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 October 31, 2009





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.


(Exact
name of registrant as specified in its charter)





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)





(662)
365-6000


Registrant’s
telephone number, including area code





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 has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).          Yes  ̈
    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 the 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





APPLICABLE
ONLY TO ISSUERS INVOLVED IN BANKRUPTCY


PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:





Indicate
by check mark whether the registrant has filed all documents and reports
required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act
of 1934 subsequent to the distribution of securities under a plan confirmed by a
court.     Yes x   
No  ̈





As of
November 28, 2009, there were 19,811,306, shares of Hancock Fabrics, Inc. $.01
par value common stock outstanding.





Table of
Contents


Hancock
Fabrics, Inc.,


INDEX
TO FORM 10-Q





PagePart I.  Financial
      InformationItem
      1.    Financial StatementsConsolidated
      Balance Sheets as of October 31, 2009, November 1, 2008 and January 31,
      2009
                            
                            3Consolidated
      Statements of Operations for the Thirteen and Thirty-nine Weeks Ended
      October 31, 2009 and November 1, 2008
                            
                            4Consolidated
      Statement of Shareholders’ Equity for the Thirty-nine Weeks Ended October
      31, 2009
                            
                            5Consolidated
      Statements of Cash Flows for the Thirty-nine Weeks Ended October 31, 2009
      and November 1, 2008
                            
                            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
                            
                            21Item
      4T.  Controls and Procedures
                            
                            22Part II.  Other
      InformationItem
      1. Legal Proceedings
                            
                            23Item
      1A. Risk Factors
                            
                            23Item
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
                            
                            23Item
      3. Defaults Upon Senior Securities
                            
                            23Item
      4. Submission of Matters to a Vote of Security Holders
                            
                            23Item
      5. Other Information
                            
                            23Item
      6. Exhibits
                            
                            23Signatures
                            
                            24


2





PART
I. FINANCIAL INFORMATION





ITEM
1. FINANCIAL STATEMENTS





HANCOCK
FABRICS, INC.


CONSOLIDATED
BALANCE SHEETS





(unaudited)October
      31,
                                                                
                                                                
                                                                November
      1,
                                                                
                                                                
                                                                January
      31,(in thousands, except for share
      amounts)
                                                                
                                                                2009
                                                                
                                                                
                                                                2008
                                                                
                                                                
                                                                2009(1)AssetsCurrent
      assets:Cash
      and cash equivalents
                                                                
                                                                $
                                                                4,265
                                                                
                                                                
                                                                $
                                                                3,540
                                                                
                                                                
                                                                $
                                                                2,338Receivables,
      less allowance for doubtful accounts
                                                                
                                                                
                                                                3,952
                                                                
                                                                
                                                                
                                                                3,146
                                                                
                                                                
                                                                
                                                                3,380Inventories
                                                                
                                                                
                                                                103,864
                                                                
                                                                
                                                                
                                                                113,906
                                                                
                                                                
                                                                
                                                                104,156Income
      taxes refundable
                                                                
                                                                
                                                                -
                                                                
                                                                
                                                                
                                                                1,879
                                                                
                                                                
                                                                
                                                                -Prepaid expenses
                                                                
                                                                
                                                                2,269
                                                                
                                                                
                                                                
                                                                2,730
                                                                
                                                                
                                                                
                                                                1,735Total
      current assets
                                                                
                                                                
                                                                114,350
                                                                
                                                                
                                                                
                                                                125,201
                                                                
                                                                
                                                                
                                                                111,609Property
      and equipment, net
                                                                
                                                                
                                                                42,758
                                                                
                                                                
                                                                
                                                                46,420
                                                                
                                                                
                                                                
                                                                45,039Goodwill
                                                                
                                                                
                                                                3,210
                                                                
                                                                
                                                                
                                                                3,406
                                                                
                                                                
                                                                
                                                                3,210Other assets
                                                                
                                                                
                                                                5,131
                                                                
                                                                
                                                                
                                                                6,116
                                                                
                                                                
                                                                
                                                                4,816Total assets
                                                                
                                                                $
                                                                165,449
                                                                
                                                                
                                                                $
                                                                181,143
                                                                
                                                                
                                                                $
                                                                164,674Liabilities
      and Shareholders' EquityCurrent
      liabilities:Accounts
      payable
                                                                
                                                                $
                                                                25,838
                                                                
                                                                
                                                                $
                                                                22,863
                                                                
                                                                
                                                                $
                                                                21,437Accrued
      liabilities
                                                                
                                                                
                                                                15,840
                                                                
                                                                
                                                                
                                                                14,430
                                                                
                                                                
                                                                
                                                                14,813Pre-petition obligations
                                                                
                                                                
                                                                1,744
                                                                
                                                                
                                                                
                                                                2,953
                                                                
                                                                
                                                                
                                                                2,796Total
      current liabilities
                                                                
                                                                
                                                                43,422
                                                                
                                                                
                                                                
                                                                40,246
                                                                
                                                                
                                                                
                                                                39,046Long-term
      debt obligations, net
                                                                
                                                                
                                                                37,821
                                                                
                                                                
                                                                
                                                                56,210
                                                                
                                                                
                                                                
                                                                42,977Capital
      lease obligations
                                                                
                                                                
                                                                3,209
                                                                
                                                                
                                                                
                                                                3,308
                                                                
                                                                
                                                                
                                                                3,287Postretirement
      benefits other than pensions
                                                                
                                                                
                                                                2,270
                                                                
                                                                
                                                                
                                                                8,972
                                                                
                                                                
                                                                
                                                                2,211Pension
      and SERP liabilities
                                                                
                                                                
                                                                23,227
                                                                
                                                                
                                                                
                                                                5,509
                                                                
                                                                
                                                                
                                                                21,706Other liabilities
                                                                
                                                                
                                                                7,678
                                                                
                                                                
                                                                
                                                                8,171
                                                                
                                                                
                                                                
                                                                8,098Total
      liabilities
                                                                
                                                                
                                                                117,627
                                                                
                                                                
                                                                
                                                                122,416
                                                                
                                                                
                                                                
                                                                117,325Commitments and
    contingenciesShareholders'
      equity:Common
      stock, $.01 par value; 80,000,000 shares authorized; 33,193,070,
      33,093,570 and  33,084,570 issued and
      19,811,306,19,726,876  and 19,716,303 outstanding,
      respectively
                                                                
                                                                
                                                                332
                                                                
                                                                
                                                                
                                                                331
                                                                
                                                                
                                                                
                                                                331Additional
      paid-in capital
                                                                
                                                                
                                                                88,780
                                                                
                                                                
                                                                
                                                                87,734
                                                                
                                                                
                                                                
                                                                88,017Retained
      earnings
                                                                
                                                                
                                                                124,780
                                                                
                                                                
                                                                
                                                                120,809
                                                                
                                                                
                                                                
                                                                124,907Treasury
      stock, at cost, 13,381,764, 13,366,694 and 13,368,267 shares held,
      respectively
                                                                
                                                                
                                                                (153,698
                                                                )
                                                                
                                                                
                                                                (153,683
                                                                )
                                                                
                                                                
                                                                (153,684
                                                                )Accumulated
      other comprehensive income (loss)
                                                                
                                                                
                                                                (12,372
                                                                )
                                                                
                                                                
                                                                3,536
                                                                
                                                                
                                                                
                                                                (12,222
                                                                )Total shareholders' equity
                                                                
                                                                
                                                                47,822
                                                                
                                                                
                                                                
                                                                58,727
                                                                
                                                                
                                                                
                                                                47,349Total liabilities and shareholders'
      equity
                                                                
                                                                $
                                                                165,449
                                                                
                                                                
                                                                $
                                                                181,143
                                                                
                                                                
                                                                $
                                                                164,674





See
accompanying notes to consolidated financial statements.





(1) From
audited balance sheet included in our annual report on Form 10-K for the fiscal
year ended January 31, 2009.


3


HANCOCK
FABRICS, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


(unaudited)


Thirteen
                                Weeks
                                Ended
                              
                              
                              Thirteen
                                Weeks
                                Ended
                              
                              
                              Thirty-nine
                                Weeks
                                Ended
                              
                              
                              Thirty-nine
                                Weeks
                                EndedOctober
      31,
                              
                              
                              November 1,
                              
                              
                              October
      31,
                              
                              
                              November 1,(in thousands, except per share
      amounts)
                              
                              2009
                              
                              
                              2008
                              
                              
                              2009
                              
                              
                              2008Sales
                              
                              $
                              72,730
                              
                              
                              $
                              70,563
                              
                              
                              $
                              196,380
                              
                              
                              $
                              198,178Cost of goods sold
                              
                              
                              38,946
                              
                              
                              
                              40,208
                              
                              
                              
                              106,368
                              
                              
                              
                              111,547Gross
      profit
                              
                              
                              33,784
                              
                              
                              
                              30,355
                              
                              
                              
                              90,012
                              
                              
                              
                              86,631Selling,
      general and administrative expense
                              
                              
                              28,211
                              
                              
                              
                              28,286
                              
                              
                              
                              82,311
                              
                              
                              
                              86,915Depreciation and
    amortization
                              
                              
                              1,064
                              
                              
                              
                              1,141
                              
                              
                              
                              3,280
                              
                              
                              
                              3,271Operating
      income (loss)
                              
                              
                              4,509
                              
                              
                              
                              928
                              
                              
                              
                              4,421
                              
                              
                              
                              (3,555
                              )Reorganization
      expense, net
                              
                              
                              182
                              
                              
                              
                              1,060
                              
                              
                              
                              592
                              
                              
                              
                              7,990Interest expense, net
                              
                              
                              1,234
                              
                              
                              
                              851
                              
                              
                              
                              3,944
                              
                              
                              
                              5,417Income
      (loss) from continuing operations before income taxes
                              
                              
                              3,093
                              
                              
                              
                              (983
                              )
                              
                              
                              (115
                              )
                              
                              
                              (16,962
                              )Income taxes
                              
                              
                              64
                              
                              
                              
                              -
                              
                              
                              
                              64
                              
                              
                              
                              -Income
      (loss) from continuing operations
                              
                              
                              3,029
                              
                              
                              
                              (983
                              )
                              
                              
                              (179
                              )
                              
                              
                              (16,962
                              )Earnings from discontinued operations (net of tax
      expense of $0 and $0)
                              
                              
                              3
                              
                              
                              
                              656
                              
                              
                              
                              52
                              
                              
                              
                              436Net income (loss)
                              
                              $
                              3,032
                              
                              
                              $
                              (327
                              )
                              
                              $
                              (127
                              )
                              
                              $
                              (16,526
                              )Basic
      earnings (loss) per share:Earnings
      (loss) from continuing operations
                              
                              $
                              0.16
                              
                              
                              $
                              (0.05
                              )
                              
                              $
                              (0.01
                              )
                              
                              $
                              (0.89
                              )Earnings from discontinued
      operations
                              
                              
                              -
                              
                              
                              
                              0.03
                              
                              
                              
                              -
                              
                              
                              
                              0.02Net earnings (loss)
                              
                              $
                              0.16
                              
                              
                              $
                              (0.02
                              )
                              
                              $
                              (0.01
                              )
                              
                              $
                              (0.87
                              )Diluted
      earnings (loss) per share:Earnings
      (loss) from continuing operations
                              
                              $
                              0.15
                              
                              
                              $
                              (0.05
                              )
                              
                              $
                              (0.01
                              )
                              
                              $
                              (0.89
                              )Earnings from discontinued
      operations
                              
                              
                              -
                              
                              
                              
                              0.03
                              
                              
                              
                              -
                              
                              
                              
                              0.02Net earnings (loss)
                              
                              $
                              0.15
                              
                              
                              $
                              (0.02
                              )
                              
                              $
                              (0.01
                              )
                              
                              $
                              (0.87
                              )Weighted
      average shares outstanding:Basic
                              
                              
                              19,427
                              
                              
                              
                              19,096
                              
                              
                              
                              19,306
                              
                              
                              
                              19,050Diluted
                              
                              
                              20,128
                              
                              
                              
                              19,096
                              
                              
                              
                              19,306
                              
                              
                              
                              19,050





See
accompanying notes to consolidated financial statements.


4


HANCOCK
FABRICS, INC.


CONSOLIDATED
STATEMENT OF SHAREHOLDERS' EQUITY


(unaudited)


AccumulatedAdditional
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            Other
                            
                            
                            TotalCommonStock
                            
                            
                            Paid-in
                            
                            
                            Retained
                            
                            
                            TreasuryStock
                            
                            
                            Comprehensive
                            
                            
                            Shareholders'(in
      thousands, except for number of
      shares)
                            
                            Shares
                            
                            
                            Amount
                            
                            
                            Capital
                            
                            
                            Earnings
                            
                            
                            Shares
                            
                            
                            Amount
                            
                            
                            Income
      (Loss)
                            
                            
                            EquityBalance
      January 31, 2009
                            
                            
                            33,084,570
                            
                            
                            $
                            331
                            
                            
                            $
                            88,017
                            
                            
                            $
                            124,907
                            
                            
                            
                            (13,368,267
                            )
                            
                            $
                            (153,684
                            )
                            
                            $
                            (12,222
                            )
                            
                            $
                            47,349Comprehensive
      loss:Net
      loss
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (127
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (127
                            )Minimum
      pension, SERP and OPEB  liabilities, net of taxes of
      $0
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (150
                            )
                            
                            
                            (150
                            )Total
      comprehensive loss
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (277
                            )Issuance
      of restricted stock
                            
                            
                            149,000
                            
                            
                            
                            1
                            
                            
                            
                            (1
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -Cancellation
      of restricted stock
                            
                            
                            (40,500
                            )
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -Stock
      compensation expense
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            661
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            661Amortization
      of directors' stock fees
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            103
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            103Purchase
      of treasury stock
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (13,497
                            )
                            
                            
                            (14
                            )
                            
                            
                            
                            
                            
                            
                            (14
                            )Balance
      October 31, 2009
                            
                            
                            33,193,070
                            
                            
                            $
                            332
                            
                            
                            $
                            88,780
                            
                            
                            $
                            124,780
                            
                            
                            
                            (13,381,764
                            )
                            
                            $
                            (153,698
                            )
                            
                            $
                            (12,372
                            )
                            
                            $
                            47,822





See
accompanying notes to consolidated financial statements.


5





Hancock Fabrics, Inc.


Consolidated
Statements of Cash Flows


(unaudited)





Thirty-nine
      Weeks EndedOctober
      31,
                                                                                                                                
                                                                                                                                
                                                                                                                                November
      1,(in thousands)
                                                                                                                                
                                                                                                                                2009
                                                                                                                                
                                                                                                                                
                                                                                                                                2008Cash
      flows from operating activities:Net
      loss
                                                                                                                                
                                                                                                                                $
                                                                                                                                (127
                                                                                                                                )
                                                                                                                                
                                                                                                                                $
                                                                                                                                (16,526
                                                                                                                                )Adjustments
      to reconcile net loss to cash flows from operating
    activitiesDepreciation
      and amortization, including cost of goods sold
                                                                                                                                
                                                                                                                                
                                                                                                                                4,788
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                4,929Amortization
      of deferred loan costs
                                                                                                                                
                                                                                                                                
                                                                                                                                185
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                468Amortization
      of bond discount
                                                                                                                                
                                                                                                                                
                                                                                                                                1,748
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                595Interest
      paid-in-kind by issuance of notes payable
                                                                                                                                
                                                                                                                                
                                                                                                                                694
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                423Interest
      accrued on Pre-Petition Obligations
                                                                                                                                
                                                                                                                                
                                                                                                                                -
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                2,219Stock
      compensation expense
                                                                                                                                
                                                                                                                                
                                                                                                                                764
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                663Reserve
      for store closings credits, including interest expense
                                                                                                                                
                                                                                                                                
                                                                                                                                294
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                (2,162
                                                                                                                                )Other
                                                                                                                                
                                                                                                                                
                                                                                                                                (104
                                                                                                                                )
                                                                                                                                
                                                                                                                                
                                                                                                                                (448
                                                                                                                                )Reorganization
      expense, net
                                                                                                                                
                                                                                                                                
                                                                                                                                592
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                7,990(Increase)
      decrease in assetsReceivables
      and prepaid expenses
                                                                                                                                
                                                                                                                                
                                                                                                                                (1,091
                                                                                                                                )
                                                                                                                                
                                                                                                                                
                                                                                                                                381Inventory
      at current cost
                                                                                                                                
                                                                                                                                
                                                                                                                                323
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                243Income
      tax refundable
                                                                                                                                
                                                                                                                                
                                                                                                                                -
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                6,239Other
      noncurrent assets
                                                                                                                                
                                                                                                                                
                                                                                                                                (488
                                                                                                                                )
                                                                                                                                
                                                                                                                                
                                                                                                                                1,725Increase
      (decrease) in liabilitiesAccounts
      payable
                                                                                                                                
                                                                                                                                
                                                                                                                                3,760
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                3,470Accrued
      liabilities
                                                                                                                                
                                                                                                                                
                                                                                                                                1,063
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                207Postretirement
      benefits other than pensions
                                                                                                                                
                                                                                                                                
                                                                                                                                (721
                                                                                                                                )
                                                                                                                                
                                                                                                                                
                                                                                                                                (607
                                                                                                                                )Long-term
      pension and SERP liabilities
                                                                                                                                
                                                                                                                                
                                                                                                                                2,151
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                543Other liabilities
                                                                                                                                
                                                                                                                                
                                                                                                                                (292
                                                                                                                                )
                                                                                                                                
                                                                                                                                
                                                                                                                                (1,165
                                                                                                                                )Net
      cash provided by operating activities before reorganization
      activities
                                                                                                                                
                                                                                                                                
                                                                                                                                13,539
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                9,187Net
      cash used for reorganization activities
                                                                                                                                
                                                                                                                                
                                                                                                                                (700
                                                                                                                                )
                                                                                                                                
                                                                                                                                
                                                                                                                                (7,255
                                                                                                                                )Net cash provided by operating
      activities
                                                                                                                                
                                                                                                                                
                                                                                                                                12,839
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                1,932Cash
      flows from investing activities:Additions
      to property and equipment
                                                                                                                                
                                                                                                                                
                                                                                                                                (2,564
                                                                                                                                )
                                                                                                                                
                                                                                                                                
                                                                                                                                (7,516
                                                                                                                                )Proceeds
      from the disposition of property and equipment
                                                                                                                                
                                                                                                                                
                                                                                                                                12
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                137Net cash used in investing
      activities
                                                                                                                                
                                                                                                                                
                                                                                                                                (2,552
                                                                                                                                )
                                                                                                                                
                                                                                                                                
                                                                                                                                (7,379
                                                                                                                                )Cash
      flows from financing activities:Net
      borrowings (payments) on revolving credit facility
                                                                                                                                
                                                                                                                                
                                                                                                                                (7,598
                                                                                                                                )
                                                                                                                                
                                                                                                                                
                                                                                                                                43,269Payments
      for pre-petition liabilities and other
                                                                                                                                
                                                                                                                                
                                                                                                                                (762
                                                                                                                                )
                                                                                                                                
                                                                                                                                
                                                                                                                                (36,562
                                                                                                                                )Net cash provided by (used in) financing
      activities
                                                                                                                                
                                                                                                                                
                                                                                                                                (8,360
                                                                                                                                )
                                                                                                                                
                                                                                                                                
                                                                                                                                6,707Increase
      in cash and cash equivalents
                                                                                                                                
                                                                                                                                
                                                                                                                                1,927
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                1,260Cash
      and cash equivalents:Beginning of period
                                                                                                                                
                                                                                                                                
                                                                                                                                2,338
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                2,280End of period
                                                                                                                                
                                                                                                                                $
                                                                                                                                4,265
                                                                                                                                
                                                                                                                                
                                                                                                                                $
                                                                                                                                3,540Supplemental
      disclosures:Cash
      paid during the period for:Interest
                                                                                                                                
                                                                                                                                $
                                                                                                                                745
                                                                                                                                
                                                                                                                                
                                                                                                                                $
                                                                                                                                2,583Income
      taxes
                                                                                                                                
                                                                                                                                $
                                                                                                                                64
                                                                                                                                
                                                                                                                                
                                                                                                                                $
                                                                                                                                -Non-cash
      activities:Warrants
      issued with notes
                                                                                                                                
                                                                                                                                $
                                                                                                                                -
                                                                                                                                
                                                                                                                                
                                                                                                                                $
                                                                                                                                (11,685
                                                                                                                                )Noncash
      change in funded status of benefit plans
                                                                                                                                
                                                                                                                                $
                                                                                                                                (150
                                                                                                                                )
                                                                                                                                
                                                                                                                                $
                                                                                                                                (539
                                                                                                                                )





See
accompanying notes to consolidated financial statements.


6





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)





NOTE 1 –  BUSINESS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES





Organization





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 October 31, 2009, Hancock operated 265 stores in 37
states and an internet store under the domain name hancockfabrics.com. Hancock
conducts business in one operating business segment.





References
herein to “Hancock,” the “Company,” “Registrant,” “we,” “our” or “us” refer to
Hancock Fabrics, Inc. and its subsidiaries unless the context specifically
indicates otherwise. References herein to third quarter 2009 and third quarter
2008 are for the 13 week periods ended October 31, 2009 and November 1, 2008,
respectively.  References to thirty-nine weeks 2009, or 2009, and
thirty-nine weeks 2008 or 2008 are for the thirty-nine week periods ended
October 31, 2009 and November 1, 2008, respectively.





Basis
of Presentation





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 January 31, 2009
filed with the U.S. Securities and Exchange Commission (“SEC”) on April 10,
2009, as amended by Form 10-K/A filed with the SEC on October 22, 2009. The
accompanying (a) consolidated balance sheet as of January 31, 2009, 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
October 31, 2009, and November 1, 2008, and our consolidated results of
operations and cash flows for the thirteen and thirty-nine weeks ended
October 31, 2009, and November 1, 2008.





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.


7





Retrospective
Application of a Change in Accounting Principle





During
the fourth quarter of 2008, the Company elected to change its method of valuing
inventory to the weighted average cost (“WAC”) method, whereas in all prior
periods inventory was valued using the last-in, first-out (“LIFO”)
method.  The Company has determined that the WAC method of accounting
for inventory is preferable as this method better reflects our inventory at
current costs and enhances the comparability of our financial statements by
changing to the predominant method utilized in our industry. The Company has
applied this change retrospectively to the consolidated financial statements for
the thirteen and thirty-nine weeks ended November 1, 2008, as defined within the
Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) 250, “Accounting Changes and Error Corrections”.Accordingly, the previously
reported cost of goods sold and net loss declined; the gross profit increased by
$2.1 million and $4.4 million, and the basic and diluted loss per share declined
by $0.11 and $0.23 for the thirteen weeks and thirty-nine weeks ended November
1, 2008, respectively. The change from LIFO to WAC also increased inventory and
shareholders equity by $40.8 million; the amount of the LIFO reserve as of
November 1, 2008.





Recently
Issued Accounting Standards





In
June 2009, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 168, “The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles – a replacement of SFAS 162”, effective for financial
statements issued for interim and annual periods ending after September 15,
2009.  The new standard establishes only two levels of U.S. GAAP,
authoritative and nonauthoritative.  The FASB Accounting Standards
Codification (“ASC”) became the single source of authoritative, nongovernmental
U.S. GAAP, except of rules and interpretive releases of the SEC, which will
continue to be sources of authoritative U.S. GAAP for SEC
registrants.  All other non-grandfathered, non-SEC accounting
literature not included in the ASC became nonauthoritative upon
adoption.  Since the new standard did not change U.S. GAAP, there was
no change to the Company’s Condensed Financial Statements other than to update
all references to U.S. GAAP to be in conformity with the ASC for the quarter
ended October 31, 2009.





In May
2009, the FASB issued ASC 855, “Subsequent Events” (“ASC 855”), which
establishes general standards of accounting for and disclosure of events that
occur after the balance sheet date but before financial statements are issued or
are available to be issued. ASC 855 is effective for financial statements issued
for interim and annual reporting periods ending after June 15, 2009. Management
completed its assessment and its adoption of ASC 855 in fiscal year 2009 and it
has no impact on the Company. The Company has assessed and disclosed reportable
subsequent events, if any, as of December 2, 2009, in connection with the
financial statements for the period ended October 31, 2009.





Several
other new accounting standards became effective during the periods presented or
will be effective subsequent to October 31, 2009. 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 a voluntary petition for reorganization under
Chapter 11 of the United States Bankruptcy Code, in the United States Bankruptcy
Court for the District of Delaware. On August 1, 2008 (the “Effective Date”),
the Company’s Plan of Reorganization (the “Plan”) became effective and the
Company emerged from bankruptcy protection.





As of the
Effective Date, in general and except as otherwise provided under the Plan, the
Company was discharged and released from all claims and interests in accordance
with the Plan.  The Plan provides for payment in full in cash plus
interest, as applicable, or reinstatement of allowed administrative, secured,
priority, and general unsecured claims in addition to the retention of ownership
by holders of equity interest in the Company.  Therefore, there were
no impaired classes of creditors or stockholders.


8





FASB ASC
852, “Reorganizations” (“ASC 852”), provides financial reporting guidance for
entities that are reorganizing under the United States Bankruptcy Code. The
Company implemented this guidance for all periods presented.  Pursuant
to ASC 852, estimated claims were presented as Liabilities Subject to Compromise
due to the uncertainty of the eventual settlement amount.  Due to the
Plan becoming effective and the claims reconciliation process being
substantially complete, there is little uncertainty as to the total amount to be
distributed under the Plan.  Therefore, after the Effective Date,
pre-petition liabilities are no longer presented as Liabilities Subject to
Compromise.





Pre-petition
obligations as of October 31, 2009, November 1, 2008, and January 31, 2009 (in
thousands):


October
      31,
                    
                    
                    November
      1,
                    
                    
                    January
      31,2009
                    
                    
                    2008
                    
                    
                    2009Real
      estate claims
                    
                    $
                    1,019
                    
                    
                    $
                    1,281
                    
                    
                    $
                    1,473Unfunded
      claims (1)
                    
                    
                    -
                    
                    
                    
                    947
                    
                    
                    
                    598Professional
      fee claim
                    
                    
                    725
                    
                    
                    
                    725
                    
                    
                    
                    725Total
      pre-petition claims
                    
                    $
                    1,744
                    
                    
                    $
                    2,953
                    
                    
                    $
                    2,796
  (1)   Amount
      represents claim checks that have been issued but remain outstanding as of
      November
      1, 2008 and January 31,
2009.





NOTE 3 –EMPLOYEE BENEFIT
PLANS





Stock Options. During the
first thirty-nine week period ended October 31, 2009, the Company
granted 673,331 stock options of which 554,331 are subject to a three-year
performance program that requires certain annual benchmarks be obtained
before vesting occurs.  All options were granted with an exercise price
equal to the fair value of the common stock on the date of the grant and vest
over periods of 3 to 4 years.  As of October 31, 2009, options to
purchase a total of 1,704,706 shares of common stock were
outstanding.





Retirement 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
first thirty-nine weeks ended October 31, 2009 and November 1, 2008 (in
thousands):





Retirement
      Plan
                                          
                                          
                                          Postretirement
      Benefit PlanThirty-nine Weeks Ended
                                          
                                          
                                          Thirty-nine Weeks EndedOctober
      31,
                                          
                                          
                                          November
      1,
                                          
                                          
                                          October
      31,
                                          
                                          
                                          November
      1,2009
                                          
                                          
                                          2008
                                          
                                          
                                          2009
                                          
                                          
                                          2008Service
      costs
                                          
                                          $
                                          307
                                          
                                          
                                          $
                                          1,055
                                          
                                          
                                          $
                                          36
                                          
                                          
                                          $
                                          188Interest
      cost
                                          
                                          
                                          3,684
                                          
                                          
                                          
                                          3,397
                                          
                                          
                                          
                                          132
                                          
                                          
                                          
                                          418Expected
      return on assets
                                          
                                          
                                          (2,414
                                          )
                                          
                                          
                                          (4,122
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Amortization
      of prior service costs
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (60
                                          )
                                          
                                          
                                          (579
                                          )
                                          
                                          
                                          (722
                                          )Recognized
      net actuarial (gain) loss
                                          
                                          
                                          630
                                          
                                          
                                          
                                          350
                                          
                                          
                                          
                                          (202
                                          )
                                          
                                          
                                          (129
                                          )Net
      periodic benefit cost
                                          
                                          $
                                          2,207
                                          
                                          
                                          $
                                          620
                                          
                                          
                                          $
                                          (613
                                          )
                                          
                                          $
                                          (245
                                          )





At
October 31, 2009, the fair value of the assets held by the pension plan was
$51.0 million reflecting a $5.5 million increase from January 31, 2009 due to
investment returns during the period.





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 holders of common stock 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.


9





COMPUTATION
OF EARNINGS (LOSS) PER SHARE





(in
      thousands, except for share and
                                
                                Thirteen
      Weeks Ended
                                
                                
                                Thirty-nine
      Weeks Endedper
      share amounts)
                                
                                October
      31,
                                
                                
                                November
      1,
                                
                                
                                October
      31,
                                
                                
                                November
      1,2009
                                
                                
                                2008
                                
                                
                                2009
                                
                                
                                2008Basic
      earnings (loss) per share:Net
      income (loss)
                                
                                $
                                3,032
                                
                                
                                $
                                (327
                                )
                                
                                $
                                (127
                                )
                                
                                $
                                (16,526
                                )Weighted
      average number of common shares outstanding during period
                                
                                
                                19,427,425
                                
                                
                                
                                19,096,214
                                
                                
                                
                                19,305,873
                                
                                
                                
                                19,049,779Basic
      earnings (loss) per share
                                
                                $
                                0.16
                                
                                
                                $
                                (0.02
                                )
                                
                                $
                                (0.01
                                )
                                
                                $
                                (0.87
                                )Diluted
      earnings (loss) per share:Net
      income (loss)
                                
                                $
                                3,032
                                
                                
                                $
                                (327
                                )
                                
                                $
                                (127
                                )
                                
                                $
                                (16,526
                                )Weighted
      average number of common shares outstanding during period
                                
                                
                                19,427,425
                                
                                
                                
                                19,096,214
                                
                                
                                
                                19,305,873
                                
                                
                                
                                19,049,779Stock
      options
                                
                                
                                54,290
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -Warrants
      to purchase common stock
                                
                                
                                626,467
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -Restricted
      stock
                                
                                
                                19,344
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -Weighted
      average number of common shares outstanding during period
                                  adjusted
      for dilutive securities
                                
                                
                                20,127,526
                                
                                
                                
                                19,096,214
                                
                                
                                
                                19,305,873
                                
                                
                                
                                19,049,779Diluted
      earnings (loss) per share
                                
                                $
                                0.15
                                
                                
                                $
                                (0.02
                                )
                                
                                $
                                (0.01
                                )
                                
                                $
                                (0.87
                                )Weighted
      average common stock equivalents not included in EPS
                                  because
      the effect would be anti-dilutive
                                
                                
                                1,212,220
                                
                                
                                
                                1,347,051
                                
                                
                                
                                10,989,080
                                
                                
                                
                                1,548,571





As of
October 31, 2009, the common stock equivalents not included in the thirty-nine
weeks EPS because the effect would be anti-dilutive includes warrants to
purchase 9.5 million shares of common stock with a per share exercise price of
$1.12 which expire August 1, 2013.




10




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 October 31, 2009, the total reserve balance
included in current liabilities was $0.8 million, which represents the present
value of the future net lease obligations for the locations which have been
closed.





The
activity in the reserve is as follows (in thousands):





Addition toJanuary
      31,
                          
                          
                          (Reduction
      in)
                          
                          
                          
                          
                          
                          
                          
                          
                          October
      31,2009
                          
                          
                          Reserve
                          
                          
                          Interest
                          
                          
                          Payments
                          
                          
                          2009Lease
      obligations
                          
                          $
                          1,219
                          
                          
                          $
                          292
                          
                          
                          $
                          2
                          
                          
                          $
                          (700
                          )
                          
                          $
                          813





During
the first thirty-nine weeks ended October 31, 2009 income of $52,000 was
recognized in earnings from discontinued operations for the settlement of claims
on stores closed in prior years. During the first thirty-nine weeks ended
November 1, 2008, income of approximately $0.4 million was recognized that is
attributable to discontinued operations from prior years.  This was the
result of changes in the closed store reserve due to settlement of certain real
estate bankruptcy claims.





NOTE
6 – FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS





FASB ASC
820, Fair Value Measurements and Disclosures, defines fair value, establishes a
three-level valuation hierarchy for disclosures of fair value measurement and
enhances disclosure requirements for fair value measures. The three levels are
defined as follows:





Level 1 - inputs
to the valuation methodology are quoted prices (unadjusted) for identical assets
or liabilities in active markets.





Level 2 - inputs
to the valuation methodology include quoted prices for similar assets and
liabilities in active markets, and inputs that are observable for the assets or
liability, either directly or indirectly, for substantially the full term of the
financial instruments.





Level 3 - inputs
to the valuation methodology are unobservable and significant to the fair
value.





The
Company measures certain financial assets (cash and cash equivalents) at fair
value on a recurring basis. The Company’s investments in cash and cash
equivalents are classified within Level 1 of the fair value hierarchy because
they are valued based on quoted market prices in active markets.  The
carrying amounts of certain of the Company’s financial instruments, which are
not required to be valued at fair value on a recurring basis, including accounts
receivable, accounts payable, accrued liabilities and debt approximate fair
value due to their short maturities or the nature and terms of the
obligation.





NOTE
7 – LONG-TERM DEBT OBLIGATIONS




At
October 31, 2009, the Company had outstanding borrowings of $25.0 million under
its revolving credit facility (the “Revolver”) with General Electric Capital
Corporation, which has a maturity date of August 1, 2013. Outstanding
standby letters of credit were $5.9 million, outstanding documentary letters of
credit were $0.1 million and availability was $43.1 million at October 31, 2009.
The Revolver is collateralized by a fully perfected first priority security
interest in all real and personal, tangible and intangible assets of the
Company.  The Company is not subject to any financial covenants
pursuant to the Revolver.


11




At the
Company’s option, any portion of the outstanding borrowings under the Revolver
can bear interest at LIBOR - based rates plus an applicable margin, or a
floating interest rate plus the applicable margins. At October 31, 2009, the
Company had all $25.0 million of its outstanding borrowings at a LIBOR-based
interest rate of 1.87%





In
addition to the Revolver, the Company has $21.6 million of Floating Rate Secured
Notes (the “Notes”) outstanding at October 31, 2009. The Notes mature on August
1, 2013, are subordinated to the Revolver, and are secured by a junior lien on
all of the Company’s assets. Interest on the Notes is payable quarterly and for
the quarterly interest periods ended November 1, 2008, February 1, 2009, May 1,
2009 and August 1, 2009 the Company had the option and elected to make the
interest payment in-kind by issuing additional Notes totaling $0.7 million. The
amount of additional notes issued was based on an effective interest rate of
6.6%.  Going forward, interest is payable quarterly in cash at a rate
of LIBOR plus 4.5%. An additional $1.7 million of interest expense has been
recorded year-to-date related to the amortization of the discount recorded at
the time of issuance of the Notes. As of October 31, 2009 the unamortized
discount was $8.8 million.




NOTE
8 – SUBSEQUENT EVENTS





On
November 17, 2009, Hancock filed Form 8-K with the SEC disclosing an amendment
to the Company’s amended and restated rights agreement. In summary, on November
12, 2009, the Board of Directors of Hancock adopted an Amendment (the
“Amendment”) to the Amended and Restated Rights Agreement (the “Rights Plan”).
The Amendment amends the Rights Plan dated as of March 23, 1987, as amended and
restated from time to time. The Rights Plan governs the terms of each right (a
“Right”) that has been issued with each share of common stock of Hancock (the
“Common Stock”). Each Right initially represents the right to purchase one share
of Common Stock.





Hancock
adopted the Amendment to preserve the value of the Company’s tax assets,
including the Company’s net operating loss carry forwards (“Tax Benefits”) for
both the Company and its stockholders. The Company’s ability to fully use its
Tax Benefits to offset future income may be limited if it experiences an
“ownership change” for purposes of Section 382 of the Internal Revenue Code of
1986.





The
Amendment is designed to reduce the likelihood that Hancock will experience an
ownership change by (i) discouraging any person (together with such person’s
affiliates or associates) from acquiring 4.95% or more of the then outstanding
Common Stock and (ii) discouraging any person (together with such person’s
affiliates or associates) that currently beneficially owns at least 4.95% of the
outstanding Common Stock from acquiring more than a specified percentage of
additional shares of Common Stock. There is no guarantee, however, that the
Rights Plan will prevent the Company from experiencing an ownership
change.


12





ITEM
      2.
              MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIALCONDITION
      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 10, 2009, as amended by Form 10-K/A
filed with the SEC on October 22, 2009 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.





Our
Business





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.  We are one of
the largest fabric retailers in the United States, operating 265 stores in 37
states as of October 31, 2009.  Our stores present a broad selection
of fabrics and notions used in apparel sewing, home decorating and quilting
projects.





Overview





Financial
highlights include:





·
            Net
      sales for the third quarter of fiscal 2009 were $72.7 million compared to
      $70.6 million for third quarter of fiscal 2008, and comparable store sales
      increased 4.0% and 2.1% in the third quarter of 2009 and third quarter
      2008, respectively.





·
            Our
      online sales for the third quarter of fiscal 2009, which are included in
      the comparable sales number above, increased 44.4% to $1.3
      million.





·
            Gross
      margin for the third quarter of fiscal 2009 was 46.5% compared with 43.0%
      for the third quarter of fiscal
2008.





·
            Operating
      income was $4.5 million in the third quarter of fiscal 2009 compared to
      $0.9 million in the third quarter of fiscal
  2008.





·
            Net
      income was $3.0 million, or $0.16 per basic share, in the third quarter of
      fiscal 2009 compared to a loss of $0.3 million, or $0.02 per share in the
      third quarter of fiscal 2008.





·
            The
      amount of cash generated from operations before reorganization activities
      increased by $4.3 million to $13.5 million during the thirty-nine weeks of
      fiscal 2009 compared to the same period of fiscal
  2008.


13


We use a
number of key performance measures to evaluate our financial performance,
including the following:





Thirteen Weeks Ended
                    
                    
                    Thirty-nine Weeks EndedOctober
      31,
                    
                    
                    November
      1,
                    
                    
                    October
      31,
                    
                    
                    November
      1,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Net
      sales (in thousands)
                    
                    $
                    72,730
                    
                    
                    $
                    70,563
                    
                    
                    $
                    196,380
                    
                    
                    $
                    198,178Gross
      margin percentage
                    
                    
                    46.5
                    %
                    
                    
                    43.0
                    %
                    
                    
                    45.8
                    %
                    
                    
                    43.7
                    %Number
      of storesOpen
      at end of period (1)
                    
                    
                    265
                    
                    
                    
                    265
                    
                    
                    
                    265
                    
                    
                    
                    265Comparable
      stores at period end (2)
                    
                    
                    262
                    
                    
                    
                    264
                    
                    
                    
                    262
                    
                    
                    
                    264Sales
      growthAll
      retail outlets
                    
                    
                    3.1
                    %
                    
                    
                    1.3
                    %
                    
                    
                    (0.9
                    )
      %
                    
                    
                    0.7
                    %Comparable
      retail outlets (2)
                    
                    
                    4.0
                    %
                    
                    
                    2.1
                    %
                    
                    
                    0.9
                    %
                    
                    
                    2.9
                    %Total
      store square footage at period end (in thousands)
                    
                    
                    3,795
                    
                    
                    
                    3,797
                    
                    
                    
                    3,795
                    
                    
                    
                    3,797Net
      sales per total square footage
                    
                    $
                    19.16
                    
                    
                    $
                    18.58
                    
                    
                    $
                    51.75
                    
                    
                    $
                    52.19





(1)
            Open
      store count does not include the internet
store.





(2)
            A
      new store is included in the comparable sales computation immediately upon
      reaching its one-year anniversary. Comparable sales computation also
      includes net sales derived from e-commerce. In those rare instances where
      stores are either expanded or down-sized, the store is not treated as a
      new store and, therefore, remains in the computation of comparable sales.
      The comparable sales increase for the thirteen and thirty-nine weeks of
      2008 excluded a 0.3% and 0.6% benefit, respectively, from liquidation
      sales.





Results
of Operations





The
following table sets forth, for the periods indicated, selected statement of
operations data expressed as a percentage of sales.  This table should
be read in conjunction with the following discussion and with our Consolidated
Financial Statements, including the related notes.





Thirteen Weeks Ended
                  
                  
                  Thirty-nine Weeks EndedOctober
      31,
                  
                  
                  November
      1,
                  
                  
                  October
      31,
                  
                  
                  November
      1,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Sales
                  
                  
                  100.0
                  %
                  
                  
                  100.0
                  %
                  
                  
                  100.0
                  %
                  
                  
                  100.0
                  %Cost
      of goods sold
                  
                  
                  53.5
                  
                  
                  
                  57.0
                  
                  
                  
                  54.2
                  
                  
                  
                  56.3Gross
      profit
                  
                  
                  46.5
                  
                  
                  
                  43.0
                  
                  
                  
                  45.8
                  
                  
                  
                  43.7Selling,
      general and administrative expense
                  
                  
                  38.8
                  
                  
                  
                  40.1
                  
                  
                  
                  41.9
                  
                  
                  
                  43.9Depreciation
      and amortization
                  
                  
                  1.5
                  
                  
                  
                  1.6
                  
                  
                  
                  1.6
                  
                  
                  
                  1.7Operating
      income (loss)
                  
                  
                  6.2
                  
                  
                  
                  1.3
                  
                  
                  
                  2.3
                  
                  
                  
                  (1.9
                  )Reorganization
      expense, net
                  
                  
                  0.2
                  
                  
                  
                  1.5
                  
                  
                  
                  0.3
                  
                  
                  
                  4.0Interest
      expense, net
                  
                  
                  1.7
                  
                  
                  
                  1.2
                  
                  
                  
                  2.0
                  
                  
                  
                  2.7Income
      (loss) from continuing operations before income taxes
                  
                  
                  4.3
                  
                  
                  
                  (1.4
                  )
                  
                  
                  0.0
                  
                  
                  
                  (8.6
                  )Income
      taxes
                  
                  
                  0.1
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Income
      (loss) from discontinued operations
                  
                  
                  -
                  
                  
                  
                  0.9
                  
                  
                  
                  -
                  
                  
                  
                  0.2Net
      income (loss)
                  
                  
                  4.2
                  %
                  
                  
                  (0.5
                  )
      %
                  
                  
                  0.0
                  %
                  
                  
                  (8.4
                  )
      %


14





Net
Sales





Thirteen Weeks Ended
                      
                      
                      Thirty-nine Weeks Ended(in
      thousands)
                      
                      October
      31,
                      
                      
                      November
      1,
                      
                      
                      October
      31,
                      
                      
                      November
      1,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Current
      store base
                      
                      $
                      71,460
                      
                      
                      $
                      68,494
                      
                      
                      $
                      193,079
                      
                      
                      $
                      190,938Closed
      stores
                      
                      
                      -
                      
                      
                      
                      1,190
                      
                      
                      
                      359
                      
                      
                      
                      4,874E-Commerce
                      
                      
                      1,270
                      
                      
                      
                      879
                      
                      
                      
                      2,942
                      
                      
                      
                      2,366Total
      net sales
                      
                      $
                      72,730
                      
                      
                      $
                      70,563
                      
                      
                      $
                      196,380
                      
                      
                      $
                      198,178





The
current store base above represents the 265 stores which are currently in
operation. Of these 265 stores, 262 were in operation at November 1, 2008. The
third quarter 2009 comparable sales (excludes e-commerce) increase of 3.5% was
driven primarily by a 3.6% increase in transaction count. Comparable sales for
the thirty-nine weeks 2009 increased 0.6% as a result of an increase of 3.8% in
transaction count offset by a decrease of 1.25% in average ticket. The sales of
apparel and notions products for the thirty-nine weeks 2009 increased
significantly and were offset by decreases in sales of home decorating products
during the third quarter 2009 and thirty-nine weeks 2009.





One store
was closed in the first thirty-nine weeks of fiscal 2009 and 7 stores closed in
the fiscal year ended January 31, 2008, which did not qualify as discontinued
operations.  The sales from these locations are included in net
sales.





The
Company launched a new e-commerce platform in August 2008, which has provided a
considerable increase in our e-commerce business.  Sales in the third
quarter of fiscal 2009 compared to the same period of 2008 were up 44.4% and
sales for the first thirty-nine weeks of 2009 are up 24.3% over the same period
of the prior year.





Our
merchandise mix has had minimal change year over year, as reflected in the table
below.  We attribute the downward shift in home decorating to the
recent national economic difficulties which limit the amount of discretionary
income available to purchase higher ticket fabrics required for
decorating.





Thirteen Weeks Ended
                      
                      
                      Thirty-nine Weeks EndedOctober
      31,
                      
                      
                      November
      1,
                      
                      
                      October
      31,
                      
                      
                      November
      1,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Apparel
      Fabrics
                      
                      
                      32
                      %
                      
                      
                      31
                      %
                      
                      
                      29
                      %
                      
                      
                      28
                      %Home
      Decorating
                      
                      
                      18
                      %
                      
                      
                      20
                      %
                      
                      
                      20
                      %
                      
                      
                      23
                      %Quilting/Craft
                      
                      
                      25
                      %
                      
                      
                      26
                      %
                      
                      
                      26
                      %
                      
                      
                      26
                      %Notions
      and Accessories
                      
                      
                      25
                      %
                      
                      
                      23
                      %
                      
                      
                      25
                      %
                      
                      
                      23
                      %100
                      %
                      
                      
                      100
                      %
                      
                      
                      100
                      %
                      
                      
                      100
                      %





Gross
Margin





Costs of
goods sold include:





·
            the
      cost of merchandise





·
            inventory
      rebates and allowances including term
discounts


15


·
            inventory
      shrinkage and valuation adjustments





·
            freight
      charges





·
            costs
      associated with our sourcing operations, including payroll and related
      benefits





·
            costs
      associated with receiving, processing, and warehousing
      merchandise





The
classification of these expenses varies across the retail industry.





Specific
components of cost of goods sold for the third quarter and first thirty-nine
weeks of fiscal 2009 and 2008 are as follows:





Thirteen Weeks Ended
                                                                                    
                                                                                    
                                                                                    Thirty-nine Weeks EndedOctober
      31,
                                                                                    
                                                                                    
                                                                                    %
      of
                                                                                    
                                                                                    
                                                                                    November
      1,
                                                                                    
                                                                                    
                                                                                    %
      of
                                                                                    
                                                                                    
                                                                                    October
      31,
                                                                                    
                                                                                    
                                                                                    %
      of
                                                                                    
                                                                                    
                                                                                    November
      1,
                                                                                    
                                                                                    
                                                                                    %
      of(in
      thousands)
                                                                                    
                                                                                    2009
                                                                                    
                                                                                    
                                                                                    Sales
                                                                                    
                                                                                    
                                                                                    2008
                                                                                    
                                                                                    
                                                                                    Sales
                                                                                    
                                                                                    
                                                                                    2009
                                                                                    
                                                                                    
                                                                                    Sales
                                                                                    
                                                                                    
                                                                                    2008
                                                                                    
                                                                                    
                                                                                    SalesTotal
      net sales
                                                                                    
                                                                                    $
                                                                                    72,730
                                                                                    
                                                                                    
                                                                                    
                                                                                    100.0
                                                                                    %
                                                                                    
                                                                                    $
                                                                                    70,563
                                                                                    
                                                                                    
                                                                                    
                                                                                    100.0
                                                                                    %
                                                                                    
                                                                                    $
                                                                                    196,380
                                                                                    
                                                                                    
                                                                                    
                                                                                    100.0
                                                                                    %
                                                                                    
                                                                                    $
                                                                                    198,178
                                                                                    
                                                                                    
                                                                                    
                                                                                    100.0
                                                                                    %Merchandise
      cost
                                                                                    
                                                                                    
                                                                                    33,682
                                                                                    
                                                                                    
                                                                                    
                                                                                    46.3
                                                                                    %
                                                                                    
                                                                                    
                                                                                    34,256
                                                                                    
                                                                                    
                                                                                    
                                                                                    48.5
                                                                                    %
                                                                                    
                                                                                    
                                                                                    90,789
                                                                                    
                                                                                    
                                                                                    
                                                                                    46.2
                                                                                    %
                                                                                    
                                                                                    
                                                                                    94,739
                                                                                    
                                                                                    
                                                                                    
                                                                                    47.8
                                                                                    %Freight
                                                                                    
                                                                                    
                                                                                    2,152
                                                                                    
                                                                                    
                                                                                    
                                                                                    2.9
                                                                                    %
                                                                                    
                                                                                    
                                                                                    2,363
                                                                                    
                                                                                    
                                                                                    
                                                                                    3.4
                                                                                    %
                                                                                    
                                                                                    
                                                                                    5,681
                                                                                    
                                                                                    
                                                                                    
                                                                                    3.0
                                                                                    %
                                                                                    
                                                                                    
                                                                                    6,667
                                                                                    
                                                                                    
                                                                                    
                                                                                    3.4
                                                                                    %Sourcing
      and warehousing
                                                                                    
                                                                                    
                                                                                    3,112
                                                                                    
                                                                                    
                                                                                    
                                                                                    4.3
                                                                                    %
                                                                                    
                                                                                    
                                                                                    3,589
                                                                                    
                                                                                    
                                                                                    
                                                                                    5.1
                                                                                    %
                                                                                    
                                                                                    
                                                                                    9,898
                                                                                    
                                                                                    
                                                                                    
                                                                                    5.0
                                                                                    %
                                                                                    
                                                                                    
                                                                                    10,141
                                                                                    
                                                                                    
                                                                                    
                                                                                    5.1
                                                                                    %Gross
      Profit
                                                                                    
                                                                                    $
                                                                                    33,784
                                                                                    
                                                                                    
                                                                                    
                                                                                    46.5
                                                                                    %
                                                                                    
                                                                                    $
                                                                                    30,355
                                                                                    
                                                                                    
                                                                                    
                                                                                    43.0
                                                                                    %
                                                                                    
                                                                                    $
                                                                                    90,012
                                                                                    
                                                                                    
                                                                                    
                                                                                    45.8
                                                                                    %
                                                                                    
                                                                                    $
                                                                                    86,631
                                                                                    
                                                                                    
                                                                                    
                                                                                    43.7
                                                                                    %





We
experienced a reduction of 220 basis points in the direct cost of merchandise as
a percentage of total net sales compared to the third quarter of 2008 and a
reduction of 160 basis points in the first thirty-nine weeks 2009 compared to
the first thirty-nine weeks 2008.  This is a result of increasing the
amount of product sourced from overseas, continually expanding our vendor
network domestically, and increasing our focus on reducing product
shrinkage.





Freight
expense, as a percentage of total net sales, has declined by 50 basis points in
the third quarter 2009 compared to the third quarter 2008 and 40 basis points
for the first thirty-nine weeks of 2009 compared to the same period of fiscal
2008.  The Company is benefitting from relatively stable fuel prices
in the thirty-nine weeks of 2009 compared to the same period 2008 as well as
efficiencies within our shipping process.





Sourcing
and warehousing costs for the Company vary based on both the level of inventory
received during any period and the rate of inventory turns. The cost decreases,
as a percentage of total net sales, of 80 basis points for the third quarter
2009 and 10 basis points for the first thirty-nine weeks 2009 compared to the
same periods in 2008 respectively, are primarily due to a decrease in corporate
expenses associated with sourcing and warehousing.





In total,
our operational initiatives have resulted in an increase in gross margin of 350
basis points in the third quarter 2009 over third quarter 2008 levels and 210
basis points for the first thirty-nine weeks 2009 over the first thirty-nine
weeks 2008 levels.


16


Sales,
General & Administrative Expenses





Sales,
general & administrative expenses include:





·
            payroll
      and related benefits (for our store operations, field management, and
      corporate functions)





·
            advertising





·
            general
      and administrative expenses





·
            occupancy
      including rent, common area maintenance, taxes and insurance for our
      retail locations





·
            operating
      costs of our headquarter facilities





·
            other
      expense (income)





Specific
components of sales, general & administrative expenses include:





Thirteen Weeks Ended
                                                                                    
                                                                                    
                                                                                    Thirty-nine Weeks EndedOctober
      31,
                                                                                    
                                                                                    
                                                                                    %
      of
                                                                                    
                                                                                    
                                                                                    November
      1,
                                                                                    
                                                                                    
                                                                                    %
      of
                                                                                    
                                                                                    
                                                                                    October
      31,
                                                                                    
                                                                                    
                                                                                    %
      of
                                                                                    
                                                                                    
                                                                                    November
      1,
                                                                                    
                                                                                    
                                                                                    %
      of(in
      thousands)
                                                                                    
                                                                                    2009
                                                                                    
                                                                                    
                                                                                    Sales
                                                                                    
                                                                                    
                                                                                    2008
                                                                                    
                                                                                    
                                                                                    Sales
                                                                                    
                                                                                    
                                                                                    2009
                                                                                    
                                                                                    
                                                                                    Sales
                                                                                    
                                                                                    
                                                                                    2008
                                                                                    
                                                                                    
                                                                                    SalesRetail
      store labor costs
                                                                                    
                                                                                    $
                                                                                    10,446
                                                                                    
                                                                                    
                                                                                    
                                                                                    14.4
                                                                                    %
                                                                                    
                                                                                    $
                                                                                    10,820
                                                                                    
                                                                                    
                                                                                    
                                                                                    15.3
                                                                                    %
                                                                                    
                                                                                    $
                                                                                    30,677
                                                                                    
                                                                                    
                                                                                    
                                                                                    15.6
                                                                                    %
                                                                                    
                                                                                    $
                                                                                    33,005
                                                                                    
                                                                                    
                                                                                    
                                                                                    16.7
                                                                                    %Advertising
                                                                                    
                                                                                    
                                                                                    2,359
                                                                                    
                                                                                    
                                                                                    
                                                                                    3.2
                                                                                    %
                                                                                    
                                                                                    
                                                                                    2,884
                                                                                    
                                                                                    
                                                                                    
                                                                                    4.1
                                                                                    %
                                                                                    
                                                                                    
                                                                                    6,965
                                                                                    
                                                                                    
                                                                                    
                                                                                    3.5
                                                                                    %
                                                                                    
                                                                                    
                                                                                    6,618
                                                                                    
                                                                                    
                                                                                    
                                                                                    3.3
                                                                                    %Store
      occupancy
                                                                                    
                                                                                    
                                                                                    7,363
                                                                                    
                                                                                    
                                                                                    
                                                                                    10.1
                                                                                    %
                                                                                    
                                                                                    
                                                                                    7,290
                                                                                    
                                                                                    
                                                                                    
                                                                                    10.3
                                                                                    %
                                                                                    
                                                                                    
                                                                                    22,053
                                                                                    
                                                                                    
                                                                                    
                                                                                    11.2
                                                                                    %
                                                                                    
                                                                                    
                                                                                    22,139
                                                                                    
                                                                                    
                                                                                    
                                                                                    11.2
                                                                                    %Retail
      SG&A
                                                                                    
                                                                                    
                                                                                    5,454
                                                                                    
                                                                                    
                                                                                    
                                                                                    7.5
                                                                                    %
                                                                                    
                                                                                    
                                                                                    4,550
                                                                                    
                                                                                    
                                                                                    
                                                                                    6.5
                                                                                    %
                                                                                    
                                                                                    
                                                                                    15,279
                                                                                    
                                                                                    
                                                                                    
                                                                                    7.9
                                                                                    %
                                                                                    
                                                                                    
                                                                                    16,091
                                                                                    
                                                                                    
                                                                                    
                                                                                    8.1
                                                                                    %Corp
      SG&A
                                                                                    
                                                                                    
                                                                                    2,589
                                                                                    
                                                                                    
                                                                                    
                                                                                    3.6
                                                                                    %
                                                                                    
                                                                                    
                                                                                    2,742
                                                                                    
                                                                                    
                                                                                    
                                                                                    3.9
                                                                                    %
                                                                                    
                                                                                    
                                                                                    7,337
                                                                                    
                                                                                    
                                                                                    
                                                                                    3.7
                                                                                    %
                                                                                    
                                                                                    
                                                                                    9,062
                                                                                    
                                                                                    
                                                                                    
                                                                                    4.6
                                                                                    %Total
      SG&A
                                                                                    
                                                                                    $
                                                                                    28,211
                                                                                    
                                                                                    
                                                                                    
                                                                                    38.8
                                                                                    %
                                                                                    
                                                                                    $
                                                                                    28,286
                                                                                    
                                                                                    
                                                                                    
                                                                                    40.1
                                                                                    %
                                                                                    
                                                                                    $
                                                                                    82,311
                                                                                    
                                                                                    
                                                                                    
                                                                                    41.9
                                                                                    %
                                                                                    
                                                                                    $
                                                                                    86,915
                                                                                    
                                                                                    
                                                                                    
                                                                                    43.9
                                                                                    %





Retail
Store Labor Costs – The Company achieved greater efficiency in store labor costs
during the first thirty-nine weeks 2009 compared to the same period
2008.  These savings were driven by a reduction in direct store labor
resulting from additional corporate oversight in relation to employee
scheduling, leveraging our technology investment in store infrastructure, and
the conversion of the majority of our store associates to
part-time.





Advertising
– The variance in advertising expense for the third quarter and
first thirty-nine weeks 2009 compared to the same periods in 2008 is due to
a more focused marketing approach. This increased focus resulted in a shift of
initiatives from the third quarter of 2009 to previous periods of 2009. The
shift of initiatives resulted in lower spending third quarter 2009 compared to
third quarter 2008 and similar spending levels in the thirty-nine weeks 2009
compared to the first thirty-nine weeks 2008.





Store
Occupancy – These costs have remained relatively constant despite the renewal of
a significant number of leases over the past twelve
months.  Significant effort has been incurred to restructure rents as
a result of the current commercial real estate market.  These efforts
in some cases resulted in rent reductions, concessions on future escalations,
and term extensions.





Retail
SG&A – Third quarter 2009 expenses compared to third quarter 2008 increased
primarily due to insurance claims and incremental housekeeping expenses. For the
first thirty-nine weeks 2009, costs associated with our retail locations have
decreased in relation to the prior year amount as a result of strict budgetary
control exercised by our store personnel.





Corporate
SG&A – Our third quarter 2009 and first thirty-nine weeks of fiscal 2009
corporate costs have been reduced by lowering the professional fees associated
with compliance requirements, reducing the expense associated with equity
grants, and a reduction in previously accrued bankruptcy claims which were
applicable to continuing operations.


17


Reorganization
Expenses, Net
 
 Thirteen Weeks Ended
                                            
                                            
                                            Thirty-nine Weeks EndedOctober
      31,
                                            
                                            
                                            %
      of
                                            
                                            
                                            November
      1,
                                            
                                            
                                            %
      of
                                            
                                            
                                            October
      31,
                                            
                                            
                                            %
      of
                                            
                                            
                                            November
      1,
                                            
                                            
                                            %
      of(in
      thousands)
                                            
                                            2009
                                            
                                            
                                            Sales
                                            
                                            
                                            2008
                                            
                                            
                                            Sales
                                            
                                            
                                            2009
                                            
                                            
                                            Sales
                                            
                                            
                                            2008
                                            
                                            
                                            SalesReorganziation
      expense, net
                                            
                                            $
                                            182
                                            
                                            
                                            
                                            0.2
                                            %
                                            
                                            $
                                            1,060
                                            
                                            
                                            
                                            1.5
                                            %
                                            
                                            $
                                            592
                                            
                                            
                                            
                                            0.3
                                            %
                                            
                                            $
                                            7,990
                                            
                                            
                                            
                                            4.0
                                            %
 
 Reorganization
expenses are comprised of the cost of professional fees associated with our
bankruptcy proceedings.  These costs were significant during the
bankruptcy through the time of emergence in August, 2008.  There are
limited bankruptcy issues remaining and these costs are not expected to be
significant going forward.
 
 Interest
Expense, Net
 
 Thirteen Weeks Ended
                                      
                                      
                                      Thirty-nine Weeks Ended(in
      thousands)
                                      
                                      October
      31,
                                      
                                      
                                      %
      of
                                      
                                      
                                      November
      1,
                                      
                                      
                                      %
      of
                                      
                                      
                                      October
      31,
                                      
                                      
                                      %
      of
                                      
                                      
                                      November
      1,
                                      
                                      
                                      %
      of2009
                                      
                                      
                                      Sales
                                      
                                      
                                      2008
                                      
                                      
                                      Sales
                                      
                                      
                                      2009
                                      
                                      
                                      Sales
                                      
                                      
                                      2008
                                      
                                      
                                      SalesInterest
      expense, net
                                      
                                      $
                                      1,234
                                      
                                      
                                      
                                      1.7
                                      %
                                      
                                      $
                                      851
                                      
                                      
                                      
                                      1.2
                                      %
                                      
                                      $
                                      3,944
                                      
                                      
                                      
                                      2.0
                                      %
                                      
                                      $
                                      5,417
                                      
                                      
                                      
                                      2.7
                                      %
 
 The
Company’s interest costs are driven by borrowings on our credit facilities and a
small number of capital leases.  Our current credit facilities consist
of both an asset-based facility and a subordinated-debt
facility.  Interest expense for the third quarter 2009 and third
quarter 2008 include $0.6 million of note discount amortization. In addition,
third quarter 2008 includes $0.4 million of interest paid with the issuance of
additional notes and interest income of $1.0 million from income tax
refunds.  Excluding these non-cash and one-time items, interest
expense for the third quarter of 2009 was $0.7 million, or 0.9% of sales,
compared to $0.9 million or 1.2% of sales in third quarter
2008.  Interest expense for the first thirty-nine weeks of 2009
includes $1.7 million of note discount amortization and $0.7 million of interest
paid with the issuance of additional notes. Interest expense for the first
thirty-nine weeks 2008 included $2.2 million of interest paid on bankruptcy
claims, interest income of $1.0 million from income tax refunds and non-cash
items of $1.0 million. Excluding these non-cash and one-time items, interest
expense for the first thirty-nine weeks of 2009 and 2008 was $1.5 million or
0.8% of sales and $3.2 million or 1.6% of sales, respectively.
 
 Income
Taxes
 Thirteen Weeks Ended
                                
                                
                                Thirty-nine Weeks Ended(in
      thousands)
                                
                                October
      31,
                                
                                
                                %
      of
                                
                                
                                November
      1,
                                
                                
                                %
      of
                                
                                
                                October
      31,
                                
                                
                                %
      of
                                
                                
                                November
      1,
                                
                                
                                %
      of2009
                                
                                
                                Sales
                                
                                
                                2008
                                
                                
                                Sales
                                
                                
                                2009
                                
                                
                                Sales
                                
                                
                                2008
                                
                                
                                SalesIncome
      taxes
                                
                                $
                                64
                                
                                
                                
                                0.1
                                %
                                
                                $
                                -
                                
                                
                                
                                0.0
                                %
                                
                                $
                                64
                                
                                
                                
                                0.0
                                %
                                
                                $
                                -
                                
                                
                                
                                0.0
                                %
 
 Income
tax expense for 2009 represents alternative minimum tax (AMT), which cannot be
fully offset by the net operating loss carryforward of the Company. ASC 740,
“Income Taxes”, requires the AMT be recognized as a tax credit carryforward to
be utilized against income taxes in a future period when income taxes exceed
AMT. The AMT credit may be carried forward with no expiration. Since the
realization of future tax credit carryforwards is dependent upon profitable
future operations, the Company has in essence recognized a full valuation
allowance against such credits and treated the payment of AMT as tax
expense.
  18
 
 Loss
from Discontinued Operations
 
 (in
      thousands)
                                    
                                    Thirteen Weeks Ended
                                    
                                    
                                    Thirty-nine Weeks EndedOctober
      31,
                                    
                                    
                                    %
      of
                                    
                                    
                                    November
      1,
                                    
                                    
                                    %
      of
                                    
                                    
                                    October
      31,
                                    
                                    
                                    %
      of
                                    
                                    
                                    November
      1,
                                    
                                    
                                    %
      of2009
                                    
                                    
                                    Sales
                                    
                                    
                                    2008
                                    
                                    
                                    Sales
                                    
                                    
                                    2009
                                    
                                    
                                    Sales
                                    
                                    
                                    2008
                                    
                                    
                                    SalesIncome
      (loss) from discountinued operations
                                    
                                    $
                                    3
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    $
                                    656
                                    
                                    
                                    
                                    0.9
                                    %
                                    
                                    $
                                    52
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    $
                                    436
                                    
                                    
                                    
                                    0.2
                                    %
 
 The
discontinued operations in 2008 and 2009 are the residual related to 26 store
closures in fiscal 2006 and 124 in fiscal 2007 that qualified for treatment as
discontinued operations. All of these store closures were part of a
reorganization plan implemented prior to seeking bankruptcy protection. No
stores closed in either fiscal 2009 or fiscal 2008 required treatment as
discontinued operations. The income in 2009 and 2008 resulted from the
settlement of leases rejected in bankruptcy at amounts less than anticipated.
The Company expects to resolve all remaining lease-related bankruptcy claims by
the end of fiscal 2009.
 
 Liquidity
and Capital Resources
 
 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, short-term trade credit in the form of
extended payment terms from suppliers for inventory purchases, and borrowings
from commercial lenders.
 
 We
anticipate that we will be able to satisfy our working capital requirements,
planned capital expenditures and debt service requirements with available cash,
proceeds from cash flows from operations, short-term trade credit, borrowings
under our revolving credit facility and other sources of
financing.  We expect to generate adequate cash flow from operating
activities to sustain current levels of operations.
 
 Hancock’s
cash flow related information as of the first thirty-nine weeks of fiscal 2009
and 2008 follows (in thousands):
 
 Thirty-nine Weeks EndedOctober
      31,
                    
                    
                    November
      1,2009
                    
                    
                    2008Net
      cash flows provided (used):Operating
      activites
                    
                    $
                    12,839
                    
                    
                    $
                    1,932Investing
      activities
                    
                    
                    (2,552
                    )
                    
                    
                    (7,379
                    )Financing
      activites
                    
                    
                    (8,360
                    )
                    
                    
                    6,707
 
 Operating
Activities
 
 Net cash
inflows provided by operating activities during the first thirty-nine weeks 2009
increased by $10.9 million compared to the first thirty-nine weeks
2008.  This increase was primarily the result of the reduction in the
Company’s net loss of $16.4 million offset by the $6.2 million income tax refund
received in 2008.
  19
 
 Investing
Activities
 
 Cash used
for investing activities consists primarily of purchases and sales of property
and equipment.  Capital expenditures during the first thirty-nine
weeks 2009 decreased significantly from the first thirty-nine weeks 2008.
Expenditures for the first thirty-nine weeks 2009 consisted primarily of two new
locations, five store remodels, technology upgrades and minor retail location
improvements compared to 63 store remodels completed during the first
thirty-nine weeks 2008.
 
 Financing
Activities
 
 Cash
provided by operations for the first thirty-nine weeks of 2009 provided funds to
reduce debt by $7.6 million and make payments of $0.7 million toward
pre-petition obligations. Activities for the first thirty-nine weeks of 2008
resulted in the Company borrowing $43.3 million from the Revolver to make
payments of $36.6 million of pre-petition debt as well as to finance store
remodel initiatives.
 
 Credit
Facilities
 
 The
following should be read in conjunction with Note 8 to the Company’s Annual
Report on Form 10-K filed with the SEC on April 10, 2009.
 
 As of
October 31, 2009, the Company had outstanding borrowings under the Revolver of
$25.0 million and outstanding letters of credit of $6.0
million.  Additional amounts available to borrow at that time were
$43.1 million.
 
 As of
October 31, 2009, the Note balance was $21.6 million and the unamortized
discount on Notes Payable related to warrants issued was $8.8
million.
 
 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 qualified 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 Revolver that provides up to $20.0 million in
letters of credit.  At October 31, 2009, Hancock had commitments of
$0.1 million on documentary letters of credit under the facility, which support
purchase orders for merchandise.  Hancock also has $5.9 million on
standby letters of credit to guarantee payment of potential insurance
claims.  Hancock leases its retail fabric store locations under
operating leases expiring at various dates through 2024.
 
 The
Company has no standby repurchase obligations or guarantees of other entities'
debt.
  20
 
 Critical
Accounting Policies and Estimates
 
 The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to adopt
accounting policies and make significant judgments and estimates to develop
amounts reflected and disclosed in the financial statements. In many cases,
there are alternative policies or estimation techniques that could be used. We
maintain a process to review the application of our accounting policies and to
evaluate the appropriateness of the many estimates that are required to prepare
the financial statements of a large corporation. However, even under optimal
circumstances, estimates routinely require adjustment based on changing
circumstances and the receipt of new or better information. There have been no
significant changes to our accounting policies and estimates as discussed in our
Annual Report on Form 10-K for the fiscal year ended January 31, 2009, except
for the adoption of FASB ASC 820, Fair Value Measurements and
Disclosures,which requires additional disclosure about fair value
measurements .
 
 Related
Party Transactions
 
 See Note
17 in the Company’s Annual Report on Form 10-K filed with the SEC on April 10,
2009, for details regarding the sole related party transaction that the Company
has entered into.
 
 The
Company has no other balances with any other related parties, nor has it had any
other material transactions with related parties during the thirty-nine week
periods ended October 31, 2009 and November 1, 2008.
 
 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, and higher employer contributions to
Hancock’s pension plan could be necessary if investment returns are
weak.  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.
 
 Seasonality
 
 Hancock's
business is seasonal.  Peak sales periods occur during the fall and
early spring weeks, while the lowest sales periods occur during the summer.
Working capital requirements needed to finance our operations fluctuate during
the year and reach their highest levels during the second and third fiscal
quarters as we increase our inventory in preparation for our peak selling season
during the fourth quarter.
 
 ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
 
 Hancock
did not hold derivative financial or commodity instruments at October 31,
2009.
 
 Interest
Rate Risk
 
 The
Company is exposed to financial market risks, including changes in interest
rates. At the Company's option, all loans under the Revolver bear interest at
either (a) a floating interest rate plus the applicable margins or (b) absent a
default, a fixed interest rate for periods of one, two or three months equal to
the reserve adjusted London Interbank Offered Rate, or LIBOR, plus the
applicable margins.
  As of
October 31, 2009, the Company had borrowings outstanding of approximately $25.0
million under the Revolver.  If interest rates increased 100 basis
points, the Company’s annual interest expense would increase approximately $0.3
million, assuming borrowings under the Revolver of $25.0 million as existed at
October 31, 2009.
  21
 
 In
addition to the Revolver, the Company issued $20.0 million of Floating Rate
Secured Notes (the “Notes”) on August 1, 2008.  Interest on the Notes
is payable quarterly at LIBOR plus 4.50%.  Interest for the first four
quarters was paid by the issuance of additional notes at a rate equal to LIBOR
plus 5.50%, which resulted in the capitalization of $1.6 million into the
balance.
 
 The
Company will pay the subsequent interest payments on the Notes in cash, the next
payment date being November 2 2009.  If interest rates increased 100
basis points, the Company’s annual interest expense would increase $0.2 million,
based on balance of the Notes of $21.6 million at October 31, 2009.
  Foreign
Currency Risk
 
 All of
the Company’s business is transacted in U.S. dollars and, accordingly,
devaluation of the dollar against other currencies can increase product costs
although this did not significantly impact the thirty-nine week period ended
October 31, 2009. As of October 31, 2009, the Company had no financial
instruments outstanding that were sensitive to changes in foreign currency
rates.
 
 ITEM
4T. CONTROLS AND PROCEDURES
 
 Disclosure
Controls and Procedures
 
 The
Company maintains disclosure controls and procedures that are designed to ensure
that information required to be disclosed in the reports filed or submitted
under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)
is recorded, processed, summarized, and reported within the time periods
specified in the Securities and Exchange Commission’s rules and forms and
that such information is accumulated and communicated to the Company’s
management, including our President  and our Chief Executive
Officer (principal executive officer) and Executive Vice President and Chief
Financial Officer (principal financial officer), as appropriate, to allow timely
decisions regarding the required disclosures. In designing and evaluating the
disclosure controls and procedures, our Management recognizes that any controls
and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives.
  In
connection with the preparation of this Quarterly Report on Form 10-Q as of
October 31, 2009), the Company’s management, under the supervision and with the
participation of the Company’s President and Chief Executive Officer and
Executive Vice President and Chief Financial Officer, performed an evaluation of
the effectiveness of our disclosure controls and procedures (as such term is
defined in the Rules 13a-15(e) and 15d-15(e) under the Exchange
Act).  Based upon this evaluation and as a result of the remediation
activities completed during fiscal 2008, the Company’s principal executive
officer and principal financial officer concluded that the Company’s disclosure
controls and procedures were effective as of October 31, 2009.
  Changes
in Internal Control Over Financial Reporting
  There
have been no changes in our internal controls over financial reporting (as such
term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) within
the fiscal quarter to which this report relates that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.
  22
  PART
II.  OTHER INFORMATION
 
 ITEM
      1. LEGAL PROCEEDINGS
 
 On March
21, 2007, the Company and its affiliated debtors filed voluntary petitions for
reorganization under Chapter 11 of the United States 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., et
al., Case No. 07-10353 (BLS)."  On June 10, 2008, the Company filed
its joint plan of reorganization (Docket No. 2746) (as modified and including
all documents ancillary thereto, the “Plan”) and, thereafter, its related
court-approved notice of plan confirmation hearing.  On July 22, 2008,
the court entered an order confirming the Plan (Docket No. 2996).  On
August 1, 2008, the Plan became effective, and the Company emerged from
bankruptcy protection.
  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 January 31,
      2009, 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
 
 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 1,756,453 shares purchased under this
authorization through October 31, 2009, and the number of shares that may yet be
purchased under this authorization is 243,547.
 
 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 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 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
  23





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)By:
              /s/ Robert W. DriskellRobert
      W. DriskellExecutive
      Vice President andChief
      Financial Officer(Principal
      Financial Officer)





Date: 
December 3, 2009


24


EXHIBIT
INDEX





Exhibit No.
              
              Description31.1
              
              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 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


25