10-Q/A 1 ten-qa.txt 10-Q/A UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A (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, 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. [X] Yes [ ] No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). [X] 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 EXPLANATORY NOTE As previously disclosed in our Form 8-K filed on March 3, 2005 and in our Form 10-K for the year ended December 31, 2004, following a review of our lease-related accounting policies, we determined that our method of accounting for leasehold improvements funded by landlord incentives or allowances (tenant improvement allowances) and our method of accounting for rent holidays were not in accordance with accounting principles generally accepted in the United States of America. As a result, we have restated, by means of our Annual Report on Form 10-K for the year ended December 31, 2004, filed on March 16, 2005, our consolidated balance sheet at December 31, 2003, and our consolidated statements of income, cash flows, and shareholders' equity for the years ended December 31, 2003 and 2002. The restatement also affected periods prior to 2002. Note 2 to the financial statements included in our 2004 Form 10-K shows the impact of the restatement adjustments to retained earnings as of January 1, 2002, to reflect the impact of the restatement on periods prior to 2002. For information on the impact of the restatement on the years 2001 and 2000, reference is made to Item 6. Selected Financial Data in our 2004 Form 10-K. Concurrently with the filing of this Form 10-Q/A, we are filing quarterly reports on Form 10-Q/A for the quarterly periods March 31, 2004 and September 30, 2004 to reflect restated amounts for the first and third quarters of 2004 and the comparable interim periods in 2003. We have historically accounted for tenant improvement allowances as a reduction of the property, plant and equipment account on our balance sheet, amortized the allowances as a reduction to depreciation expense in our income statement and reflected the cash received within investing activities in our statement of cash flows. FASB Technical Bulletin 88-1 ("FTB 88-1"), "Issues Relating to Accounting for Leases," requires these allowances to be recorded as deferred rent liabilities on the consolidated balance sheets and amortized as a reduction to rent expense on the income statement. In addition, the cash received by us should have been recorded as a component of operating activities on our consolidated statements of cash flows. Depreciation of the leasehold improvement begins effective with the opening of the store as we have accounted for it in the past. However, amortization of the landlord allowance commences on the date we have the right to control the use of the leased property, which is consistent with the recording of rent expense as described below. Previously, we had commenced amortization on the date the store was opened. We have historically recognized rent holiday periods on a straight-line basis over the lease term commencing with the opening date for each store. The period during which the store was being fixtured and stocked with merchandise was excluded from the straight-line rent schedule. FASB Technical Bulletin 85-3 ("FTB 85-3"), "Accounting for Operating Leases with Scheduled Rent Increases," states that rent holidays should be recognized on a straight-line basis over the lease term, which commences on the date we have the right to control the use of the leased property. For us, this is generally one to three months prior to a store opening date. The amount of rent expensed prior to store opening will be included in "Pre-opening expenses" on our consolidated statements of income. This Amendment No. 1 on Form 10-Q/A to our quarterly report on Form 10-Q for the quarter ended June 30, 2004 ("Original Filing"), initially filed with the Securities and Exchange Commission ("SEC") on August 9, 2004, is being filed to reflect restatements of our consolidated balance sheet at June 30, 2004 and our consolidated statements of income and consolidated cash flows for the three and six month periods ended June 30, 2004 and 2003 and the notes related thereto. For a more detailed description of these restatements, see Note 2, "Restatement of Financial Statements" to the accompanying consolidated financial statements and the section entitled "Restatement" in Management's Discussion and Analysis of Financial Condition and Results of Operations contained in this Form 10Q/A. For the convenience of the reader, this Form 10-Q/A includes the Original Filing in its entirety. However, this Form 10-Q/A only amends and restates Items 1, 2, 3 and 4 of Part I of the Original Filing and i no other material information in the Original Filing is amended hereby. The foregoing items have not been updated to reflect other events concerning our business or financial condition occurring after the Original Filing or to modify or update those disclosures affected by subsequent events. In addition, pursuant to the rules of the SEC, Item 6 of Part II of the Original Filing has been amended to contain currently-dated certifications from our Chief Executive Officer and Chief Financial Officer, as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. The certifications of our Chief Executive Officer and Chief Financial Officer are attached to this Form 10-Q/A as Exhibits 31.1, 31.2 and 32, respectively. ii 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 (Restated) and December 31, 2003.....................................................................1 Consolidated Statements of Income for the three and six month periods ended June 30, 2004 and 2003 (Restated)...................................................2 Consolidated Statements of Cash Flows for the six month periods ended June 30, 2004 and 2003 (Restated).........................................................3 Notes to Consolidated Financial Statements................................................4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......9 Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................15 Item 4. Controls and Procedures....................................................................15 PART II: OTHER INFORMATION Item 1. Legal Proceedings..........................................................................16 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities ..........16 Item 3. Defaults Upon Senior Securities............................................................16 Item 4. Submission of Matters to a Vote of Security Holders........................................16 Item 5. Other Information..........................................................................16 Item 6. Exhibits and Reports on Form 8-K...........................................................17 SIGNATURES...............................................................................................18
iii PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS A.C. MOORE ARTS & CRAFTS, INC. CONSOLIDATED BALANCE SHEETS (dollars in thousands)
June 30, December 31, 2004 2003 -------------- -------------- (as restated, See Note 2) (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 75,891 51,075 Other assets 1,768 1,801 -------------- -------------- $ 254,076 $ 235,163 ============== ============== 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 4,385 3,977 Other long-term liabilities 10,836 10,523 -------------- -------------- 43,291 14,500 -------------- -------------- 85,878 69,904 -------------- -------------- 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 61,799 60,236 -------------- -------------- 168,198 165,259 -------------- -------------- $ 254,076 $ 235,163 ============== ==============
See accompanying notes to financial statements 1 A.C. MOORE ARTS & CRAFTS, INC. CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except per share data) (unaudited)
Three months ended Six months ended June 30, June 30, ------------------------------ ------------------------------ 2004 2003 2004 2003 ------------- ------------- ------------- ------------- (as restated, (as restated, (as restated, (as restated, See Note 2) See Note 2) See Note 2) See Note 2) 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 38,541 32,783 78,005 65,313 Store pre-opening expenses 380 478 968 882 ------------- ------------- ------------- ------------- Income from operations 421 1,532 2,299 2,133 Net interest (income) (123) (118) (243) (227) ------------- ------------- ------------- ------------- Income before income taxes 544 1,650 2,542 2,360 Provision for income taxes 209 631 979 903 ------------- ------------- ------------- ------------- Net income $ 335 $ 1,019 $ 1,563 $ 1,457 ============= ============= ============= ============= Basic net income per share $ 0.02 $ 0.05 $ 0.08 $ 0.08 ============= ============= ============= ============= Diluted net income per share $ 0.02 $ 0.05 $ 0.08 $ 0.07 ============= ============= ============= =============
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, ------------------------------ 2004 2003 ------------- ------------- (as restated, (as restated, See Note 2) See Note 2) Cash flows from operating activities: Net income $ 1,563 $ 1,457 Adjustments to reconcile net income to net cash (used in) operating activities: Depreciation and amortization 3,988 3,440 Provision for deferred income taxes 408 693 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 942 1,110 Other 33 30 ------------- ------------- Net cash used in operating activities (10,980) (5,093) ------------- ------------- Cash flows from investing activities: Capital expenditures (29,433) (6,673) Investment in marketable securities 736 (14,189) ------------- ------------- Cash flows used in investing activities (28,697) (20,862) ------------- ------------- 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 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 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) RESTATEMENT OF FINANCIAL STATEMENTS Subsequent to the issuance of the Company's interim consolidated financial statements for the period ended June 30, 2004, and following a review of its lease-related accounting policies, the Company's management determined that its method of accounting for leasehold improvements funded by landlord incentives or allowances (tenant improvement allowances) and its method of accounting for rent holidays were not in accordance with accounting principles generally accepted in the United States of America. As a result, the Company's management is restating its interim financial statements as of and for the quarterly period ended June 30, 2004 in this Amendment No. 1 on Form 10-Q/A. The Company has historically accounted for tenant improvement allowances as a reduction of the property, plant and equipment account on its balance sheet, amortized the allowances as a reduction to depreciation expense in its income statement and reflected the cash received within investing activities in its statement of cash flows. FASB Technical Bulletin 88-1 ("FTB 88-1"), "Issues Relating to Accounting for Leases," requires these allowances to be recorded as deferred rent liabilities on the consolidated balance sheets and amortized as a reduction to rent expense on the income statement. In addition, the cash received by the Company should have been recorded as a component of operating activities on the consolidated statements of cash flows. Depreciation of the leasehold improvement begins effective with the opening of the store as the Company has accounted for it in the past. However, amortization of the landlord allowance commences on the date the Company has the right to control the use of the leased property, which is consistent with the recording of rent expense as described below. Previously, the Company had commenced amortization on the date the store was opened. The Company has historically recognized rent holiday periods on a straight-line basis over the lease term commencing with the opening date for each store. The period during which the store was being fixtured and stocked with merchandise was excluded from the straight-line rent schedule. FASB Technical Bulletin 85-3 ("FTB 85-3"), "Accounting for Operating Leases with Scheduled Rent Increases," states that rent holidays should be recognized on a straight-line basis over the lease term, which commences on the date the Company has the right to control the use of the leased property. For our Company, this is generally one to three months prior to a store opening date. The amount of rent expensed prior to store opening will be included in "Pre-opening expenses" on the Company's consolidated statements of income. The correction of this accounting resulted in the Company recording additional deferred rent in "Accrued lease liability," additional leasehold improvements in "Property and equipment, net" and to 4 adjust "Retained earnings" on the consolidated balance sheets, as well as to correct "Pre-opening expenses" and "Selling, general and administrative expenses" in the consolidated statements of income. The following is a summary of the impact of the restatement on the consolidated statements of income for the three month and six month periods ended June 30, 2004 and 2003, the consolidated balance sheets at December 31, 2003 and June 30, 2004 and the consolidated statements of cash flows for the six month periods ended June 30, 2004 and 2003.
CONSOLIDATED STATEMENTS OF INCOME ---------------------------------------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) AS PREVIOUSLY REPORTED ADJUSTMENT AS RESTATED ------------- ------------- ------------- Three months ended June 30, 2004 Selling, general and administrative expenses .... 38,603 (62) 38,541 Store pre-opening expenses ...................... 253 127 380 Income from operations .......................... 486 (65) 421 Income before income taxes ...................... 609 (65) 544 Provision for income taxes ...................... 234 (25) 209 Net income ...................................... 375 (40) 335 Six months ended June 30, 2004 Selling, general and administrative expenses .... 78,129 (124) 78,005 Store pre-opening expenses ...................... 819 149 968 Income from operations .......................... 2,324 (25) 2,299 Income before income taxes ...................... 2,567 (25) 2,542 Provision for income taxes ...................... 988 (9) 979 Net income ...................................... 1,579 (16) 1,563 Three months ended June 30, 2003 Selling, general and administrative expenses .... 32,838 (55) 32,783 Store pre-opening expenses ...................... 372 106 478 Income from operations .......................... 1,583 (51) 1,532 Income before income taxes ...................... 1,701 (51) 1,650 Provision for income taxes ...................... 650 (19) 631 Net income ...................................... 1,051 (32) 1,019 Basic net income per share ...................... 0.06 (0.01) 0.05 Six months ended June 30, 2003 Selling, general and administrative expenses .... 65,424 (111) 65,313 Store pre-opening expenses ...................... 750 132 882 Income from operations .......................... 2,154 (21) 2,133 Income before income taxes ...................... 2,381 (21) 2,360 Provision for income taxes ...................... 910 (7) 903 Net income ...................................... 1,471 (14) 1,457
5
CONSOLIDATED BALANCE SHEETS ---------------------------------------------- (DOLLARS IN THOUSANDS) AS PREVIOUSLY REPORTED ADJUSTMENT AS RESTATED ------------- ------------- ------------- June 30, 2004 Property and equipment, net ..................... 72,746 3,145 75,891 Deferred tax liability .......................... 5,367 (982) 4,385 Other long-term liabilities ..................... 5,241 5,595 10,836 Retained earnings ............................... 63,267 (1,468) 61,799 Shareholders' equity ............................ 169,666 (1,468) 168,198 Total liabilities and shareholders' equity ...... 250,931 3,145 254,076
CONSOLIDATED STATEMENTS OF CASH FLOWS ---------------------------------------------- (DOLLARS IN THOUSANDS) AS PREVIOUSLY REPORTED ADJUSTMENT AS RESTATED ------------- ------------- ------------- Six months ended June 30, 2004 Net cash (used in) operating activities ......... (11,609) 629 (10,980) Cash flows (used in) investing activities ....... (28,068) (629) (28,697) Six months ended June 30, 2003 Net cash (used in) operating activities ......... (6,007) 914 (5,093) Cash flows (used in) investing activities ....... (19,948) (914) (20,862)
(3) 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. (4) 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. (5) 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. 6 (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 covenants that, among other things, restrict the Company's ability to incur additional indebtedness or guarantee obligations in excess of $8 million, engage in mergers or consolidations, dispose of assets, make acquisitions requiring a cash outlay in excess of $10 million, make loans or advances in excess of $1 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, 2004 the Company was in compliance with these agreements. (7) REVENUE RECOGNITION The Company recognizes revenue at the time of sale of merchandise to its customers. 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. (8) 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, ----------------------------- ----------------------------- 2004 2003 2004 2003 ------------- ------------- ------------- ------------- (as restated) (as restated) (as restated) (as restated) (in thousands, except per share data) Net Income .............................. $ 335 $ 1,019 $ 1,563 $ 1,457 ============= ============= ============= ============= Weighted average shares: Basic ................................. 19,439 19,033 19,408 18,939 Incremental shares from assumed exercise of stock option ............. 669 729 637 681 ------------- ------------- ------------- ------------- Diluted ............................... 20,108 19,762 20,045 19,620 ============= ============= ============= ============= Basic net income per share .............. $ 0.02 $ 0.05 $ 0.08 $ 0.08 ============= ============= ============= ============= Diluted net income per share ............ $ 0.02 $ 0.05 $ 0.08 $ 0.07 ============= ============= ============= ============= Stock options excluded from calculation because exercise price was greater than average market price .................. 0 306 315 306 ------------- ------------- ------------- -------------
7 (9) 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 restated)........ As reported $ 335,000 $ 1,019,000 $ 1,563,000 $ 1,457,000 Compensation cost, net 433,000 277,000 872,000 554,000 Pro forma (98,000) 742,000 691,000 903,000 Basic earnings per share........ As reported $ .02 $ .05 $ .08 $ .08 Pro forma (.01) .04 .04 .05 Diluted earnings per share...... As reported $ .02 $ .05 $ .08 $ .07 Pro forma .00 .04 .03 .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. (10) 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. In 2003 the Company recorded vendor advertising support as a reduction of selling, general and administrative expenses in the amount of $1.8 million in the second quarter and $3.8 million in the six-month period. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESTATEMENT Following a review of our lease-related accounting policies, management determined that our method of accounting for leasehold improvements funded by landlord incentives or allowances (tenant improvement allowances) and our method of accounting for rent holidays were not in accordance with accounting principles generally accepted in the United States of America. As a result, we are restating our interim financial statements as of and for the quarterly period ended June 30, 2004 in this Amendment No. 1 on Form 10-Q/A. We have historically accounted for tenant improvement allowances as a reduction of the property, plant and equipment account on our balance sheet, amortized the allowances as a reduction to depreciation expense in our income statement and reflected the cash received within investing activities in our statement of cash flows. FASB Technical Bulletin 88-1 ("FTB 88-1"), "Issues Relating to Accounting for Leases," requires these allowances to be recorded as deferred rent liabilities on the consolidated balance sheets and amortized as a reduction to rent expense on the income statement. In addition, the cash received by us should have been recorded as a component of operating activities on the consolidated statements of cash flows. Depreciation of the leasehold improvement begins effective with the opening of the store as we have accounted for it in the past. However, amortization of the landlord allowance commences on the date we have the right to control the use of the leased property, which is consistent with the recording of rent expense as described below. Previously, we had commenced amortization on the date the store was opened. We have historically recognized rent holiday periods on a straight-line basis over the lease term commencing with the opening date for each store. The period during which the store was being fixtured and stocked with merchandise was excluded from the straight-line rent schedule. FASB Technical Bulletin 85-3 ("FTB 85-3"), "Accounting for Operating Leases with Scheduled Rent Increases," states that rent holidays should be recognized on a straight-line basis over the lease term, which commences on the date we have the right to control the use of the leased property. For us, this is generally one to three months prior to a store opening date. The amount of rent expensed prior to store opening will be included in "Pre-opening expenses" in our consolidated statements of income. The effects of the restatement adjustments are discussed in Note 2 in the notes to the consolidated financial statements. The following has been updated to give effect to the restatement. 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 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. 9 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. 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 4th. 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. 10 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 ....................... 0.4% 0.5% 0.4% 0.4% ----------- ----------- ----------- ----------- Income from operations ........................... 0.4% 1.6% 1.1% 1.2% Net interest (income) expense .................... (0.1)% (0.1)% (0.1)% (0.1)% ----------- ----------- ----------- ----------- Income before income taxes ....................... 0.5% 1.7% 1.2% 1.3% Income tax expense ............................... 0.2% 0.6% 0.5% 0.5% ----------- ----------- ----------- ----------- Net income ....................................... 0.3% 1.1% 0.7% 0.8% =========== =========== =========== =========== Number of stores open at end of period............ 84 74
Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003 NET SALES. Net sales increased $7.5 million, or 8.0%, to $101.2 million in the three months ended June 30, 2004 from $93.7 million in the comparable 2003 period. This increase is comprised of (i) net sales of $2.3 million from three new stores opened in 2004, (ii) net sales of $6.3 million from stores opened in 2003 not included in the comparable store base, and (iii) a comparable store sales decrease of $1.1 million, or 1%. Sales during the quarter ended June 30, 2004 were impacted by negative weather conditions compared with the quarter ended June 30, 2003. Stores are added to the comparable store base at the beginning of the fourteenth full month of operation. 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. The gross margin increased to 38.9% of net sales in the three months ended June 30, 2004 from 37.1% in the three months ended June 30, 2003. The impact of the change in accounting in accordance with EITF 02-16 represented an increase of 2.1%. Additional distribution costs associated with the move to our new distribution center and corporate office complex impacted gross margin by 0.7%. The remaining difference of 0.4% is due to the mix of merchandise sold. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses include (a) direct store level expenses, including rent and related operating costs, payroll, advertising, 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 increased $5.7 million, or 17.6%, in the three months ended June 30, 2004 to $38.5 million from $32.8 million in the three months ended June 30, 2003. Of the increase $3.1 million 11 represents the impact of the accounting change in accordance with EITF 02-16. The remainder of the increase is principally accountable from stores opened in 2004 and the stores opened in 2003 not in the comparable store base. As a percentage of sales, selling, general and administrative costs was 38.1% and 35.0% of net sales in the three months ended June 30, 2004 and June 30, 2003, respectively. The impact of the accounting change was 3.1% of net sales. As a percentage of sales, other selling, general and administrative costs for the three months ended June 30, 2004 were comparable to the three months ended June 30, 2003. STORE PRE-OPENING EXPENSES. We expense store pre-opening expenses as they are incurred which would include rent holidays prior to store opening. Pre-opening expenses for the store we relocated in the second quarter of 2004 and the stores we opened in July 2004 amounted to $380,000. In the second quarter of 2003, we incurred store pre-opening expenses of $478,000 related to the store opened in that quarter and the two stores opened in July 2003. NET INTEREST (INCOME). In the second quarter of 2004, we had net interest income of $123,000 compared with net interest income of $118,000 in 2003. INCOME TAXES. Our effective income tax rate was 38.5% for the second quarter ended June 30, 2004 and 38.2% for the second quarter ended June 30, 2003. Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003 NET SALES. Net sales increased $27.1 million, or 14.6%, to $212.7 million in the six months ended June 30, 2004 from $185.6 million in the comparable 2003 period. This increase is comprised of (i) net sales of $4.0 million from three new stores opened in 2004, (ii) net sales of $15.6 million from stores opened in 2003 not included in the comparable store base, and (iii) a comparable store sales increase of $7.5 million, or 4%. Sales during the six months ended June 30, 2004 benefited from positive weather conditions in the first quarter but were negatively impacted by weather conditions in the second quarter compared with the comparable periods in 2003. GROSS MARGIN. The gross margin increased to 38.2% of net sales in the six months ended June 30, 2004 from 36.8% in the six months ended June 30, 2003. The impact of the change in accounting in accordance with EITF 02-16 generated an increase of 1.5%. Additional distribution costs impacted the margin negatively by 0.4%. There was a 0.3% increase due to the mix of merchandise sold. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased $12.7 million, or 19.4%, in the six months ended June 30, 2004 to $78.0 million from $65.4 million in the six months ended June 30, 2003. Of the increase $5.8 million represents the impact of the accounting change in accordance with EITF 02-16. The remainder of the increase is principally accountable from stores opened in 2004 and the stores opened in 2003 not in the comparable store base. As a percentage of sales, selling, general and administrative costs was 36.7% of net sales for the six months ended June 30, 2004 compared with 35.2% in the six months ended June 30, 2003. The impact of the accounting change was 2.7% of net sales. Other selling, general and administrative costs decreased 1.2% in the six months ended June 30, 2004 compared with the six months ended June 30, 2003. This decrease came from leveraging our store costs due to our sales increase and leveraging our corporate office costs over a greater sales base. Corporate office costs were reduced to 3.6% of sales in the six months ended June 30, 2004 compared with 3.7% in the same period in the prior year. STORE PRE-OPENING EXPENSES. Pre-opening expenses for the three new stores opened in the first half of 2004, the two stores we relocated and the stores we opened in July 2004 amounted to 12 $968,000. In the first half of 2003, we incurred store pre-opening expenses of $882,000 related to the three stores opened in that half and the two stores opened in July 2003. NET INTEREST (INCOME). In the first half of 2004, we had net interest income of $243,000 compared with net interest income of $227,000 in 2003. INCOME TAXES. Our effective income tax rate was 38.5% for the first half of 2004 and 38.2% for the first half of 2003. 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, the net proceeds we received from our initial public offering in 1997 and from a secondary offering in 2002. In the first half of 2004 we borrowed $30 million under two mortgage agreements we have with Wachovia Bank to finance our new corporate offices and distribution center. At June 30, 2004 and December 31, 2003 our working capital was $133.8 million and $112.8 million, respectively. Cash used in operations was $11.0 million for the six months ended June 30, 2004 as a result of an increase in inventory of $1.9 million to support the new stores, a reduction in accounts payable and other accrued expenses of $8.1 million, and a reduction in income tax payables of $5.3 million. Net cash used in investing activities during the six months ended June 30, 2004 was $28.7 million of which $29.4 million was for capital expenditures. In 2004, we expect to spend approximately $41.0 million on capital expenditures, which includes approximately $27.5 million related to the building, equipment and systems for our new distribution center, $10.5 million for new store openings, and the remainder for remodeling existing stores, upgrading systems in existing stores, and corporate systems development. The total cost of the new distribution center is estimated to be $45.0 million. 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 expected 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 covenants that, among other things, restrict our ability to incur additional indebtedness or guarantee obligations in excess of $8 million, engage in mergers or consolidations, dispose of assets, make acquisitions requiring a cash outlay in excess of $10 million, make loans or advances in excess of $1 million, or change the nature of its 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, 2004 the Company was in compliance with these agreements. We currently have a $25.0 million line of credit agreement with Wachovia Bank, which expires on January 1, 2005. Borrowing under this line will bear interest at LIBOR plus 95 basis points. At June 30, 2004 there were no borrowings outstanding under this agreement. 13 We believe the cash generated from operations during the year, funds received through the financing of the new distribution center and available borrowings under the credit agreement (which we intend to renew) will be sufficient to finance our working capital and capital expenditure requirements for at least the next 12 months. CHANGE IN ACCOUNTING PRINCIPLE The costs incurred for advertising are expensed the first time the advertising takes place, and are offset by reimbursements received under cooperative advertising programs with certain vendors. Co-op advertising funds are only recognized when we have performed our contractual obligation under a co-op advertising agreement. For all vendor contracts entered into or modified after January 1, 2003, the Company has adopted 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 our 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 our income statement. The prospective adoption of EITF 02-16 reduced our first half net income by $1.7 million or $0.08 per share. For the full year 2004, we estimate that the change in the timing of income recognition will reduce EPS by approximately $0.13 per share. The adoption of this standard does not change the ultimate cash to be received under these agreements, only the timing of when it is reflected in our net income. CRITICAL ACCOUNTING ESTIMATES Except for the change in accounting principle described above, 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 fiscal year ended December 31, 2003. 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 are believed 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: o merchandise inventories; o impairment of long-lived assets; o income taxes; and o other estimates. The foregoing critical accounting estimates are more fully described in our annual report on Form 10-K for the fiscal year ended December 31, 2003. During the six months ended June 30, 2004, we did not 14 make any material changes to our estimates or methods by which estimates are derived with regard to our critical accounting estimates. 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, 2004 approximated carrying value. We had no borrowings outstanding under the line of credit at June 30, 2004. 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 existing at June 30, 2004, the impact of a hypothetical increase or decrease in interest rates of 10% compared with the rates in effect at June 30, 2004 would result in an increase or decrease in our interest expense of $63,000 annually, and an increase or decrease in our interest income of $66,000 annually. ITEM 4. CONTROLS AND PROCEDURES In connection with the restatement and the filing of this Form 10-Q/A, our management, with the participation of our chief executive officer and chief financial officer, re-evaluated the effectiveness of our disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e), as of the end of the period covered by this report. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 (the "Exchange Act") are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. In making this evaluation, our management considered matters relating to our restatement of previously issued financial statements for the periods covered by this report, including the process that was undertaken to ensure that all material adjustments necessary to correct the previously issued financial statements were recorded. As set forth in Note 2, "Restatement of Financial Statements" to the accompanying consolidated financial statements, we restated our financial statements for the periods covered by this report. The restatement resulted from a deficiency that we identified related to periodic review of the application of generally accepted accounting principles. Following a review of our lease-related accounting policies, we determined that our method of accounting for leasehold improvements funded by landlord incentives or allowances (tenant improvement allowances) and our method of accounting for rent holidays were not in accordance with accounting principles generally accepted in the United States of America. We have remediated the control deficiency by conducting the review of our lease accounting practices, restating our financial statements and correcting our accounting practices, all as further described in Note 2. During the quarter ended June 30, 2004, there has not occurred any change in our internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f), that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 15 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not Applicable. ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASERS OF EQUITY SECURITIES Not Applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We held our Annual Meeting of Shareholders on June 18, 2004. At the meeting, shareholders voted on the following: 1. To elect two Class B directors to hold office for a term of three years until their successors are duly elected and qualified. 2. To ratify the appointment of PricewaterhouseCoopers LLP as the Company's independent auditors for the fiscal year ending December 31, 2004. The results of the voting were as follows:
For Against Abstain Withhold Authority ----------- ----------- ----------- ------------------- Richard J. Bauer 16,792,541 0 1,021,210 0 Richard J. Drake 14,247,412 0 3,566,339 0 Ratification of PricewaterhouseCoopers LLP 17,739,888 71,675 2,188 0
The term of office for each of the following directors continued after the meeting: William Kaplan, John E. Parker, Lawrence H. Fine, Richard Lesser and Eli J. Segal. ITEM 5. OTHER INFORMATION On June 23, 2004, our board of directors increased the size of the board to eight directors and elected Michael J. Joyce as a director of the Company. Mr. Joyce will serve as a Class B director and will serve until 2007 and until his successor is elected and qualified. Mr. Joyce recently retired from the public accounting firm of Deloitte & Touche LLP where he was most recently the New England Managing Partner. Mr. Joyce joined the predecessor firm of Deloitte in 1967 and became an accounting and auditing partner in 1975. Simultaneously with his joining our Board, Mr. Joyce was also appointed to serve on our Audit and Compensation Committees and was designated as our Board's "audit committee financial expert." 16 Mr. Joyce currently serves on the board of Brandywine Realty Trust and Heritage Property Investment Trust, Inc. and has served on the boards of numerous civic, cultural and educational institutions, including the Boston Symphony Orchestra, the Greater Boston Chamber of Commerce, the Massachusetts Business Roundtable, the Philadelphia United Way and Board of Visitors of the Northeastern University Business School. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended ("Exchange Act"). 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) promulgated under the Exchange Act. 32 Certification of the Company's Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K furnished in the quarter ended June 30, 2004: 8-K, Item 12, furnished on April 8, 2004 regarding a Company press release concerning earnings and other information. 8-K, Item 12, furnished on April 21, 2004 regarding a Company press release concerning earnings and other information. 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Amendment No. 1 on Form 10-Q/A to be signed on its behalf by the undersigned thereunto duly authorized. A.C. MOORE ARTS & CRAFTS, INC. Date: April 19, 2005 By: /s/ John E. Parker ------------------------------------ John E. Parker Chief Executive Officer (duly authorized officer and principal executive officer) Date: April 19, 2005 By: /s/ Leslie H. Gordon ------------------------------------ Leslie H. Gordon Executive Vice President and Chief Financial Officer (duly authorized officer and principal financial officer) 18 Exhibit Index Exhibit No. Description ----------- ---------------------------------------------------------------- 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) promulgated under the Exchange Act. 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) promulgated under the Exchange Act. 32 Certification of the Company's Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.