Jo-Ann's Threadbare Days

Jo-Ann Stores (NYSE: JAS  ) posted fiscal 2007 first-quarter results, and they weren't pretty. Still, investors anticipated the weakness well in advance -- witness its cratered stock in the latter half of 2005 -- and good things may be just around the corner.

In the quarterly earnings conference call, management described the current environment as a "challenging" one affecting the entire industry. The language was a bit more colorful in later remarks, indicating the company is in the middle of the "severest industry downturn in some time." Sales for the current period, or lack thereof, certainly point to this weakness.

The top line increased a meager 1%, as comparable same-store sales dropped 3.9% versus the year-ago period. A decline in customer transactions was mostly to blame for the sagging comps. Two product categories in particular hurt the company against year-ago comparisons: yarn and fleece, both of which were strong points last year.

On top of poor sales performance, gross margins continue to be negatively affected. Cost of sales as a percentage of net revenue was 46.6% for the quarter, below last year's mark of 48.7%. The bulk of the profitability weakness is attributed to markdowns associated with its inventory reduction efforts. Jo-Ann Stores still has inventory that it needs to get rid of as it prepares to offer new merchandise. As it continues to move the older, outdated inventory, investors should expect to see this negative margin pressure continue into the second quarter.

By the beginning of the third quarter, Jo-Ann Stores anticipates having a fresh line of products on the shelves. While few specifics were provided on what these assortments entail, we can glean from other remarks that investors should expect a renewed emphasis on crafts. The company's sewing department is No. 1 in the industry, and Jo-Ann wants to leverage this position by expanding its presence in crafts. To this end, it has signed a licensing agreement with an unnamed but well-known TV personality. Recent remarks by Martha Stewart Living Omnimedia (NYSE: MSO  ) and its mention of a new deal to get in on the "$3 billion scrapbooking" industry might give us a clue.

Will the new product assortment be enough to entice shoppers in what management has already described as the most severe sales environment in recent memory? When Jo-Ann Stores releases second-quarter results in the coming months, prospective investors should look for a more favorable read on the industry before considering Jo-Ann too seriously.

We've crafted further Foolishness:

• Michaels (NYSE: MIK  ) is looking for a buyer.
• Fool contributor Rich Duprey warned that A.C. Moore (Nasdaq: ACMR  ) was an expensive stock in its retail niche.

Fool contributor Jeremy MacNealy has no financial interest in any company mentioned.