A C MOORE ARTS & CRAFTS INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

	(Mark One)

		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
		THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2004

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 charter)

Pennsylvania				22-3527763

(State or other jurisdiction of				(I.R.S. Employer
incorporation or organization)				Identification No.)

500 University Court, Blackwood, NJ 08012

(Address of principal executive offices) (Zip Code)

(856) 228-6700

(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.

Yes No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes 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 6, 2004

Common Stock, no par value		19,496,015

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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, 2004	3
	and December 31, 2003

	Consolidated Statements of Income for the three and six	4
	month periods ended June 30, 2004 and 2003

	Consolidated Statements of Cash Flows for the six	5
	month periods ended June 30, 2004 and 2003

	Notes to Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial	8
	Condition and Results of Operations

Item 3.	Quantitative and Qualitative Disclosures About	13
	Market Risk

Item 4.	Controls and Procedures	13

PART II: OTHER INFORMATION

	Item 1.	Legal Proceedings	14

	Item 2.	Changes in Securities, Use of Proceeds and Issuer	14
		Purchases of Equity Securities

	Item 3.	Defaults Upon Senior Securities	14

	Item 4.	Submission of Matters to a Vote of Security Holders	14

	Item 5.	Other Information	14

	Item 6.	Exhibits and Reports on Form 8-K	15

SIGNATURES			16

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PART I FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

A.C. MOORE ARTS & CRAFTS, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)

		June 30, 2004		December 31, 2003

		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	34,013	$	43,700
Marketable securities		13,396		—
Inventories		123,416		121,493
Prepaid expenses and other current assets		5,592		2,962

		176,417		168,155
Non-current assets:
Marketable securities		—		14,132
Property and equipment, net		72,746		47,706
Other assets		1,768		1,801

	$	250,931	$	231,794
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	1,930	$	504
Trade accounts payable		27,537		33,558
Accrued payroll and payroll taxes		3,747		4,501
Accrued expenses		8,733		10,015
Income taxes payable		640		6,826

		42,587		55,404
Long-term liabilities:
Long-term debt		28,070		—
Deferred tax liability		5,367		4,950
Other long-term liabilities		5,241		4,729

		38,678		9,679

		81,265		65,083
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 19,467,615 shares at
June 30, 2004 and 19,357,541 at December 31, 2003		106,399		105,023

Retained earnings		63,267		61,688

		169,666		166,711

	$	250,931	$	231,794

See accompanying notes to financial statements

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A.C. MOORE ARTS & CRAFTS, INC.
CONSOLIDATED STATEMENT OF INCOME
(dollars in thousands, except per share data)
(unaudited)

		Three months ended June 30,						Six months ended June 30,

		2004			2003			2004			2003

Net sales	$	101,194		$	93,686		$	212,663		$	185,638

Cost of sales (including buying and distribution costs)		61,852			58,893			131,391			117,310

Gross margin		39,342			34,793			81,272			68,328
Selling, general and administrative expenses		38,603			32,838			78,129			65,424
Store pre-opening expenses		253			372			819			750

Income from operations		486			1,583			2,324			2,154
Net interest (income)		(123	)		(118	)		(243	)		(227	)

Income before income taxes		609			1,701			2,567			2,381
Provision for income taxes		234			650			988			910

Net income	$	375		$	1,051		$	1,579		$	1,471

Basic net income per share	$	0.02		$	0.06		$	0.08		$	0.08

Weighted average shares outstanding		19,438,837			19,033,158			19,407,541			18,939,205

Diluted net income per share	$	0.02		$	0.05		$	0.08		$	0.07

Weighted average shares outstanding plus impact of stock options		20,108,417			19,762,411			20,044,554			19,620,269

See accompanying notes to financial statements

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A.C. MOORE ARTS & CRAFTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)

	Six Months Ended June 30,

		2004			2003

Cash flows from operating activities:
Net income	$	1,579		$	1,471

Adjustments to reconcile net income to net cash (used in) operating activities:
Depreciation and amortization		3,764			3,297
Provision for deferred income taxes		417			700
Changes in assets and liabilities:
Inventories		(1,923	)		(6,386	)
Prepaid expenses and other current assets		(2,630	)		(1,860	)
Accounts payable, accrued payroll payroll taxes and accrued expenses		(8,057	)		(1,436	)
Income taxes payable		(5,304	)		(2,141	)
Other long-term liabilities		512			318
Other assets		33			30

Net cash used in operating activities		(11,609	)		(6,007	)

Cash flows from investing activities:
Capital expenditures		(28,804	)		(5,759	)
Investment in marketable securities		736			(14,189	)

Cash flows used in investing activities		(28,068	)		(19,948	)

Cash flows from financing activities:
Exercise of stock options		494			1,559
Increase in long-term debt		30,000			—
Repayment of capital leases		(504	)		(685	)

Net cash provided by financing activities		29,990			874

Net decrease in cash		(9,687	)		(25,081	)

Cash and cash equivalents at beginning of period		43,700			61,584

Cash and cash equivalents at end of period	$	34,013		$	36,503

See accompanying notes to financial statements

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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 84 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, 2003. 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 presentation of the interim financial statements. In the opinion of management, all such adjustments are of a normal and recurring nature.

(2) Management Estimates

The preparation of these consolidated financial statements in conformity with generally accepted accounting principles 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, 2004 and 2003 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.

(3) 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.

(4) Change in Accounting Principle

For all vendor contracts entered into or modified after January 1, 2003, the Company has adopted the Emerging Issues Task Force (EITF) 02-16, Accounting by a Customer (including a Reseller) for Cash Consideration Received from a Vendor. EITF 02-16 addresses the accounting for cash consideration received by a customer from a vendor (e.g., slotting fees, cooperative advertising payments, buydowns) and rebates or refunds from a vendor that is payable only if the customer completes a specified cumulative level of purchases or remains a customer for a specified time period. The change in accounting means that vendor monies which support the Company’s advertising programs are now being recorded as a reduction in the cost of inventory, and are recognized as a reduction of cost of goods sold when the inventory is sold. Previously, they were accounted for as an offset to advertising costs. This accounting change results in a timing difference as to when these monies are recognized in the Company’s income statement. The prospective adoption of EITF 02-16 reduced the Company’s second quarter net income by $0.6 million or $0.03 per share and the six months net income by $1.7 million or $0.08 per share. In the second quarter, the change increased gross margin by $2.0 million, increased selling, general and administrative costs by $3.1 million, and decreased inventory by $1.1 million. For the six months, the change increased gross margin by $3.1 million, increased selling, general and administrative costs by $5.8 million, and decreased inventory by $2.7 million.

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(5) Stock-Based Compensation

The Company accounts for its employee stock options using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25). Compensation cost for stock options is measured as the excess of the quoted market price of the Company’s stock at the date of grant over the amount an employee must pay to acquire the stock.

Had compensation cost for the Company’s stock-based compensation plan been determined based on the fair value at the grant date for awards under those plans, consistent with the requirements of SFAS No. 123, “Accounting for Stock-Based Compensation,” net income and earnings per share would have been reduced to the following pro-forma amounts:

			Three Months Ended					Six Months Ended
			June 30,					June 30,

			2004			2003		2004		2003

Net income	As reported	$	375,000		$	1,051,000	$	1,579,000	$	1,471,000
	Compensation cost, net		433,000			277,000		872,000		554,000
	Pro forma		(58,000	)		774,000		707,000		917,000

Basic earnings per share	As reported	$	.02		$	.06	$	.08	$	.08
	Pro forma		.00			.04		.04		.05

Diluted earnings per share	As reported	$	.02		$	.05	$	.08	$	.07
	Pro forma		.00			.04		.04		.05

The pro forma results may not be representative of the effects on reported operations for future years. The fair value of the options was calculated using a Black-Scholes options pricing model with the following weighted-average assumptions: risk-free interest rate of 3.2% for 2003, 4.1% for 2002, 5.1% for 2001, 6.3% for 2000 and; no dividend yield; and a weighted average expected life of the options of 4.5 years for 2003 and seven years for 2002, 2001 and 2000. In accordance with the provisions of SFAS No. 123 the expected stock price volatility was 56.0% for 2003, 45.2% for 2002, 48.4% for 2001, and 46.6% for 2000.

The weighted average shares outstanding includes the impact of stock options in the amount of 669,580 and 729,253 for the second quarter of 2004 and 2003, respectively, and 637,013 and 681,064 for the first six months of 2004 and 2003, respectively. The number of options excluded from the calculation because the options’ exercise price was greater than the average market price of the common shares was 315,350 shares in the first six months of 2004 and 306,350 shares in both the second quarter and six months of 2003. No shares were excluded from the calculations for the three months ended June 30, 2004.

(6) Long-Term Debt

On October 28, 2003 we signed two mortgage agreements with Wachovia Bank relating to the new corporate offices and distribution center. The mortgages totaling $30.0 million, all of which was outstanding at June 30, 2004, are secured by land, building, and equipment. Of the $30 million, $22.5 million is repayable over 15 years and $7.5 million is repayable over 7 years. Monthly payments totaling $214,000 are anticipated to start in October 2004. 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 certain financial covenants including those relating to tangible net worth, funded debt and current ratio. The Company was in compliance with these agreements at June 30, 2004.

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ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 EITF Issue 02-16, customer demand, the effect of economic conditions, the impact of adverse 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, supply constraints or difficulties, the effectiveness of advertising strategies and the impact of the threat of terrorist attacks and war. 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 the heading “Cautionary Statement Relating to Forward-Looking Statements” in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission.

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.

Starting in 2004, vendor monies which support our advertising programs are now being recorded as a reduction in the cost of inventory, and are being recognized as a reduction to cost of goods sold when the inventory is sold. Through 2003, they were accounted for as an offset to advertising costs. This accounting change results in a timing difference as to when these monies are recognized in our income statement. The accounting change related to the adoption of EITF 02-16 reduced our second quarter net income by $0.6 million or $0.03 per share. For the six months, the accounting change reduced our net income by $1.7 million or $0.08 per share.

The Financial Accounting Standards Board is working on a project to develop a new standard for accounting for stock-based compensation. Tentative decisions by the FASB indicate that expensing of stock options will be required beginning January 1, 2005. The FASB issued an exposure draft, which is subject to public comment, in the first quarter 2004 and expects to issue its final standard in the second half of 2004.

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Subsequent event:

On July 27, 2004 a section of the roof on the Company’s Blackwood, NJ warehouse and corporate headquarters facility collapsed. The facility employs over 150 team members, none of whom were injured in the incident.

At the time of the incident, the Company had been in the process of constructing a new distribution center in Winslow Township, NJ, less than 9 miles away from the Blackwood facility and the move to the Winslow facility was underway. The move of the offices was expedited and completed on August 4^th.

The damage to the Blackwood facility was such that the Company was unable to access inventory in the entire building for one week. At the time of the incident, the facility was holding an estimated $15.0 million of inventory. As of August 6, 2004, $2.5 million of the inventory is still unavailable as approximately 25% of the building is unsafe, and an additional $4.2 million in inventory is currently being relocated to the new distribution center. The remaining inventory in the Blackwood facility is available for shipping to the stores as required.

Two-thirds of the Company’s merchandise in its stores is delivered directly from vendors without going through the Company’s distribution facility, and the Company believes that any disruption in the supply of merchandise to the stores due to the unavailability of Company inventory is temporary. As a result, the Company believes there could be some impact on sales for several weeks but, as management believes the Company is adequately covered by insurance, they anticipate that there will be no material adverse financial impact.

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,

	2004		2003		2004		2003

Net sales	100.0	%	100.0	%	100.0	%	100.0	%
Cost of sales	61.1	%	62.9	%	61.8	%	63.2	%

Gross margin	38.9	%	37.1	%	38.2	%	36.8	%
Selling, general and administrative expenses	38.1	%	35.0	%	36.7	%	35.2	%
Store pre-opening expenses	0.3	%	0.4	%	0.4	%	0.4	%

Income from operation	0.5	%	1.7	%	1.1	%	1.2	%
Net interest (income) expense	(0.1	)%	(0.1	)%	(0.1	)%	(0.1	)%

Income before income taxes	0.6	%	1.8	%	1.2	%	1.3	%
Income tax expense	0.2	%	0.7	%	0.5	%	0.5	%