UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C.  20549
 
 FORM
10-Q
 
 [X]
Quarterly Report Pursuant to Section 13 or 15(d) of the
 Securities
Exchange Act of 1934
 
 For
the quarterly period ended   May 3, 2008
 
 OR
 
 [    ]
Transition Report Pursuant to Section 13 or 15(d) of the
 Securities Exchange
Act of 1934
  For the
transition period from_____________to___________.
  Commission File Number
1-9482
  HANCOCK FABRICS, INC.
  
 Delaware
                64-0740905(State
      or other jurisdiction
                (I.R.S.
      EmployerOf
      incorporation or organization)
                Identification
      No.)One
      Fashion Way, Baldwyn, MS
                38824(Address
      of principal executive offices)
                (Zip
      Code)
 Registrant’s
      telephone number, including area
code
 (662)
      365-6000
 
 Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.Yes [X]     No []
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company.  See definitions of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
 
 Large
Accelerated
Filer      [  ]                                                                Accelerated
Filer    [  ]
 
 Non-Accelerated
Filer   [
]                                                                Smaller
Reporting Company   [X]
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).Yes [   ]     No
[X]
 
 Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practical date.
    
 
 As of May
3, 2008, there were 19,400,012, shares of Hancock Fabrics, Inc. $.01 par value
common stock outstanding.
 
 INDEX
  Part
      I.  Financial Informaiton:PageItem
      1.  Financial StatementsConsolidated Balance
      Sheets as of May 3, 2008 and February 2, 2008
                
                3Consolidated
      Statements of Operations for the Thirteen WeeksEnded May 3, 2008
      and May 5, 2007
                
                4Consolidated
      Statement of Shareholders' Equity for the ThirteenWeeks Ended May 3,
      2008
                
                5Consolidated
      Statements of Cash Flows for the Thirteen WeeksEnded May 3, 2008
      and May 5, 2007
                
                6Notes to
      Consolidated Financial Statements
                
                7Item 2. 
      Management's Discussion and Analysis of Financial
      Conditionand Results of
      Operations
                
                14Item 3. 
      Quantitative and Qualitative Disclosures about Market
      Risks
                
                17Item 4. 
      Controls and Procedures
                
                18Part
      II.  Other Information:Item 1.  Legal
      Proceedings
                
                20Item 1A.  Risk
      Factors
                
                20Item 2. 
      Unregistered Sales of Equity Securities and Use of
      Proceeds
                
                20Item 3. 
      Defaults Upon Senior Securities
                
                21Item 4. 
      Submission of Matters to a Vote of Security Holders
                
                21Item 5.  Other
      Information
                
                21Item 6. 
      Exhibits
                
                21Signatures
                
                22
    
 2
 
  PART
      I. FINANCIAL INFORMATIONITEM
      1. FINANCIAL STATEMENTSHANCOCK FABRICS, INC.(Debtor-In-Possession)CONSOLIDATED
      BALANCE SHEETS(unaudited)May
      3,
                
                
                
                February
      2,(in
      thousands, except for share and per share amounts)
                
                2008
                
                
                
                2008
      (1)AssetsCurrent
      assets:Cash
      and cash equivalents
                
                $
                2,705
                
                
                
                $
                2,280Receivables,
      less allowance for doubtful accounts
                
                
                4,037
                
                
                
                
                4,453Inventories
                
                
                81,150
                
                
                
                
                77,907Income
      taxes refundable
                
                
                8,118
                
                
                
                
                8,118Prepaid
      expenses
                
                
                1,058
                
                
                
                
                1,748Total
      current assets
                
                
                97,068
                
                
                
                
                94,506Property
      and equipment, net
                
                
                44,531
                
                
                
                
                43,683Goodwill
                
                
                3,406
                
                
                
                
                3,406Other
      assets
                
                
                7,653
                
                
                
                
                7,107Total
      assets
                
                $
                152,658
                
                
                
                $
                148,702Liabilities
      and Shareholders' EquityLiabilities
      not subject to compromise:Current
      liabilities:Accounts
      payable
                
                $
                17,906
                
                
                
                $
                19,393Accrued
      liabilities
                
                
                13,996
                
                
                
                
                14,354Total
      current liabilities
                
                
                31,902
                
                
                
                
                33,747Long-term
      debt obligations
                
                
                36,981
                
                
                
                
                23,608Postretirement
      benefits other than pensions
                
                
                384
                
                
                
                
                315Pension
      and SERP liabilities
                
                
                396
                
                
                
                
                270Other
      liabilities
                
                
                2,986
                
                
                
                
                3,071Total
      liabilities not subject to compromise
                
                
                72,649
                
                
                
                
                61,011Liabilities
      subject to compromise
                
                
                58,808
                
                
                
                
                60,635Total
      liabilities
                
                
                131,457
                
                
                
                
                121,646Commitments
      and contingencies (See Note 6)Shareholders'
      equity:Common
      stock, $.01 par value; 80,000,000 shares authorized;32,748,983
      and  32,601,483 issued and 19,400,012 and19,285,235
      outstanding, respectively
                
                
                327
                
                
                
                
                326Additional
      paid-in capital
                
                
                75,770
                
                
                
                
                75,324Retained
      earnings
                
                
                94,869
                
                
                
                
                100,953Treasury
      stock, at cost, 13,348,971 and 13,316,248shares
      held, respectively
                
                
                (153,661
                )
                
                
                
                (153,622
                )Accumulated
      other comprehensive income
                
                
                3,896
                
                
                
                
                4,075Total
      shareholders' equity
                
                
                21,201
                
                
                
                
                27,056Total
      liabilities and shareholders' equity
                
                $
                152,658
                
                
                
                $
                148,702See
      accompanying notes to consolidated financial statements.(1)
      Derived from audited balance sheet included in our annual report on Form
      10-K for the fiscal year February 2, 2008.
 3
   HANCOCK
      FABRICS, INC.(Debtor-In-Possession)CONSOLIDATED
      STATEMENTS OF OPERATIONS(unaudited)Thirteen
      Weeks Ended
                
                
                Thirteen
      Weeks EndedMay
      3,
                
                
                May
      5,(in
      thousands, except per share amounts)
                
                2008
                
                
                2007Sales
                
                $
                63,816
                
                
                $
                69,182Cost
      of goods sold
                
                
                36,014
                
                
                
                38,126Gross
      profit
                
                
                27,802
                
                
                
                31,056Selling,
      general and administrative expense
                
                
                29,750
                
                
                
                28,725Depreciation
      and amortization
                
                
                1,013
                
                
                
                742Operating
      income (loss)
                
                
                (2,961
                )
                
                
                1,589Reorganization
      expense, net
                
                
                2,676
                
                
                
                4,125Interest
      expense, net
                
                
                989
                
                
                
                2,044Loss
      from continuing operations before income taxes
                
                
                (6,626
                )
                
                
                (4,580
                )Income
      taxes
                
                
                -
                
                
                
                -Loss
      from continuing operations
                
                
                (6,626
                )
                
                
                (4,580
                )Earnings
      from discontinued operations, (net of tax expense of $0 and
      $0)
                
                
                542
                
                
                
                3,369Net
      loss
                
                $
                (6,084
                )
                
                $
                (1,211
                )Basic
      and diluted loss per share:Loss
      from continuing operations
                
                $
                (0.35
                )
                
                $
                (0.24
                )Earnings
      from discontinued operations
                
                
                0.03
                
                
                
                0.18Net
      loss
                
                $
                (0.32
                )
                
                $
                (0.06
                )Weighted
      average shares outstanding:Basic
      and diluted
                
                
                18,984
                
                
                
                18,847See
      accompanying notes to consolidated financial statements
   4
 
 HANCOCK FABRICS, INC.(Debtor-In-Possession)CONSOLIDATED
      STATEMENT OF SHAREHOLDERS' EQUITY(unaudited)Thirteen
      Weeks Ended May 3, 2008AccumulatedAdditional
                
                
                
                
                
                
                
                
                
                
                
                Other
                
                
                TotalCommon
      Stock
                
                
                Paid-in
                
                
                Retained
                
                
                Treasury
      Stock
                
                
                Comprehensive
                
                
                Shareholders'(in
      thousands, except for number of shares)
                
                Shares
                
                
                Amount
                
                
                Capital
                
                
                Earnings
                
                
                Shares
                
                
                Amount
                
                
                Income
      (Loss)
                
                
                EquityBalance
      February 2, 2008
                
                
                32,601,483
                
                
                $
                326
                
                
                $
                75,324
                
                
                $
                100,953
                
                
                
                (13,316,248
                )
                
                $
                (153,622
                )
                
                $
                4,075
                
                
                $
                27,056Comprehensive
      loss:Net
      loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (6,084
                )
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (6,084
                )Minimum
      pension, SERP and OPEB  liabilities, net of taxes of
      $0
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (179
                )
                
                
                (179
                )Total
      comprehensive loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (6,263
                )Issuance
      of restricted stock
                
                
                149,500
                
                
                
                1
                
                
                
                (1
                )
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                -Cancellation
      of restricted stock
                
                
                (2,000
                )
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                -Stock
      compensation expense
                
                
                
                
                
                
                
                
                
                
                447
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                447Purchase
      of treasury stock
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (32,723
                )
                
                
                (39
                )
                
                
                
                
                
                
                (39
                )Balance
      May 3, 2008
                
                
                32,748,983
                
                
                $
                327
                
                
                $
                75,770
                
                
                $
                94,869
                
                
                
                (13,348,971
                )
                
                $
                (153,661
                )
                
                $
                3,896
                
                
                $
                21,201See
      accompanying notes to consolidated financial statements.
           5
   Hancock Fabrics, Inc.(Debtor-In-Possession)Condensed
      Consolidated Statements of Cash Flows(unaudited)(in
      thousands)
                
                Thirteen
      Weeks EndedMay
      3,
                
                
                May
      5,2008
                
                
                2007Cash
      flows from operating activities:Net
      loss
                
                $
                (6,084
                )
                
                $
                (1,211
                )Adjustments
      to reconcile net loss to cash flows provided by (used in) operating
      activitiesDepreciation
      and amortization, including cost of goods sold
                
                
                1,584
                
                
                
                2,325Amortization
      of deferred loan costs
                
                
                156
                
                
                
                929LIFO
      inventory reserve
                
                
                767
                
                
                
                (4,318
                )Stock
      compensation expense
                
                
                447
                
                
                
                419Reserve
      for store closings credits, including interest expense
                
                
                (545
                )
                
                
                2,079Reserve
      for obsolete inventory
                
                
                (194
                )
                
                
                (25
                )Reserve
      for sales returns and bad debts
                
                
                -
                
                
                
                (81
                )Stepped
      rent accrual
                
                
                (22
                )
                
                
                (116
                )Gain
      on disposition of property and equipment
                
                
                17
                
                
                
                211Compensation
      expense for issuance of shares under directors' stock plan
                
                
                -
                
                
                
                69Reorganization
      expense, net
                
                
                2,676
                
                
                
                4,125(Increase)
      decrease in assetsReceivables
      and prepaid expenses
                
                
                1,106
                
                
                
                (1,983
                )Inventory
      at current cost
                
                
                (4,163
                )
                
                
                46,011Other
      noncurrent assets
                
                
                (227
                )
                
                
                (354
                )Increase
      (decrease) in liabilitiesAccounts
      payable
                
                
                (2,538
                )
                
                
                4,416Accrued
      liabilities
                
                
                (333
                )
                
                
                (1,041
                )Postretirement
      benefits other than pensions
                
                
                (215
                )
                
                
                (696
                )Long-term
      pension and SERP liabilities
                
                
                96
                
                
                
                430Other
      liabilities
                
                
                (229
                )
                
                
                (445
                )Net
      cash provided by (used in) operating activities before reorganization
      activities
                
                
                (7,701
                )
                
                
                50,744Net
      cash used for reorganization activities
                
                
                (2,616
                )
                
                
                (3,503
                )Net
      cash provided by (used in) operating activities
                
                
                (10,317
                )
                
                
                47,241Cash
      flows from investing activities:Additions
      to property and equipment
                
                
                (2,144
                )
                
                
                (784
                )Proceeds
      from the disposition of property and equipment
                
                
                43
                
                
                
                493Net
      cash used in investing activities
                
                
                (2,101
                )
                
                
                (291
                )Cash
      flows from financing activities:Net
      payments on revolving credit facility
                
                
                -
                
                
                
                (59,584
                )Net
      borrowings on DIP credit facility
                
                
                13,373
                
                
                
                15,893Payments
      for capital leases
                
                
                (16
                )
                
                
                (29
                )Payments
      for loan costs
                
                
                (475
                )
                
                
                (775
                )Purchase
      of treasury stock
                
                
                (39
                )
                
                
                (32
                )Net
      cash provided by (used in) financing activities
                
                
                12,843
                
                
                
                (44,527
                )Increase
      in cash and cash equivalents
                
                
                425
                
                
                
                2,423Cash
      and cash equivalents:Beginning
      of period
                
                
                2,280
                
                
                
                2,499End
      of period
                
                $
                2,705
                
                
                $
                4,922Supplemental
      disclosures:Cash
      paid during the period for:Interest
                
                $
                903
                
                
                $
                1,099Income
      taxes
                
                
                -
                
                
                
                -Non-cash
      activities:Noncash
      change in funded status of benefit plans
                
                $
                (179
                )
                
                $
                292Decrease
      in capital lease obligations
                
                
                (18
                )
                
                
                (34
                )Issuance
      of restricted stock
                
                
                35
                
                
                
                18Cancellation
      of restricted stock
                
                
                (6
                )
                
                
                (605
                )See
      accompanying notes to consolidated financial statements
 
 6
   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE
1:  BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
 
 Organization
and Basis of Presentation
 
 Hancock
Fabrics, Inc. (“Hancock” or the “Company”) is a specialty retailer committed to
serving creative enthusiasts with a complete selection of fashion and home
decorating textiles, sewing accessories, needlecraft supplies and sewing
machines.  As of May 3, 2008, Hancock operated 270 stores in 37 states
and an internet store under the domain name
hancockfabrics.com.  Hancock conducts business in one operating
business segment.  As discussed in Note 2, the Company is operating as
a debtor-in-possession under Chapter 11 of the U.S. Bankruptcy
Code.
 
 References
herein to “Hancock”, the “Company”, “we”, “our”, or “us” refer to Hancock
Fabrics, Inc. and its subsidiaries unless the context specifically indicates
otherwise.
 
 We
maintain our financial records on a 52-53 week fiscal year ending on the
Saturday closest to January 31.
 
 The
accompanying unaudited Consolidated Financial Statements should be read in
conjunction with our audited Consolidated Financial Statements and accompanying
notes in our Annual Report on Form 10-K for the year ended February 2, 2008
filed with the U.S. Securities and Exchange Commission (SEC) on April 17,
2008. The accompanying (a) consolidated balance sheet as of February 2,
2008, which has been derived from audited financial statements, and
(b) unaudited consolidated financial statements have been prepared pursuant
to SEC Rule 10-01 of Regulation S-X. Certain information and note
disclosures normally included in annual financial statements prepared in
accordance with generally accepted accounting principles in the United States of
America (GAAP) have been condensed or omitted pursuant to those rules and
regulations, although we believe that the disclosures made are adequate to make
the information not misleading.
 
 The
unaudited results of operations for the interim periods shown in these financial
statements are not necessarily indicative of operating results for the entire
year. In the opinion of management, the accompanying unaudited Consolidated
Financial Statements recognize all adjustments of a normal recurring nature
considered necessary to fairly state our consolidated financial position as of
May 3, 2008, and our consolidated results of operations and cash flows for the
thirteen weeks ended May 3, 2008, and May 5, 2007.
 
 The
Consolidated Financial Statements have been prepared in accordance with
accounting principles generally accepted in the United States applicable to a
going concern. Except as otherwise disclosed, these principles assume that
assets will be realized and liabilities will be discharged in the ordinary
course of business. Since March 21, 2007, the Company has been operating as a
debtor-in-possession under Chapter 11 of the Bankruptcy Code, and its
continuation as a going concern is contingent upon, among other things, its
ability to gain approval of the plan of reorganization by the requisite parties
under the Bankruptcy Code and have the plan confirmed by the Bankruptcy Court,
comply with terms of loan agreements, return to profitability, generate
sufficient cash flows from operations and obtain financing sources to meet
future obligations. There can be no assurance that the Company will be able to
achieve any of these results, which could raise substantial doubts about our
ability to continue as a going concern and result in the complete liquidation of
all assets for the benefit of our creditors. The consolidated financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amounts and classification of
liabilities that might result from the outcome of these
uncertainties.
     7
  Reclassification
 
 The
Company has netted $2.2 million of deferred tax assets against deferred tax
liabilities of the same amount as of February 2, 2008, in the accompanying
condensed consolidated balance sheet to conform with the current year
presentation.
 
 Recently
Issued Accounting Standards
 
 In
December 2007, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 141 (Revised 2007) (“SFAS
No. 141R”), Business Combinations. SFAS No. 141(R) will change
accounting for business combinations. Under SFAS No. 141(R), an acquiring
entity will be required to recognize all the assets acquired and liabilities
assumed in a transaction at the acquisition-date fair value with limited
exceptions. SFAS No. 141(R) also will change the accounting treatment and
disclosures for certain specific items in a business combination. SFAS
No. 141(R) applies prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. SFAS No. 141(R) will
have an impact on accounting for business combinations once adopted, but the
effect is dependent upon acquisitions effectuated after its effective
date.
 
 In December 2007,
the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated
Financial Statements” — An Amendment of ARB No. 51. SFAS 160 establishes
new accounting and reporting standards for the non-controlling interest in a
subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective
for fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2008. Earlier adoption is prohibited. The Company is in
the process of determining the effect, if any, that the adoption of SFAS
No. 160 will have on its results of operations or financial
position.
 
 In
March 2008, the FASB issued SFAS No. 161, “Disclosures about
Derivative Instruments and Hedging Activities—an amendment of FASB Statement
No. 133” (“SFAS 161”). SFAS 161 changes the disclosure requirements for
derivative instruments and hedging activities. Entities are required to provide
enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under Statement 133 and its related interpretations, and
(c) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance, and cash flows. The guidance in SFAS
161 is effective for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008, with early application
encouraged. This Statement encourages, but does not require, comparative
disclosures for earlier periods at initial adoption. The Company does not
believe the adoption of SFAS 161 will have an effect on our Consolidated
Financial Statements.
 
 Several
other new accounting standards became effective during the periods presented or
will be effective subsequent to May 3, 2008. None of these new standards had or
is expected to have a significant impact on Hancock’s Consolidated Financial
Statements.
 
 NOTE
2 – PROCEEDINGS UNDER CHAPTER 11 AND RELATED FINANCINGS
 
 On March
21, 2007, the Company filed voluntary petition for reorganization under Chapter
11 of the United States Bankruptcy Code (the "Bankruptcy Code"), in the United
States Bankruptcy Court for the District of Delaware (the "Court") (Case No.
07-10353). The reorganization case is being administered under the caption "In
re Hancock Fabrics, Inc., Case No. 07-10353."
 
 We have
in place a Court-approved $105 million debtor-in-possession credit facility (the
“DIP Credit Facility”) to supplement our cash flow during the reorganization
process. In addition, the Company has an additional loan of up to $17.5 million
(the “Loan Agreement”).  This loan is also being utilized for general
working capital purposes.  See Note 6 to the accompanying Consolidated
Financial Statements for further discussion of the DIP Credit Facility and Loan
Agreement.
    8
 
 The
Company is currently operating within a motion submitted to the Court which
extends the period which the Company has the exclusive right to file a plan
through and including June 30, 2008, and has the exclusive right to solicit
acceptances thereof through and including August 30, 2008.
 
 Under
Chapter 11, we are continuing to operate our business without interruptions as a
debtor-in-possession under the jurisdiction of the Court and in accordance with
the applicable provisions of the Bankruptcy Code. In general, a
debtor-in-possession is authorized under Chapter 11 to continue to operate as an
ongoing business, but may not engage in transactions outside the ordinary course
of business without the prior approval of the Court.
 
 The
Company and General Electric Capital Corporation (“GE Capital”) have entered
into a financing commitment letter, which was subsequently approved by the
Court, whereby GE Capital has committed to a senior revolving line of credit to
replace the current DIP Credit Facility and Loan Agreement.  The
closing of this facility remains subject to a number of conditions, including
but not limited to Court confirmation of a Plan.
 
 The
Company also filed a  registration statement on Form S-1 with the
Securities and Exchange Commission on May 16, 2008. The Company is registering
the offering of $20 million of floating rate secured notes and warrants to
purchase 9,500,000 shares of common stock.   We have entered into
an agreement with certain parties to subscribe for and purchase any of the
secured notes which are not subscribed for and purchased by other
shareholders.  This commitment letter is subject to approval by the
Court and can be found in its entirety as an exhibit to the Current Report on
Form 8-K filed on May 30, 2008.  This additional $20 million in
financing satisfies one of the conditions required under the GE Capital
financing.
 
 The
Company intends to file a plan of reorganization during the second calendar
quarter of 2008 and exit Chapter 11 thirty to sixty days later.
 
 American
Institute of Certified Public Accountant Statement of Position 90-7, “Financial
Reporting by Entities in Reorganization under the Bankruptcy Code” (“SOP 90-7”)
provides financial reporting guidance for entities that are reorganized under
Bankruptcy Code. The Company implemented this guidance for the year ended
February 2, 2008. Under Chapter 11, certain claims against the Company in
existence prior to the filing of the petitions for relief under the federal
bankruptcy laws are stayed while the Company continues business operations as
debtor-in-possession.  Per SOP 90-7, these estimated claims are
reflected in the May 3, 2008, Consolidated Balance Sheet as Liabilities Subject
to Compromise and are summarized in the table below.  Such claims
remain subject to future adjustments which may result from actions of the
bankruptcy court, negotiations, rejection or acceptance of executory contracts,
proofs of claim, or other events. Additional pre-petition claims (liabilities
subject to compromise) may arise due to the rejection of executory contracts or
as a result of the allowance of contingent or disputed claims. Claims are
recorded at the amount of the expected allowed claim even if they may be settled
for lesser amounts.
                   9
 
 Liabilities
      Subject to Compromise as of May 3, 2008 and February 2, 2008 (in
      thousands):May
      3,
                
                
                February
      2,2008
                
                
                2008Accounts
      payable
                
                $
                27,432
                
                
                $
                28,483Accrued
      liabilities:Payroll
      and benefits
                
                
                68
                
                
                
                132Rent
      liability
                
                
                581
                
                
                
                576Capital
      lease obligations
                
                
                70
                
                
                
                67Store
      closing liability
                
                
                4,838
                
                
                
                5,396Customer
      liability and property claims
                
                
                738
                
                
                
                695Deferred
      compensation
                
                
                290
                
                
                
                290Other
                
                
                154
                
                
                
                167Total
      accrued liabilities
                
                
                6,739
                
                
                
                7,323Income
      taxes payable
                
                
                1,500
                
                
                
                1,500Long
      term capital lease obligations
                
                
                3,347
                
                
                
                3,365Post
      retirement benefits other than pensions
                
                
                8,414
                
                
                
                8,414Pension
      and SERP liability
                
                
                5,007
                
                
                
                5,007Other
      Liabilities:Long
      Term Deferred Compensation
                
                
                3,812
                
                
                
                3,948Long
      Term Stepped Rent
                
                
                2,158
                
                
                
                2,186Unapplied
      Rent Credit
                
                
                367
                
                
                
                390Other
                
                
                32
                
                
                
                19Total
      other liabilities
                
                
                6,369
                
                
                
                6,543Total
      liabilities subject to compromise
                
                $
                58,808
                
                
                $
                60,635
  NOTE
3: EMPLOYEE BENEFIT PLANS
 
 The
following summarizes the net periodic benefit cost for Hancock’s defined benefit
pension retirement plan and its postretirement health care benefit plan for the
thirteen weeks ended May 3, 2008 and May 5, 2007 (in
thousands):
  Retirement
      Plan
                
                
                Postretirement
      Benefit Plan2008
                
                
                2007
                
                
                2008
                
                
                2007Service
      costs
                
                $
                352
                
                
                $
                597
                
                
                $
                63
                
                
                $
                77Interest
      cost
                
                
                1,132
                
                
                
                1,094
                
                
                
                139
                
                
                
                132Expected
      return on assets
                
                
                (1,374
                )
                
                
                (1,403
                )
                
                
                -
                
                
                
                -Amortization
      of prior service costs
                
                
                (20
                )
                
                
                25
                
                
                
                (240
                )
                
                
                (294
                )Recognized
      net actuarial (gain) loss
                
                
                117
                
                
                
                209
                
                
                
                (43
                )
                
                
                (42
                )Net
      periodic benefit cost
                
                $
                207
                
                
                $
                522
                
                
                $
                (81
                )
                
                $
                (127
                )
  NOTE
4:  EARNINGS (LOSS) PER SHARE
 
 Earnings
(loss) per share is presented for basic and diluted earnings per
share.  Basic earnings per share excludes dilution and is computed by
dividing income available to common shareholders by the weighted-average number
of common shares outstanding for the period.  Diluted earnings per
share reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the
Company.
   
 10
 
 COMPUTATION
      OF EARNINGS (LOSS) PER SHARE(in
      thousands, except for share and
                
                Thirteen
      Weeks Endedper
      share amounts)
                
                May
      3,
                
                
                May
      5,2008
                
                
                2007Basic
      earnings (loss) per share:Net
      loss
                
                $
                (6,084
                )
                
                $
                (1,211
                )Weighted
      average number of common shares outstanding during period
                
                
                18,983,877
                
                
                
                18,846,855Basic
      earnings (loss) per share
                
                $
                (0.32
                )
                
                $
                (0.06
                )Diluted
      earnings (loss) per share:Net
      loss
                
                $
                (6,084
                )
                
                $
                (1,211
                )Weighted
      average number of common shares outstanding during period
                
                
                18,983,877
                
                
                
                18,846,855Stock
      options
                
                
                -
                
                
                
                -Restricted
      stock and deferred stock units
                
                
                -
                
                
                
                -Weighted
      average number of common shares outstanding during periodadjusted
      for dilutive securities
                
                
                18,983,877
                
                
                
                18,846,855Diluted
      earnings (loss) per share
                
                $
                (0.32
                )
                
                $
                (0.06
                )Weighted
      average common stock equivalents not included in EPS(stock
      options) because the effect would be anti-dilutive
                
                
                1,484,109
                
                
                
                2,183,239
 NOTE
5:  RESERVE FOR STORE CLOSINGS AND DISCONTINUED
OPERATIONS
 
 Reserves
for store closings are established based on estimates of net lease obligations
and other store closing costs.
 
 At May 3,
2008, the total reserve balance included in current and noncurrent liabilities
was $4,851, which represents the present value of the future net lease
obligations for the locations which have been closed.
 
 During
the thirteen weeks ended May 3, 2008, there was approximately $542,000 in income
attributable to discontinued operations from prior years.  This was the
result of a reduction in the closed store reserve due to settlement of certain
real estate bankruptcy claims. During the 13 weeks ended May 5, 2007,
discontinued operations produced earnings of $3.4 million from the liquidation
of inventory in 124 store locations.
 
 The
Company made the decision during the first quarter of 2008 to close four stores,
and these closings are expected to take place during the second quarter of
2008.  These closings are not included in discontinued operations because
they are insignificant and part of the normal course of business.  The
Company’s methodology related to discontinued operations is that store closings
are included in discontinued operations when; 1) a decision is made to close a
significant number of stores under a store closure plan 2) the operations and
cash flows have been (or will be) eliminated from the ongoing operations of the
Company as a result of the closure and 3) there will be no significant
continuing involvement in the store operations subsequent to their
closure.  Store closings in the ordinary course of business are not
considered discontinued operations.
    11
 
 The
activity in the reserve is as follows (in thousands):
 
 Addition toFebruary
      2,
                
                
                (Reduction
      in)
                
                
                
                
                
                
                
                
                May
      3,2008
                
                
                Reserve
                
                
                Interest
                
                
                Payments
                
                
                2008Lease
      obligations
                
                $
                5,396
                
                
                $
                (542
                )
                
                $
                3
                
                
                $
                (6
                )
                
                $
                4,851
 NOTE
6 – LONG-TERM DEBT OBLIGATIONS
 
 From June
29, 2005 to March 22, 2007, the Company operated under a senior collateralized
revolving loan facility with Wachovia Bank and other lenders.
 
 The
Credit Facility was a five-year $110 million commitment, although there were
minimum levels of availability that had to be maintained, which had the effect
of limiting the amount that could be borrowed to less than $110 million. The
level of borrowings was subject to a borrowing base as defined in the agreement.
This agreement provided for an unused line fee, ranging from .25% to .35%
depending upon excess availability. The Company had the option of selecting
either a "prime rate" or Eurodollar loan.  Advances under the Credit
Facility accrued interest either at the Applicable Margin (as defined in the
Loan and Security Agreement) plus the higher of (i) the rate of interest
periodically announced by Wachovia as its "prime rate", or (ii) the federal
funds effective rate from time to time plus 0.50% or at the Applicable Margin
plus the Adjusted Eurodollar Rate (which is a rate derived from the London
Interbank Offered Rate).  Most borrowings under the Credit Facility
were made at the Applicable Margin plus the Adjusted Eurodollar Rate and were
outstanding for 30 day periods.
 
 The
Credit Facility was collateralized by a first priority perfected collateral
interest in and liens upon all of the Company's present and future
assets.  The Credit Facility also contemplated the issuance of letters
of credit aggregating up to $25 million, provided that all borrowings under the
Credit Facility did not exceed $110 million.
 
 The
Credit Facility contained several covenants, including but not limited to,
timely filing of financial statements and limitations on liens, additional
indebtedness, sale of assets, investments/acquisitions, loans, and the payment
of dividends.  In addition, there was a financial covenant that
required the Company to maintain at least $25 million of excess availability, as
defined.  In March of 2007, the Company received a notice of default
(as of February 28, 2007) due to the delay in filing its quarterly financial
statements and due to the Company's inability to comply with the financial
covenant requiring the Company to have at least $25 million of excess
availability.
 
 As
previously discussed, in March 2007, the Company filed a voluntary petition for
reorganization under Chapter 11 of the United States Bankruptcy
Code.   On March 22, 2007, the Company received interim approval
of the Court of a $105 million "debtor-in-possession" financing arrangement
(the “Senior Secured Revolving Credit Facility” or “DIP Credit Facility”) with
Wachovia Bank, N.A.. This financing arrangement effectively amended the above
Credit Facility.  The DIP Credit Facility calls for $105 million
maximum credit.  Similar to the previous Credit Facility, there are
minimum levels of availability that must be maintained, which have the effect of
limiting the amount that can be borrowed to less than $105 million. Also, the
level of borrowings is subject to a borrowing base as defined in the agreement.
The borrowing base is mainly reliant on certain portions of the Company’s credit
card receivables, inventory, and real property. The DIP Credit Facility is
collateralized by a first priority perfected collateral interest in and liens
upon all of the Company's present and future assets.  Also similar to
the replaced Credit Facility, the DIP Credit Facility may be used for letters of
credit up to an aggregate amount of $25 million.  This agreement
provides for an unused line fee of .25% to .35%. The Company may elect that the
loans under the DIP Credit Facility bear interest at a rate of the Adjusted
Eurodollar Rate plus 1.75% or Prime plus 0.25%, as such terms are defined in the
agreement. Upon default the interest rate would be increased by 2% above the
highest pre-default rate.
    12
 
 The DIP
Credit Facility is for a term ending on the earliest of: 1) two years following
the closing of the DIP Credit Facility (two years from March 22, 2007 or March
22, 2009), 2) confirmation of the Company’s plan of reorganization, or 3) the
last termination date set forth in the Company’s interim financing orders
related to bankruptcy, unless the Company’s permanent financing order has been
entered prior to such date.
 
 The DIP
Credit Facility contains several covenants, including but not limited to
limitations on liens, additional indebtedness, sale of assets,
investments/acquisitions, loans, and the payment of dividends.  Under
the DIP Credit Facility, the Company is currently required to maintain at least
$17.5 million of excess availability, as defined.  The Company is
currently in compliance with covenants under the DIP Credit
Facility.  However, future violations of the covenants are possible
and would permit the lenders to restrict the Company’s ability to borrow or
initiate letters of credit, and require immediate repayment of amounts
outstanding.
 
 At May 3,
2008, and February 2, 2008, Hancock had outstanding borrowings of approximately
$19.5 million and $6.1 million, respectively under the DIP credit
facility.
 
 At May 3,
2008 and February 2, 2008, Hancock had commitments under the above credit
facility of $2.0 million and $716,000, respectively under documentary and
standby letters of credit, which support purchase orders for
merchandise.  Hancock also has a standby letter of credit to guarantee
payment of potential future workers’ compensation claims.  This letter
of credit amounted to $5.8 million as of May 3, 2008, and February 2,
2008.
  Also on
June 15, 2007, the Company reached a definitive agreement (the "Loan Agreement")
with another lender for an additional loan of up to
$17.5 million.
  The Loan
Agreement provides for a term loan facility in the aggregate principal amount of
up to $17.5 million. The Company has and will continue to use the proceeds of
the loans made under the Loan Agreement for general working capital purposes and
to pay fees and expenses related to the Loan Agreement. As of May 3, 2008 and
February 2, 2008, $17.5 million is outstanding under the Loan
Agreement.
  
  
       
  
 13
   ITEM
2:  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
 
 FORWARD
LOOKING STATEMENTS
  This
Quarterly Report on Form 10-Q (“Quarterly Report”) contains forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995.  Such statements are not historical facts and reflect our
current views regarding matters such as operations and financial
performance.  In general, forward-looking statements are identified by
such words or phrases as “anticipates,” “believes,” “approximates,” “estimates,”
“expects,” “intends” or “plans” or the negative of those words or other
terminology.  Forward-looking statements involve inherent risks and
uncertainties; our actual results could differ materially from those expressed
in our forward-looking statements.  The risks and uncertainties,
either alone or in combination, that could cause our actual results to differ
from those expressed in our forward-looking statements include, but are not
limited to, those that are discussed in our Annual Report on Form 10-K filed
with the SEC on April 17, 2008, under Item 1A. Risk Factors.  Other
risks not presently known to us, or that we currently believe are immaterial,
could also adversely affect our business, financial condition or results of
operations.  Forward-looking statements speak only as of the date
made, and neither Hancock nor its management undertakes any obligation to update
or revise any forward-looking statement.
 
 GENERAL
 
 Hancock
Fabrics, Inc. is a specialty retailer committed to serving creative enthusiasts
with a complete selection of fashion and home decorating textiles, sewing
accessories, needlecraft supplies and sewing machines. As of May 3, 2008, we
operated 270 stores in 37 states and an internet store under the domain
name hancockfabrics.com. As discussed in Note 2 to the accompanying financial
statements, the Company is operating as a debtor-in-possession under Chapter 11
of the U.S. Bankruptcy Code.  We conduct our business in one operating
business segment.
 
 FINANCIAL
CONDITION
 
 Hancock's
primary capital requirements are for the financing of inventories and, to a
lesser extent, for capital expenditures relating to store locations and its
distribution facility.  Funds for such purposes have historically been
generated from Hancock's operations, credit extended by suppliers and borrowings
from commercial lenders.
 
 For the
first thirteen weeks of the fiscal year, the Company started its aggressive
remodeling program to implement the new store prototype, which was tested in 6
stores last year. Inventory increased $4.2 million due to purchases in support
of the new store format, as well as, expansion of high potential product lines.
In addition $2.1 million of capital expenditures were made primarily for store
fixtures relating to the Company’s remodeling program.  Accounts
payable decreased $2.5 million due to more products being imported, which
typically have shorter payment terms than domestically sourced
items.
 
 During
the thirteen weeks ended May 3, 2008, operating losses, which included $2.7
million of reorganization cost, the inventory growth, capital expenditures and
change in payable support, discussed above, resulted in an increase in
outstanding borrowings of $13.4 million.
 
 We opened
one store during the thirteen weeks ended May 3, 2008, and relocated two others,
resulting in 270 stores in operation at quarter end compared to 373 stores as of
May 5, 2007.
      14
 
 RESULTS
OF OPERATIONS
 
 Thirteen
weeks ended May 3, 2008 compared with thirteen weeks ended May 5,
2007
 
 As
previously disclosed in our Annual Report on Form 10-K for the year ended
February 2, 2008, and in Note 2 of this Form 10-Q, the Company filed a voluntary
petition of reorganization under Chapter 11 of the United States Bankruptcy Code
on March 21, 2007. During the first quarter of 2007, the Company also fully
liquidated and closed 30 retail store locations and began liquidation sales in
104 other stores that were completed by the end of June. One hundred and twenty
four of the 134 liquidating locations qualified for discontinued operations
treatment and are excluded from the 2007 continuing operating results
presented.  Ten stores did not qualify for discontinued operations
treatment mainly due to the migration of revenues to other existing stores.
Therefore, their results are reflected in the continuing operating results of
the Company and in the following explanations. During the thirteen weeks ended
May 3, 2008, there was approximately $542,000 in income attributable to
discontinued operations from prior years.  This was the result of a
reduction in the closed store reserve due to settlement of certain real estate
bankruptcy claims. During the 13 weeks ended May 5, 2007, discontinued
operations produced earnings of $3.4 million from the liquidation of
inventory.
 
 The net
loss from continuing operations was $6.6 million, or $0.35 per basic and diluted
share, compared with a net loss of $4.6 million, or $0.24 per basic and diluted
share, in the first quarter of 2007.
 
 Sales
decreased to $63.8 million from $69.2 million in the same quarter of the
previous year, as a result of the 10 stores in liquidation during 2007 that did
not qualify for discontinuing operations treatment, therefore those sales were
included in the prior year results and comparable store sales declined
3.1%.
 
 Gross
margin declined from 44.9% in 2007 to 43.6% in the current year, although 2007
includes the benefit of a LIFO credit of $1.2 million while 2008 includes a LIFO
charge of $767,000.  With the LIFO effect excluded, gross margin
improved over the prior year by 1.6%. This swing in LIFO can be primarily
attributed to increases in inventory and inflation in the first quarter of 2008
and the inventory reductions that occurred in the same period of
2007.
 
 Selling,
general and administrative expenses as a percentage of sales were 46.6% in the
first quarter of 2008 compared to 41.5% in the first quarter of
2007.  This increase in the expense percentage occurred partially from
the inclusion of the 10 liquidating stores in prior year results, which
leveraged the expense percentage. For 2008, the additional cost incurred in
support of the 20 store remodels completed during the first quarter and 58 more
physical inventories than in the prior year also impacted the ratio. The
percentage was also adversely affected by the absence of leveraging that would
result from positive comparable store sales.
 
 Depreciation
and amortization expense increased to $1.0 million in the first quarter of 2008
from $742,000 in 2007, due to new fixtures being added to remodeled locations
and infrastructure improvements made in the prior year.
 
 Reorganization
expense decreased from $4.1 million for the first quarter of 2007 to $2.7
million for the same period of 2008 due to a reduction in the number of
professionals engaged, as the reorganization process nears an end.
 
 Interest
expense decreased approximately $1 million due to the write-off of deferred loan
costs in the first quarter of 2007.
 
 An income
tax benefit was not recognized in the first quarter of either year presented.
The income tax benefits available from refunds due to NOL carrybacks have all
been recognized in prior periods. Until it is more likely than not that current
losses can be used to offset future tax obligations, additional benefits will
not be recorded.
       15
   LIQUIDITY
AND CAPITAL RESOURCES
 
 Bank
credit facility
 
 During
the first quarter of 2007 the Company entered a $105 million
debtor-in-possession financing arrangement with Wachovia Bank to replace the
previously existing $110 million facility. As of May 3, 2008, approximately
$19.5 million is outstanding under the DIP facility with additional borrowing
capacity of $40.5 million remaining.
 
 The DIP
Credit Facility contains several covenants, including but not limited to
limitations on liens, additional indebtedness, sale of assets,
investments/acquisitions, loans, and the payment of dividends.  Under
the DIP Credit Facility the Company is currently required to maintain at least
$17.5 million of excess availability, as defined.  The Company is
currently in compliance with covenants under the DIP Credit
Facility.  However, future violations of the covenants are possible
and would permit the lenders to restrict the Company’s ability to borrow or
initiate letters of credit, and require immediate repayment of amounts
outstanding.
 
 Also on
June 15, 2007, the Company reached a definitive agreement (the "Loan Agreement")
with another lender for an additional loan of up to $17.5 million, which
was outstanding as of May 3, 2008 (See Form 10-K dated February 2,
2008).
 
 The
Company and General Electric Capital Corporation (“GE Capital”) have entered
into a financing commitment letter, which subsequently was approved by the
Court, whereby GE Capital has committed to a senior revolving line of credit to
replace the current DIP Credit Facility and Loan Agreement.  The
closing of this facility remains subject to a number of conditions, including
but not limited to Court confirmation of a Plan.
 
 The
Company also filed a registration statement on Form S-1 with the Securities and
Exchange Commission on May 16, 2008. The Company is registering for the offering
of $20 million of floating rate secured notes and warrants to purchase 9,500,000
shares of common stock.   We have entered into an agreement with
certain parties to subscribe for and purchase any of the secured notes which are
not subscribed for and purchased by other shareholders.  This
commitment letter is subject to approval by the Court and can be found in its
entirety as an exhibit to the Current Report on Form 8-K filed on May 30,
2008.  This additional $20 million in financing satisfies one of the
conditions required under the GE Capital financing.
 
 CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
 
 The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the recorded amount of assets and
liabilities at the date of the financial statements and revenues and expenses
during the period.  Significant accounting policies employed by
Hancock, including the use of estimates and assumptions, are presented in the
Notes to Consolidated Financial Statements contained in our Annual Report on
Form 10-K for the fiscal year ended February 2, 2008.  Management
bases its estimates on its historical experience, together with other relevant
factors, in order to form the basis for making judgments, which will affect the
carrying values of assets and liabilities. On an ongoing basis, management
evaluates its estimates and makes changes to carrying values as deemed
necessary.
 
 The
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States applicable to a
going concern. Except as otherwise disclosed, these principles assume that
assets will be realized and liabilities will be discharged in the ordinary
course of business. Since March 21, 2007, the Company has been operating as a
debtor-in-possession under Chapter 11 of the Bankruptcy Code, and its
continuation as a going concern is contingent upon, among other things, its
ability to gain approval of the plan of reorganization by the requisite parties
under the Bankruptcy Code and have the plan confirmed by the Bankruptcy Court,
comply with terms of loan agreements, return to profitability, generate
sufficient cash flows from operations and obtain financing sources to meet
future obligations. There can be no assurance that the Company will be able to
achieve any of these results, which could raise substantial doubts about our
ability to continue as a going concern and result in the complete liquidation of
all assets for the benefit of our creditors. The consolidated financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amounts and classification of
liabilities that might result from the outcome of these
uncertainties.
      16
 
 OFF-BALANCE
SHEET ARRANGEMENTS
 
 Hancock
has no off-balance sheet financing arrangements. Hancock leases its retail
fabric store locations mainly under non-cancelable operating leases. Four of the
Company’s store leases qualify for capital lease treatment. Future payments
under operating leases are appropriately excluded from the Company’s balance
sheet.  Capital lease obligations are, however, reflected on the
Company’s balance sheet.
 
 CONTRACTUAL
OBLIGATIONS AND COMMERCIAL COMMITMENTS
 
 Hancock
has an arrangement within its collateralized revolving credit facility that
provides up to $25 million in letters of credit.  At May 3, 2008,
Hancock had commitments of $2.0 million on documentary and standby letters of
credit under the facility, which support purchase orders for
merchandise.  Hancock also has a $5.8 million standby letter of credit
to guarantee payment of potential future workers’ compensation
claims.  Hancock leases its retail fabric store locations under
operating leases expiring at various dates through 2024.
 
 Hancock
has no standby repurchase obligations or guarantees of other entities’
debt.
 
 EFFECTS
OF INFLATION
 
 Inflation
in labor and occupancy costs could significantly affect Hancock's
operations.  Many of Hancock's employees are paid hourly rates related
to federal and state minimum wage requirements; accordingly, any increases in
those requirements will affect Hancock.  In addition, payroll taxes,
employee benefits and other employee costs continue to
increase.  Health insurance costs, in particular, continue to rise at
a high rate in the United States each year.  Costs of leases for new
store locations remain stable, but renewal costs of older leases continue to
increase.  Hancock believes the practice of maintaining adequate
operating margins through a combination of price adjustments and cost controls,
careful evaluation of occupancy needs and efficient purchasing practices are the
most effective tools for coping with increased costs and expenses.
 
 Inflation
is one of the key factors used in the calculation of the LIFO charge or credit
to Cost of goods sold.
 
 SEASONALITY
 
 Hancock’s
business is seasonal.  Peak sales periods occur during the fall and
pre-Easter weeks, while the lowest sales periods occur during the summer
months.
 
 ITEM
3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
 
 Hancock
does not hold derivative financial or commodity instruments at May 3, 2008.
Hancock is exposed to financial market risks, including changes in interest
rates.
       17
  The
Company may elect that the loans under the DIP Credit Facility bear interest at
a rate of the Adjusted Eurodollar Rate plus 1.75% or Prime plus 0.25%, as such
terms are defined in the agreement. Upon default, the interest rate would be
increased by 2% above the highest pre-default rate.
 
 Certain
borrowings under the Company’s Loan Agreement ("Prime Rate Loans") bear interest
at a rate equal to two (2%) percent per annum in excess of the greater of (a)
8.25%, (b) the rate from time to time publicly announced by JPMorgan Chase Bank
in New York, New York, or its successors, as its prime rate, whether or not such
announced rate is the best rate available at such bank or (c) the federal
funds rate as published by the Federal Reserve Bank of New York in effect on
such day plus one-half
(1/2%) percent. Other borrowings under the Loan Agreement ("Eurodollar Rate
Loans") will bear interest at a rate equal to five (5%) percent per annum in
excess of rate per annum determined by dividing (a) the rate of interest per
annum appearing on Reuters Screen LIBOR Page as the London Interbank Offered
Rate for deposits in dollars at approximately 11:00 a.m. (London time) two
business days prior to the first day of the applicable interest period by (b) a
percentage equal to: (i) one (1) minus (ii) the percentage that is in effect
from time to time under Regulation D of the Board of Governors of the Federal
Reserve System as the maximum reserve requirement applicable with respect to
Euro-denominated liabilities, provided that such rate shall not be less than
5.25%. The agent may, at its option or at the direction of the requisite number
of Lenders, increase the interest rates to the rate of five (5%) percent per
annum in excess of the applicable rate for Prime Rate Loans and the rate of
eight (8%) percent per annum in excess of the applicable rate for Eurodollar
Rate Loans in certain circumstances.
 
 An
increase in interest rates of 100 basis points would increase Hancock’s annual
interest expense by $370,000 assuming borrowings of $37.0 million as existed at
May 3, 2008.  All of Hancock’s business is transacted in U.S. dollars
and, accordingly, foreign exchange rate fluctuations have never had a
significant impact on Hancock, and they are not expected to in the foreseeable
future.
 
 ITEM
4T. CONTROLS AND PROCEDURES
 
 Disclosure
Controls and Procedures
 
 We
maintain disclosure controls and procedures designed to ensure that information
required to be disclosed in reports filed under the Securities Exchange Act of
1934, as amended (Exchange Act), is recorded, processed, summarized, and
reported within the specified time periods and accumulated and communicated to
our management, including our principal executive officer and principal
financial officer, as appropriate to allow timely decisions regarding required
disclosure.
 
 Our
management, with the participation of our President and Chief Executive Officer
(CEO) and our Senior Vice President and Chief Financial Officer (CFO), evaluated
the effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) or 15d-15(e) promulgated under the Exchange Act), as of May 3,
2008.
 
 Based on
that evaluation, our CEO and CFO concluded that, as of that date, our disclosure
controls and procedures required by paragraph (b) of Exchange Act Rules 13a-15
or 15d-15 were not effective at a reasonable assurance level because of the
identification of material weaknesses in our internal control over financial
reporting, which we view as an integral part of our disclosure controls and
procedures. The effect of such weaknesses on our disclosure controls and
procedures, as well as remediation actions taken and planned, are described in
Item 9A, Controls and Procedures, of our Annual Report on Form 10-K for the year
ended February 2, 2008.
 
 Notwithstanding
the material weaknesses, management has concluded that our unaudited
consolidated financial statements recognize all adjustments of a normal
recurring nature considered necessary and were prepared in accordance with GAAP.
Accordingly, and to the best of management’s knowledge, the unaudited condensed
consolidated financial statements included in this Quarterly Report on
Form 10-Q fairly present in all material respects our financial position,
results of operations and cash flows for the periods presented in accordance
with GAAP.
          18
 
 Remediation
and Changes in Internal Controls
 
 The
Company reported one material weakness in internal control in Form 10-K for the
fiscal year ended February 2, 2008.  This material weakness was the
result of the Company not maintaining a sufficient complement of personnel with
a level of financial reporting expertise that is commensurate with the Company’s
financial reporting requirements. Management has taken actions to remediate the
material weakness by:
 
 ·
              Hiring
      a new Senior Vice President and Chief Financial Officer to supplement the
      existing financial executive team.
 ·
              Continuing
      the engagement of a third party accounting and consulting firm to assist
      with accounting and disclosure matters related to the financial reporting
      and accounting requirements.
 ·
              Realigning
      internal resources to improve the staffing and knowledge of the financial
      reporting and accounting functions.
 
 Management
will continue to assess the complement of personnel needed to assist with
accounting and disclosure matters related to the financial reporting and
accounting requirements in the next several months, and additional changes are
expected to be made.
 
 Other
than as described above, there have not been any other changes in our internal
control over financial reporting in the three months ended May 3, 2008, which
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
                         
  19
   PART
II.  OTHER INFORMATION:
  ITEM
1:  LEGAL PROCEEDINGS
  On March
21, 2007, the Company filed a voluntary petition for reorganization under
Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the
District of Delaware. The reorganization case is being administered under the
caption "In re Hancock Fabrics, Inc., Case No. 07-10353." The Company continues
to operate its business as a "debtor-in- possession" under the jurisdiction of
the Court and in accordance with the applicable provisions of the Bankruptcy
Code and orders of the Court.
  The
Company is a party to several legal proceedings and claims. Although the
outcome of such proceedings and claims cannot be determined with certainty, we
are of the opinion that it is unlikely that these proceedings and claims will
have a material effect on the financial condition or operating results of the
Company.
  ITEM 1A:  RISK
FACTORS
  The
      risk factors listed in Part I “Item 1A. Risk Factors” in the
      Annual Report on Form 10-K for the fiscal year ended February 2,
      2008, should be considered with the information provided elsewhere in this
      Quarterly Report on Form 10-Q, which could materially adversely affect the
      business, financial condition or results of operations.  There have
      been no material changes to the risk factors as previously disclosed in
      such Annual Report on Form 10-K.
 
 ITEM
      2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
    PROCEEDS
   Period
                Total
      Number of
                  Shares
      Purchased (1)
                Average
      Price
                  Paid
      Per Share
                Total
      Number of
                  Shares
      Purchased as
                  Part
      of Publicly
                  Announced
      Plans (2)
                Maximum
                  Number
      of Shares That
                  May
      Yet Be Purchased
                  Under
      the PlansFebruary
      3, 2008 through
                  March
      1, 2008
                5,045
                $1.08
                -
                243,617March
      2, 2008 through
                  April
      5, 2008
                27,678
                $1.23
                -
                243,617April
      6, 2008 through
                  May
      3, 2008
                -
                -
                -
                243,617Total
                32,723
                $1.19
                -
                243,617
 (1) The
number of shares purchased during the first quarter consisted of 7,304 and
25,419 shares deemed surrendered to the Company to satisfy tax withholding
obligations arising from the lapse of restrictions on shares and the issuance of
long-term incentive stock, respectively.
    20
 
 (2) In
June of 2000 the Board of Directors authorized the repurchase of up to 2,000,000
shares of the Company’s Common Stock from time to time when warranted by market
conditions.  There have been 1,756,383 shares purchased under this
authorization through May 3, 2008. The shares discussed in footnote (1) are
excluded from this column.
 
 The
Registrant did not sell any unregistered equity securities during the period
covered by this Quarterly Report.
 
 ITEM
3: DEFAULTS UPON SENIOR SECURITIES
 
 None.
 
 ITEM
      4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY
  HOLDERS
 
 None.
 
 ITEM
      5: OTHER INFORMATION
 
 None.
 
 ITEM
6: EXHIBITS
 
 31.1
              Certification
      of Chief Executive Officer Pursuant to Rule 13a-14(a) Under The Securities
      Exchange Act of 1934
  31.2
              Certification
      of Chief Financial Officer Pursuant to Rule 13a-14(a) Under The Securities
      Exchange Act of 1934
  32
              Certification
      of Chief Executive Officer and Chief Financial Officer Pursuant to 18
      U.S.C. Section 1350, as Adopted Pursuant To Section 906 of The
      Sarbanes-Oxley Act of 2002
 
  
  
  
  
  
  
  
  21
 
  SIGNATURE
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
 
 HANCOCK FABRICS, INC.
 (Registrant)
   /s/ Robert W.
Driskell
    
  June 9,
2008
 
 
 
               
 
                              22