Exhibit 10.1

                                 April 25, 2005


To:  Jamie Austin

         Re:      Separation Agreement and Release and Waiver

Dear Jamie:

     The  purpose  of  this  letter  agreement,  sometimes  referred  to as  the
"Agreement,"  is to  put  into  writing  our  mutual  agreement  related  to the
termination of your employment with Hancock Fabrics, Inc., sometimes referred to
as the  "Company".  It also  describes  the  separation  pay and  certain  other
benefits,  sometimes referred to as the "Separation  Package",  the Company will
provide you in  consideration  of your  release of any and all legal  claims you
might have against the Company  arising out of or related to your employment and
termination of your employment with the Company.

     This  Agreement sets forth the pay and benefits which you will receive upon
this Agreement becoming effective. In return for the Release and Waiver executed
by you, the Separation  Package the Company is offering you exceeds any benefits
the Company is required to provide terminated employees.

     You are  encouraged,  of course,  to consult  with such  persons as you may
choose before you sign this Agreement,  including your financial, legal or other
advisors.

<PAGE>

     After you have signed this Agreement and it becomes  effective as described
below, in  consideration  for your Release and Waiver,  the Company will provide
you with the following Separation Package:

          1. Upon the effective  date of this  Agreement,  you will be placed on
     paid separation leave that will extend through July 24, 2005,  during which
     time you will receive your regular pay, less withholding  required by state
     and  federal  laws (as is the  current  practice  with  your  pay  checks).
     Furthermore,  the period of paid  separation  leave will be extended beyond
     July 24,  2005,  until  such  time as you have  secured  other  employment;
     provided that in no event shall the total period of paid  separation  leave
     under this  subparagraph (1) (the  "Separation  Leave") extend past October
     23, 2005. The Company will also maintain you on its medical insurance plans
     during the Separation  Leave at the present level of employee  contribution
     to the premium,  but you will not be entitled to any other fringe  benefits
     except as expressly provided by this Agreement.

          2. Any  restricted  stock  subject to vesting  will  continue  to vest
     during the Separation  Leave, and any stock options  otherwise  exercisable
     will remain exercisable during the Separation Leave.

          3. The Company's  personnel  records will reflect that you voluntarily
     resigned your  employment  in good  standing  effective the last day of the
     Separation Leave.

          4. You will be allowed to keep your Company car during the  Separation
     Leave and after  termination of your  employment.  The Company will arrange
     for transfer of the title to your name upon termination of your employment.

     In order to receive the  Separation  Package  described in this  Agreement,
you: (i) must return all Company property upon the Company's request except your
Company car; (ii) agree to abide by the disparagement  agreement set forth later

<PAGE>

in  this  letter;  (iii)  agree  to  the  limited  non-competition  restrictions
contained  in  Attachment  A to  this  Agreement,  and  (iv)  agree  not to seek
re-employment  with the Company in the future.

     By accepting  this  Agreement,  you  understand and agree that on behalf of
yourself,  your  heirs,  assigns  and other  representatives,  you hereby  fully
release Hancock Fabrics, Inc. and its past, present and future owners,  parents,
subsidiaries,   affiliates,   predecessors,   successors,   assigns,   officers,
directors,  stockholders,  employees,  former employees, and agents from any and
all claims and waive all rights,  known or unknown, you may now have or claim to
have arising out of or related to your  employment  or the  termination  of your
employment  with the  Company  arising  before  the date on which  you sign this
Agreement, including but not limited to any and all claims, losses, liabilities,
demands,  damages,  causes of action, costs, expenses, fees including attorney's
fees,  compensation,  back  or  front  pay,  employee  benefits  and  any  other
obligation and liability,  including but not limited to all claims and causes of
action arising under Title VII of the Civil Rights Act of 1964, as amended;  the
Employee Retirement Income Security Act ("ERISA");  The Family and Medical Leave
Act of 1993  ("FMLA");  The Americans  with  Disabilities  Act ("ADA"),  The Age
Discrimination in Employment Act, as amended ("ADEA");  The Older Worker Benefit
Protection Act of 1990 ("OWBPA");  and, without  limitation,  any other federal,
state or local  statute,  ordinance  or  regulation,  governing  employment  and
employment  discrimination;  as well as all claims and causes of action  arising
under common law; state tort law; the law of wrongful or  retaliatory  discharge
(including but not limited to any claim of being a "whistleblower"),  or express
or implied contract.

     Because this Agreement includes a release and waiver as to claims under the
Age Discrimination in Employment Act ("ADEA"), your signature below acknowledges
that you  confirm,  understand,  and agree to the terms and  conditions  of this
Agreement;  that these terms are written in lay person terms,  and that you have
been  fully  advised  of your  rights  to seek  the  advice  and  assistance  of

<PAGE>

consultants,  including an  attorney,  as well as tax  advisors,  to review this
Agreement. It also acknowledges that you do not waive any rights or claims under
the Age  Discrimination  in  Employment  Act that may arise  after the date this
Agreement  is signed by you, and  specifically,  under this  Agreement,  you are
receiving  money and benefits  beyond anything of value to which you are already
entitled.

     You agree that you will make no disparaging remarks about the Company,  its
services,  its officers and directors,  or any of its employees.  If you violate
this  disparagement  agreement,  you agree that the  Company may  terminate  any
payments  under this  Agreement  and that you will be obligated to return to the
Company the monies received under this Agreement as liquidated damages.

     To ensure  that you have  adequate  time and  opportunity  to  review  this
Agreement  and consult with legal counsel and other  advisors of your  choosing,
you have up to 21 days to  consider  whether to accept and sign this  Agreement.
Should you sign and date this  Agreement  before the  expiration  of this 21-day
period,  your signature will evidence your voluntary  election to forego waiting
the full 21 days to sign this  Agreement.  If you choose  not to accept,  or the
21-day period expires without your acceptance,  then the offer is null and void.
The offer  embodied in this letter can in no way be construed as an admission of
wrongdoing by the Company or any other released party.

     Your signature also  acknowledges  that, in compliance with the OWBPA,  you
have been fully  advised by the Company of your right to revoke and nullify this
Agreement,  and that your revocation must be exercised,  if at all, within seven
(7) days of the date you sign this Agreement.  You may revoke your acceptance at
any time within the seven (7) days  following  your signing of this Agreement by
notifying me in writing of your decision to revoke your  acceptance.  Acceptance
of this offer is strictly voluntary.

<PAGE>

     This letter serves as the only  Agreement with respect to the terms of your
separation  from the  Company  and may be  modified  only in  writing  expressly
referencing this Agreement signed by you and an authorized Company official.

     By signing and accepting this Agreement,  you acknowledge  that the Company
has already paid you all salary,  vacation  pay, or other  compensation  due you
through the date of termination; that the Separation Package offered you exceeds
the pay and benefits  otherwise  available to you upon the  termination  of your
employment;  and, that there are no other  promises or  undertakings  related to
your  employment and the termination of your employment with the Company between
the  Company  and you  except  as set out in this  Agreement.  Consequently,  if
accepted by you, the Separation  Package  provided by this Agreement shall be in
lieu of any other compensation or Company paid benefits.

     YOU ALSO AFFIRM THAT YOU HAVE SIGNED THIS AGREEMENT VOLUNTARILY OF YOUR OWN
FREE WILL AND THAT YOU HAVE BEEN GIVEN FULL  OPPORTUNITY  TO DISCUSS THIS MATTER
PRIVATELY  AND  THOROUGHLY  WITH AN  ATTORNEY  OF YOUR CHOICE AND THAT YOU FULLY
UNDERSTAND THE MEANING AND INTENT OF THIS AGREEMENT,  INCLUDING, BUT NOT LIMITED
TO ITS FINAL AND BINDING EFFECT.

     If accepted and signed by you, this  Agreement  shall become  effective and
enforceable only after the seven (7) day revocation period has expired; provided
that,  the paid  Separation  Leave will be deemed to have commenced on April 26,
2005.  Should you decline to accept this Agreement,  or if it is revoked by you,
you will not receive the proposed Separation Package.

     If you agree to these terms, please sign the Acceptance which appears below
on the  enclosed  copy of this letter and return a signed copy of the letter and
Acceptance to me.

<PAGE>

                                Sincerely yours,


                                /s/ Jane F. Aggers
                                -----------------------------
                                for Hancock Fabrics, Inc.

                                Date:    April 25, 2005
                                      -------------------


                                   ACCEPTANCE

   (Must be executed and returned no later than 21 days after initial receipt)
   ---------------------------------------------------------------------------

     By signing this Agreement,  I represent that I have read this Agreement;  I
understand  and  knowingly  agree to its terms;  I was in no way coerced to sign
this  Agreement;  and I understand  that I have executed a release of all claims
arising before my execution of this acceptance.


 /s/ Jamie Austin                                       April 29, 2005
------------------                                   ---------------------
Jamie Austin                                         Date