This discussion provides the reader with information that will assist in an overall understanding of our financial statements, changes in certain key indicators from year to year, the factors that account for those changes and how certain accounting principles have impacted our financial statements. This discussion should be read in conjunction with the audited consolidated financial statements and notes to the consolidated financial statements presented in this Form 10-K. In addition, the financial information presented for years prior to fiscal 2009 has been reclassified for certain amounts to conform to the current year presentation.

Overview

We are the nation's largest specialty retailer of fabrics and one of the largest specialty retailers of crafts, serving customers in their pursuit of apparel and craft sewing, crafting, home decorating and other creative endeavors. Our retail stores and website feature a variety of competitively priced merchandise used in sewing, crafting and home decorating projects, including fabrics, notions, crafts, frames, paper crafting material, artificial floral, home accents, finished seasonal and home dιcor merchandise.

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

• Net sales. We closely monitor our net sales, including net sales from stores open one year or more ("same-store sales"), by our two store formats, small-format stores and large-format stores. Net sales in the aggregate and by store type are compared to previous periods to measure our overall sales growth and same-store sales are compared to previous periods to determine whether existing stores are growing their sales volume. We also closely monitor average ticket value, both in total and by store format. Average ticket represents total sales divided by the total number of customer transactions. Customer transactions are impacted by the number of customers that shop in our stores. These indicators help to measure the effectiveness of our product assortments, promotions and service.

• Gross margin. Our management uses gross margin to evaluate merchandising, marketing and operating effectiveness for the company. Merchandise selection and other future decisions such as pricing and promotional activity are, in part, based on gross margin performance.

• Selling, general and administrative expense as a percent of sales. We monitor the leveraging of selling, general and administrative expense in relation to our sales in order to measure the effectiveness of managing expenses.

• Inventory. We closely monitor our inventory investment, which is our single largest invested asset, and our inventory turnover rate. Due to the large investment in inventory, changes in inventory levels can have a significant impact on our liquidity. Also, inventory turnover is an indicator of how effectively we manage our inventory levels in relation to our sales.

• Debt to total capitalization and excess credit availability. We monitor our debt balances and leverage as a percent of total capitalization. We also monitor current and projected excess availability, as defined under our senior bank credit facility, in order to ensure that adequate flexibility is available to execute our operating plans.

An overview of our fiscal 2009 performance compared with fiscal 2008 performance follows:

• Net sales increased 1.2 percent to $1.901 billion. Same-store sales increased 0.5 percent versus a 3.5 percent same-store sales increase for the prior year. The increase in same-store sales primarily was driven by a 0.5 percent increase in average ticket due to better in-stocks, more effective marketing and the benefit of competitive withdrawals in the sewing business.

• Our gross margin rate, as a percentage of net sales, was consistent with the prior year at 46.4 percent. We entered the fourth quarter of fiscal 2009 with a 60 basis point increase for the first nine months of the year, as the result of a smaller percentage of clearance sales to total sales during the first nine months of fiscal 2009 as compared to the same period of the prior year and lower costs from global

sourcing initiatives, particularly related to fabrics. Due to economic pressures, we elected to take pricing actions on seasonal products earlier in the fourth quarter as compared to the fourth quarter of fiscal 2008 in order to ensure a reasonable sell-through, resulting in a full year gross margin rate at a comparable rate with the prior year.

• Our selling, general and administrative expenses ("SG&A") as a percentage of net sales, excluding those expenses separately identified in the statement of operations, decreased 40 basis points from 41.2 percent last year to 40.8 percent this year. The decrease is primarily the result of our continued efforts to control expenses.

• Inventory decreased by $42.8 million in fiscal 2009. Our inventory turnover improved from 2.2 turns for fiscal 2008 to 2.3 turns for fiscal 2009. The improvement is the result of our inventory initiatives to reduce seasonal and fashion merchandise, which have a higher promotional and clearance risk than our basic inventory categories.

• Our debt to total capitalization ratio improved 640 basis points from 18.5 percent last year to 12.1 percent for fiscal 2009. During the year, we purchased $34 million of our senior subordinated notes. As of fiscal 2009 year end, we had approximately $235.2 million of excess availability under our senior bank credit facility.

Executive Overview of Fiscal 2009


                                               Qtr 1        Qtr 2         Qtr 3         Qtr 4          Total
                                                                   (Dollars in millions)

Net sales                                     $ 446.1      $ 403.0       $ 480.1       $ 571.9       $ 1,901.1
Same-store sales percent change                   4.5 %        3.3 %        (1.5 )%       (2.9 )%          0.5 %
Gross margin                                  $ 206.8      $ 191.8       $ 235.3       $ 248.6       $   882.5
Gross margin percent                             46.4 %       47.6 %        49.0 %        43.5 %          46.4 %
Gross margin basis point change from prior
year                                              (90 )        190           100          (150 )             -
Selling, general and administrative
expenses                                      $ 184.5      $ 191.6       $ 199.5       $ 199.7       $   775.3
SG&A percent to sales                            41.4 %       47.5 %        41.6 %        34.9 %          40.8 %
SG&A basis point decrease (increase) from
prior year                                        230           90           (10 )         (40 )            40
Net income (loss)                             $   3.0      $ (11.7 )     $  10.2       $  20.4       $    21.9
Net income (loss) percent to sales                0.7 %       (2.9 )%        2.1 %         3.6 %           1.2 %
Net income (loss) basis point change from
prior year                                        110          180            40          (110 )            40

During fiscal 2009, we continued to execute and refine the operational and merchandising initiatives that we introduced at the end of fiscal 2007, which included the following objectives:

• improve the customer shopping experience in our stores;

• enhance our marketing and merchandising offers; and

• refine our store development program.

At the end of fiscal 2008, we added a number of new initiatives for fiscal 2009 including:

• implementation of a new point-of-sale and store systems SAP Retail package, including new human resources and workforce management applications;

• continued integration of our Joann.com Internet business, to achieve stronger synergy with our retail stores; and

• remerchandising approximately 200 of our small-format stores, over and above those we remodeled.

We achieved solid earnings and cash flow improvements in fiscal 2009. Our key initiatives succeeded in growing sales, controlling expenses and managing inventory:

• Notwithstanding the economic pressures encountered by retailers during the second half of fiscal 2009, we were able to achieve a 0.5 percent growth in same-store sales for fiscal 2009.

• We gained expense leverage, as SG&A as a percentage of net sales decreased 40 basis points from last year. The improvement was driven primarily by expense leverage in store labor and distribution expenses.

• Earnings per share for the year improved to $0.86 per diluted share, compared with earnings of $0.62 per diluted share in the prior year.

• We ended fiscal 2009 with 9.0 percent less inventory than the prior year. We believe the quality of our inventory is better and we have maintained strong in-stocks at our distribution centers and at the store level.

• Our store remodel and optimization programs continued to generate incremental sales. Our core sewing and craft business delivered positive same-store sales for the full year, including the fourth quarter.

• We decreased our debt levels during the year by purchasing $34 million of our senior subordinated notes.

• We ended fiscal year 2009 with a $55.2 million increase in cash and cash equivalents.

The fiscal 2009 fourth quarter business was very challenging. Same-store sales were down 2.9 percent in the fourth quarter of fiscal 2009, compared to a 3.3 percent increase in the fourth quarter of fiscal 2008. Customer transactions and average ticket were both down versus the fourth quarter of fiscal 2008 by 1.0 percent and 1.9 percent, respectively.

Our fourth quarter fiscal 2009 sales and earnings were negatively affected by the weak performance of our seasonal merchandise sales during the holidays. Seasonal category sales have been very soft during the current economic downturn.

However, our core sewing business, which includes fleece, quilting and flannel fabrics, enjoyed positive same-store sales during the fourth quarter of fiscal 2009. Yarn, kids' crafts and food crafting performed well on the non-sewing side of our business.

Our small-format stores performed better than the large-format stores, due to the benefit of remodels in the small-format stores and the presence of more seasonal merchandise in the large-format stores.

As mentioned previously, our inventory management initiatives allowed us to begin fiscal 2010 with no seasonal carryover. However, our gross margin rate declined by 150 basis points in the fourth quarter of fiscal 2009, as we elected to take deeper pricing actions on seasonal products earlier in the quarter in order to ensure a reasonable sell-through. In fiscal 2009, we continued selling Christmas seasonal products into February 2009 at substantial discounts.

By tightly controlling expenses and inventory in this challenging sales environment, we were able to strengthen our balance sheet during fiscal 2009. We purchased $13.6 million of our senior subordinated notes during the fourth quarter of fiscal 2009 for a total purchase of $34 million for the full year. We also ended fiscal 2009 with cash and cash equivalents of $80.6 million, which exceeded our long-term debt of $66 million.

We opened six new stores during the fourth quarter of fiscal 2009, which resulted in a total of 21 store openings for fiscal 2009. We also made progress in revitalizing our existing store base by completing one additional remodel during the fourth quarter of fiscal 2009, which brought total stores remodeled to 29 during the year.

Recent Developments and Business Update

As we look ahead to fiscal 2010, we are hopeful that the economy will begin to improve in the second half of the year. However, we believe it is prudent to expect and plan for negative trends in both customer transactions and average ticket in the near term. Therefore, we have not assumed any improvement in sales trends for fiscal 2010.

We will continue to focus on those elements of our business that we can control, including expenses, inventory and the customer experience. We will continue to optimize free cash flow to further strengthen our balance sheet.

Our key initiatives for fiscal 2010 are:

• Margin expansion;

• Further enhance our customer shopping experience;

• Continue to update our store base; and

• Improve our leasing terms.

We believe margin expansion provides the most significant opportunity to improve our financial results. The factors that cause us to believe that margin expansion can be achieved include:

• The percentage of products that we source directly from Asia is expected to increase again this year;

• The inflationary pressure we experienced a year ago on products sourced from Asia appears to have reversed, and we are now seeing product cost deflation;

• Freight expense decreases along with lower oil prices, which reduces our cost of sourcing products both globally and domestically;

• We intend to buy significantly less fashion and seasonal merchandise in fiscal year 2010, which is expected to reduce our exposure to promotional and clearance markdowns; and

• The new store systems we rolled-out last year are expected to provide additional tools for managing markdowns and give us new promotional capabilities to enhance margins.

In addition to our work on gross margin expansion, we are focused on a number of initiatives to drive sales and further enhance our customer shopping experience. For example, we intend to modify our marketing content to deliver a stronger value message. We also intend to enhance our industry-leading education and in-store demonstration programs. We also intend to continue to expand the product offering and functionality of the Joann.com website.

Given the economic environment, we intend to reduce capital spending, net of landlord allowances, by approximately 50 percent, from $63.6 million in fiscal 2009 to between $30 and $32 million for fiscal year 2010. Most of the reduction will come from normalizing our investment in information technology, following the major store systems upgrade that occurred during fiscal year 2009. Our new store and remodel activity will be comparable to fiscal 2009, with approximately 20 new stores and 30 remodels.

We also have approximately 110 leases expiring in fiscal year 2010, 37 of which have renewal options. Given the current market conditions, we believe there are opportunities to improve the lease terms in a number of these store locations.

Results of Operations

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

                                                                       Fiscal Year-Ended
                                                      Jan 31, 2009        Feb 2, 2008        Feb 3, 2007

Net sales                                                     100.0 %            100.0 %            100.0 %
Gross margin                                                   46.4 %             46.4 %             46.5 %
Selling, general and administrative expenses                   40.8 %             41.2 %             42.7 %
Store pre-opening and closing costs                             0.6 %              0.4 %              0.6 %
Depreciation and amortization                                   2.9 %              2.8 %              2.7 %

Operating profit                                                2.1 %              2.0 %              0.5 %

Comparison of the 52 Weeks Ended January 31, 2009 and February 2, 2008 and 53 Weeks Ended February 3, 2007

Net sales. Net sales represent retail sales, net of estimated returns and exclude sales taxes. The following tables summarize the year-over-year comparison of our consolidated net sales and sales by segment for the periods indicated:

Consolidated Net Sales:


                                                                                             Percentage           Percentage
                                                                                               Change               Change
(Dollars in millions)                        FY09            FY08            FY07           FY09 vs. FY08        FY08 vs. FY07


Consolidated net sales                      $1,901.1        $1,878.8        $1,850.6                   1.2 %                1.5 %
Increase from prior year                       $22.3           $28.2
Same-store sales percentage change               0.5 %           3.5 %          (5.9 )%

Fiscal 2009:

Overall, consolidated net sales increased for fiscal 2009 primarily due to increased sales in our Joann.com entity. Fiscal 2009 represents our first full year of sales since we acquired the entity in the fourth quarter of fiscal 2008. With respect to our stores, same-store sales increased 0.5 percent compared with a same-store sales increase of 3.5 percent for fiscal 2008. The increase in fiscal 2009 same-store sales primarily was driven by an approximate 0.5 percent increase in average ticket due to a continuation of better in-stocks, more effective marketing and the benefit of competitive withdrawals in the sewing business. Our total store count at the end of the year of 764 was down ten stores compared with fiscal 2008; however, total store square footage increased slightly from 15.9 million square feet at the end of fiscal 2008 to 16.0 million square feet at the end of fiscal 2009. In total, we opened 21 new stores and closed 31 stores during fiscal 2009, compared to fiscal 2008 when we opened six new stores and closed 33 stores.

On a category basis, our sewing businesses represented 51 percent of our fiscal 2009 sales volume as compared to 50 percent of our fiscal 2008 sales volume. During fiscal 2009, our sewing businesses increased approximately 3.9 percent on a same-store sales basis as compared to an increase of approximately 5.6 percent during fiscal 2008. During fiscal 2009, we experienced positive same-store sales in the majority of our fabric and sewing notions merchandise categories, especially in quilting and fleece.

Our non-sewing businesses represented 49 percent of our fiscal 2009 sales volume compared to 50 percent of our fiscal 2008 sales volume. During fiscal 2009, our non-sewing businesses decreased 3.4% on a same-store sales basis primarily due to sales declines in seasonal categories. Excluding seasonal categories, craft same-store sales were slightly positive during fiscal 2009, with particular strength in the yarn and basic craft shops.

Fiscal 2008:

Consolidated net sales for fiscal 2008 increased primarily due to the increase in same-store sales, offset in part by the impact of fiscal year 2007 having 53 weeks. Same-store sales increased 3.5 percent compared with a same-store sales decrease of 5.9 percent for fiscal 2007. Our total store count at the end of the year of 774 was down 27 stores compared with fiscal 2007, and total store square footage decreased from 16.2 million square feet at the end of fiscal 2007 to 15.9 million square feet at the end of fiscal 2008.

On a category basis, our sewing businesses represented 50 percent of our fiscal 2008 sales volume, and increased approximately 5.6 percent on a same-store sales basis. The increase in our sewing businesses was driven by consistent growth throughout our fabric and sewing accessory categories.

On a category basis, our non-sewing businesses represented 50 percent of our fiscal 2008 sales volume and increased slightly on a same-store basis. We experienced positive sales results in our craft and party categories, which were mostly offset by lower sales of seasonal categories.

Sales by Segment:


                                                                                           Percentage            Percentage
                                                                                             Change                Change
(Dollars in millions)                          FY09           FY08          FY07          FY09 vs. FY08         FY08 vs. FY07


Large-format stores
Net sales                                      $983.6         $975.3        $915.3                   0.9 %                 6.6 %
Increase from prior year                         $8.3          $60.0
Same-store sales percentage change               (1.0 )%         3.9 %        (8.0 )%


Small-format stores
Net sales                                      $881.8         $891.6        $935.3                  (1.1 %)               (4.7 %)
Decrease from prior year                        $(9.8 )       $(43.7 )
Same-store sales percentage change                2.1 %          3.0 %        (4.1 )%


Other
Net sales                                       $35.7          $11.9
Increase from prior year                        $23.8          $11.9

Fiscal 2009:

Sales for large-format stores increased for fiscal 2009 primarily due to the net increase in the number of new stores, partially offset by negative same-store sales.

Same-store sales for large-format stores decreased 1.0 percent for fiscal 2009, versus a same-store sales increase of 3.9 percent for the same period last year. Large-format stores have a greater mix of seasonal product and higher ticket items compared to our small-format stores, which contributed to the weaker performance of the large-format stores during fiscal 2009. Customer transactions and average ticket for large-format stores decreased by approximately 0.6 percent and 0.4 percent, respectively. Large-format stores accounted for 51.7 percent and 51.9 percent of total net sales during fiscal 2009 and fiscal 2008, respectively.

The number of large-format stores in operation increased to 210 from 196 in fiscal 2009, which is the net result of eleven new stores and five small-format stores that were reclassified as large-format stores due to remodeling efforts during fiscal 2009, less the closing of two large-format stores.

Sales for small-format stores decreased for fiscal 2009 due to the decrease in total store count, partially offset by the increase in same-store sales.

The number of small-format stores in operation decreased to 554 in fiscal 2009 from 578 in the prior year, which is the net result of the closing of 29 small-format stores, the opening of ten new small-format stores and the previously mentioned reclassification of five small-format stores to large-format stores during the year.

Same-store sales performance for small-format stores increased 2.1 percent for fiscal 2009 versus a same-store sales increase of 3.0 percent for fiscal 2008. The fiscal 2009 increase in same-store sales for small-format stores was due to an approximate 1.8 percent increase in average ticket combined with an approximate 0.3 percent increase in customer transactions. Small-format stores accounted for 46.4 percent and 47.5 percent of total net sales during fiscal 2009 and fiscal 2008, respectively.

Sales included in our "other" segment represents sales from Joann.com, which was acquired in the fourth quarter of fiscal 2008. The increase in sales for fiscal 2009 is attributable to experiencing a full year of sales from Joann.com as compared to one quarter in fiscal 2008.

Fiscal 2008:

Large-format stores net sales for fiscal 2008 increased due to the increase in the number of new stores and by the increase in same-store sales performance. Same-store sales for large-format stores increased 3.9 percent for fiscal 2008, versus a same-store sales decrease of 8.0 percent for the same period of the prior year. The large-format store improvement was due to changes in our marketing program, improved store in-stocks and overall store conditions, which drove an increase in customer transactions and an increase in average ticket. The number of large-format stores in operation increased to 196 from 186 in fiscal 2007, which is the net result of six new stores and five small-format stores that were reclassified as large-format stores due to remodeling efforts during fiscal 2008, less the closing of one large-format store. Large-format stores accounted for approximately 52 percent of total net sales during fiscal 2008 compared with approximately 49 percent of total net sales for fiscal 2007.

Small-format stores net sales for fiscal 2008 decreased due to the decrease in total store count, partially offset by the increase in same-store sales performance. Our same-store sales performance for small-format stores increased 3.0 percent for fiscal 2008 versus a same-store sales decrease of 4.1 percent for the same period last year. The increase in same-store sales for small-format stores was primarily due to increases in average ticket. The number of small-format stores decreased to 578 during fiscal 2008 from 615 in fiscal 2007 due to the closing of 32 small-format stores, and the previously mentioned reclassification of five small-format stores to large-format stores during the year. Small-format stores accounted for approximately 47 percent of total net sales during fiscal 2008 as compared to 51 percent for the same period in the prior year.

Sales included in our "other" segment represents sales from Joann.com, which was acquired in the fourth quarter of fiscal 2008.

Gross margin. Gross margin may not be comparable to that of our competitors and other retailers. Some retailers include all of the costs related to their distribution network in cost of sales, while we exclude the indirect portion from gross margin and include it within SG&A. We include distribution costs that are directly associated with the acquisition of our merchandise in cost of sales. These costs are primarily in-bound and out-bound freight. We incur in-bound freight costs as a result of merchandise shipments from the vendor to our distribution centers or directly to our stores via "drop shipment." In-bound freight and duties related to import purchases and internal transfer costs are considered to be direct costs of our merchandise and accordingly are recognized as cost of sales when the related merchandise is sold. We incur out-bound freight costs when we ship the merchandise to our stores from the distribution centers. Purchasing and receiving costs, warehousing costs and other costs of our distribution network and store occupancy costs are considered to be period costs not directly attributable to the value of merchandise and, accordingly, are expensed as incurred as SG&A.

Gross Margin:


                                                                                    Percentage           Percentage
                                                                                      Change               Change
(Dollars in millions)                     FY09          FY08          FY07         FY09 vs. FY08        FY08 vs. FY07


Gross margin                              $882.5        $872.4        $859.8                  1.2 %                1.5 %
Increase from prior year                   $10.1         $12.6
Percentage of consolidated net sales        46.4 %        46.4 %        46.5 %                  -              (10 bps )

. . .