ACMR ACM Research Inc-A

Operator

Good day, everyone, and welcome to the A.C. Moore second quarter 2011 earnings conference call. Today’s conference is being recorded. At this time, I would like to turn the conference to David Stern. Please go ahead, sir.

David Stern

Welcome to the A.C. Moore second quarter 2011 conference call. Before we begin, I will remind you that statements contained in this conference call that are not historical facts constitute forward-looking statements within the meaning of Securities Laws. These statements are subject to risks and uncertainties, which may cause results to differ materially from current expectations expressed or implied by such statements. The risks and uncertainties that are most likely to cause actual results to differ materially from our current expectations are described in our filings with the SEC. A.C. Moore undertakes no obligations to update or revise any forward-looking statement in the future. Now, I’ll turn the call over to Joe Jeffries, CEO. Joe?

Joe Jeffries

This morning, in addition to David Stern, I’m joined by David Abelman, our Chief Marketing and Merchandising Officer. I will begin by commenting on our performance and discuss some operational initiatives in the first quarter. Dave Stern will take you through our financial performance for the quarter and then David Abelman will touch upon some of our activities in merchandising and marketing. For the second quarter 2011, total sales decline 0.8% from the same period a year earlier, and our same-store sales declined by 0.7%. As referenced on the prior call, Easter occurred three weeks later in 2011 than in 2010. This change caused a shift in Easter related sales for the three weeks preceding Easter from the first quarter in 2010 to the second quarter in 2011. Our gross margin ended at 43.8%, which is a 0.6 percentage point improvement, year over year. Shifting our attention towards our merchandizing departments and inventory management efforts, we had several departments perform well during beginning with cake and candy. It’s important to point out that we conducted a rather extensive merchandising expansion of cake and candy during the quarter. We are very encouraged with the early results, and expect this category to continue to deliver strong positive sales growth for the remainder of the year. Other departments that performed well were floral, driven by everyday stem program, as well as floral accessories and designer made arrangements. Needle crafts which contains yarn continued to perform well, as our customers responded well to our selection, in-stock and promotions. David Abelman will discuss the merchandising performance in more detail during his portion of today’s call. Inventory ended down 1.6% at 116.5 million at cost, a reduction of 1.9 million. The composition of our inventory continues to improve, as we move to change the ratio of warehouse to store inventory. In summary, inventory is down overall, and has been shifted to the stores leading to better in-stocks. We ended the quarter three with improved in-stock positions and equally important, we are set and prepared much earlier this year in our fall harvest seasonal programs, as well as our early fall and Christmas craft programs. Now I’d like to quickly recap our store opening, closing and remodel activity. During the quarter, we remodeled three stores, and prepared to close one store in the third quarter. We had no openings, relocations or closures during the second quarter. Additionally in anticipation of questions about the company’s February 15 announcement of the Board of Directors is exploring strategic alternatives, the company does not intend to disclose any developments regarding this process, and so the Board has something definitive to share. Now I’d like to turn the call over to Dave Stern, who will update you, further on our financial performance. Dave.

Dave Stern

I will start with a review of the results for the second quarter and first six months of the year, followed by a review of the cash and inventory positions as of July 2, 2011, and finish by providing some insights regarding our expectations for the 2011 fiscal year. Sales for the quarter were 99.0 million, a decrease of 0.8% compared to sales of 99.9 million during the second quarter of last year. This decline is primarily due to a decrease in comparable store sales of 0.7%. The comparable store sales decrease was composed of a 1.1% decrease in transactions and a 0.4% increase in the average ticket. As Joe referenced, second quarter sales were positively impacted by the Easter shift this year. At the end of the second quarter in both 2011 and 2010, there are 135 stores in operation. Gross margin for the quarter was 43.8%, a 0.6 percentage point increase from the second quarter of last year. This increase is primarily the result of supply chain efficiencies and improvements in inventory control and security, partially offset by a decline in merchandise margins. Selling and General administrative expenses for the quarter were 51.0 million, essentially flat or a 0.1 million decrease compared to last year. This is primarily due to (inaudible) advertising spend partially offset by increased store payroll [stance]. Selling, general and administrated expenses were 51.5% of sales, compared to 51.2% of sales in the second quarter of last year. Depreciation and amortization expense for the second quarter of 2011 and 2010 were 4.2 million and 3.8 million respectively. Store pre-opening and closing cost for the second quarter of 2011 and 2010 were 0.3 million and 1.0 million [in spite of waiting]. These expenses were primarily related to revisions in the estimates for the net future rent obligations for stores that were closed in prior years. The loss from operations in the second quarter of 2011 and 2010 was 8.0 million and 9.0 million respectively. The net interest expense for the second quarters of both 2011 and 2010 was 0.2 million. During the second quarter of 2011, there was an income tax benefit of 0.3 million. This was due to the closing of IRS audits for tax years 2003 to 2008, which resulted in a reduction in the amount of unrecognized tax benefits. During the second quarter of 2010, tax [expense] was 0.5 million. During that quarter the company reached preliminary agreement with the IRS on the audits. This agreement resulted in a $0.5 million reduction of a refund related to a previously filed net operating loss carry back plan. The net loss for the second quarter was 7.9 million or $0.32 per share in to a net loss of 9.7 million or $0.40 per share for the second quarter of 2010. For the second quarter of 2011, capital expenditures were 2.5 million compared to 2.8 million for the comparable period last year. Now I’ll move through results for the two quarters ended July 2, 2011. Sales were 201.7 million, a decrease of 1.7% compared to sales of 205.2 million during the comparable period last year. This decrease was primarily due to a decrease in comparable store sales of 1.7%. Gross margin for the first half of the year was 43.3%, a 0.3 percentage points increase from the comparable period last year. This increase is primarily the result of supply chain efficiencies and improvements in inventory control and security partially offset by a decline in merchandize margins. Selling, general and administrative expenses for the two quarter were 101.7 million, a decrease of 1.7 million or 1.7% compared to last year. This is primarily due to reduced advertising spend and cost related to retirement of the prior CEO, partially offset by increased through (inaudible). Selling, general and administrative expenses for the first two quarters of both 2011 and 2010 were [15.4%] of sales. Depreciation and amortization expense was 8.2 million and 7.5 million for the first half of 2011 and 2010 respectively. Store pre-opening and closing costs for the first two quarters of 2011 was 0.9 million, and were primarily related to cost for the two stores that opened, the one store that closed during the period and revisions to the estimated net future rent obligation for stores closed in prior years. Store pre-opening and closing cost for the two quarters of 2010 were 1.1 million and were primarily related to revisions to the estimated net future rent obligations for storage closed in prior years and cost for the one store that opened in the first quarter of last year. Loss from operations in first two quarter of 2011 and 2010 was 15.2 million and 16.3 million respectively. Net interest expense is 0.4 million for the first two quarters of both 2011 and 2010. As previously referenced, there is an income tax benefit of 0.3 million for the first two quarters of 2011, and expense of 0.5 million for the comparable period in 2010. The net loss for the first two quarters of 2011 was 15.3 million or $0.62 per share, compared to a net loss from the capital period of 2010 of 17.2 million or $0.71 per share. For the first two quarters of 2011, capital expenditures were 4.5 million compared to 5.2 million for the comparable period of last year. Moving to the balance sheet; as of July 2, 2011, cash was 16.2 million or a decrease of 15.2 million from the comparable point last year. As of July 2, inventory is 116.5 million, 1.9 million lower than at the comparable point last year. Total inventory on per store basis was down 1.6% (inaudible). Importantly, all of this decrease was in the distribution center. Overall store inventory was higher than last year at end of the second quarter. Looking to full year fiscal 2011, we anticipate generating a lower net loss than in 2010; two new store openings which occurred in the first quarter of this year; four remodels which occurred in the first and second quarters; capital expenditures in the range of 8 million to 9 million to end the year with approximately 30 million in cash; to close two stores, the one that closed in the first quarter and one scheduled to close in the third quarter. We are able to negotiate advantageous early lease terminations for under performing stores that include exit or closure fees. Those additional terminations could affect our projected net loss and cash positions. Now I will turn the call over to David Abelman, Chief Marketing and Merchandising Officer.

David Abelman

I’ll provide some insights on our merchandising and marketing initiatives for Q2 2011 and our year-to-date performance through Q2 2011. Our overall comp sales were down 0.7% in Q2, but we continue to make progress. Our comp loss was primarily due to the impact of losses in scrapbooking and Kids Crafts. Kids Crafts which has performed well over the past year, suffered significant losses in both comp sales and gross margin [starting] Q2. This loss was primarily based on the success of silly bands related products, a line of collectible silicon bracelets last year. We believe in particular, that the loss in silly bands impacted our overall traffic and our overall market basket throughout the store. We also experienced weak sales during the second quarter of paper crafting, due to a major reset in clearance activities during Q2 last year. As Joe mentioned previously, departments that experienced comp sales increases in Q2 included, cake decorating and candy making supplies and everyday floral and yarns. For Q2 year-to-date, our comp sales were down 1.7%. Consistent with our Q2 results we experience comp sales increases in our cake decorating and candy making departments, everyday floral and yarn and needle craft. Our largest category comp sales losses year-to-date Q2 were organic kids craft, scrapbooking and seasonal. The majority of the kids craft loss occurred in Q2, as I previously mentioned, when the silly bands trend was at its peak last year. Our scrapbooking losses which occurred in Q2 as well were attributable to extensive clearance activity along with a major reset in Q2 of 2010. Seasonal sales in Easter had some key item success. But we continued to experience soft seasonal sales trend over the past two years in this area. Let met touch on our merchandize assortment for a moment. A customer looks for new and differentiated product in our assortment. While we have made significant less [reset] activity in 2011, we continue to strategically refresh our departments based on our sales and margin potential and customer demands. During the first half of 2011, key resets were completed in our cake decorating department as Joe mentioned earlier in our T-shirt and embellishment department. Quick review of our advertising marketing. Our largest spend continues to be current advertising, which is primary circulars. With our extensive rewards, frequent customer database, we are less reliant on print and continue to diversify our marketing and advertising methods. Consistent with Q1, we lowered our marketing stand in Q2, based on testing and validation over the past year. We know who our customer is, and we believe that our product mix, our advertising marketing mix and our in-store presentation offer crafters a better differentiated choice in the markets in which we compete. Now I will turn the call back over to Joe.

Joe Jeffries

I think this will be good time to take questions. Operator if we can take the first question.

Operator

(Operator Instruction). We’ll take our first question from Bernard Sosnick from Gilford Securities.

Bernard Sosnick

First I’d like to say that looking at your stores I see improvement, so congratulations on that. But with regards to sales in the second quarter, it appears that it was somewhat front end loaded with the Easter shift. How did sales progress through the quarter, particularly in June and July with respect to comp store numbers.

David Abelman

Bernie this is David and I’ll answer this. As I mentioned in my comments, the silly bands hot-hot trend really ramped up beginning Q2 last year and good and bad and fortunately it slowed to a crawl near the end of Q2 which spilt over a little bit in the Q3. But we believe silly bands more than anything impacted sales margin and traffic to the store.

Bernard Sosnick

That still doesn’t address what the comps looked like in June and July versus a year ago.

David Abelman

I believe we don’t provide any granular look month by month, and have really just posted a quarter.

Bernard Sosnick

No, I am not expecting that you give me specific numbers, but was it front-end loaded and towards the end of the quarter, were we somewhere in the range of the first quarter same-store sales decline, better or worse.

Joe Jeffries

Bernie this is Joe. Obviously the Easter shift brought in a good entrance in to the quarter. It slowed down in the middle of the quarter and then it came back on at the end of the quarter. That was kind of the trend if you could visualize that.

Bernard Sosnick

Okay. So if we were to take out the Easter shift and look at the six month numbers overall, you’d say that you were running pretty much at the six months rate of decline as the quarter ended.

Dave Stern

This is Dave Bernie. I am not sure our six month comps were down 1.6%, as we talk about was it the Easter shift, there was a (inaudible) in Q1, there was a benefit in Q2. As David mentioned Easter sales in particular were a little bit soft this year as we’ve experienced in the past couple of years. But regardless the Easter sales did shift in to Q2 this year. So we did get a benefit. That’s why I think looking at the full six months is a more appropriate look, because we had that disparity about Q1 and Q2.

Bernard Sosnick

Okay. What are some of the highlights in the merchandizing sense? Going in to the third quarter you said earlier four seasonal events.

Joe Jeffries

We are Bernie. Our product arrived significantly earlier. We’ve said earlier in all of our fall harvest, fall craft and early Christmas craft programs. We’ve improved our quality, we’ve bought deeper in the items that mattered the most, we have validated all of our assumptions with some vendor partners strategically, and we feel really good about where we are from a presentation perspective. I have been in and out of stores a lot over the past three weeks, both our own stores and in our competitors stores and I am very, very comfortable with what I am seeing in the market place, and the way that we are positioned this year. I think it’s much improved.

Bernard Sosnick

I’d agree on the presentation. Just one final things, candy and cakes, what percent of total sales roughly does that account for?

David Abelman

That business has continued to grow over the last three or four years, and its double-digits.

Bernard Sosnick

As a percent of total sales.

David Abelman

Correct. That’s correct Bernie.

Operator

Moving on we’ll take our next question from Jack Balos from Focus Research.

Jack Balos

What is happening with your Nevada stores, what kind of sales trend are they still having and are there more stores going to be converted to that format?

Dave Stern

Sure Jack. Yes, we’ve remodeled stores during the second quarter, which were converted in to that format. On the last call we mentioned that the stores were remodeled, had an improvement in comps relative to the rest of the chain of about 380 basis points. That class of stores is getting a little dated and so the farther we get out from the point of the remodel, the more noise there is in that. But looking at that same class of stores, it’s now performing at a higher rate in the 380 basis points that we referenced on the last call. Of course, the stores that we converted in Q2 are now too young to get a good read on those sales, but we’ll track those and have some information on a subsequent call.

Jack Balos

On an overall basis, how many Nevada stores do you currently have and what are your plans to have more in the future.

Dave Stern

We’ve got about 30% of our chain as Nevada stores. We got 41 Nevadas in total, and any new stores which you mentioned there are no more for this year. But going forward any new stores will be in that model and remodels will be to that model. We continue to be pleased with it or we are pleased with the results, and the rate at which we’ll rollout the remodel is dependent on a number of factors such as our plans for that particular store, the land lords cooperation and contributions to the remodels of that particular and what the other dynamics are within that specific center. So we are pleased with Nevada and that will be our model going forward.

Jack Balos

I think you said, you still expect losses for the rest of the year, is that correct?

Dave Stern

Yeah we said we anticipate loss in 2011 to be less than that in 2010. But yes we are anticipating a loss for 2011.

Jack Balos

And that includes your fourth quarter?

Dave Stern

Well we talked about what we expected for the full fiscal year. We haven’t seen them in [five] quarter forecasted income.

Jack Balos

I see. So the only thing that can make a change in this would be better sales as opposed to new program to more tightly control expenses.

Dave Stern

Well, you never get to the point where you dust your hands off and you are done looking at expenses, as you know it’s a continual process. But if you look at our SG&A expense which obviously includes all the corporate overhead. On a per store basis, you will see we’re around historic lows for this company. So as we’ve talked about, we’ll continue to look at expenses and continue to try to drive that down. But yes, we need to drive gross margin dollars by getting the right mix of top line sales and gross margin rate.

Jack Balos

So, given that you have the computer transformation completed, right, and you have your distribution centers working properly, structurally internally you are where you want to be, the only different is, you don’t have a sufficient track of merchandising policies to drive sale. Is that the way to look at it?

Joe Jeffries

This Joe Bernie. Obviously our infrastructure is in line. From what you referenced all of our systems upgrades are done, our distribution center, our supply chain is rather tight and teams in those departments are doing a great job and our efficiencies improved everyday. Our merchandising programs I believe are improving and have improved in many categories, and I think we are more competitive today at shelf edged than we have been in the past. We are entering our selling seasons. As you well know, we are primed and ready to do business, and I think we won’t disappoint those customers that visit with us this year.

Operator

Moving on, we’ll take our next question from Mark Mandel from ThinkEquity.

Mark Mandel

Just a couple of follow-ups. First on the expense side, last year in the third quarter your SG&A declined 6.8%. How should we look at this year’s third quarter in modeling that line?

Dave Stern

Mark we haven’t provided guidance by quarter or specifically around expense. But as you’ve seen us trending, there were significant cost reductions previously, and of course as you cycle prior year cost reductions, they become more difficult to continue reducing them the amounts that we were able to in the past.

Mark Mandel

I am just trying remember was the expense level last year unusually lower, unusually depressed or is that moving towards a more normal and sustainable level.

Dave Stern

Markets you were referring to?

Mark Mandel

The third quarter of last year.

Dave Stern

There were not unusual aberrations in last year’s costs.

Mark Mandel

Okay. And moving on [Audio gap]: Our seasonal assortment in the core categories floral to core are better than in recent years. We are very, very excited about our assortment as well as other seasonal offerings throughout the store. So we are pretty excited about where we are growing with products.

Joe Jeffries

Mark this is Joe. Our investment of inventory for our selling seasons on those key items that we need to be deep on this year is significantly greater than they were last year. Our intentions are to maximize every sales opportunity that we have in front of us.

Mark Mandel

Okay. And then finally, any change, anything noteworthy on the competitive front that you can call out.

Joe Jeffries

It’s a very competitive market; we’ve had several new store, competitive openings in our market place this year. I think for the past three or four years, it’s been extremely competitive in the markets in which we do business. I don’t think anything is changed. It’s competitive and it’s promotional.

Operator

Moving on, we’ll take our next question from Russ Silvestri from Skiritai Cap.

Russ Silvestri

Three real questions. First of all easy one; what was the comp last year in Q3?

Dave Stern

Down 7%.

Russ Silvestri

Down 7, okay. And then you talk about, you know your customer and I was just trying to understand that how do you know your customer and how do you know that you are not losing your customer.

David Abelman

This David. Unless we know our customer we have for the last close to two years, we have a rewards loyalty program. And over the course of the two years, we’ve done a very good job in-store and through our promotional vehicles of signing up a very good portion of our customers on this program. So we understand the percentage of transactions in sales through this program. So we have a very good understanding of frequency, what they are buying, how often they shop, and we gravitate more of our marketing towards this database.

Russ Silvestri

So can you talk a little bit more specifically in terms of your transactions how many customers you had using your loyalty program this year versus last year and if there is any growth there, and may be the average spend per customer in the royalty program.

David Abelman

We’ve not provided that level of detail for competitive reasons. But I will tell you that our core customer, we are finding ways successfully to market to them, whether its content or promotion, and drive more business and more sales, and we are excited about the prospects of the program.

Russ Silvestri

I guess the shareholder is not operating particularly efficiently. It’s somewhat disappointing that you won’t share those numbers, I mean we are all looking for signpost of the company making progress, and this would be something that would be specific that you could may be just -- you don’t have to give the absolute numbers, but perhaps just the growth in those customers in the loyalty program might be helpful for the investor. I find it disappointing that you are willing to share that information. I have a hard time understanding how it would be adverse to you on a competitive front. That’s more a statement than a question. And the last question is, can you tell me how you get to the $30 million in cash at the end of the year.

Dave Stern

Again we haven’t provided that level of detail. We are talking about, as you know we anticipate less of a loss in last year. We’ve got the 8 million to 9 million we referred to capital expenditures, and we don’t anticipate anything significant in the financing section of the cash flow statement.

Russ Silvestri

So that cash refund it was a $0.5 million that you lost is that right.

Dave Stern

We picked up 300,000, took a benefit in Q2 of this year, so we can expand in Q2 of last year.

Russ Silvestri

Okay. So that would be in essence a favorable development.

Dave Stern

That’s correct.

Russ Silvestri

Okay. And last what percentage of sales were represented by Silly bands.

David Abelman

I don’t have the percentage of business, but I will tell you that the total loss in kids was all reflective of silly bands, and we actually had growth in many of our new programs and silly bands loss was significant and the margin of silly bands was far greater than our average margin in the kids’ category.

Russ Silvestri

Okay. I guess last, I know you mentioned that you didn’t want to talk about the process that you might be going in terms of strategic alternatives. But can you at least mention if it’s still ongoing or may be what has happened, I am not asking to look forward, but if you can just say what has happened in that process.

Joe Jeffries

Russ, I can tell you that it is ongoing and when the Board has something definitive this year with everyone they certainly will do that. But I cannot speak for what has transpired thus far, just not able to do that.

Operator

(Operator Instruction). Moving on we’ll take our next question from Richard Mansouri from Ridge Road Asset Management.

Richard Mansouri

Just two questions. One, my recollection in three of the last four years, you guys have held your annual meeting in June. To my knowledge we haven’t seen any notice this year even of preliminary day for an annual meeting. Can you help us understand that.

Joe Jeffries

We can’t. We’ve done it in June, we also did one in August a couple of years ago, if I remember correctly. But I wanted to tell you that since we are in the strategic alternatives review lots of things change; regular schedules of practices are sometimes delayed or changed. So therefore accordingly the date for the meeting has not been set yet.

Richard Mansouri

I understand, thank you. Okay, well then secondly, and you mentioned the strategic alternative process and the gentlemen beforehand asked about it. And I understand what you said in your preliminary comments that you are not going to disclose developments. I am not asking for anybody to disclose any prospective developments, but I just want to go to that press release on February 15 that you put out, and may be you can help us understand some of the wording in it. Specifically, it says here, A.C. Moore today announced that its Board of Directors is exploring to see alternatives to enhance shareholder value. What I would like to know is if you can explain to us how you measure this shareholder value that you are referring to, how do you measure shareholder value is my first question.

Dave Stern

Sure Rich. Clearly the Board is looking out for the best interest of the shareholders. The three options outlined in the memo in the press release that you referred to as well as the option to perhaps not go down any those paths is what the special committee of the Board is accessing. So their intend (inaudible) share responsibility is to maximize shareholder value.

Richard Mansouri

Let me just stop you right there for one second, because again I don’t want to get to hairsplitting, but just so I understand. From a public investor perspective, shareholder value is generally defined out of the stock price. So by my reading enhance shareholder value means increase stock price. Is that the fair way of looking at it? You guys are trying to figure out a way to increase the stock price. So that’s fair to say that that’s what the board is trying to do.

Dave Stern

The Board is trying to enhance shareholder value, and a measure of that is the stock price.

Richard Mansouri

Okay, fair enough. So let me ask you. I don’t know if any one on the Board is on this call, but is the Board aware of the stock prices relatively anemic performance in the last several months. Is the Board aware that stock is down by my calculations somewhere around 30% from the day you guys made this announcement? Is the Board aware of that, is the Board concerned about that and is the Board prepared to take whatever steps possible to deliver shareholder value which by a public investors perspective would mean an increased stock price. Is the Board aware of that, I just want to try and understand.

Dave Stern

Certainly the Board is aware of that, all of those factors.

Richard Mansouri

So the Board is aware of the stock price.

Dave Stern

Yes, of course they are.

Operator

Moving on we’ll take our next question from Jeff Kobylarz from Stone Harbor Investments.

Jeff Kobylarz

Curios, if you could share with us the categories that you’ve reset in the first half.

David Abelman

Sure. I will walk through, as Joe had mentioned our cake decorating and candy making was significant undertaking. That area was expanded. There is a totally refreshed assortment and a good deal floor space. Also mentioned the T-shirt and embellishment area. We completed reset that area in terms of assortment on our clothing products as well as our T-shirt embellishments all of our fabric paints, and that was significant. We did a fairly significant refresh in our needle craft area, and expanded our line of pre-cut fabrics. We actually launched the line called Baby Bolts. That’s three yards of fabric that’s refreshed on a regular basis. Then as we do in every key category, line-in line-outs. So there has been items refreshed in virtually every area of store, but those were the major resets in the first half of the year.

Jeff Kobylarz

Any resets for the third quarter?

David Abelman

We have two happening now. So right now our largest undertaking is in our home décor area. So, we’ve done some work in candles and fragrances, we are doing work in our wicker and container area, and our glassware.

Jeff Kobylarz

Okay. And in general is there any newness in the craft category in general, besides these resets that can help drive intra-sales.

David Abelman

Absolutely. One of the product that we are very excited about is the product called deco mesh, and it’s a new (inaudible) in, it’s used to decorate trees, it’s used for craft projects and that item in that category is expanded and done exceedingly well, and there’s a few areas in the core base of craft items around few surfaces beyond wood, we’ve had a lot of success with. In fact if you walk in our stores today, you will see large plates of glass blocks that traditionally were a commercial item in office building. So it’s now a surface for painting and decorating and lighting. So throughout the store, we think there is a (inaudible) assortment and some exciting refreshments that customer is taking notice of.

Jeff Kobylarz

And then you also mentioned that there were a number of competitive opening against you, can you say how many or competitor stores opened against you so far this year.

Joe Jeffries

Approximately five we’ve experienced so far this year.

Jeff Kobylarz

Are there anymore coming up this year, throughout this year?

Joe Jeffries

I think we have a couple of more that we can see on our radar screen.

Jeff Kobylarz

And then inventory, there is inflation in the cost of merchandize and that’s what the talk is out there. Can you say how much inflation you are seeing and are you passing that on or what are you doing there?

David Abelman

Yeah, we’ve seen some cost pressure in particular, and a disproportionate amount of product is sourced in the far east, specifically China, and between labor cost pressure, some raw material cost, there’s been some price pressures throughout the year, and we regularly do competitive price shops. We know our top items, and we shop it regularly, and it’s not adversely affected on the margin.

Jeff Kobylarz

Can you say how much the cost inflation is what you’ve experience so far.

David Abelman

I would say on average 3% to 5%.

Jeff Kobylarz

But it has been shown up in your merchandise margin there. Well your merchandise margin was down a little bit you said in the second quarter.

David Abelman

It was down negligible amount and it was primarily the impact of what we discussed in (inaudible).

Jeff Kobylarz

Going forward do you intend to kind of pass on this cost inflation. I would think more of it is going to show up in the second half.

David Abelman

I think we partner really well with our suppliers and we really understand the cost components that influence our cost of goods, and I think we are very strategic in how we handle our pricing. We’ve worked very hard to get the margin rate go in the right direction, and we don’t intend to back off.

Operator

Moving on we’ll take our next question from Bernard Sosnick from Gilford Securities.

Bernard Sosnick

I’d like to come back to the expense point for the third quarter. Last year if my numbers are correct, you expense level decreased $3.7 million in the third quarter. This year in the first quarter and second quarter, expenses were not down anywhere near that. So, I am wondering what can we expect in dollar amounts in the third quarter, something similar to what we saw in the second quarter or something to what we saw in the third quarter last year?

Dave Stern

Bernie this is Dave. As you know we don’t give quarterly guidance on SG&A. But I think if you go back a little further, you will see there were significant decreases (inaudible) achieving SG&A going back over a number of years. And of course now we are going [kind] of cycling those decreases. It’s harder and harder to achieve sequential decreases year-over-year, given that we are hovering around historic lows per SG&A dollars per store. So it will be more and more difficult to continue sequentially achieving those decreases.

Bernard Sosnick

So, can I take it then that whatever little expense level was in the second quarter, roughly speaking that’s what we could expect in the third quarter, a tad more or less.

Dave Stern

Fairly we haven’t given guidance at quarterly level around SG&A.

Bernard Sosnick

But you can just tell us what the run rate is of expenses. I mean that was abnormally down a year ago, and I think it’s inappropriate not to give us some hint, as to whether or not last year’s number is sustainable this year or if the second quarter number is more likely in the third quarter.

Dave Stern

Bernie I can understand what you are saying, but doing that is in fact giving guidance at the SG&A level by quarter, and that’s something that the company hasn’t done historically, and because of the process that we are in now, it’s inappropriate for us to start providing guidance at levels that we haven’t provided before the process was initiated. So because of that w are not able to do that.

Bernard Sosnick

The gross margin in the second quarter, again if my numbers are correct and my history is right; the gross margin in ’01 for the second quarter was 37% and it was almost 700 basis points higher in the second quarter this year. You are expecting to increase the gross margin I presume, but does there come a point where the increases become more difficult to sustain.

Dave Stern

I am not sure where you are getting this 700 basis points. Our year-to-date gross margin rate is 43.3% and in Q2 it was 43.8%.

Bernard Sosnick

Well, I am getting the 37% from the second quarter of ’01, 37%; ’02, 37%; ’03, 37.1. I mean essentially there has been a significant increase in the gross margin and how far do you think that this trend is sustainable.

Dave Stern

Got it. I didn’t realize you are going back 10 years. My apologies. I think that we have strategically worked on promotions, everyday pricing, our assortment over the last few years, and we think we are very competitive in promotion and everyday pricing on all key items throughout the store, and we are going to continue to look for opportunities. We don’t think we are high priced, we think we are very competitive and we thinking as long terms business these margin rates are fair, and there’s room for growth.

Operator

Moving on we’ll take another follow-up from Mark Mandel from ThinkEquity.

Mark Mandel

Just one quick follow-up. I just wanted to clarify something. Did you say that the transactions were down 1.1% and the average ticket was up 0.4%?

Dave Stern

We did say that Mark.

Operator

Moving on we’ll take our next question from Harsha Gada from Blue Shore Capital.

Harsha Gada

I am just following up with a point that I spoke in the last call about how it looks like, your cost basis is definitely not coming down, and it’s worrisome for me that it seems to be continuing, especially looks like it will be the fourth year of a net loss. And I don’t understand why there is a continuous capital expenditure when you can’t even put out a profit. So what’s the plan. It doesn’t seem like there is any other plan except this user of a strategic review and something might happen. Now, we are starting to reach a point where it looks like the company itself is threatened at this rate of loss continuously. So, what is the plan?

Joe Jeffries

Well the capital expenditures that we have in totality are minor with only one new store and we’ve had the remodels that we’ve talked about for the total year. The rest of the capital expenditure that you see are maintenance related, and those are things that we got to maintain and run the business. So we are extremely conscious of our capital expenditure as a company, and we’ll continue to look for ways to control that particular line and conserve cash and of course grow cash. The strategic alternative process that you talked about certainly is ongoing and we can’t get in to that. But keep in mind as well, we have a sell strategy. We are not sitting back on our laurels trying to just manage expenses here. We have a plan in place to grow our business. Certainly we’ve had some headwinds that we’ve been dealing with for some time. We are seeing some signs of improvement across multiple departments, small improvements year-over-year on key performance indicators and we are heading in to the back half of our year we are in it, and our busier selling weeks and days are fast approaching us. And I stated earlier in the call, we are poised and ready to perform this year. What we can’t predict is whether or not the customer is going to respond and behave the way that we want them to and are hoping for obviously. Those are things that are out of our control, but we’ve prepped and prepared and went through a variety of checks to make sure that we are ready to execute in Q3 and Q4.

Harsha Gada

But the issue here is not - it doesn’t look like this is a sales issue especially when you also look at gross margins increasing by so much in the past decade, and the continuous improvement, through meager recently. It really looks like it’s a cost issue, and the fact that we have continuous losses, it seems like there should be no discussion of expansion. We should even look at may be shrinking the business. If we can’t make money at this point, I don’t understand how - you would need a dramatic increase in sales. And even with a dramatic increase in sales, if SG&A continues at this ratio, I don’t even see how you guys can make any money.

Dave Stern

Sure. I’ll take that, and this is Dave. Let me mention a couple of points. While I think you are saying it’s not a sales issue as much of it as an expense issue. If you look at our dollars per store, you’ll see it is around historic lows, and so as we talked about earlier on the call, you are never at the point where you are done evaluating expenses. It’s an ongoing process, and we’ll continue to do it. But expenses and SG&A have been brought down significantly. Where I would disagree with you is that it’s a sales issue or not. Sales have come down by larger degree than the costs have come down. So we need to drive sales. We’ve talked about it on this call, we’ve talked about it on prior calls as well, and it’s really driving gross margin dollars by getting the right mix of top line sales growth and gross margin rate. One other points you mentioned was essentially shrinking the store of the company which obviously would mean decreasing the store count. We talked about that in the past and in fact earlier on the scripts, I did mention that if we are able to negotiate (inaudible) early lease terminations, we would take advantage of doing that, and so that’s what’s not specifically built in to the plan, it is something that’s in process as well.

Harsha Gada

I understand that David and we spoke about this a couple of weeks back. But the big issue is 2010. The economy picked up, we understand the performance in 2008 and 2009. Economy is picking up significantly losses at A.C. Moore. Now we are entering or finishing up this year, it looks like things are slowing down again, we are projecting another loss this year, possibly even more significant loss next year. So I don’t understand how this business is even sustainable at this rate.

Dave Stern

Again a couple of things. One you mentioned slowing down this year. We said earlier that we anticipate the net loss this year to be lower than that of last year.

Harsha Gada

That’s not a good thing by the way.

Dave Stern

Okay. The comp sales while are declining are not something that any of us are pleased with are the lowest decline the company has experienced in years. I think you mentioned next year’s loss, and we haven’t given any guidance around that yet.

Harsha Gada

But the issue is a real question of what can be done to keep this business alive. I mean that’s my approach because I am sitting as a shareholder for a multiple years now, watching things continuously deteriorate, especially as many other retailers were able to turn a profit. And I just want to know, how are you going to stop the failure of this entire business, because more important than any quarterly sales change, I am really concerned about the business surviving. Because I don’t see how it’s possible. Every year we are loosing a little bit more money, a little bit more cash. There has not even been a pickup as the economy rebound. So, what is the end game here, because there are ways to take a business such as this and make it profitable. I have seen other retailers that are in much more difficult industries such as specialty music that have been able to turn a profit, generate free cash flows. So I don’t understand why A.C. Moore, which is not in a declining industry per say, does have a customer base, why is it that we cannot turn a profit year, get some free cash flows going consistently.

Dave Stern

I agree with what you said that other retailers have been in similar situations or worse and turned it around. That’s something we’ve talked about on this call routinely and its going through this time what we’ve talked about, and need to grow gross margin dollars by growing the top line at an appropriate gross margin rate. Continuing to look at the cost structure which we’ve done; we’ve brought down significantly, and will continue to review that. Been very close tabs on capital expenditures, so as you know we’ve opened up fewer stores this year than last year, and we are generating a lower loss this year than we did last year. And this quarter we’ve got, again as we talked about, while we are not pleased with a negative comp, it is far lower than the company has experienced in years.

Harsha Gada

Well guys again, I just want to see a little bit more sense of desperation, a sense of let’s turn this ship around and get it healthy again. I hope I can convey that thought, those thoughts, but I am just a little worried to tell you the truth. And especially, are we going to have an annual meeting this year? I just want to make sure because you specified that it happened sometimes in August, but there’s no notice and we are already in August. I just want to make sure that’s still planned.

Joe Jeffries

I appreciate your concern. Regarding the sense of desperation; no it’s not a sense of desperation. We’ve got a plan in place, we are executing on it. But what we do have is a high sense of urgency, and there’s a significant difference between those two. Regarding the shareholders meeting, it won’t take place in August, but of course while the strategic alternatives or view is in place, typically these things are delayed if changed, and accordingly a date has not been set for the meeting.

Harsha Gada

I just want to make sure that there will be one in 2011.

Joe Jeffries

We are not saying definitively whether there will or will not be one, but obviously if appropriate, we will have one. I think it’s time for us to wrap up the call.

Operator

Certainly sir, then at this time please go ahead with any closing or final remarks.

Joe Jeffries

I would like close by saying that our management team here at the store supports and appreciates all the efforts of all of our associates in the organization across our chain and their teams and their commitments. All of them are working hard and committed to our performance. I want to thank those on the call today for joining us and for your continued interest in A.C. Moore.