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A Retailers Riches to Rags Story

After a hefty loss last year, a crafts chain files for bankruptcy protection.HAWTHRONE – A downtick in the $29.5 billion do-it-yourself crafts market appears to have helped push a Hawthorne crafts retailer into bankruptcy. Last week, the Chapter 11 filing of Rag Shops Inc. was formally consolidated with the bankruptcy petitions of its 62 affiliates across the country and Crafts Retail Holding Corp., the chain’s parent company.

On a combined basis, the companies reported an $8.4 million loss in fiscal 2006, according to documents filed in the U.S. Bankruptcy Court in Brooklyn, N.Y. Bankruptcy generally puts a hold on creditors’ attempts to collect on pre-existing debt, and may allow a retailer like Rag Shops to terminate or renegotiate costly store leases and other agreements.

But with $52.5 million in liabilities—including $37.3 million of debt—and only $35.3 million of assets, Crafts Retail CEO Seth Udasin has his work cut out for him. His company is an affiliate of Sun Capital Partners Inc., a Boca Raton, Fla.-based private equity firm. In October 2004, Crafts Retail bought the then-publicly traded Rag Shops and took it private.

“Increased competition and unfavorable market conditions” dried up the cash flow of the do-it-yourself crafts chain and drove it to file for Chapter 11, said Udasin in an affidavit submitted to the court May 2. “Despite substantial efforts at restructuring over the past two years, the debtors have become unable to service their indebtedness.”

If Rag Shops can’t get its finances in shape, Udasin may try to sell the business, which has 400 full-time and 1,000 part-time employees in New Jersey, Pennsylvania, New York, Florida and Connecticut. The company currently has 35 stores in New Jersey, in Secaucus, Lakewood and West Orange.

There’s a lot of interest in do-it-yourself crafts, which encompass projects like creating curtains, designing dried floral arrangements and woodworking, says Sandy Ghezzi, vice president of marketing and member services at the Craft & Hobby Association in Elmwood Park. She adds that the crafts segment appeals to men and women across a wide range of ages. Still, there’s some weakness in the market, with the association reporting a 3 percent slip in sales for the industry compared with 2005 results.

Even a small downturn can hurt crafts retailers, which typically operate on slim profit margins and depend on high volume to generate enough revenue to cover overhead and other fixed expenses. In 2006, for example, a publicly traded crafts retailer, Berlin-based A.C. Moore Arts & Crafts Inc., reported a $2.4 million profit on sales of $589.5 million. The company had eked out a .41 percent profit margin.

Ghezzi says she can’t speculate on what may have gone wrong at Rag Shops, a privately owned company that doesn’t report detailed results, but she does observe that retailers appear to be re-examining their product lines with an eye toward generating more profits.

Rag Shops is not the only company in its industry to have stumbled. In March, Hancock Fabrics Inc., a publicly held crafts retailer based in Baldwyn, Miss., filed a Chapter 11 petition in U.S. Bankruptcy Court in Delaware.

But stock analysts don’t expect to see a flood of bankruptcies.

“Many crafts retailers face challenges from big-box stores like Wal-Mart that may carry similar products at a lower price,” says Laura Richardson, an analyst with BB&T Capital Markets in Vienna, Va. She reports on A.C. Moore, which saw first-quarter profits jump to $572,000 on revenues of $135.4 million from profits of $250,000 on revenues of $132.9 million in the year-ago quarter.

“Rag Shops likely faced many of the same challenges as A.C. Moore, but Rag Shops is an older operation that has had performance issues for some years,” says Richardson.

She rates A.C. Moore a “hold” in her May 8 research report, citing its “strong consumer and industry following.” But her upbeat outlook on this one company is tempered by the broader environment for crafts, which she says shows weakness.

Rag Shops Inc. was formed in April 1991, but traces its history to a number of smaller subsidiaries that operated retail stores as far back as 1963.

Even in the 1990s, Rag Shops exhibited erratic performance, posting a $941,517 profit on $90.6 million of sales in fiscal 1998, only to see its net income plunge to $401,623 on $94.8 million of sales the next year. In fiscal 2003, the company’s last final full-year filing with the Securities and Exchange Commission, Rag Shops reported a $705,395 loss on sales of $115.5 million.

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