Jo-ann Stores, Inc. (JAS) - Description of business

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Item 1.  Business
      We are the nation’s largest specialty retailer of fabrics and one of the largest specialty retailers of crafts, serving customers in their pursuit of apparel and craft sewing, crafting, home decorating and other creative endeavors. Our retail stores (operating as Jo-Ann Fabrics and Crafts traditional stores and Jo-Ann superstores) feature a variety of competitively priced merchandise used in sewing, crafting and home decorating projects, including fabrics, notions, crafts, frames, paper crafting material, artificial and dried flowers, home accents, finished seasonal and home décor merchandise.

      As of January 28, 2006, we operated 838 stores in 47 states (684 traditional stores and 154 superstores). Our traditional stores offer a complete selection of fabrics and notions and a convenience assortment of crafts, floral, finished seasonal and home décor merchandise. Our traditional stores average approximately 14,650 square feet and generated net sales per store of approximately $1.6 million in fiscal 2006. Our superstores offer an expanded and more comprehensive product assortment than our traditional stores. Our superstores also offer custom framing and educational programs that our traditional stores do not. Our larger superstores, that were opened prior to fiscal 2003, average approximately 45,000 square feet and generated net sales per store of approximately $6.3 million in fiscal 2006. Our current superstore prototype averages 35,000 square feet. We opened 40 of these prototype superstores in fiscal 2006 and we had 83 of the prototype superstores in operation at January 28, 2006. Forty-three of the prototype superstores had been open at least one year, as of January 28, 2006, and averaged $5.0 million in net sales in fiscal 2006.

      We believe stability in our business and our industry is partially a function of recession-resistant characteristics. For example, according to a 2005 research study conducted by the Craft & Hobby Association, approximately 58 percent of all U.S. households participated in crafts and hobbies. While expenditures for such projects are generally discretionary in nature, our average sales ticket during fiscal 2006 was $23 in our superstores and $17 in our traditional stores. Industry sales, according to the Craft & Hobby Association’s 2005 research study, were approximately $31 billion, an 11 percent increase from 2002. Our market is highly fragmented and is served by multi-store fabric retailers, arts and crafts retailers, mass merchandisers, small local specialty retailers, mail order vendors and a variety of other retailers.

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

      We believe that our superstores are uniquely designed to offer a destination location for our customers. We offer over 80,000 stock-keeping units (“SKUs”) across three broad product categories in our superstores: sewing, crafting and home decorating components. We manage our vast product selection with SAP Retail. Through the core SAP application and integration with peripheral processing systems, we continue to drive operational and execution improvements, to review and enhance forecasting and replenishment capabilities, and to streamline operations.

Recent Developments and Business Update

      During fiscal 2006 a number of executive officers left the company. On November 21, 2005, we announced that we were separating the role of chairman from that of president and chief executive officer, and commenced a search for a president and chief executive officer. On February 28, 2006, we announced that in order to attract a broader pool of experienced candidates the new president and chief executive officer would also assume the chairman position and that our current chairman, president and chief executive officer, Alan Rosskamm, will step down from these positions and become an outside director upon the naming of his successor. An executive search firm has been retained and is conducting the search for a chairman, president and chief executive officer. Following the appointment of a new chief executive officer, we expect to complete searches for a chief financial officer and head merchant.

      Fiscal 2006 was a challenging year compared with the prior year, as the retail environment experienced softness throughout the year. The primary source of our softness was the home decorating portions of our business, such as finished seasonal, floral and home décor merchandise, as well as home decorating textiles. The quilting and apparel fabrics portions of our business have softened as well, particularly in the third and fourth quarters. Our sales performance for the year was extremely disappointing, and occurred despite an increased level of marketing events and advertising, as well as more aggressive promotional pricing. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion of our performance.

      We expect the current year, fiscal 2007, to be a year of transition as we implement our Repair Plan initiatives described below. We anticipate a challenging first half of the year, but we expect to be positioned for substantial improvement in our operational and financial performance in the second half of the year, as a result of the execution of our Repair Plan initiatives and significant merchandise assortment changes in our superstores. We believe that the execution of the Repair Plan will enable us to finish the year as a stronger, more disciplined organization with a much improved inventory position and lower outstanding debt balances.

      Each of the major Repair Plan initiatives is addressed below.

	•	Inventory reduction. We are aggressively promoting clearance merchandise and those categories where we are carrying excess inventory. We also have taken steps to reduce the number of weeks of supply on-hand of many of our basic product categories and are reducing purchase commitments for fiscal 2007.
	•	Adjustment of store merchandise assortments. We expect to reduce space and inventory investment in under-performing categories such as finished seasonal and home décor, while emphasizing better performing product categories, such as craft components.
	•	Gross margin rate restoration. We expect to improve our overall advertising and marketing effectiveness, be more discrete with coupons, and take steps to reduce clearance through tighter purchasing disciplines. We also anticipate being more disciplined by eliminating excessive in-season promotional discounts.
	•	Selling, general and administrative expense reduction. We are aggressively reviewing all areas of our business for opportunities to reduce and control expenses. The following are the major expense reduction and control opportunities.

	•	Advertising spending. Our fiscal 2007 budget is comparable to fiscal 2006. Increased costs per advertising event, driven by our increased number of superstore markets, will be offset by a reduced number of advertising events.
	•	Distribution center costs. Completion of our new distribution center in Opelika, Alabama, which began operations in April 2006, will improve efficiencies in the distribution and logistics network starting in the second-half of the year. Inventory purchases are being significantly reduced, inventory flow will be managed closer to need, and the addition of the third distribution center will reduce freight costs. We also expect to reduce outside storage costs and associated logistics inefficiencies as we sell-through excess inventory.

  •   Workforce reduction. In mid-January 2006, we completed a workforce reduction of certain administrative personnel. A total of 75 positions were eliminated, consisting of terminations and eliminations of positions that we will not fill. In addition, we are aggressively challenging positions as employees leave the Company, and have identified additional positions that will not be filled.
      On February 23, 2006, we completed an amendment of our senior bank credit facility. We increased the senior bank credit facility from $350 million to $425 million. The term of the facility remains unchanged, extending through April 2009. The amendment, among other things, also improved advance rates on inventory during peak borrowing periods and modified the consolidated net worth covenant. The amendment is discussed further below under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

Product Selection

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

		Fiscal Year-Ended
		January 28,			January 29,			January 31,
		2006			2005			2004
Principal product line:
	Softlines			56	%			56	%			57	%
	Hardlines and seasonal			44	%			44	%			43	%
		Total			100	%			100	%			100	%

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

	•	fashion and sportswear fabrics, used primarily in the construction of garments for the customer seeking a unique, fashion forward look;
	•	special occasion fabrics used to construct evening wear, bridal and special occasion outfits;
	•	craft fabrics, used primarily in the construction of quilts, craft and seasonal projects for the home;
	•	juvenile designs for the construction of garments as well as blankets and décor accessories;
	•	special-buy or fabrics representing special values for our customer;
	•	home decorating fabrics and accessories used in home related projects such as window treatments, furniture and bed coverings (in addition to the in-store assortment, we offer a special order capability for additional designs);
	•	a wide array of notions, which represent items incidental to sewing-related projects — including cutting implements, threads, zippers, trims, tapes, pins, elastics, buttons and ribbons, as well as the patterns necessary for most sewing projects; and
	•	sewing-related accessories including lighting, organizers, and sewing machines. Our high volume stores offer a wider selection of sewing machines through leased departments with third parties from whom we receive sublease income.

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

	•	yarn and accessories, as well as needlecraft kits and supplies;
	•	paper crafting components, such as albums, papers, stickers, stamps, and books used in the popular home based activities of scrapbooking and card making;
	•	craft materials, including items used for stenciling, jewelry making, decorative painting, wall décor, and kids crafting;
	•	brand-name fine art materials, including items such as pastels, water colors, oil paints, acrylics, easels, brushes, paper and canvas;
	•	a comprehensive assortment of books and magazines to provide inspiration for our customer;
	•	framed art, photo albums and ready-made frames and, in superstores, full service in-store framing departments;
	•	floral products, including artificial flowers, dried flowers and artificial plants, sold separately or in ready-made and custom floral arrangements and a broad selection of accessories essential for floral arranging and wreath making; and
	•	home décor accessories including baskets, candles and accent collections designed to complement our home décor fashions.

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

      During the Christmas selling season, a significant portion of floor and shelf space is devoted to seasonal crafts, decorating and gift-making merchandise. Due to the project-oriented nature of these items, our peak selling season extends longer than that of other retailers and generally runs from September through December. In fiscal 2006, approximately 57 percent of our net sales occurred in the third and fourth quarter, and approximately 32 percent occurred in the fourth quarter alone.

      During fiscal 2006, 42 percent of superstore net sales were derived from softlines and 58 percent from hardlines. For our traditional stores, 62 percent of net sales were derived from softlines and 38 percent from hardlines during fiscal 2006.

Marketing

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

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

      As we market the Jo-Ann Stores concept, we also focus on developing long-term relationships with our customers. These efforts include providing knowledge and inspiration through in-store classes, demonstrations and project sheets.

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

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

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

Purchasing

      We have numerous domestic and international sources of supply available for each category of product that we sell. During fiscal 2006, approximately two-thirds of our purchases were sourced domestically and one-third was sourced internationally. Our domestic suppliers source some of the products sold to us internationally. Although we have no material long-term purchase commitments with any of our suppliers, we strive to maintain continuity with them. All purchases are centralized through our store support center, allowing store team leaders and store team members to focus on customer sales and service and enabling us to negotiate volume discounts, control product mix and ensure quality. Currently, our top supplier represents approximately four percent of our annual purchase volume and the top ten suppliers represent approximately 23 percent of our total annual purchase volume. We currently utilize approximately 700 merchandise suppliers, with the top 140 representing more than 80 percent of our purchasing volume.

Logistics

      At the end of fiscal 2006, we owned and operated two distribution centers, in Hudson, Ohio and Visalia, California, which ship merchandise to all of our stores on a weekly basis. We completed construction of our third distribution center during March 2006. This facility is located in Opelika, Alabama, and will support our existing stores and future growth in key southeastern states. We began shipping from this new distribution center in April 2006. Based on purchase dollars, approximately 84 percent of the products in our stores are shipped through our distribution center network, with the remaining 16 percent of our purchases shipped directly from our suppliers to our stores. Once the Opelika distribution center is fully operational, we expect that 50 percent of our store base will be supplied from the Hudson distribution center, 30 percent from our Visalia distribution center and 20 percent from our Opelika distribution center.

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

Store Operations

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

proximity to highway access, traffic patterns, availability of convenient parking and ease of entry from the major roadways framing the location.

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

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

      Store Management. Traditional stores generally have four full-time team members and 15 to 25 part-time team members, while superstores typically have approximately ten full-time team members and 35 to 45 part-time team members. Store team leaders are compensated with a base salary plus a bonus, which is tied to quarterly store sales, annual store controllable profit and annual store shrink rates.

      Traditional store team leaders are typically promoted from a group of top performing assistant managers, some of whom started as our customers. This continuity serves to solidify long-standing relationships between our stores and our customers. When a traditional store is closed due to the opening of a superstore, we generally retain its team members to staff the new superstore. Superstore team leader positions primarily have been staffed with individuals from outside the Company who have previous experience in managing “big-box” retail concepts. In fiscal 2005 the Company implemented “Superstore University,” designed to develop and prepare more superstore managers from within our organization. This comprehensive training program has proven to be highly successful. We believe that developing more of our future managers from within the organization is essential to our superstore growth strategy. Each store is under the supervision of a district team leader who reports to a regional vice president.

Stores

      The following table shows our stores by type and state at January 28, 2006:

		Traditional			Superstore			Total
Alabama			1				—				1
Alaska			4				2				6
Arizona			11				6				17
Arkansas			1				—				1
California			82				11				93
Colorado			9				4				13
Connecticut			13				2				15
Delaware			2				1				3
Florida			39				14				53
Georgia			8				4				12
Idaho			9				—				9
Illinois			30				11				41
Indiana			23				5				28
Iowa			11				—				11
Kansas			6				2				8
Kentucky			4				—				4
Louisiana			5				—				5
Maine			5				—				5
Maryland			16				4				20
Massachusetts			24				—				24
Michigan			32				19				51
Minnesota			15				6				21
Missouri			11				2				13
Montana			7				—				7
Nebraska			5				—				5
Nevada			4				2				6
New Hampshire			8				—				8
New Jersey			12				1				13
New Mexico			6				—				6
New York			35				9				44
North Carolina			7				—				7
North Dakota			4				—				4
Ohio			49				12				61
Oklahoma			4				—				4
Oregon			23				2				25
Pennsylvania			39				9				48
Rhode Island			1				—				1
South Carolina			2				—				2
South Dakota			2				—				2
Tennessee			1				3				4
Texas			36				7				43
Utah			8				2				10
Vermont			4				—				4
Virginia			22				—				22
Washington			23				10				33
West Virginia			5				—				5
Wisconsin			16				4				20
Total			684				154				838

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

						Stores in					Total
		Stores			Stores			Operation at			Expanded or			Square
Fiscal Year		Opened			Closed			Year-End			Relocated			Footage
2002			12				(60	)			959				10				15,897
2003			3				(43	)			919				6				15,435
2004			19				(46	)			892				—				15,377
2005			31				(72	)			851				2				15,453
2006			44				(57	)			838				2				16,198

      Our new store opening costs depend on the building type, store size and general cost levels in the geographical area. During fiscal 2006, we opened 40 superstores which represented our 35,000 square foot prototype. Our average net investment in a superstore is approximately $2.0 million, which includes leasehold improvements, furniture, fixtures and equipment, inventory (net of payable support) and pre-opening expenses. Also, during fiscal 2006, we opened four traditional stores with an average square footage of approximately 25,000 square feet. Our average net opening cost of a traditional store is $1.3 million, which includes leasehold improvements, furniture, fixtures and equipment, inventory (net of payable support) and pre-opening expenses.

      During fiscal 2007, we expect to open approximately 21 new superstores and five traditional stores and close approximately 55 to 60 traditional stores, most of which are related to the superstore openings. We have committed to substantially all the leases for our fiscal 2007 planned openings.

Information Technology

      Our point-of -sale register transactions are polled nightly and our point-of -sale system interfaces with both our financial and merchandising systems. We utilize point-of -sale registers and scanning devices to record the sale of product at a SKU level at our stores. We also utilize handheld radio frequency devices for a variety of store tasks including price look-up, perpetual inventory exception counting, merchandise receiving, vendor returns and fabric sales processing. We have broadband communication and store controllers in all of our stores, resulting in an enhanced customer checkout experience and a better platform to further automate internal store communications. We believe this will enable us to provide higher levels of customer and associate satisfaction, while providing a platform that we can build on and leverage over the coming years.

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

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

Status of Product or Line of Business

      During fiscal 2006, there was no public announcement nor is there a public announcement anticipated, about either a new product line or line of business involving the investment of a material portion of our assets.

Trademarks

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

Seasonal Business

      Our business exhibits seasonality which is typical for most retail companies, with much stronger sales in the second half of the year than in the first half of the year. Net earnings are highest during the months of September through December when sales volumes provide significant operating leverage. In fiscal 2006, approximately 57 percent of our net sales occurred in the third and fourth quarter, and approximately 32 percent occurred in the fourth quarter alone.

Customer Base

      We are engaged in the retail sale of merchandise to the general public and, accordingly, no part of our business is dependent upon a single customer or a few customers. During fiscal 2006, no single store accounted for more than one percent of total net sales.

Backlog of Orders

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

Competitive Conditions

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

      There are two public companies that we compete with nationally in the fabric and craft specialty retail industry, one in the fabric segment (Hancock Fabrics, Inc. — 443 stores and $403 million in revenues) and one in the craft segment (Michaels Stores, Inc. — 1,076 stores and $3.7 billion in revenues). There is also a public company competitor in the craft segment (A.C. Moore Arts & Crafts, Inc.) that is a rapidly growing regional operator of 109 stores with $539 million in revenues. The balance of our competition is comprised of regional and local operators. We believe that there are only three or four other competitors, in addition to those described above, with fabric or craft sales exceeding $100 million annually. We believe that we have several advantages over most of our smaller competitors, including:

	•	purchasing power;
	•	ability to support efficient nationwide distribution; and
	•	the financial resources to execute our strategy going forward.

Research and Development

      During the three fiscal years ended January 28, 2006, we have not incurred any material expense on research activities relating to the development of new products or services or the improvement of existing products or services.

Environmental Disclosure

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

Employees

      As of January 28, 2006, we had approximately 24,060 full and part-time employees, of whom 22,240 worked in our stores, 480 were employed in our Hudson distribution center, 270 were employed in our Visalia distribution center, 100 were employed in our Opelika distribution center and 970 were employed at our store support center in Hudson. The number of part-time employees is substantially higher during our peak selling season. We believe our employee turnover is below average for retailers, primarily because our stores often are staffed with sewing and crafting enthusiasts. In addition, we provide an attractive work environment, employee discounts, flexible hours and competitive compensation packages within the local labor markets. Our ability to offer flexible scheduling is important in attracting and retaining these employees since approximately 75 percent of our employees work part-time.

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

Foreign Operations and Export Sales

      In fiscal 2006, we purchased approximately one-third of our products directly from manufacturers located in foreign countries. These foreign suppliers are located primarily in China and other Asian countries. In addition, many of our domestic suppliers purchase a portion of their products from foreign suppliers. Because a large percentage of our products are manufactured or sourced abroad, we are required to order these products further in advance than would be the case if the products were manufactured domestically. We do not have material long-term contracts with any manufacturers.

Other Available Information

      We also make available, free of charge, on our website at www.joann.com, our annual reports on Form  10-K, quarterly reports on Form  10-Q, current reports on Form  8-K and amendments to reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as we file such material, or furnish it to, the Securities and Exchange Commission (“SEC”). We have posted on our website the charters of our Audit, Compensation and Corporate Governance Committees; our Corporate Governance Guidelines, Code of Business Conduct and Ethics (including the Code of Ethics for the Chief Executive Officer and Financial Officers), and any amendments or waivers thereto. These documents are also available in print to any person requesting a copy from our Investor Relations department at our principal executive offices.

      As required by Section 303A.12 of the Listed Company Manual of the New York Stock Exchange (the “NYSE”), our chief executive officer submitted to the NYSE his annual certification on July 7, 2005 stating that he was not aware of any violation by our Company of the corporate governance listing standards of the NYSE. In addition, we have filed, as exhibits to this annual report on Form  10-K for the year-ended January 28, 2006, the certifications of our principal executive officer and principal financial officer required under Sections 302 and 906 of the Sarbanes-Oxley Act of 2002.

Item 1A. Risk Factors

      Our business and financial performance is subject to various risks and uncertainties. There are many factors that affect our business and financial performance, some of which are beyond our control. In addition to the factors discussed elsewhere in this Report, the following risks and uncertainties could materially adversely affect our business, prospects, financial condition, and results of operations. Other factors not

presently known to us, or that we presently believe are not material, could also affect our business and financial performance.

Economic Risks

          Changes in economic conditions could have a material adverse effect on our business, revenue and profitability

      In general, our sales represent discretionary spending by our customers. Discretionary spending is affected by many factors, including, among other things, general business conditions, interest rates, the availability of consumer credit, taxation, weather and consumer confidence in future economic conditions. Our customers’ purchases of discretionary items, including our products, could decline during periods when disposable income is lower (for example, as a result of higher energy prices) or during periods of actual or perceived unfavorable economic conditions. If this occurs, our revenues and profitability will decline. In addition, our sales could be adversely affected by a downturn in the economic conditions in the markets in which we operate. A prolonged economic downturn could have a material adverse effect on our business, financial condition, and results of operations.

If customer interest in fabric and craft products declines, our revenues may decline
      The success of our business depends on our customers purchasing our fabric and craft products. Our products are not necessities and compete with numerous other leisure activities and other forms of entertainment. If our customers’ interest in fabric and craft products declines, that decline would result in the reduction of our revenues and have a negative impact on our business and prospects. The inability of the Company and our vendors to develop and introduce new products which excite our customers also could adversely affect our operating results. In addition, changes in demographic and societal trends could have a material adverse effect on our business and prospects.

Changes in interest rates could adversely impact profitability
      We are subject to market risk from exposure to changes in interest rates which affect our financing, investing and cash management activities. Changes in interest rates could have a negative impact on our profitability.

External Business Risks

Competition could negatively impact our operations
      Competition is intense in the retail fabric and craft industry. This competition could result in the reduction of our prices and a loss of market share. We must remain competitive in the areas of quality, price, selection, customer service and convenience. The location and atmosphere of retail stores are additional competitive factors in the retail business.

      Our primary competition is comprised of specialty fabric retailers and specialty craft retailers such as Michaels Stores, Inc., a national chain which operates craft and framing stores, Hobby Lobby, a regional chain which operates craft stores, Hancock Fabrics, Inc., a national chain which operates fabric stores, and A.C. Moore Arts & Crafts, Inc., a regional chain which operates craft stores in the eastern United States. We also compete with mass merchants, including Wal-Mart, that dedicate a portion of their selling space to a limited selection of fabrics, craft supplies and seasonal and holiday merchandise. Some of our competitors have stores nationwide, several operate regional chains and numerous others are local merchants. Some of our competitors, particularly the mass merchants, are larger and have greater financial resources than we do. Our sales are also impacted by store liquidations of our competitors. In addition, alternative methods of selling fabrics and crafts, such as over the Internet, could result in additional competitors in the future and increased price competition since our customers could more readily comparison shop. Moreover, we ultimately compete against alternative sources of entertainment and leisure activities of our customers that are unrelated to the fabric and crafts industry.

Our suppliers may encounter business issues and not meet our needs
      Many of our suppliers are small companies that produce a limited number of items. Given their limited resources and lack of financial flexibility, many of these firms are susceptible to cash flow issues, production difficulties, quality control issues, and problems in delivering agreed-upon quantities on schedule. We cannot assure that we would be able, if necessary, to return products to these suppliers and obtain refunds of our purchase price or obtain reimbursement or indemnification from them if their products prove defective. These suppliers may be unable to withstand a downturn in economic conditions. Significant failures on the part of our key suppliers could have a material adverse effect on our operating results.

      In addition, many of these suppliers require extensive advance notice of our requirements in order to supply products in the quantities we desire. This long lead time requires us to place orders far in advance of the time when certain products will be offered for sale, exposing us to shifts in demand.

          Our dependence on foreign suppliers subjects us to possible delays in receipt of merchandise and to the risks involved in foreign operations

      In fiscal 2006, we purchased approximately one-third of our products directly from manufacturers located in foreign countries. A majority of our foreign suppliers are located in Hong Kong, China and Taiwan. In addition, many of our domestic suppliers purchase a portion of their products from foreign suppliers. Because a large percentage of our products are manufactured or sourced abroad, we are required to order these products further in advance than would be the case if products were manufactured domestically.

      Foreign manufacturing is also subject to a number of other risks, including work stoppages; transportation delays and interruptions; epidemics; political instability; economic disruptions; the imposition of tariffs, duties, quotas, import and export controls and other trade restrictions; changes in governmental policies and other events. If any of these events occur, it could result in a material adverse effect on our business, financial condition, results of operations and prospects. In addition, reductions in the value of the U.S. dollar or revaluation of the Chinese currency, or other foreign currencies, could ultimately increase the prices that we pay for our products. All of our products manufactured overseas and imported into the United States are subject to duties collected by the United States Customs Service. We may be subjected to additional duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of import privileges if we or our suppliers are found to be in violation of U.S. laws and regulations applicable to the importation of our products. We also depend on letters of credit with respect to imports. Our inability to obtain letters of credit could have a material adverse effect on our business.

Our business depends on shopping center traffic and our ability to identify suitable store locations
      Our stores generally are located in strip shopping centers and “big box” shopping centers. Our sales are dependent in part on a high volume of shopping center traffic. Shopping center traffic may be adversely affected by, among other things, economic downturns, the closing of anchor stores, new shopping centers or other retail developments, or changes in customer shopping preferences. A decline in the popularity of shopping center shopping among our target customers could have a material adverse effect on customer traffic and reduce our sales and net earnings.

      To take advantage of customer traffic and the shopping preferences of our customers, we need to maintain or acquire stores in desirable locations and competition for suitable store locations is intense. We cannot assure that desirable store locations will continue to be available.

The seasonality of our sales may negatively impact our operating results
      Our business is seasonal, with a significant amount of sales and earnings occurring in the third and fourth fiscal quarters. Our best quarter in terms of sales and profitability historically has been the fourth quarter. In addition, excluding the effects of new store openings, our inventories and related short-term financing needs have been seasonal, with the greatest requirements occurring primarily during our third fiscal

quarter as we increase our inventory in preparation for our peak selling season. Weak sales during the second half of the year will negatively impact our operating results and cash flow generation.

          Increases in transportation costs due to transportation industry challenges and rising fuel costs may negatively impact our operating results

      We rely upon various means of transportation, including shipments by air, sea and truck, to deliver products to our distribution centers from vendors and from our distribution centers to our stores. Labor shortages in the transportation industry could negatively affect transportation costs and our ability to supply our stores in a timely manner. In addition, long-term disruptions to the national and international transportation infrastructure that lead to delays or interruptions of service could adversely affect our business. In particular, our business is highly dependent on the trucking industry to deliver products to our distribution centers and our stores. Our operating results may be adversely affected if we are unable to secure adequate trucking resources to fulfill our delivery schedules to the stores, particularly as we deliver our fall and Christmas seasonal merchandise.

      The price of oil has risen significantly in the last year. This increase and any future increases may result in an increase in our transportation costs for distribution to our stores, as well as our vendors’ transportation costs, which could decrease our operating profits.

          Our business could be negatively impacted by changes in the labor market and our cost of doing business could increase as a result of changes in federal, state or local regulation

      Our performance is dependent on attracting and retaining a large and growing number of quality associates. Many of those associates are in entry level or part-time positions with historically high rates of turnover. Our ability to meet labor needs while controlling our costs is subject to external factors such as unemployment levels, prevailing wage rates, minimum wage legislation, workers compensation costs and changing demographics. Changes that adversely impact our ability to attract and retain quality associates could adversely affect our performance. Unanticipated changes in the federal or state minimum wage or living wage requirements or changes in other wage or workplace regulations, including, for example, health care mandate regulations, could adversely affect our financial condition and operating results.

Operational Business Risks
          The loss of key executives and failure to attract qualified management could limit our growth and negatively impact our operations

      Our future success depends in large part on our ability to recruit and retain our senior management team. During fiscal 2006, we had significant turnover in our executive management personnel. Our chief financial officer, general counsel, executive vice president — merchandising and marketing, and our executive vice president — human resources all left the Company. In addition, we have commenced a search for a new chief executive officer and announced that our current chief executive officer will resign as a Company employee upon the selection of his successor. Searches also currently are underway for a new chief financial officer and a new head merchant, but it is unlikely that these positions will be filled until the new chief executive officer is selected. We named a replacement for our general counsel in November 2005. Our inability to promptly recruit and retain highly qualified individuals to fill the open executive positions could materially adversely impact the management and operation of our business, which would impact our financial condition and results of operations. In addition, our continued success depends upon our ability to attract and retain qualified management, administrative and store personnel to support our future growth. Our inability to do so may have a material adverse effect on our business and prospects.

          Our Repair Plan strategy execution may disrupt our business. In addition, the strategy may not be successful

      Beginning in the fourth quarter of fiscal 2006, we undertook a series of related initiatives (the “Repair Plan”) to make fundamental improvements in our business, profitability and cash flows. The Repair Plan

strategy contains four major components: inventory reduction, adjustment of store merchandise assortments, gross margin rate restoration, and expense reduction. See “Recent Developments and Business Update” contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below for further discussion. This Repair Plan strategy may lead to disruptions in our business. These disruptions could adversely affect our business operations and our financial performance. While we believe any disruptions would be short-term, we cannot assure that the impact (whether short-term or long-term) from these disruptions would not be material. In addition, if our Repair Plan strategy is not successful, or if we do not execute the strategy effectively, our business operations and financial performance could be adversely affected.

Failure to manage inventory effectively will negatively impact sales and earnings
      We strive to ensure the merchandise we offer remains fresh and compelling to our customers. However, due to the nature of our business, we purchase much of our inventory well in advance of each selling season. If we are not successful at predicting our sales trends and misjudge consumer preferences or demands, we will experience lower sales than expected and will have excess inventory that may need to be held for a long period of time, written down or sold at prices lower than expected in order to clear excess inventory at the end of a selling season. These actions would reduce our operating performance. Conversely, if we underestimate consumer demand, we may not be able to provide products to our customers to meet their demand. Shortages of key items could also have a material adverse impact on our business, financial condition and results of operations.

      In addition, inventory shrink (inventory theft or loss) rates can significantly impact our business performance and financial results. We devote substantial efforts to minimize inventory shrink. Failure to manage inventory shrink rates could materially adversely affect our business, financial condition and results of operations.

Failure to adequately maintain our perpetual inventory and automated replenishment systems
      We currently operate perpetual inventory, automated replenishment, and weighted average cost inventory systems. We believe these are necessary to adequately forecast, manage, and analyze our inventory levels, monitor our gross margin, and manage merchandise ordering quantities. If we fail to adequately support and maintain these systems, it could have a material adverse impact on our financial condition and results of operations.

Inability to provide new and improved product selection
      Our products appeal to a broad range of consumers whose preferences cannot be predicted with certainty and are subject to rapid change. Our success depends, in large part, upon our ability to anticipate, identify and respond to changing product trends and consumer demand in a timely manner. The retailing industry fluctuates according to changing tastes and seasons, and merchandise usually must be ordered well in advance, frequently before consumer tastes are evidenced by consumer purchases. In addition, in order to ensure sufficient quantities and selection of products, we are required to maintain substantial levels of inventory, especially prior to peak selling seasons when we build up our inventory.

      We cannot assure that we will be able to continue to offer an assortment of products that will appeal to our customers or that will satisfy consumer demands in the future. The failure to continue to identify and stock our stores with appealing products could result in reduced sales and thus have a material adverse effect on our business and financial performance.

Failure to grow sales may impact operations
      Our comparable same-store sales have fluctuated significantly in the past, on both an annual and a quarterly basis, and we expect them to continue to fluctuate in the future. A variety of factors affect our same-store sales results, including, among other things, fashion trends, the highly competitive retail store sales environment, new competing stores (ours or competitors in proximity to existing stores), economic

conditions, timing and effectiveness of promotional events, changes in our merchandise mix, calendar shifts and weather conditions. Annual revenue growth is driven by the opening of new stores and increased same-store sales. We cannot provide assurance that we can continue to open stores or increase same-store sales.

          Our failure to manage our new store growth, and overall store transition strategy, would have a negative impact on our operations

      Our growth is dependent, in large part, upon our ability to successfully add new stores and close smaller traditional store locations. Our superstores accounted for 41 percent of our total fiscal 2006 net sales. Our growth strategy contemplates the development of additional superstores and an increasing percentage of our revenues coming from our superstores. The success of this strategy will depend upon a number of factors, summarized as follows:

Store specific risks

	•	our ability to saturate existing markets and penetrate new markets;
	•	the availability of desirable locations and the negotiation of acceptable leases for these sites;
	•	the availability of management resources in a particular area;
	•	the timely construction, fixturing, merchandising, and hiring and training of store personnel;
	•	the closure of unsuccessful stores may result in the retention of liability for expensive leases;

General risks

	•	our ability to generate sufficient cash flow from operations;
	•	the availability of working capital;
	•	our ability to obtain financing;
	•	the expansion of our logistics systems to support new stores;
	•	the maintenance or upgrade of our information processing systems and the integration of those systems at new stores;
	•	a significant portion of our management’s time and energy may be consumed with issues unrelated to advancing our core business strategy, which could result in a deterioration of our operating results;
	•	our suppliers may be unable to meet the increased demand of additional stores in a timely manner;
	•	the inability to expand our existing distribution centers or use third-party distribution centers on a cost-effective basis to provide merchandise for sale by our new stores, and;
	•	general economic conditions and specific retail economic conditions.

      Our failure to open new stores on a timely basis, obtain acceptance in markets in which we currently have limited or no presence, attract qualified management and personnel or appropriately adjust operational systems and procedures would have an adverse effect on our growth and profitability prospects. There can be no assurance that we will be able to successfully implement our store transition strategy. Not all of our superstores are producing acceptable levels of sales and operating profit. If our superstore strategy is not successful, this will negatively impact our effort to diversify into the crafts business and affect our sales growth and profitability capabilities.

          The loss of, or disruption in, or our inability to efficiently operate our distribution network could have a negative impact on our business

      We operate three distribution centers to support our business. If complications arise with any one facility or any facility is severely damaged or destroyed, the other distribution centers may not be able to

support the resulting additional distribution demands. This may adversely affect our ability to receive and deliver inventory on a timely basis.

      The majority of our inventory is shipped directly from suppliers to our distribution centers where the inventory is then processed, sorted, picked, and shipped to our stores. We rely in large part on the orderly operation of this receiving and distribution process, which depends on adherence to shipping schedules and effective management of our distribution network. Although we believe that our receiving and distribution process is efficient and well positioned to support our expansion plans, we cannot assure that we have anticipated all issues or that events beyond our control, such as disruptions in operations due to fire or other catastrophic events, labor disagreements or shipping problems, will not result in delays in the delivery of merchandise to our stores. Moreover, our third distribution center, located in Opelika, Alabama recently started up operations. If we encounter significant start up problems at this center, such problems could have a material adverse effect on our business operations and financial performance.

          The efficient operation of our business is dependent on our information systems. Our failure to maintain and upgrade our management information systems could compromise our competitive position

      We depend on a variety of information systems for the efficient functioning of our business. In particular, we rely on our information systems to effectively process transactions, manage inventory, purchase, sell and ship goods on a timely basis and maintain cost-efficient operations. The failure of our information systems to perform as designed could disrupt our business and harm sales and profitability. Any material disruption or slowdown of our systems could cause information to be lost or delayed, which could have a negative impact on our business. We may experience operational problems with our information systems as a result of system failures, viruses, computer “hackers” or other causes. We cannot assure that our systems will be adequate to support future growth.

      In addition, costs and potential problems and interruptions associated with the implementation of new or upgraded systems and technology or with maintenance or adequate support of existing systems could also disrupt or reduce the efficiency of our operations. We also rely heavily on our information technology staff. If we cannot meet our staffing needs in this area, we may not be able to fulfill our technology or business initiatives while continuing to provide maintenance on existing systems.

      Excessive technological change affects the effectiveness of the adoption of, and could adversely affect the realization of business benefits from, technology. Conversely, not implementing sufficient technological changes could also compromise the operation of our business.

          Our existing indebtedness could restrict our operations, making us more vulnerable to adverse economic conditions

      We have and will continue to have a significant amount of debt. Our existing level of indebtedness could have negative consequences. For example, it could:

	•	make it more difficult for us to satisfy our obligations;
	•	reduce the availability of our cash flow from operations to fund working capital, capital expenditures, acquisitions and other general corporate requirements because we will have to dedicate a significant portion of our cash flow from operations to payments of our indebtedness;
	•	limit our ability to borrow funds to pay for future working capital, capital expenditures, acquisitions and other general corporate requirements;
	•	limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
	•	place us at a disadvantage compared to our competitors that have less debt; and
	•	make us more vulnerable to negative changes in economic and industry conditions.

      Our ability to make payments on our indebtedness depends upon our ability to generate cash flow in the future. Our ability to generate that cash flow depends upon, among other things, our future operating performance and our ability to refinance indebtedness when necessary. To some extent, each of these factors depends upon economic, financial, competitive and other factors beyond our control. If we cannot generate enough cash from operations to make payments on our indebtedness, we will need to refinance our indebtedness, obtain additional financing, or sell assets. We do not anticipate any issues in generating sufficient cash flow, but we cannot assure that this will be the case, nor can we assure that we will be able to obtain acceptable financing to satisfy our debt obligations.

          We may not be able to finance future needs or adapt our business plan to changes because of restrictions placed on us by our senior bank credit facility and indenture

      The indenture governing our senior subordinated notes and our senior bank credit facility contain restrictive and financial covenants, which limit our ability to borrow money, make investments, redeem or make payments on our capital stock, incur liens and take other actions.

      We currently are in compliance with all of these covenants and do not foresee any issues in continuing to comply with these covenants. However, our ability to remain in compliance with these covenants and tests may be affected by unanticipated events or events beyond our control. If we fail to meet these tests or breach any of the covenants, the lenders under the senior bank credit facility or the holders of the notes could declare all amounts outstanding under their indebtedness, including accrued interest, to be immediately due and payable. A declaration of acceleration under the senior bank credit facility would constitute a default under the indenture, and a default under the indenture would constitute a default under the senior bank credit facility. We believe that we have sufficient credit availability to finance our operations and capital needs; however, we cannot assure that the operating and financial restrictions in our credit facilities will not adversely affect and limit or prohibit our ability to finance future acquisitions, or longer term capital needs.

          We could incur more debt

      Our management currently believes that the cash generated by operations, together with the borrowing availability under the senior bank credit facility, will be sufficient to meet our working capital needs during fiscal 2007. However, if we are unable to generate sufficient cash from operations, we may be required to adopt one or more alternatives to raise cash, such as incurring additional indebtedness, selling assets, raising additional debt or equity capital or restructuring. If adequate financing is unavailable or is unavailable on acceptable terms, we may be unable to maintain, develop or enhance our operations, including the opening of new stores, or the introduction of new products and services, to take advantage of future opportunities or respond to competitive pressures.

          Failure to adequately maintain the security of our electronic and other confidential information could materially adversely affect our financial condition and results of operations

      We are dependent upon automated information technology processes. Any failure to maintain the security of our data and our employees’ and customers’ confidential information, including via the penetration of our network security and the misappropriation of confidential information, could put us at a competitive disadvantage, result in deterioration in our employees’ and customers’ confidence in us, and thus have a material adverse impact on our business, financial condition and results of operations.

Failure to comply with various regulations may result in damage to our business
      Our policies and procedures are designed to comply with all applicable laws and regulations, including those imposed by the SEC and NYSE. With recent high profile business failures on accounting-related issues, additional legal and regulatory requirements such as the Sarbanes-Oxley Act have increased the complexity of the regulatory environment. Also, various aspects of our operations are subject to federal, state, local and foreign laws, rules and regulations, any of which may change from time to time. Additionally, we are regularly

involved in various litigation matters that arise in the ordinary course of our business, including liability claims and allegations that we have infringed on third-party intellectual property rights.

      Litigation or regulatory developments could adversely affect our business operations and financial performance. Also, failure to comply with the various regulations may result in damage to our reputation, civil and criminal liability, fines and penalties, increased cost of regulatory compliance, and restatements of financial statements.

Other Factors
      The foregoing list of risk factors is not all inclusive. Other factors and unanticipated events could adversely affect our business. We do not undertake to revise or update these risks to reflect events or circumstances that occur after the date of this report.

Item 1B. Unresolved Staff Comments.

      None.