---

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT of 1934

For the fiscal year-ended January 29, 2005

Commission File No. 1-6695

JO-ANN STORES, INC.

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (330) 656-2600

Securities registered pursuant to Section 12(b) of the Act:

      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 o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K.     x

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes x     No o

      The aggregate market value of the common stock of the registrant held by non-affiliates of the registrant as of July 31, 2004 was $508.0 million, based upon the closing sales price of the registrant’s common stock on that date as reported on the New York Stock Exchange. All executive officers and directors of the registrant have been deemed, solely for the purpose of the foregoing calculation, to be “affiliates” of the registrant.

      The number of common shares outstanding, as of April 1, 2005, of the registrant’s Common Stock was 23,010,927.

      Documents incorporated by reference: Portions of the following documents are incorporated by reference:

---

---

PART I

      Except as otherwise stated, the information contained in this report is given as of January 29, 2005, the end of our latest fiscal year. The words “Jo-Ann Stores, Inc.,” “Jo-Ann Stores,” “Jo-Ann Fabrics and Crafts,” “Jo-Ann etc,” “Registrant,” “Company,” “we,” “our” and “us” refer to Jo-Ann Stores, Inc. and, unless the context requires otherwise, to our subsidiaries. Jo-Ann Stores, Inc. is an Ohio corporation, founded in 1943. Our fiscal year ends on the Saturday closest to January 31 and refers to the year in which the period ends (e.g., fiscal 2005 refers to the period ended January 29, 2005).

      We are the nation’s largest specialty retailer of fabrics and one of the largest specialty retailers of crafts, serving customers in their pursuit of apparel and craft sewing, crafting, home decorating and other creative endeavors. We have a well-established, national brand name. Our retail stores (operating as Jo-Ann Fabrics and Crafts traditional stores and Jo-Ann superstores) feature a variety of competitively priced merchandise used in sewing, crafting and home decorating projects, including fabrics, notions, crafts, frames, scrapbooking material, artificial and dried flowers, home accents, finished seasonal and home décor merchandise.

      As of January 29, 2005, we operated 851 stores in 47 states (737 traditional stores and 114 superstores). Our traditional stores offer a complete selection of fabrics and notions and a convenience assortment of crafts, floral, finished seasonal and home décor merchandise. Our traditional stores average approximately 14,500 square feet and generated net sales per store of approximately $1.6 million in fiscal 2005. Our superstores offer an expanded and more comprehensive product assortment than our traditional stores. Our superstores also offer custom framing, floral arrangement and educational programs that our traditional stores do not. Our larger superstores, that were opened prior to fiscal 2003, average approximately 45,000 square feet and generated net sales per store of approximately $6.3 million in fiscal 2005. Our current superstore prototype averages 35,000 square feet and targets sales of $5.25 million in its first year of operation. We opened 29 of these new prototype superstores in fiscal 2005 and we currently have 43 of the prototype superstores in operation at January 29, 2005. Fourteen of the prototype superstores have been open at least one year and averaged $5.0 million in net sales for their first year of operation.

      We believe stability in our business and our industry is partially a function of recession-resistant characteristics. For example, according to a 2002 research study conducted by the Hobby Industry Association, approximately 60 percent of all U.S. households participated in crafts and hobbies in 2002. While expenditures for such projects are generally discretionary in nature, our average sales ticket during fiscal 2005 was relatively low at $23 in our superstores and $17 in our traditional stores. Industry sales, according to the Hobby Industry Association’s research study, were approximately $29 billion, a 13 percent increase from $25.7 billion in 2001. Our market is highly fragmented and is served by multi-store fabric retailers, arts and crafts retailers, mass merchandisers, small local specialty retailers, mail order vendors and a variety of other retailers.

      We provide a solution-oriented shopping experience with employees who are encouraged to assist customers in creating and completing creative projects. Many of our store level employees are sewing and/or crafting enthusiasts, which we believe enables them to provide exceptional customer service. We believe our focus on service contributes to a high proportion of repeat business from our customers. A significant portion of our advertising budget is allocated to our direct mail program targeting more than three million of our preferred customers on a regular basis.

      We believe that our superstores are uniquely designed to offer a destination location for our customers. We offer over 80,000 SKUs across three broad product categories in our superstores: sewing, crafting and home decorating components. We manage our vast product selection with SAP Retail, which was implemented in fiscal 2001. Through the core SAP application and integration with peripheral processing systems, we continue to drive operational and execution improvements, to review and enhance forecasting and replenishment capabilities, and to streamline operations. From fiscal 2001 through fiscal 2005, our inventory turns have increased from 1.8 to 2.3 times. Our concerted focus on continuous improvement and on key

metrics continues to yield results, including improved grand-opening results, better in-stock positions and improved visibility throughout our supply chain.

Business Strategy

      We intend to improve our operating performance by opening additional superstores, growing same-store sales and improving operating margins and inventory productivity. Key elements of this business strategy are:

      Open Additional Superstores. Roll out our refined superstore format across the nation. Our research has demonstrated that our customers have a better perception of the quality and pricing of our products when they are presented in our superstore format. We believe that our prototype 35,000 square foot superstore gives us a competitive advantage in the industry. Our superstores provide a unique shopping experience by offering a full creative selection — sewing, crafting, floral, framing, seasonal and home décor accessories — all under one roof. On average, we close 1.1 traditional stores for each superstore that we open. Our superstores average over three times the revenues of the traditional stores they replace. In markets where we have opened multiple superstores, we have been able to grow our revenues significantly and, we believe, expanded the market size and our share of market. For example, in Phoenix, Arizona, we have replaced eight of the 15 traditional stores in that market with four superstores over the last seven years, and we have increased our revenues in that market from $13 million to $39 million. We believe we have an opportunity to replace the remaining traditional stores in that market with superstores and further grow our revenues. We believe we have an opportunity to replicate our performance in Phoenix in the top 100 to 125 markets across the nation. As of January 29, 2005, we operated 114 superstores in 23 states.

      Grow Same-Store Sales. Both our traditional stores and superstores present opportunities to improve same-store sales. Our focus in this effort is on improving in-stocks, customer service and merchandise-driven initiatives. We primarily market via direct mail, although in superstore markets we use an integrated direct and mass marketing program. We believe that we can more efficiently and effectively drive repeat business by fine-tuning our direct mail and newspaper insert promotions. We frequently update the category merchandise offerings in our stores to keep our product offering fresh and compelling to our customers. Our focus is on placing key items at compelling prices on our end-cap displays. Because many of our store team members are sewing and crafting enthusiasts themselves, we also believe we can drive increased sales by providing knowledgeable customer service and assistance.

      Improve Margins. We believe we have the ability to improve margins by further reducing our level of clearance inventory and continuing to focus on our promotional activity, a strategy we successfully executed in fiscal 2005 and 2004, through the use of less aggressive coupons and tighter seasonal purchase commitments. We believe we can also improve margins by refining our supply chain management and merchandising in our stores. We continually examine our partnerships with our vendors to improve supply chain efficiency. We also continue to explore new product sourcing opportunities. We continuously monitor store performance to optimize our store portfolio. Of stores that have been open at least one year, we have only three stores that are not cash flow positive on a four-wall basis.

      Improve Inventory Productivity. Our enterprise-wide inventory management system enables us to improve our product mix on an ongoing basis. Our SAP Retail merchandising systems have been in operation since March 2000, and we have been operating since July 2001 on our current automated replenishment systems. We believe we have further opportunities to improve the accuracy of our perpetual inventories, perfect our merchandise and assortment planning tools and develop more sophisticated sales forecasting tools in order to replenish goods in our stores more efficiently and effectively.

Product Selection

      The following table shows our net sales by principal product line as a percentage of total net sales:

      We offer a broad and comprehensive assortment of fabrics in both our traditional and superstore formats. These fabrics are merchandised by end use and are sourced from throughout the world to offer our customers a combination of unique design, fashion forward trends, and value. Our stores are organized in the following categories for the convenience of the sewer:

      We offer a broad assortment of hardlines merchandise for the creative enthusiast. Our superstores offer the complete array of categories while our traditional stores, due to their smaller size, carry edited or convenience assortments. We offer the following hardline selections in our superstores:

      In addition to the basic categories described above, our stores regularly feature seasonal products, which complement our core merchandising strategy. Our seasonal offering spans all product lines and includes finished decorations, gifts and accessories that focus on holidays including Easter, Halloween and Christmas, as well as seasonal categories such as patio/garden. We own several private label seasonal brands including the “Cottontale Collection^tm,” “Spooky Hollow®,” “Santa’s Workbench®,” and “Garden Gate Designs^tm.”

      During the Christmas selling season, a significant portion of floor and shelf space is devoted to seasonal crafts, decorating and gift-making merchandise. Due to the project-oriented nature of these items, our peak selling season extends longer than that of other retailers and generally runs from September through December. In fiscal 2005, approximately 33 percent of our net sales and over 60 percent of our operating profits were generated in the fourth quarter.

      During fiscal 2005, 43 percent of superstore net sales were derived from softlines and 57 percent from hardlines. For our traditional stores, 62 percent of net sales were derived from softlines and 38 percent from hardlines during fiscal 2005.

Marketing

      Our marketing efforts are key to the ongoing success and growth of our stores. Our primary focus is on acquiring and retaining customers through an integrated direct and mass marketing program.

      We use our proprietary customer database to provide ongoing communication to our most frequent customers through a robust direct mail program. This allows us to cost efficiently and effectively reach our target market on a regular basis throughout the year. To drive customer acquisition, we supplement our direct mail advertising with newspaper insert advertising, primarily in superstore markets. Our direct mail and newspaper inserts showcase our exciting sales events, feature numerous products offered at competitive prices and broadcast the wide selection of merchandise available in our stores.

      As we market the Jo-Ann Stores concept, we also focus on developing long-term relationships with our customers. These efforts include providing knowledge and inspiration through in-store classes, demonstrations and project sheets. This inspiration is reinforced in our quarterly Jo-Ann magazine, sold in our stores and other outlets.

      Our grand opening program plays an integral role in the successful opening of each new superstore. We utilize our existing customer base to build awareness and excitement in each market around the opening of each new store. This is paired with newspaper inserts and popular in-store promotions during grand opening weekend to drive customer traffic. We continue to drive customer awareness and traffic after the grand opening through ongoing advertising efforts in the market.

      We also reach our customers through our relationship with IdeaForest, operator of joann.com, an on-line retailer of sewing and crafting merchandise, creative ideas, advice and supplies. We hold a minority investment in IdeaForest, which functions as an independent entity. In this relationship, we advise on product trends and make product available to IdeaForest, while technology support, customer fulfillment and service are handled by IdeaForest.

      Overall, our direct, mass, grand opening, in-store and on-line marketing efforts are focused on meeting our customers’ desires and building our brand image as we reposition our stores.

Purchasing

      We have numerous domestic and international sources of supply available for each category of product that we sell. During fiscal 2005, approximately 70 percent of our purchases were sourced domestically and 30 percent were sourced internationally. Although we have no long-term purchase commitments with any of our suppliers, we strive to maintain continuity with them. All purchases are centralized through our store support center, allowing store team leaders and store team members to focus on customer sales and service and enabling us to negotiate volume discounts, control product mix and ensure quality. Currently, none of our suppliers represent more than three percent of our annual purchase volume and the top ten suppliers represent less than 20 percent of our total annual purchase volume. We currently utilize approximately 1,000 merchandise suppliers, with the top 200 representing more than 80 percent of our purchasing volume.

Logistics

      At the end of fiscal 2005, we operated two owned distribution centers which ship merchandise to all of our stores on a weekly basis. We will break ground for our third distribution center during April 2005. This facility will be located in Opelika, Alabama, to support our existing stores and future growth in key southeastern states. Based on purchase dollars, approximately 84 percent of the products in our stores are shipped through our distribution center network, with the remaining 16 percent of our purchases shipped directly from our suppliers to our stores. Our primary distribution center facility is located in Hudson, Ohio and supplies product to approximately two-thirds of our store base and our Visalia, California distribution center services the remaining one-third of our store base.

      We transport product from our distribution centers to our stores utilizing contract carriers. Merchandise is shipped directly from our distribution centers to our stores using dedicated core carriers for approximately 90 percent of our store base. For the remainder of our chain, we transport product to the stores using less than truckload carriers or through three regional “hubs” where it is cross-docked for local delivery. We do not own either the regional hubs or the local delivery vehicles.

Store Operations

      Site Selection. We believe that our store locations are integral to our success. New sites are selected through a coordinated effort of our real estate, finance and operations management teams. In evaluating the desirability of a potential store site, we consider both market demographics and site-specific criteria. Market criteria that we consider important include our traditional stores performance in that immediate market, distance to other Jo-Ann store locations, as well as total population, number of households, median household income, percentage of home ownership versus rental, and historical and projected population growth over a ten-year period. Site-specific criteria that we consider important include rental terms, the store location position and visibility within the shopping center, size of the shopping center, co-tenants, proximity to highway access, traffic patterns, availability of convenient parking and ease of entry from the major roadways framing the strip location.

      Our expansion strategy is to give priority to adding stores in existing superstore markets in order to create economies of scale associated with advertising, distribution, field supervision, and other regional expenses. We believe that there are attractive opportunities in most of our existing markets and in numerous new markets.

      Costs of Opening Stores. Standard operating procedures are employed to efficiently open new stores and integrate them into our information management and distribution systems. We have developed a standardized floor plan, inventory layout, and marketing program for each store we open. We typically open stores during the period from February through October to maximize sales, and minimize disruption to store operations, during our fourth-quarter peak selling season.

      Store Management. Traditional stores generally have four full-time team members and 15 to 25 part-time team members, while superstores typically have approximately 10 full-time team members and 35 to

45 part-time team members. Store team leaders are compensated with a base salary plus a bonus, which is tied to quarterly store sales, annual store controllable profit and annual store shrink rates.

      Traditional store team leaders are typically promoted from a group of top performing assistant managers, some of whom started as our customers. This continuity serves to solidify long-standing relationships between our stores and our customers. When a traditional store is closed due to the opening of a superstore, we generally retain its team members to staff the new superstore. Superstore team leaders have primarily been staffed with individuals from outside the Company who have previous experience in managing “big-box” retail concepts. During the past year, the Company implemented “Superstore University” designed to develop and prepare more superstore managers from within our organization. This comprehensive training program is currently training the first two classes of trainees for superstores opening in fiscal 2006. We believe that developing more of our future managers from within the organization is essential to our superstore growth strategy. Each store is under the supervision of a district team leader who reports to a regional vice president.

Stores

      The following table shows our stores by type and state at January 29, 2005:

      The following table reflects the number of stores opened, expanded or relocated and closed during each of the past five fiscal years (square footage in thousands):

      Our new store opening costs depend on the building type, store size and general cost levels in the geographical area. During fiscal 2005, we opened 29 superstores, all of which represented our 35,000 square foot prototype. Our average net investment in a superstore is $2.0 million, which includes leasehold improvements, furniture, fixtures and equipment, inventory (net of payable support) and pre-opening expenses. Also during fiscal 2005, we opened two traditional stores, with an average square footage of approximately 23,000 square feet. Our average net opening cost of a traditional store is $1.2 million, which includes leasehold improvements, furniture, fixtures and equipment, inventory (net of payable support) and pre-opening expenses.

      During fiscal 2006, we expect to open approximately 40 new superstores and five traditional stores and close approximately 50 to 55 traditional stores, most of which are related to the superstore openings. We have committed to substantially all the leases for our fiscal 2006 planned openings.

Information Technology

      Our point-of-sale register transactions are polled nightly and our point-of-sale system interfaces with both our financial and merchandising systems. We utilize point-of-sale registers and scanning devices to record the sale of product at a stock-keeping units (“SKU”) level at our stores. We also utilize handheld radio frequency devices for a variety of store tasks including price look-up, perpetual inventory exception counting, merchandise receiving, vendor returns and fabric sales processing. In the last several years, we have installed broadband communication and new store controllers in all of our stores, resulting in a greatly enhanced customer checkout experience and a better platform to further automate internal store communications. During fiscal 2006, we will continue to upgrade the store’s technology, beginning with our superstores, by replacing handheld units, registers and radio frequency devices. We believe these upgrades will enable us to provide higher levels of customer and associate satisfaction, while providing a platform that we can build on and leverage over the coming years.

      Information obtained from item-level scanning through our point-of-sale system enables us to identify important trends to increase in-stock levels of more popular SKUs, eliminate less profitable SKUs, analyze product margins and generate data for advertising cost/benefit evaluations. We also believe that our point-of-sale system allows us to provide better customer service by increasing the speed and accuracy of register checkout, enabling us to more rapidly re-stock merchandise and efficiently re-price sale items.

      The Company operates on SAP Retail. The completion of the retail portion of this project in fiscal 2001 merged all of our financial, merchandise and retail systems and linked business processes on a single software platform. In-stock positions and inventory turns have significantly improved, primarily driven by our auto-replenishment and improved inventory management capabilities. In the spring of 2004, we upgraded our SAP application and continue to see additional operational efficiencies and further opportunities as a result of the integrated platform.

Status of Product or Line of Business

      During fiscal 2005, there was no public announcement nor is there a public announcement anticipated, about either a new product line or line of business involving the investment of a material portion of our assets.

Trademarks

      We do business under the federally registered trademark “Jo-Ann Fabrics and Crafts” and we also own several trademarks relating to our private label products. We believe that our trademarks are significant to our business.

Seasonal Business

      Our business exhibits seasonality which is typical for most retail companies, with much stronger sales in the second half of the year than in the first half of the year. Net earnings are highest during the months of September through December when sales volumes provide significant operating leverage. In fiscal 2005, approximately 33 percent of our net sales and over 60 percent of our operating profit were generated in the fourth quarter. Borrowing requirements needed to finance our operations fluctuate during the year and reach their highest levels in the third fiscal quarter as we increase our inventory in preparation for our peak selling season.

Customer Base

      We are engaged in the retail sale of merchandise to the general public and, accordingly, no part of our business is dependent upon a single customer or a few customers. During fiscal 2005 no single store accounted for more than one percent of total net sales.

Backlog of Orders

      We sell merchandise to the general public on a cash and carry basis and, accordingly, we have no significant backlog of orders.

Competitive Conditions

      We are the nation’s largest specialty retailer of fabrics and one of the largest specialty retailers of crafts, serving customers in their pursuit of apparel and craft sewing, crafting, home decorating and other creative endeavors. Our stores compete with other specialty fabric and craft retailers and selected mass merchants, including Wal-Mart, that dedicate a portion of their selling space to a limited selection of fabrics and craft supply items. We compete on the basis of product assortment, price, convenience and customer service. We believe the combination of our product assortment, outstanding sales events and knowledgeable, customer focused team members provide us with a competitive advantage.

      There are two public companies that we compete with nationally in the fabric and craft specialty retail industry, one in the fabric segment (Hancock Fabrics, Inc. — 447 stores and $427 million in revenues) and one in the craft segment (Michaels Stores, Inc. — 1,021 stores and $3.4 billion in revenues). There is also a public company competitor in the craft segment (A.C. Moore, Arts & Crafts, Inc.) that is a rapidly growing regional operator of 96 stores and $498 million in revenues. The balance of our competition is comprised of regional and local operators. We believe that there are only three or four other competitors, in addition to those described above, with fabric or craft sales exceeding $100 million annually. We believe that we have several advantages over most of our smaller competitors, including:

Research and Development

      During the three fiscal years ended January 29, 2005, we have not incurred any material expense on research activities relating to the development of new products or services or the improvement of existing products or services.

Environmental Disclosure

      We are not engaged in manufacturing. Accordingly, we do not believe that compliance with federal, state and local provisions regulating the discharge of material into the environment or otherwise relating to the protection of the environment will have a material adverse effect upon our capital expenditures, income or competitive position.

Employees

      As of January 29, 2005, we had approximately 22,250 full and part-time employees, of whom 20,650 worked in our stores, 400 were employed in our Hudson distribution center, 250 were employed in our Visalia distribution center and 950 were employed at our store support center in Hudson. The number of part-time employees is substantially higher during our peak selling season. We believe our employee turnover is below average for retailers primarily because our stores often are staffed with sewing and crafting enthusiasts. In addition, we provide an attractive work environment, employee discounts, flexible hours and competitive compensation packages within the local labor markets. Our ability to offer flexible scheduling is important in attracting and retaining these employees since approximately 75 percent of our employees work part-time.

      The United Steelworkers of America, Upholstery and Allied Industries Division currently represents employees who work in our Hudson, Ohio distribution center. Our current contract expires on May 5, 2007. We believe that our relations with our employees and the union are good.

Foreign Operations and Export Sales

      In fiscal 2005, we purchased approximately 30 percent of our products directly from manufacturers located in foreign countries. These foreign suppliers are located primarily in China and other Asian countries. In addition, many of our domestic suppliers purchase a portion of their products from foreign suppliers. Because a large percentage of our products are manufactured or sourced abroad, we are required to order these products further in advance than would be the case if the products were manufactured domestically. If we underestimate consumer demand, we may not be able to fully satisfy our customers on a timely basis. If we overestimate consumer demand, we may be required to hold goods in inventory for a longer period of time or to reduce selling prices in order to clear excess inventory at the end of a selling season. We do not have long-term contracts with any manufacturers.

      Foreign manufacturing is also subject to a number of other risks, including work stoppages, transportation delays and interruptions, political instability, economic disruptions, including raw material and energy shortages, the imposition of tariffs and import and export controls, changes in governmental policies and other events. If any of these events occur, it could result in a material adverse effect on our business, financial condition, results of operations and prospects. In addition, reductions in the value of the U.S. dollar could ultimately increase the prices that we pay for our products. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Comparison of the 52 Weeks Ended January 29, 2005 and January 31, 2004.”

Other Available Information

      We also make available, free of charge, on our website at www.joann.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as we file such material, or furnish it to, the Securities and Exchange Commission. We have posted on our website the charters of our Audit, Compensation and Corporate Governance Committees; our Corporate Governance

Guidelines, Code of Business Conduct and Ethics (including the Code of Ethics for the CEO and Financial Officers), and any amendments or waivers thereto. These documents are also available in print to any person requesting a copy from our Investor Relations department at our principal executive offices.

      As required by Section 303A.12 of the Listed Company Manual of the New York Stock Exchange (the “NYSE”), our chief executive officer submitted to the NYSE his annual certification on June 18, 2004 stating that he was not aware of any violation by our Company of the corporate governance listing standards of the NYSE. In addition, we have filed, as exhibits to this annual report on Form 10-K for the year-ended January 29, 2005, the certifications of our chief executive officer and chief financial officer required under Sections 302 and 906 of the Sarbanes-Oxley Act of 2002.

      Our store support center and Hudson distribution center are located in a 1.4 million square foot facility on 105 acres in Hudson, Ohio. We own both the facility and the real estate. The distribution center occupies 1.0 million square feet and the remainder is used as our store support center, a superstore, and office space we lease to another tenant. In addition, we own 65 acres of land adjacent to our Hudson, Ohio facility.

      We also operate a 630,000 square foot distribution center located on an 80-acre site in Visalia, California. We own both the facility and the real estate.

      On January 13, 2005, we announced the commitment to construct our third distribution center, to be located in Opelika, Alabama. We have a ground lease on 105 acres of land to construct this facility.

      The remaining properties that we occupy are leased retail store facilities, located primarily in high-traffic shopping centers. All store leases are operating leases. Traditional store leases generally have initial terms of five to ten years and renewal options for up to 20 years. Superstore leases generally have initial terms of 10 to 15 years and renewal options generally ranging from 10 to 20 years. Certain store leases contain escalation clauses and contingent rents based on a percent of net sales in excess of defined minimums. During the fiscal year-ended January 29, 2005, we incurred $151.4 million of rental expense, including common area maintenance, taxes and insurance for store locations. As we pursue our transformation plan to replace traditional stores with superstores over time, we have been able to build flexibility by reducing the outstanding term of existing traditional store leases through splitting of renewal options or negotiating short-term renewals. Despite closing almost 260 stores over the last five years, we presently are only paying rent on eight closed store locations where we have been unable to reach an early lease termination settlement with the landlord or sublease the property.

      As of January 29, 2005, the current terms of our store leases, assuming we exercise all lease renewal options, were as follows:

Item 3. Legal Proceedings

      We are involved in various litigation matters in the ordinary course of our business. We are not currently involved in any litigation which we expect, either individually or in the aggregate, will have a material adverse effect on our financial condition or results of operations.

Item 4. Submission of Matters to a Vote of Security Holders

      No matters were submitted to a vote of shareholders during the fourth quarter.

Executive Officers of the Registrant

      The following information is set forth pursuant to Item 401(b) of Regulation S-K.

      Our executive officers are as follows:

      Alan Rosskamm has been Chairman of the Board, President and Chief Executive Officer of our Company for more than five years. He is a member of one of the two founding families of our Company and has been employed by us since 1978. Mr. Rosskamm is also a Director of Charming Shoppes Inc., a women’s apparel retailer.

      Dave Bolen has been Executive Vice President, Merchandising and Marketing of our Company since March 2001. He was Executive Vice President, Stores and Business Development from August 1997 to March 2001 and Senior Vice President, General Manager of Jo-Ann etc from March 1997 to August 1997. Prior to joining our Company, he was Executive Vice President-Operations of Michaels Stores, Inc., a national craft retailer, from July 1994 to August 1996.

      Brian Carney has been Executive Vice President, Chief Financial Officer of our Company for more than five years. Prior to joining our Company, he was Senior Vice President-Finance of Revco D.S., Inc., a retail drugstore chain (acquired by CVS Corporation in 1997).

      Valerie Gentile Sachs has been Executive Vice President, General Counsel and Secretary of our Company since January 2003. Prior to joining our Company, she was the General Counsel of Marconi plc, of London, England, a global company serving the communications industry, from March 2002. Previously she was Executive Vice President and General Counsel from April 2001 to March 2002, and Vice President and General Counsel from November 2000 to April 2001 of Marconi Communications, Inc., the operating company for Marconi in the Americas. From December 1997 to November 2000, she was Vice President, General Counsel and Secretary for RELTEC Corporation, a network equipment and network services provider. RELTEC Corporation went public in March 1998 and was acquired by Marconi in April 1999.

      David Holmberg has been Executive Vice President, Operations of our Company since November 28, 2004. Prior to joining our Company, he was President of Cole License Businesses of Cole National Corporation, a retailer of eyewear and optometry services, from April 2001 to October 2004. Prior to that, he spent seven years with Zale Corporation, a specialty retailer of fine jewelry, advancing to President of Zale Canada Co. in May 1999.

      Rosalind Thompson has been Executive Vice President, Human Resources of our Company since December 1999. She was previously Senior Vice President, Human Resources from March 1992 to December 1999.

PART II

      The Company’s common shares are traded on the New York Stock Exchange under the ticker symbol “JAS.” As of April 1, 2005, there were 855 common shareholders of record. The closing price of the shares on April 1, 2005 was $27.06.

      On November 4, 2003, the Company announced that shareholders approved the reclassification of its Class A and Class B common shares into a single class of stock. All references to the number of shares of Common Stock, stock options, per share prices, and earnings per share amounts in the “Selected Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and accompanying notes included in this Annual Report on Form 10-K reflect the share reclassification. Shares of the single class of common stock began trading on the New York Stock Exchange on November 5, 2003, under the symbol “JAS.”

      In the reclassification, Class B common shares, which did not have voting rights other than as required by law, were amended to have one vote per share and were re-designated as “common shares.” Each of the Class A common shares, which had one vote per share, were reclassified into 1.15 common shares. This resulted in approximately 1.6 million incremental common shares being issued at the time of the reclassification, increasing the number of common shares outstanding by approximately 8 percent.

      The quarterly high and low closing stock prices for fiscal 2005 and 2004 are presented in the table below:

      The Company did not pay cash dividends on its common stock during fiscal 2005 and fiscal 2004. The Company’s dividend policy has been to retain earnings for the operation and growth of its business. Payments of dividends, if any, in the future will be determined by the Board of Directors in light of appropriate business conditions.

      See Part III, Item 12 for a description of our equity compensation plans.

      In December 1998, the Company’s Board of Directors authorized a discretionary program that allowed the Company to buy back 2,150,000 common shares. That program does not have a stated expiration date. In the table above, the total number of shares purchased represents shares repurchased directly from the market, as well as shares repurchased from employees related to employee stock options used to satisfy related tax withholding requirements.

Item 6. Selected Financial Data

      The following table presents the Company’s selected financial data for each of the five years ending January 29, 2005. The selected financial data for fiscal years 2005, 2004 and 2003 was derived from the audited financial statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and notes thereto. The Company reclassified certain amounts in the financial statements for the four years ending January 31, 2004 to conform to the current period presentation.

Item 6. Selected Financial Data (Continued)

Item 6. Selected Financial Data (Continued)

      This discussion provides the reader with information that will assist in an overall understanding of our financial statements, changes in certain key indicators in those financial statements from year to year, the factors that account for those changes and how certain accounting principles have impacted our financial statements. This discussion should be read in conjunction with the audited consolidated financial statements and notes to the consolidated financial statements presented in this Form 10-K. The financial information presented for periods prior to fiscal 2005 have been restated to reflect the correction of an error in accounting for leases. See “Restatement of Financial Statements” below. In addition, the financial information presented for years prior to fiscal 2005 have been reclassified for certain amounts to conform to the fiscal 2005 presentation.

Overview

      We are the nation’s largest specialty retailer of fabrics and one of the largest specialty retailers of crafts, serving customers in their pursuit of apparel and craft sewing, crafting, home decorating and other creative endeavors. Our retail stores (operating as Jo-Ann Fabrics and Crafts traditional stores and Jo-Ann superstores) feature a variety of competitively priced merchandise used in sewing, crafting and home decorating projects, including fabrics, notions, crafts, frames, scrapbooking material, artificial and dried flowers, home accents, finished seasonal and home décor merchandise.

      As of January 29, 2005, we operated 851 stores in 47 states (737 traditional stores and 114 superstores). Our traditional stores offer a complete selection of fabric and a convenience assortment of crafts, floral, finished seasonal and home décor merchandise. Our traditional stores average 14,550 square feet and generated net sales per store of approximately $1.6 million in fiscal 2005. Our superstores offer an expanded and more comprehensive product assortment than our traditional stores. Our superstores also offer custom framing, floral arrangement and educational programs that our traditional stores do not. Our superstores that opened prior to fiscal 2003 average approximately 45,000 square feet and generated net sales per store of approximately $6.3 million in fiscal 2005. Our current superstore prototype averages 35,000 square feet and targets sales of $5.25 million for its first year of operation. We opened 29 of these new prototype superstores in fiscal 2005 and we currently have 43 of the prototype superstores in operation at January 29, 2005. Fourteen of the prototype superstores have been open at least one year and averaged $5.0 million in net sales in their first year of operation.

      We review and manage to a number of key indicators in evaluating financial performance, the most significant of which are:

Restatement of Financial Statements

      We have restated the consolidated balance sheet at January 31, 2004, and the consolidated statements of operations, changes in stockholders’ equity and cash flows for the years ended January 31, 2004 and February 1, 2003 in this Annual Report on Form 10-K. We have also restated our quarterly financial information for fiscal 2004 and the first three quarters of fiscal 2005. See note 2 in notes to the consolidated financial statements for a further discussion of the restatement and a summary of the effects of these changes on our consolidated balance sheets as of January 31, 2004, as well as on our consolidated statements of operations and cash flows for fiscal years 2004 and 2003. The accompanying Management’s Discussion and Analysis gives effect to these corrections.

      On February 7, 2005, the Office of the Chief Accountant of the Securities and Exchange Commission (“SEC”) issued a letter to the Center for Public Company Audit Firms of the American Institute of Certified Public Accountants, which clarified existing generally accepted accounting principles (“GAAP”) applicable to leases and leasehold improvements. We have consistently accounted for leases in accordance with our interpretation of GAAP and common industry practice. After conducting an internal review of our lease accounting procedures, and after discussion by management and the Chairperson of the Audit Committee of the Board of Directors of the Company with its independent registered public accounting firm, we determined that our historical accounting for leases was not consistent with the accounting principles described in the SEC’s letter. Accordingly, we decided to restate our financial statements for prior periods to correct these errors. We do not believe the differences in prior years’ financial statements were material to any individual year presented. Further, the restatement adjustments are non-cash and had no impact on net sales or same-store sales figures.

      We have reviewed our property lease portfolio and have recognized the effect of pre-opening “rent holidays” over the related lease terms on a straight-line basis. Tenant allowances have been reclassified from net property and equipment to other long-term liabilities in the consolidated balance sheets. Tenant allowances have also been reclassified from a reduction of depreciation and amortization expense to a reduction of rent expense in the consolidated statements of operations and from a reduction of capital expenditures to an increase in cash provided by operating activities in the consolidated statements of cash flows.

      Retained earnings at the beginning of fiscal year 2003 have been adjusted for the after-tax impact of earlier periods. While we do not consider the net dollar amounts to be material to net earnings, financial position or net cash flows for any individual period presented, we believe it is appropriate to align our historical accounting results with the SEC’s comments on lease accounting under GAAP, and we have done so, as reflected in our decision to restate results for certain prior years. These accounting changes reduced net income by $0.9 million for the fiscal year-ended January 31, 2004 and increased net income by $0.5 million for the fiscal year-ended February 1, 2003, and resulted in a $5.0 million reduction in retained earnings at the beginning of fiscal year 2003.

      We have not amended and do not intend to amend our previously filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the periods affected by the restatement that ended prior to January 29, 2005. For this reason, the consolidated financial statements, auditors’ reports and related financial information for the affected periods contained in such reports should no longer be relied upon.

Executive Overview of Fiscal 2005

      Fiscal 2005 represented our third consecutive year of strong operating performance, after completing a turnaround announced at the end of fiscal 2001 that was substantially completed in fiscal 2003.

      Our strategy is to grow by replacing many of our existing traditional stores with superstores. Our research has demonstrated that our customers have a better perception of the quality and pricing of our products when they are presented in our superstore format. We believe that our prototype 35,000 square foot superstore gives us a competitive advantage in the industry. Our superstores provide a unique shopping experience by offering a full creative selection — sewing, crafting, framing, seasonal, floral and home décor accessories — all under one roof. On average we close 1.1 traditional stores for every superstore that we open. Our superstores typically average over three times the revenues of the traditional stores they replace. In markets where we have opened multiple superstores, we have been able to grow our revenues significantly and, we believe, expanded the market size and our market share.

      In addition to the strong operating performance, a number of strategic initiatives were accomplished in fiscal 2005:

      Highlights of our financial performance in fiscal 2005 are as follows:

Results of Operations

      The following table sets forth the financial information through operating profit, expressed as a percentage of net sales. The following discussion should be read in conjunction with our consolidated financial statements and related notes thereto.

Comparison of the 52 Weeks Ended January 29, 2005 and January 31, 2004

      Net sales. Net sales for fiscal 2005 increased 4.5 percent to $1.812 billion from $1.734 billion in the prior year. Same-store sales increased 3.2 percent compared with a same-store sales increase of 3.6 percent for fiscal 2004. We operated fewer stores in fiscal 2005 versus a year ago. Our total store count at the end of the year was down 41 stores, or 4.6 percent from last year; however, the number of superstores in operation increased to 114 from 86 in fiscal 2004. Total store square footage increased slightly from fiscal 2004, to 15.453 million square feet. Superstores accounted for approximately 33 percent of total net sales during fiscal 2005 compared with approximately 27 percent of total net sales for fiscal 2004.

      By store format, our same-store sales performance for traditional stores increased 3.5 percent versus a same-store sales increase of 3.7 percent for fiscal 2004. Same-store sales for superstores increased 2.6 percent versus a same-store sales increase of 3.1 percent for the prior year. In both store formats, we saw an increase in average ticket partially offset by a slight decline in customer traffic for the full fiscal year. Our strategy to be less promotional, which has benefited our realized selling margins, has had a larger negative impact on superstore sales than traditional store sales because of our dual vehicle advertising strategy (direct mail and newspaper inserts) in superstores.

      By product category, the businesses that performed well were our sewing and crafting categories, led by strong performances in the fleece, paper crafting and yarn businesses. Our sewing and crafting businesses, excluding home decorating textiles, represented 61 percent of our total year net sales, and are up approximately 6.6 percent on a same-store sales basis on improved margin rates. Product categories that are tied more closely to home décor experienced softness. Our home decorating textile category is down approximately 1.9 percent on a same-store sales basis for the year. Our toughest category of the business continues to be finished seasonal. Same-store sales of finished seasonal goods decreased approximately 8.3 percent.

      Gross margin. Gross margins may not be comparable to those of our competitors and other retailers. Some retailers include all of the costs related to their distribution network in cost of sales, while we exclude a portion of them from gross margin, including those costs instead within selling, general and administrative expenses. As a percent of net sales, gross margin was 47.6 percent for fiscal 2005 compared with 46.7 percent in the prior year, an overall increase of 90 basis points. Our strategy to be less promotional has been successful in improving our realized selling margins. This strategy has primarily benefited the selling

margins in superstores, where we run multiple advertising vehicles. In addition, we have been able to improve gross margins by improving our product sourcing opportunities.

      During the third quarter, we recorded a $1.7 million charge which was paid in the fourth quarter in connection with a voluntary “prior disclosure” made to U.S. Customs, which lowered our fiscal 2005 gross margin rate by 10 basis points. Over a five-year period encompassing fiscal years 2000 through 2004, we had inadvertently failed to adequately assess anti-dumping duty on certain candles imported from China. The failures resulted from certain products being inaccurately classified at the time of import.

      Selling, general and administrative expenses. Selling, general and administrative (“SG&A”) expenses include store and administrative payroll, employee benefits, distribution costs, store occupancy costs, advertising expenses and administrative expenses. SG&A expenses, excluding other expenses separately identified in the statement of operations, were $700.8 million for fiscal 2005 versus $664.8 million in the prior year. As a percentage of net sales, SG&A expenses increased to 38.7 percent versus 38.3 percent for fiscal 2004 with most of the increase for the full year attributable to increased distribution costs and higher administrative costs.

      Depreciation and amortization. Depreciation and amortization expense increased $4.0 million to $43.0 million in fiscal 2005 from $39.0 million in fiscal 2004, due to the increased level of capital expenditures. Further discussion of capital expenditures is provided under “Liquidity and Capital Resources.”

      Store pre-opening and closing costs. Pre-opening costs are expensed as incurred and relate to the costs incurred prior to a new store opening, which includes lease costs recognized prior to the store opening, hiring and training costs for new employees and processing of initial merchandise. Store closing costs consist of lease termination costs, lease costs for closed locations, loss on disposal of fixtures and equipment, severance for employees, third party inventory liquidation costs and other costs incidental to store closings. Store pre-opening and closing costs increased $5.2 million to $18.5 million in fiscal 2005, due to the increased level of real estate activity year-over-year. As a percentage of sales, store pre-opening and closing costs for fiscal 2005 increased to 1.0 percent from 0.8 percent in the prior year. During fiscal 2005, we opened 29 superstores and two traditional stores, and we closed 72 traditional stores. As we continue to increase the number of new store openings, we expect our store pre-opening and closing costs will continue to rise.

      Stock-based compensation expense. Stock-based compensation expense includes the expensing of stock options under Statement of Financial Accounting Standard (“SFAS”) No. 123, “Accounting for Stock-Based Compensation Expense,” which we adopted in the first quarter of fiscal 2004, and the amortization of the value of restricted stock granted to employees. Stock-based compensation expense was $7.7 million in fiscal 2005, compared with $6.4 million in the prior year.

      Debt repurchase and share reclassification expenses. Debt repurchase and share reclassification expenses for fiscal 2005 were $4.2 million versus $5.5 million in the prior year. The fiscal 2005 expense represents the premium paid to repurchase $64.4 million of our 10.375 percent senior subordinated notes during the first quarter at an aggregate premium of 103.4 percent to par value and write-off of the related deferred financing costs.

      During fiscal 2004 we redeemed or repurchased approximately $58.5 million of our senior subordinated notes at an aggregate premium of 105.4 percent to par value, and we recorded a $4.3 million pre-tax charge for debt repurchase expenses including the cash premium paid to par value and the write-off of deferred finance charges and original issue discount. Share reclassification expenses associated with the reclassification of our former Class A and Class B common shares into a single class of common stock totaled $1.2 million in fiscal 2004.

      As stated above, we completed certain capital financing initiatives during the first quarter of fiscal 2005, which are discussed further below under “Liquidity and Capital Resources.”

      Operating profit. Operating profit was $87.9 million in fiscal 2005, compared with $81.6 million for fiscal 2004.

      Interest expense. Interest expense for fiscal 2005 decreased $2.8 million to $13.7 million from $16.5 million in fiscal 2004. The decrease is attributable to a decrease in our average debt levels between years, and a lower all-in borrowing rate. Our average debt levels were $160 million this fiscal year versus $174 million last year.

      Income taxes. Our effective income tax rate for fiscal 2005 decreased to 37.7 percent from 38.4 percent in the prior year. The reduction in the effective tax rate is primarily based on an anticipated higher realization of certain jobs tax credits.

Comparison of the 52 Weeks Ended January 31, 2004 and February 1, 2003

      Net sales. Net sales for fiscal 2004 increased 3.1 percent to $1.734 billion from $1.682 billion in the prior year. Same-store sales increased 3.6 percent compared with a same-store sales increase of 8.4 percent for fiscal 2003. Approximately 80 percent of this increase was driven by an increase in average ticket. Same-store sales growth generated all of the overall net sales increase, as we operated fewer stores at the end of fiscal 2004 than a year ago. Our total store count at the end of the year was down 27 stores; however, the number of superstores in operation increased to 86 in fiscal 2004 from 72 in fiscal 2003. Store square footage decreased slightly to 15.377 million square feet during the year. Superstores accounted for approximately 27 percent of total net sales for fiscal 2004 versus 25 percent for fiscal 2003.

      By store format, our same-store sales performance for traditional stores increased 3.7 percent for fiscal 2004 versus a same-store sales increase of 8.5 percent in fiscal 2003, with almost the entire increase attributable to an increase in average ticket. Same-store sales for superstores increased 3.1 percent versus a same-store sales increase of 7.8 percent for the prior year. The majority of the increase, over 80 percent, was driven by an increase in customer traffic.

      During the year, we saw sales strength with positive same-store sales increases in all of our major product categories, with the exception of finished seasonal goods. Same-store sales of finished seasonal goods, which represented 12 percent of our total same-store sales for the year, decreased approximately 3.7 percent; however the gross margin rate in this category improved over 200 basis points versus fiscal 2003. We made the decision to be less aggressive in our promotional pricing during the second half of the year versus the prior year. The finished seasonal business, specifically Fall, Halloween and Christmas merchandise, was the category most affected by our decision to reduce promotional expenses and product markdowns.

      Gross margin. Gross margins may not be comparable to those of our competitors and other retailers. Some retailers include all of the costs related to their distribution network in cost of sales, while we exclude a portion of them from gross margin, including those costs instead within our selling, general and administrative expenses. As a percent of net sales, gross margin was 46.7 percent for fiscal 2004 compared with 46.2 percent in the prior year, an increase of 50 basis points. An increase in selling margins of 10 basis points, which was accomplished by a strong performance in the second half of the fiscal year due to a less promotional stance, coupled with a 40 basis point improvement in store shrink rates, were the primary contributors to the increase in the gross margin rate for the year.

      Selling, general and administrative expenses. SG&A expenses include store and administrative payroll, employee benefits, distribution costs, store occupancy costs, advertising expenses and administrative expenses. SG&A expenses were $664.8 million for fiscal 2004 versus $633.2 million in the prior year. As a percentage of net sales, SG&A expenses increased to 38.3 percent versus 37.6 percent for fiscal 2003. Higher advertising costs in the third quarter, due to our 60th Anniversary celebration, and increased logistics costs, attributable to the decision to flow seasonal product to stores differently and replenish in-season, were the primary contributors to the deterioration in expense leverage.

      Depreciation and amortization. Depreciation and amortization expense increased $1.1 million to $39.0 million in fiscal 2004 from $37.9 million in fiscal 2003, due to the increased level of capital expenditures.

      Store pre-opening and closing costs. Pre-opening costs are expensed as incurred and relate to the costs incurred prior to a new store opening, which includes lease costs recognized prior to the store opening, hiring and training costs for new employees and processing of initial merchandise. Store closing costs consist of lease termination costs, lease costs for closed locations, loss on disposal of fixtures and equipment, severance for employees, third party inventory liquidation costs and other costs incidental to store closings. Store pre-opening and closing costs increased $7.0 million to $13.3 million in fiscal 2004, due to the increased level of real estate activity year-over-year. As a percentage of sales, store pre-opening and closing costs for fiscal 2004 increased to 0.8 percent from 0.4 percent in the prior year. During fiscal 2004, we opened 16 superstores, converted four larger traditional stores to the superstore format and opened three larger traditional stores. We also closed 45 traditional stores and one superstore.

      Stock-based compensation expense Stock-based compensation expense includes the expensing of stock options due to our adoption of the fair-value based method of accounting for stock-based compensation under SFAS No. 123, and the amortization of the value of restricted stock granted to employees. We adopted SFAS No. 123 in the first quarter of fiscal 2004 under the modified-prospective method allowed under the transition provisions provided under SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an Amendment of FASB Statement No. 123.” Stock-based compensation expense was $6.4 million in fiscal 2004, compared with $0.2 million in fiscal 2003. See Note 1 — Significant Accounting Policies — Stock-Based Compensation for pro-forma information.

      Debt repurchase and share reclassification expenses. Debt repurchase and share reclassification expenses for fiscal 2004 were $5.5 million versus $1.9 million in the prior year, a $3.6 million increase. Share reclassification expenses associated with the reclassification of our former Class A and Class B common shares into a single class of common stock totaled $1.2 million for the fiscal year. Debt repurchase expenses of $4.3 million were incurred to repurchase approximately $58.5 million of our 10.375 percent senior subordinated notes in fiscal 2004 versus $1.9 million of expenses incurred to repurchase $27.1 million of senior subordinated notes in fiscal 2003. The charges include the cash premium paid for the early redemption and the write-off of the related deferred finance charges.

      Operating profit. Operating profit was $81.6 million in fiscal 2004, compared with $98.0 million for fiscal 2003.

      Interest expense. Interest expense for fiscal 2004 decreased $8.2 million to $16.5 million from $24.7 million in fiscal 2003. The decrease is primarily due to a reduction of approximately $65 million in our average debt levels between years. Our average debt levels were $174 million in fiscal 2004 versus $239 million in fiscal 2003.

      Income taxes. Our effective income tax rate for fiscal 2004 increased to 38.4 percent from 38.0 percent in fiscal 2003, as a result of an adjustment to the effective rate in fiscal 2004 due to a permanent tax difference related to stock-based compensation expense, under SFAS No. 123.

Store Closing Charges

      In fiscal 2001, we experienced significant difficulty with the implementation of SAP Retail. As a result of these implementation issues, declining operating margins and an increase in debt levels due to higher capital spending to install SAP Retail and the opening of a second distribution center in fiscal 2002, our strategy shifted from accelerating the growth of our superstore concept to improving the productivity of our existing asset base and realizing the benefits from our completed infrastructure investments. At the end of fiscal 2001, we implemented a turnaround plan (the “Turnaround Plan”).

      At the end of fiscal 2003, a decision was made to continue to operate eight locations, originally targeted for closure in the Turnaround Plan, due to our inability to successfully negotiate an acceptable arrangement to exit the lease. A total of $7.7 million for estimated lease obligations of stores to be closed as part of the Turnaround Plan was reversed in the fourth quarter of fiscal 2003. The reversal related to stores where estimates were revised, as well as the eight stores we chose not to close. We also recorded an asset impairment charge in the fourth quarter of fiscal 2003 of $6.7 million for various store locations, representing

the difference between the asset carrying value and the future net discounted cash flows estimated to be generated by those assets. The remainder of the store closing charges in fiscal 2003 and the store closing charges incurred in fiscal 2004 and fiscal 2005, highlighted in the table below, represent lease obligations and other costs associated with stores identified for closure that were not accrued as part of the Turnaround Plan. As of the end of fiscal 2005, all stores identified for closing as part of the Turnaround Plan have been closed.

      As discussed in Note 1 — Significant Accounting Policies, effective December 31, 2002, we began accounting for the costs of store closings in accordance with the provisions of SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.” We account for asset impairment in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” We review the productivity of our store base on an ongoing basis and actively manage our real estate to preserve maximum flexibility in lease terms. As a result, we have only a limited number of mature stores where the store contribution is not cash flow positive. In addition, we are paying rent on just eight store locations where we have not yet obtained a sublease tenant or executed a lease termination.

      The charges to the statement of operations related to store closings were $8.9 million, $3.7 million and $1.5 million in fiscal 2005, 2004 and 2003, respectively. These charges are included in the line item “Store pre-opening and closing costs” in the statements of operations included in the consolidated financial statements.

      Summarized below is a reconciliation of the beginning and ending store closing reserve balances for the three fiscal years ended January 29, 2005:

      Non-cancelable lease obligations for fiscal 2003 include the lesser of the estimated buyout or remaining lease obligations of the stores to be closed. Estimated lease obligations were reduced by anticipated sublease rental income. As discussed in Note 1, in fiscal 2005 and 2004, these costs are accounted for in accordance with SFAS No. 146, which requires certain lease costs to be expensed as incurred.

      Asset impairments include write-downs of fixed assets to estimated fair value for stores closed, or scheduled to be closed, where impairment exists. The asset impairment represents the difference between the asset carrying value and our estimate of the future net discounted cash flows to be generated by those assets.

      Other costs represent other miscellaneous store closing costs, including among other things, costs related to third-party inventory liquidation and fixtures, signage and register removal.

Liquidity and Capital Resources

      Our capital requirements are primarily for capital expenditures in connection with infrastructure investments, new store openings and working capital requirements for seasonal inventory builds and new store inventory purchases. Working capital requirements needed to finance our operations fluctuate during the year and reach their highest levels during the third fiscal quarter as we increase our inventory in preparation for our peak selling season during the months of September through December. These requirements will be funded through a combination of internally generated cash flows from operations, credit extended by suppliers and borrowings under our bank credit facility.

      The following table provides cash flow related information for the three fiscal years ended January 29, 2005.

Net Cash Provided By Operating Activities

      Net cash provided by operating activities was $141.9 million in fiscal 2005, compared with $51.7 million in fiscal 2004, an increase of $90.2 million. The increase was generated by changes in operating assets and liabilities, which in 2005 represented a $35.8 million source of cash versus a $49.0 million use of cash in 2004. Cash flows from operating activities, before changes in operating assets and liabilities, were $106.1 million in fiscal 2005 versus $100.7 million generated in fiscal 2004.

      Inventories, net of payable support, decreased $10.1 million in fiscal 2005, compared with an increase of $49.4 million in fiscal 2004. Inventories increased $35.1 million in fiscal 2005 to support our superstore growth plans in fiscal 2006. We plan to open 11 of the 40 fiscal 2006 planned superstores in the first quarter of fiscal 2006. To support these openings we had the merchandise in our distribution center at year-end. We also increased inventory levels in core product categories such as scrapbooking, yarn, and fleece fabric which have experienced solid sales performances, while reducing our investment in other categories such as finished seasonal. Inventory turns for fiscal 2005 were approximately 2.3 times, compared with 2.4 times in fiscal 2004 and 2.5 times in fiscal 2003.

      Net cash provided by operating activities was $51.7 million in fiscal 2004, compared with $119.7 million in fiscal 2003, a decrease of $68.0 million, primarily caused by an increase in inventory and a decrease in accounts payable, together totaling a decrease of $62.1 million from fiscal 2003. Cash flows from operating activities, before changes in operating assets and liabilities, were $100.7 million in fiscal 2004 versus $109.2 million in fiscal 2003.

Net Cash Used For Investing Activities

      Net cash used for investing activities for fiscal 2005 totaled $67.1 million compared with $51.1 million in fiscal 2004. Capital expenditures were $67.1 million during fiscal 2005 versus $57.6 million in fiscal 2004 and are discussed further below under the caption “Capital Expenditures.” Partially offsetting the increase in capital expenditures for fiscal 2004 was $6.5 million of consideration received from the sale of our equity investment in BouClair, Inc., a Canadian fabric retailer.

      Net cash used for investing activities in fiscal 2004 totaled $51.1 million compared with $23.2 million in fiscal 2003 which consisted entirely of capital expenditures.

Capital Expenditures

      Capital expenditures estimated for fiscal 2006 and for the last three fiscal years consist of cash expenditures and cash expenditures reimbursed by the landlord. Capital expenditures primarily relate to the operation of the stores, including new store openings, maintenance capital and information technology. We also incur capital outlays for distribution center equipment and other non-store capital investments. Landlord reimbursed capital expenditures represent the cost of assets acquired with landlord lease incentives. Capital expenditures are summarized as follows:

      Capital expenditures for fiscal 2005 totaled $67.1 million. Store related expenditures, including our superstore openings, accounted for over 75 percent of total capital spending in fiscal 2005.

      Capital expenditures for fiscal 2004 totaled $57.6 million. Store related expenditures, including 19 new store openings, represented over 80 percent of the capital spending. During the year, we opened 16 superstores, converted four larger traditional stores to the superstore format and opened three larger traditional stores.

      Capital expenditures for fiscal 2003 totaled $23.2 million, our lowest level of capital spending in six years, as we focused on maximizing cash flow to reduce debt. During fiscal 2003, we opened one superstore and two traditional stores and converted two larger traditional stores to our superstore format. We also relocated four traditional stores.

      We anticipate capital expenditures in fiscal 2006 of approximately $130 to $140 million, to support increased superstore openings and the construction of our third full-service distribution center scheduled to open in April of 2006 in Opelika, Alabama. This facility will be approximately 700,000 square feet in size, and we estimate it will cost approximately $45 million to build. We expect approximately $35 million to $40 million of the capital spending for this third distribution center to occur in fiscal 2006.

      During fiscal 2006, we plan to open approximately 40 new superstores. As we open more new stores and begin to increase capital expenditures in future years, we envision our growth plans will be largely self-funded using cash from operations.

Net Cash Used For Financing Activities

      Net cash used for financing activities was $12.6 million during fiscal 2005 compared with $46.4 million during fiscal 2004. Long-term debt at the end of fiscal 2005 was $100 million, our lowest year-end debt level in seven years. Debt levels decreased $13.7 million during fiscal 2005, compared with a net decrease of $49.2 million in the prior year. During the first quarter of fiscal 2005, we completed two capital financing initiatives. In February 2004, we issued $100 million of 7.500 percent senior subordinated notes, which enabled us to repurchase the remaining $64.4 million of our 10.375 percent senior subordinated notes that

were outstanding at the beginning of the year at an aggregate premium of 103.4 percent to par value. In April, we amended our senior credit facility, extending the term until May 2009 and reducing the commitment to $350 million. Further discussion of these financing initiatives are discussed under Sources of Liquidity below.

      As of January 29, 2005, we had the ability to borrow up to an additional $204.1 million under our Credit Facility.

      Net cash used for financing activities was $46.4 million during fiscal 2004 compared with $54.4 million during fiscal 2003. Long-term debt at the end of fiscal 2004 was $113.7 million. Debt levels decreased $49.2 million during fiscal 2004, compared with a net decrease of $60.8 million in the prior year. During fiscal 2004, we redeemed or repurchased in the open market, approximately $58.5 million of our 10.375 percent senior subordinated notes at an aggregate premium of 105.4 percent to par value. These purchases were made utilizing excess cash on hand and borrowings under our bank credit facility.

      Net cash used for financing activities during fiscal 2003 was $54.4 million, primarily related to a $60.8 million net decrease in debt borrowings resulting from cash generated by strong operating performance. During fiscal 2003 we repurchased, in the open market, $27.1 million of our 10.375 percent senior subordinated notes at a purchase price of $28.3 million or 104.3 percent to par value.

Common Share Repurchases

      During fiscal 2005, we purchased a total of 0.1 million of our common shares at an aggregate price of $3.3 million, utilizing proceeds received from stock option exercises. As of January 29, 2005, we are authorized to purchase up to an additional 1.3 million shares of our common stock under previous authorizations from our Board of Directors.

Sources of Liquidity

      We have three principal sources of liquidity: cash from operations, cash and cash equivalents on hand, and our senior bank credit facility.

      We believe that our senior bank credit facility, coupled with cash on hand and cash from operations, will be sufficient to cover our working capital, capital expenditure and debt service requirement needs for the foreseeable future.

      Our liquidity is based, in part, on maintaining our current debt ratings. As of January 29, 2005, our long-term unsecured debt was rated “B2” by Moody’s Investor Services and “B-” by Standard & Poor’s. In assessing our credit strength, both Moody’s and Standard & Poor’s consider our capital structure and financial policies, as well as our consolidated balance sheet and other financial information. If our debt ratings are downgraded, it could adversely impact, among other things, our future borrowing costs, access to capital markets and new store operating lease costs.

      Our current debt obligations as of the end of fiscal 2005 include no borrowings outstanding under our $350 million senior bank credit facility, and $100 million outstanding under our 7.500 percent senior subordinated notes.

      Senior Bank Credit Facility. In April 2004, we amended and extended the expiration date of our senior bank credit facility originally entered into in April 2001 and led by Bank of America Retail Finance, Inc. (formerly Fleet Retail Group, Inc.). The senior bank credit facility, as amended (the “Credit Facility”), is a $350 million revolver that expires April 30, 2009. The prior senior bank credit facility provided for a $325 million revolver and a $40 million term loan, and would have expired in April 2005. The Credit Facility is secured by a first priority perfected security interest in our inventory, accounts receivable, property and other assets and guaranteed by each of our subsidiaries. The Credit Facility contains a sub-limit for letters of credit of $200 million. Deferred financing costs related to the amendment of the Credit Facility in the amount of $1.6 million, as well as the unamortized portion of the deferred financing costs related to the original financing, are being amortized over the term of the Credit Facility.

      In fiscal 2002 we established an interest rate swap with Bank of America Retail Finance, Inc. with a fixed London Interbank Offered Rate (“LIBOR”) of 6.72 percent, a notional amount of $90.0 million which decreased to $40 million on May 1, 2003 and an expiration date of April 30, 2005.

      As of January 29, 2005, we had $67.9 million of letters of credit outstanding under our Credit Facility. There were no outstanding borrowings under the Credit Facility at January 29, 2005.

      Our weighted average interest rate (including the impact of the interest rate swaps referred to above) and weighted average borrowings under the Credit Facility and prior senior bank credit facility were 6.7 percent and $57.3 million during fiscal 2005 and 6.3 percent and $88.3 million during fiscal 2004, respectively.

      The Credit Facility contains covenants that, among other things, restrict our ability to incur additional indebtedness or guarantee obligations, engage in mergers or consolidations, dispose of assets, make investments, acquisitions, loans or advances, engage in certain transactions with affiliates, conduct certain corporate activities, create liens, or change the nature of our business. We are restricted in our ability to prepay or modify the terms of other indebtedness, pay dividends and make other distributions and are required to comply with a minimum net worth financial covenant. As of January 29, 2005, excess availability, as defined, was $204.1 million, and at our peak borrowing level during fiscal 2005, the excess availability was $172.3 million. The Credit Facility also defines various events of default, including cross default provisions, defaults for any material judgments or a change in control. At January 29, 2005, we are in compliance with all covenants under the Credit Facility.

      Senior Subordinated Notes. In the first quarter of fiscal 2005, we issued $100 million 7.500 percent senior subordinated notes (the “Notes”) due 2012. Deferred debt costs recorded at issuance of $2.6 million are reflected in other long-term assets and are being amortized as interest expense over the term of the Notes utilizing the effective interest method. We have the option of redeeming the Notes at any time after March 1, 2008 in accordance with certain call provisions of the related Note indenture. The Notes represent unsecured obligations that are subordinated to the Credit Facility and are fully and unconditionally guaranteed by each of our wholly-owned subsidiaries. Of the approximately $97.4 million of net proceeds from the placement of the Notes, $64.4 million was used to repurchase the remaining 10.375 percent senior subordinated notes due 2007 in fiscal 2005, and the remainder was used for general corporate purposes. As a result of the repurchase transactions, we incurred a $4.2 million charge primarily for a cash premium paid to repurchase some of the 10.375 percent senior subordinated notes and to write-off remaining deferred debt costs which are reflected in the debt repurchase and share reclassification expenses line item on the statement of operations. The financing transactions we completed in fiscal 2005 provided us the appropriate capital structure to enable our long-term growth strategy.

      The Note indenture contains covenants that, among other things, restrict our ability to incur additional indebtedness, make restricted payments, engage in certain transactions with affiliates, create liens, sell assets, issue guarantees of and pledges securing indebtedness and require an offer to repurchase the Notes in the event of a change in control. The indenture defines various events of default, including cross default provisions and defaults for any material judgments. At January 29, 2005, we are in compliance with all covenants under the Note indenture.

      Failure to comply with these restrictions and covenants could result in defaults under our Credit Facility and/or the Notes indenture. Any default, if not waived, could result in our debt becoming immediately due and payable.

      During fiscal 2005, 2004 and 2003, we purchased $64.4 million, $58.5 million and $27.1 million, respectively, in face value of the 10.375 percent senior subordinated notes. The purchases were made at an aggregate premium of 103.4 percent, 105.4 percent and 104.3 percent, respectively, to par value. During fiscal 2005, 2004 and 2003, we recorded pre-tax charges of $4.2 million, $4.3 million and $1.9 million, respectively, primarily for the cash premium paid and the related write-off of applicable deferred debt costs, which are reflected in the debt repurchase and share reclassification expenses line item in the statement of operations.

Restricted Stock Program

      In fiscal 2005, we implemented changes in our long-term compensation for employees, which we believe will help us continue to attract and retain the best employees, and better align employee interests with those of our shareholders. Annual grants to employees are now being made in restricted stock awards instead of stock options. The award of restricted stock offers employees the opportunity to earn shares of our stock over time, rather than options that provide employees the right to purchase stock at a set price. Stock options continue to be awarded on a selective basis to new employees and employees who are promoted into certain management positions.

      In fiscal 2005, the Compensation Committee of the Board of Directors approved an annual base award of restricted stock to certain of our employees that serves as both a retention vehicle and is coupled with performance awards. The base and performance awards vest 50 percent at the end of three years, with the remaining 50 percent vesting at the end of the fourth year. The base award grants, which are time-based awards, amounted to approximately 205,000 restricted shares in fiscal 2005. The performance-based award provides the potential to receive generally up to three-times that amount in additional shares. The number of performance award shares ultimately received, if any, will depend on achieving certain earnings performance goals over the three-year time frame. The expense recognition for the value of restricted shares is based on the vesting period and an estimate regarding certain performance levels over the three-year measurement period.

Off-Balance Sheet Transactions

      Our liquidity is not currently dependent on the use of off-balance sheet transactions other than letters of credit and operating leases, which are typical in a retail environment.

Contractual Obligations and Commitments

      The following table summarizes our future cash outflows resulting from contractual obligations and commitments as of January 29, 2005:

Seasonality and Inflation

      Our business exhibits seasonality, which is typical for most retail companies. Our sales are much stronger in the second half of the year than the first half of the year. Net earnings are highest during the months of September through December when sales volumes provide significant operating leverage. 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.

      Summarized below are key line items by quarter from our statements of operations and balance sheets:

      We believe that inflation has not had a significant effect on the growth of net sales or on net income over the past three years. There can be no assurance, however, that our operating results will not be affected by inflation in the future.

Critical Accounting Policies and Estimates

      Management strives to report the Company’s financial results in a clear and understandable manner. We follow generally accepted accounting principles in preparing our consolidated financial statements. The principles require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and on other assumptions that we believe to be relevant under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates under different assumptions and/or conditions. We continually evaluate the information used to make these estimates as our business and the economic environment changes. The use of estimates is pervasive throughout our financial statements, but the accounting policies and estimates we consider most critical are as follows:

Inventory Valuation

      Inventories are stated at the lower of cost or market with cost determined on a first-in, first-out basis. Inventory valuation methods require certain management estimates and judgments. These include estimates of shrink, as well as estimates of net realizable value on product designated for clearance, which affects the ending inventory valuation at cost as well as the gross margins reported for the year.

      Our accrual for shrink is based on the actual historical shrink results of our recent store physical inventories. These estimates are compared to actual results as physical inventory counts are taken and reconciled to the general ledger. Substantially all of our store physical inventory counts are taken in the first three quarters of each year and the shrink accrual recorded at January 29, 2005 is based on shrink results of prior physical inventories. All of our store locations that have been open one year or more are physically inventoried once a year. We will continue to monitor and adjust our shrink rate estimates based on the results of store physical inventories and shrink trends.

      We estimate our reserve for clearance product based on the consideration of a variety of factors, including, but not limited to, quantities of slow moving or carryover seasonal merchandise on hand, historical recovery statistics and future merchandising plans. The accuracy of our estimates can be affected by many factors, some of which are beyond our control, including changes in economic conditions and consumer buying trends.

Vendor Allowances

      All vendor consideration received, including cash discounts, volume discounts and co-operative advertising fees are included as a reduction of cost of sales. Cash discounts and volume discounts are recognized in cost of sales when the related merchandise is sold. Historically, we have recognized co-operative advertising fees when received from our vendors. Beginning January 1, 2003, upon the adoption of EITF Issue 02-16, “Accounting by a Customer (including a Reseller) for Certain Consideration Received from a Vendor,” and the execution of new or modifications of existing vendor agreements, we recognize co-operative advertising fees when the related merchandise is sold. The effect of adopting EITF Issue 02-16 did not have a material impact on our results of operations or financial position.

Gift cards

      Proceeds from the sale of gift cards are recorded as a gift card liability and recognized as sales when redeemed by the holder.

Valuation of Long-Lived Assets

      Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future estimated net cash flows to be generated by those assets. If such assets are considered to be impaired, the impairment recognized is the amount by which the carrying amount of the assets exceeds the fair value of the assets.

      In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” in the fourth quarter of fiscal 2005, 2004 and 2003, we performed the required annual impairment test of the carrying amount of goodwill and determined that no goodwill impairment existed.

Accrued Store Closing Costs

      Prior to December 31, 2002, we accrued costs related to stores closed or identified for closing, which included future rental obligations, carrying costs, and other closing costs. These expenses were accrued when we had committed to closing or relocating a store and were calculated at the lesser of future rental obligations remaining under the lease (less estimated sublease rental income) or the estimated lease termination cost. The determination of the accrual was dependent on our ability to make estimates of costs to be incurred post-closing and of sublease rental income to be received from subleases. Differences in our estimates and assumptions could result in an accrual requirement different from the calculated accrual.

      In July 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 146 which requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. SFAS No. 146 replaces EITF Issue No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002, and we began to account for the costs of store closings under SFAS No. 146 on that date.

Accrued Expenses

      We estimate certain material expenses in an effort to record those expenses in the period incurred. Our most material estimates relate to compensation, taxes and insurance related expenses, portions of which are self-insured. Our workers’ compensation and general liability insurance accruals are recorded based on insurance claims processed as well as historical claims experience for claims incurred but not yet reported. These estimates are based on historical loss development factors. Our employee medical insurance accruals are recorded based on our medical claims processed as well as historical medical claims experience for claims incurred but not yet reported. Differences in our estimates and assumptions could result in an accrual

requirement materially different from the calculated accrual. However, such differences have not been historically significant for fiscal years 2005, 2004 and 2003.

Operating Leases

      Rent expense for our operating leases, which may have escalating rentals over the term of the lease, is recorded on a straight-line basis over the initial lease term and those renewal periods that are reasonably assured. The initial lease term includes the “build-out” period of our leases, where no rent payments are typically due under the terms of the lease. The difference between rent expense and rent paid is recorded as deferred rent and is included in the consolidated balance sheets.

      Construction allowances received from landlords are recorded as a deferred rent credit and amortized to rent expense over the initial term of the lease. The Company’s statement of cash flows reflects the receipt of construction allowances as an increase in cash flows from operating activities.

Income Taxes

      We do business in various jurisdictions that impose income taxes. Management determines the aggregate amount of income tax expense to accrue and the amount currently payable based upon the tax statutes of each jurisdiction. This process involves adjusting income determined using GAAP for items that are treated differently by the applicable taxing authorities. Deferred tax assets and liabilities are reflected on our balance sheet for temporary differences that will reverse in subsequent years. If different judgments had been made, our tax expense, assets and liabilities could have been different. Our current tax provision can be affected by our mix of income and identification or resolution of uncertain tax positions. Because income from different jurisdictions may be taxed at different rates, the shift in mix during a year or over years can cause the effective tax rate to change. We base our rate during the year on our best estimate of an annual effective rate, and update those estimates quarterly. We also regularly evaluate the status and likely outcome of uncertain tax positions.

      As a matter of course, we are regularly audited by federal and state tax authorities. We provide reserves for potential exposures when we consider it probable that a taxing authority may take a sustainable position on a matter contrary to our position. We evaluate these reserves, including interest thereon, on a quarterly basis to insure that they have been appropriately adjusted for events, including audit settlements, that may impact our ultimate payment for such exposures.

Recent Accounting Pronouncements

      In addition to the accounting pronouncements referenced above in our discussion of critical accounting policies, the following accounting pronouncements may have an impact on our results of operations or financial position, as discussed further below.

Statement of Financial Accounting Standard (SFAS) No. 123(Revised 2004), Share-Based Payment

      In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123R replaces SFAS No. 123, supersedes Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statement of Cash Flows.” SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. SFAS No. 123R amends SFAS No. 95 to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid.

      SFAS No. 123R is effective for public companies at the beginning of the first interim or annual period beginning after June 15, 2005. Currently, we use the Black-Scholes option pricing model to estimate the value of stock options granted and are evaluating option valuation models, including the Black-Scholes, to determine which model we will utilize upon adoption of SFAS No. 123R. We plan to adopt SFAS No. 123R

using the modified-prospective method. We do not anticipate that the adoption of SFAS No. 123R will have a material impact on the Company’s stock-based compensation expense.

FASB Interpretation No. 46, Consolidation of Variable Interest Entities

      In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities.” FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” for certain entities which do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest (“variable interest entities”). Variable interest entities will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected returns, or both, as a result of holding variable interests, which are ownership, contractual, or other pecuniary interests in an entity. We adopted FIN 46 in our first quarter of fiscal 2005. The adoption of FIN 46 had no impact on our consolidated financial statements.

Cautionary Statement Concerning Forward-Looking Statements

      Certain statements contained in this report that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements which reflect our current views of future events and financial performance, involve certain risks and uncertainties. When used herein, the terms “anticipates,” “plans,” “estimates,” “expects,” “believes,” and similar expressions as they relate to us or future events or conditional verbs such as “will,” “should,” “would,” “may,” and “could” are intended to identify such forward-looking statements. Our actual results, performance or achievements may materially differ from those expressed or implied in the forward-looking statements. Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general economic conditions, changes in customer demand, changes in trends in the fabric and craft industry, seasonality, the availability of merchandise, changes in the competitive pricing for products, longer-term unseasonable weather or wide spread severe weather, the impact of our and our competitors store openings and closings, fuel and energy costs, changes in tariff and freight rates, consumer debt levels, and other capital market and geo-political conditions. We caution readers not to place undue reliance on these forward-looking statements. We assume no obligation to update any of the forward-looking statements.

      We are exposed to foreign currency fluctuations on merchandise that is sourced internationally and the impact of interest rate changes on our outstanding borrowings under our credit facility.

      We believe foreign currency exchange rate fluctuations do not contain significant market risk due to the nature of our relationships with our international vendors. All merchandise contracts are denominated in U.S. dollars and are subject to negotiation prior to our commitment for purchases. As a result, there is not a direct correlation between merchandise prices and fluctuations in the exchange rate. We sourced approximately 30 percent of our purchases internationally in fiscal 2005. Our international purchases are concentrated in China and other Asian countries.

      In the normal course of business, we employ established policies and procedures to manage our exposure to changes in interest rates. Our objective in managing the exposure to interest rate changes is to limit the volatility and impact of interest rate changes on earnings and cash flows. This is accomplished through the debt structure we set in place in early fiscal 2005, which consisted of the fixed rate $100 million Notes and our variable rate Credit Facility, which is designed to be a working capital facility. We estimate that a one-percent increase or decrease in interest rates, based on fiscal 2005 average debt levels, would cause an increase or decrease to interest expense of $0.2 million.

      In the past, we also utilized interest rate swaps to achieve our objective of managing our exposure to interest rate changes. We utilized interest rate swaps to manage net exposure to interest rate changes related

to our variable rate bank credit facilities. We have a $40.0 million interest rate swap with a fixed LIBOR of 6.72 percent that expires on April 30, 2005.

      In accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” we have reviewed and designated our interest rate swap agreement as a cash flow hedge and recognized the fair value of our interest rate swap agreement on the balance sheet in accrued expenses. Changes in the fair value of this agreement is recorded in other comprehensive income (loss) and reclassified into earnings as the underlying hedged item affects earnings. During fiscal 2005 and fiscal 2004, unrealized after-tax net gains of $1.6 million and $1.0 million, respectively, were recorded in other comprehensive income (loss). The fiscal 2002 after-tax net loss included a $1.7 million cumulative transition adjustment, as of the date of adoption of SFAS No. 133. The hedge ineffectiveness (income) expense for fiscal 2005, 2004 and 2003 was $0.4 million, $(0.7) million and $(0.3) million, respectively, and is reflected in interest expense.

Item 8. Financial Statements and Supplementary Data

Jo-Ann Stores, Inc.

Index to Consolidated Financial Statements

Report of Independent Registered Public Accounting Firm

To the Shareholders and Board of Directors of Jo-Ann Stores, Inc.:

      We have audited the accompanying consolidated balance sheets of Jo-Ann Stores, Inc. (the Company) as of January 29, 2005 and January 31, 2004, and the related consolidated statements of operations, cash flows, and shareholders’ equity for each of the three years in the period ended January 29, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

      We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Jo-Ann Stores, Inc. at January 29, 2005 and January 31, 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended January 29, 2005, in conformity with U.S. generally accepted accounting principles.

      As discussed in Note 2 to the consolidated financial statements, the Company restated its 2004 and 2003 financial statements. Also, as discussed in Note 1 to the consolidated financial statements, in 2004 the Company changed its method of accounting for stock based compensation.

      We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Jo-Ann Stores, Inc.’s internal control over financial reporting as of January 29, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 31, 2005 expressed an unqualified opinion on management’s assessment and an adverse opinion on the effectiveness of internal control over financial reporting due to the effect of the Company’s insufficient controls over the selection and monitoring of appropriate assumptions and factors affecting its lease accounting practices.

Cleveland, Ohio,

March 31, 2005

Jo-Ann Stores, Inc.

Consolidated Balance Sheets

See notes to consolidated financial statements

Jo-Ann Stores, Inc.

Consolidated Statements of Operations

See notes to consolidated financial statements

Jo-Ann Stores, Inc.

Consolidated Statements of Cash Flows

See notes to consolidated financial statements