UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended August 1, 2015

 

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]

 

 

As of August 28, 2015, there were 22,955,773 shares of Hancock Fabrics, Inc. $.01 par value common stock outstanding.

 

 

Hancock Fabrics, Inc.,

INDEX TO FORM 10-Q

 

Part I. Financial Information	Page
Item 1. Condensed Financial Statements (unaudited)
Consolidated Balance Sheets as of August 1, 2015, July 26, 2014, and January 31, 2015	4
Consolidated Statements of Operations and Comprehensive Loss for the Thirteen and Twenty-six Weeks Ended August 1, 2015 and July 26, 2014	5
Consolidated Statement of Shareholders’ Deficit for the Twenty-six Weeks Ended August 1, 2015	6
Consolidated Statements of Cash Flows for the Twenty-six Weeks Ended August 1, 2015 and July 26, 2014	7
Notes to Consolidated Financial Statements	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3. Quantitative and Qualitative Disclosures about Market Risks	21
Item 4. Controls and Procedures	22
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	23
Item 3. Defaults Upon Senior Securities	23
Item 4. Mine Safety Disclosures	23
Item 5. Other Information	23
Item 6. Exhibits	23
Signatures	24

 

 

PART I. FINANCIAL INFORMATION

ITEM 1. CONDENSED FINANCIAL STATEMENTS

HANCOCK FABRICS, INC.

CONSOLIDATED BALANCE SHEETS

 

 

See accompanying notes to consolidated financial statements.

(1) From consolidated audited balance sheet included in our annual report on Form 10-K for the fiscal year ended January 31, 2015.

 

 

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' 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 twenty-six weeks ended August 1, 2015, 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 31, 2015 filed with the Securities and Exchange Commission (“SEC”) on May 1, 2015. 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 2014” or “2014” refers to the fiscal year ended January 31, 2015). Fiscal years consist of 52 weeks, comprised of four 13-week fiscal quarters, unless noted otherwise. References herein to second quarter 2015 and second quarter 2014 are for the 13 week periods ended August 1, 2015 and July 26, 2014, respectively. References to twenty-six weeks 2015, first half 2015 or 2015, and twenty-six weeks 2014, first half 2014 or 2014 are for the 26 week periods ended August 1, 2015 and July 26, 2014, 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: adverse economic conditions; 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; our inability to effectively implement our growth strategy; risks associated with obtaining merchandise from foreign suppliers; transportation industry challenges and rising fuel costs; delays or interruptions in the flow of merchandise between our suppliers and/or our distribution center and our stores; our current cash resources might not be sufficient to meet our expected near-term cash needs; and those other risks that are discussed in our Annual Report on Form 10-K filed with the SEC on May 1, 2015 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 as of August 1, 2015, 260 stores in 37 states 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:

 

●

Sales for the second quarter of 2015 were $58.7 million compared to $59.3 million for the second quarter of 2014, and comparable store sales decreased 1.3% in the second quarter of 2015 following an increase of 0.9% in the second quarter of 2014. Sales for the first half of 2015 were $120.4 million compared to $122.3 million for the first half of 2014 and comparable store sales declined 1.6% following a decrease of 0.1% in the first half of 2014. Management believes the disruption of product flow into our distribution center and stores due to the West Coast port issues early in the year has hindered our efforts to gain sales momentum through the spring and into the summer, and also required aggressive promotional activity which is reflected in our gross profit results.

 

●

Our online sales for the second quarter of 2015, which are included in the sales number and comparable sales percentage above, increased 28.4% to $1.2 million compared to $0.9 million for the second quarter of 2014 and increased by 30.7% to $2.3 million in the first half of 2015 compared to $1.8 million in the first half of 2014.

 

 

●

Gross profit for the second quarter and first half of 2015 was 42.1% and 42.9%, respectively, compared with 44.6% and 44.9% for the second quarter and first half of 2014, respectively.

 

●

Selling, general and administrative expenses for the second quarter of 2015 were $27.0 million compared to $27.4 million for the second quarter of 2014 and were $54.2 million for the first twenty-six weeks of 2015 compared to $53.9 million for the same period of 2014.

 

●

Operating loss was $3.4 million for the second quarter of 2015 compared to a loss of $1.9 million in the second quarter of 2014. For the first half of 2015, operating loss was $4.7 million compared to an operating loss of $1.0 million for the first half of 2014.

 

●

Net loss was $4.9 million, or $0.23 per basic share, in the second quarter of 2015 compared to a net loss of $3.3 million, or $0.16 per basic share in the second quarter of 2014. Net loss was $9.1 million or $0.43 per basic share in the first half of 2015 compared to a net loss of $3.8 million or $0.18 per basic share in the first half of 2014.

 

●

The amount of cash used in operating activities was $8.2 million during the first half of 2015 compared to $8.5 million of cash used in operating activities for the first half of 2014.

 

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

 

		Thirteen Weeks Ended								Twenty-six Weeks Ended
		August 1,				July 26,				August 1,				July 26,
		2015				2014				2015				2014
Net sales (in thousands)		$	58,738			$	59,317			$	120,406			$	122,311
Gross margin percentage			42.1	%			44.6	%			42.9	%			44.9	%
Number of stores
Open at end of period (1)			260				260				260				260
Comparable stores at period end (2)			251				257				251				257
Sales growth
All retail outlets			(1.0	)%			0.3	%			(1.6	)%			(0.5	)%
Comparable sales (3)			(1.3	)%			0.9	%			(1.6	)%			(0.1	)%
Total store square footage at period end (in thousands)			3,522				3,600				3,522				3,600
Net sales per total square footage		$	16.68			$	16.48			$	34.19			$	33.98

 

 

(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 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.
(3)	Comparable sales change includes net sales derived from e-commerce.

 

 

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								Twenty-six Weeks Ended
		August 1,				July 26,				August 1,				July 26,
		2015				2014				2015				2014
Net sales			100.0	%			100.0	%			100.0	%			100.0	%
Cost of goods sold			57.9				55.4				57.1				55.1
Gross profit			42.1				44.6				42.9				44.9
Selling, general and administrative expense			46.0				46.1				45.0				44.1
Depreciation and amortization			1.9				1.7				1.8				1.6
Operating loss			(5.8	)			(3.2	)			(3.9	)			(0.8	)
Interest expense, net			2.6				2.4				3.7				2.3
Loss before income taxes			(8.4	)			(5.6	)			(7.6	)			(3.1	)
Income taxes			0.0				0.0				0.0				0.0
Net loss			(8.4	)%			(5.6	)%			(7.6	)%			(3.1	)%

 

Sales

 

		Thirteen Weeks Ended								Twenty-six Weeks Ended
(change as % of prior year)		August 1,				July 26,				August 1,				July 26,
		2015				2014				2015				2014
Retail comparable store base			(1.8	)%			0.8	%		$	(2.1	)%			(0.3	)%
E-Commerce			28.4	%			6.6	%			30.7	%			4.5	%
Comparable sales			(1.3	)%			0.9	%			(1.6	)%			(0.1	)%

 

The retail comparable store base percentage presented in the table above was computed based on sales of all stores that have reached their 53^rd week of operation. The second quarter 2015 retail comparable store base sales decrease of 1.8% was the result of a 2.6% decrease in transaction count, partially offset by a 0.8% improvement in average ticket evidencing higher sales volumes for each individual transaction. The first half 2015 retail comparable store base decline of 2.1% resulted from a 2.3% decline in transaction count partially offset by a 0.2% increase in average ticket.

 

Sales provided by our e-commerce channel increased 28.4% and 30.7% in the second quarter and the twenty-six weeks of fiscal 2015, respectively, compared to the same periods in fiscal 2014. The continuing sales improvement is due to improvements in areas such as paid search, organic search, social marketing and merchandising.

 

 

Nine new stores opened and nine stores, where we chose not to stay in the market, have closed since the second quarter of 2014, the sales from these locations are included in net sales. During the second quarter of 2015, the Company opened one new location and closed three, ending the period with 260 stores.

 

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

 

		Thirteen Weeks Ended								Twenty-six Weeks Ended
		August 1,				July 26,				August 1,				July 26,
		2015				2014				2015				2014
Apparel and Craft Fabrics			43	%			43	%			43	%			43	%
Home Decorating Fabrics			12	%			12	%			12	%			12	%
Sewing Accessories			32	%			32	%			32	%			32	%
Non-Sewing Products			13	%			13	%			13	%			13	%
			100	%			100	%			100	%			100	%

 

Gross Margin

 

Costs of goods sold include:

 

●

the cost of merchandise

 

●

inventory rebates and allowances including term discounts

 

●

inventory shrinkage and valuation adjustments

 

●

freight charges

 

●

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

 

●

costs associated with receiving, processing, and warehousing merchandise

 

The classification of these expenses varies across the retail industry.

 

Specific components of cost of goods sold for the second quarters and the twenty-six weeks of fiscal 2015 and 2014 are as follows:

 

		Thirteen Weeks Ended																Twenty-six Weeks Ended
		August 1,				% of				July 26,				% of				August 1,				% of				July 26,				% of
(dollars in thousands)		2015				Sales				2014				Sales				2015				Sales				2014				Sales
Total net sales		$	58,738				100.0	%		$	59,317				100.0	%		$	120,406				100.0	%		$	122,311				100.0	%
Merchandise cost			28,394				48.3	%			27,403				46.2	%			57,738				48.0	%			56,787				46.4	%
Freight			2,200				3.8	%			2,240				3.8	%			4,465				3.7	%			4,374				3.6	%
Sourcing and warehousing			3,434				5.8	%			3,195				5.4	%			6,578				5.4	%			6,236				5.1	%
Gross Profit		$	24,710				42.1	%		$	26,479				44.6	%		$	51,625				42.9	%		$	54,914				44.9	%

 

 

Merchandise cost increased as a percentage of sales for the second quarter of 2015 as compared to the same period of 2014 by 210 basis points. This increase resulted primarily from promotional activity and inventory shrinkage. For the twenty-six weeks of 2015 compared to the twenty-six weeks of 2014, merchandise cost increased by 160 basis points. The increase resulted from promotional activity, inventory valuation charges primarily caused by merchandise placed in the clearance program at quarter end, and inventory shrinkage for the twenty-six week period.

 

Freight expense was flat as a percentage of sales for the second quarter of 2015 as compared to 2014 and 10 basis points over last year for the twenty-six weeks of 2015 reflecting the additional freight cost incurred in the first quarter as a result of the West Coast shipping disruption.

 

Sourcing and warehousing costs for the Company vary based on the volume of inventory received during any period, the rate at which inventory is shipped out, and inventory turns. The cost difference for the second quarter and twenty-six weeks of 2015 compared to the same periods in 2014 is due to increased sourcing and warehousing costs and improving inventory turns.

 

In total, gross margin declined by 250 basis points in the second quarter 2015 from second quarter 2014 and by 200 basis points for the twenty-six weeks of 2015 as compared to the same period of 2014.

 

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																Twenty-six Weeks Ended
		August 1,				% of				July 26,				% of				August 1,				% of				July 26,				% of
(dollars in thousands)		2015				Sales				2014				Sales				2015				Sales				2014				Sales
Retail store labor costs		$	10,047				17.1	%		$	9,838				16.6	%		$	20,014				16.6	%		$	19,333				15.8	%
Advertising			1,996				3.4	%			2,498				4.2	%			4,193				3.5	%			4,708				3.8	%
Store occupancy			7,554				12.9	%			7,376				12.4	%			15,285				12.7	%			14,998				12.3	%
Retail SG&A			4,866				8.3	%			4,876				8.2	%			9,300				7.7	%			9,292				7.6	%
Corp SG&A			2,557				4.3	%			2,781				4.7	%			5,411				4.5	%			5,598				4.6	%
Total SG&A		$	27,020				46.0	%		$	27,369				46.1	%		$	54,203				45.0	%		$	53,929				44.1	%

 

 

Retail Store Labor Costs – The Company’s store labor costs increased during the second quarter and first twenty-six weeks of 2015 as compared to the same periods in 2014. The increases were primarily the result of increased benefit costs for medical claims and pension expense as compared to 2014.

 

Advertising – The reduction in advertising expense for the second quarter of 2015 and the twenty-six weeks of 2015 were achieved through continuing improvements to our marketing program and one less direct mail piece as compared to the same periods of 2014, due to a calendar shift in our marketing program.

 

Store Occupancy – Store occupancy expense increased as compared to the same period of the prior year for both the second quarter and the twenty-six weeks of 2015. This increase was driven by higher direct occupancy cost in both periods of 2015 and higher repair and maintenance expenditures in the second quarter.

 

Retail SG&A – Retail selling, general and administrative expenses for the second quarter and the twenty-six weeks of 2015 were basically flat as compared to the same periods of 2014. During the second quarter of 2015, reductions in supply and utility costs were offset by higher telephone expenses and reduced net commission income from a third party loyalty program. For the first twenty-six weeks of 2015, reduced loyalty program net commissions and higher telephone expense were offset by reductions in claim based insurance cost, supplies and utilities.

 

Corporate SG&A – These are costs related primarily to staffing and operation of the Company’s headquarters. Corporate SG&A declined for the second quarter and first twenty-six weeks of 2015 as compared to the same periods of 2014. Reductions in professional fees, stock-based compensation and accrued vacation expense was partially offset by higher corporate payroll cost primarily driven by increased cost for medical claims and pension expense during the second quarter. The reduction for the twenty-six weeks of 2015 as compared to the same period of 2014 is due to reductions in stock-based compensation, accrued vacation expense and the gain recognized from sale of an owned store location, partially offset by increased professional fees.

 

Interest Expense

 

		Thirteen Weeks Ended																Twenty-six Weeks Ended
(dollars in thousands)		August 1,				% of				July 26,				% of				August 1,				% of				July 26,				% of
		2015				Sales				2014				Sales				2015				Sales				2014				Sales
Interest expense, net		$	1,553				2.6	%		$	1,442				2.4	%		$	4,387				3.7	%		$	2,808				2.3	%

 

The Company’s interest costs are driven by borrowings on our credit facilities and a small number of capital leases. We currently have an asset-based facility and subordinated-debt outstanding. Interest expense for the first twenty-six weeks of 2015 includes $1.4 million of costs resulting from the early termination of the amended and restated loan and security agreement with General Electric Capital Corporation on April 22, 2015 (see Note 4 to the Consolidated Financial Statements included in this report). Excluding the non-recurring item, interest expense was $3.0 million or 2.5% of sales for the first twenty-six weeks of 2015.

 

Income Taxes

 

The Company did not recognize any income tax benefit during the periods of fiscal 2015 or 2014 presented in this report given the uncertainty in realizing the future benefit. As of August 1, 2015, January 31, 2015, and July 26, 2014 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 borrowings from commercial lenders.

 

We have a history of losses over the three year period ended January 31, 2015 and we have generated positive operating cash flow in only the year ended January 31, 2015. During the years ended January 31, 2015, January 25, 2014 and January 26, 2013, the Company had net losses of $3.2 million, $1.9 million and $8.5 million, respectively and net cash provided by (used in) operating activities for the corresponding periods was $3.2 million, $(5.7) million and $(11.3) million, respectively. As a result, since fiscal 2011, it has been necessary to rely on bank borrowings for our capital needs to fund the Company’s required cash contribution to the Company’s defined benefit pension plan, for capital expenditures, and working capital needs.

 

At August 1, 2015, the Company had outstanding long-term indebtedness and capital lease obligations of $95.8 million compared to $52.3 million as of January 28, 2012. As a consequence of our significant amount of indebtedness as of August 1, 2015, 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 31, 2015 filed with the SEC on May 1, 2015. In addition, at August 1, 2015, the Company had limited cash resources, with cash of $2.3 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 31, 2015 filed with the SEC on May 1, 2015.

 

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 30, 2016 will be approximately $2.2 to $2.5 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 August 1, 2015, we have $6.5 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 margin 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 31, 2015 filed with the SEC on May 1, 2015.

 

 

Hancock’s cash flow related information as of the twenty-six weeks of fiscal 2015 and 2014 follows:

 

		Twenty-six Weeks Ended
		August 1,				July 26,
		2015				2014
Net cash flows provided by (used in):
Operating activites		$	(8,186	)		$	(8,528	)
Investing activities			(1,214	)			(2,351	)
Financing activites			8,841				11,446

 

Operating Activities

 

In the first twenty-six weeks of 2015, the net loss plus non-cash adjustments used $4.9 million of cash compared to $0.5 million used in the same period of 2014. The increased cash usage can be attributed to the larger net loss incurred in the first twenty-six weeks of 2015 as compared to 2014 partially offset by the non-cash charge for amortization of deferred loan cost which was inflated by $0.9 million due to the early termination of the amended and restated loan and security agreement with General Electric Capital Corporation on April 22, 2015. In addition, a $2.5 million inventory build, $1.1 million reduction in accrued liabilities and $0.9 million decrease in pension related liabilities partially offset by a $1.2 million increase in accounts payable resulted in $8.2 million of cash used in operating activities for the first twenty-six weeks of 2015.

 

For the twenty-six weeks of 2014, net loss plus non-cash adjustments used of $0.5 million which combined with an inventory increase of $6.8 million and a $1.4 million decline in pension and SERP liabilities were the primary contributors to the $8.5 million of cash used in operating activities.

 

Investing Activities

 

Cash used for investing activities consists primarily of purchases of property and equipment. Capital expenditures during the twenty-six weeks of 2015 consisted primarily of store fixtures, for three new stores and two relocated units, store technology upgrades, and maintenance capital expenditures for the stores and distribution center. Capital expenditures during the twenty-six weeks of 2014 consisted primarily of store fixtures and leasehold improvements for two relocated units, one new store which opened and several other locations which will open later in the year, and development cost related to the re-launch of the Company website.

 

Financing Activities

 

During the twenty-six weeks of 2015, working capital needs, expenditures for investing activities discussed above, the required contribution to the defined benefit pension plan and payment of $2.2 million of debt issuance costs related to the refinancing in April 2015 increased outstanding borrowings by $11.2 million. For the twenty-six 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 produced a net increase in cash provided by financing activities of $11.4 million.

 

Credit Facilities

 

The following should be read in conjunction with Note 4 to the Consolidated Financial Statements included in this report.

 

 

As of August 1, 2015, the Company had outstanding borrowings under the Revolver of $67.8 million and $17.5 million under the term loan facility entered into on April 22, 2015 (the “Term Loan”), and amounts available to borrow of $6.5 million.

 

At August 1, 2015, Hancock had commitments under the Revolver for $1.2 million of documentary letters of credit, which support purchase orders for merchandise. Hancock also has standby letters of credit for $5.4 million, to guarantee payment of potential insurance claims, shipments of inventory, security bonds and freight charges, and backstop letters of credit issued to its previous lender for $0.7 million.

 

As of August 1, 2015, the Company had an outstanding balance of $8.2 million on the Floating Rate Secured Notes due 2017 (the “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 revolving credit agreement that provides up to $15.0 million in letters of credit. At August 1, 2015, Hancock had commitments for $1.2 million of documentary letters of credit, which support purchase orders for merchandise. Hancock also has standby letters of credit for $5.4 million, to guarantee payment of potential insurance claims, shipments of inventory, security bonds and freight charges, and backstop letters of credit issued to its previous lender for $0.7 million. Hancock leases its retail fabric store locations under operating leases expiring at various dates through 2026.

 

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 31, 2015.

 

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 31, 2015.

 

 

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 31, 2015 filed with the SEC on May 1, 2015, for details regarding the related party transactions that the Company has entered into.

 

The Company has no other balances with related parties, nor has it had any other material transactions with related parties during the twenty-six week period ended August 1, 2015.

 

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 and 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 August 1, 2015.

 

Interest Rate Risk

 

We are exposed to financial market risks, including changes in interest rates. At our option, borrowings under the revolving credit facility bear interest at a rate equal to, either (a) a LIBOR rate determined by reference to the offered rate for deposits in dollars for the interest period relevant to such borrowing or (b) a base rate, in each case plus an applicable margin and adjusted for certain additional costs and fees and the term loan bears interest at a LIBOR rate. As of August 1, 2015, we had borrowings outstanding of approximately $67.8 million under the Revolver and $17.5 million under the Term Loan. If interest rates increased 100 basis points, our annual interest expense would increase approximately $853,000, assuming borrowings under the Revolver and Term Loan as existed at August 1, 2015.

 

 

In addition to the Revolver and Term Loan, as of August 1, 2015 the Company has outstanding Notes for $8.2 million on which interest is payable quarterly on the issuance date anniversary. The quarterly interest is payable at LIBOR plus 12.0% on the Notes. If interest rates increased 100 basis points, our annual interest expense would increase $82,000, assuming borrowings under the Notes as existed at August 1, 2015.

 

 

Foreign Currency Risk

 

All of the Company’s business is transacted in U.S. dollars and, accordingly, devaluation of the dollar against other currencies can increase product costs although this did not significantly impact the twenty-six week period ended August 1, 2015. As of August 1, 2015, 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 August 1, 2015, 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 August 1, 2015.

 

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

 

The Company was a party to a consolidated action pending in the Northern District of Mississippi, captioned Hancock Fabrics, Inc. v. Rowdec, LLC d/b/a Westlake Associates, Case No. 1:12-cv-131-SA-DAS, and Case No. 1:12-cv-222-SA-DAS.  The action stemmed from a March 22, 2012 arbitration award, which involved a dispute over calculating royalties under a Consulting and Sales Agreement between the Company and Rowdec, LLC d/b/a Westlake Associates (“Westlake”). Westlake sought royalties on sales in all of the Company’s nearly 270 stores and on the internet and attorneys’ fees. On April 24, 2013 Westlake filed a motion to confirm the award through which it sought to have the court broaden the arbitration award and grant it royalties on sales in all stores and on the internet. On November 19, 2013, the United States District Court for the Northern District of Mississippi issued a Judgment and Order upholding the arbitral award of attorneys’ fees but declining to order the Company to pay royalties on sales in all of the Company’s stores. Following the district court’s decision, the matter was closed.   On January 23, 2014, Westlake tried to revive the closed case by filing a motion to enforce judgment and for contempt against the Company and sought to appoint an independent auditor at the Company’s expense and attorneys’ fees for the costs of bringing its motion. The Court denied Westlake’s motion in full on September 23, 2014.

 

On November 26, 2014, Westlake filed an Arbitration Demand with AAA, in which it seeks the same relief that it already sought in federal court. On December 10, 2014, the Company filed a motion to stay the arbitration and for sanctions against Westlake. On August 27, 2015, the district court denied Hancock’s motion to stay the arbitration. The district court held that Westlake did not waive its right to arbitrate, and refused to decide whether Westlake’s Arbitration Demand is barred by the federal court decision, finding that that issue should be resolved by the arbitrator. Hancock plans to appeal to the United States Court of Appeals for the Fifth Circuit. The arbitration may go forward while the appeal is being briefed and heard. We believe Westlake’s position is meritless and plan to continue to contest the matter vigorously, but if we do not prevail on appeal and the arbitration were to reach a conclusion that is adverse to us, we could be required to pay damages that could be material. 

 

“Item 3. Legal Proceedings” of our Form 10-K for the fiscal year ended January 31, 2015 includes a discussion of other legal proceedings. There have been no other 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 31, 2015, 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 31, 2015.

 

 

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 August 1, 2015, 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.

 

The Company did not sell any unregistered equity securities during the period covered by this Quarterly Report.

 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not Applicable

 

 

ITEM 5. OTHER INFORMATION

 

The previously reported purchase agreement between the Company and F9 Properties LLC for the sale of its corporate headquarters was terminated on July 23, 2015 as conditions to closing the transaction were not met because final terms could not be agreed to.

 

In connection with Mr. O. Pierce Crockett’s appointment as interim Chief Financial Officer (CFO), Mr. Crockett will be entitled to an initial annual base salary of $175,000 while serving as interim CFO. This was approved by the Management Review and Compensation Committee of the Board of Directors on September 4, 2015.

 

 

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)
10.1	Amended and Restated 2001 Stock Incentive Plan, effective as of May 1, 2015
10.2	Purchase Agreement between Hancock Fabrics, Inc. and F9 Properties LLC dated June 4, 2015 (terminated as of July 23, 2015)
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 Brown
		James Brown
		Executive Vice President and
		Chief Financial Officer
		(Principal Financial Officer)

Date: September 4, 2015

 

 

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)
10.1	Amended and Restated 2001 Stock Incentive Plan, effective as of May 1, 2015
10.2	Purchase Agreement between Hancock Fabrics, Inc. and F9 Properties LLC dated June 4, 2015 (terminated as of July 23, 2015)
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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