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 August 1, 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 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
August 25, 2009, there were 19,810,075, shares of Hancock Fabrics, Inc. $.01 par
value common stock outstanding.










INDEX





PagePart
      I.  Financial Information:Item
      1.  Financial StatementsConsolidated
      Balance Sheets as of August 1, 2009, August 2, 2008 and January 31,
      2009
                3Consolidated
      Statements of Operations for the Thirteen and Twenty-six Weeks Ended
      August 1, 2009 and August 2, 2008
                4Consolidated
      Statement of Shareholders’ Equity for the Twenty-six Weeks Ended August 1,
      2009
                5Consolidated
      Statements of Cash Flows for the Twenty-six Weeks Ended August 1, 2009 and
      August 2, 2008
                6Notes
      to Consolidated Financial Statements
                7Item
      2.  Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
                12Item
      3.  Quantitative and Qualitative Disclosures about Market
      Risks
                20Item
      4T.  Controls and Procedures
                21Part
      II.  Other Information:Item
      1. Legal Proceedings
                21Item
      1A. Risk Factors
                22Item
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
                22Item
      3. Defaults Upon Senior Securities
                22Item
      4. Submission of Matters to a Vote of Security Holders
                22Item
      5. Other Information
                23Item
      6. Exhibits
                23Signatures
                24





Index to
Exhibits





EX-10.1


EX-10.2


EX-31.1


EX-31.2


EX-32.1




2




PART
I. FINANCIAL INFORMATION





ITEM
1. FINANCIAL STATEMENTS





HANCOCK
FABRICS, INC.


CONSOLIDATED
      BALANCE SHEETS(unaudited)August
      1,
                                                                                              
                                                                                              
                                                                                              August
      2,
                                                                                              
                                                                                              
                                                                                              January
      31,(in
      thousands, except for share amounts)
                                                                                              
                                                                                              2009
                                                                                              
                                                                                              
                                                                                              2008
                                                                                              
                                                                                              
                                                                                              2009
      (1)AssetsCurrent
      assets:Cash
      and cash equivalents
                                                                                              
                                                                                              $
                                                                                              2,724
                                                                                              
                                                                                              
                                                                                              $
                                                                                              5,451
                                                                                              
                                                                                              
                                                                                              $
                                                                                              2,338Receivables,
      less allowance for doubtful accounts
                                                                                              
                                                                                              
                                                                                              3,479
                                                                                              
                                                                                              
                                                                                              
                                                                                              3,910
                                                                                              
                                                                                              
                                                                                              
                                                                                              3,380Inventories
                                                                                              
                                                                                              
                                                                                              99,952
                                                                                              
                                                                                              
                                                                                              
                                                                                              117,333
                                                                                              
                                                                                              
                                                                                              
                                                                                              104,156Income
      taxes refundable
                                                                                              
                                                                                              
                                                                                              -
                                                                                              
                                                                                              
                                                                                              
                                                                                              8,118
                                                                                              
                                                                                              
                                                                                              
                                                                                              -Prepaid
      expenses
                                                                                              
                                                                                              
                                                                                              2,263
                                                                                              
                                                                                              
                                                                                              
                                                                                              2,182
                                                                                              
                                                                                              
                                                                                              
                                                                                              1,735Total
      current assets
                                                                                              
                                                                                              
                                                                                              108,418
                                                                                              
                                                                                              
                                                                                              
                                                                                              136,994
                                                                                              
                                                                                              
                                                                                              
                                                                                              111,609Property
      and equipment, net
                                                                                              
                                                                                              
                                                                                              43,042
                                                                                              
                                                                                              
                                                                                              
                                                                                              45,860
                                                                                              
                                                                                              
                                                                                              
                                                                                              45,039Goodwill
                                                                                              
                                                                                              
                                                                                              3,210
                                                                                              
                                                                                              
                                                                                              
                                                                                              3,406
                                                                                              
                                                                                              
                                                                                              
                                                                                              3,2101Other
      assets
                                                                                              
                                                                                              
                                                                                              5,293
                                                                                              
                                                                                              
                                                                                              
                                                                                              6,685
                                                                                              
                                                                                              
                                                                                              
                                                                                              4,816Total
      assets
                                                                                              
                                                                                              $
                                                                                              159,963
                                                                                              
                                                                                              
                                                                                              $
                                                                                              192,945
                                                                                              
                                                                                              
                                                                                              $
                                                                                              164,674Liabilities
      and Shareholders' EquityCurrent
      liabilities:Accounts
      payable
                                                                                              
                                                                                              $
                                                                                              20,308
                                                                                              
                                                                                              
                                                                                              $
                                                                                              20,347
                                                                                              
                                                                                              
                                                                                              $
                                                                                              21,437Accrued
      liabilities
                                                                                              
                                                                                              
                                                                                              14,567
                                                                                              
                                                                                              
                                                                                              
                                                                                              17,836
                                                                                              
                                                                                              
                                                                                              
                                                                                              14,813Pre-petition
      obligations
                                                                                              
                                                                                              
                                                                                              1,748
                                                                                              
                                                                                              
                                                                                              
                                                                                              35,143
                                                                                              
                                                                                              
                                                                                              
                                                                                              2,796Total
      current liabilities
                                                                                              
                                                                                              
                                                                                              36,623
                                                                                              
                                                                                              
                                                                                              
                                                                                              73,326
                                                                                              
                                                                                              
                                                                                              
                                                                                              39,046Long-term
      debt obligations, net
                                                                                              
                                                                                              
                                                                                              42,670
                                                                                              
                                                                                              
                                                                                              
                                                                                              34,401
                                                                                              
                                                                                              
                                                                                              
                                                                                              42,977Capital
      lease obligations
                                                                                              
                                                                                              
                                                                                              3,233
                                                                                              
                                                                                              
                                                                                              
                                                                                              3,328
                                                                                              
                                                                                              
                                                                                              
                                                                                              3,287Postretirement
      benefits other than pensions
                                                                                              
                                                                                              
                                                                                              2,251
                                                                                              
                                                                                              
                                                                                              
                                                                                              8,927
                                                                                              
                                                                                              
                                                                                              
                                                                                              2,211Pension
      and SERP liabilities
                                                                                              
                                                                                              
                                                                                              22,720
                                                                                              
                                                                                              
                                                                                              
                                                                                              5,432
                                                                                              
                                                                                              
                                                                                              
                                                                                              21,706Other
      liabilities
                                                                                              
                                                                                              
                                                                                              7,848
                                                                                              
                                                                                              
                                                                                              
                                                                                              8,547
                                                                                              
                                                                                              
                                                                                              
                                                                                              8,098Total
      liabilities
                                                                                              
                                                                                              
                                                                                              115,345
                                                                                              
                                                                                              
                                                                                              
                                                                                              133,961
                                                                                              
                                                                                              
                                                                                              
                                                                                              117,325Commitments
      and contingenciesShareholders'
      equity:Common
      stock, $.01 par value; 80,000,000 shares authorized;33,139,070,
      32,751,983 and  33,084,570 issued and
19,758,075,19,385,343  and
      19,716,303 outstanding, respectively
                                                                                              
                                                                                              
                                                                                              331
                                                                                              
                                                                                              
                                                                                              
                                                                                              328
                                                                                              
                                                                                              
                                                                                              
                                                                                              331Additional
      paid-in capital
                                                                                              
                                                                                              
                                                                                              88,558
                                                                                              
                                                                                              
                                                                                              
                                                                                              87,487
                                                                                              
                                                                                              
                                                                                              
                                                                                              88,017Retained
      earnings
                                                                                              
                                                                                              
                                                                                              121,748
                                                                                              
                                                                                              
                                                                                              
                                                                                              121,136
                                                                                              
                                                                                              
                                                                                              
                                                                                              124,907Treasury
      stock, at cost, 13,380,995, 13,366,640and
      13,368,267 shares held, respectively
                                                                                              
                                                                                              
                                                                                              (153,697
                                                                                              )
                                                                                              
                                                                                              
                                                                                              (153,683
                                                                                              )
                                                                                              
                                                                                              
                                                                                              (153,684
                                                                                              )Accumulated
      other comprehensive income (loss)
                                                                                              
                                                                                              
                                                                                              (12,322
                                                                                              )
                                                                                              
                                                                                              
                                                                                              3,716
                                                                                              
                                                                                              
                                                                                              
                                                                                              (12,222
                                                                                              )Total
      shareholders' equity
                                                                                              
                                                                                              
                                                                                              44,618
                                                                                              
                                                                                              
                                                                                              
                                                                                              58,984
                                                                                              
                                                                                              
                                                                                              
                                                                                              47,349Total
      liabilities and shareholders' equity
                                                                                              
                                                                                              $
                                                                                              159,963
                                                                                              
                                                                                              
                                                                                              $
                                                                                              192,945
                                                                                              
                                                                                              
                                                                                              $
                                                                                              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)ThirteenWeeksEnded
                                                                                          
                                                                                          
                                                                                          Twenty-sixWeeksEndedAugust
      1,
                                                                                          
                                                                                          
                                                                                          August
      2,
                                                                                          
                                                                                          
                                                                                          August
      1,
                                                                                          
                                                                                          
                                                                                          August
      2,(in
      thousands, except per share amounts)
                                                                                          
                                                                                          2009
                                                                                          
                                                                                          
                                                                                          2008
                                                                                          
                                                                                          
                                                                                          2009
                                                                                          
                                                                                          
                                                                                          2008Sales
                                                                                          
                                                                                          $
                                                                                          59,581
                                                                                          
                                                                                          
                                                                                          $
                                                                                          63,799
                                                                                          
                                                                                          
                                                                                          $
                                                                                          123,650
                                                                                          
                                                                                          
                                                                                          $
                                                                                          127,615Cost
      of goods sold
                                                                                          
                                                                                          
                                                                                          32,265
                                                                                          
                                                                                          
                                                                                          
                                                                                          36,092
                                                                                          
                                                                                          
                                                                                          
                                                                                          67,422
                                                                                          
                                                                                          
                                                                                          
                                                                                          71,339Gross
      profit
                                                                                          
                                                                                          
                                                                                          27,316
                                                                                          
                                                                                          
                                                                                          
                                                                                          27,707
                                                                                          
                                                                                          
                                                                                          
                                                                                          56,228
                                                                                          
                                                                                          
                                                                                          
                                                                                          56,276Selling,
      general and administrative expense
                                                                                          
                                                                                          
                                                                                          26,919
                                                                                          
                                                                                          
                                                                                          
                                                                                          28,879
                                                                                          
                                                                                          
                                                                                          
                                                                                          54,100
                                                                                          
                                                                                          
                                                                                          
                                                                                          58,629Depreciation
      and amortization
                                                                                          
                                                                                          
                                                                                          1,127
                                                                                          
                                                                                          
                                                                                          
                                                                                          1,117
                                                                                          
                                                                                          
                                                                                          
                                                                                          2,216
                                                                                          
                                                                                          
                                                                                          
                                                                                          2,130Operating
      loss
                                                                                          
                                                                                          
                                                                                          (730
                                                                                          )
                                                                                          
                                                                                          
                                                                                          (2,289
                                                                                          )
                                                                                          
                                                                                          
                                                                                          (88
                                                                                          )
                                                                                          
                                                                                          
                                                                                          (4,483
                                                                                          )Reorganization
      expense, net
                                                                                          
                                                                                          
                                                                                          171
                                                                                          
                                                                                          
                                                                                          
                                                                                          4,254
                                                                                          
                                                                                          
                                                                                          
                                                                                          410
                                                                                          
                                                                                          
                                                                                          
                                                                                          6,930Interest
      expense, net
                                                                                          
                                                                                          
                                                                                          1,376
                                                                                          
                                                                                          
                                                                                          
                                                                                          3,577
                                                                                          
                                                                                          
                                                                                          
                                                                                          2,710
                                                                                          
                                                                                          
                                                                                          
                                                                                          4,566Loss
      from continuing operations before income taxes
                                                                                          
                                                                                          
                                                                                          (2,277
                                                                                          )
                                                                                          
                                                                                          
                                                                                          (10,120
                                                                                          )
                                                                                          
                                                                                          
                                                                                          (3,208
                                                                                          )
                                                                                          
                                                                                          
                                                                                          (15,979
                                                                                          )Income
      taxes
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          -Loss
      from continuing operations
                                                                                          
                                                                                          
                                                                                          (2,277
                                                                                          )
                                                                                          
                                                                                          
                                                                                          (10,120
                                                                                          )
                                                                                          
                                                                                          
                                                                                          (3,208
                                                                                          )
                                                                                          
                                                                                          
                                                                                          (15,979
                                                                                          )Earnings
      (Loss) from discontinued operations (net of tax expense of $0 and
      $0)
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          (762
                                                                                          )
                                                                                          
                                                                                          
                                                                                          49
                                                                                          
                                                                                          
                                                                                          
                                                                                          (220
                                                                                          )Net
      loss
                                                                                          
                                                                                          $
                                                                                          (2,277
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          (10,882
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          (3,159
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          (16,199
                                                                                          )Basic
      and diluted loss per share:Loss
      from continuing operations
                                                                                          
                                                                                          $
                                                                                          (0.12
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          (0.53
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          (0.16
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          (0.84
                                                                                          )Earnings
      (Loss) from discontinued operations
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          (0.04
                                                                                          )
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          (0.01
                                                                                          )Net
      loss
                                                                                          
                                                                                          $
                                                                                          (0.12
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          (0.57
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          (0.16
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          (0.85
                                                                                          )Weighted
      average shares outstanding:Basic
      and diluted
                                                                                          
                                                                                          
                                                                                          19,272
                                                                                          
                                                                                          
                                                                                          
                                                                                          19,069
                                                                                          
                                                                                          
                                                                                          
                                                                                          19,245
                                                                                          
                                                                                          
                                                                                          
                                                                                          19,027





See
accompanying notes to consolidated financial statements.




4




HANCOCK FABRICS, INC.


CONSOLIDATED
STATEMENT OF SHAREHOLDERS' EQUITY


(unaudited)AccumulatedAdditional
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            Other
                                            
                                            
                                            TotalCommon Stock
                                            
                                            
                                            Paid-in
                                            
                                            
                                            Retained
                                            
                                            
                                            Treasury Stock
                                            
                                            
                                            Comprehensive
                                            
                                            
                                            Shareholders'(in
      thousands, except for number of shares)
                                            
                                            Shares
                                            
                                            
                                            Amount
                                            
                                            
                                            Capital
                                            
                                            
                                            Earnings
                                            
                                            
                                            Shares
                                            
                                            
                                            Amount
                                            
                                            
                                            Income (Loss)
                                            
                                            
                                            EquityBalance
      January 31, 2009
                                            
                                            
                                            33,084,570
                                            
                                            
                                            $
                                            331
                                            
                                            
                                            $
                                            88,017
                                            
                                            
                                            $
                                            124,907
                                            
                                            
                                            
                                            (13,368,267
                                            )
                                            
                                            $
                                            (153,684
                                            )
                                            
                                            $
                                            (12,222
                                            )
                                            
                                            $
                                            47,349Comprehensive
      loss:Net
      loss
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (3,159
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (3,159
                                            )Minimum
      pension, SERP and OPEB  liabilities, net of taxes of
      $0
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (100
                                            )
                                            
                                            
                                            (100
                                            )Total
      comprehensive loss
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (3,259
                                            )Issuance
      of restricted stock
                                            
                                            
                                            95,000
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            -Cancellation
      of restricted stock
                                            
                                            
                                            (40,500
                                            )
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            -Stock
      compensation expense
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            438
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            438Amortization
      of directors' stock fees
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            103
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            103Purchase
      of treasury stock
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (12,728
                                            )
                                            
                                            
                                            (13
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            (13
                                            )Balance
      August 1, 2009
                                            
                                            
                                            33,139,070
                                            
                                            
                                            $
                                            331
                                            
                                            
                                            $
                                            88,558
                                            
                                            
                                            $
                                            121,748
                                            
                                            
                                            
                                            (13,380,995
                                            )
                                            
                                            $
                                            (153,697
                                            )
                                            
                                            $
                                            (12,322
                                            )
                                            
                                            $
                                            44,618





See
accompanying notes to consolidated financial statements.




5




Hancock Fabrics, Inc.


Consolidated
Statements of Cash Flows


(unaudited)Twenty-six Weeks EndedAugust 1,
                                                              
                                                              
                                                              August 2,(in
      thousands)
                                                              
                                                              2009
                                                              
                                                              
                                                              2008Cash
      flows from operating activities:Net
      loss
                                                              
                                                              $
                                                              (3,159
                                                              )
                                                              
                                                              $
                                                              (16,199
                                                              )Adjustments
      to reconcile net loss to cash flows from operating
    activitiesDepreciation
      and amortization, including cost of goods sold
                                                              
                                                              
                                                              3,187
                                                              
                                                              
                                                              
                                                              3,244Amortization
      of deferred loan costs
                                                              
                                                              
                                                              124
                                                              
                                                              
                                                              
                                                              403Amortization
      of bond discount
                                                              
                                                              
                                                              1,165
                                                              
                                                              
                                                              
                                                              13Interest
      paid-in-kind by issuance of notes payable
                                                              
                                                              
                                                              694
                                                              
                                                              
                                                              
                                                              -Interest
      accrued on Pre-Petition Obligations
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              2,219Stock
      compensation expense
                                                              
                                                              
                                                              541
                                                              
                                                              
                                                              
                                                              480Reserve
      for store closings credits, including interest expense
                                                              
                                                              
                                                              302
                                                              
                                                              
                                                              
                                                              (899
                                                              )Other
                                                              
                                                              
                                                              (81
                                                              )
                                                              
                                                              
                                                              (230
                                                              )Reorganization
      expense, net
                                                              
                                                              
                                                              410
                                                              
                                                              
                                                              
                                                              6,930(Increase)
      decrease in assetsReceivables
      and prepaid expenses
                                                              
                                                              
                                                              (615
                                                              )
                                                              
                                                              
                                                              165Inventory
      at current cost
                                                              
                                                              
                                                              4,260
                                                              
                                                              
                                                              
                                                              (2,835
                                                              )Other
      noncurrent assets
                                                              
                                                              
                                                              (589
                                                              )
                                                              
                                                              
                                                              1,221Increase
      (decrease) in liabilitiesAccounts
      payable
                                                              
                                                              
                                                              (1,770
                                                              )
                                                              
                                                              
                                                              2,323Accrued
      liabilities
                                                              
                                                              
                                                              (193
                                                              )
                                                              
                                                              
                                                              (175
                                                              )Postretirement
      benefits other than pensions
                                                              
                                                              
                                                              (480
                                                              )
                                                              
                                                              
                                                              (369
                                                              )Long-term
      pension and SERP liabilities
                                                              
                                                              
                                                              1,434
                                                              
                                                              
                                                              
                                                              363Other
      liabilities
                                                              
                                                              
                                                              (178
                                                              )
                                                              
                                                              
                                                              (1,056
                                                              )Net
      cash provided by (used in) operating activities before reorganization
      activities
                                                              
                                                              
                                                              5,052
                                                              
                                                              
                                                              
                                                              (4,402
                                                              )Net
      cash used for reorganization activities
                                                              
                                                              
                                                              (504
                                                              )
                                                              
                                                              
                                                              (4,725
                                                              )Net
      cash provided by (used in) operating activities
                                                              
                                                              
                                                              4,548
                                                              
                                                              
                                                              
                                                              (9,127
                                                              )Cash
      flows from investing activities:Additions
      to property and equipment
                                                              
                                                              
                                                              (1,265
                                                              )
                                                              
                                                              
                                                              (5,565
                                                              )Proceeds
      from the disposition of property and equipment
                                                              
                                                              
                                                              9
                                                              
                                                              
                                                              
                                                              101Net
      cash used in investing activities
                                                              
                                                              
                                                              (1,256
                                                              )
                                                              
                                                              
                                                              (5,464
                                                              )Cash
      flows from financing activities:Net
      borrowings (payments) on revolving credit facility
                                                              
                                                              
                                                              (2,166
                                                              )
                                                              
                                                              
                                                              22,465Payments
      for pre-petition liabilities and other
                                                              
                                                              
                                                              (740
                                                              )
                                                              
                                                              
                                                              (4,703
                                                              )Net
      cash provided by (used in) financing activities
                                                              
                                                              
                                                              (2,906
                                                              )
                                                              
                                                              
                                                              17,762Increase
      in cash and cash equivalents
                                                              
                                                              
                                                              386
                                                              
                                                              
                                                              
                                                              3,171Cash
      and cash equivalents:Beginning
      of period
                                                              
                                                              
                                                              2,338
                                                              
                                                              
                                                              
                                                              2,280End
      of period
                                                              
                                                              $
                                                              2,724
                                                              
                                                              
                                                              $
                                                              5,451Supplemental
      disclosures:Cash
      paid during the period for:Interest
                                                              
                                                              $
                                                              720
                                                              
                                                              
                                                              $
                                                              2,343Income
      taxes
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              -Non-cash
      activities:Warrants
      issued with notes
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              (11,685
                                                              )Noncash
      change in funded status of benefit plans
                                                              
                                                              
                                                              (100
                                                              )
                                                              
                                                              
                                                              (359
                                                              )





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 August 1, 2009, Hancock operated 264 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 second quarter 2009 and second quarter
2008 are for the 13 week periods ended August 1, 2009 and August 2, 2008,
respectively.  References to twenty-six weeks 2009, first half 2009 or
2009, and twenty-six weeks 2008, first half 2008 or 2008 are for the 26 week
periods ended August 1, 2009 and August 2, 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. 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
August 1, 2009 and August 2, 2008, and our consolidated results of operations
and cash flows for the twenty-six weeks ended August 1, 2009, and August 2,
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 twenty-six weeks ended August 2, 2008 as defined within
Statement of Financial Accounting Standards (“SFAS”) No. 154: Accounting Changes
and Error Corrections. Accordingly, the previously reported cost of goods sold
and net loss declined, the gross profit increased by $1.5 million and $2.3
million, and the basic and diluted loss per share declined by $0.08 and $0.12
for the thirteen weeks and twenty-six weeks ended August 2, 2008, respectively.
The elimination of LIFO also increased inventory and shareholders equity by
$38.6 million, the amount of the LIFO reserve as of August 2, 2008.




Recently
Issued Accounting Standards





In
April 2009, the Financial Accounting Standards Board (“FASB”) issued FSP
No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of
Financial Instruments.” FSP No. FAS 107-1 and APB 28-1 amends SFAS
No. 107, “Disclosures about Fair Value of Financial Instruments,” and
requires disclosures about fair value of financial instruments for interim
reporting periods as well as for annual financial statements. Additionally, the
guidance amends APB Opinion No. 28, “Interim Financial Reporting,” and
requires those disclosures in summarized financial information at interim
reporting periods. The provisions of FSP No. FAS 107-1 and APB 28-1 are
effective for interim reporting periods ending after June 15, 2009.
Management has completed its assessment and its adoption in fiscal 2009 and it
has no impact on the Company.





In 2008,
the FASB issued EITF 07-05, Determining whether an Instrument (or Embedded
Feature) Is Indexed to an Entity's Own Stock, ("EITF 07-05"). EITF 07-05
provides guidance on determining what types of instruments or embedded features
in an instrument held by a reporting entity can be considered indexed to its own
stock for the purpose of evaluating the first criteria of the scope exception in
paragraph 11(a) of SFAS 133. EITF 07-05 is effective for financial statements
issued for fiscal years beginning after December 15, 2008 and early application
is not permitted. Management has completed its assessment and its adoption of
EITF 07-05 in fiscal 2009 and it has no impact on the Company.





Effective
February 3, 2008, the Company adopted SFAS No. 157, “Fair Value
Measurements” (“SFAS 157”).   SFAS 157 defines fair value, establishes a
framework for measuring fair value, and requires additional disclosures about
fair value measurements.  In February 2008, the FASB issued FASB Staff
Position No. 157-2, Effective Date of Statement No. 157, which
provided a one year deferral of the effective date of SFAS 157 for non-financial
assets and non-financial liabilities, except those that are recognized or
disclosed in the financial statements at fair value at least annually.
Therefore, the Company adopted the provisions of SFAS 157 with respect to
its financial assets and financial liabilities only in fiscal 2008. The adoption
of this statement had no impact on the Company’s financial statements. 
Effective February 1, 2009, the Company adopted SFAS 157 for
non-financial assets and non-financial liabilities, and such adoption had no
impact on the Company’s financial statements.





In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS  165”),
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. SFAS 165 is effective for financial
statements issued for interim and annual reporting periods ending after June 15,
2009. Management has completed its assessment and its adoption of SFAS 165 in
fiscal 2009 and it has no impact on the Company. The Company has assessed and
disclosed reportable subsequent events, if any, as of August 24, 2009, in
connection with the financial statements for the period ended August 1,
2009.




8




In
June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles (“the
Codification”), effective for financial statements issued for interim and annual
periods ending after September 15, 2009. Other than resolving certain minor
inconsistencies, the Codification is not supposed to change US GAAP, but is
intended to make it easier to find and research guidance applicable to
particular transactions or specific accounting issues. The Codification is a new
structure which takes accounting pronouncements and organizes them by
approximately ninety accounting topics. The Codification will be the single
source of authoritative US GAAP. All guidance included in the Codification will
be considered authoritative at that time, even guidance that comes from what is
currently deemed to be a non-authoritative section of a standard. Once the
Codification becomes effective, all non-grandfathered, non-SEC accounting
literature not included in the Codification will become
non-authoritative.





Several
other new accounting standards became effective during the periods presented or
will be effective subsequent to August 1, 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.





AICPA
Statement of Position 90-7 (“SOP 90-7”), Financial Reporting by Entities in
Reorganization under the Bankruptcy Code, provides financial reporting guidance
for entities that are reorganizing under the Bankruptcy Code. The Company
implemented this guidance for all periods presented.  Per SOP 90-7,
estimated claims are 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.  As such, pre-petition liabilities after the Effective
Date are no longer presented as subject to compromise.





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





August 1,
                  
                  
                  January 31,2009
                  
                  
                  2009Real
      estate claims
                  
                  $
                  1,023
                  
                  
                  $
                  1,473Unfunded
      claims (1)
                  
                  
                  -
                  
                  
                  
                  598Professional
      fee claim
                  
                  
                  725
                  
                  
                  
                  725Total
      pre-petition claims
                  
                  $
                  1,748
                  
                  
                  $
                  2,796





(1)Amount represents
claim checks that have been issued but remain outstanding as ofJanuary
31, 2009.





NOTE
3: EMPLOYEE BENEFIT PLANS





Stock Options. During the
twenty six week period ended August 1, 2009, the Company granted 650,887 stock
options of which 547,887 are subject to a three-year performance program
that require 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 August 1, 2009 stock options for a total of 1,683,762 shares
were outstanding.




9




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
twenty-six weeks ended August 1, 2009 and August 2, 2008 (in
thousands):





Retirement Plan
                    
                    
                    Postretirement Benefit PlanTwenty-six Weeks Ended
                    
                    
                    Twenty-six Weeks EndedAugust 1,
                    
                    
                    August 2,
                    
                    
                    August 1,
                    
                    
                    August 2,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Service
      costs
                    
                    $
                    205
                    
                    
                    $
                    704
                    
                    
                    $
                    24
                    
                    
                    $
                    125Interest
      cost
                    
                    
                    2,456
                    
                    
                    
                    2,298
                    
                    
                    
                    88
                    
                    
                    
                    278Expected
      return on assets
                    
                    
                    (1,609
                    )
                    
                    
                    (2,749
                    )
                    
                    
                    -
                    
                    
                    
                    -Amortization
      of prior service costs
                    
                    
                    -
                    
                    
                    
                    (41
                    )
                    
                    
                    (386
                    )
                    
                    
                    (481
                    )Recognized
      net actuarial (gain) loss
                    
                    
                    420
                    
                    
                    
                    248
                    
                    
                    
                    (135
                    )
                    
                    
                    (86
                    )Net
      periodic benefit cost
                    
                    $
                    1,472
                    
                    
                    $
                    460
                    
                    
                    $
                    (409
                    )
                    
                    $
                    (164
                    )





At July
31, 2009, the fair value of the assets held by the pension plan was $50.1
million reflecting a $4.5 million increase from January 31, 2009 due to
investment returns during the period.





NOTE
4:  LOSS PER SHARE





Loss per
share is presented for basic and diluted earnings per share.  Basic
earnings per share excludes dilution and is computed by dividing income
available to common shareholders by the weighted-average number of common shares
outstanding for the period.  Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the
Company.





COMPUTATION OF LOSS PER SHARE





(in thousands, except for share and
                          
                          Thirteen Weeks Ended
                          
                          
                          Twenty-six Weeks Endedper share amounts)
                          
                          August 1,
                          
                          
                          August 2,
                          
                          
                          August 1,
                          
                          
                          August 2,2009
                          
                          
                          2008
                          
                          
                          2009
                          
                          
                          2008Basic
      and diluted loss per share:Net
      loss
                          
                          $
                          (2,277
                          )
                          
                          $
                          (10,882
                          )
                          
                          $
                          (3,159
                          )
                          
                          $
                          (16,199
                          )Weighted
      average number of common shares outstanding during period
                          
                          
                          19,271,598
                          
                          
                          
                          19,069,246
                          
                          
                          
                          19,245,097
                          
                          
                          
                          19,026,562Basic
      and diluted loss per share
                          
                          $
                          (0.12
                          )
                          
                          $
                          (0.57
                          )
                          
                          $
                          (0.16
                          )
                          
                          $
                          (0.85
                          )Weighted
      average common stock equivalents not included in EPSbecause the
      effect would be anti-dilutive
                          
                          
                          10,727,825
                          
                          
                          
                          1,400,164
                          
                          
                          
                          11,033,558
                          
                          
                          
                          1,436,844





As of
August 1, 2009, the common stock equivalents not included in EPS because the
effect would be anti-dilutive includes warrants to purchase 9.5 million shares
of common stock with an 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 August 1, 2009, the total reserve balance
included in current and noncurrent 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)
                      
                      
                      
                      
                      
                      
                      
                      
                      August 1,2009
                      
                      
                      Reserve
                      
                      
                      Interest
                      
                      
                      Payments
                      
                      
                      2009Lease
      obligations
                      
                      $
                      1,219
                      
                      
                      $
                      301
                      
                      
                      $
                      1
                      
                      
                      $
                      (699
                      )
                      
                      $
                      822





During
the twenty-six weeks ended August 1, 2009, income of $49,000 was recognized in
earnings from discontinued operations for the settlement of claims on stores
closed in prior years. During the twenty-six weeks ended August 2, 2008, there
was a loss of approximately $0.2 million 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





SFAS 157
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
Corporation measures certain financial assets (cash and cash equivalents) at
fair value on a recurring basis. The Corporation’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 Corporation’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
August 1, 2009, the Company had outstanding borrowings of $30.5 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 $0.6 million and availability was $30.9 million at
August 1, 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 this Credit Facility.




11




At the
Company’s option, any portion of the outstanding borrowings can be converted to
LIBOR - based rates plus an applicable margin, and the remainder bears interest
at a floating interest rate plus the applicable margins. At August 1, 2009,
the floating interest rate was 3.25% and the Company had $29.0 million of its
outstanding borrowings at a LIBOR based interest rate of 1.93%





In
addition to the Revolver, the Company has $21.6 million of Floating Rate Secured
Notes (the “Notes”) outstanding at August 1, 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 May 1, 2009 and August 1, 2009 the Company
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%.  An additional $1.2 million of
interest expense was recorded in 2009 related to the amortization of the
discount recorded at the time of issuance of the Notes. As of August 1, 2009 the
unamortized discount was $9.3 million.




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, 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 264 stores in 37
states as of August 1, 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 second quarter of fiscal 2009 were $59.6 million compared to
      $63.8 million  for the second quarter of fiscal 2008, and
      comparable store sales decreased 4% compared to an increase of
      11%  in the second quarter of fiscal
  2008.




12




·
            Our
      online sales for the second quarter of fiscal 2009, which are included in
      the comparable sales number above, increased 16% to $0.8
      million.





·
            Gross
      margin for the second quarter of fiscal 2009 was 45.8% compared with 43.4%
      for the second quarter of fiscal
2008.





·
            Operating
      loss was reduced to $0.7 million in second quarter of fiscal 2009 from
      $2.3 million in the second quarter of fiscal
  2008.





·
            The
      net loss narrowed to $2.2 million, or $0.12 per share, in the second
      quarter of fiscal 2009 from $10.9 million, or $0.57 per share in the
      second quarter of fiscal 2008.





·
            The
      amount of cash generated from operations before reorganization activities
      increased by $9.5 million to $5.1 million during the first half of fiscal
      2009 compared to the first half of fiscal
2008.





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





Thirteen Weeks Ended
                                  
                                  
                                  Twenty-six Weeks EndedAugust 1,
                                  
                                  
                                  August 2,
                                  
                                  
                                  August 1,
                                  
                                  
                                  August 2,2009
                                  
                                  
                                  2008
                                  
                                  
                                  2009
                                  
                                  
                                  2008Net
      sales (in thousands)
                                  
                                  $
                                  59,581
                                  
                                  
                                  $
                                  63,799
                                  
                                  
                                  $
                                  123,650
                                  
                                  
                                  $
                                  127,615Gross
      margin percentage
                                  
                                  
                                  45.8
                                  %
                                  
                                  
                                  43.4
                                  %
                                  
                                  
                                  45.5
                                  %
                                  
                                  
                                  44.1
                                  %Number
      of storesOpen
      at end of period (1)
                                  
                                  
                                  264
                                  
                                  
                                  
                                  267
                                  
                                  
                                  
                                  264
                                  
                                  
                                  
                                  267Comparable
      stores at period end (2)
                                  
                                  
                                  262
                                  
                                  
                                  
                                  266
                                  
                                  
                                  
                                  262
                                  
                                  
                                  
                                  266Sales
      growthAll
      retail outlets
                                  
                                  
                                  (6.6
                                  )%
                                  
                                  
                                  9.9
                                  %
                                  
                                  
                                  (3.1
                                  )%
                                  
                                  
                                  0.3
                                  %Comparable
      retail outlets (2)
                                  
                                  
                                  (4.2
                                  )%
                                  
                                  
                                  10.8
                                  %
                                  
                                  
                                  (0.9
                                  )%
                                  
                                  
                                  3.3
                                  %Total
      store square footage at period end (in thousands)
                                  
                                  
                                  3,772
                                  
                                  
                                  
                                  3,819
                                  
                                  
                                  
                                  3,772
                                  
                                  
                                  
                                  3,819Net
      sales per total square footage
                                  
                                  $
                                  15.80
                                  
                                  
                                  $
                                  16.71
                                  
                                  
                                  $
                                  32.78
                                  
                                  
                                  $
                                  33.42





(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.  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 twenty-six weeks
      of 2008 excluded a 1.1% 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.




13




Thirteen Weeks Ended
                    
                    
                    Twenty-six Weeks EndedAugust 1,
                    
                    
                    August 2,
                    
                    
                    August 1,
                    
                    
                    August 2,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Sales
                    
                    
                    100.0
                    %
                    
                    
                    100.0
                    %
                    
                    
                    100.0
                    %
                    
                    
                    100.0
                    %Cost
      of goods sold
                    
                    
                    54.2
                    
                    
                    
                    56.6
                    
                    
                    
                    54.5
                    
                    
                    
                    55.9Gross
      profit
                    
                    
                    45.8
                    
                    
                    
                    43.4
                    
                    
                    
                    45.5
                    
                    
                    
                    44.1Selling,
      general and administrative expense
                    
                    
                    45.2
                    
                    
                    
                    45.3
                    
                    
                    
                    43.8
                    
                    
                    
                    45.9Depreciation
      and amortization
                    
                    
                    1.9
                    
                    
                    
                    1.8
                    
                    
                    
                    1.8
                    
                    
                    
                    1.7Operating
      income (loss)
                    
                    
                    (1.3
                    )
                    
                    
                    (3.7
                    )
                    
                    
                    (0.1
                    )
                    
                    
                    (3.5
                    )Reorganization
      expense, net
                    
                    
                    0.3
                    
                    
                    
                    6.7
                    
                    
                    
                    0.3
                    
                    
                    
                    5.4Interest
      expense, net
                    
                    
                    2.3
                    
                    
                    
                    5.6
                    
                    
                    
                    2.2
                    
                    
                    
                    3.6Loss
      from continuing operations before income taxes
                    
                    
                    (3.9
                    )
                    
                    
                    (16.0
                    )
                    
                    
                    (2.6
                    )
                    
                    
                    (12.5
                    )Income
      taxes
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Income
      (loss) from discontinued operations
                    
                    
                    -
                    
                    
                    
                    (1.1
                    )
                    
                    
                    -
                    
                    
                    
                    (0.2
                    )Net
      loss
                    
                    
                    (3.9
                    )%
                    
                    
                    (17.1
                    )%
                    
                    
                    (2.6
                    )%
                    
                    
                    (12.7
                    )%





Net
Sales





Thirteen Weeks Ended
                      
                      
                      Twenty-six Weeks Ended(in thousands)
                      
                      August 1,
                      
                      
                      August 2,
                      
                      
                      August 1,
                      
                      
                      August 2,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Current
      store base
                      
                      $
                      58,726
                      
                      
                      $
                      61,131
                      
                      
                      $
                      121,626
                      
                      
                      $
                      122,325Closed
      stores
                      
                      
                      101
                      
                      
                      
                      2,019
                      
                      
                      
                      352
                      
                      
                      
                      3,803E-Commerce
                      
                      
                      754
                      
                      
                      
                      649
                      
                      
                      
                      1,672
                      
                      
                      
                      1,487Total
      net sales
                      
                      $
                      59,581
                      
                      
                      $
                      63,799
                      
                      
                      $
                      123,650
                      
                      
                      $
                      127,615





The
current store base above represents the 264 stores which are currently in
operation. Of these 264 stores, 262 were in operation at August 2, 2008. The
current quarter comparable sales decrease of 4.2% was driven by a reduction in
our home decorating business in conjunction with the anniversary of 29 grand
re-opening events at our remodeled stores which occurred in the second quarter
of 2008. Comparable sales of these 262 stores decreased 1.0% from the prior year
for the first half of fiscal 2008.  The decrease was driven by a 3.8%
increase in transactions offset by a 4.6% decrease in average
ticket.





There
were 2 stores closed in the first half of fiscal 2009 and 7 stores closed in
fiscal 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 second
quarter of fiscal 2009 compared to the same period of 2008 were up 16.2% and
sales for the first half of 2009 are up 12.4% 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.




14






Thirteen Weeks Ended
                            
                            
                            Twenty-six Weeks EndedAugust 1,
                            
                            
                            August 2,
                            
                            
                            August 1,
                            
                            
                            August 2,2009
                            
                            
                            2008
                            
                            
                            2009
                            
                            
                            2008Apparel
      Fabrics
                            
                            
                            27
                            %
                            
                            
                            26
                            %
                            
                            
                            27
                            %
                            
                            
                            27
                            %Home
      Decorating
                            
                            
                            22
                            %
                            
                            
                            25
                            %
                            
                            
                            22
                            %
                            
                            
                            24
                            %Quilting/Craft
                            
                            
                            26
                            %
                            
                            
                            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





·
            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 second quarter and first twenty-six
weeks of fiscal 2009 and 2008 are as follows:





Thirteen Weeks Ended
                    
                    
                    Twenty-six Weeks EndedAugust 1,
                    
                    
                    % of
                    
                    
                    August 2,
                    
                    
                    % of
                    
                    
                    August 1,
                    
                    
                    % of
                    
                    
                    August 2,
                    
                    
                    % of(in thousands)
                    
                    2009
                    
                    
                    Sales
                    
                    
                    2008
                    
                    
                    Sales
                    
                    
                    2009
                    
                    
                    Sales
                    
                    
                    2008
                    
                    
                    SalesTotal
      net sales
                    
                    $
                    59,581
                    
                    
                    
                    100.0
                    %
                    
                    $
                    63,799
                    
                    
                    
                    100.0
                    %
                    
                    $
                    123,650
                    
                    
                    
                    100.0
                    %
                    
                    $
                    127,615
                    
                    
                    
                    100.0
                    %Merchandise
      cost
                    
                    
                    27,380
                    
                    
                    
                    46.0
                    %
                    
                    
                    30,603
                    
                    
                    
                    48.0
                    %
                    
                    
                    57,108
                    
                    
                    
                    46.2
                    %
                    
                    
                    60,483
                    
                    
                    
                    47.4
                    %Freight
                    
                    
                    1,730
                    
                    
                    
                    2.9
                    %
                    
                    
                    2,253
                    
                    
                    
                    3.5
                    %
                    
                    
                    3,528
                    
                    
                    
                    2.9
                    %
                    
                    
                    4,304
                    
                    
                    
                    3.4
                    %Sourcing
      and warehousing
                    
                    
                    3,155
                    
                    
                    
                    5.3
                    %
                    
                    
                    3,236
                    
                    
                    
                    5.1
                    %
                    
                    
                    6,786
                    
                    
                    
                    5.4
                    %
                    
                    
                    6,552
                    
                    
                    
                    5.1
                    %Gross
      Profit
                    
                    $
                    27,316
                    
                    
                    
                    45.8
                    %
                    
                    $
                    27,707
                    
                    
                    
                    43.4
                    %
                    
                    $
                    56,228
                    
                    
                    
                    45.5
                    %
                    
                    $
                    56,276
                    
                    
                    
                    44.1
                    %





We have
seen a reduction of 200 basis points in the direct cost of merchandise compared
to the second quarter of 2008 and 120 basis point reduction in the first half
compared to the prior year.  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 has declined by 60 basis points in the second quarter compared to the
same quarter last year and 50 basis points for the first half of fiscal 2009
compared to the first half of fiscal 2008.  The Company is benefitting
from relatively stable fuel prices compared to the prior year as well as
efficiencies within our shipping process. The efficiencies gained within our
shipping process are expected to continue to help offset any increase in fuel
costs going forward.


15


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 increases
of 20 basis points for the quarter and 40 basis points for the first half are
primarily due to an increase in inventory turns, which reduces the costs
capitalized in inventory at the end of the period.





In total,
our operational initiatives have resulted in an increase in gross margin of 240
basis points over 2008 levels for the second quarter and 140 basis points for
the first half over previous year levels.





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
                    
                    
                    Twenty-six Weeks EndedAugust 1,
                    
                    
                    % of
                    
                    
                    August 2,
                    
                    
                    % of
                    
                    
                    August 1,
                    
                    
                    % of
                    
                    
                    August 2,
                    
                    
                    % of(in thousands)
                    
                    2009
                    
                    
                    Sales
                    
                    
                    2008
                    
                    
                    Sales
                    
                    
                    2009
                    
                    
                    Sales
                    
                    
                    2008
                    
                    
                    SalesRetail
      store labor costs
                    
                    $
                    10,164
                    
                    
                    
                    17.1
                    %
                    
                    $
                    11,316
                    
                    
                    
                    17.7
                    %
                    
                    $
                    20,231
                    
                    
                    
                    16.4
                    %
                    
                    $
                    22,185
                    
                    
                    
                    17.4
                    %Advertising
                    
                    
                    2,496
                    
                    
                    
                    4.2
                    %
                    
                    
                    1,887
                    
                    
                    
                    3.0
                    %
                    
                    
                    4,607
                    
                    
                    
                    3.7
                    %
                    
                    
                    3,734
                    
                    
                    
                    2.9
                    %Store
      occupancy
                    
                    
                    7,326
                    
                    
                    
                    12.3
                    %
                    
                    
                    7,353
                    
                    
                    
                    11.5
                    %
                    
                    
                    14,690
                    
                    
                    
                    11.9
                    %
                    
                    
                    14,850
                    
                    
                    
                    11.6
                    %Retail
      SG&A
                    
                    
                    4,812
                    
                    
                    
                    8.1
                    %
                    
                    
                    5,661
                    
                    
                    
                    8.9
                    %
                    
                    
                    9,824
                    
                    
                    
                    7.9
                    %
                    
                    
                    11,541
                    
                    
                    
                    9.0
                    %Corp
      SG&A
                    
                    
                    2,121
                    
                    
                    
                    3.5
                    %
                    
                    
                    2,662
                    
                    
                    
                    4.2
                    %
                    
                    
                    4,748
                    
                    
                    
                    3.8
                    %
                    
                    
                    6,319
                    
                    
                    
                    5.0
                    %Total
      SG&A
                    
                    $
                    26,919
                    
                    
                    
                    45.2
                    %
                    
                    $
                    28,879
                    
                    
                    
                    45.3
                    %
                    
                    $
                    54,100
                    
                    
                    
                    43.8
                    %
                    
                    $
                    58,629
                    
                    
                    
                    45.9
                    %





Retail
Store Labor Costs – The Company achieved greater efficiency in store labor costs
during 2009 compared to the same period last year.  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 increase in advertising expense was driven equally by an incremental
increase in advertising to support our e-commerce business and by a limited
amount of store advertising shifting from the second half of the year back to
the first half.


16





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
have resulted in rent reductions, concessions on future escalations, and term
extensions.





Retail
SG&A – These costs associated with our retail locations have decreased
significantly in relation to the prior year amount as a result of strict
budgetary control exercised by our store personnel.  Certain recurring
expenditures have been evaluated as to the timing and extent necessary and have
been eliminated when possible if there is no direct impact on service to our
customers.





Corporate
SG&A – Our second quarter and first half 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.





Reorganization
Expenses, Net





Thirteen Weeks Ended
                
                
                Twenty-six Weeks EndedAugust 1,
                
                
                % of
                
                
                August 2,
                
                
                % of
                
                
                August 1,
                
                
                % of
                
                
                August 2,
                
                
                % of(in thousands)
                
                2009
                
                
                Sales
                
                
                2008
                
                
                Sales
                
                
                2009
                
                
                Sales
                
                
                2008
                
                
                SalesReorganziation
      expense, net
                
                $
                171
                
                
                
                0.3
                %
                
                $
                4,254
                
                
                
                6.7
                %
                
                $
                410
                
                
                
                0.3
                %
                
                $
                6,930
                
                
                
                5.4
                %





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 as compared to the prior year.





Interest
Expense, Net





Thirteen Weeks Ended
                
                
                Twenty-six Weeks Ended(in thousands)
                
                August 1,
                
                
                % of
                
                
                August 2,
                
                
                % of
                
                
                August 1,
                
                
                % of
                
                
                August 2,
                
                
                % of2009
                
                
                Sales
                
                
                2008
                
                
                Sales
                
                
                2009
                
                
                Sales
                
                
                2008
                
                
                SalesInterest
      expense, net
                
                $
                1,376
                
                
                
                2.3
                %
                
                $
                3,577
                
                
                
                5.6
                %
                
                $
                2,710
                
                
                
                2.2
                %
                
                $
                4,566
                
                
                
                3.6
                %





The
Company’s interest costs are driven by borrowings on our credit
facilities.  Our current credit facilities consist of both an asset
based facility and a subordinated debt facility.  Interest expense for
the second quarter of fiscal 2009 includes $0.6 million of note discount
amortization costs and $0.4 million of interest paid with the issuance of
additional notes.  Excluding these non-cash items, interest expense
for the second quarter of 2009 was $0.5 million, or 0.8% of sales, compared to
$3.6 million or 5.6% of sales in 2008.  Interest expense for the first
half of fiscal 2009 includes $1.2 million of note discount amortization and $0.7
million of interest paid with the issuance of additional notes. Interest expense
for the second quarter and first half of 2008 included $2.2 million of interest
paid on bankruptcy claims, which equated to 3.5% of sales for the
quarter.





Income
Taxes





No income
tax benefit was recognized during any periods presented due to the Company’s
uncertainty in realizing future tax benefits generated by tax
losses.


17


Loss
from Discontinued Operations





(in thousands)
                
                Thirteen Weeks Ended
                
                
                Twenty-six Weeks EndedAugust 1,
                
                
                % of
                
                
                August 2,
                
                
                % of
                
                
                August 1,
                
                
                % of
                
                
                August 2,
                
                
                % of2009
                
                
                Sales
                
                
                2008
                
                
                Sales
                
                
                2009
                
                
                Sales
                
                
                2008
                
                
                SalesIncome
      (loss) from discountinued operations
                
                $
                -
                
                
                
                0.0
                %
                
                $
                (762
                )
                
                
                -1.2
                %
                
                $
                49
                
                
                
                0.0
                %
                
                $
                (220
                )
                
                
                -0.2
                %





The
results shown relate to 26 store closures in 2006 and 124 in 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 were closed in either 2009 or 2008 that required treatment as
discontinued operations. The income in 2009 resulted from the settlement of
leases rejected in bankruptcy at amounts less than anticipated, and the losses
in 2008 resulted from updated estimates of store closure expenses.





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 twenty-six weeks of fiscal 2009
and 2008 follows (in thousands):





Twenty-six Weeks EndedAugust 1,
                  
                  
                  August 2,2009
                  
                  
                  2008Net
      cash flows provided (used):Operating
      activites
                  
                  $
                  4,548
                  
                  
                  $
                  (9,127
                  )Investing
      activities
                  
                  
                  (1,256
                  )
                  
                  
                  (5,464
                  )Financing
      activites
                  
                  
                  (2,906
                  )
                  
                  
                  17,762





Operating
Activities





Net cash
inflows provided by operating activities increased by $13.7 million compared to
the prior year.  This increase was primarily the result of the
significant reduction in inventory balances as increased emphasis is being
placed on supply chain management combined with a much smaller net
loss.




18





Investing
Activities





Cash used
for investing activities consists primarily of purchases and sales of property
and equipment.  Capital expenditures during the current year consisted
primarily of two new locations, five store remodels, technology upgrades and
minor retail location improvements.





Financing
Activities





Cash
provided by operations provided funds to reduce debt by $2.2 million and make
payments of $0.7 million toward pre-petition obligations.





Credit
Facilities





The
following should be read in conjunction with Note 8 to the Company’s Annual
Report on Form 10-K filed April 10, 2009.





As of
August 1, 2009, the Company had outstanding borrowings under the Revolver of
$30.5 million and outstanding letters of credit of $6.5
million.  Additional amounts available to borrow at that time were
$30.9 million.





As of
August 1, 2009, the Note balance was $21.6 million and the discount on Notes
Payable related to warrants issued was $9.3 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 secured revolving credit facility that provides up
to $20 million in letters of credit.  At August 1, 2009, Hancock had
commitments of $0.6 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.





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 SFAS 157 “Fair Value Measurements,” which requires
additional disclosure about fair value measurements .


19





Related
Party Transactions





See Note
17 in the Company’s Annual Report on Form 10-K filed 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 twenty-six week
periods ended August 1, 2009 and August 2, 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
does not hold derivative financial or commodity instruments at August 1,
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
August 1, 2009, the Company had borrowings outstanding of approximately $30.5
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 $30.5 million as existed at
August 1, 2009.





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 1, 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 August 1,
2009.


20




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 twenty-six week period ended
August 1, 2009.  As of August 1, 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 Exchange Act is recorded, processed, summarized, and reported within
the time periods specified in the SEC’s rules and forms and that such
information is accumulated and communicated to the Company’s management,
including the President  and 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.




As of the
end of the period covered by this report (August 1, 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  August 1, 2009.




Changes
in Internal Control Over Financial Reporting




There
have not been any 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.




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.


21





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 1,756,437 shares purchased under this
authorization through August 1, 2009, and the number of shares that may yet be
purchased under this authorization remains unchanged from the year ended January
31, 2009 at 243,563.





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


Registrant's
Annual Meeting of Stockholder was held on June 9, 2009.





The
following individuals were elected to serve as directors of the Company until
2010, with votes cast as shown.





Nominees:
                      
                      For
                      
                      WithheldJane
      F. Aggers
                      
                      17,897,035
                      
                      282,175Carl
      E. Berg (1)
                      
                      16,877,465
                      
                      1,301,745Sam
      P. Cortez
                      
                      17,853,905
                      
                      325,305Steven
      D. Scheiwe
                      
                      17,040,448
                      
                      1,138,762Harry
      D. Schulman
                      
                      17,920,920
                      
                      258,290





(1) Mr.
Berg resigned  from his position as a director of the Company
effective August 4, 2009. The remaining directors have elected Neil S.
Subin  to serve as a director until the next annual meeting of
stockholders.





Ratification
of the appointment of Burr, Pilger & Mayer, LLP as the Registrant’s
independent auditors for the fiscal year ending January 30, 2010, with votes
cast as shown.





For
                
                Against
                
                Abstain18,100,185
                
                10,891
                
                68,134







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ITEM
5: OTHER INFORMATION





None.





ITEM
6: EXHIBITS




10.1†
                    Deposit
      Account Control Agreement, dated July 24, 2009 by and among BancorpSouth
      Bank, Hancock Fabrics, Inc. and Deutsche Bank National Trust Company, in
      its capacity as trustee.10.2†
                    Second
      Lien Deposit Account Control Agreement (Elavon Account) dated July 24,
      2009 by and among BancorpSouth Bank, Hancock Fabrics, Inc. and Deutsche
      Bank National Trust Company, in its capacity as
trustee.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†Confidential
      treatment has been requested with respect to certain provisions of these
      agreements. Omitted portions have been filed separately with the
      SEC


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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




Date:  August
27, 2009


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