##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended November 1, 2008
 OR
 o
    
    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 
of incorporation or organization)
    
    (I.R.S. Employer
Identification No.)One Fashion Way, Baldwyn, MS
(Address of principal executive offices)
    
    38824
(Zip Code)
 (662) 365-6000
 þ o
  Large accelerated filer oAccelerated filer oNon-accelerated filer o(Do not check if a smaller reporting company)Smaller reporting company þ o þ
  þ o




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##### 



PagePart I. Financial Information:Item 1. Financial StatementsConsolidated Balance Sheets as of November 1, 2008 and February 2, 2008
    
    
    3Consolidated Statements of Operations for the Thirteen and Thirty-nine Weeks
Ended November, 1, 2008 and November 3, 2007
    
    
    4Consolidated Statement of Shareholders Equity for the Thirty-nine
Weeks Ended November 1, 2008
    
    
    5Consolidated Statements of Cash Flows for the Thirty-nine Weeks
Ended November 1, 2008 and November 3, 2007
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3. Quantitative and Qualitative Disclosures about Market Risks
    
    
    19Item 4. Controls and Procedures
    
    
    19Part II. Other Information:Item 1. Legal Proceedings
    
    
    21Item 1A. Risk Factors
    
    
    21Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    22Item 6. Exhibits
    
    
    23Signatures
    
    
    23EX-31.1EX-31.2EX-32.1EX-32.2
  2




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PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 
 HANCOCK FABRICS, INC.
CONSOLIDATED BALANCE SHEETS
 (unaudited)November 1,
    
    February 2,(in thousands, except for share and per share amounts)
    
    2008
    
    2008(1)AssetsCurrent assets:Cash and cash equivalents
    
    $
    3,540
    
    
    $
    2,280Receivables, less allowance for doubtful accounts
    
    
    3,146
    
    
    
    4,453Inventories, net
    
    
    73,109
    
    
    
    77,907Income taxes refundable
    
    
    1,879
    
    
    
    8,118Prepaid expenses
    
    
    2,730
    
    
    
    1,748Total current assets
    
    
    84,404
    
    
    
    94,506Property and equipment, net
    
    
    46,420
    
    
    
    43,683Goodwill
    
    
    3,406
    
    
    
    3,406Other assets
    
    
    6,116
    
    
    
    7,107Total assets
    
    $
    140,346
    
    
    $
    148,702Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    22,863
    
    
    $
    19,393Accrued liabilities
    
    
    14,430
    
    
    
    14,354Other pre-petition obligations
    
    
    2,953
    
    
    
    Total current liabilities
    
    
    40,246
    
    
    
    33,747Long-term debt obligations
    
    
    56,210
    
    
    
    23,608Capital lease obligations
    
    
    3,308
    
    
    
    Postretirement benefits other than pensions
    
    
    8,972
    
    
    
    315Pension and SERP liabilities
    
    
    5,509
    
    
    
    270Other liabilities
    
    
    8,171
    
    
    
    3,071Total liabilities not subject to compromise
    
    
    122,416
    
    
    
    61,011Liabilities subject to compromise (See Note 2)
    
    
    
    
    
    
    60,635Total liabilities
    
    
    122,416
    
    
    
    121,646Commitments and contingenciesShareholders equity:Common stock, $.01 par value; 80,000,000 shares authorized;
33,093,570 and 32,601,483 issued and 19,726,876 and
19,285,235 outstanding, respectively
    
    
    331
    
    
    
    326Additional paid-in capital
    
    
    87,734
    
    
    
    75,324Retained earnings
    
    
    80,012
    
    
    
    100,953Treasury stock, at cost, 13,366,694 and 13,316,248
shares held, respectively
    
    
    (153,683
    )
    
    
    (153,622
    )Accumulated other comprehensive income
    
    
    3,536
    
    
    
    4,075Total shareholders equity
    
    
    17,930
    
    
    
    27,056Total liabilities and shareholders equity
    
    $
    140,346
    
    
    $
    148,702
  (1)
    
    Derived from audited balance sheet included in our annual report on Form 10-K for the fiscal year ended February 2, 2008. 3




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HANCOCK FABRICS, INC.  CONSOLIDATED STATEMENTS OF OPERATIONS
 Thirteen Weeks Ended
    
    Thirty-nine Weeks EndedNovember 1,
    
    November 3,
    
    November 1,
    
    November 3,(in thousands, except per share amounts)
    
    2008
    
    2007
    
    2008
    
    2007Sales
    
    $
    70,563
    
    
    $
    69,650
    
    
    $
    198,178
    
    
    $
    196,862Cost of goods sold
    
    
    42,356
    
    
    
    38,577
    
    
    
    115,962
    
    
    
    110,084Gross profit
    
    
    28,207
    
    
    
    31,073
    
    
    
    82,216
    
    
    
    86,778Selling, general and administrative expense
    
    
    28,286
    
    
    
    31,059
    
    
    
    86,915
    
    
    
    84,584Depreciation and amortization
    
    
    1,141
    
    
    
    874
    
    
    
    3,271
    
    
    
    2,650Operating income (loss)
    
    
    (1,220
    )
    
    
    (860
    )
    
    
    (7,970
    )
    
    
    (456
    )Reorganization expense, net
    
    
    1,060
    
    
    
    4,164
    
    
    
    7,990
    
    
    
    12,048Interest expense, net
    
    
    851
    
    
    
    1,113
    
    
    
    5,417
    
    
    
    4,290Loss from continuing operations before income taxes
    
    
    (3,131
    )
    
    
    (6,137
    )
    
    
    (21,377
    )
    
    
    (16,794
    )Income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Loss from continuing operations
    
    
    (3,131
    )
    
    
    (6,137
    )
    
    
    (21,377
    )
    
    
    (16,794
    )Income
(loss) from discontinued operations, (net of tax expense of $0)
    
    
    656
    
    
    
    
    
    
    
    436
    
    
    
    (3,888
    )Net loss
    
    $
    (2,475
    )
    
    $
    (6,137
    )
    
    $
    (20,941
    )
    
    $
    (20,682
    )Basic and diluted loss per share:Loss from continuing operations
    
    $
    (0.16
    )
    
    $
    (0.32
    )
    
    $
    (1.12
    )
    
    $
    (0.89
    )Income (loss) from discontinued operations
    
    
    0.03
    
    
    
    
    
    
    
    0.02
    
    
    
    (0.21
    )Net loss
    
    $
    (0.13
    )
    
    $
    (0.32
    )
    
    $
    (1.10
    )
    
    $
    (1.10
    )Weighted average shares outstanding:Basic and diluted
    
    
    19,096
    
    
    
    18,908
    
    
    
    19,050
    
    
    
    18,883
  4




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HANCOCK FABRICS, INC.  CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY
 Thirty-nine Weeks Ended November 1, 2008
 AccumulatedAdditional
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20,941
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20,941
    )Minimum pension, SERP and OPEB
liabilities, net of taxes of $0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (539
    )
    
    
    (539
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,480
    )Issuance of restricted stock
    
    
    371,500
    
    
    
    4
    
    
    
    70
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    74Stock issued for Directors fees
    
    
    119,187
    
    
    
    1
    
    
    
    50
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    51Cancellation of restricted stock
    
    
    (13,000
    )
    
    
    (0
    )
    
    
    (74
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (74
    )Stock compensation expense
    
    
    
    
    
    
    
    
    
    
    663
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    663Warrants issued with notes
    
    
    
    
    
    
    
    
    
    
    11,685
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,685Warrants exercised
    
    
    14,400
    
    
    
    0
    
    
    
    16
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (50,446
    )
    
    
    (61
    )
    
    
    
    
    
    
    (61
    )Balance November 1, 2008
    
    
    33,093,570
    
    
    $
    331
    
    
    $
    87,734
    
    
    $
    80,012
    
    
    
    (13,366,694
    )
    
    $
    (153,683
    )
    
    $
    3,536
    
    
    $
    17,930
  5




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Hancock Fabrics, Inc.  Consolidated Statements of Cash Flows
 Thirty-nine Weeks EndedNovember 1,
    
    November 3,(in thousands)
    
    2008
    
    2007Cash flows from operating activities:Net loss
    
    $
    (20,941
    )
    
    $
    (20,682
    )Adjustments to reconcile net loss to cash flows (used in) provided by operating activitiesDepreciation and amortization, including cost of goods sold
    
    
    4,929
    
    
    
    5,318Amortization of deferred loan costs
    
    
    468
    
    
    
    1,798Amortization of bond discount
    
    
    595
    
    
    
    LIFO inventory reserve
    
    
    4,415
    
    
    
    (5,618
    )Interest on Pre-Petition Obligations
    
    
    2,219
    
    
    
    Interest paid-in-kind on Notes
    
    
    423
    
    
    
    Stock compensation expense
    
    
    663
    
    
    
    742Reserve for store closings credits, including interest expense
    
    
    (2,162
    )
    
    
    4,095Reserve for obsolete inventory
    
    
    (194
    )
    
    
    (112
    )Reserve for sales returns and bad debts
    
    
    (56
    )
    
    
    (19
    )Stepped rent accrual
    
    
    (295
    )
    
    
    (706
    )Loss (gain) on disposition of property and equipment
    
    
    46
    
    
    
    (1,230
    )Gain on disposition of lease financing obligations
    
    
    
    
    
    
    (153
    )Compensation expense for issuance of shares under Directors
stock plan
    
    
    51
    
    
    
    69Reorganization expense, net
    
    
    7,990
    
    
    
    10,921(Increase) decrease in assetsReceivables and prepaid expenses
    
    
    381
    
    
    
    (3,296
    )Inventory at current cost
    
    
    243
    
    
    
    50,094Income tax refundable
    
    
    6,239
    
    
    
    1,870Other noncurrent assets
    
    
    1,725
    
    
    
    (1,038
    )Increase (decrease) in liabilitiesAccounts payable
    
    
    3,470
    
    
    
    13,503Accrued liabilities
    
    
    207
    
    
    
    (3,890
    )Income tax payable
    
    
    
    
    
    
    1,000Postretirement benefits other than pensions
    
    
    (607
    )
    
    
    (2,687
    )Long-term pension and SERP liabilities
    
    
    543
    
    
    
    1,267Other liabilities
    
    
    (1,165
    )
    
    
    (419
    )Net cash provided by operating activities before reorganization activities
    
    
    9,187
    
    
    
    50,827Net cash used for reorganization activities
    
    
    (7,255
    )
    
    
    (10,921
    )Net cash provided by operating activities
    
    
    1,932
    
    
    
    39,906Cash flows from investing activities:Additions to property and equipment
    
    
    (7,516
    )
    
    
    (2,494
    )Proceeds from the disposition of property and equipment
    
    
    137
    
    
    
    4,089Net cash provided by (used in) investing activities
    
    
    (7,379
    )
    
    
    1,595Cash flows from financing activities:Net borrowings (payments) on credit facilities
    
    
    43,269
    
    
    
    (40,051
    )Payments for capital leases
    
    
    (47
    )
    
    
    (59
    )Payments for loan costs
    
    
    (1,202
    )
    
    
    (30
    )Payments for Pre-Petition Obligations
    
    
    (35,268
    )
    
    
    Proceeds from exercise of equity instruments
    
    
    16
    
    
    
    Purchase of treasury stock
    
    
    (61
    )
    
    
    (77
    )Net cash provided by (used in) financing activities
    
    
    6,707
    
    
    
    (40,217
    )Increase in cash and cash equivalents
    
    
    1,260
    
    
    
    1,284Cash and cash equivalents:Beginning of period
    
    
    2,280
    
    
    
    2,499End of period
    
    $
    3,540
    
    
    $
    3,783Supplemental disclosures:Cash paid during the period for:Interest
    
    $
    2,583
    
    
    $
    3,910Non-cash activities:Warrants issued with notes
    
    $
    (11,685
    )
    
    $
    Noncash change in funded status of benefit plans
    
    
    (539
    )
    
    
    1,435Decrease in capital lease obligations
    
    
    (57
    )
    
    
    (2,383
    )Issuance of restricted stock
    
    
    74
    
    
    
    67Cancellation of restricted stock
    
    
    (74
    )
    
    
    (735
    )
  6




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
 NOTE 1: BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Organization and Basis of Presentation
      Reclassification
   7




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Recently Issued Accounting Standards
    NOTE 2  PROCEEDINGS UNDER CHAPTER 11 AND RELATED FINANCINGS
 Emergence from Bankruptcy Protection
  Fresh Start Reporting
  Discharge and Treatment of Claims and Interests
   8




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Exit Financing
  Claims Resolution and Plan Distributions
  Liabilities Subject to Compromise
  Subsequent Distribution
  NOTE 3: EMPLOYEE BENEFIT PLANS
  Retirement Plan
    
    Postretirement Benefit Plan2008
    
    2007
    
    2008
    
    2007Service costs
    
    $
    1,055
    
    
    $
    1,789
    
    
    $
    188
    
    
    $
    231Interest cost
    
    
    3,397
    
    
    
    3,239
    
    
    
    418
    
    
    
    395Expected return on assets
    
    
    (4,122
    )
    
    
    (4,209
    )
    
    
    
    
    
    
    Amortization of prior service costs
    
    
    (60
    )
    
    
    (74
    )
    
    
    (722
    )
    
    
    (881
    )Recognized net actuarial (gain) loss
    
    
    350
    
    
    
    613
    
    
    
    (129
    )
    
    
    (125
    )(Gain)/Loss due to Curtailment
    
    
    
    
    
    
    (488
    )
    
    
    
    
    
    
    (399
    )Net periodic benefit cost
    
    $
    620
    
    
    $
    870
    
    
    $
    (245
    )
    
    $
    (779
    )
   NOTE 4: LOSS PER SHARE
  9




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COMPUTATION OF LOSS PER SHARE
 Thirteen Weeks Ended
    
    
    Thirty-nine Weeks Ended(in thousands, except for share and
    
    November 1,
    
    
    November 3,
    
    
    November 1,
    
    
    November 3,per share amounts)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Basic and diluted loss per share:Net loss
    
    $
    (2,475
    )
    
    $
    (6,137
    )
    
    $
    (20,941
    )
    
    $
    (20,682
    )Weighted average number of common shares outstanding during
period
    
    
    19,096,214
    
    
    
    18,907,960
    
    
    
    19,049,779
    
    
    
    18,883,315Basic and diluted loss per share
    
    $
    (0.13
    )
    
    $
    (0.32
    )
    
    $
    (1.10
    )
    
    $
    (1.10
    )Weighted average common stock equivalents not included in EPS
(stock options) because the effect would be anti-dilutive
    
    
    1,347,051
    
    
    
    1,696,643
    
    
    
    1,548,571
    
    
    
    1,887,702
 NOTE 5: RESERVE FOR STORE CLOSINGS AND DISCONTINUED OPERATIONS
      Addition toFebruary 2,
    
    
    (Reduction in)
    
    
    
    
    
    
    
    
    
    
    November 1,2008
    
    
    Reserve
    
    
    Interest
    
    
    Payments
    
    
    2008Lease obligations
    
    $
    5,396
    
    
    $
    (2,171
    )
    
    $
    9
    
    
    $
    (1,860
    )
    
    $
    1,374
 10




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NOTE 6  LONG-TERM DEBT OBLIGATIONS
          11




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12




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ITEM 2:
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 FORWARD LOOKING STATEMENTS
  GENERAL
  RESULTS OF OPERATIONS
  Thirteen weeks ended November 1, 2008 compared with thirteen weeks ended November 3, 2007
   13




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Thirty-nine weeks ended November 1, 2008 compared with thirty-nine weeks ended November 3, 2007
    14




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th
     LIQUIDITY AND CAPITAL RESOURCES
 Capital sources and uses
    15




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Revolving credit facility and Notes
       16




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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
   17




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OFF-BALANCE SHEET ARRANGEMENTS
  CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
   EFFECTS OF INFLATION
   SEASONALITY
  18




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ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     
 ITEM 4: CONTROLS AND PROCEDURES
 Disclosure Controls and Procedures
     19




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Remediation and Changes in Internal Controls
  
    
    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.
   20




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PART II. OTHER INFORMATION:
 
 ITEM 1: LEGAL PROCEEDINGS
   
 ITEM 1A: RISK FACTORS
  We may be adversely affected by the general economic conditions and the current financial crisis
  Significant changes in discount rates, actual investment return on pension assets, and other
factors could affect the Companys earnings, equity, and pension contributions in future periods.
  21




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ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
   Total Number of
    
    
    MaximumShares Purchased as
    
    
    Number of Shares ThatTotal Number of
    
    
    Average Price
    
    
    Part of Publicly
    
    
    May Yet Be PurchasedPeriod
    
    Shares Purchased (1)
    
    
    Paid Per Share
    
    
    Announced Plans (1)
    
    
    Under the PlansAugust 3, 2008 through
August 30, 2008
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    243,617August 31, 2008 through
October 4, 2008
    
    
    54
    
    
    $
    1.70
    
    
    
    54
    
    
    
    243,563October 5, 2008 through
November 1, 2008
    
    
    
    
    
    
    
    
    
    
    0
    
    
    
    243,563Total
    
    
    54
    
    
    $
    1.70
    
    
    
    54
    
    
    
    243,563
 
 (1)
    
    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 1,756,437 shares purchased under this authorization through November 1, 2008.  22




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ITEM 6: EXHIBITS
 31.1
    
    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) Under The Securities
Exchange Act of 193431.2
    
    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) Under The Securities
Exchange Act of 193432.1
    
    Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant To Section 906 of The Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002
 
 SIGNATURE
  HANCOCK FABRICS, INC.
(Registrant)By:
    /s/ Robert W. DriskellRobert W. DriskellSenior Vice President and
Chief Financial Officer  23