UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2006
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number: 000-23157
A.C. MOORE ARTS & CRAFTS, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 22-3527763
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
130 A.C. Moore Drive, Berlin, NJ 08009
(Address of principal executive offices) (Zip Code)
(856) 768-4930
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if
changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [_] No
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
[_] Large accelerated filer [X] Accelerated filer [_] Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
[_] Yes [X] No
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
CLASS OUTSTANDING AT AUGUST 4, 2006
Common Stock, no par value 19,857,896
A.C. MOORE ARTS & CRAFTS, INC.
TABLE OF CONTENTS
PAGE
NUMBER
------
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of June 30, 2006,
December 31, 2005 and June 30, 2005..................... 1
Consolidated Statements of Operations for the three and
six month periods ended June 30, 2006 and 2005.......... 2
Consolidated Statements of Cash Flows for the six month
periods ended June 30, 2006 and 2005.................... 3
Notes to Consolidated Financial Statements................. 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 16
Item 4. Controls and Procedures....................................... 16
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................. 18
Item 1A. Risk Factors.................................................. 18
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds... 18
Item 3. Defaults Upon Senior Securities............................... 18
Item 4. Submission of Matters to a Vote of Security Holders........... 19
Item 5. Other Information............................................. 19
Item 6. Exhibits...................................................... 19
SIGNATURES........................................................................ 20
i
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
A.C. MOORE ARTS & CRAFTS, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
June 30, December 31, June 30,
2006 2005 2005
----------- ------------ -----------
(unaudited) (unaudited)
ASSETS
Current assets:
Cash and cash equivalents ..................................... $ 24,716 $ 57,748 $ 22,229
Marketable securities ......................................... -- 5,224 14,237
Inventories ................................................... 176,068 152,646 154,019
Prepaid expenses and other current assets ..................... 5,688 6,900 6,567
Prepaid income taxes .......................................... 2,134 -- 3,946
Deferred tax asset ............................................ 981 734 258
-------- -------- --------
209,587 223,252 201,256
Non current assets:
Property and equipment, net ................................... 91,834 88,098 83,060
Other assets .................................................. 1,390 1,407 1,398
-------- -------- --------
$302,811 $312,757 $285,714
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt ............................. $ 2,571 $ 2,571 $ 2,571
Trade accounts payable ........................................ 41,002 46,445 34,432
Accrued payroll and payroll taxes ............................. 2,480 3,928 4,329
Accrued expenses .............................................. 9,939 10,044 6,211
Income taxes payable .......................................... -- 1,679 --
-------- -------- --------
55,992 64,667 47,543
-------- -------- --------
Non current liabilities:
Long-term debt ................................................ 22,929 24,215 25,500
Deferred tax liability ........................................ 7,430 8,039 8,076
Accrued lease liability ....................................... 17,402 17,327 15,176
-------- -------- --------
47,761 49,581 48,752
-------- -------- --------
103,753 114,248 96,295
-------- -------- --------
Shareholders' Equity:
Preferred stock, no par value, 10,000,000 shares
authorized; none issued ....................................... -- -- --
Common stock, no par value, 40,000,000 shares authorized; issued
and outstanding 19,857,896 shares at June 30, 2006, 19,816,774
at December 31, 2005 and 19,687,982 at June 30, 2005 ....... 113,451 111,383 111,133
Retained earnings ................................................ 85,607 87,126 78,286
-------- -------- --------
199,058 198,509 189,419
-------- -------- --------
$302,811 $312,757 $285,714
======== ======== ========
See accompanying notes to financial statements.
1
A.C. MOORE ARTS & CRAFTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
(unaudited)
Three months ended Six months ended
June 30, June 30,
------------------- -------------------
2006 2005 2006 2005
-------- -------- -------- --------
Net sales ..................................... $129,815 $113,489 $262,733 $236,368
Cost of sales (including buying and
distribution costs) ........................ 77,023 67,800 156,788 142,551
-------- -------- -------- --------
Gross margin .................................. 52,792 45,689 105,945 93,817
Selling, general and administrative expenses 53,185 44,766 105,029 90,610
Costs related to change in management ......... 1,811 -- 2,027 --
Store pre-opening expenses .................... 671 944 1,295 1,105
-------- -------- -------- --------
Income (loss) from operations ................. (2,875) (21) (2,406) 2,102
Interest expense ........................ 390 292 758 550
Interest (income) ....................... (317) (231) (632) (428)
-------- -------- -------- --------
Income (loss) before income taxes ............. (2,948) (82) (2,532) 1,980
Provision (benefit) for income taxes .... (1,179) (32) (1,013) 778
-------- -------- -------- --------
Net income (loss) ............................. $ (1,769) $ (50) $ (1,519) $ 1,202
======== ======== ======== ========
Basic net income (loss) per share ............. $ (0.09) $ (0.00) $ (0.08) $ 0.06
======== ======== ======== ========
Diluted net income (loss) per share ........... $ (0.09) $ (0.00) $ (0.08) $ 0.06
======== ======== ======== ========
See accompanying notes to financial statements.
2
A.C. MOORE ARTS & CRAFTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
Six months ended
June 30,
-------------------
2006 2005
-------- --------
Cash flows from operating activities:
Net income (loss) ........................................... $ (1,519) $ 1,202
Adjustments to reconcile net income to net cash (used in)
operating activities:
Depreciation and amortization ............................ 5,850 5,220
Stock based compensation ................................. 1,734 --
Disposal of assets ....................................... -- 438
Provision for (benefit of) deferred income taxes, net .... (857) --
Changes in assets and liabilities:
Inventories ........................................... (23,422) (11,187)
Prepaid expenses and other current assets ............. (922) 1,088
Accounts payable, accrued payroll, payroll taxes and
accrued expenses ................................... (6,996) (17,563)
Income taxes payable .................................. (1,679) (4,501)
Accrued lease liability ............................... 75 1,381
Other ................................................. 17 349
-------- --------
Net cash (used in) operating activities ..................... (27,719) (23,573)
-------- --------
Cash flows from investing activities:
Capital expenditures .................................. (9,586) (5,499)
Proceeds from maturation of marketable securities ..... 5,224 3,598
Investment in marketable securities ................... -- (277)
-------- --------
Cash flows (used in) investing activities ................... (4,362) (2,178)
-------- --------
Cash flows from financing activities:
Exercise of stock options ............................. 216 838
Tax benefit of stock based compensation ............... 119 --
Repayment of long-term debt ........................... (1,286) (1,286)
-------- --------
Net cash (used in) financing activities ..................... (951) (448)
-------- --------
Net (decrease) in cash and cash equivalents ................. (33,032) (26,199)
Cash and cash equivalents at beginning of period ............ 57,748 48,428
-------- --------
Cash and cash equivalents at end of period .................. $ 24,716 $ 22,229
======== ========
See accompanying notes to financial statements.
3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) BASIS OF PRESENTATION
The consolidated financial statements included herein include the accounts of
A.C. Moore Arts & Crafts, Inc. and its wholly owned subsidiaries (collectively
the "Company"). The Company is a chain of 114 retail stores selling arts and
crafts merchandise. The stores are located throughout the eastern United States.
These financial statements have been prepared by management without audit and
should be read in conjunction with the consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2005. Due to the seasonality of the Company's business, the
results for the interim periods are not necessarily indicative of the results
for the year. The accompanying consolidated financial statements reflect, in the
opinion of management, all adjustments necessary for a fair statement of the
interim financial statements. In the opinion of management, all such adjustments
are of a normal and recurring nature. On January 1, 2006, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 123(R), "Share-Based
Payment."
In July 2006, the Financial Accounting Standards Board ("FASB") issued Financial
Accounting Standards Board Interpretation ("FIN") No. 48, "Accounting for
Uncertainty in Income Taxes." FIN 48 is an interpretation of Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in an enterprise's tax return. This interpretation also
provides guidance on the derecognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition of tax positions. The
recognition threshold and measurement attribute is part of a two step tax
position evaluation process prescribed in FIN 48. FIN 48 is effective after the
beginning of an entity's first fiscal year that begins after December 15, 2006.
The Company will adopt FIN 48 as of January 1, 2007, and is currently evaluating
the impact to the Company's consolidated financial statements.
(2) COSTS RELATED TO CHANGE IN MANAGEMENT
On June 1, 2006 the Company appointed a new Chief Executive Officer to replace
the previous Chief Executive Officer who retired June 1, 2006. In June 2006, the
Company also announced the retirement of its Chief Financial Officer, effective
July 31, 2006, and its Executive Vice President, Merchandising, effective June
30, 2006. In connection with these and other similar changes, effective July 31,
2006, the Company incurred costs of $1.8 million and $2.0 million in the three
and six month periods ended June 30, 2006, respectively, including severance
costs relating to departing executives as well as the recruitment costs for new
executives. It is anticipated that the Company will continue to incur additional
expenses of this nature as it implements various other changes.
(3) STOCK-BASED COMPENSATION
The Company has two stock option plans under which the Company may grant up to
3,500,000 shares of common stock. Stock options expire ten years from the date
of grant and vest ratably over a three-year period. Shares available for future
grants under the plans amounted to 487,508 at June 30, 2006.
4
On January 1, 2006 the Company adopted SFAS No. 123(R), "Share-Based Payment,"
requiring the recognition of compensation expense in the Consolidated Statement
of Income related to the fair value of its employee share-based options. SFAS
No. 123(R) revises SFAS No. 123, "Accounting for Stock-Based Compensation," and
supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS
No. 123(R) is supplemented by SEC Staff Accounting Bulletin ("SAB") No. 107. SAB
No. 107 expresses the SEC staff's views regarding the interaction between SFAS
No. 123(R) and certain SEC rules and regulations including the valuation of
share-based payment arrangements.
The Company will recognize the cost of all employee stock options on a
straight-line attribution basis over their respective vesting periods, net of
estimated forfeitures. The Company has selected the modified prospective method
of transition; accordingly, prior periods have not been restated. Prior to
adopting SFAS No. 123(R), the Company applied APB Opinion No. 25, and related
interpretations in accounting for its stock-based compensation plans. Subsequent
to the Company's initial public offering in 1997, employee stock options were
granted at the grant date market price. Accordingly, before January 1, 2006, no
compensation cost was recognized for stock option grants. Under the modified
prospective method, compensation expense will be recorded for the unvested
portion of previously issued awards that remain outstanding at January 1, 2006
using the same estimate of the grant date fair value and the same attribution
method used to determine the pro forma disclosure under SFAS No. 123.
The Company determines fair value of such awards using the Black-Scholes options
pricing model with the following weighted-average assumptions:
2006 2005 2004 2003
----- ----- ------ ------
Average fair value of options granted... $8.90 $9.79 $11.15 $12.99
Risk free interest rate................. 5.0% 4.4% 3.8% 3.2%
Dividend yield.......................... -- -- -- --
Average expected life................... 6.0 yrs 5.0 yrs 4.9 yrs 4.5 yrs
Expected stock price volatility...... 44.4% 38.9% 54.9% 56.0%
Expected volatilities were based on a blend of historical and implied
volatilities of our common stock for 2006 and 2005, and on historical
volatilities for 2004 and 2003; the expected life represents the weighted
average period of time that options granted are expected to be outstanding
giving consideration to vesting schedules and our historical exercise patterns;
and the risk-free rate is based on the U.S. Treasury yield curve in effect at
the time of grant for periods corresponding with the expected life of the
option.
For the first half of 2006, the Company recognized $1,734,000 of share-based
compensation expense. Of this amount $1,584,000 was included as a component of
selling, general and administrative expense and $150,000 was included in costs
related to a change in management. The effect on net income was $621,000 or $.03
per diluted share in the second quarter and $1,040,000 or $.05 per share in the
first six months of 2006.
Prior to January 1, 2006, the Company accounted for stock-based awards to
employees using the intrinsic value method in accordance with APB Opinion No.
25, "Accounting for Stock Issued to Employees." The following table illustrates
the effect on first half and second-quarter 2005 net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123, as amended by SFAS No. 148:
5
Six Months Ended June 30, 2005 Three Months Ended June 30, 2005
(in thousands except per share data) (in thousands except per share data)
-------------------------------------- --------------------------------------
Stock-Based Stock-Based
Compensation Compensation
As Reported Cost Pro forma As Reported Cost Pro forma
----------- ------------ --------- ----------- ------------ ---------
Income (loss) from
operations................. $2,102 $1,560 $ 542 $ (21) $ 778 $ (799)
Income (loss) before income
taxes ..................... 1,980 1,560 420 (82) 778 (860)
Net Income (loss)............. 1,202 947 255 (50) 472 (522)
Basic net income (loss) per
share...................... 0.06 0.05 $0.01 (0.00) (0.02) (0.03)
Diluted net income (loss) per
share...................... $ 0.06 $ 0.05 $0.01 $(0.00) $(0.02) $(0.03)
Activity in the Company's stock option plans for the first half of 2006 was as
follows:
Weighted
Average
Outstanding at beginning of year Options Exercise Price
-------------------------------- --------- --------------
Activity: 1,485,067 $16.87
Granted 160,000 17.74
Forfeited 10,348 22.72
Exercised 41,122 5.21
--------- ------
Outstanding at end of period 1,593,597 $17.31
========= ======
The aggregate intrinsic value of stock options outstanding at June 30, 2006 was
$5.2 million, all of which related to vested awards. Intrinsic value for stock
options is calculated based on the exercise price of the underlying awards and
the quoted price of the Company's common stock as of the reporting date where
there is positive value. The total market value at date of exercise in excess of
grant price of options exercised during the first half of 2006 was $460,000.
As of June 30, 2006, there was $3.9 million of total unrecognized compensation
cost related to nonvested share-based compensation arrangements granted under
the Company's stock options plans. That cost is expected to be recognized over
the next 26 months.
6
The following table summarizes information about stock options outstanding at
June 30, 2006.
STOCK OPTIONS OUTSTANDING STOCK OPTIONS EXERCISABLE
--------------------------------------------- -------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING LIFE AVERAGE AVERAGE
EXERCISE PRICES SHARES (YEARS) EXERCISE PRICE SHARES EXERCISE PRICE
--------------- --------- ---------------- -------------- -------- --------------
2.88-4.50 321,309 2.8 $ 3.77 321,309 $ 3.77
7.69-8.32 140,636 3.9 8.10 140,636 8.10
17.74 160,000 9.9 17.74 0 --
19.11-21.95 450,144 7.0 20.35 319,221 19.70
23.51-27.15 521,508 8.0 25.38 199,642 26.68
--------- --- ------ ------- ------
1,593,597 6.5 $17.31 980,808 $14.24
========= === ====== ======= ======
(4) MANAGEMENT ESTIMATES
The preparation of these consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of expenses during the reported period and related
disclosures. Significant estimates made as of and for the three and six month
periods ended June 30, 2006 and 2005 include provisions for shrinkage,
capitalized buying, warehousing and distribution costs related to inventory, and
markdowns of merchandise inventories. Actual results could differ materially
from those estimates.
(5) MARKETABLE SECURITIES
Marketable securities represent investments in fixed financial instruments, are
classified as held-to-maturity and recorded at amortized cost. Securities with
maturities in excess of 12 months are classified as long-term.
(6) INVENTORIES
Inventories, which consist of general consumer merchandise held for sale, are
stated at the lower of cost or market. The cost of store inventories is
determined by the retail inventory method. Warehouse inventories are stated at
cost determined on a first-in, first-out basis. The Company includes as
inventoriable costs certain indirect costs, such as purchasing and receiving
costs, inbound freight, duties related to import purchases, internal transfer
costs and warehousing costs. The Company records vendor monies which support its
advertising programs as a reduction in the cost of inventory, and are recognized
as a reduction of cost of goods sold when the inventory is sold.
7
(7) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is provided on a
straight-line basis over the estimated useful lives of the assets. Buildings and
building improvements are depreciated over periods of twenty to forty years,
furniture, fixtures and equipment are depreciated over periods of five to ten
years and leasehold improvements are depreciated over the shorter of their
estimated useful lives or the term of the related lease.
(8) LONG-TERM DEBT
The Company maintains two mortgage agreements with Wachovia Bank on its
corporate offices and distribution center of which $25.5 million and $26.7
million was outstanding at June 30, 2006 and December 31, 2005, respectively.
The mortgages are secured by land, building, and equipment. Of the original
$30.0 million in mortgages, $22.5 million ($19.8 million at June 30, 2006) is
repayable over 15 years and $7.5 million ($5.7 million at June 30, 2006) is
repayable over 7 years. Monthly payments are $214,000. The mortgages bear
interest at rates that will vary between LIBOR plus 85 basis points and LIBOR
plus 135 basis points, depending on the debt service coverage ratio and the
length of the mortgage payment. The Company has the option of fixing the
interest rate at any time. The mortgages contain covenants that, among other
things, restrict the Company's ability to incur additional indebtedness or
guarantee obligations in excess of $8.0 million, engage in mergers or
consolidations, dispose of assets, make acquisitions requiring a cash outlay in
excess of $10.0 million, make loans or advances in excess of $1.0 million, or
change the nature of its business. The Company is restricted in capital
expenditures, paying dividends and making other distributions unless certain
financial covenants are maintained including those relating to tangible net
worth, funded debt and a current ratio. The mortgages also define various events
of default, including cross default provisions, defaults for any material
judgments or a change in control. At June 30, 2006 the Company was in compliance
with these agreements.
(9) REVENUE RECOGNITION
The Company recognizes revenue at the time of sale of merchandise to its
customers, or if the merchandise is custom framing, at the time of delivery of
the finished product. The value of point of sale coupons, which have a very
limited life, and other discounts that result in a reduction of the price paid
by the customer are recorded as a reduction of sales. Sales returns, which are
reserved for based on historical experience, are provided for in the period that
the related sales are recorded. Proceeds from the sale of gift cards are
recorded as gift card liability and recognized as revenue when redeemed by the
holder.
(10) INSURANCE CLAIMS
The Company records any insurance claim receivable based upon its net realizable
value when the amounts are estimable and the recovery is probable. Gains on
recovery of inventory in excess of cost are recognized in gross margin.
(11) INCOME TAXES
The Company's effective tax rate for the first half of 2006 was 40.0%, compared
to 39.3% for the first half of 2005. This is the result of an expected tax rate
of 38.0% for the year ended December 31, 2006 plus the expected impact of
accounting for incentive stock options (ISOs) under SFAS No. 123(R). Tax
benefits relating to ISOs are recognized in future periods when and if
disqualifying dispositions occur.
8
The effective tax rate was 40.0% for the second quarter of 2006 compared to
39.0% for the second quarter of 2005.
(12) EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -----------------
2006 2005 2006 2005
------- -------- ------- -------
(in thousands, except per share data)
Net Income (loss) ........................ $(1,769) $ (50) $(1,519) $ 1,202
======= ======= ======= =======
Weighted average shares:
Basic ................................. 19,857 19,743 19,847 19,709
Incremental shares from assumed
exercise of stock options .......... -- -- -- 477
------- ------- ------- -------
Diluted ............................... 19,857 19,743 19,847 20,186
======= ======= ======= =======
Basic net income (loss) per share ........ $ (0.09) $ (0.00) $ (0.08) $ 0.06
======= ======= ======= =======
Diluted net income (loss) per share ...... $ (0.09) $ (0.00) $ (0.08) $ 0.06
======= ======= ======= =======
Stock options excluded from calculation
because exercise price was greater than
average market price .................. 1,132 0 1,132 0
------- ------- ------- -------
Potentially dilutive shares excluded from
calculation as the result would be
anti-dilutive ......................... 462 491 462 0
------- ------- ------- -------
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following discussion and analysis contains certain forward-looking
statements. These forward-looking statements do not constitute historical facts
and involve risks and uncertainties. Actual results could differ materially from
those referred to in the forward-looking statements due to a number of factors,
including, but not limited to, the following: the impact of the adoption of SFAS
No. 123(R) (as defined below), customer demand and trends in the arts and crafts
industry, related inventory risks due to shifts in customer demand, the effect
of economic conditions and rising gasoline prices, the impact of unfavorable
weather conditions, the impact of competitors' locations or pricing, the
availability of acceptable real estate locations for new stores, difficulties
with respect to new information system technologies, difficulties in
implementing measures to reduce costs and expenses, supply constraints or
difficulties, the effectiveness of advertising strategies, the impact of the
threat of terrorist attacks and war, the costs associated with a change in
senior management and our ability to maintain an effective system of internal
control over financial reporting. For additional information concerning factors
that could cause actual results to differ materially from the information
contained herein, reference is made to the information under Part I, "Item 1A.
Risk Factors" in our Annual Report on Form 10-K for the year ended December 31,
2005 as filed with the Securities and Exchange Commission (the "SEC"), as
updated in this Quarterly Report on Form 10-Q under Part II, "Item 1A. Risk
Factors."
Due to the importance of our peak selling season, which includes Fall/Halloween,
Thanksgiving and Christmas, the fourth quarter has historically contributed, and
we expect it will continue to contribute, disproportionately to our
profitability for the entire year. As a result, our quarterly results of
operations may fluctuate. In addition, results of a period shorter than a full
year may not be indicative of results expected for the entire year.
Our quarterly results of operations also may fluctuate based upon such factors
as the length of holiday seasons, the date on which holidays fall, the number
and timing of new store openings, the amount of store pre-opening expenses, the
amount of net sales contributed by new and existing stores, the mix of products
sold, the amount of sales returns, the timing and level of markdowns and other
competitive factors.
CHANGE IN ACCOUNTING: STOCK-BASED COMPENSATION
On January 1, 2006, we adopted SFAS No. 123(R), "Share-Based Payment" ("SFAS No.
123(R)") requiring the recognition of compensation expense in the consolidated
statement of income related to the fair value of our employee share-based
options. SFAS No. 123(R) revises SFAS No. 123, "Accounting for Stock-Based
Compensation," and supercedes APB Opinion No. 25, "Accounting for Stock Issued
to Employees" ("APB Opinion No. 25"). SFAS No. 123(R) is supplemented by SEC
Staff Accounting Bulletin ("SAB") No. 107. SAB No. 107 expresses the SEC staff's
views regarding the interaction between SFAS No. 123(R) and certain SEC rules
and regulations including the valuation of share-based payment arrangements.
We have two stock option plans under which we may grant up to 3,500,000 shares
of common stock. Stock options expire ten years from the date of grant and vest
ratably over a three-year period. Shares available for future grants under the
plans amounted to 487,508 at June 30, 2006.
10
SFAS No. 123(R) requires us to measure compensation cost for all outstanding
unvested share-based awards at fair value and recognize compensation over the
service period for awards expected to vest. The estimation of stock awards that
will ultimately vest requires judgment, and to the extent actual results differ
from our estimates, such amounts will be recorded as a cumulative adjustment in
the period estimates are revised. We consider many factors when estimating
expected forfeitures, including types of awards, employee class and historical
experience. Actual results may differ substantially from these estimates.
We will recognize the cost of all employee stock options on a straight-line
attribution basis over their respective vesting periods, net of estimated
forfeitures. We have selected the modified prospective method of transition;
accordingly, prior periods have not been restated. Prior to adopting SFAS No.
123(R), we applied APB Opinion No. 25, and related interpretations in accounting
for our stock-based compensation plans. Subsequent to our initial public
offering in 1997, employee stock options were granted at the grant date market
price. Accordingly, before January 1, 2006, no compensation cost was recognized
for stock option grants. Under the modified prospective method, compensation
expense will be recorded for the unvested portion of previously issued awards
that remain outstanding at January 1, 2006 using the same estimate of the grant
date fair value and the same attribution method used to determine the pro forma
disclosure under SFAS No. 123.
We recognized share-based compensation expense of $1,035,000 in the second
quarter and $1,734,000 in the first half of 2006. We also recognized a deferred
tax asset of $406,000 in the first half of 2006. The effect on net income was
$621,000, or $.03 per diluted share in the second quarter of 2006 and $1,040,000
or $.05 per share in the first six months of 2006.
Prior to January 1, 2006, we accounted for stock-based awards to employees using
the intrinsic value method in accordance with APB Opinion No. 25. The following
table illustrates the effect on first-half and first quarter 2005 net income and
earnings per share if we had applied the fair value recognition provisions of
SFAS No. 123, as amended by SFAS No. 148:
Six Months Ended June 30, 2005 Three Months Ended June 30, 2005
-------------------------------------- --------------------------------------
(in thousands except per share data) (in thousands except per share data)
Stock-Based Stock-Based
Compensation Compensation
As Reported Cost Pro forma As Reported Cost Pro forma
----------- ------------ --------- ----------- ------------ ---------
Income (loss) from
operations .............. $2,102 $1,560 $ 542 $ (21) $ 778 $ (799)
Income (loss) before
income taxes ............ 1,980 1,560 420 (82) 778 (860)
Net Income
(loss) .................. 1,202 947 255 (50) 472 (522)
Basic net income (loss)
per share ............... 0.06 0.05 $0.01 (0.00) (0.02) (0.03)
Diluted net income (loss)
per share ............... $ 0.06 $ 0.05 $0.01 $(0.00) $(0.02) $(0.03)
11
As of June 30, 2006, there was $3.9 million of total unrecognized compensation
cost related to nonvested share-based compensation arrangements granted under
our stock option plans. That cost is expected to be recognized over the next 26
months.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, selected statement of
operations data expressed as a percentage of net sales and the number of stores
open at the end of each such period:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
2006 2005 2006 2005
----- ----- ----- -----
Net sales...................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales.................................. 59.3 59.7 59.7 60.3
----- ----- ----- -----
Gross margin................................... 40.7 40.3 40.3 39.7
Selling, general and administrative expenses... 41.0 39.5 40.0 38.3
Costs related to change in management.......... 1.4 0.0 0.7 0.0
Store pre-opening expenses..................... 0.5 0.8 0.5 0.5
----- ----- ----- -----
Income (loss) from operations.................. (2.2) (0.0) (0.9) 0.9
Net interest expense........................... 0.1 0.0 0.1 0.1
----- ----- ----- -----
Income (loss) before income taxes.............. (2.3) (0.0) (1.0) 0.8
Provision (benefit) for income taxes........... (0.9) (0.0) (0.4) 0.3
----- ----- ----- -----
Net income (loss).............................. (1.4)% (0.0)% (0.6)% 0.5%
===== ===== ===== =====
Number of stores open at end of period......... 114 98
THREE MONTHS ENDED JUNE 30, 2006 COMPARED TO THREE MONTHS ENDED JUNE 30, 2005
NET SALES. Net sales increased $16.3 million or 14.0% to $129.8 million in the
three months ended June 30, 2006 from $113.5 million in the comparable 2005
period. This increase is comprised of (i) net sales of $3.3 million from stores
opened in 2006, (ii) net sales of $9.7 million from stores opened in 2005 not
included in the comparable store base, and (iii) a comparable store sales
increase of $3.3 million or 3.0%. For the three months ended June 30, 2006, in
comparable stores the number of customer transactions were flat and the average
sale increased by 3.0% compared with the same period in 2005.
GROSS MARGIN. Gross margin is net sales minus the cost of merchandise which
includes purchasing and receiving costs, inbound freight, duties related to
import purchases, internal transfer costs and warehousing costs. Gross margin as
a percent of net sales was 40.7% for the three months ended June 30, 2006, and
40.3% for the three months ended June 30, 2005. The mix of merchandise sold
increased margins by 0.3% and the improved productivity in our warehouse
increased margins by 0.1% as a result of a reduction in our distribution costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses include (a) direct store level expenses, including rent
and related operating costs, payroll, advertising,
12
depreciation and other direct costs, and (b) corporate level costs not directly
associated with or allocable to cost of sales, including executive salaries,
accounting and finance, corporate information systems, office facilities and
other corporate expenses.
Selling, general and administrative expenses, as a percent of sales, increased
1.5% in the three months ended June 30, 2006 to 41.0% from 39.5% in the three
months ended June 30, 2005. In 2006 we began expensing stock-based compensation
as required by SFAS No.123(R). This expense totaled $1,035,000 for the second
quarter, of which $885,000 was included in selling, general and administrative
expenses. Stock based compensation accounted for 0.7% for the increase in
selling, general and administrative expenses. Costs associated with workers
compensation, general liability claims and medical expenses, were 0.8% greater
in the second quarter of 2006 than in 2005.
COSTS RELATED TO CHANGE IN MANAGEMENT. On June 1, 2006 we appointed a new Chief
Executive Officer to replace the previous Chief Executive Officer who retired
June 1, 2006. In June 2006, we also announced the retirement of our Chief
Financial Officer, effective July 31, 2006, and our Executive Vice President,
Merchandising, effective June 30, 2006. In connection with these and other
similar changes, we incurred $1.8 million in costs including severance and stock
compensation expense costs relating to departing executives as well as the
recruitment costs for new executives. It is anticipated that we will continue to
incur additional expenses of this nature as we implement various other changes.
STORE PRE-OPENING EXPENSES. We expense store pre-opening expenses as they are
incurred which include rent holidays prior to a store opening. Pre-opening
expenses for the one store we opened in the second quarter of 2006, and lease
costs related to the new stores which we will open later in 2006 amounted to
$671,000. In the second quarter of 2005, we incurred store pre-opening expenses
of $944,000 related to the stores opened in that quarter and lease costs related
to stores opened later in 2005.
NET INTEREST EXPENSE. In the second quarter of 2006, we had net interest expense
of $73,000 compared with net interest expense of $61,000 for the same period in
2005.
INCOME TAXES. Our tax provision rate for the second quarter of 2006 was 40.0%.
This tax provision is the result of an expected income tax rate 38.0% for the
year ended December 31, 2006 plus the expected impact of accounting for
incentive stock options ("ISOs") under SFAS No. 123(R). Tax benefits relating to
ISOs are recognized in future periods when and if disqualifying dispositions
occur. The effective tax rate was 39.0% for the three months ended June 30,
2005.
SIX MONTHS ENDED JUNE 30, 2006 COMPARED TO SIX MONTHS ENDED JUNE 30, 2005
NET SALES. Net sales increased $26.4 million or 11% to $262.7 million in the six
months ended June 30, 2006 from $236.4 million in the comparable 2005 period.
This increase is comprised of (i) net sales of $4.9 million from four stores
opened in 2006, (ii) net sales of $20.5 million from stores opened in 2005 not
included in the comparable store base, and (iii) a comparable store sales
increase of $1.0 million. For the six months ended June 30, 2006, customer
transactions in comparable stores were down 0.4% and the average sale increased
by 0.9% compared with the same period in 2005.
GROSS MARGIN. Gross margin as a percent of net sales was 40.3% for the six
months ended June 30, 2006, and 39.7% for the six months ended June 30, 2005.
The mix of merchandise sold increased margins by 0.3% and the improved
productivity in our warehouse increased margins by 0.3% as a result of a
reduction in our distribution costs.
13
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses, as a percent of sales, increased 1.7% in the six months
ended June 30, 2006 to 40.0% from 38.3% in the six months ended June 30, 2005.
Stock-based compensation totaled $1,734,000 for the six months ended June 30,
2006, of which $1,584,000 was included in selling, general and administrative
expenses. Stock- based compensation accounted for 0.6% of the increase in
selling, general and administrative expenses. Workers compensation, general
liability claims and medical costs were 0.3% greater in the first half of 2006
compared with the same period in 2005. The remainder of the increase was due to
greater first quarter advertising costs and the impact of a first quarter
comparable store sales decrease.
COSTS RELATED TO CHANGE IN MANAGEMENT. On June 1, 2006 we appointed a new Chief
Executive Officer to replace the previous Chief Executive Officer who retired
June 1, 2006. In June 2006 we also announced the retirement of our Chief
Financial Officer, effective July 31, 2006, and our Executive Vice President,
Merchandising, effective June 30, 2006. In connection with these and other
similar changes in the first half of 2006 we incurred $2.0 million in costs
including severance costs and stock compensation expense relating to departing
executives as well as the recruitment costs for new executives. It is
anticipated that we will continue to incur additional expenses of this nature as
we implement various other changes.
STORE PRE-OPENING EXPENSES. Pre-opening expenses for the five stores we opened
in the first six months of 2006, and lease costs related to the new stores which
we will open later in 2006 amounted to $1,295,000. In the first six months of
2005, we incurred store pre-opening expenses of $1,105,000 related to the stores
opened and lease costs related to stores opened later in 2005.
NET INTEREST EXPENSE. In the first six months of 2006, we had net interest
expense of $126,000 compared with net interest expense of $122,000 for the same
period in 2005.
INCOME TAXES. Our tax provision rate for the first half of 2006 was 40.0%. This
tax provision is the result of an expected income tax rate 38.0% for the year
ended December 31, 2006 plus the expected impact of accounting for incentive
stock options ("ISOs") under SFAS No. 123(R). Tax benefits relating to ISOs are
recognized in future periods when and if disqualifying dispositions occur. The
effective tax rate was 39.3% for the six months ended June 30, 2005.
LIQUIDITY AND CAPITAL RESOURCES
Our cash is used primarily for working capital to support inventory requirements
and capital expenditures, pre-opening expenses and beginning inventory for new
stores. In recent years, we have financed our operations and new store openings
primarily with cash from operations and the net proceeds we received from a
secondary offering in 2002. In the first half of 2004 we borrowed $30.0 million
under two mortgage agreements we have with Wachovia Bank to finance the
construction of our corporate offices and distribution center.
At June 30, 2006 and December 31, 2005, our working capital was $153.6 million
and $158.6 million, respectively. Cash used in operations was $27.7 million for
the six months ended June 30, 2006 principally as a result of an increase in
inventories of $23.4 million due to expected seasonal increases and to support
new stores. For the six months ended June 30, 2005, cash used in operations was
$23.6 million, principally as a result of a seasonal increase in inventories of
$11.2 million and a seasonal decrease in accounts payable and accrued expenses
of $17.6 million.
14
Net cash used in investing activities during the three months ended June 30,
2006 was $4.4 million, including $9.6 million for capital expenditures offset by
proceeds from maturation of marketable securities of $5.2 million. In 2006, we
expect to spend approximately $19.0 million on capital expenditures, which
includes $11.0 million for new store openings, and the remainder for remodeling
existing stores, upgrading systems in existing stores, warehouse equipment and
corporate systems development. Of the $11.0 million in new store capital
expenditures, we expect to receive $1.5 million back from landlords.
We have two mortgage agreements with Wachovia Bank on our corporate offices and
distribution center of which $25.5 million was outstanding at June 30, 2006. The
mortgages are secured by land, building and equipment. Of the original $30.0
million in mortgages, $22.5 million ($19.8 million as of June 30, 2006) is
repayable over 15 years and $7.5 million ($5.7 million as of June 30, 2006) is
repayable over 7 years. Monthly payments are $214,000. The mortgages bear
interest at rates that will vary between LIBOR plus 85 basis points and LIBOR
plus 135 basis points, depending on the debt service coverage ratio and the
length of the mortgage payment. We have the option of fixing the interest rate
at any time. The mortgages contain covenants that, among other things, restrict
our ability to incur additional indebtedness or guarantee obligations in excess
of $8.0 million, engage in mergers or consolidations, dispose of assets, make
acquisitions requiring a cash outlay in excess of $10.0 million, make loans or
advances in excess of $1.0 million, or change the nature of our business. We are
restricted in capital expenditures, paying dividends and making other
distributions unless certain financial covenants are maintained including those
relating to tangible net worth, funded debt and a current ratio. The mortgages
also define various events of default, including cross default provisions,
defaults for any material judgments or a change in control. At June 30, 2006, we
were in compliance with these agreements.
We currently have a $35.0 million line of credit with Wachovia Bank which
expires on May 31, 2007. Borrowings under this line will bear interest at LIBOR
plus 95 basis points and are subject to the same covenants as the mortgages
described above. At June 30, 2006, there were no borrowings outstanding under
this agreement.
We believe the cash generated from operations during the year and available
borrowings under the line of credit agreement will be sufficient to finance our
working capital and capital expenditure requirements for at least the next 12
months.
CRITICAL ACCOUNTING ESTIMATES
Except as described below, our accounting policies are fully described in Note 1
of our notes to consolidated financial statements included in our Annual Report
on Form 10-K for the year ended December 31, 2005. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions about future events that affect the
amounts reported in our consolidated financial statements and accompanying
notes. Since future events and their effects cannot be determined with absolute
certainty, actual results may differ from those estimates. Management makes
adjustments to its assumptions and judgments when facts and circumstances
dictate. The amounts currently estimated by us are subject to change if
different assumptions as to the outcome of future events were made. We evaluate
our estimates and judgments on an ongoing basis and predicate those estimates
and judgments on historical experience and on various other factors that
management believes to be reasonable under the circumstances. Management
believes the following critical accounting estimates encompass the more
significant judgments and estimates used in preparation of our consolidated
financial statements:
15
o merchandise inventories;
o impairment of long-lived assets;
o stock-based compensation under SFAS No. 123(R);
o income taxes; and
o other estimates.
Other than accounting for stock-based compensation under SFAS No. 123(R), which
is described below, the foregoing critical accounting estimates are more fully
described in our Annual Report on Form 10-K for the year ended December 31,
2005. We believe that there have been no significant changes during the three
months ended June 30, 2006 to the items that we disclosed as our critical
accounting policies and estimates in our Annual Report Form 10-K for the year
ended December 31, 2005, except as described below.
STOCK-BASED COMPENSATION EXPENSE UNDER SFAS NO. 123(R)
Effective January 1, 2006, we account for stock-based compensation in
accordance with the provisions of SFAS No. 123(R). Under the fair value
recognition provisions of SFAS No. 123(R), stock-based compensation cost is
estimated at the grant date based on the fair value of the award and is
recognized as expense ratably over the service period for awards expected to
vest. Determining the appropriate fair value model and calculating the fair
value of stock-based awards requires judgment, including estimating stock price
volatility, forfeiture rates and expected lives. For more discussion of
stock-based compensation under SFAS No. 123(R), see Note 3 in our notes to
consolidated financial statements contained in this Quarterly Report on Form
10-Q.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We invest cash balances in excess of operating requirements primarily in money
market mutual funds and to a lesser extent in interest-bearing securities with
maturities of less than two years. The fair value of our cash and equivalents at
June 30, 2006 approximated carrying value. We had no borrowings outstanding
under our line of credit at June 30, 2006. The interest rates on our mortgages
fluctuate with market rates and therefore the value of these financial
instruments will not be impacted by a change in interest rates. Based on the
amounts outstanding at June 30, 2006, the impact of a hypothetical increase or
decrease in interest rates of 10% compared with the rates in effect at June 30,
2006 would result in an increase or decrease in our interest expense of $160,000
annually, and an increase or decrease in our interest income of $112,000
annually.
ITEM 4. CONTROLS AND PROCEDURES
We carried out an evaluation, with the participation of our principal executive
officer and principal financial officer, of the effectiveness of our disclosure
controls and procedures as of June 30, 2006. Based on this evaluation, our
principal executive officer and principal financial officer concluded that, as
of June 30, 2006, our disclosure controls and procedures, as defined in Rule
13a-15(e), were effective at the reasonable assurance level, to ensure that (i)
information required to be disclosed by the issuer in the reports that it files
or submits under the Securities Exchange Act of 1934 (the "Exchange Act") is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms and (ii) information
required to be disclosed by an issuer in the reports that it files or submits
under the Exchange Act is accumulated and communicated to the issuer's
16
management including its principal executive and principal financial officers,
or persons performing similar functions, as appropriate to allow timely
decisions regarding required disclosure.
Our management carried out an evaluation, with the participation of our
principal executive officer and principal financial officer, of changes in our
internal control over financial reporting, as defined in Exchange Act Rule
13a-15(f). Based on this evaluation, our management determined that no change in
our internal control over financial reporting occurred during the quarter ended
June 30, 2006 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
17
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in
our Annual Report on Form 10-K for the year ended December 31, 2005, which could
materially affect our business, financial condition or future results. The risks
described in our Annual Report on Form 10-K for the year ended December 31, 2005
are not the only risks facing our Company. Additional risks and uncertainties
not currently known to us or that we currently deem to be immaterial also may
materially adversely affect our business, financial condition and/or operating
results.
The information presented below updates, and should be read in conjunction with,
the risks described in our Annual Report on Form 10-K for the year ended
December 31, 2005.
OUR SUCCESS DEPENDS ON KEY PERSONNEL WHOM WE MAY NOT BE ABLE TO RETAIN OR HIRE.
We are dependent on the services, abilities and experience of our senior
management team. On June 1, 2006, we appointed Rick A. Lepley as our new Chief
Executive Officer. Our Chief Financial Officer and Executive Vice President,
Merchandising retired in July 2006 and June 2006, respectively, and our
Executive Vice President, Merchandising and Marketing resigned in July 2006. We
currently have searches in process to fill these positions. There are no
assurances as to when we will find suitable candidates for these positions and
what the financial cost of their compensation packages will be. In addition, due
to competition for qualified executives, we may be required to increase the
level of compensation paid to existing and new executives, which could increase
our operating expenses.
The loss of the services of senior executives and any general instability in the
composition of our senior management team could have a negative impact on our
ability to execute on our business and operating strategy. Our business may be
impacted by the familiarity of newly appointed executives with our business, and
their abilities to develop relationships with our team members and vendors and
to implement or change our business and operating strategy.
We do not maintain any key man life insurance on any members of our senior
management team. Our success in the future will also be dependent upon our
ability to attract and retain other qualified personnel, including store
managers.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not Applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS
31.1 Certification pursuant to Rule 13a-14(a) promulgated under the Securities
Exchange Act of 1934, as amended ("Exchange Act").
31.2 Certification pursuant to Rule 13a-14(a) promulgated under the Exchange
Act.
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
A.C. MOORE ARTS & CRAFTS, INC.
Date: August 10, 2006 By: /s/ Rick A. Lepley
----------------------------------
Rick A. Lepley
Chief Executive Officer (duly
authorized officer and principal
executive officer)
Date: August 10, 2006 By: /s/ Jason Cesare
----------------------------------
Jason Cesare
Senior Vice President, Finance
(duly authorized officer and
principal financial officer)
20
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
31.1 Certification pursuant to Rule 13a-14(a) promulgated under the
Exchange Act.
31.2 Certification pursuant to Rule 13a-14(a) promulgated under the
Exchange Act.
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.