity compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4.2
    
    
    
    Stock-based compensation
    
    
    (29
    )
    
    
    
    
    
    
    
    
    
    
    4.0
    
    
    
    Year-to-date activity
    
    
    565
    
    
    
    (32
    )
    
    
    
    
    
    
    15.1
    
    
    
    (1.9
    )Balance, July 31, 2004
    
    
    22,393
    
    
    
    3,743
    
    
    $
    1.3
    
    
    $
    144.1
    
    
    $
    (43.2
    )
 Note 7    Recent Accounting Pronouncements FASB Interpretation No. 46, Consolidation of Variable Interest Entities In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest
Entities. FIN 46 clarifies the application of Accounting Research Bulletin
No. 51, Consolidated Financial Statements, for certain entities which do not
have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties or in
which equity investors do not have the characteristics of a controlling
financial interest (variable interest entities). Variable interest entities
will be required to be consolidated by their primary beneficiary. The primary
beneficiary of a variable interest entity is determined to be the party that
absorbs a majority of the entitys expected losses, receives a majority of its
expected returns, or both, as a result of holding variable interests, which
are ownership, contractual, or other pecuniary interests in an entity. The
Company adopted FIN 46 during its fiscal 2005 first quarter. The adoption of
FIN 46 had no impact on the Companys consolidated financial statements. 7




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Note 8   Consolidating Financial Statements (Unaudited) The Companys 7.5% senior subordinated notes and credit facility are
fully and unconditionally guaranteed, on a joint and several basis, by the
wholly-owned subsidiaries of the Company. The senior subordinated notes are
subordinated to the Companys credit facility. Summarized consolidating
financial information of the Company (excluding its subsidiaries) and the
guarantor subsidiaries as of July 31, 2004 and January 31, 2004 and for the
thirteen and twenty-six weeks ended July 31, 2004 and August 2, 2003 are as
follows: Consolidating Balance SheetsJuly 31, 2004 GuarantorParent
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(Dollars in millions)AssetsCurrent assets:Cash and cash equivalents
    
    $
    14.8
    
    
    $
    2.9
    
    
    $
    
    
    
    $
    17.7Inventories
    
    
    173.4
    
    
    
    335.0
    
    
    
    
    
    
    
    508.4Deferred income taxes
    
    
    19.0
    
    
    
    5.6
    
    
    
    
    
    
    
    24.6Prepaid expenses and other current assets
    
    
    13.5
    
    
    
    6.4
    
    
    
    
    
    
    
    19.9Total current assets
    
    
    220.7
    
    
    
    349.9
    
    
    
    
    
    
    
    570.6Property, equipment and leasehold improvements, net
    
    
    81.1
    
    
    
    123.4
    
    
    
    
    
    
    
    204.5Goodwill, net
    
    
    
    
    
    
    26.5
    
    
    
    
    
    
    
    26.5Other assets
    
    
    9.0
    
    
    
    1.4
    
    
    
    
    
    
    
    10.4Investment in subsidiaries
    
    
    70.7
    
    
    
    
    
    
    
    (70.7
    )
    
    
    Intercompany receivable
    
    
    379.3
    
    
    
    
    
    
    
    (379.3
    )
    
    
    Total assets
    
    $
    760.8
    
    
    $
    501.2
    
    
    $
    (450.0
    )
    
    $
    812.0Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    148.2
    
    
    $
    27.8
    
    
    $
    
    
    
    $
    176.0Accrued expenses
    
    
    56.9
    
    
    
    (1.7
    )
    
    
    
    
    
    
    55.2Total current liabilities
    
    
    205.1
    
    
    
    26.1
    
    
    
    
    
    
    
    231.2Long-term debt
    
    
    161.7
    
    
    
    
    
    
    
    
    
    
    
    161.7Deferred income taxes
    
    
    18.8
    
    
    
    20.6
    
    
    
    
    
    
    
    39.4Other long-term liabilities
    
    
    7.8
    
    
    
    4.5
    
    
    
    
    
    
    
    12.3Intercompany payable
    
    
    
    
    
    
    379.3
    
    
    
    (379.3
    )
    
    
    Shareholders equity:Preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock
    
    
    1.3
    
    
    
    
    
    
    
    
    
    
    
    1.3Additional paid-in capital
    
    
    144.1
    
    
    
    
    
    
    
    
    
    
    
    144.1Retained earnings
    
    
    266.0
    
    
    
    70.7
    
    
    
    (70.7
    )
    
    
    266.0Accumulated other comprehensive loss
    
    
    (0.8
    )
    
    
    
    
    
    
    
    
    
    
    (0.8
    )410.6
    
    
    
    70.7
    
    
    
    (70.7
    )
    
    
    410.6Treasury stock, at cost
    
    
    (43.2
    )
    
    
    
    
    
    
    
    
    
    
    (43.2
    )Total shareholders equity
    
    
    367.4
    
    
    
    70.7
    
    
    
    (70.7
    )
    
    
    367.4Total liabilities and shareholders equity
    
    $
    760.8
    
    
    $
    501.2
    
    
    $
    (450.0
    )
    
    $
    812.0
 8




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##### Table of Contents



Note 8   Consolidating Financial Statements (Unaudited)  CONTINUED Consolidating Balance SheetsJanuary 31, 2004 GuarantorConsolidating Balance Sheets
    
    Parent
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(Dollars in millions)AssetsCurrent assets:Cash and cash equivalents
    
    $
    14.3
    
    
    $
    3.1
    
    
    $
    
    
    
    $
    17.4Inventories
    
    
    154.0
    
    
    
    250.6
    
    
    
    
    
    
    
    404.6Deferred income taxes
    
    
    19.4
    
    
    
    5.6
    
    
    
    
    
    
    
    25.0Prepaid expenses and other current assets
    
    
    15.1
    
    
    
    8.4
    
    
    
    
    
    
    
    23.5Total current assets
    
    
    202.8
    
    
    
    267.7
    
    
    
    
    
    
    
    470.5Property, equipment and leasehold improvements, net
    
    
    80.1
    
    
    
    123.1
    
    
    
    
    
    
    
    203.2Goodwill, net
    
    
    
    
    
    
    26.5
    
    
    
    
    
    
    
    26.5Other assets
    
    
    6.1
    
    
    
    1.4
    
    
    
    
    
    
    
    7.5Investment in subsidiaries
    
    
    55.5
    
    
    
    
    
    
    
    (55.5
    )
    
    
    Intercompany receivable
    
    
    331.7
    
    
    
    
    
    
    
    (331.7
    )
    
    
    Total assets
    
    $
    676.2
    
    
    $
    418.7
    
    
    $
    (387.2
    )
    
    $
    707.7Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    112.0
    
    
    $
    10.0
    
    
    $
    
    
    
    $
    122.0Accrued expenses
    
    
    78.9
    
    
    
    (2.8
    )
    
    
    
    
    
    
    76.1Total current liabilities
    
    
    190.9
    
    
    
    7.2
    
    
    
    
    
    
    
    198.1Long-term debt
    
    
    113.7
    
    
    
    
    
    
    
    
    
    
    
    113.7Deferred income taxes
    
    
    18.8
    
    
    
    20.6
    
    
    
    
    
    
    
    39.4Other long-term liabilities
    
    
    6.6
    
    
    
    3.7
    
    
    
    
    
    
    
    10.3Intercompany payable
    
    
    
    
    
    
    331.7
    
    
    
    (331.7
    )
    
    
    Shareholders equity:Preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock
    
    
    1.3
    
    
    
    
    
    
    
    
    
    
    
    1.3Additional paid-in capital
    
    
    129.0
    
    
    
    
    
    
    
    
    
    
    
    129.0Retained earnings
    
    
    258.8
    
    
    
    55.5
    
    
    
    (55.5
    )
    
    
    258.8Accumulated other comprehensive loss
    
    
    (1.6
    )
    
    
    
    
    
    
    
    
    
    
    (1.6
    )387.5
    
    
    
    55.5
    
    
    
    (55.5
    )
    
    
    387.5Treasury stock, at cost
    
    
    (41.3
    )
    
    
    
    
    
    
    
    
    
    
    (41.3
    )Total shareholders equity
    
    
    346.2
    
    
    
    55.5
    
    
    
    (55.5
    )
    
    
    346.2Total liabilities and shareholders equity
    
    $
    676.2
    
    
    $
    418.7
    
    
    $
    (387.2
    )
    
    $
    707.7
 9




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##### Table of Contents



Note 8   Consolidating Financial Statements (Unaudited)  CONTINUED Consolidating Statements of OperationsThirteen Weeks Ended July 31, 2004 and August 2, 2003 July 31, 2004GuarantorParent
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(Dollars in millions)Net sales
    
    $
    197.9
    
    
    $
    296.7
    
    
    $
    (123.6
    )
    
    $
    371.0Cost of sales
    
    
    117.1
    
    
    
    195.6
    
    
    
    (123.6
    )
    
    
    189.1Gross margin
    
    
    80.8
    
    
    
    101.1
    
    
    
    
    
    
    
    181.9Selling, general and administrative expenses
    
    
    79.0
    
    
    
    81.8
    
    
    
    
    
    
    
    160.8Store pre-opening and closing costs
    
    
    2.0
    
    
    
    2.6
    
    
    
    
    
    
    
    4.6Depreciation and amortization
    
    
    4.0
    
    
    
    5.9
    
    
    
    
    
    
    
    9.9Stock-based compensation expense
    
    
    2.0
    
    
    
    
    
    
    
    
    
    
    
    2.0Debt repurchase expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating profit (loss)
    
    
    (6.2
    )
    
    
    10.8
    
    
    
    
    
    
    
    4.6Interest expense, net
    
    
    1.6
    
    
    
    2.2
    
    
    
    
    
    
    
    3.8Income (loss) before income taxes
    
    
    (7.8
    )
    
    
    8.6
    
    
    
    
    
    
    
    0.8Income tax provision (benefit)
    
    
    (3.0
    )
    
    
    3.3
    
    
    
    
    
    
    
    0.3Income (loss) before equity income
    
    
    (4.8
    )
    
    
    5.3
    
    
    
    
    
    
    
    0.5Equity income from subsidiaries
    
    
    5.3
    
    
    
    
    
    
    
    (5.3
    )
    
    
    Net income
    
    $
    0.5
    
    
    $
    5.3
    
    
    $
    (5.3
    )
    
    $
    0.5
 August 2, 2003GuarantorParent
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(Dollars in millions)Net sales
    
    $
    195.4
    
    
    $
    295.0
    
    
    $
    (131.2
    )
    
    $
    359.2Cost of sales
    
    
    120.8
    
    
    
    197.0
    
    
    
    (131.2
    )
    
    
    186.6Gross margin
    
    
    74.6
    
    
    
    98.0
    
    
    
    
    
    
    
    172.6Selling, general and administrative expenses
    
    
    80.6
    
    
    
    78.2
    
    
    
    
    
    
    
    158.8Store pre-opening and closing costs
    
    
    1.6
    
    
    
    1.0
    
    
    
    
    
    
    
    2.6Depreciation and amortization
    
    
    3.2
    
    
    
    5.7
    
    
    
    
    
    
    
    8.9Stock-based compensation expense
    
    
    1.6
    
    
    
    
    
    
    
    
    
    
    
    1.6Debt repurchase expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating profit (loss)
    
    
    (12.4
    )
    
    
    13.1
    
    
    
    
    
    
    
    0.7Interest expense, net
    
    
    1.7
    
    
    
    2.5
    
    
    
    
    
    
    
    4.2Income (loss) before income taxes
    
    
    (14.1
    )
    
    
    10.6
    
    
    
    
    
    
    
    (3.5
    )Income tax benefit
    
    
    (1.2
    )
    
    
    (0.1
    )
    
    
    
    
    
    
    (1.3
    )Income (loss) before equity income
    
    
    (12.9
    )
    
    
    10.7
    
    
    
    
    
    
    
    (2.2
    )Equity income from subsidiaries
    
    
    10.7
    
    
    
    
    
    
    
    (10.7
    )
    
    
    Net income (loss)
    
    $
    (2.2
    )
    
    $
    10.7
    
    
    $
    (10.7
    )
    
    $
    (2.2
    )
 10




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##### Table of Contents



Note 8   Consolidating Financial Statements (Unaudited)  CONTINUED Consolidating Statements of OperationsTwenty-Six Weeks Ended July 31, 2004 and August 2, 2003 July 31, 2004GuarantorParent
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(Dollars in millions)Net sales
    
    $
    418.3
    
    
    $
    609.0
    
    
    $
    (251.4
    )
    
    $
    775.9Cost of sales
    
    
    245.9
    
    
    
    400.5
    
    
    
    (251.4
    )
    
    
    395.0Gross margin
    
    
    172.4
    
    
    
    208.5
    
    
    
    
    
    
    
    380.9Selling, general and administrative expenses
    
    
    162.5
    
    
    
    163.5
    
    
    
    
    
    
    
    326.0Store pre-opening and closing costs
    
    
    3.1
    
    
    
    4.4
    
    
    
    
    
    
    
    7.5Depreciation and amortization
    
    
    8.0
    
    
    
    11.6
    
    
    
    
    
    
    
    19.6Stock-based compensation expense
    
    
    4.0
    
    
    
    
    
    
    
    
    
    
    
    4.0Debt repurchase expenses
    
    
    4.2
    
    
    
    
    
    
    
    
    
    
    
    4.2Operating profit (loss)
    
    
    (9.4
    )
    
    
    29.0
    
    
    
    
    
    
    
    19.6Interest expense, net
    
    
    3.6
    
    
    
    4.3
    
    
    
    
    
    
    
    7.9Income (loss) before income taxes
    
    
    (13.0
    )
    
    
    24.7
    
    
    
    
    
    
    
    11.7Income tax provision (benefit)
    
    
    (5.0
    )
    
    
    9.5
    
    
    
    
    
    
    
    4.5Income (loss) before equity income
    
    
    (8.0
    )
    
    
    15.2
    
    
    
    
    
    
    
    7.2Equity income from subsidiaries
    
    
    15.2
    
    
    
    
    
    
    
    (15.2
    )
    
    
    Net income
    
    $
    7.2
    
    
    $
    15.2
    
    
    $
    (15.2
    )
    
    $
    7.2
 August 2, 2003GuarantorParent
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(Dollars in millions)Net sales
    
    $
    400.9
    
    
    $
    581.5
    
    
    $
    (248.4
    )
    
    $
    734.0Cost of sales
    
    
    243.6
    
    
    
    385.7
    
    
    
    (248.4
    )
    
    
    380.9Gross margin
    
    
    157.3
    
    
    
    195.8
    
    
    
    
    
    
    
    353.1Selling, general and administrative expenses
    
    
    158.4
    
    
    
    153.5
    
    
    
    
    
    
    
    311.9Store pre-opening and closing costs
    
    
    2.4
    
    
    
    2.3
    
    
    
    
    
    
    
    4.7Depreciation and amortization
    
    
    6.5
    
    
    
    11.4
    
    
    
    
    
    
    
    17.9Stock-based compensation expense
    
    
    2.9
    
    
    
    
    
    
    
    
    
    
    
    2.9Debt repurchase expenses
    
    
    3.4
    
    
    
    
    
    
    
    
    
    
    
    3.4Operating profit (loss)
    
    
    (16.3
    )
    
    
    28.6
    
    
    
    
    
    
    
    12.3Interest expense, net
    
    
    3.9
    
    
    
    5.3
    
    
    
    
    
    
    
    9.2Income (loss) before income taxes
    
    
    (20.2
    )
    
    
    23.3
    
    
    
    
    
    
    
    3.1Income tax provision (benefit)
    
    
    1.4
    
    
    
    (0.2
    )
    
    
    
    
    
    
    1.2Income (loss) before equity income
    
    
    (21.6
    )
    
    
    23.5
    
    
    
    
    
    
    
    1.9Equity income from subsidiaries
    
    
    23.5
    
    
    
    
    
    
    
    (23.5
    )
    
    
    Net income
    
    $
    1.9
    
    
    $
    23.5
    
    
    $
    (23.5
    )
    
    $
    1.9
 11




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##### Table of Contents



Note 8   Consolidating Financial Statements (Unaudited)  CONTINUED Consolidating Statements of Cash FlowsTwenty-Six Weeks Ended July 31, 2004 and August 2, 2003 July 31, 2004GuarantorParent
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(Dollars in millions)Net cash (used for) provided by operating activities
    
    $
    (36.2
    )
    
    $
    12.1
    
    
    $
    
    
    
    $
    (24.1
    )Net cash flows used for investing activities:Capital expenditures
    
    
    (9.3
    )
    
    
    (12.3
    )
    
    
    
    
    
    
    (21.6
    )Net cash used for investing activities
    
    
    (9.3
    )
    
    
    (12.3
    )
    
    
    
    
    
    
    (21.6
    )Net cash flows provided by financing activities:Proceeds from issuance of 7.5% senior subordinated notes, net
    
    
    97.0
    
    
    
    
    
    
    
    
    
    
    
    97.0Purchase of 10 3/8% senior subordinated notes
    
    
    (66.6
    )
    
    
    
    
    
    
    
    
    
    
    (66.6
    )Net change in revolving credit facility
    
    
    12.4
    
    
    
    
    
    
    
    
    
    
    
    12.4Proceeds from stock benefit plans
    
    
    7.1
    
    
    
    
    
    
    
    
    
    
    
    7.1Other, net
    
    
    (3.9
    )
    
    
    
    
    
    
    
    
    
    
    (3.9
    )Net cash provided by financing activities
    
    
    46.0
    
    
    
    
    
    
    
    
    
    
    
    46.0Net increase (decrease) in cash and cash equivalents
    
    
    0.5
    
    
    
    (0.2
    )
    
    
    
    
    
    
    0.3Cash and cash equivalents at beginning of period
    
    
    14.3
    
    
    
    3.1
    
    
    
    
    
    
    
    17.4Cash and cash equivalents at end of period
    
    $
    14.8
    
    
    $
    2.9
    
    
    $
    
    
    
    $
    17.7
 August 2, 2003GuarantorParent
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(Dollars in millions)Net cash (used for) provided by operating activities
    
    $
    (67.1
    )
    
    $
    10.1
    
    
    $
    
    
    
    $
    (57.0
    )Net cash flows used for investing activities:Capital expenditures
    
    
    (8.3
    )
    
    
    (10.2
    )
    
    
    
    
    
    
    (18.5
    )Net cash used for investing activities
    
    
    (8.3
    )
    
    
    (10.2
    )
    
    
    
    
    
    
    (18.5
    )Net cash flows provided by financing activities:Purchase of 10 3/8% senior subordinated notes
    
    
    (48.4
    )
    
    
    
    
    
    
    
    
    
    
    (48.4
    )Net change in revolving credit facility
    
    
    73.5
    
    
    
    
    
    
    
    
    
    
    
    73.5Proceeds from stock benefit plans
    
    
    3.7
    
    
    
    
    
    
    
    
    
    
    
    3.7Other, net
    
    
    (0.4
    )
    
    
    
    
    
    
    
    
    
    
    (0.4
    )Net cash provided by financing activities
    
    
    28.4
    
    
    
    
    
    
    
    
    
    
    
    28.4Net decrease in cash
    
    
    (47.0
    )
    
    
    (0.1
    )
    
    
    
    
    
    
    (47.1
    )Cash and cash equivalents at beginning of period
    
    
    60.2
    
    
    
    3.0
    
    
    
    
    
    
    
    63.2Cash and cash equivalents at end of period
    
    $
    13.2
    
    
    $
    2.9
    
    
    $
    
    
    
    $
    16.1
 12




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations General Overview Managements Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) should be read in conjunction with the accompanying
unaudited consolidated financial statements and notes thereto and the Companys
Form 10-K Annual Report to Shareholders for the fiscal year ended January 31,
2004. The financial information presented for the second quarter and
year-to-date of fiscal 2004 has been reclassified for certain amounts to
conform to the fiscal 2005 presentation. We are the nations largest specialty retailer of fabrics and one of the
largest specialty retailers of crafts, serving customers in their pursuit of
apparel and craft sewing, crafting, home decorating and other creative
endeavors. Our retail stores (operating as Jo-Ann Fabrics and Crafts
traditional stores and Jo-Annsuperstores) feature a variety of competitively
priced merchandise used in sewing, crafting and home decorating projects,
including fabrics, notions, crafts, frames, scrapbooking material, artificial
and dried flowers, home accents, finished seasonal and home décor merchandise. Our strategy is to grow by replacing many of our existing traditional
stores with superstores over time. Our research has demonstrated that our
customers have a better perception of the quality and pricing of our products
when they are presented in our superstore format. We believe that our
prototype 35,000 square foot superstore gives us a competitive advantage in the
industry. Our superstores provide a unique shopping experience by offering a
full creative selectionsewing, crafting, framing, seasonal, floral and home
décor accessoriesall under one roof. On average we close 1.3 nearby traditional
stores for every superstore that we open. In
markets where we have opened multiple superstores, we have been able to grow
our revenues significantly and, we believe, expand the market size and our
share of the market. As of July 31, 2004, we operated 863 stores in 47 states (766 traditional
stores and 97 superstores). Our traditional stores offer a complete selection
of fabric and a convenience assortment of crafts, floral, finished seasonal and
home décor merchandise. Our traditional stores average 14,500 square feet and
generated net sales per store of approximately $1.5 million in fiscal 2004.
Our superstores offer an expanded and more comprehensive product assortment
than our traditional stores. Our superstores also offer custom framing and
educational programs that our traditional stores do not. Our superstores
opened prior to fiscal 2003 average 45,000 square feet and generated net sales
per store of approximately $6.0 million in fiscal 2004. Our current superstore
prototype averages 35,000 square feet. We opened 11 of these new prototype
superstores in the first half of fiscal 2005 and at the end of the second
quarter, we had 25 prototype superstores in operation. Executive Overview Through the first two quarters of fiscal 2005, we have continued to improve
upon our fiscal 2004 performance. We have delivered 13 consecutive
quarters of positive same-store sales increases. We continue to execute well
on our strategic initiatives of opening our new 35,000 square foot prototype
superstores, improving margins, and improving the productivity of our store
base. Our financial performance for the second quarter of fiscal 2005 improved
from the second quarter of fiscal 2004. Highlights of the second quarter are
as follows:  
    
    Net sales increased 3.3% to $371.0 million. Same-store sales
increased 3.1% versus a 2.4% same-store sales increase for the second
quarter last year. 13




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##### Table of Contents




    
    We expanded our gross margin rate by 90 basis points, to 49.0%
of net sales this quarter versus 48.1% for the second quarter last
year, continuing a trend we established in the third quarter of last
year. We have generated a positive same-store sales increase while
improving our gross margin rate for four consecutive quarters. This
improvement was driven by a comprehensive strategy we have been
pursuing to be less promotional.
    
    Our selling, general and administrative expenses (SG&A),
excluding those expenses separately identified in the statement of
operations, improved 90 basis points as a rate to net sales from
44.2% in the second quarter last year to 43.3% this year. SG&A
benefited from a $1.9 million payment received related to the early
termination of a store lease at the request of a landlord, which
accounted for 50 basis points of the improvement in SG&A during the
quarter.
    
    Net income was $0.02 per diluted share, versus a net loss of
$0.10 per share last year.
    
    We opened three of our new 35,000 square foot superstores in
the second quarter, and we had 25 of these prototype superstores in
operation at the end of the second quarter. Results of Operations The following table sets forth our results of operations through
operating profit, expressed as a percentage of net sales. The following
discussion should be read in conjunction with our consolidated financial
statements and related notes thereto. Thirteen
    
    Twenty-Six WeeksWeeks Ended
    
    EndedJuly 31,
    
    August 2,
    
    July 31,
    
    August 2,2004
    
    2003
    
    2004
    
    2003Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Gross margin
    
    
    49.0
    %
    
    
    48.1
    %
    
    
    49.1
    %
    
    
    48.1
    %Selling, general and administrative expenses
    
    
    43.3
    %
    
    
    44.2
    %
    
    
    42.0
    %
    
    
    42.5
    %Store pre-opening and closing costs
    
    
    1.3
    %
    
    
    0.7
    %
    
    
    1.0
    %
    
    
    0.6
    %Depreciation and amortization
    
    
    2.7
    %
    
    
    2.5
    %
    
    
    2.5
    %
    
    
    2.4
    %Stock-based compensation expense
    
    
    0.5
    %
    
    
    0.5
    %
    
    
    0.5
    %
    
    
    0.4
    %Debt repurchase expenses
    
    
    
    
    
    
    
    
    
    
    0.6
    %
    
    
    0.5
    %Operating profit
    
    
    1.2
    %
    
    
    0.2
    %
    
    
    2.5
    %
    
    
    1.7
    %
 Comparison of the Thirteen Weeks Ended July 31, 2004 and August 2, 2003 Net sales for the second quarter of fiscal 2005 increased 3.3%, or $11.8
million, to $371.0 million from $359.2 million in the prior year. Net sales
from stores open one year or more (same-store sales) accounted for the
majority of the overall net sales increase, increasing 3.1% compared with a
same-store sales increase of 2.4% for the prior year second quarter. We
operated fewer stores in the second quarter versus a year ago. The Companys
total store count at the end of the quarter was down 46 units, or 5.1% from
last years second quarter; however, the number of superstores in operation
increased to 97 from 83 in last years second quarter. Total store square
footage decreased 1.5% from last years second quarter. The 97 superstores in
operation accounted for approximately 30% of total net sales for the second
quarter. By store format, our same-store sales performance for traditional stores
increased 4.6% versus a same-store sales increase of 2.2% for the prior year
second quarter. Same-store sales for superstores decreased 0.6% for the
quarter versus a same-store sales increase of 3.0% for the prior year second
quarter. In both store formats, average ticket dollars increased, with
customer traffic down 2% in traditional stores 14




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##### Table of Contents



and 5% in superstores. Our strategy to be less promotional, which has
benefited our realized selling margins, has had a larger negative impact on
superstore sales than traditional store sales because of our multiple vehicle
advertising strategy (direct mail and newspaper inserts) in superstores. With
the exception of our finished seasonal business, which represented
approximately 12% of total net sales in the second quarter, all of our major
product categories experienced growth in same-store gross margin dollars,
through positive same-store sales growth and/or improved selling
margin rates during the quarter. As a percent of net sales, gross margin was 49.0% for the second quarter
of fiscal 2005 compared with 48.1% for the same quarter a year earlier, an
improvement of 90 basis points. This was our fourth consecutive quarter of
year-over-year improvement in gross margin rate. This is primarily attributable to our
strategy to be less
promotional. This change in strategy had a more favorable impact on superstores than traditional stores during the second quarter. SG&A expenses, excluding other expenses separately identified in the
statement of operations, were $160.8 million in the second quarter compared
with $158.8 million in the prior year second quarter. As a percentage of net
sales, SG&A expenses improved to 43.3% of net sales from 44.2% of net sales in
the second quarter of last year. Fifty basis points of this improvement is due
to net proceeds of $1.9 million, pre-tax, related to an early termination of a
store lease at the request of the landlord. Higher distribution costs, due to
a higher level of merchandise purchases during the second quarter, were more
than offset by leverage gained in administrative expenses. Store pre-opening and closing costs increased $2.0 million during the
second quarter of fiscal 2005, to $4.6 million resulting from a higher level
of real estate activity than in the prior year. As a percentage of net sales,
store pre-opening and closing costs increased to 1.3% of net sales from 0.7%
last year. As we continue to increase the number of new store openings, we
expect our store pre-opening and closing costs to increase. On average, we
close 1.3 traditional stores for every superstore that we open. For the full
fiscal year, our store pre-opening and closing costs are projected at $18
million, pre-tax, versus $10.9 million last year. Depreciation and amortization expense increased $1.0 million to $9.9
million from $8.9 million, primarily due to the increased level of capital
expenditures year-over-year. Stock-based compensation expense includes the expensing of stock options
under Statement of Financial Accounting Standard (SFAS) No. 123, Accounting
for Stock-Based Compensation Expense, which we adopted in the first quarter
of fiscal 2004, and the amortization of the value of restricted stock granted
to employees. Last year we reported the amortization of restricted stock in
depreciation and amortization. Stock-based compensation expense was $2.0
million for the second quarter of fiscal 2005, compared with $1.6 million in
the same period last year. Stock-based compensation expense, consisting of
both stock option related expense and restricted stock amortization is
estimated at approximately $8.5 to $9.0 million, pre-tax, for the full 2005
fiscal year versus $6.4 million last year. In early fiscal 2005, we implemented changes in our long-term compensation
for management employees that we believe will help us continue to attract and retain the
best management employees, and to better align employee interests with those of our
shareholders. Annual grants to employees are generally being made in
restricted stock awards rather than stock options. The award of restricted
stock offers employees the opportunity to earn shares of our stock over time,
rather than options that provide employees the right to purchase stock at a set
price. Stock options continue to be awarded to new employees and employees who
are promoted into certain management positions. 15




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##### Table of Contents



Early this year, the Compensation Committee of the Board of Directors
approved an annual base award of restricted stock to certain of our employees
that serves as both a retention vehicle and is coupled with performance awards.
The base and performance awards vest 50% at the end of three years, with the
remaining 50% vesting at the end of the fourth year. The base award consisted
of approximately 187,000 restricted shares. The performance-based award
provides the potential to receive up to three-times that amount in additional
shares. The number of performance award shares ultimately received, if any,
will depend on achieving certain performance criteria that are measured at the
end of the third year. Interest expense in the second quarter of fiscal 2005 decreased $0.4
million to $3.8 million from $4.2 million in the second quarter of fiscal
2004. The decrease is attributable primarily to a lower all-in average
borrowing rate, although our average debt levels also were lower at $141
million during the second quarter of fiscal 2005 compared with $148 million in
the prior year second quarter. Our effective income tax rate for the second quarter of fiscal 2005 was
38.5% versus 38.0% in the second quarter of the prior year. For the full
fiscal year, our effective tax rate is estimated at 38.5%. Comparison of the Twenty-Six Weeks Ended July 31, 2004 and August 2, 2003 Net sales for the first two quarters of fiscal 2005 increased 5.7%, or
$41.9 million, to $775.9 million from $734.0 million in the prior year.
Same-store sales accounted for the majority of the overall net sales increase,
increasing 4.9% compared with a same-store sales increase of 2.5% for the
prior year. We operated fewer stores versus a year ago. The Companys total
store count at the end of the quarter was down 46 units, or 5.1% from last
years second quarter; however, the number of superstores in operation
increased to 97 from 83 in last years second quarter. Total store square
footage decreased 1.5% from last years second quarter. The 97 superstores in
operation accounted for approximately 30% of the total net sales for the
second quarter year-to-date. By store format, our same-store sales performance for traditional stores
increased 6.1% versus a same-store sales increase of 2.5% for the prior year
second quarter year-to-date. Same-store sales for superstores increased 1.7%
versus a same-store sales increase of 2.6% for the prior year second quarter
year-to-date. In both store formats, the increase was entirely due to an
increased average ticket, with customer traffic down 1% in traditional stores
and 2% in superstores. Our strategy to be less promotional, which has
benefited our realized selling margins, has had a larger negative impact on
superstore sales than traditional sales because of our multiple vehicle
advertising strategy (direct mail and newspaper inserts) in superstores.
Other than our finished seasonal business, all of our major product categories
experienced growth in same-store gross margin dollars, through positive same-store sales growth and/or improved selling margin rate during
the year-to-date period. Our finished seasonal business, representing
approximately 11% of net sales for the second quarter year-to-date, was down
7% on a same-store sales basis. As a percent of net sales, gross margin was 49.1% for the first two
quarters of fiscal 2005 compared with 48.1% for the same period a year
earlier, an improvement of 100 basis points due to our less promotional
strategy. As addressed above, the superstore same-store sales results were
more significantly impacted due to this less promotional strategy. The
positive result is that while our overall gross margin rate improved 100 basis
points, the gross margin rate improvement in superstores is approximately 180
basis points year-to-date, while traditional stores improved approximately 60 basis points year-to-date. SG&A expenses, excluding other expenses separately identified in the
statement of operations, were $326.0 million in the first two quarters of
fiscal 2005 versus $311.9 million in the prior year. As a percentage of net
sales, SG&A expenses improved to 42.0% of net sales from 42.5% last year.
Twenty-five basis points of this improvement is due to net proceeds of $1.9
million, pre-tax, related to an early termination 16




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##### Table of Contents



of a store lease at the request of the landlord. Higher distribution
costs related to a higher level of merchandise purchases during the first half
of the year, were offset by leverage gained in certain administrative expenses. Store pre-opening and closing costs increased $2.8 million year-to-date
during the first two quarters of fiscal 2005, to $7.5 million reflecting the
increased level of real estate activity year over year. We opened 11
superstores and one traditional store and closed 41 stores during the first
two quarters of fiscal 2005. This compares with nine superstore openings, two
traditional store openings, and 21 closings in the same period in the prior
year. As a percentage of net sales, store pre-opening and closing costs
increased to 1.0% of net sales from 0.6% last year. As we continue to
increase the number of new store openings, we expect our store pre-opening and
closing costs to increase. For the full fiscal year, our store pre-opening
and closing costs are projected at $18 million, pre-tax, versus $10.9 million
last year. Depreciation and amortization expense increased $1.7 million to $19.6
million in the first two quarters of fiscal 2005 from $17.9 million last year,
primarily due to the increased level of capital expenditures year-over-year. Stock-based compensation expense was $4.0 million for the first half of
fiscal 2005, compared with $2.9 million in the same period last year. Stock-based compensation expense, consisting of both stock option related expense
and restricted stock amortization is estimated at approximately $8.5 to $9.0
million, pre-tax, for the full 2005 fiscal year versus $6.4 million in fiscal
2004. Debt repurchase expenses were $4.2 million for the second quarter
year-to-date compared with $3.4 million in the prior year. The fiscal 2005
charge represents the premium paid to repurchase $64.4 million of 10 3/8%
senior subordinated notes and write-off the related deferred financing costs.
We have been de-leveraging our balance sheet over the last three years, and as
a consequence, we have been recording charges related to the early repayment
of debt. Our capital financing initiatives were completed in the first
quarter of fiscal 2005, which is discussed further below under Liquidity and
Capital Resources.During the first quarter of fiscal 2004, we redeemed or
repurchased in the open market, approximately $46.0 million of senior
subordinated notes at an aggregate premium of 105.4% to par value, and we
recorded a $3.4 million pre-tax charge for debt repurchase expenses including
the cash premium to par value and the write-off of deferred financing costs
and original issue discount. Interest expense in the first two quarters of fiscal 2005 decreased $1.3
million to $7.9 million from $9.2 million in the same period in the prior
year. The decrease is attributable to a decrease in our average debt levels
between years and a lower all-in average borrowing rate. Our average debt
levels year-to-date in fiscal 2005 were $143 million compared with $153
million for the same period in fiscal 2004. Our effective income tax rate for fiscal 2005 was 38.5% versus 38.0% in
the prior year. For the full fiscal year, our effective tax rate is estimated
at 38.5%. Liquidity and Capital Resources We believe that our credit facility, coupled with cash on hand and
internally generated cash flows from operations, will be sufficient to cover
our working capital, capital expenditure and debt service requirement needs
for the foreseeable future. During the first quarter, we completed certain capital financing
initiatives. In February, we issued $100 million of 7.5% senior subordinated
notes, which enabled us to repurchase the remaining $64.4 million of our 10
3/8% senior subordinated notes that were outstanding at the beginning of the
year. In April, we amended our $365 million bank credit facility, extending
the term until May 2009 and reducing 17




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##### Table of Contents



the commitment to $350 million. These financing initiatives are expected
to save approximately $1 million in annual interest expense for fiscal 2005,
and more importantly, position us to successfully execute our growth strategy
over the next three to five years. Cash and cash equivalents increased $0.3 million during fiscal 2005 to
$17.7 million as of July 31, 2004. Net cash used for operating activities was $24.1 million in fiscal 2005
compared with $57.0 million in fiscal 2004. Cash flows provided by operating
activities, before changes in operating assets and liabilities, were $40.9
million in fiscal 2005 versus $28.4 million generated in fiscal 2004. Inventories, net of payable support, increased $49.8 million, compared
with an increase of $66.1 million in fiscal 2004. Inventory typically builds
during the first three quarters of the fiscal year, as we prepare for the peak
selling season in the fourth quarter. Substantially all of the increase in
inventories was in core product categories such as scrapbooking and fabric,
which have experienced solid net sales performances. We believe we have
properly invested in these areas, and that we are well positioned for our
second half merchandising initiatives. Net cash used for investing activities, totaled $21.6 million in fiscal
2005 compared with $18.5 million in fiscal 2004 and consisted entirely of
capital spending for both periods. We continue to anticipate capital
expenditures for the full fiscal year 2005 to be approximately $70 to $75
million. The increase in capital spending over the prior year is attributable
to increased store opening activity and the replacement of the
point-of-sale systems in our superstores. During
the first two quarters of fiscal 2005, we opened 11 superstores and one larger
traditional store and closed 41 traditional stores. For the full fiscal year, we expect to open 29 superstores and two larger
traditional stores. Of the 18 superstores yet to be opened, all are scheduled
to open in the third quarter. For the full fiscal year, we expect to close
approximately 70 traditional stores, about 40 related to the superstore
openings and 30 that are performance related. Of these expected 70 store
closings, 41 stores were closed in the first two quarters of fiscal 2005. Net cash provided by financing activities was $46.0 million during fiscal
2005 compared with $28.4 million during fiscal 2004. Debt borrowings were
$161.7 million at the end of the second quarter, which represents an increase
of $48.0 million from the beginning of the year and a decrease of $28.8
million from the same period in the prior year. As of July 31, 2004, the
Company had the ability to borrow up to an additional $191.3 million under the
Credit Facility. Our debt-to-capitalization ratio was 30.6% at July 31, 2004, 24.7% at
January 31, 2004 and 38.9% at August 2, 2003. We have a stated goal of
maintaining our year-end debt to total capitalization ratio in future years in
the low 20% range. Off-Balance Sheet Transactions Our liquidity is not currently dependent on the use of off-balance
sheet transactions other than letters of credit and operating leases,
which are typical in a retail environment. Business Outlook In a press release dated August 16, 2004, which was furnished to the
Securities and Exchange Commission on Form 8-K, the Company provided guidance
for the full fiscal year and third quarter of 18




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##### Table of Contents



fiscal 2005. The Company increased its expectations for fiscal 2005 to
approximately $2.25 to $2.30 per diluted share from its earlier stated
guidance of $2.20 to $2.25 per diluted share. For the third quarter, the
Company stated that it is estimating earnings of $0.47 to $0.52 per diluted
share, compared with earnings of $0.54 per diluted share in the prior year.
The decrease in expected earnings per share in the third quarter is due to a
special 60th Anniversary promotion that was beneficial to last years third
quarter results which is not being repeated in the current year. The change in guidance was predicated on the strength of the Companys
second quarter earnings performance versus its expectations. The following
should be taken into consideration related to our guidance:  
    
    Same-store sales growth of three percent was assumed for the
remainder of the fiscal year.
    
    Diluted shares outstanding are estimated to be approximately
23 million by the end of the fiscal year.
    
    Included in our earnings guidance is approximately $8.5  $9.0
million pre-tax expense related to stock-based compensation.
    
    Not included in the guidance for the full year is a charge of
$4.2 million, pre-tax, related to debt repurchase expenses that were
recorded in the first quarter. Our actual results in the third quarter and full year are highly
dependent on the net sales and operating margin performance we are able to
achieve. As a result, our estimates are subject to further refinement, which
we will provide, if necessary, during the fiscal year. Seasonality and Inflation Our business exhibits seasonality, which is typical for most retail
companies. Our net sales are much stronger in the second half of the year
than the first half of the year. Net earnings are highest during the months
of September through December when sales volumes provide significant operating
leverage. Working capital requirements needed to finance our operations
fluctuate during the year and reach their highest levels during the second and
third fiscal quarters as we increase our inventory in preparation for our peak
selling season. We believe that inflation has not had a significant effect on net sales
or on net income. There can be no assurance, however, that our operating
results will not be affected by inflation in the future. Critical Accounting Policies Our 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 fiscal 2004 Annual Report on Form
10-K, in the notes to the consolidated financial statements, Note 1 and the
Critical Accounting Policies section. Cautionary Statement Concerning Forward-Looking Statements Certain statements contained in this report that are not historical facts
are forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward- 19




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##### Table of Contents



looking statements, which reflect the Companys current views of future events
and financial performance, involve certain risks and uncertainties. When used
herein, the terms anticipates, plans, estimates, expects, believes,
and similar expressions as they relate to us or future or conditional verbs
such as will, should, would, may, and could are intended to identify
such forward-looking statements. Our actual results, performance or
achievements may materially differ from those expressed or implied in the
forward-looking statements. Risks and uncertainties that could cause or
contribute to such material differences include, but are not limited to,
general economic conditions, changes in customer demand, changes in trends in
the fabric and craft industry, seasonality, the availability of merchandise,
changes in the competitive pricing for products, the impact of our and our
competitors store openings and closings, fuel and energy costs, changes in
tariff and freight rates, consumer debt levels, and other capital market and
geo-political conditions. We caution readers not to place undue reliance on
these forward-looking statements. We assume no obligation to update any of
the forward-looking statements. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk We use derivative financial instruments at various times to manage the
risk associated with interest rate fluctuations. The Company is subject to
risk resulting from interest rate fluctuations, as interest on the Companys
credit facility is based on variable rates. The Companys objective in
managing its interest rate exposure is to limit the impact of interest rate
changes on earnings and cash flows. Interest rate swaps are primarily
utilized to achieve this objective, effectively converting a portion of our
variable-rate exposures to fixed interest rates (See Note 5  Fair Value of
Derivative Financial Instruments). 
 Item 4. Controls and Procedures As of the end of the period covered by this report, the Company conducted
an evaluation, under the supervision and with the participation of the
principal executive officer and principal financial officer, of the Companys
disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)).
Based on this evaluation, the principal executive officer and principal
financial officer concluded that the Companys disclosure controls and
procedures are effective to ensure that information required to be disclosed
by the Company in reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms. There was no change in
the Companys internal control over financial reporting during the Companys
most recently completed fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Companys internal control over
financial reporting. 20




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##### Table of Contents



PART II OTHER INFORMATION 
 Item 1. Legal Proceedings We are involved in various litigation matters in the ordinary course of
our business. We are not currently involved in any litigation which we expect,
either individually or in the aggregate, will have a material adverse effect on
our financial condition or results of operations. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Purchases of Equity Securities by the Company and Affiliated
Purchasers. Purchases of Equity Securities by Jo-Ann Stores, Inc. Total Number of
    
    Maximum Number ofShares Purchased as
    
    Shares that May YetPart of Publicly
    
    Be Purchased UnderTotal Number of
    
    Average Price Paid
    
    Announced Plans or
    
    the Plans orShares Purchased
    
    per Share
    
    Programs
    
    ProgramsMay 2-29, 2004
    
    
    10,857
    
    
    $
    27.18
    
    
    
    826,369
    
    
    
    1,323,631May 30, 2004  July 3, 2004
    
    
    15,229
    
    
    $
    28.57
    
    
    
    841,598
    
    
    
    1,308,402July 4-31, 2004
    
    
    715
    
    
    $
    27.67
    
    
    
    842,313
    
    
    
    1,307,687Total
    
    
    26,801
    
    
    $
    27.98
    
    
    
    842,313
    
    
    
    1,307,687
 In December 1998, the Companys Board of Directors authorized a
discretionary program that allowed the Company to buy back 2,150,000 common
shares. That program does not have a stated expiration date. In the table
above, the total number of shares purchased represents shares repurchased
directly from the market, as well as shares repurchased from employees related
to the lapse of restricted shares and employee stock options used to satisfy
related tax withholding requirements. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders  a)
    
    An Annual Meeting of Shareholders of the Company was
held on June 10, 2004.b)
    
    Ira Gumberg and Patricia Morrison were elected to the
Board of Directors in the class whose term of office expires
in 2007.c)
    
    The nominees for Directors as listed in the proxy
statement were elected with the following vote: Nominee
    
    Votes For
    
    Votes WithheldIra Gumberg
    
    
    13,791,162
    
    
    
    6,869,677Patricia Morrison
    
    
    19,586,119
    
    
    
    1,074,720
 At the Annual Meeting shareholders voted to approve amendments to the
Companys Amended and Restated Code of Regulations that would: 21




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##### Table of Contents




    
    reduce from 80% to 66 2/3 % the shareholder vote required for
any change in number of directors when not approved in advance by
the Companys Board of Directors, by the following vote: Votes For
    
    Votes Against
    
    Abstentions18,111,185
    
    
    277,539
    
    
    
    15,941
  
    
    reduce from 80% to 66 2/3 % the shareholder vote required to
alter or eliminate certain shareholder protective measures,
including the Companys staggered board when not approved in advance
by the Board of Directors, by the following vote: Votes For
    
    Votes Against
    
    Abstentions18,041,142
    
    
    344,703
    
    
    
    18,820
 Also at the Annual Meeting shareholders voted to approve the Material
Terms of the Performance Goals Under the Companys 1998 Incentive
Compensation Plan. Votes For
    
    Votes Against
    
    Abstentions17,055,108
    
    
    930,775
    
    
    
    317,647
 
 Item 5. Other Information None. 
 Item 6. Exhibits  a)
    
    Exhibits  31.1
    
    Section 302 Certification By Chief Executive Officer31.2
    
    Section 302 Certification By Chief Financial Officer32.1
    
    Section 906 Certification of Principal Executive Officer and
Principal Financial Officer 22




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##### Table of Contents



SIGNATURES 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. JO-ANN STORES, INC.DATE: September 9, 2004
    
    /s/ Alan RosskammAlan Rosskamm,President and Chief Executive Officer/s/ Brian P. CarneyBrian P. Carney,Executive Vice President and Chief Financial Officer
 23