##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
 For the quarterly period ended August 2, 2008
 OR
 o
    
    Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
 For
the transition period from

to
.
 Commission
File Number 1 - 9482
 HANCOCK FABRICS, INC.
  Delaware
(State or other jurisdiction 
of incorporation or organization)
    
    64-0740905
(I.R.S. Employer
Identification No.)One Fashion Way, Baldwyn, MS
(Address of principal executive offices)
    
    38824
(Zip Code)
 (662) 365-6000
 þ o
  Large accelerated filer oAccelerated filer oNon-accelerated filer o(Do not check if a smaller reporting company)Smaller reporting company þ o þ
 þ o




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##### 



PagePart I. Financial Information:Item 1. Financial StatementsConsolidated Balance Sheets as of August 2, 2008 and February 2, 2008
    
    
    3Consolidated Statements of Operations for the Thirteen and Twenty-six Weeks
Ended August 2, 2008 and August 4, 2007
    
    
    4Consolidated Statement of Shareholders Equity for the Twenty-six
Weeks Ended August 2, 2008
    
    
    5Consolidated Statements of Cash Flows for the Twenty-six Weeks
Ended August 2, 2008 and August 4, 2007
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    14Item 3. Quantitative and Qualitative Disclosures about Market Risks
    
    
    19Item 4. Controls and Procedures
    
    
    20Part II. Other Information:Item 1. Legal Proceedings
    
    
    21Item 1A. Risk Factors
    
    
    21Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    21Item 3. Defaults Upon Senior Securities
    
    
    22Item 4. Submission of Matters to a Vote of Security Holders
    
    
    22Item 5. Other Information
    
    
    22Item 6. Exhibits
    
    
    23Signatures
    
    
    23EX-10.1 2001 Stock Incentive PlanEx-31.1 Section 302 Certification of the CEOEx-31.2 Section 302 Certification of the CFOEx-32.1 Section 906 Certification of the CEOEx-32.2 Section 906 Certification of the CFO
  2




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PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 
 HANCOCK FABRICS, INC.
CONSOLIDATED BALANCE SHEETS
 (unaudited)August 2,
    
    February 2,(in thousands, except for share and per share amounts)
    
    2008
    
    2008 (1)AssetsCurrent assets:Cash and cash equivalents
    
    $
    5,451
    
    
    $
    2,280Receivables, less allowance for doubtful accounts
    
    
    3,910
    
    
    
    4,453Inventories, net
    
    
    78,684
    
    
    
    77,907Income taxes refundable
    
    
    8,118
    
    
    
    8,118Prepaid expenses
    
    
    2,182
    
    
    
    1,748Total current assets
    
    
    98,345
    
    
    
    94,506Property and equipment, net
    
    
    45,860
    
    
    
    43,683Goodwill
    
    
    3,406
    
    
    
    3,406Other assets
    
    
    6,685
    
    
    
    7,107Total assets
    
    $
    154,296
    
    
    $
    148,702Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    20,347
    
    
    $
    19,393Accrued liabilities
    
    
    17,836
    
    
    
    14,354Other pre-petition obligations
    
    
    35,143
    
    
    
    Total current liabilities
    
    
    73,326
    
    
    
    33,747Long-term debt obligations
    
    
    34,401
    
    
    
    23,608Capital lease obligations
    
    
    3,328
    
    
    
    Postretirement benefits other than pensions
    
    
    8,927
    
    
    
    315Pension and SERP liabilities
    
    
    5,432
    
    
    
    270Other liabilities
    
    
    8,547
    
    
    
    3,071Total liabilities not subject to compromise
    
    
    133,961
    
    
    
    61,011Liabilities subject to compromise
    
    
    
    
    
    
    60,635Total liabilities
    
    
    133,961
    
    
    
    121,646Commitments and contingencies (See Note 6)Shareholders equity:Common stock, $.01 par value; 80,000,000 shares authorized;
32,751,983 and 32,601,483 issued and 19,385,343 and
19,285,235 outstanding, respectively
    
    
    328
    
    
    
    326Additional paid-in capital
    
    
    87,487
    
    
    
    75,324Retained earnings
    
    
    82,487
    
    
    
    100,953Treasury stock, at cost, 13,366,640 and 13,316,248
shares held, respectively
    
    
    (153,683
    )
    
    
    (153,622
    )Accumulated other comprehensive income
    
    
    3,716
    
    
    
    4,075Total shareholders equity
    
    
    20,335
    
    
    
    27,056Total liabilities and shareholders equity
    
    $
    154,296
    
    
    $
    148,702
 (1)
    
    Derived from audited balance sheet included in our annual report
on Form 10-K for the fiscal year ended February 2, 2008.  3




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HANCOCK FABRICS, INC.  CONSOLIDATED STATEMENTS OF OPERATIONS
 Thirteen Weeks Ended
    
    Twenty-six Weeks EndedAugust 2,
    
    August 4,
    
    August 2,
    
    August 4,(in thousands, except per share amounts)
    
    2008
    
    2007
    
    2008
    
    2007Sales
    
    $
    63,799
    
    
    $
    58,030
    
    
    $
    127,615
    
    
    $
    127,212Cost of goods sold
    
    
    37,592
    
    
    
    33,381
    
    
    
    73,606
    
    
    
    71,507Gross profit
    
    
    26,207
    
    
    
    24,649
    
    
    
    54,009
    
    
    
    55,705Selling, general and administrative expense
    
    
    28,879
    
    
    
    24,800
    
    
    
    58,629
    
    
    
    53,525Depreciation and amortization
    
    
    1,117
    
    
    
    1,034
    
    
    
    2,130
    
    
    
    1,776Operating income (loss)
    
    
    (3,789
    )
    
    
    (1,185
    )
    
    
    (6,750
    )
    
    
    404Reorganization expense, net
    
    
    4,254
    
    
    
    3,759
    
    
    
    6,930
    
    
    
    7,884Interest expense, net
    
    
    3,577
    
    
    
    1,133
    
    
    
    4,566
    
    
    
    3,177Loss from continuing operations before income taxes
    
    
    (11,620
    )
    
    
    (6,077
    )
    
    
    (18,246
    )
    
    
    (10,657
    )Income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Loss from continuing operations
    
    
    (11,620
    )
    
    
    (6,077
    )
    
    
    (18,246
    )
    
    
    (10,657
    )Loss from discontinued operations, (net of tax expense of $0 and $0)
    
    
    (762
    )
    
    
    (7,257
    )
    
    
    (220
    )
    
    
    (3,888
    )Net loss
    
    $
    (12,382
    )
    
    $
    (13,334
    )
    
    $
    (18,466
    )
    
    $
    (14,545
    )Basic and diluted loss per share:Loss from continuing operations
    
    $
    (0.61
    )
    
    $
    (0.32
    )
    
    $
    (0.96
    )
    
    $
    (0.56
    )Loss from discontinued operations
    
    
    (0.04
    )
    
    
    (0.38
    )
    
    
    (0.01
    )
    
    
    (0.21
    )Net loss
    
    $
    (0.65
    )
    
    $
    (0.71
    )
    
    $
    (0.97
    )
    
    $
    (0.77
    )Weighted average shares outstanding:Basic and diluted
    
    
    19,069
    
    
    
    18,895
    
    
    
    19,027
    
    
    
    18,871
  4




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HANCOCK FABRICS, INC.  CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY    Twenty-six Weeks Ended August 2, 2008
 AccumulatedAdditional
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    TotalCommon Stock
    
    
    Paid-in
    
    
    Retained
    
    
    Treasury Stock
    
    
    Comprehensive
    
    
    Shareholders(in thousands, except for number of shares)
    
    Shares
    
    
    Amount
    
    
    Capital
    
    
    Earnings
    
    
    Shares
    
    
    Amount
    
    
    Income (Loss)
    
    
    EquityBalance February 2, 2008
    
    
    32,601,483
    
    
    $
    326
    
    
    $
    75,324
    
    
    $
    100,953
    
    
    
    (13,316,248
    )
    
    $
    (153,622
    )
    
    $
    4,075
    
    
    $
    27,056Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (18,466
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (18,466
    )Minimum pension, SERP and OPEB
liabilities, net of taxes of $0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (359
    )
    
    
    (359
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (18,825
    )Issuance of restricted stock
    
    
    161,500
    
    
    
    2
    
    
    
    72
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    74Cancellation of restricted stock
    
    
    (11,000
    )
    
    
    
    
    
    
    (74
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (74
    )Stock compensation expense
    
    
    
    
    
    
    
    
    
    
    480
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    480Warrants issued with notes
    
    
    
    
    
    
    
    
    
    
    11,685
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,685Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (50,392
    )
    
    
    (61
    )
    
    
    
    
    
    
    (61
    )Balance August 2, 2008
    
    
    32,751,983
    
    
    $
    328
    
    
    $
    87,487
    
    
    $
    82,487
    
    
    
    (13,366,640
    )
    
    $
    (153,683
    )
    
    $
    3,716
    
    
    $
    20,335
  5




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Hancock Fabrics, Inc.  Condensed Consolidated Statements of Cash Flows
 (in thousands)
    
    Twenty-six Weeks EndedAugust 2,
    
    August 4,2008
    
    2007Cash flows from operating activities:Net loss
    
    $
    (18,466
    )
    
    $
    (14,545
    )Adjustments to reconcile net loss to cash flows (used in) provided by operating activitiesDepreciation and amortization, including cost of goods sold
    
    
    3,244
    
    
    
    4,050Amortization of deferred loan costs
    
    
    403
    
    
    
    1,346Amortization of Bond Discount
    
    
    13
    
    
    
    LIFO inventory reserve
    
    
    2,267
    
    
    
    (5,918
    )Interest accrued on Pre-Petition Obligations
    
    
    2,219
    
    
    
    Stock compensation expense
    
    
    480
    
    
    
    556Reserve for store closings credits, including interest expense
    
    
    (899
    )
    
    
    3,730Reserve for obsolete inventory
    
    
    (194
    )
    
    
    (112
    )Reserve for sales returns and bad debts
    
    
    (56
    )
    
    
    (78
    )Stepped rent accrual
    
    
    (6
    )
    
    
    (802
    )Loss (Gain) on disposition of property and equipment
    
    
    26
    
    
    
    (1,217
    )Gain on disposition of lease financing obligations
    
    
    
    
    
    
    (153
    )Compensation expense for issuance of shares under directors
stock plan
    
    
    
    
    
    
    69Reorganization expense, net
    
    
    6,930
    
    
    
    7,884(Increase) decrease in assetsReceivables and prepaid expenses
    
    
    165
    
    
    
    (2,907
    )Inventory at current cost
    
    
    (2,835
    )
    
    
    61,531Other noncurrent assets
    
    
    1,221
    
    
    
    (870
    )Increase (decrease) in liabilitiesAccounts payable
    
    
    2,323
    
    
    
    7,014Accrued liabilities
    
    
    (175
    )
    
    
    (3,987
    )Postretirement benefits other than pensions
    
    
    (369
    )
    
    
    (2,466
    )Long-term pension and SERP liabilities
    
    
    363
    
    
    
    794Other liabilities
    
    
    (1,056
    )
    
    
    (462
    )Net cash (used in) provided by operating activities before reorganization activities
    
    
    (4,402
    )
    
    
    53,457Net cash used for reorganization activities
    
    
    (4,725
    )
    
    
    (7,884
    )Net cash (used in) provided by operating activities
    
    
    (9,127
    )
    
    
    45,573Cash flows from investing activities:Additions to property and equipment
    
    
    (5,565
    )
    
    
    (1,032
    )Proceeds from the disposition of property and equipment
    
    
    101
    
    
    
    4,074Net cash (used in) provided by investing activities
    
    
    (5,464
    )
    
    
    3,042Cash flows from financing activities:Net borrowings (payments) on credit facilities
    
    
    22,465
    
    
    
    (42,084
    )Payments for capital leases
    
    
    (32
    )
    
    
    (47
    )Payments for loan costs
    
    
    (1,202
    )
    
    
    Payments for Pre-Petition Obligations
    
    
    (3,408
    )
    
    
    Purchase of treasury stock
    
    
    (61
    )
    
    
    (77
    )Net cash (used in) provided by financing activities
    
    
    17,762
    
    
    
    (42,208
    )Increase in cash and cash equivalents
    
    
    3,171
    
    
    
    6,407Cash and cash equivalents:Beginning of period
    
    
    2,280
    
    
    
    2,499End of period
    
    $
    5,451
    
    
    $
    8,906Supplemental disclosures:Cash paid during the period for:Interest
    
    $
    2,343
    
    
    $
    3,192Non-cash activities:Warrants issued with notes
    
    $
    (11,685
    )
    
    $
    Noncash change in funded status of benefit plans
    
    
    (359
    )
    
    
    1,586Decrease in capital lease obligations
    
    
    (37
    )
    
    
    (2,366
    )Issuance of restricted stock
    
    
    74
    
    
    
    40Cancellation of restricted stock
    
    
    (74
    )
    
    
    (718
    )
  6




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




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Recently Issued Accounting Standards
    NOTE 2  PROCEEDINGS UNDER CHAPTER 11 AND RELATED FINANCINGS
 Emergence from Bankruptcy Protection
  8




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Fresh Start Reporting
  Discharge and Treatment of Claims and Interests
   Exit Financing
  Claims Resolution and Plan Distributions
     9




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Leases and Contracts
  Liabilities Subject to Compromise
   10




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February 2,2008Accounts payable
    
    $
    28,483Accrued liabilities:Payroll and benefits
    
    
    132Rent liability
    
    
    576Capital lease obligations
    
    
    67Store closing liability
    
    
    5,396Customer liability and property claims
    
    
    695Deferred compensation
    
    
    290Other
    
    
    167Total accrued liabilities
    
    
    7,323Total current liabilities
    
    
    35,806Income taxes payable
    
    
    1,500Long term capital lease obligations
    
    
    3,365Post retirement benefits other than pensions
    
    
    8,414Pension and SERP liability
    
    
    5,007Other Liabilities:Long Term Deferred Compensation
    
    
    3,948Long Term Stepped Rent
    
    
    2,186Unapplied Rent Credit
    
    
    390Other
    
    
    19Total other liabilities
    
    
    6,543Total liabilities subject to compromise
    
    $
    60,635
 Subsequent Distribution
  NOTE 3: LOSS PER SHARE
  11




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COMPUTATION OF LOSS PER SHARE
 Thirteen Weeks Ended
    
    
    Twenty-six Weeks EndedAugust 2,
    
    
    August 4,
    
    
    August 2,
    
    
    August 4,(in thousands, except for share and per share amounts)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Basic and diluted loss per share:Net loss
    
    $
    (12,382
    )
    
    $
    (13,334
    )
    
    $
    (18,466
    )
    
    $
    (14,545
    )Weighted average number of common shares outstanding during
period
    
    
    19,069,246
    
    
    
    18,895,130
    
    
    
    19,026,562
    
    
    
    18,870,993Basic and diluted loss per share
    
    $
    (0.65
    )
    
    $
    (0.71
    )
    
    $
    (0.97
    )
    
    $
    (0.77
    )Weighted average common stock equivalents not included in EPS
(stock options) because the effect would be anti-dilutive
    
    
    1,400,164
    
    
    
    1,779,191
    
    
    
    1,436,844
    
    
    
    1,993,716
 NOTE 4: RESERVE FOR STORE CLOSINGS AND DISCONTINUED OPERATIONS
      Addition toFebruary 2,
    
    
    (Reduction in)
    
    
    
    
    
    
    
    
    
    
    August 2,2008
    
    
    Reserve
    
    
    Interest
    
    
    Payments
    
    
    2008Lease obligations
    
    $
    5,396
    
    
    $
    849
    
    
    $
    7
    
    
    $
    (1,755
    )
    
    $
    4,497
 12




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NOTE 5  LONG-TERM DEBT OBLIGATIONS
          13




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ITEM 2:
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 FORWARD LOOKING STATEMENTS
  GENERAL
  FINANCIAL CONDITION
   14




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RESULTS OF OPERATIONS
  Thirteen weeks ended August 2, 2008 compared with thirteen weeks ended August 4, 2007
      15




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Twenty-six weeks ended August 2, 2008 compared with twenty-six weeks ended August 4, 2007
     th
  16




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LIQUIDITY AND CAPITAL RESOURCES
 Revolving credit facility and Notes
       17




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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
   18




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OFF-BALANCE SHEET ARRANGEMENTS
  CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
   EFFECTS OF INFLATION
   SEASONALITY
  
 ITEM 3:
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     19




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ITEM 4:
    
    CONTROLS AND PROCEDURES
 Disclosure Controls and Procedures
     Remediation and Changes in Internal Controls
  
    
    Hiring a new Senior Vice President and Chief Financial Officer to supplement the
existing financial executive team.
    
    Continuing the engagement of a third party accounting and consulting firm to assist with
accounting and disclosure matters related to the financial reporting and accounting
requirements.
    
    Realigning internal resources to improve the staffing and knowledge of the financial
reporting and accounting functions.
   20




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PART II. OTHER INFORMATION:
 
 ITEM 1:
    
    LEGAL PROCEEDINGS
   
 ITEM 1A:
    
    RISK FACTORS
  
 ITEM 2:
    
    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  21




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Total Number of
    
    
    MaximumShares Purchased as
    
    
    Number of Shares ThatTotal Number of
    
    
    Average Price
    
    
    Part of Publicly
    
    
    May Yet Be PurchasedPeriod
    
    Shares Purchased (1)
    
    
    Paid Per Share
    
    
    Announced Plans (2)
    
    
    Under the PlansMay 4, 2008 through
May 31, 2008
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    243,617June 1, 2008 through
July 5, 2008
    
    
    17,669
    
    
    $
    1.24
    
    
    
    
    
    
    
    243,617July 6, 2008 through
August 2, 2008
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    243,617Total
    
    
    17,669
    
    
    $
    1.24
    
    
    
    
    
    
    
    243,617
 
 (1)
    
    The shares purchased during the second quarter consisted of 17,669 shares deemed
surrendered to the Company to satisfy tax withholding obligations arising from the lapse of
restrictions on shares.(2)
    
    In June of 2000 the Board of Directors authorized the repurchase of up to 2,000,000 shares
of the Companys Common Stock from time to time when warranted by market conditions. There
have been 1,756,383 shares purchased under this authorization through August 2, 2008. The
shares discussed in footnote (1) are excluded from these numbers.The Registrant did not sell any unregistered equity securities during the period covered by
this Quarterly Report. 
 ITEM 3:
    
    DEFAULTS UPON SENIOR SECURITIES
  
 ITEM 4:
    
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 ITEM 5:
    
    OTHER INFORMATION
  22




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ITEM 6:
    
    EXHIBITS
 10.1
    
    2001 Stock Incentive Plan, as amended August 4, 200831.1
    
    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) Under The Securities
Exchange Act of 193431.2
    
    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) Under The Securities
Exchange Act of 193432.1
    
    Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant To Section 906 of The Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002
 
 SIGNATURE
  HANCOCK FABRICS, INC.
(Registrant)By:
    /s/ Robert W. DriskellRobert W. DriskellSenior Vice President and
Chief Financial Officer   23