UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended October 25, 2014

 

OR

 

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from_____________to___________.

 

Commission File Number 1 – 9482

 

HANCOCK FABRICS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware	64-0740905
(State or other jurisdiction	(I.R.S. Employer
of incorporation or organization)	Identification No.)
One Fashion Way, Baldwyn, MS	38824
(Address of principal executive offices)	(Zip Code)

 

(662) 365-6000

Registrant’s telephone number, including area code

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X]     No [ ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).          Yes [X]     No [ ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer (Do not check if a smaller reporting company) [ ] Smaller reporting company [ X ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes [  ]     No [X]

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  Yes [X]     No [ ]

 

As of December 3, 2014, there were 21,945,297, shares of Hancock Fabrics, Inc. $.01 par value common stock outstanding.

 

 

Table of Contents

 

Hancock Fabrics, Inc.,

INDEX TO FORM 10-Q

 

Part I. Financial Information	Page
Item 1. Condensed Financial Statements (unaudited)
Consolidated Balance Sheets as of October 25, 2014, October 26, 2013, and January 25, 2014	3
Consolidated Statements of Operations and Comprehensive Loss for the Thirteen and Thirty-nine Weeks Ended October 25, 2014 and October 26, 2013	4
Consolidated Statement of Shareholders’ Equity (Deficit) for the Thirty-nine Weeks Ended October 25, 2014	5
Consolidated Statements of Cash Flows for the Thirty-nine Weeks Ended October 25, 2014 and October 26, 2013	6
Notes to Consolidated Financial Statements	7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3. Quantitative and Qualitative Disclosures about Market Risks	20
Item 4. Controls and Procedures	21
Part II. Other Information
Item 1. Legal Proceedings	22
Item 1A. Risk Factors	22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	22
Item 3. Defaults Upon Senior Securities	22
Item 4. Mine Safety Disclosures	22
Item 5. Other Information	22
Item 6. Exhibits	23
Signatures	23

 

 

PART I. FINANCIAL INFORMATION            

ITEM 1. CONDENSED FINANCIAL STATEMENTS            

HANCOCK FABRICS, INC.            

CONSOLIDATED BALANCE SHEETS            

 

 

See accompanying notes to consolidated financial statements.

 

⁽¹⁾ From audited balance sheet included in our annual report on Form 10-K for the fiscal year ended January 25, 2014.

 

 

 

HANCOCK FABRICS, INC.                

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS               

(unaudited)

 

See accompanying notes to consolidated financial statements.

 

 

 

HANCOCK FABRICS, INC.                                

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)                  

(unaudited)

 

See accompanying notes to consolidated financial statements.

 

 

HANCOCK FABRICS, INC.        

CONSOLIDATED STATEMENTS OF CASH FLOWS        

(unaudited)

 

See accompanying notes to consolidated financial statements.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

 

 

 

 

 

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

 

The following discussion should be read in conjunction with the consolidated financial statements as of and for the thirteen and thirty-nine weeks ended October 25, 2014, including the notes to those statements, appearing elsewhere in this report. We also suggest that management’s discussion and analysis appearing in this report be read in conjunction with the management’s discussion and analysis and consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended January 25, 2014. Our fiscal year ends on the last Saturday in January and refers to the calendar year ended immediately prior to such date, which contained the substantial majority of the fiscal period (e.g., “fiscal 2013” or “2013” refers to the fiscal year ended January 25, 2014). Fiscal years consist of 52 weeks, comprised of four 13-week fiscal quarters, unless noted otherwise. References herein to third quarter 2014 and third quarter 2013 are for the 13 week periods ended October 25, 2014 and October 26, 2013, respectively. References to thirty-nine weeks 2014 or 2014, and thirty-nine weeks 2013 or 2013 are for the 39 week periods ended October 25, 2014 and October 26, 2013, respectively. References herein to “Hancock,” the “Company,” “Registrant,” “we,” “our,” or “us” refer to Hancock Fabrics, Inc. and its subsidiaries unless the context specifically indicates otherwise.

 

 

Forward Looking Statements

 

 

This Quarterly Report on Form 10-Q (“Quarterly Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). Such statements are not historical facts and reflect our current views regarding matters such as operations and financial performance. In general, forward-looking statements are identified by such words or phrases as “anticipates,” “believes,” “approximates,” “estimates,” “expects,” “intends” or “plans” or the negative of those words or other terminology. Forward-looking statements involve inherent risks and uncertainties; our actual results could differ materially from those expressed in our forward-looking statements.

 

The risks and uncertainties, either alone or in combination, that could cause our actual results to differ from those expressed in our forward-looking statements include, but are not limited to, the following: our business and operating results may be adversely affected by the general economic conditions and the ongoing slow economic recovery; intense competition and adverse discounting actions taken by competitors; our merchandising initiatives and marketing emphasis may not provide expected results; changes in customer demands and failure to manage inventory effectively could adversely affect our operating results; our inability to effectively implement our growth strategy and access funds for future growth may have an adverse effect on sales growth; our ability to attract and retain skilled people is important to our success; we have significant indebtedness and interest rate increases could negatively impact profitability; significant changes in discount rates, mortality rates, actual investment return on pension assets, changes in consumer demand or purchase patterns and other factors could affect our earnings, equity, and pension contributions in future periods; business matters encountered by our suppliers may adversely impact our ability to meet our customers’ needs; tightening of purchase terms by suppliers and their factories may have a negative impact on our business; we are vulnerable to risks associated with obtaining merchandise from foreign suppliers; transportation industry challenges and rising fuel costs may negatively impact our operating results; delays or interruptions in the flow of merchandise between our suppliers and/or our distribution center and our stores could adversely impact our operating results; changes in the labor market and in federal, state, or local regulations could have a negative impact on our business; taxing authorities could disagree with our tax treatment of certain deductions or transactions, resulting in unexpected tax assessments; our current cash resources might not be sufficient to meet our expected near-term cash needs; a disruption in our information systems would negatively impact our business; a failure to adequately maintain the security of confidential information could have an adverse effect on our business; failure to comply with various laws and regulations as well as litigation developments could adversely affect our business operations and financial performance; we may not be able to maintain or negotiate favorable lease terms for our retail stores; changes in accounting principles may have a negative impact on our reported results; our results may be adversely affected by serious disruptions or catastrophic events, including geo-political events and weather; changes in newspaper subscription rates may result in reduced exposure to our circular advertisement; unexpected or unfavorable consumer responses to our promotional or merchandising programs could materially adversely affect our sales, results of operations, cash flow and financial condition; and other risks and uncertainties that are discussed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on April 25, 2014 under Item 1A. Risk Factors. Forward-looking statements speak only as of the date made, and neither Hancock nor its management undertakes any obligation to update or revise any forward-looking statement.

 

Our Business

 

Hancock Fabrics, Inc. is a specialty retailer committed to nurturing creativity through a complete selection of fashion and home decorating textiles, sewing accessories, needlecraft supplies and sewing machines. We are one of the largest fabric retailers in the United States, operating 262 stores in 37 states as of October 25, 2014 and an internet store under the domain name hancockfabrics.com. Our stores present a broad selection of fabrics and notions used in apparel sewing, home decorating and quilting projects. None of the information on the website referenced above is incorporated by reference into our reports filed with, or furnished to, the SEC.

 

 

Overview

 

Financial Summary:

 

●

Comparable store sales increased 0.3% in the third quarter of 2014 following an increase of 1.1% in the third quarter of 2013. Sales for the third quarter of 2014 were $72.0 million compared to $71.8 million for the third quarter of 2013. Sales for the first thirty-nine weeks of 2014 were $194.3 million compared to $194.7 million for the first thirty-nine weeks of 2013 and comparable store sales improved by 0.1% following a decrease of 0.1% in the first thirty-nine weeks of 2013. Management believes severe winter weather in the first quarter negatively impacted the first thirty-nine weeks of 2014 by approximately $1.8 million.

 

●

Our online sales for the third quarter of 2014, which are included in the sales number and comparable sales percentage above, increased 18.1% to $1.6 million compared to $1.4 million for the third quarter of 2013, and increased by 10.5% to $3.4 million in the first thirty-nine weeks of 2014 compared to $3.1 million in the first thirty-nine weeks of 2013.

 

●

Gross profit for the third quarter and first thirty-nine weeks of 2014 was 42.3% and 43.9%, respectively, compared with 41.6% and 43.9% for the third quarter and first thirty-nine weeks of 2013, respectively. This represents an increase of 70 basis points for the third quarter of 2014 over the same period of 2013.

 

●

Operating income was $0.7 million for the third quarter of 2014 compared to $0.8 million in the third quarter of 2013. For the first thirty-nine weeks of 2014, the operating loss was $0.3 million compared to operating income of $0.9 million for the first thirty-nine weeks of 2013.

 

●

Net loss was $0.8 million, or $0.04 per basic and diluted share, in the third quarter of 2014 compared to a net loss of $0.6 million, or $0.03 per basic and diluted share in the third quarter of 2013. Net loss was $4.6 million or $0.22 per basic and diluted share in the first thirty-nine weeks of 2014 compared to a net loss of $3.7 million or $0.18 per basic and diluted share in the comparable period of 2013.

 

●

The amount of cash used in operating activities was $9.1 million during the first thirty-nine weeks of 2014 compared to $11.5 million of cash used in operating activities for the first thirty-nine weeks of 2013.

 

 

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

 

		Thirteen Weeks Ended								Thirty-nine Weeks Ended
		October 25,				October 26,				October 25,				October 26,
		2014				2013				2014				2013
Net sales (in thousands)		$	72,012			$	71,810			$	194,323			$	194,685
Gross margin percentage			42.3	%			41.6	%			43.9	%			43.9	%
Number of stores (1)
Open at end of period			262				261				262				261
Comparable stores at period end (2)			256				258				256				258
Sales growth
All stores and e-commerce			0.3	%			(0.1	)%			(0.2	)%			(0.8	)%
Comparable stores and e-commerce			0.3	%			1.1	%			0.1	%			(0.1	)%
Total store square footage at period end (in thousands)			3,584				3,682				3,584				3,682
Net sales per total square footage		$	20.09			$	19.50			$	54.22			$	52.87

 

(1)	Store count does not include the internet store.
(2)	A new store is included in the comparable sales computation immediately upon reaching its one-year anniversary. In those instances where stores are either expanded, down-sized or relocated within an existing market, the store is not treated as a new store and, therefore, remains in the computation of comparable sales.

 

Results of Operations

 

The following table sets forth, for the periods indicated selected statement of operations data expressed as a percentage of sales. This table should be read in conjunction with the following discussion and with our Consolidated Financial Statements, including the related notes.

 

		Thirteen Weeks Ended								Thirty-nine Weeks Ended
		October 25,				October 26,				October 25,				October 26,
		2014				2013				2014				2013
Net sales			100.0	%			100.0	%			100.0	%			100.0	%
Cost of goods sold			57.7				58.4				56.1				56.1
Gross profit			42.3				41.6				43.9				43.9
Selling, general and administrative expense			39.9				39.2				42.5				42.0
Depreciation and amortization			1.4				1.2				1.5				1.4
Operating income (loss)			1.0				1.2				(0.1	)			0.5
Interest expense, net			2.1				2.0				2.2				2.5
Loss before income taxes			(1.1	)			(0.8	)			(2.3	)			(2.0	)
Income taxes			0.0				0.0				0.0				0.0
Net loss			(1.1	)%			(0.8	)%			(2.3	)%			(2.0	)%

 

 

Net Sales

 

		Thirteen Weeks Ended								Thirty-nine Weeks Ended
(in thousands)		October 25,				October 26,				October 25,				October 26,
		2014				2013				2014				2013
Retail comparable store base		$	69,413			$	68,851			$	189,030			$	186,897
E-Commerce			1,608				1,361				3,420				3,095
Comparable sales			71,021				70,212				192,450				189,992
New stores			991				345				1,873				674
Closed stores			-				1,253				-				4,019
Total net sales		$	72,012			$	71,810			$	194,323			$	194,685

 

For 2014, the retail comparable store base above consists of the stores which were included in the comparable sales computation for the respective periods. For 2013, the retail comparable store base above excludes new stores for that period and stores that have closed subsequent to that period. The third quarter 2014 comparable sales, (excluding e-commerce) which was unchanged from the third quarter of 2013, was the result of a 1.6% improvement in average ticket offset by a 1.6% decline in transactions evidencing higher sales volumes for each individual transaction. Comparable sales were also unchanged for the first thirty-nine weeks of 2014 due to a 2.6% improvement in average ticket offset by a 2.6% decrease in transaction count.

 

Sales provided by our e-commerce channel increased 18.1% in the third quarter of 2014 compared to the third quarter of 2013 and 10.5% for the first thirty-nine weeks of fiscal 2014 compared to the same period in 2013, due to the launch of a new website and expansion of the product assortment offered to online customers.

 

Six new stores opened and five stores, where we chose not to stay in the market, have closed since the third quarter of 2013. The sales from these locations are included in net sales. During the trailing 12 months, the Company has relocated 7 stores and as of October 25, 2014 had 262 stores in operation.

 

Our merchandise mix has had minimal change year over year, as reflected in the table below. 

 

		Thirteen Weeks Ended								Thirty-nine Weeks Ended
		October 25,				October 26,				October 25,				October 26,
		2014				2013				2014				2013
Apparel and Craft Fabrics			47	%			46	%			45	%			43	%
Home Decorating Fabrics			10	%			11	%			11	%			12	%
Sewing Accessories			30	%			30	%			31	%			32	%
Non-Sewing Products			13	%			13	%			13	%			13	%
			100	%			100	%			100	%			100	%

 

Gross Profit

 

Costs of goods sold include:

 

●

the cost of merchandise

 

●

inventory rebates and allowances including term discounts

 

  

●

inventory shrinkage and valuation adjustments

 

●

freight charges

 

●

costs associated with our sourcing operations, including payroll and related benefits

 

●

costs associated with receiving, processing, and warehousing merchandise

 

The classification of these expenses varies across the retail industry.

 

Specific components of cost of goods sold for the third quarters and first thirty-nine weeks of fiscal 2014 and 2013 are as follows:

 

		Thirteen Weeks Ended																Thirty-nine Weeks Ended
		October 25,				% of				October 26,				% of				October 25,				% of				October 26,				% of
(dollars in thousands)		2014				Sales				2013				Sales				2014				Sales				2013				Sales
Total net sales		$	72,012				100.0	%		$	71,810				100.0	%		$	194,323				100.0	%		$	194,685				100.0	%
Merchandise cost			34,845				48.4	%			35,745				49.8	%			91,632				47.2	%			93,234				47.9	%
Freight			2,937				4.1	%			2,705				3.8	%			7,311				3.8	%			6,696				3.4	%
Sourcing and warehousing			3,766				5.2	%			3,480				4.8	%			10,002				5.1	%			9,357				4.8	%
Gross Profit		$	30,464				42.3	%		$	29,880				41.6	%		$	85,378				43.9	%		$	85,398				43.9	%

 

Merchandise cost declined as a percentage of sales by 140 basis points for the third quarter of 2014 as compared to the same period of 2013, due to better inventory management, improvements in inventory shrinkage and a reduction in the amount charged to the inventory valuation reserve. For the thirty-nine weeks of 2014 as compared to 2013, merchandise cost declined by 70 basis points due to improvements in inventory shrinkage, a reduction in the amount charged to the inventory valuation reserve, and improved inventory management during the thirty-nine week period ended October 25, 2014.

 

Freight expense was higher as a percentage of sales for the third quarter and thirty-nine weeks of 2014 as compared to the same periods of 2013. These costs were the result of increases in inbound and outbound shipments of inventory to the Company’s distribution center and retail store locations.

 

Sourcing and warehousing costs for the Company vary based on both the volume of inventory received during any period, the rate at which inventory is shipped out and inventory turns. The cost difference for the thirty-nine weeks of 2014 compared to the same period in 2013 includes a one-time benefit in 2013 which resulted from a change in the inventory turn calculation that increased the amount of sourcing and warehousing costs capitalized in inventory.

 

In total, gross profit increased by 70 basis points in the third quarter 2014 from third quarter 2013 levels and was unchanged for the first thirty-nine weeks of 2014 as compared to the same period of 2013.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses include:

 

●

payroll and related benefits (for our store operations, field management, and corporate functions)

 

●

advertising

 

●

general and administrative expenses

 

●

occupancy including rent, common area maintenance, taxes and insurance for our retail locations

 

 

●

operating costs of our headquarter facilities

 

●

other expense (income)

 

Specific components of selling, general and administrative expenses (SG&A) include:

 

		Thirteen Weeks Ended																Thirty-nine Weeks Ended
		October 25,				% of				October 26,				% of				October 25,				% of				October 26,				% of
(dollars in thousands)		2014				Sales				2013				Sales				2014				Sales				2013				Sales
Retail store labor costs		$	10,216				14.2	%		$	10,135				14.1	%		$	29,549				15.2	%		$	29,207				15.0	%
Advertising			2,426				3.4	%			2,599				3.6	%			7,134				3.7	%			7,551				3.9	%
Store occupancy			7,610				10.6	%			7,470				10.4	%			22,608				11.6	%			22,485				11.5	%
Retail SG&A			5,535				7.7	%			5,126				7.2	%			14,827				7.6	%			14,491				7.4	%
Corp SG&A			2,984				4.0	%			2,796				3.9	%			8,582				4.4	%			8,102				4.2	%
Total SG&A		$	28,771				39.9	%		$	28,126				39.2	%		$	82,700				42.5	%		$	81,836				42.0	%

  

Retail Store Labor Costs – The Company store labor costs increased slightly for third quarter and thirty-nine weeks of 2014 as compared to the same periods in 2013, with labor for new store relocations and employee health insurance driving the increase.

 

Advertising – The reduction in advertising expense for the third quarter and thirty-nine weeks of 2014 as compared to the same periods of 2013 were in line with expectations and reflect improvements in our marketing program which allow us to reach a larger audience with a smaller expenditure.

 

Store Occupancy – The Company’s store occupancy expense increased slightly for the quarter and thirty-nine weeks as compared to the same periods of the prior year. The increase for the quarter was driven by rent related costs and maintenance expenditures. For the thirty-nine weeks, increases in rent related costs were partially offset by reductions in maintenance costs.

 

Retail SG&A – Retail selling, general and administrative expense increased for the third quarter of 2014 as compared to the third quarter of 2013 primarily due to increases in travel cost, utilities, insurance and contract labor. For the first thirty-nine weeks of 2014 retail SG&A compared to same period of 2013 increased primarily due to increased costs for utilities, insurance, travel and contract labor related to store relocations. SG&A expenses for both periods of 2014 were partially offset by commission income from a third party loyalty program which began in the fourth quarter of 2013.

 

Corporate SG&A – These increased for the third quarter of 2014 over the prior year due to travel, labor, and professional fees. The increases for the thirty-nine week period compared to the prior year were primarily due to professional fees, labor, and health insurance.

 

Interest Expense

 

		Thirteen Weeks Ended																Thirty-nine Weeks Ended
(dollars in thousands)		October 25,				% of				October 26,				% of				October 25,				% of				October 26,				% of
		2014				Sales				2013				Sales				2014				Sales				2013				Sales
Interest expense, net		$	1,498				2.1	%		$	1,444				2.0	%		$	4,306				2.2	%		$	4,569				2.4	%

 

 

The Company’s interest costs are driven by borrowings on our credit facilities and a small number of capital leases. Interest expense for the thirty-nine weeks of 2013 includes $379,000 of non-cash expense for note discount amortization (see Note 4 to the Consolidated Financial Statements included in this report). Excluding the non-cash items, interest expense was $4.2 million or 2.2% for the thirty-nine weeks of 2013.

 

Income Taxes

 

The Company did not recognize any income tax benefit during the periods of fiscal 2014 or 2013 presented in this report given the uncertainty in realizing the future benefit. As of October 25, 2014, January 25, 2014, and October 26, 2013 the Company has established a 100% valuation allowance to offset the net deferred tax assets related to net operating loss carryforwards and other book-tax timing differences.

 

Liquidity and Capital Resources

 

Hancock's primary capital requirements are for the financing of inventories and, to a lesser extent, for capital expenditures relating to store locations and its distribution facility. Funds for such purposes have historically been generated from Hancock's operations, short-term trade credit in the form of extended payment terms from suppliers for inventory purchases, and long-term borrowings from commercial lenders.

 

Due to our history of losses over the past three fiscal years, we have not generated positive operating cash flow during such period. As a result, since fiscal 2011, we have increasingly relied on borrowings for our capital needs to fund the Company’s working capital needs, its required cash contribution to the Company’s defined benefit pension plan, for capital expenditures, and losses from operations. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation-Liquidity and Capital Resources” in our Annual Report on Form 10-K for the year ended January 25, 2014 filed with the SEC on April 25, 2014.

 

At October 25, 2014, the Company had outstanding long-term indebtedness of $93.3 million. As a consequence of our significant amount of indebtedness as of October 25, 2014, a significant portion of our cash flow from operations must be dedicated to interest and principal payments on our indebtedness, thereby reducing the availability of our cash flow to fund capital expenditures or other growth initiatives and other general corporate requirements, see “Item 1A. Risk Factors − Risks Related to Our Business − We have a significant amount of indebtedness, which could have important negative consequences to us” in our Annual Report on Form 10-K for the year ended January 25, 2014 filed with the SEC on April 25, 2014. In addition, at October 25, 2014, the Company had limited cash resources, with cash and cash equivalents of $3.1 million, see “Item 1A. Risk Factors − Risks Related to Our Business − Our current cash resources might not be sufficient to meet our expected near-term cash needs” in our Annual Report on Form 10-K for the year ended January 25, 2014 filed with the SEC on April 25, 2014.

 

Our short-term and long-term liquidity needs arise primarily from our working capital requirements, required cash contributions to the defined benefit pension plan, planned capital expenditures and debt service requirements. We anticipate that capital expenditures for the fiscal year ending January 31, 2015 will be approximately $4.1 to $4.5 million, primarily for store and technology upgrades. We anticipate that we will be able to satisfy our short-term and long-term liquidity needs highlighted above through the next twelve months with available cash, proceeds from cash flows from operations, short-term trade credit, borrowings under our revolving credit facility (the “Revolver”) and other sources of financing. As of October 25, 2014, we have $16.3 million available to borrow under the Revolver. We consolidate our daily cash receipts into a centralized account. In accordance with the terms of our $100.0 million Revolver, on a daily basis, all collected and available funds are applied to the outstanding loan balance. We then determine our daily cash requirements and request those funds from the Revolver availability.

 

 

Our ability to improve our liquidity in future periods will depend on generating positive operating cash flow, primarily through comparable store sales increases, improved gross profit and controlling our expenses, which in turn, may be impacted by prevailing economic conditions and other financial and business factors, some of which are beyond our control, see “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended January 25, 2014 filed with the SEC on April 25, 2014.

 

Hancock’s cash flow related information for the first thirty-nine weeks of fiscal 2014 and 2013 follows:

 

		Thirty-nine Weeks Ended
		October 25,				October 26,
		2014				2013
Net cash flows provided by (used in):
Operating activities		$	(9,133	)		$	(11,526	)
Investing activities			(4,059	)			(3,161	)
Financing activities			14,510				13,322

 

Operating Activities

 

Net cash from operating activities, before changes in assets and liabilities, was a gain of $189,000 as compared to a gain of $2.4 million for the thirty-nine weeks of 2014 and 2013, respectively. This can be primarily attributed to the larger net loss for 2014 than the prior year, the non-cash charge of $379,000 for bond discount amortization in 2013 and the decline in inventory valuation of $0.8 million in 2014 as compared to 2013.

 

For the thirty-nine weeks of 2014, the inventory increase of $14.2 million and a $1.1 million decline in pension and SERP liabilities reduced by $6.6 million of accounts payable support resulted in the $9.1 million of cash used in operating activities. For the thirty-nine weeks of 2013, the increase of $14.6 million of inventory and $1.5 million of accounts receivable and prepaid expenses combined with a $2.7 million decline in pension and SERP liabilities reduced by $6.4 million of accounts payable support primarily resulted in the $11.5 million of net cash used in operating activities for 2013.

 

Investing Activities

 

Cash used for investing activities consists primarily of purchases of property and equipment. Capital expenditures of $4.1 million during the first thirty-nine weeks of 2014 consisted primarily of store fixtures and leasehold improvements for five new stores, five relocated units, and development costs related to the re-launch of the Company website. Capital expenditures of $3.2 million during the first thirty-nine weeks of 2013 consisted primarily of store fixtures for two new stores, four relocated units, and maintenance capital expenditures for the Corporate headquarters and distribution center.

 

 

Financing Activities

 

For the thirty-nine weeks of 2014, the seasonal build up of inventory, expenditures for investing activities discussed above and the required contribution to the defined benefit pension plan caused a net increase in cash provided by financing activities of $14.5 million. During the first thirty-nine weeks of 2013, the seasonal build up of inventory and fixtures for six stores drove up net debt obligations by $13.4 million, excluding the remainder of the discount on notes of $379,000, which has been fully amortized. This change in debt obligations and a reduction in the amount outstanding for capital leases produced a net increase in cash provided by financing activities of $13.3 million.

 

Credit Facilities

 

The following should be read in conjunction with Note 4 to the Consolidated Financial Statements included in this report and Note 5 to the Company’s Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K filed with the SEC on April 25, 2014.

 

As of October 25, 2014, the Company had outstanding borrowings under the Revolver of $70.1 million and $15.0 million under the Term Loan, and amounts available to borrow of $16.3 million.

 

At October 25, 2014, Hancock had commitments under the above credit facility of $1.0 million, on documentary letters of credit, which support purchase orders for merchandise. Hancock also has standby letters of credit to guarantee payment of potential insurance claims, shipments of inventory and freight charges. These letters of credit amounted to $5.1 million as of October 25, 2014.

 

As of October 25, 2014, the Company had an outstanding balance of $8.2 million on the New Notes.

 

Off-Balance Sheet Arrangements

 

Hancock has no off-balance sheet financing arrangements. Hancock leases its retail fabric store locations mainly under non-cancelable operating leases. Four of the Company’s store leases qualified for capital lease treatment and are reflected on the Company’s balance sheet. Future payments under the operating leases are excluded from the Company’s balance sheet.

 

Contractual Obligations and Commercial Commitments

 

Hancock has an arrangement within its Revolver that provides up to $20.0 million in letters of credit. At October 25, 2014, Hancock had commitments of $1.0 million on documentary letters of credit under the facility, which support purchase orders for merchandise. Hancock also has $5.1 million on standby letters of credit to guarantee payment of potential insurance claims, shipments of inventory and freight charges. Hancock leases its retail fabric store locations under operating leases expiring at various dates through 2025.

 

The Company has no standby repurchase obligations or guarantees of other entities' debt.

 

For further information on our contractual obligations, please refer to Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations and Commercial Commitments” as presented in our Annual Report on Form 10-K for the fiscal year ended January 25, 2014.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to adopt accounting policies and make significant judgments and estimates to develop amounts reflected and disclosed in the financial statements. In many cases, there are alternative policies or estimation techniques that could be used. We maintain a process to review the application of our accounting policies and to evaluate the appropriateness of the many estimates that are required to prepare the financial statements of a large corporation. However, even under optimal circumstances, estimates routinely require adjustment based on changing circumstances and the receipt of new or better information. There have been no significant changes to our accounting policies and estimates as discussed under Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended January 25, 2014.

 

 

Related Party Transactions

 

See Note 14 to the Company’s Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 25, 2014 filed with the SEC on April 25, 2014, for details regarding the related party transactions that the Company has entered into.

 

On July 24, 2014, Neil Subin, a director of Hancock Fabrics, Inc., acquired warrants for 600,000 shares issued on November 20, 2012 at an exercise price per share of $0.59 for which he declared indirect ownership. The 600,000 warrant shares acquired by Mr. Subin were sold by Lenado Partners, Series A of Lenado Capital Partners, L.P., a member of a group owning more than 5% of our common stock.

 

On that same date, Mr. Subin acquired $4.2 million of our Floating Rate Series A Secured Notes Due 2017 from Lenado Capital Partners, L.P., SPV Quatro, LLC and SPV UNO, LLC., members of a group owning more than 5% of our common stock.

 

The Company has no other balances with related parties, nor has it had any other material transactions with related parties during the thirty-nine week period ended October 25, 2014.

 

Effects of Inflation

 

Inflation in labor and occupancy costs could significantly affect Hancock's operations. Many of Hancock's employees are paid hourly rates related to federal and state minimum wage requirements; accordingly, any increases in those requirements will affect Hancock. In addition, payroll taxes, employee benefits, and other employee costs continue to increase, and the full impact of the recently enacted health care reform legislation will not be known for several years. Health insurance costs, in particular, continue to rise at a high rate in the United States each year, and higher employer contributions to Hancock’s pension plan could be necessary if investment returns are weak. Costs of leases for new store locations remain stable, but renewal costs of older leases continue to increase. Hancock believes the practice of maintaining adequate operating margins through a combination of price adjustments and cost controls, careful evaluation of occupancy needs, and efficient purchasing practices are the most effective tools for coping with increased costs and expenses.

 

Seasonality

 

Hancock's business is seasonal. Peak sales periods occur during the fall and early spring weeks, while the lowest sales periods occur during the summer. Working capital requirements needed to finance our operations fluctuate during the year and reach their highest levels during the second and third fiscal quarters as we increase our inventory in preparation for our peak selling season during the fourth quarter.

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

 

Hancock did not hold derivative financial or commodity instruments at October 25, 2014.

 

 

Interest Rate Risk

 

We are exposed to financial market risks, including changes in interest rates. At our option, all loans under the Revolver and the Term Loan bear interest at either (a) a floating interest rate plus the applicable margins or (b) absent a default, a fixed interest rate for periods of one, two or three months equal to the reserve adjusted London Interbank Offered Rate, or LIBOR, plus the applicable margins. As of October 25, 2014, we had borrowings outstanding of approximately $70.1 million under the Revolver and $15.0 million under the Term Loan. If interest rates increased 100 basis points, our annual interest expense would increase approximately $851,000, assuming borrowings under the Revolver and Term Loan as existed at October 25, 2014.

 

In addition to the Revolver and Term Loan, as of October 25, 2014, the Company has outstanding New Notes for $8.2 million on which interest is payable quarterly based on the issuance date of November 20, 2012. The quarterly interest is payable at LIBOR plus 12.0% on the New Notes. If interest rates increased 100 basis points, our annual interest expense would increase $82,000, assuming borrowings under the New Notes as existed at October 25, 2014.

 

Foreign Currency Risk

 

All of the Company’s business is transacted in U.S. dollars and, accordingly, devaluation of the dollar against other currencies can increase product costs although this did not significantly impact the thirty-nine week period ended October 25, 2014. As of October 25, 2014, the Company had no financial instruments outstanding that were sensitive to changes in foreign currency exchange rates.

 

 

ITEM 4. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to the Company’s management, including our President and Chief Executive Officer (principal executive officer) and Executive Vice President and Chief Financial Officer (principal financial officer), as appropriate, to allow timely decisions regarding the required disclosures.

 

In connection with the preparation of this Quarterly Report on Form 10-Q as of October 25, 2014, the Company’s management, under the supervision and with the participation of the Company’s President and Chief Executive Officer and Executive Vice President and Chief Financial Officer, performed an evaluation of the effectiveness of our disclosure controls and procedures (as such term is defined in the Rules 13a-15(e) and 15d-15(e) under the Exchange Act).  Based upon this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures were effective as of October 25, 2014.

 

Changes in Internal Control Over Financial Reporting

 

There have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) within the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

“Item 3. Legal Proceedings” of our Form 10-K for the fiscal year ended January 25, 2014 includes a discussion of other legal proceedings. There have been no material changes from the legal proceedings described in our Form 10-K.

 

 

ITEM 1A. RISK FACTORS

 

The risk factors listed in Part I “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended January 25, 2014, should be considered with the information provided elsewhere in this Quarterly Report on Form 10-Q, which could materially adversely affect the Company’s business, financial condition or results of operations.  There are no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended January 25, 2014.

 

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

In June of 2000 the Board of Directors authorized the repurchase of up to 2,000,000 shares of the Company’s Common Stock from time to time when warranted by market conditions. There have been 1,756,755 shares purchased under this authorization through October 25, 2014, and the number of shares that may yet be purchased under this authorization is 243,245. The Company did not repurchase any shares in the market during the period covered by this Quarterly Report, but did accept shares in settlement of tax withholding obligations on restricted shares.

 

On June 17, 2014, the Company granted to certain employees of the Company (i) options for an aggregate of 30,430 shares of common stock, at an option exercise price of $0.94, subject to performance-based vesting and time vesting with 25% vesting on each of June 17, 2015, June 17, 2016, June 17, 2017 and June 17, 2018, and (ii) restricted stock grants for an aggregate of 10,000 shares subject to time vesting with 20% vesting on each of June 17, 2015, June 17, 2016, June 17, 2017, June 17, 2018 and June 17, 2019.

 

On September 9, 2014, the Company granted to certain employees of the Company (i) options for an aggregate of 51,870 shares of common stock, at an option exercise price of $0.77, subject to performance-based vesting and time vesting with 25% vesting on each of September 9, 2015, September 9, 2016, September 9, 2017 and September 9, 2018, and (ii) restricted stock grants for an aggregate of 16,000 shares subject to time vesting with 20% vesting on each of September 9, 2015, September 9, 2016, September 9, 2017, September 9, 2018 and September 9, 2019.

 

On October 17, 2014, the Company granted to Steven Morgan, the Company’s Chief Executive Officer, 320,000 shares subject to time vesting with 25% vesting on each of October 17, 2015, October 17, 2016, October 17, 2017 and October 17, 2018.

 

All of the issuances above were pursuant to the exemption from registration provided by Section 4(a)(2) of the Securities Act of 1933, as amended.

 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not Applicable.

 

 

ITEM 5. OTHER INFORMATION

 

None.

 

 

ITEM 6. EXHIBITS

 

3.1	Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on July 31, 2008)
3.2	Amended and Restated By-Laws (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on June 8, 2012)
31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) Under The Securities Exchange Act of 1934
31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) Under The Securities Exchange Act of 1934
32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002
101 INS	XBRLInstance Document
101 SCH	XBRLTaxonomy Extension Schema Document
101 CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101 DEF	XBRL Taxonomy Extension Definition Linkbase Document
101 LAB	XBRL Taxonomy Extension Label Linkbase Document
101 PRE	XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

 

SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	HANCOCK FABRICS, INC.
	(Registrant)
	By:	/s/ James B. Brown
		James B. Brown
		Executive Vice President and Chief Financial Officer
		(Principal Financial Officer)

 

Date: December 9, 2014

 

 

EXHIBIT INDEX

 

 

Exhibit No.		Description
3.1		Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on July 31, 2008)
3.2		Amended and Restated By-Laws (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on June 8, 2012)
31.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) Under The Securities Exchange Act of 1934
31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) Under The Securities Exchange Act of 1934
32.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002
101 INS		XBRLInstance Document
101 SCH		XBRLTaxonomy Extension Schema Document
101 CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101 DEF		XBRL Taxonomy Extension Definition Linkbase Document
101 LAB		XBRL Taxonomy Extension Label Linkbase Document
101 PRE		XBRL Taxonomy Extension Presentation Linkbase Document

 

  

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