Ac Moore Arts & Crafts, Inc (ACMR) - Description of business
ITEM 1. BUSINESS.
We are a specialty retailer offering a vast selection of arts, crafts, and floral merchandise to a broad demographic of consumers. Our stores are located in the eastern United States from Maine to Florida. We have grown from 17 stores in January 1997 to 122 stores as of December 31, 2006. Our stores typically range from 20,000 to 25,000 square feet. In 2006, for stores open for the full calendar year, our average sales per square foot was $234, and our average sales per store was $5.4 million.
Our assortment of merchandise consists of more than 60,000 stock keeping units, or SKUs, with approximately 45,000 SKUs offered at each store at any one time. We believe we offer an arts and crafts shopping experience that is differentiated by our broad merchandise assortment, high in-stock positions, exciting stores, knowledgeable sales associates and competitive prices. We also offered custom framing in 53 stores as of December 31, 2006 and anticipate that the number of stores with custom framing will increase to approximately 100 stores by the end of 2007. In-store events and programs for children and adults provide hands-on arts and crafts experience and encourage the creativity of our customers.
Due to the importance of our peak selling season, which includes Fall/Halloween, Thanksgiving and Christmas, the fourth quarter has historically contributed, and is expected to continue to contribute, a significant portion of our profitability for the entire year. As a result, any factors negatively affecting us
during the fourth quarter of any year, including adverse weather and unfavorable economic conditions, would have a material adverse effect on our results of operations for the entire year.
We became a holding company in July 1997 by incorporating in Pennsylvania and exchanging 4,300,000 shares of our common stock for all of the capital stock of our operating subsidiary which was organized in 1984.
In its 2006 Attitude & Usage Study, the Craft and Hobby Association (CHA) found that industry size was approximately $30.2 billion as a result of a 2.6% annual growth rate since 2002. Our market is highly fragmented and is served by multi-store arts and crafts retailers, mass merchandisers, small, local specialty retailers, mail order vendors, hardware stores and a variety of other retailers. According to this study, only 14% of crafters stated that they have a specific purchase in mind when shopping, with the majority of purchases made on impulse.
The size and growth of our market is sustained by the popularity of arts and crafts. The CHA study referred to above reported that 57% of U.S. households, or approximately 62 million, participated in crafts in the past year, with the average annual spending per crafting household averaging $476. A December 2005 Craftrends magazine consumer participation survey identified that 94% of all crafters are female, 70% are under the age of 55, 48% are between the ages of 35 and 54, 74% have incomes over $40,000 per year and 44% have incomes over $60,000 per year. The crafter is educated, with 92% having graduated from high school and almost 60% having attended college.
Our merchandising strategy is to offer the broadest and deepest assortment of arts, crafts and floral merchandise and to provide our customers with all of the components necessary for their crafting projects on a regular basis. Below is a representative list of our merchandise:
|||Art Supplies and Scrapbooking: paints, brushes, canvas, drawing tools, rubber stamps and stationery, scrapbooking supplies and stencils.|
|||Traditional Crafts: stitchery, yarn, cake and candy making supplies, glass crafts, wood crafts, kids crafts, felt, glitter, dollmaking, dollhouses and furniture, and instructional books.|
|||Floral, Floral Accessories and Silk Plants: silk flowers, silk plants, accessories like vases and other products to assist in the arrangement of flowers and pre-made and custom made floral arrangements.|
|||Fashion Crafts: t-shirts and sweatshirts, decorative items like patches and rhinestones, and jewelry making supplies like beads.|
|||Frames: custom framing, ready-made frames, frame hardware and accessories, framed art and prints.|
|||Home Décor: ribbon and lace, wedding-related items, potpourri, candles, candle making supplies, wicker baskets, decorative storage containers and childrens furniture.|
Seasonal Items : craft making materials, decorations and floral products for all major holidays and seasons, including Christmas, Fall/Halloween, Spring/Easter, Valentines Day and St. Patricks Day.
Recent Developments in Business and Operating Strategy
The year 2006 was a year of transition for our Company, as the composition of our senior management team changed substantially. Our new Chief Executive Officer joined us on June 1, 2006 and our new Chief Financial Officer joined us on September 13, 2006. See Item 1A. Risk Factors and Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for more information on recent changes in management.
Our financial and sales performance for 2006 was disappointing. See Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for further discussion of our results in 2006. We expect that 2007 will also be a year of transition as our new management team is focused on reviewing and adjusting various aspects of our business and operations to position ourselves for improved performance. The business and operating initiatives discussed below supplement the business and operating strategies discussed under Business and Operating Strategy.
Selling, general and administrative expense reduction
We are aggressively reviewing all facets of our business for opportunities to reduce expenses. The following are our major expense reduction initiatives:
|||Store payroll costs. We introduced a new store general manager compensation plan based on pay-for-performance beginning in January 2007. Bonuses earned in one year are no longer rolled into base salary for the coming year. We also tested different store staffing models, including an appropriate mix of full- and part-time team members, in the second half of 2006 that we believe will assist us in improving our results of operations through payroll savings.|
|||Advertising spending. We are in the process of experimenting with the reach, frequency and timing of our advertisements. During the fourth quarter of 2006, we moved approximately 75% of our print advertising from a mid-week, varying between Wednesday, Thursday and Friday, to Sunday. While we are still analyzing the results from this change, we believe that a uniform approach within the chain to advertising strategy will result in overall efficiencies.|
|||Real estate site location strategy. We believe that our selling, general and administrative expenses may be significantly reduced if we increase store openings in existing markets in order to leverage advertising costs. In the future, we intend to increase store density in existing markets. In addition, previously we entered new markets opening only a single store. When we enter new markets in the future, as appropriate, we intend to open more than one store at the same time that we enter that market.|
During the fourth quarter of 2006, we reviewed the level and composition of our store inventories and took steps to reduce excess inventory. We will attempt to improve control in the future over inventory through aggressive clearance procedures and more centrally directed purchasing.
Improved information technology
We are committed to enhancing our information technology to increase operating efficiencies, improve merchandise selection and better serve our customers. During the fourth quarter of 2006, we completed the upgrade of our point of sales, or POS, system and began to construct a sales audit system which will help us better manage the information available from our POS system. We are currently investigating the development of both a perpetual inventory and an automated replenishment system, which we anticipate will be implemented in 2007 and 2008, respectively.
Globally sourced and private label products
We are currently investigating increased global sourcing of products. We anticipate that products imported directly through an arrangement with a global sourcing supplier will be sold in our stores beginning in the second half of 2007. We expect that the number of products globally sourced will substantially increase in the future as a result of this new arrangement. We also intend to introduce in our stores private-label products bearing the A.C. Moore name and logo beginning in the second half of 2007. We believe that increased global sourcing and sale of private label products will result in substantial margin improvement.
Centrally directed operations
We are committed to increasing the level of standardization in our operations and centrally directed management practices. This initiative includes, without limitation, standardizing the presentation in our stores, managing store classroom programs from our corporate office and advertising strategy. We believe that increased centrally directed management will improve our operating efficiencies.
Business and Operating Strategy
Our goal is to provide our customers with the tools and ideas for their creative endeavors in a solution-oriented environment that exceeds their expectations and encourages repeat business. We believe that our assortment, convenience, service and pricing differentiate us from our competitors. In addition to the business and operating priorities discussed above under Recent Developments in Business and Operating Strategy, we pursue the business and operating strategies described below in order to achieve our goal.
We strive to offer the broadest and deepest assortment of arts, crafts and floral merchandise.
We believe key elements in our customers decision as to where to shop are variety and selection of merchandise. We strive to offer the broadest and deepest selection of arts, crafts and floral merchandise in our industry. Each of our stores stocks more than 60,000 SKUs across our major merchandise categories during the course of a year, with approximately 45,000 SKUs offered at each store at any one time.
We strive to maintain a superior in-stock merchandise position.
Craft projects usually require multiple components. Providing all of the components for a particular craft project in a single store on a regular basis is critical to meeting the demands of our customers. Therefore, we designed our merchandise distribution systems and distribution operations to ensure rapid replenishment of inventory and high levels of in-stock positions in our stores and distribution operations.
We strive to operate exciting, easy-to-shop stores.
We believe that our customers expect exceptional service in an exciting and easy-to-shop store. We regularly provide in-store presentations of various crafting techniques, completed projects and consumer crafting events. We offer a multitude of in-store classes for children and adults in most of our stores on a wide variety of craft skills such as scrapbooking and knitting. Our stores are designed to be well organized and well lit. Store personnel, whom we provide with educational materials about various crafting products and techniques, assist customers with merchandise selection and project ideas.
We strive to drive sales and optimize profit through merchandising creativity.
We strive to foster merchandising creativity in our stores while providing centralized direction and support from our corporate office. General managers and store personnel are empowered and encouraged to identify merchandising opportunities and to tailor displays to local preferences for craft projects. If proven successful, merchandising ideas generated by a general manager can be implemented quickly throughout our chain. We believe this helps us to increase sales and profitability. Our focus on empowering our employees helps in recruiting, hiring and retaining talented personnel.
We strive to provide superior price/value for our customers.
We believe that our customers consider the relationship between the price and quality of merchandise to be important factors in their buying decisions. Therefore, we strive to be the price/value leader in all of our merchandise categories. Our merchants and general managers actively monitor competitors prices to ensure we maintain low prices while preserving merchandise quality. We believe that our price/value strategy enhances customer loyalty.
The industry in which we operate is large and fragmented. We believe that this presents an opportunity to continue to grow our business for the foreseeable future. Our objective is to improve our market share in existing geographic markets and to expand into new geographic markets while enhancing our profitability through greater leverage of our corporate infrastructure. We believe by systematically increasing our store base we can obtain economies of scale in advertising, distribution, purchasing and management costs and, as a result, improve our operating margins.
During the next two years we intend to increase our store base of 122 locations at December 31, 2006 by approximately 10% to 15% per year. Our current strategy is to open new stores within the range of our corporate headquarters and distribution center located in suburban Philadelphia. Ultimately, we believe that we can operate a minimum of 175 stores within the range of our distribution center without significantly diluting sales in our existing stores. In the future, we anticipate opening stores in other regions.
Our site selection strategy is overseen by our Vice President of Real Estate who is responsible for identifying favorable store locations in both existing and new markets. Our site selection criteria include an assessment of demographic characteristics of the trade area, including growth trends, customer traffic patterns, demographic analysis, performance of other retailers, co-tenants within potential projects, potential cannibalization, competition and projected profitability. We also employ the services of two real estate brokerage firms to facilitate real estate research, selection and leasing.
We have developed a standardized procedure for opening new stores which we continue to refine. Our new store opening team develops the floor plan and merchandise plan based on our store prototype and hires and trains team members in preparation for the opening of each new store. For each new store we open in the next two years, we expect to spend approximately $1.4 million, which includes $400,000 for fixtures and equipment, $300,000 in pre-opening costs (including lease costs from date of possession) and $700,000 for in-store inventory, net of accounts payable.
In 2006, for stores open at least one full calendar year, our average sales per square foot was $234 and our average sales per store was approximately $5.4 million. In each of 2006 and 2005, sales in comparable stores declined by 3%. Previously, our comparable store sales grew by 4% in 2004, 2% in 2003, 5% in 2002 and 8% in 2001. Stores are added to the comparable store base at the beginning of their fourteenth full month of operation. Our primary method of growing sales in our existing stores over the long-term is to successfully execute our business and operating strategies, including reducing expenses as a percentage of sales, described above under Recent Developments in Business and Operating Strategy and Business and Operating Strategy. There can be no assurance that our comparable store sales will increase in the future.
Our merchandising strategy is to offer the broadest and deepest assortment of arts, crafts and floral merchandise and to provide our customers with all of the components necessary for their crafting projects on a regular basis. We believe our merchandise appeals to a wide range of recreational and professional crafters of all ages and economic backgrounds, with our primary customers being women ages 25 to 55. Our buyers actively seek new merchandising opportunities by monitoring industry trends, working with domestic and international vendors, and regularly attending trade and consumer shows.
The following table describes net sales for each of our merchandise categories as a percentage of our total net sales for the years ended December 31, 2004 through 2006:
|Year Ended December 31,|
Art & scrapbooking
Floral and accessories
Our buyers develop a planogram for each of our basic and seasonal merchandise categories which is implemented at the store level. A planogram is a diagram that shows how and where each specific
retail product should be placed on shelves or displays. The planograms are developed by a team consisting of our buyers and members of our planogram department, with input from key vendors. The planograms are developed using information about the products, such as size, shape, colors, theme, sales volume and inventory levels. By analyzing past and current sales patterns, we can then adjust our planograms to present merchandise in a manner that helps maximize sales.
Our POS system allows us to make better merchandising decisions by identifying sales volume and seasonality patterns of particular items of merchandise. With this information we can make better decisions regarding when to stock, reorder, mark-down and discontinue merchandise.
Our purchasing staff and general managers actively monitor competitors prices to ensure we maintain low prices while preserving merchandise quality and value. Our policy of beating any competitors advertised price by 10% is displayed in our stores. On a weekly basis, we advertise select items generally at 20% to 50% off their everyday low prices. We also accept competitors coupons. We believe that our strategy of price/value enhances customer loyalty.
Our stores regularly feature seasonal merchandise that complements our core merchandising strategy. Seasonal merchandise is offered for all major holidays and seasons, including Christmas, Fall/Halloween, Spring/Easter, Valentines Day and St. Patricks Day. By far the greatest portion of our seasonal merchandise is sold during the Christmas season. This includes merchandise in our seasonal department as well as seasonal products sold in other merchandise categories. Our Christmas holiday merchandise is given floor and shelf space in our stores beginning in late summer. The Christmas holiday season is longer for our stores than for many traditional retailers because of the project-oriented nature of Christmas crafts and gift-making ideas.
Our stores typically range from 20,000 to 25,000 square feet. Most of our stores are located in strip centers that are easily accessible from main traffic arteries and have convenient parking. Our store size varies based on market demographics and real estate availability. Store leases generally have an initial term of ten years, with three five year renewal options, and provide for predetermined escalations in minimum annual rent. Rent payments are amortized over the initial lease term commencing on the date we take possession. Our stores are generally open from 9:30 a.m. to 9:00 p.m., Monday through Saturday, and from 10:00 a.m. to 6:00 p.m. on Sunday.
Store layout and operations
Our stores provide a one-stop-shopping destination for arts, crafts and floral merchandise. We design our stores to be attractive and easy-to-shop with a layout intended to lead customers through the entire store in order to expose them to all of our merchandise categories. We use end-of-aisle displays to feature best-selling items and promotional merchandise. Generally, the center of the store contains the floral area, which includes a ribbon center and counter for free floral arrangement services. Our stores contain a customer service area and typically eight or more checkout registers. Our prototype store is apportioned approximately 80% to selling space with the remainder devoted to delivery, storage, classroom and office areas.
Store management and training
Each store is managed by a general manager who is assisted by two or three assistant general managers, three to five department managers and an appropriate mix of full-time and part-time team
members to service our customers. The number of store personnel is substantially higher during our peak selling season. Our general managers and assistant general managers are responsible for store results, primarily merchandising, customer service, training, hiring store level team members, inventory management and expense control. The department managers are responsible for merchandise ordering, inventory management and customer service. Typically, general managers are promoted from within our organization. We selectively hire experienced store managers from other retailers. We also develop assistant general managers from retail trainees and other internal candidates.
Our training program for store management includes Company-sponsored forums to refine and develop skills in merchandising, merchandise trends, store operations, financial controls, human resources and general management. We provide our team members with educational materials on various crafting products and techniques to create a sales staff with a strong focus on customer service and a willingness to assist customers in assembling and coordinating their craft projects.
Each general manager reports to a district manager. Our stores are organized into ten districts. Our district managers also participate in Company-sponsored forums that focus on human resources, profit improvement, general management, marketing and other initiatives.
Our purchasing programs are designed to support our business strategy of providing customers with the broadest and deepest assortment of high quality arts, crafts and floral merchandise at value prices while maintaining high in-stock positions. Our buying staff oversees all of our purchasing. Buyers regularly attend trade and consumer shows to monitor industry trends and to obtain new craft ideas.
In-store department managers are responsible for daily reordering of merchandise for their departments. In 2006, approximately 99% of our merchandise orders were placed through our electronic data interchange, or EDI, system. Approximately 63% of our orders were shipped directly from vendors to our stores; the remaining 37%, approximately one-third of which are floral and seasonal items, were shipped from our distribution center. Merchandise assortments at our stores can be enhanced by products ordered by general managers to meet the unique needs of their customers. All purchases are monitored through centralized system controls.
In 2006, we purchased our inventory from more than 500 vendors worldwide. One of the key criteria for the selection of vendors is their responsiveness to our delivery requirements and timing needs. In 2006:
|||the largest 25 domestic vendors accounted for approximately 48% of our purchases,|
|||the largest vendor, SBARS, Inc., a distributor of arts and crafts merchandise, accounted for approximately 22% of our purchases, and|
|||approximately 13% of our merchandise, primarily floral and seasonal items, was directly imported from foreign manufacturers or their agents, almost exclusively from the Peoples Republic of China.|
All of our overseas purchases are denominated in U.S. dollars.
Our distribution strategy is focused on supporting our stores and maintaining high in-stock positions in all of our merchandise categories. Our stores receive merchandise deliveries one to three times per week, depending on store volume and time of year.
In the third quarter of 2004 we moved into our new distribution center and office facility. This facility contains 710,000 square feet for distribution and warehousing plus 60,000 square feet of office space. We believe this facility is positioned to handle our future expansion and will enable us to service at least 175 stores. The new facility includes an automated picking and sortation system. The total cost of this facility was $46.3 million.
Our distribution center and warehouse operations are supported by our real-time warehouse management system which uses hand-held computers and radio frequency communication technology to track merchandise. We believe our warehouse management system, which was upgraded in 2004, helps to make our distribution center and warehouse operations efficient and is instrumental in helping us meet our commitment to provide superior inventory replenishment to each of our stores.
We lease a fleet of tractors and trailers to deliver merchandise to 61 of our 122 stores directly from our distribution center. Additionally, we have contracted with a dedicated third-party carrier to deliver merchandise to the 61 stores where an overnight stay is required because of travel time. In 2006, approximately 37% of our merchandise was delivered from our distribution center to our stores. In the second half of 2006, we implemented new processes within our supply chain, including routing, or cross-docking, which increased amounts of merchandise and additional SKUs through our distribution center.
Our marketing and advertising is designed to attract current customers and appeal to prospective customers. A study published in Craftrends magazine in December 2005 surveyed over 1,000 craft customers across the country. Of the participants, 61% were between the ages of 26 and 54, 94% were female and 44% had an annual income greater than $60,000. We believe that our target customer is consistent with this demographic profile.
In 2006, we advertised 50 weeks of the year, typically in midweek editions of local and/or regional newspapers. In September 2006, we changed approximately 75% of our print advertising from mid-week, varying between Wednesday, Thursday and Friday, to Sunday. We are currently analyzing the results from this switch in advertising strategy. In addition, prior to store openings, we generally use radio advertisements to develop customer awareness and we place special pre-opening advertisements, normal advertising copy and/or grand opening inserts in newspapers. We create all of our advertising in-house. We are currently experimenting with the overall visual presentation of our ads in an effort to increase impact.
Our website, www.acmoore.com , is designed to drive additional store traffic by providing information, inspiration and ideas to our visitors. It also serves as another marketing channel to build brand name awareness. Our website offers a collection of over 300 different how-to videos that customers can view to learn the latest crafting tips, techniques and project ideas. Our website also features weekly advertisements, a store locator and an in-store class schedule, as well as suggested craft projects for children and adults with accompanying instructions and shopping lists for merchandise to be purchased at our stores. We also employ e-marketing that allows us to email all customers in our
database our weekly advertisements, news flashes regarding upcoming events and special offers. Gift cards may be purchased online. At this time, we do not sell our merchandise on our website.
As discussed above under Recent Developments in Business and Operating Strategy, we are committed to enhanced information technology as an operating priority. During the fourth quarter of 2006, we analyzed our current information technology situation to determine how we can become a more technologically driven company and better utilize computer generated metrics to drive performance.
A technology project life cycle was introduced to the organization in the fourth quarter of 2006. This is a formal, structured approach to application development initiatives. This will ensure that proper coding and testing disciplines are woven into our project practices as we build quality systems that will serve as the back bone for future growth.
We completed the conversion of our POS systems in the fourth quarter of 2006. In addition to faster transaction speeds and an improved customer returns database, this conversion provided additional functionality such as debit cards and zip code collection. More importantly, it now provides us the framework for future initiatives that bring additional value and a better experience to the customer.
During the fourth quarter of 2006, we began to build a sales audit system that will be used for data cleansing from the POS to assure we have a single source of data in which to feed all reporting. We recently held initial discovery meetings with our business teams and various vendors to determine the best approach for delivering perpetual inventory. Introduction of a perpetual inventory program will be a significant milestone as it is a prerequisite to launching an automated replenishment system. Automated replenishment utilizes sales history and vendor lead times to automatically place orders to vendors on a by SKU, by store basis. This eliminates manual involvement for ordering basic, repeatable product. This system will help us better control our inventories, make better buying decisions and reduce our store labor costs. We remain confident that we will have automated replenishment in place during the 2008 calendar year.
The market in which we compete is highly fragmented, containing multi-store arts and crafts retailers, mass merchandisers, small local specialty retailers, mail order vendors, hardware stores and a variety of other retailers. We believe we are one of five retailers in the United States dedicated to serving the arts and crafts market that have annual sales in excess of $100.0 million. We compete with many retailers and classify our principal competition within the following three categories:
Multi-store arts and crafts retailers . This category includes several multi-store arts and crafts chains operating more than 35 stores and comprises: Michaels Stores, Inc., a chain which operates approximately 925 Michaels stores throughout the United States and Canada; Jo-Ann Stores, Inc., which operates approximately 630 traditional Jo-Ann Fabrics and Crafts stores and 175 Jo-Ann superstores nationwide; Hobby Lobby Stores, Inc., a chain which operates approximately 390 stores primarily in the midwest United States; Garden Ridge, Inc., which operates approximately 35 stores primarily in the southeast and midwest United States; and Rag Shops, Inc., which operates approximately 60 stores located primarily in New Jersey and Florida.
Mass merchandisers . This category includes Wal-Mart Stores, Inc., and other mass merchandisers. These retailers typically dedicate a relatively small portion of their selling space to a limited assortment of arts and crafts supplies and floral merchandise.
Small, local specialty retailers . This category includes thousands of local independent arts and crafts retailers. Typically, these are single store operations managed by the owner. The stores generally offer a limited selection and have limited resources for advertising, purchasing and distribution. Many of these stores have established a loyal customer base within a given community and compete on customer service.
We believe that the principal competitive factors of our business are assortment, convenience, service and pricing. We believe that we are well positioned to compete on each of these factors.
As of December 31, 2006, we had 2,109 full-time and 2,832 part-time team members, 4,622 of whom worked at our stores, 164 at our distribution center and 155 at our corporate offices. None of our team members are covered by a collective bargaining agreement, and we believe our relationship with our team members is good.
A.C. Moore, Fashion Forward, Splendor of Spring, Holiday Hues, Harvest Hues, Easy as 1*2*3, Shades of the Season and Creations for All Generations are trademarks that have been registered with the U. S. Patent and Trademark Office. Stow N Go, Make It Yours, Make It for Less, Frames N Moore, Frames @ Moore, Frames and Moore and Frames & Moore are common law trademarks for which applications are now pending with the U.S. Patent and Trademark Office. We use the A.C. Moore name and logo as a trade name and as a service mark in connection with the sale of our merchandise. The Fashion Forward name and logo is used on the exclusive packaging of some of our picture frames. Splendor of Spring, Holiday Hues, Harvest Hues, Shades of the Season are all used on packaging for products. All other trademarks are used in advertising campaigns and point of purchase displays.
Website and Availability of Information
Our internet address is www.acmoore.com . We make available free of charge on or through www.acmoore.com our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Additionally, charters for the Audit, Compensation and Nominating and Corporate Governance Committees of our Board of Directors and our Corporate Code of Ethics can be found on our Internet website at www.acmoore.com under the heading Investor Relations, Corporate Profile.
We will provide, at no cost, paper or electronic copies of our reports and other filings made with the SEC. Requests should be directed to:
Chief Financial Officer
A.C. Moore Art & Crafts, Inc.
130 A.C. Moore Drive
Berlin, New Jersey 08009
The information on the website listed above is not, and should not be considered, part of this annual report on Form 10-K, and is not incorporated by reference in this document. This website is only intended to be an inactive textual reference.
ITEM 1A. RISK FACTORS.
An increase in our sales, profitability and cash flow will depend on our ability to increase the number of stores we operate and increase the productivity and profitability of our existing stores.
Key components of our operating strategy are to increase the number of stores we operate and increase the productivity and profitability of our existing stores. If we are unable to implement this strategy, our ability to increase our sales, profitability and cash flow could be significantly impaired. To the extent we are unable to open new stores as planned, our sales growth would come only from increases in comparable store sales. There can be no assurance that we will be able to increase our comparable store sales, improve our margins or reduce costs as a percentage of sales. Growth in profitability in that case would depend significantly on our ability to increase margins or reduce our costs as a percentage of sales. Further, as we implement new initiatives to reduce the cost of operating our stores, our sales and profitability may be negatively impacted. In particular, we are currently evaluating our store model as it relates to levels of staffing and compensation. There can be no assurance as to whether and to what extent a new store format will be successful.
There are many factors, some of which are beyond our control, which could impact our ability to implement our strategy to increase productivity and profitability of our current and future store locations. These factors include:
|||our ability to identify suitable markets in which to expand,|
|||the availability of suitable sites for additional stores,|
|||the ability to negotiate acceptable lease terms for sites we identify,|
|||the availability of acceptable financing to support our growth,|
|||our ability to hire, train and retain a sufficient number of qualified general managers and other store personnel, which ability may be impacted by changes to store personnel compensation and staffing, and|
|||the effectiveness of our advertising strategies.|
If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud.
Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent or detect fraud. Any inability to provide reliable financial reports or prevent or detect fraud could harm our business. We continue to evaluate our internal control procedures to satisfy the requirements of the Sarbanes-Oxley Act of 2002, which requires management and our independent registered public accounting firm to evaluate and assess the effectiveness of our internal controls. If we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we could be subject to regulatory scrutiny, civil or criminal penalties or shareholder litigation. In addition, failure to maintain adequate internal controls could result in financial statements that do not accurately reflect our financial condition or results.
Our success will depend on how well we manage our growth.
Even if we are able to implement, to a significant degree, our operating strategies of expanding our store base and increasing the productivity and profitability of our existing stores, we may experience problems relating to our growth, which may prevent any significant increase in profitability or negatively impact our cash flow. For example:
|||The costs of opening and operating new stores may offset the increased sales generated by the additional stores;|
|||The opening of additional stores in an existing market could reduce net sales from existing stores in that market;|
|||The opening of stores in new geographic markets may present competitive and merchandising challenges that are different than those we face in our existing geographic markets;|
|||The closing or relocation of under-performing stores may result in us retaining liability for outstanding lease obligations;|
|||Our growth may outpace our ability to expand, upgrade and improve our administrative, operational and management systems, controls and resources;|
|||Our suppliers may be unable to meet our increased demand for merchandise as a result of the additional stores and increased productivity of our existing stores; and|
|||We may be unable to expand our existing distribution capabilities, or employ third-party distribution services on a cost-effective basis, to provide sufficient merchandise for sale by our new stores.|
A weak fourth quarter would have a material adverse effect on our operating results for the year.
Our business is affected by the seasonality pattern common to most retailers. Due to the importance of our peak selling season, which includes Fall/Halloween, Thanksgiving and Christmas, the fourth quarter has historically contributed, and is expected to continue to contribute, a significant portion of our net income for the entire year. In anticipation of increased sales activity during the fourth quarter, we incur significant additional expense both prior to and during the fourth quarter. These expenses may include acquisition of additional inventory, advertising, in-store promotions, seasonal staffing needs and
other similar items. As a result, any factors negatively affecting us during the fourth quarter of any year, including adverse weather and unfavorable economic conditions, would have a material adverse effect on our results of operations for the entire year.
Our quarterly results fluctuate due to a variety of factors and are not a meaningful indicator of future performance.
Our quarterly results have fluctuated in the past and may fluctuate significantly in the future depending upon a variety of factors, including, among other things:
|||the mix of merchandise sold,|
|||the timing and level of markdowns,|
|||promotional events and changes in advertising,|
|||adverse weather conditions,|
|||store openings and closings,|
|||remodels or relocations of our stores,|
|||length and timing of the holiday seasons,|
|||competitive factors, and|
|||general economic and political conditions.|
We believe that period-to-period comparisons of past operating results cannot be relied upon as indicators of future performance. If our operating results in any future period fall below the expectations of securities analysts and investors, the market price of our securities would likely decline.
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. The year 2006 involved substantial change in our senior management team. On June 1, 2006, we appointed Rick A. Lepley as our new Chief Executive Officer. On September 13, 2006, we appointed Marc Katz as our new Chief Financial Officer. 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 each other, our team members and vendors and to implement or change our business and operating strategy. In addition, our success in the future is dependent upon our ability to attract and retain other qualified personnel, including general managers. Any inability to do so may have a material adverse impact on our business and operating results.
We face an extremely competitive retail business market.
The arts and crafts retailing business is highly competitive. We currently compete against a diverse group of retailers, including multi-store arts and crafts retailers, mass merchandisers, small local
specialty retailers, mail order vendors, hardware stores and a variety of other retailers. Almost all of our stores face aggressive competition in their market area from one or more of our major competitors. In addition, alternative methods of selling crafts, such as over the Internet or direct marketing, could result in additional future competitors and increased price competition because our customers could more readily comparison shop. Some of our competitors, particularly the mass merchandisers and national arts and crafts chains, have substantially greater financial resources and operate more stores than we do. We also compete with these and other retailers for customers, suitable retail locations, suppliers and qualified employees and management personnel. Moreover, increased competition may result in potential or actual litigation between us and our competitors relating to such activities as competitive sales and hiring practices, exclusive relationships with key suppliers and manufacturers and other matters. As a result, increased competition may adversely affect our future financial performance, and we cannot assure you that we will be able to compete effectively in the future.
We may not be able to successfully anticipate changes in merchandise trends and consumer demands and our failure to do so may lead to loss of sales and the closing of under-performing stores.
Our success depends, in large part, on our ability to anticipate and respond in a timely manner to changing merchandise trends and consumer demand. Accordingly, any delay or failure by us in identifying and correctly responding to changing merchandise trends and consumer demand could adversely affect consumer acceptance of the merchandise in our stores. In addition, we make decisions regarding merchandise well in advance of each of the seasons in which such merchandise will be sold. Significant deviations from projected demand for merchandise would have a material adverse effect on our results of operations and financial condition, either from lost sales due to insufficient inventory or lower margins due to the need to mark down excess inventory.
A material decline in sales and other adverse conditions resulting from our failure to accurately anticipate changes in merchandise trends and consumer demands may require us to close under-performing stores. Closing stores would subject us to additional costs including, but not limited to, taking reserves on impaired assets, loss of customer goodwill and costs associated with outstanding lease obligations.
Unexpected consumer response to changes in our advertising strategy could materially and adversely affect our sales, profitability and cash flow.
Advertising promotions have a significant impact on consumers shopping decisions. We are in the process of experimenting with the reach, frequency and timing of our print advertisements, as well as the overall visual presentation. During the fourth quarter of 2006, we moved approximately 75% of our print advertising from mid-week, varying between Wednesday, Thursday and Friday, to Sunday. We are still analyzing the results from these changes and are unable to predict what effect these changes will have on our business. In addition, we may from time to time change our other promotional activities. If we misjudge consumer response to these changes, our financial condition and operating results could be materially and adversely impacted.
Because of our small store base adverse events could have a greater impact on us than if we had a larger store base.
As of December 31, 2006, we operated a chain of 122 stores. Because our current and planned stores are located in the eastern United States, the effect on us of adverse events in this region (such as weather or unfavorable regional economic conditions) may be greater than if our stores were more
geographically dispersed. Because overhead costs are spread over a smaller store base, increases in our general and administrative expenses could affect our profitability more negatively than if we had a larger store base. Due to our relatively small store base, one or more unsuccessful new stores, or a decline in sales at an existing store, will have a more significant effect on our results of operations than would be the case if we had a larger store base.
A disruption in the operations of our distribution center could have a material adverse effect on our financial condition and results of operations.
Our distribution center in suburban Philadelphia currently handles approximately 37% of the merchandise sold in our stores. As part of our efforts to improve operating efficiencies, we are implementing new processes within our supply chain, including routing, or cross-docking, increased amounts of merchandise and additional SKUs through our distribution center. Significant changes to our supply chain could have a material adverse impact on our operating results. Our distribution center, and thus our distribution operations, is vulnerable to damage or interruption from fire, flood, power loss, break-ins and similar events. We have no formal disaster recovery plan for our distribution center. The occurrence of unanticipated problems at our distribution center, all of which may not be covered by insurance, could cause interruptions or delays in our business which would have a material adverse effect on our financial condition and results of operations.
We depend on a number of key vendors to supply our merchandise, and the loss of any one of our key vendors may result in a loss of sales and significantly harm our operating results.
Our performance depends on our ability to purchase our merchandise in sufficient quantities at competitive prices. Our future success is dependent upon our ability to maintain a good relationship with our suppliers. SBARS, one of our suppliers, accounted for approximately 22% of the aggregate dollar volume of our purchases in 2006. We do not have any long-term purchase agreements or other contractual assurances of continued supply, pricing or access to new products, and any vendor or distributor could discontinue selling to us at any time. We may not be able to acquire desired merchandise in sufficient quantities or on terms acceptable to us in the future, or be able to develop relationships with new vendors to replace discontinued vendors. Our inability to acquire suitable merchandise in the future or the loss of one or more key vendors and our failure to replace any one or more of them may have a material adverse effect on our business, results of operations and financial condition. Our smaller vendors generally have limited resources, production capacities and operating histories, and some of our vendors have limited the distribution of their merchandise in the past. These vendors may be susceptible to cash flow problems, downturns in economic conditions, production difficulties, quality control issues and difficulty delivering agreed-upon quantities on schedule. We also cannot assure you that we would be able, if necessary, to return product to these vendors and obtain refunds of our purchase price or obtain reimbursement or indemnification from any of our vendors if their products prove defective.
We face risks associated with sourcing and obtaining merchandise from foreign sources.
We have in recent years placed increased emphasis on obtaining floral, seasonal and other items from overseas vendors, with approximately 13% of all of our merchandise being purchased directly by us from overseas vendors in 2006. In addition, many of our domestic suppliers purchase a portion of their merchandise from foreign sources. Our future success will depend in large measure upon our ability to
maintain our existing foreign supplier relationships and to develop new ones. While we rely on our long-term relationships with our foreign vendors, we have no long-term contracts with them. Virtually all of the merchandise which we purchase from foreign sources is manufactured in the Peoples Republic of China. Many of our imported products are subject to duties, tariffs and quotas that may limit the quantity of some types of goods which we may import into the United States. Our dependence on foreign imports also makes us vulnerable to risks associated with products manufactured abroad, including, among other things:
|||changes in import duties, tariffs and quotas,|
|||loss of most favored nation trading status by the United States in relation to a particular foreign country, including the Peoples Republic of China,|
|||delays in shipments,|
|||revaluation of the Chinese currency and fluctuations in exchange rates,|
|||freight cost increases,|
|||economic uncertainties, including inflation,|
|||foreign government political unrest, and|
|||trade restrictions, including the United States retaliating against protectionist foreign trade practices.|
If any of these or other factors were to render the conduct of business in particular countries undesirable or impractical, our financial condition and results of operations could be materially and adversely affected because we would have difficulty sourcing the merchandise we need to remain competitive. An interruption or delay in supply from our foreign sources, or the imposition of additional duties, taxes or other charges on these imports could have a material adverse effect on our business, financial condition and results of operations unless and until alternative supply arrangements are secured. Products from alternative sources may be of lesser quality and/or more expensive than those we currently purchase, resulting in a loss of sales and/or profit to us.
We face risks relating to inventory.
We depend upon our in-store department managers to reorder the majority of our merchandise. The failure of these department managers to accurately respond to inventory requirements could adversely affect consumer acceptance of the merchandise in our stores and negatively impact sales which could have a material adverse effect on our results of operations and financial condition. If we misjudge the market, we may significantly overstock unpopular products and be forced to take significant inventory markdowns, which would have a negative impact on our operating results and cash flow. Conversely, shortages of key items could have a material adverse impact on our operating results. In addition, we
conduct a physical inventory in our stores once a year, and quarterly results are based on an estimated gross margin and accrual for estimated inventory shrinkage.
Our information technology may prove inadequate.
We depend on our information technology systems for many aspects of our business. Some of our key software has been developed by our own programmers and this software may not be easily integrated with other software and systems. Our business will be materially and adversely affected if our systems are disrupted or if we are unable to improve, upgrade, integrate or expand upon our systems, particularly in light of our intention to significantly increase the number of stores that we operate.
An increase in the cost of fuel oil and oil-based products could impact our earnings and margins.
Prices for oil have fluctuated dramatically in the past and rose substantially in 2006. These fluctuations impact our distribution costs and the distribution costs of our vendors. If the price of fuel oil continues to increase, our distribution costs will increase, which could impact our earnings. In addition, many of the products we sell, such as paints, are oil-based. If the price of oil continues to increase, the price of the oil-based products we purchase and sell may increase, which could impact our margins.
Terrorist attacks and threats or actual war may impact all aspects of our operations, revenues, costs and stock price in unpredictable ways.
Terrorist attacks in the United States, as well as future events occurring in response or in connection to them, including, without limitation, future terrorist attacks against U.S. targets, rumors or threats of war, actual conflicts involving the United States or its allies or military or trade disruptions impacting our domestic or foreign suppliers of merchandise, may impact our operations, including, among other things, causing delays or losses in the delivery of merchandise to us and decreased sales of the products we carry. More generally, any of these events could cause consumer confidence and spending to decrease or result in increased volatility in the United States and worldwide financial markets and economy. They also could result in a deepening of any economic recession in the United States or abroad. These events could also temporarily increase demand for our products as consumers respond by traveling less and engaging in home-based leisure activities which could contribute to a temporary increase in our sales which may not be sustainable. Any of these occurrences could have a significant impact on our operating results, revenues and costs and may result in the volatility of the market price for our common stock.
EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers are as follows:
Rick A. Lepley
|56||Chief Executive Officer and Director|
Lawrence H. Fine
|53||President, Chief Operating Officer and Director|
|42||Executive Vice President and Chief Financial Officer|
|35||Vice President and General Counsel|
Mr. Lepley has served as Chief Executive Officer and a director of the Company since June 2006. Previously, Mr. Lepley was Executive Vice President of North American Retail for Office Depot, Inc., global supplier of office products and services, a position he held from March 2004 to April 2006. Mr. Lepley was President, Office Depot Japan from May 2001 to March 2004 and was responsible for all of that companys operations in Japan. From 1994 to 2000, Mr. Lepley served as founder and President of Retail Investment Concepts, Inc., an independent retailer and Office Depot licensee for Eastern Europe. From 1982 to 1993, Mr. Lepley was employed by Mitsubishi Motor Sales of America, Inc., the exclusive U.S. distributor of Mitsubishi Motors-brand cars and vehicles, where he held various positions, including Senior Vice President of Sales and Marketing, and was responsible for more than 500 Mitsubishi Motors dealerships in the United States. He was one of 11 executives who founded Mitsubishi Motor Sales of America, Inc. in 1982.
Mr. Fine has served as the President of the Company since June 2001, a director since August 2002 and Chief Operating Officer since February 2003. Previously, Mr. Fine was Executive Vice President General Merchandise Manager for arts and crafts retailer Michaels Stores, Inc., a position he held since November 1996. From 1995 until joining Michaels in November 1996, he was Senior Vice President of Merchandising for Party City Corp., a specialty retailer of party merchandise. Prior to joining Party City, Mr. Fine held a variety of merchandising positions with the Jamesway Corporation, a retail mass-merchandiser, for nearly 16 years.
Mr. Katz has served as Executive Vice President and Chief Financial Officer of the Company since September 2006. Previously, Mr. Katz was Senior Vice President and Chief Information Officer of Foot Locker, Inc., a specialty athletic retailer, a position he held from May 2003 to September 2006. Mr. Katz served as Vice President and Chief Information Officer of Foot Locker from July 2002 to May 2003. From 1997 to 2002, Mr. Katz served in the following capacities at the financial services center of Foot Locker: Vice President and Controller from July 2001 to July 2002; Controller from December 1999 to July 2001; Retail Controller from October 1997 to December 1999; and Director Inventory Control from June 1997 to October 1997. Prior to his employment with Foot Locker, Mr. Katz served for eight years at The May Department Stores Company, an operator of department store chains, in various financial positions.
Ms. Rhoades has served as Vice President and General Counsel of the Company since July 2006. From April 2003 to July 2006, Ms. Rhoades was an attorney at Blank Rome LLP, a law firm based in Philadelphia, Pennsylvania. Ms. Rhoades joined Blank Rome as a summer associate in 2001.
ITEM 1B. UNRESOLVED STAFF COMMENTS.