FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 28, 2001

OR

(    ) TRANSITION REPORT PURSUANT TO SECTION 13 OF 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
(State or other jurisdiction of
incorporation or organization) 64-0740905
(I. R. S. Employer
Identification No.)

3406 West Main Street, Tupelo, MS 38803
(Address of principal executive offices)
(Zip Code)

(662) 842-2834
(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 the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

As of October 28, 2001, the registrant had outstanding an aggregate of 18,000,200 shares of common stock, $.01 par value.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
		CONSOLIDATED BALANCE SHEET
		CONSOLIDATED STATEMENT OF EARNINGS
		CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
		CONSOLIDATED STATEMENT OF CASH FLOWS
		NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
PART II. OTHER INFORMATION:
	Item 3: Quantitative and Qualitative Disclosures about Market Risks
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURE

INDEX

			Page
			Numbers
Part I. Financial Information:
	Item 1. Financial Statements (unaudited)
		Consolidated Balance Sheet as of October 28, 2001 and January 28, 2001		3
		Consolidated Statement of Earnings for the Thirteen Weeks and Thirty-nine Weeks Ended October 28, 2001 and October 29, 2000		4
		Consolidated Statement of Shareholders’ Equity for the Thirty-nine Weeks Ended October 28, 2001		5
		Consolidated Statement of Cash Flows for the Thirty-nine Weeks Ended October 28, 2001 and October 29, 2000		6
		Notes to Consolidated Financial Statements		7 - 8
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			8 - 11
Part II. Other Information:
	Item 3. Quantitative and Qualitative Disclosures about Market Risks			11
	Item 6. Exhibits and Reports on Form 8-K			11
	Signature			11

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PART I. FINANCIAL INFORMATION

HANCOCK FABRICS, INC.

CONSOLIDATED BALANCE SHEET

(unaudited)

(in thousands, except for			October 28,			January 28,
share and per share amounts)			2001			2001
Assets
Current assets:
		Cash and cash equivalents	$	4,678		$	3,891
		Receivables, less allowance for doubtful accounts		982			589
		Inventories		141,091			138,657
		Prepaid expenses		2,131			1,677
		Total current assets		148,882			144,814
Property and equipment, at depreciated cost				28,502			25,616
Deferred tax asset				7,776			10,486
Pension payment in excess of required contribution				3,642			3,078
Other assets				8,665			8,735
		Total assets	$	197,467		$	192,729
Liabilities and Shareholders’ Equity
Current liabilities:
		Accounts payable	$	41,153		$	38,665
		Accrued liabilities		15,274			15,367
		Deferred tax liabilities		2,959			4,726
		Income taxes		2,191			6,179
		Total current liabilities		61,577			64,937
Long-term debt obligations				17,000			16,000
Postretirement benefits other than pensions				21,730			21,278
Reserve for store closings				2,004			3,012
Other liabilities				4,496			4,950
		Total liabilities		106,807			110,177
Commitments and contingencies
Shareholders’ equity:
	Common stock, $.01 par value; 80,000,000 shares authorized; 30,010,288 and 29,190,335 issued and outstanding, respectively			300			292
	Additional paid-in capital			45,178			39,094
	Retained earnings			188,610			183,917
	Treasury stock, at cost, 12,010,088 and 11,905,378 shares held, respectively			(136,304	)		(135,583	)
	Deferred compensation on restricted stock incentive plan			(7,124	)		(5,168	)
		Total shareholders’ equity		90,660			82,552
		Total liabilities and shareholders’ equity	$	197,467		$	192,729

See accompanying notes to consolidated financial statements.

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CONSOLIDATED STATEMENT OF EARNINGS

(unaudited)

(in thousands, except
per share amounts)		Thirteen Weeks Ended						Thirty-nine Weeks Ended
		October 28,			October 29,			October 28,			October 29,
		2001			2000			2001			2000
Sales		$	103,753		$	99,864		$	288,184		$	284,033
Cost of goods sold			51,679			49,337			143,968			142,055
	Gross profit		52,074			50,527			144,216			141,978
Expenses (income)
	Selling, general and administrative		44,512			43,814			128,348			127,053
	Depreciation and amortization		1,383			1,338			4,108			3,939
	Interest expense		354			614			1,168			1,994
	Interest income		(29	)		(52	)		(94	)		(153	)
	Total operating and interest expenses		46,220			45,714			133,530			132,833
Earnings before taxes			5,854			4,813			10,686			9,145
Income taxes			2,126			1,747			3,880			3,314
Net earnings and comprehensive income		$	3,728		$	3,066		$	6,806		$	5,831
Earnings per share
	Basic	$	0.22		$	0.19		$	0.41		$	0.34
	Diluted	$	0.22		$	0.19		$	0.40		$	0.34
Weighted average shares outstanding
	Basic		16,891			16,448			16,676			16,943
	Diluted		17,298			16,470			16,951			16,950
Dividends per share		$	0.04		$	0.025		$	0.12		$	0.075

See accompanying notes to consolidated financial statements.

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CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(unaudited)

(in thousands, except for	Common Stock					Additional						Treasury Stock									Total
number of shares)						Paid-in			Retained									Deferred			Shareholders'
	Shares			Amount		Capital			Earnings			Shares			Amount			Compensation			Equity
Thirty-nine weeks ended October 28, 2001
Balance January 28, 2001		29,190,335		$	292	$	39,094		$	183,917			(11,905,738	)		($135,583	)		($5,168	)	$	82,552
Net earnings										6,806												6,806
Cash dividend — $.04 per share on a quarterly basis										(2,113	)											(2,113	)
Amortization and vesting of deferred compensation on restricted stock incentive plan							(79	)											1,495			1,416
Issuance of restricted stock		459,100			4		3,478												(3,482	)
Cancellation of restricted stock		(4,100	)				(31	)											31
Purchase of treasury stock													(104,350	)		(721	)					(721	)
Issuance of shares under directors’ stock plan		16,805					126															126
Exercise of stock options		347,850			4		2,587															2,591
Stock issuances as compensation for professional services		298					3															3
Balance October 28, 2001		30,010,288		$	300	$	45,178		$	188,610			(12,010,088	)		($136,304	)		($7,124	)	$	90,660

See accompanying notes to consolidated financial statements.

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CONSOLIDATED STATEMENT OF CASH FLOWS

(unaudited)

(in thousands)
					Thirty-nine Weeks Ended
					October 28,			October 29,
					2001			2000
Cash flows from operating activities:
	Net earnings				$	6,806		$	5,831
	Adjustments to reconcile net earnings to cash provided by (used in) operating activities Depreciation and amortization					4,108			3,939
		LIFO				300			300
		Deferred income taxes				943			2,555
		Amortization of deferred compensation on restricted stock incentive plan				1,495			1,408
				Issuance of shares as compensation for professional services		3			95
		Interest expense on closed store accrual				153			196
		(Increase) decrease in assets
				Receivables and prepaid expenses		(847	)		2,399
				Inventory at current cost		(2,734	)		1,489
				Pension payment in excess of required contribution		(564	)		(3,078	)
				Other noncurrent assets		70			(1,569	)
		Increase (decrease) in liabilities
				Accounts payable		2,488			3,251
				Accrued liabilities		(93	)		3,841
				Current income tax obligations		(4,067	)		(1,491	)
				Postretirement benefits other than pensions		452			397
				Payments against closed store accrual		(1,161	)		(2,151	)
				Other liabilities		(454	)		502
			Net cash (used in) provided by operating activities			6,898			17,914
Cash flows from investing activities:
	Additions to property and equipment					(6,994	)		(3,224	)
	Other								268
			Net cash used in investing activities			(6,994	)		(2,956	)
Cash flows from financing activities:
	Net borrowings (repayments) on revolving credit agreement					1,000			(10,000	)
	Purchase of treasury stock					(721	)		(5,495	)
	Issuance of shares under directors’ stock plan					126
	Proceeds from exercise of stock options					2,591
	Cash dividends paid					(2,113	)		(1,332	)
			Net cash provided by (used in) financing activities			883			(16,827	)
Increase (decrease) in cash and cash equivalents						787			(1,869	)
Cash and cash equivalents:
	Beginning of period					3,891			6,904
	End of period				$	4,678		$	5,035
Supplemental disclosures:
	Cash paid during the period for:
		Interest			$	887		$	1,700
		Income taxes			$	7,450		$	1,807

See accompanying notes to consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements of Hancock Fabrics, Inc. (“Hancock” or the “Company”) have been prepared in accordance with the instructions to Form 10-Q and therefore do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles. The statements do reflect all adjustments (consisting of only normal recurring entries) which are, in the opinion of management, necessary for a fair presentation of financial position in conformity with generally accepted accounting principles. The statements should be read in conjunction with the Notes to the Consolidated Financial Statements for the fiscal year ended January 29, 2001 incorporated into the Company’s Annual Report on Form 10-K.

The results of operations for the thirteen and thirty-nine week periods are not necessarily indicative of the results to be expected for the full fiscal year.

NOTE 2: 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 EARNINGS PER SHARE

(unaudited)

(dollars in thousands, except for share and			Thirteen Weeks Ended				Thirty-nine Weeks Ended
per share amounts)
			October 28,		October 29,		October 28,		October 29,
			2001		2000		2001		2000
Basic earnings per share
	Net earnings		$	3,728	$	3,066	$	6,806	$	5,831
	Weighted average number of common shares outstanding during period			16,891,489		16,448,010		16,676,279		16,943,034
Basic earnings per share (1)			$	0.22	$	0.19	$	0.41	$	0.34
Diluted earnings per share
	Net earnings		$	3,728	$	3,066	$	6,806	$	5,831
	Weighted average number of common shares outstanding during period			16,891,489		16,448,010		16,676,279		16,943,034
		Common stock equivalents		306,145		21,686		275,004		7,462
		Contingently issuable shares		100,052		0		0		0
				17,297,686		16,469,696		16,951,283		16,950,496
Diluted earnings per share (1)			$	0.22	$	0.19	$	0.40	$	0.34
Weighted average common stock equivalents not included in EPS because the effect would be anti-dilutive				0		281,987		98,335		391,408

(1) Per share amounts are based on average shares outstanding during each quarter and may not add to the total for the year.

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NOTE 3: RESERVE FOR STORE CLOSINGS

Store closing reserves are established based on estimates of net lease obligations and other store closing costs. During the fourth quarter of 1998, the Company recorded a charge of $8,604,000 for revised estimates of net lease obligations for stores closed at January 31, 1999 and stores committed to be closed in fiscal 1999. This charge, when combined with an already existing reserve, resulted in a total reserve of $9,022,000 at January 31, 1999.

At October 28, 2001, the balance in this reserve was $3,068,000 which represents the present value of the future net lease obligations required for the locations which have been closed. The 2001 activity in the reserve is as follows:

		January 29,		Imputed		Lease			October 28,
		2001		Interest		Payments			2001
Lease obligations		$	4,076	$	153		($1,161	)	$	3,068
	(in thousands)

NOTE 4: RECENT ACCOUNTING PRONOUNCEMENTS

On June 29, 2001, the Financial Accounting Standards Board issued Statement No. 141 (“SFAS 141”), “Business Combinations”. SFAS 141 requires the use of the purchase method of accounting for all business combinations. It also provides new criteria for determining whether intangible assets acquired in a business combination should be recognized separately from goodwill. SFAS 141 is effective for all business combinations (as defined) initiated after June 30, 2001 and for all business combinations accounted for by the purchase method that are completed after June 30, 2001. The Company adopted SFAS 141 in the quarter ended July 29, 2001 and there was no impact upon the Company’s financial statements.

On June 29, 2001, the Financial Accounting Standards Board also issued Statement No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets”. SFAS 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their acquisition and supersedes APB 17, “Intangible Assets.” SFAS 142 requires that goodwill and indefinite lived intangible assets be tested for impairment at least annually at the reporting unit level and ceases the amortization of such assets. SFAS 142 allows the amortization period of intangible assets with finite lives to be in excess of forty years. SFAS 142 is effective for fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recorded by the Company at that date, regardless of when those assets were initially recognized. Management has not yet evaluated the impact the adoption of SFAS 142 will have upon the Company’s financial statements.

The Financial Accounting Standards Board recently issued Statement No. 144 (“SFAS 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS 144 supersedes FAS 121 and applies to all long-lived assets (including discontinued operations). SFAS 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. SFAS 144 is effective for fiscal years beginning after December 15, 2001 and, generally, its provisions are to be applied prospectively. Management has not yet evaluated the impact of the adoption of SFAS 144 will have upon the Company's financial statements.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FINANCIAL CONDITION

Historically, cash flow from operations has been sufficient to finance the expansion and operation of Hancock’s business. Hancock’s principal capital requirements are for the financing of inventories and to a lesser extent for capital expenditures relating to store locations and its warehouse and distributions facility. Funds for such

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purposes are generated from Hancock’s operations and, if necessary, supplemented by borrowings from commercial lenders. In addition to cash dividends, Hancock has historically used excess cash and, if necessary, borrowings from commercial lenders to purchase treasury stock as market and financial conditions dictate. Hancock opened 8 stores and closed 7 stores during the thirteen weeks ended October 28, 2001, resulting in a total of 437 stores at period end.

During the thirty-nine weeks ended October 28, 2001, net earnings of $6.8 million and an increase of $2.5 million in accounts payable were used to fund additions to property and equipment of $7.0 million, an increase of $2.6 million in inventory and the payment of income tax obligations of $4.1 million. At October 28, 2001, the Company had $17 million in outstanding debt, or about 16% of total capitalization, compared to $21 million in outstanding debt at the end of last year’s third quarter.

RESULTS OF OPERATIONS

Thirteen weeks ended October 28, 2001 compared to thirteen weeks ended October 29, 2000

Net earnings were $3.7 million, or $.22 per diluted share, compared with $3.1 million, or $.19 per diluted share in the same period of the prior year. Earnings were influenced by higher sales and lower expenses as a percentage of sales than last year.

Sales increased to $103.8 million from $99.9 million in last year’s third quarter, as the result of an increase of 5.7% in comparable store sales, offset by a $1.5 million decrease in sales from net store opening and closing activity. Sales benefited from the aggressive store remodeling and product mix changes that the Company has implemented, but were partially offset by having ten fewer stores than a year ago. Gross margins declined slightly to 50.2% from 50.6% last year.

In the third quarter of 2001, total selling, general and administrative expenses as a percentage of sales were 42.9% compared to 43.9% in 2000 due to expense leverage from comparable store sales increases and continued efficiencies gained in advertising expenditures.

Interest expense was lower due to a decrease in interest rates by the Federal Reserve Bank and a decline in the average outstanding debt.

Thirty-nine weeks ended October 28, 2001 compared to thirty-nine weeks October 29, 2000

Net earnings were $6.8 million or $.40 per diluted share, compared with $5.8 million, or $.34 per diluted share in the same period of the prior year. The increase in earnings resulted from higher sales margins and lower expenses as a percentage of sales.

Sales increased to $288.1 million from $284.0 million in the first thirty-nine weeks of last year, as the result of an increase of 3.1% in comparable store sales, offset by a $4.2 million decrease in sales from net store opening and closing activity. Sales benefited from the aggressive store remodeling and product mix changes that the Company has implemented, but were offset by having fewer stores than a year ago. Gross margins were 50.0% for the thirty-nine week period for both the current and previous year.

For the thirty-nine week period, total selling, general and administrative expenses as a percentage of sales decreased to 44.5% from 44.7% due to expense leverage from comparable store sales increase and continued efficiencies gained in advertising expenditures.

Interest expense was lower due to a decrease in interest rates by the Federal Reserve Bank and a reduction in the average outstanding debt level.

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EFFECTS OF INFLATION

The impact of inflation on labor and occupancy costs can significantly affect Hancock’s operations. Many of Hancock’s employees are paid hourly rates related to the Federal minimum wage; accordingly, any increases will affect Hancock. In addition, payroll taxes, employee benefits and other employee related costs continue to increase. Costs of leases for new store locations remain stable, but renewal costs of older leases continue to increase. Taxes, maintenance and insurance costs have also risen. 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 is the most effective tool for coping with increasing costs and expenses.

Inflation is one of the key factors used in the calculation of the LIFO charge to Cost of Sales. In the last four fiscal quarters, an increase in the PPI indices resulted in a LIFO charge of $650 thousand.

SEASONALITY

The Company’s business is slightly seasonal. Peak sales periods occur in the fall and pre-Easter weeks, while the lowest sales periods occur during the summer and the month of January.

RECENT ACCOUNTING PRONOUNCEMENTS

On June 29, 2001, the Financial Accounting Standards Board issued Statement No. 141 (“SFAS 141”), “Business Combinations”. SFAS 141 requires the use of the purchase method of accounting for all business combinations. It also provides new criteria for determining whether intangible assets acquired in a business combination should be recognized separately from goodwill. SFAS 141 is effective for all business combinations (as defined) initiated after June 30, 2001 and for all business combinations accounted for by the purchase method that are completed after June 30, 2001. The Company adopted SFAS 141 in the quarter ended July 29, 2001 and there was no impact upon the Company’s financial statements.

On June 29, 2001, the Financial Accounting Standards Board also issued Statement No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets”. SFAS 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their acquisition and supersedes APB 17, “Intangible Assets”. SFAS 142 requires that goodwill and indefinite lived intangible assets be tested for impairment at least annually at the reporting unit level and ceases the amortization of such assets. SFAS 142 allows the amortization period of intangible assets with finite lives to be in excess of forty years. SFAS 142 is effective for fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recorded by the Company at that date, regardless of when those assets were initially recognized. Management has not yet evaluated the impact the adoption of SFAS 142 will have upon the Company’s financial statements.

The Financial Accounting Standards Board recently issued Statement No. 144 (“SFAS 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS 144 supersedes FAS 121 and applies to all long-lived assets (including discontinued operations). SFAS 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. SFAS 144 is effective for fiscal years beginning after December 15, 2001 and, generally, its provisions are to be applied prospectively. Management has not yet evaluated the impact of the adoption of SFAS 144 will have upon the Company’s financial statements.

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FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for certain qualifying forward-looking statements. Certain information included in this Form 10-Q contains statements that are forward-looking, such as statements related to financial items and results, plans for future expansion, store closure and other business development activities, capital spending or financing sources, capital structure, stability of interest rates during periods of borrowings and the effects of regulation, general economic trends, changes in consumer demand or purchase patterns, delays or interruptions in the flow of merchandise between the Company’s suppliers and/or its distribution center and its stores, a disruption in the Company’s data processing services and competition. Such forward-looking information involves important risks and uncertainties that could significantly impact anticipated results in the future. Accordingly, such results may differ materially from those expressed in any forward-looking statements by or on behalf of Hancock. These risks and uncertainties include, but are not limited to, those described above.

PART II. OTHER INFORMATION:

Item 3: Quantitative and Qualitative Disclosures about Market Risks

The Company is not holding any derivative financial or commodity instruments at October 28, 2001. The Company is exposed to financial market risks, including changes in interest rates. All borrowings under the Company’s Revolving Credit Agreement bear interest at a negotiated rate, a floating rate (the higher of the federal funds rate plus 1/2% or the prime rate), a rate derived from the Money Market Rate, or a rate derived from the London Interbank Offered Rate. An increase in interest rates of 100 basis points would not significantly affect the Company’s income. All of the Company’s business is transacted in U. S. dollars and, accordingly, foreign exchange rate fluctuations have never had a significant impact on the Company, and they are not expected to in the foreseeable future.

Item 6. Exhibits and Reports on Form 8-K

     (b)  Reports on Form 8-K

          None

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/ Bruce D. Smith
Bruce D. Smith
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

     December 12, 2001

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