Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549


 

FORM 10-Q

 

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

 

For the quarterly period ended May 4, 2019

 

Commission file number 001-36501


 

THE MICHAELS COMPANIES, INC.

A Delaware Corporation

 

IRS Employer Identification No. 37-1737959

 

 

8000 Bent Branch Drive

Irving, Texas 75063

 

(972) 409-1300


Securities registered pursuant to Section 12(b) of the Act:

 

 

 

 

 

Title of each class

    

Trading Symbol

    

Name of each exchange on which registered

Common Stock, $0.06775 par value

 

MIK

 

Nasdaq Stock Exchange

The Michaels Companies, Inc. (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

The Michaels Companies, Inc. has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

The Michaels Companies, Inc. is a large accelerated filer.

The Michaels Companies, Inc. is not (1) a shell company, (2) a small reporting company or (3) an emerging growth company (as defined in Rule 12b-2 of the Exchange Act).

As of May 30, 2019, 158,170,366 shares of The Michaels Companies, Inc.’s common stock were outstanding.

 

 

 

 

 

 

Table of Contents

THE MICHAELS COMPANIES, INC.

 

TABLE OF CONTENTS

 

 

 

 

 

Part I—FINANCIAL INFORMATION 

 

 

 

Page

 

 

 

Item 1. 

Financial Statements

3

 

 

 

 

Consolidated Statements of Comprehensive Income for the 13 weeks ended May 4, 2019 and May 5, 2018 (unaudited)

3

 

 

 

 

Consolidated Balance Sheets as of May 4, 2019, February 2, 2019 and May 5, 2018 (unaudited)

4

 

 

 

 

Consolidated Statements of Cash Flows for the 13 weeks ended May 4, 2019 and May 5, 2018 (unaudited)

5

 

 

 

 

Consolidated Statements of Stockholders’ Deficit for the 13 weeks ended May 4, 2019 and May 5, 2018 (unaudited)

6

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

7

 

 

 

Item 2. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

24

 

 

 

Item 4. 

Controls and Procedures

24

 

 

 

Part II—OTHER INFORMATION 

 

 

 

Item 1. 

Legal Proceedings

25

 

 

 

Item 1A. 

Risk Factors

25

 

 

 

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

25

 

 

 

Item 6. 

Exhibits

26

 

 

 

Signatures 

 

27

 

 

 

2

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Part I—FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands, except per share data)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

 

2019

 

2018

Net sales

 

$

1,093,720

 

$

1,155,511

Cost of sales and occupancy expense

 

 

676,080

 

 

698,948

Gross profit

 

 

417,640

 

 

456,563

Selling, general and administrative

 

 

320,597

 

 

328,617

Restructure charges

 

 

3,087

 

 

47,498

Store pre-opening costs

 

 

1,226

 

 

1,505

Operating income

 

 

92,730

 

 

78,943

Interest expense

 

 

37,359

 

 

34,594

Other expense (income), net

 

 

3,105

 

 

(1,693)

Income before income taxes

 

 

52,266

 

 

46,042

Income taxes

 

 

14,575

 

 

19,157

Net income

 

$

37,691

 

$

26,885

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

Foreign currency translation and other

 

 

(4,826)

 

 

(7,053)

Comprehensive income

 

$

32,865

 

$

19,832

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

Basic

 

$

0.24

 

$

0.15

Diluted

 

$

0.24

 

$

0.15

Weighted-average common shares outstanding:

 

 

 

 

 

 

Basic

 

 

157,749

 

 

181,523

Diluted

 

 

157,861

 

 

182,652

 

See accompanying notes to consolidated financial statements.

 

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THE MICHAELS COMPANIES, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

May 4,

 

February 2,

 

May 5,

ASSETS

 

2019

 

2019

 

2018

Current Assets:

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

246,727

 

$

245,887

 

$

422,454

Merchandise inventories

 

 

1,101,729

 

 

1,108,715

 

 

1,121,563

Prepaid expenses and other

 

 

65,304

 

 

98,659

 

 

108,481

Accounts receivable, net

 

 

32,203

 

 

57,328

 

 

30,033

Income taxes receivable

 

 

4,020

 

 

4,935

 

 

2,818

Total current assets

 

 

1,449,983

 

 

1,515,524

 

 

1,685,349

Property and equipment, at cost

 

 

1,676,751

 

 

1,656,098

 

 

1,569,720

Less accumulated depreciation and amortization

 

 

(1,242,869)

 

 

(1,217,021)

 

 

(1,144,815)

Property and equipment, net

 

 

433,882

 

 

439,077

 

 

424,905

Operating lease assets

 

 

1,613,719

 

 

 —

 

 

 —

Goodwill

 

 

112,069

 

 

112,069

 

 

119,074

Other intangible assets, net

 

 

16,960

 

 

17,238

 

 

21,376

Deferred income taxes

 

 

25,577

 

 

25,005

 

 

33,338

Other assets

 

 

27,068

 

 

19,423

 

 

29,496

Total assets

 

$

3,679,258

 

$

2,128,336

 

$

2,313,538

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

406,947

 

$

485,004

 

$

449,687

Accrued liabilities and other

 

 

354,398

 

 

378,742

 

 

384,630

Current portion of operating lease liabilities

 

 

300,489

 

 

 —

 

 

 —

Current portion of long-term debt

 

 

24,900

 

 

24,900

 

 

24,900

Income taxes payable

 

 

55,339

 

 

43,907

 

 

82,219

Total current liabilities

 

 

1,142,073

 

 

932,553

 

 

941,436

Long-term debt

 

 

2,675,602

 

 

2,681,000

 

 

2,696,408

Long-term operating lease liabilities

 

 

1,380,175

 

 

 —

 

 

 —

Other liabilities

 

 

68,766

 

 

140,978

 

 

159,615

Total liabilities

 

 

5,266,616

 

 

3,754,531

 

 

3,797,459

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Deficit:

 

 

 

 

 

 

 

 

 

Common stock, $0.06775 par value, 350,000 shares authorized; 158,126 shares issued and outstanding at May 4, 2019; 157,774 shares issued and outstanding at February 2, 2019; and 182,055 shares issued and outstanding at May 5, 2018

 

 

10,620

 

 

10,594

 

 

12,225

Additional paid-in-capital

 

 

11,900

 

 

5,954

 

 

27,463

Accumulated deficit

 

 

(1,590,494)

 

 

(1,628,185)

 

 

(1,512,896)

Accumulated other comprehensive loss

 

 

(19,384)

 

 

(14,558)

 

 

(10,713)

Total stockholders’ deficit

 

 

(1,587,358)

 

 

(1,626,195)

 

 

(1,483,921)

Total liabilities and stockholders’ deficit

 

$

3,679,258

 

$

2,128,336

 

$

2,313,538

 

See accompanying notes to consolidated financial statements.

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THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

    

2019

 

2018

Cash flows from operating activities:

 

 

 

 

 

 

Net income

 

$

37,691

 

$

26,885

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

Amortization of operating lease assets

 

 

81,371

 

 

 —

Depreciation and amortization

 

 

31,489

 

 

29,458

Share-based compensation

 

 

7,251

 

 

6,969

Debt issuance costs amortization

 

 

1,237

 

 

1,274

Loss on write-off of investment

 

 

5,036

 

 

 —

Accretion of long-term debt, net

 

 

(130)

 

 

(126)

Restructure charges

 

 

3,087

 

 

47,498

Deferred income taxes

 

 

140

 

 

2,580

Changes in assets and liabilities:

 

 

 

 

 

 

Merchandise inventories

 

 

6,966

 

 

(18,755)

Prepaid expenses and other

 

 

(6,412)

 

 

1,523

Accounts receivable

 

 

23,705

 

 

(4,892)

Other assets

 

 

(12,964)

 

 

(842)

Operating lease liabilities

 

 

(56,843)

 

 

 —

Accounts payable

 

 

(81,237)

 

 

(46,639)

Accrued interest

 

 

7,706

 

 

8,325

Accrued liabilities and other

 

 

(25,611)

 

 

(35,356)

Income taxes

 

 

12,318

 

 

11,689

Other liabilities

 

 

(1,002)

 

 

2,912

Net cash provided by operating activities

 

 

33,798

 

 

32,503

 

 

 

 

 

 

 

Cash flows used in investing activities:

 

 

 

 

 

 

Additions to property and equipment

 

 

(25,101)

 

 

(27,824)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Common stock repurchased

 

 

(2,172)

 

 

(2,119)

Payments on term loan credit facility

 

 

(6,225)

 

 

(6,225)

Payment of dividends

 

 

 —

 

 

(317)

Proceeds from stock options exercised

 

 

540

 

 

540

Net cash used in financing activities

 

 

(7,857)

 

 

(8,121)

 

 

 

 

 

 

 

Net change in cash and equivalents

 

 

840

 

 

(3,442)

Cash and equivalents at beginning of period

 

 

245,887

 

 

425,896

Cash and equivalents at end of period

 

$

246,727

 

$

422,454

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

 

Cash paid for interest

 

$

29,164

 

$

25,344

Cash paid for taxes

 

$

2,320

 

$

5,370

 

See accompanying notes to consolidated financial statements.

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THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT

(in thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

Number of

 

 

 

 

Additional

 

 

 

 

Other

 

 

 

 

Common

 

Common

 

Paid-in

 

Accumulated

 

Comprehensive

 

 

 

 

Shares

  

Stock

  

Capital

  

Deficit

  

Loss

  

Total

Balance at February 2, 2019

  

157,774

 

$

10,594

 

$

5,954

 

$

(1,628,185)

 

$

(14,558)

 

$

(1,626,195)

Net income

 

 —

 

 

 —

 

 

 —

 

 

37,691

 

 

 —

 

 

37,691

Foreign currency translation and other

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(4,826)

 

 

(4,826)

Share-based compensation

 

 —

 

 

 —

 

 

7,604

 

 

 —

 

 

 —

 

 

7,604

Exercise of stock options and other awards

 

555

 

 

38

 

 

502

 

 

 —

 

 

 —

 

 

540

Repurchase of stock and retirements

 

(229)

 

 

(12)

 

 

(2,160)

 

 

 —

 

 

 —

 

 

(2,172)

Issuance of restricted stock awards

 

26

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Balance at May 4, 2019

 

158,126

 

$

10,620

 

$

11,900

 

$

(1,590,494)

 

$

(19,384)

 

$

(1,587,358)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at February 3, 2018

  

181,919

  

$

12,206

  

$

21,740

  

$

(1,539,781)

  

$

(3,660)

  

$

(1,509,495)

Net income

 

 —

  

 

 —

 

 

 —

 

 

26,885

 

 

 —

 

 

26,885

Foreign currency translation and other

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(7,053)

 

 

(7,053)

Share-based compensation

 

 —

 

 

 —

 

 

7,321

 

 

 —

 

 

 —

 

 

7,321

Exercise of stock options and other awards

 

374

 

 

25

 

 

515

 

 

 —

 

 

 —

 

 

540

Repurchase of stock and retirements

 

(238)

 

 

(6)

 

 

(2,113)

 

 

 —

 

 

 —

 

 

(2,119)

Balance at May 5, 2018

 

182,055

 

$

12,225

 

$

27,463

 

$

(1,512,896)

 

$

(10,713)

 

$

(1,483,921)

 

See accompanying notes to consolidated financial statements.

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THE MICHAELS COMPANIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. BASIS OF PRESENTATION

 

All expressions of the “Company”, “us”, “we”, “our”, and all similar expressions are references to The Michaels Companies, Inc. and our consolidated, wholly-owned subsidiaries, unless otherwise expressly stated or the context otherwise requires. Our consolidated financial statements include the accounts of The Michaels Companies, Inc. and our wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10‑Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Therefore, these financial statements should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended February 2, 2019 filed with the Securities and Exchange Commission (“SEC”) pursuant to Section 13 or 15(d) under the Securities Exchange Act of 1934. In the opinion of management, all adjustments (consisting of normal recurring accruals and other items) considered necessary for a fair presentation have been included.

 

We report on the basis of a 52-week or 53-week fiscal year, which ends on the Saturday closest to January 31. All references to fiscal year mean the year in which that fiscal year began. References to “fiscal 2019” relate to the 52 weeks ending February 1, 2020 and references to “fiscal 2018” relate to the 52 weeks ended February 2, 2019. In addition, all references to “the first quarter of fiscal 2019” relate to the 13 weeks ended May 4, 2019 and all references to “the first quarter of fiscal 2018” relate to the 13 weeks ended May 5, 2018. Because of the seasonal nature of our business, the results of operations for the 13 weeks ended May 4, 2019 are not indicative of the results to be expected for the entire year.

 

Restructure Charges

 

In March 2018, we closed substantially all of our Aaron Brothers stores and in January 2019, we closed all 36 of our Pat Catan’s stores. In the first quarter of fiscal 2019, we recorded a restructure charge related to Pat Catan’s totaling $3.1 million, primarily related to employee-related expenses. In the first quarter of fiscal 2018, we recorded a restructure charge related to Aaron Brothers totaling $47.5 million, primarily related to the transfer of the rights to sell inventory and other assets to a third party to facilitate the store closures and assist with the disposition of our remaining lease obligations and employee-related expenses. In the first quarter of fiscal 2018, Pat Catan's and Aaron Brothers had net sales totaling approximately $25.8 million and $12.9 million, respectively. Excluding the restructure charges, Aaron Brothers and Pat Catan’s did not have a material impact on the Company’s operating income in the periods presented.

 

Share Repurchase Program

 

In September 2018, the Board of Directors authorized a new share repurchase program for the Company to purchase $500.0 million of the Company’s common stock on the open market or through accelerated share repurchase transactions. The share repurchase program does not have an expiration date, and the timing and number of repurchase transactions under the program will depend on market conditions, corporate considerations, debt agreements and regulatory requirements. Shares repurchased under the program are held as treasury shares until retired. As of May 4, 2019, we had $398.4 million of availability remaining under our current share repurchase program.

 

Accounting Pronouncement Recently Adopted

 

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)" ("ASU 2016-02"). Under ASU 2016‑02, an entity is required to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. ASU 2016-02 offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising

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from leases. The lease standard requires companies to use a modified retrospective transition approach as of the beginning of the earliest comparable period presented in the company’s financial statements. In July 2018, the FASB issued ASU 2018-11, “Leases (Topic 842): Targeted Improvements”  which provided an additional transition option that allows companies to continue applying the guidance under the current lease standard in the comparative periods presented in the consolidated financial statements. We utilized the additional transition option to adopt ASU 2016-02 in the first quarter of fiscal 2019. As a result, the standard was applied starting February 3, 2019 and prior periods were not restated. We also elected the practical expedient permitted under the transition guidance which permits companies not to reassess prior conclusions on lease identification, historical lease classification and initial direct costs. The adoption of the standard resulted in the recognition of operating lease assets and liabilities of approximately $1.7 billion as of February 3, 2019. The adoption did not result in a material impact on our consolidated statements of comprehensive income.

 

2. FAIR VALUE MEASUREMENTS

 

As defined in Accounting Standards Codification (“ASC”) 820, Fair Value Measurements (“ASC 820”), fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three-level valuation hierarchy for fair value measurements. These valuation techniques are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect less transparent active market data, as well as internal assumptions. These two types of inputs create the following fair value hierarchy:

 

·

Level 1—Quoted prices for identical instruments in active markets;

 

·

Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose significant inputs are observable; and

 

·

Level 3—Instruments with significant unobservable inputs.

 

Impairment losses related to store-level operating lease assets and property and equipment are calculated using significant unobservable inputs including the present value of future cash flows expected to be generated using a risk-adjusted weighted-average cost of capital and comparable store sales growth assumptions and, therefore, are classified as a Level 3 measurement in the fair value hierarchy.

 

The carrying value of cash and cash equivalents, accounts receivable and accounts payable approximates their estimated fair values due to the short maturities of these instruments.

 

The table below provides the fair values of our senior secured term loan facility (“Amended and Restated Term Loan Credit Facility”), our 5.875% senior subordinated notes maturing in 2020 (“2020 Senior Subordinated Notes’’) and our interest rate swaps.

 

 

 

 

 

 

 

 

 

 

 

 

 

May 4,

 

February 2,

 

May 5,

 

 

2019

 

2019

 

2018

 

 

(in thousands)

Assets

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

 —

 

$

 —

 

$

1,106

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Term loan credit facility

 

$

2,187,467

 

$

2,177,098

 

$

2,237,256

Senior subordinated notes

 

 

511,275

 

 

511,913

 

 

518,925

Short-term portion of interest rate swaps

 

 

3,686

 

 

2,557

 

 

4,930

Long-term portion of interest rate swaps

 

 

5,408

 

 

3,809

 

 

 —

 

The fair values of our Amended and Restated Term Loan Credit Facility and our 2020 Senior Subordinated Notes were determined based on quoted market prices which are considered Level 1 inputs within the fair value hierarchy.

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The fair value of our interest rate swaps was calculated using significant observable inputs including the present value of estimated future cash flows using the applicable interest rate curves and, therefore, were classified as Level 2 inputs within the fair value hierarchy. The short-term and long-term interest rate swap liabilities are recorded in accrued liabilities and other liabilities, respectively, in our consolidated balance sheets. The interest rate swap asset in fiscal 2018 is recorded in other assets in our consolidated balance sheets.

 

3. REVENUE RECOGNITION

 

Our revenue is primarily associated with sales of merchandise to customers within our stores, customers utilizing our e-commerce platforms and through our Darice wholesale business (“Darice”). Revenue from sales of our merchandise is recognized when the customer takes possession of the merchandise. Payment for our retail sales is typically due at the time of the sale.

 

Right of Return 

 

A sales return reserve is established using historical customer return behavior and reduces both revenue and cost of goods sold. The Company presents the gross sales return reserve in other current liabilities and the estimated value of the merchandise expected to be returned in prepaid expenses and other in the consolidated balance sheets.

 

Customer Receivables

 

As of May 4, 2019, February 2, 2019 and May 5, 2018, receivables from customers, which consist primarily of trade receivables related to Darice, were approximately $22.4 million, $32.1 million and $18.4 million, respectively, and are included in accounts receivable, net in the consolidated balance sheets.

 

Gift Cards

 

The gift card liability is included in accrued liabilities and other in the consolidated balance sheets. The following table includes activity related to gift cards (in thousands):

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

 

2019

 

2018

Balance at beginning of period

 

$

61,071

 

$

56,729

Issuance of gift cards

 

 

11,325

 

 

11,543

Revenue recognized (1)

 

 

(15,747)

 

 

(15,916)

Gift card breakage

 

 

(941)

 

 

(843)

Balance at end of period

 

$

55,708

 

$

51,513


(1)

Revenue recognized from the beginning liability during the first quarters of fiscal 2019 and fiscal 2018 totaled $10.7 million. 

 

 

4. LEASES

 

We lease our retail store locations, distribution centers, office facilities and certain equipment under non-cancelable operating leases. Substantially all store leases have initial lease terms of approximately 10 years, the majority of which provide for one or more five-year renewal options. The exercise of lease renewal options is at the Company’s sole discretion. We include the lease renewal option periods in the calculation of our operating lease assets and liabilities when it is reasonably certain that we will renew the lease.

Our operating lease assets represent our right to use an underlying asset for the lease term and our operating lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. In addition, operating lease assets exclude lease incentives received. As most of our leases do not contain an implicit rate of return, we

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use our estimated incremental borrowing rate based on the information available at the lease commencement date in determining the present value of lease payments. For operating leases that commenced prior to the adoption date of the new lease accounting standard, we used the incremental borrowing rate as of the adoption date. Lease expense for lease payments is recognized on a straight-line basis over the lease term. 

We have lease agreements with lease and non-lease components, which are generally accounted for as a single lease component. Our short-term non-real estate leases, which have a non-cancelable lease term of less than one year, are not included in the operating lease assets or liabilities. Short-term lease expense is recognized on a straight-line basis over the lease term. 

 

The components of lease costs are as follows (in thousands):

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

 

2019

Operating lease cost (1)

  

$

105,465

Variable lease cost  (2)

 

 

36,440

Total lease cost

 

$

141,905


(1)

Includes an immaterial amount related to short-term non-real estate leases.

(2)

Includes taxes, insurance and common areas maintenance costs for our leased facilities which are paid based on actual cost incurred by the lessor. Also includes contingent rent which is immaterial in the period presented.

 

Additional information related to our operating leases is as follows (in thousands, except weighted-average data):

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

 

2019

Operating cash outflows included in the measurement of lease liabilities

 

$

106,998

Operating lease assets obtained in exchange for new operating lease liabilities

 

$

52,709

Weighted-average remaining lease term

 

 

6.2 years

Weighted-average discount rate

 

 

5.6 %

 

Maturities of our lease liabilities are as follows as of May 4, 2019 (in thousands):

 

 

 

 

 

Fiscal Year

 

 

2019

 

$

284,284

2020

 

 

392,335

2021

 

 

337,625

2022

 

 

276,194

2023

 

 

213,765

Thereafter

 

 

509,549

Total lease payments

 

$

2,013,752

Less: Interest

 

 

(333,088)

Present value of lease liabilities

 

$

1,680,664

 

Lease payments exclude $125.2 million related to 33 leases that have been signed as of May 4, 2019 but have not yet commenced.

 

 

 

 

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5. DEBT

 

Long-term debt consists of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

May 4,

 

February 2,

 

May 5,

 

Interest Rate

 

2019

 

2019

 

2018

Term loan credit facility

Variable

 

$

2,201,225

 

$

2,207,450

 

$

2,226,125

Senior subordinated notes

5.875

%

 

510,000

 

 

510,000

 

 

510,000

Total debt

 

 

 

2,711,225

 

 

2,717,450

 

 

2,736,125

Less unamortized discount/premium and debt costs

 

 

 

(10,723)

 

 

(11,550)

 

 

(14,817)

Total debt, net

 

 

 

2,700,502

 

 

2,705,900

 

 

2,721,308

Less current portion

 

 

 

(24,900)

 

 

(24,900)

 

 

(24,900)

Long-term debt

 

 

$

2,675,602

 

$

2,681,000

 

$

2,696,408

 

Revolving Credit Facility

 

As of May 4, 2019 and May 5, 2018, the borrowing base under our senior secured asset-based revolving credit facility was $784.3 million and $770.7 million, respectively, of which Michaels Stores, Inc. (“MSI”) had unused borrowing capacity of $677.1 million and $674.0 million, respectively. As of May 4, 2019 and May 5, 2018, outstanding standby letters of credit, which reduce our borrowing base, totaled $107.2 million and $96.7 million, respectively.

 

Interest Rate Swaps

 

In April 2018, we executed two interest rate swaps with an aggregate notional value of $1.0 billion associated with our outstanding Amended and Restated Term Loan Credit Facility. The interest rate swaps have a maturity date of April 30, 2021 and were executed for risk management and are not held for trading purposes. The objective of the interest rate swaps is to hedge the variability of cash flows resulting from fluctuations in the one-month LIBOR. The swaps replaced the one-month LIBOR with a fixed interest rate of 2.7765% and payments are settled monthly. The swaps qualify as cash flow hedges and changes in the fair values are recorded in accumulated other comprehensive income in the consolidated balance sheet. The changes in fair value are reclassified from accumulated other comprehensive income to interest expense in the same period that the hedged items affect earnings. Amounts reclassified from accumulated other comprehensive income to interest expense during the first quarters of fiscal 2019 and fiscal 2018 were not material.

 

6. ACCUMULATED OTHER COMPREHENSIVE LOSS

 

The following table includes detail regarding changes in the composition of accumulated other comprehensive loss (in thousands):

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

 

2019

    

2018

Beginning of period

  

$

(14,558)

 

$

(3,660)

Foreign currency translation adjustment

 

 

(2,807)

 

 

(4,147)

Interest rate swaps

 

 

(2,019)

 

 

(2,906)

End of period

 

$

(19,384)

 

$

(10,713)

 

 

7. INCOME TAXES

 

The effective tax rate was 27.9% for the first quarter of fiscal 2019 compared to 41.6% for the first quarter of fiscal 2018. The effective tax rate for the first quarter of fiscal 2019 was lower than the same period in the prior year due primarily to an $8.1 million charge in the first quarter of 2018 related to repatriation taxes for accumulated earnings of our foreign subsidiaries associated with the enactment of the Tax Cuts and Jobs Act of 2017. The decrease was partially offset by $1.8 million of tax expense recorded in the first quarter of fiscal 2019 primarily related to the vesting of restricted shares.

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8. EARNINGS PER SHARE

 

The Company’s unvested restricted stock awards contain non-forfeitable rights to dividends and meet the criteria of a participating security as defined by ASC 260, “Earnings Per Share”. In applying the two-class method, net income is allocated to both common and participating securities based on their respective weighted-average shares outstanding for the period. Basic earnings per share is computed by dividing net income allocated to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share is computed by dividing income available to common shareholders by the weighted-average common shares outstanding plus the potential dilutive impact from stock options and restricted stock units. Common equivalent shares are excluded from the computation if their effect is anti-dilutive. There were 11.1 million and 5.7 million anti-dilutive shares during the first quarters of fiscal 2019 and fiscal 2018, respectively.

 

The following table sets forth the computation of basic and diluted earnings per common share (in thousands, except per share data):

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

 

2019

 

2018

Basic earnings per common share:

 

 

 

 

 

 

Net income

 

$

37,691

  

$

26,885

Less income related to unvested restricted shares

 

 

(39)

 

 

(67)

Income available to common shareholders - Basic

 

$

37,652

 

$

26,818

 

 

 

 

 

 

 

Weighted-average common shares outstanding - Basic

 

 

157,749

 

 

181,523

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.24

 

$

0.15

 

 

 

 

 

 

 

Diluted earnings per common share:

 

 

 

 

 

 

Net income

 

$

37,691

 

$

26,885

Less income related to unvested restricted shares

 

 

(39)

 

 

(66)

Income available to common shareholders - Diluted

 

$

37,652

 

$

26,819

 

 

 

 

 

 

 

Weighted-average common shares outstanding - Basic

 

 

157,749

 

 

181,523

Effect of dilutive stock options and restricted stock units

 

 

112

 

 

1,129

Weighted-average common shares outstanding - Diluted

 

 

157,861

 

 

182,652

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.24

 

$

0.15

 

 

9. SEGMENTS AND GEOGRAPHIC INFORMATION

 

We consider Michaels-U.S., Michaels-Canada, Pat Catan’s and Darice to be our operating segments for purposes of determining reportable segments based on the criteria of ASC 280, Segment Reporting (“ASC 280”). We determined that Michaels-U.S., Michaels-Canada and Pat Catan’s have similar economic characteristics and meet the aggregation criteria set forth in ASC 280. Therefore, we combine these operating segments into one reporting segment. Darice does not meet the materiality criteria in ASC 280 and, therefore, is not disclosed separately as a reportable segment. Our chief operating decision makers evaluate historical operating performance and forecast future periods’ operating performance based on operating income.

 

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Our net sales by country are as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

 

2019

 

2018

United States(1)

 

$

994,101

 

$

1,048,001

Canada

 

 

99,619

 

 

107,510

Total

 

$

1,093,720

 

$

1,155,511


(1)

In the first quarter of fiscal 2018 we closed substantially all of our Aaron Brothers stores and in the fourth quarter of fiscal 2018 we closed all of our Pat Catan’s stores. In the first quarter of fiscal 2018, Pat Catan’s and Aaron Brothers sales totaled approximately $25.8 million and $12.9 million, respectively.

 

10. RELATED PARTY TRANSACTIONS

 

Affiliates of, or funds advised by, Bain Capital Private Equity, L.P. (“Bain Capital”) and The Blackstone Group L.P. (“The Blackstone Group”, together with Bain Capital and their applicable affiliates, the “Sponsors”) owned approximately 46% of our outstanding common stock as of May 4, 2019.

 

The Blackstone Group owns a majority equity position in RGIS, a vendor we utilized until February 2018 to count our store inventory. There were no payments associated with this vendor during the first quarter of fiscal 2019. Payments associated with this vendor during the first quarter of fiscal 2018 were $0.7 million. These expenses are included in selling, general and administrative (“SG&A”) in the consolidated statements of comprehensive income.

 

The Blackstone Group owns a majority equity position in ShopCore Properties, LP, Blackstone Real Estate DDR Retail Holdings III, LLC and Blackstone Real Estate RC Retail Holdings, LLC and has significant influence over Edens Limited Partnership, vendors we utilize to lease certain properties. Payments associated with these vendors during the first quarters of fiscal 2019 and fiscal 2018 were $2.3 million and $2.8 million, respectively. These expenses are included in cost of sales and occupancy expense in the consolidated statements of comprehensive income.

 

The Blackstone Group owns a majority equity position in JDA Software Group, Inc., a vendor we utilize for transportation and supply chain software. Payments associated with this vendor during the first quarters of fiscal 2019 and fiscal 2018 were $0.7 million and $1.3 million, respectively. These expenses are included in SG&A in the consolidated statements of comprehensive income.

 

Three of our current directors, Joshua Bekenstein, Ryan Cotton and Peter F. Wallace, are affiliates of either Bain Capital or The Blackstone Group. As such, some or all of such directors may have an indirect material interest in payments with respect to debt securities of the Company that have been purchased by affiliates of Bain Capital and The Blackstone Group. As of May 4, 2019, affiliates of The Blackstone Group held $93.8 million of our Amended and Restated Term Loan Credit Facility.

 

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11. CONDENSED CONSOLIDATED FINANCIAL INFORMATION

 

Our debt covenants restrict MSI, and certain subsidiaries of MSI, from various activities including the incurrence of additional debt, payment of dividends and the repurchase of MSI’s capital stock (subject to certain exceptions), among other things. The following condensed consolidated financial information represents the financial information of MSI and its wholly-owned subsidiaries subject to these restrictions. The information is presented in accordance with the requirements of Rule 12-04 under the SEC’s Regulation S-X.

 

Michaels Stores, Inc.

Condensed Consolidated Balance Sheets

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

May 4,

 

February 2,

 

May 5,

ASSETS

    

2019

 

2019

 

2018

Current assets:

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

245,944

 

$

245,108

 

$

421,685

Merchandise inventories

 

 

1,101,729

 

 

1,108,715

 

 

1,121,563

Prepaid expenses and other current assets

 

 

101,423

 

 

160,767

 

 

141,229

Total current assets

 

 

1,449,096

 

 

1,514,590

 

 

1,684,477

Property and equipment, net

 

 

433,882

 

 

439,077

 

 

424,905

Operating lease assets

 

 

1,613,719

 

 

 —

 

 

 —

Goodwill

 

 

112,069

 

 

112,069

 

 

119,074

Other assets

 

 

69,607

 

 

61,667

 

 

84,608

Total assets

 

$

3,678,373

 

$

2,127,403

 

$

2,313,064

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

406,947

 

$

485,004

 

$

449,687

Accrued liabilities and other

 

 

353,961

 

 

378,313

 

 

384,170

Current portion of operating lease liabilities

 

 

300,489

 

 

 —

 

 

 —

Current portion of long-term debt

 

 

24,900

 

 

24,900

 

 

24,900

Other current liabilities

 

 

55,339

 

 

43,907

 

 

127,568

Total current liabilities

 

 

1,141,636

 

 

932,124

 

 

986,325

Long-term debt

 

 

2,675,602

 

 

2,681,000

 

 

2,696,408

Long-term operating lease liabilities

 

 

1,380,175

 

 

 —

 

 

 —

Other liabilities

 

 

125,761

 

 

199,705

 

 

173,162

Total stockholders’ deficit

 

 

(1,644,801)

 

 

(1,685,426)

 

 

(1,542,831)

Total liabilities and stockholders’ deficit

 

$

3,678,373

 

$

2,127,403

 

$

2,313,064

 

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Michaels Stores, Inc.

Condensed Consolidated Statements of Comprehensive Income

(in thousands)

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

    

2019

    

2018

Net sales

 

$

1,093,720

 

$

1,155,511

Cost of sales and occupancy expense

 

 

676,080

 

 

698,948

Gross profit

 

 

417,640

 

 

456,563

Selling, general and administrative

 

 

320,387

 

 

328,392

Restructure charges

 

 

3,087

 

 

47,498

Store pre-opening costs

 

 

1,226

 

 

1,505

Operating income

 

 

92,940

 

 

79,168

Interest and other expense, net

 

 

40,469

 

 

32,904

Income before income taxes

 

 

52,471

 

 

46,264

Income taxes

 

 

14,624

 

 

19,211

Net income

 

$

37,847

 

$

27,053

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

Foreign currency translation and other

 

 

(4,826)

 

 

(7,053)

Comprehensive income

 

$

33,021

 

$

20,000

 

 

 

Michaels Stores, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

 

2019

 

2018

Cash flows from operating activities:

 

 

 

 

 

 

Net cash provided by operating activities

 

$

32,162

 

$

30,605

 

 

 

 

 

 

 

Cash flows used in investing activities:

 

 

 

 

 

 

Additions to property and equipment

 

 

(25,101)

 

 

(27,824)

 

 

 

 

 

 

 

Cash flows used in financing activities:

 

 

 

 

 

 

Net repayments of debt

 

 

(6,225)

 

 

(6,225)

 

 

 

 

 

 

 

Net change in cash and equivalents

 

 

836

 

 

(3,444)

Cash and equivalents at beginning of period

 

 

245,108

 

 

425,129

Cash and equivalents at end of period

 

$

245,944

 

$

421,685

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements of the Company (and the related notes thereto included elsewhere in this quarterly report), the audited consolidated financial statements of the Company (and the related notes thereto) and the Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the fiscal year ended February 2, 2019 (“Annual Report”) filed with the Securities and Exchange Commission (“SEC”) pursuant to Section 13 or 15(d) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) on March 19, 2019.

 

All of the “Company”, “us”, “we”, “our”, and similar expressions are references to The Michaels Companies, Inc. (“Michaels”) and our consolidated wholly-owned subsidiaries,  unless otherwise expressly stated or the context otherwise requires.

 

We report on the basis of a 52-week or 53-week fiscal year, which ends on the Saturday closest to January 31. All references to fiscal year mean the year in which that fiscal year began. References to “fiscal 2019” relate to the 52 weeks ending February 1, 2020 and references to “fiscal 2018” relate to the 52 weeks ended February 2, 2019. In addition, all references to “the first quarter of fiscal 2019” relate to the 13 weeks ended May 4, 2019 and all references to “the first quarter of fiscal 2018” relate to the 13 weeks ended May 5, 2018. Because of the seasonal nature of our business, the results of operations for the 13 weeks ended May 4, 2019 are not indicative of the results to be expected for the entire year.

 

Overview

 

We are the largest arts and crafts specialty retailer in North America (based on store count) providing materials, project ideas and education for creative activities, primarily under the Michaels retail brand. We also operate a wholesale business under the Darice brand name and a market-leading, vertically-integrated custom framing business under the Artistree brand name. As of May 4, 2019, we operated 1,260 Michaels stores.

 

Net sales for the first quarter of fiscal 2019 decreased 5.3% compared to the same period in the prior year. The decrease in net sales was due primarily to the closure of our Pat Catan’s stores and substantially all of our Aaron Brothers stores in fiscal 2018 and a 2.9% decrease in comparable store sales. The decrease was partially offset by net sales related to 17 additional Michaels stores opened (net of closures) since the first quarter of fiscal 2018. Gross profit as a percent of net sales decreased 130 basis points to 38.2% during the first quarter of fiscal 2019 due primarily to higher distribution related costs, occupancy cost deleverage and a change in sales mix. Operating income as a percent of net sales increased to 8.5% for the first quarter of fiscal 2019 compared to 6.8% in the same period in the prior year. The increase was primarily due to the restructure charge of $47.5 million related to the closure of substantially all of our Aaron Brothers stores in the first quarter of fiscal 2018. 

 

Comparable Store Sales

 

Comparable store sales represents the change in net sales for stores open the same number of months in the comparable period of the previous year, including stores that were relocated or expanded during either period, as well as e-commerce sales. A store is deemed to become comparable in its 14th month of operation in order to eliminate grand opening sales distortions. A store temporarily closed more than two weeks is not considered comparable during the month it is closed. If a store is closed longer than two weeks but less than two months, it becomes comparable in the month in which it reopens, subject to a mid-month convention. A store closed longer than two months becomes comparable in its 14th month of operation after its reopening.

 

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Operating Information

 

The following table sets forth certain operating data: 

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

 

May 4,

 

May 5,

 

 

 

2019

 

2018

 

Michaels stores:

 

 

 

 

 

 

 

Open at beginning of period

 

 

1,258

 

 

1,238

 

New stores

 

 

 4

 

 

 6

 

Relocated stores opened

 

 

 7

 

 

 9

 

Closed stores

 

 

(2)

 

 

(1)

 

Relocated stores closed

 

 

(7)

 

 

(9)

 

Open at end of period

 

 

1,260

 

 

1,243

 

 

 

 

 

 

 

 

 

Aaron Brothers stores:

 

 

 

 

 

 

 

Open at beginning of period

 

 

 —

 

 

97

 

Closed stores

 

 

 —

 

 

(94)

 

Open at end of period

 

 

 —

 

 

 3

 

 

 

 

 

 

 

 

 

Pat Catan's stores:

 

 

 

 

 

 

 

Open at beginning and end of period

 

 

 —

 

 

36

 

Total store count at end of period

 

 

1,260

 

 

1,282

 

 

 

 

 

 

 

 

 

Other Operating Data:

 

 

 

 

 

 

 

Average inventory per Michaels store (in thousands) (1)

 

$

822

 

$

814

 

Comparable store sales

 

 

(2.9)

%

 

0.4

%

Comparable store sales, at constant currency

 

 

(2.5)

%

 

 —

%


(1)

The calculation of average inventory per Michaels store excludes our Aaron Brothers and Pat Catan’s stores.

 

Results of Operations

 

The following table sets forth the percentage relationship to net sales of line items in our consolidated statements of comprehensive income. This table should be read in conjunction with the following discussion and with our consolidated financial statements, including the related notes.

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

 

May 4,

 

May 5,

 

 

 

2019

 

2018

 

Net sales

 

100.0

%

100.0

%

Cost of sales and occupancy expense

 

61.8

 

60.5

 

Gross profit

 

38.2

 

39.5

 

Selling, general and administrative

 

29.3

 

28.4

 

Restructure charges

 

0.3

 

4.1

 

Store pre-opening costs

 

0.1

 

0.1

 

Operating income

 

8.5

 

6.8

 

Interest expense

 

3.4

 

3.0

 

Other expense (income), net

 

0.3

 

(0.1)

 

Income before income taxes

 

4.8

 

4.0

 

Income taxes

 

1.3

 

1.7

 

Net income

 

3.4

%

2.3

%

 

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13 Weeks Ended May 4, 2019 Compared to the 13 Weeks Ended May 5, 2018

 

Net Sales. Net sales decreased $61.8 million in the first quarter of fiscal 2019, or 5.3%, to $1,093.7 million compared to the first quarter of fiscal 2018. The decrease in net sales was due to a $38.7 million decrease related to the closure of our Pat Catan’s stores and substantially all of our Aaron Brothers stores during fiscal 2018, a $31.3 million decrease in comparable store sales and a $2.7 million decrease in wholesale revenue. The decrease was partially offset by $11.2 million of net sales related to 17 additional Michaels stores opened (net of closures) since May 5, 2018. Comparable store sales decreased 2.9%, or 2.5% at constant exchange rates, compared to the first quarter of fiscal 2018 due to a decrease in customer transactions, partially offset by an increase in average ticket. 

 

Gross Profit. Gross profit was 38.2% of net sales in the first quarter of fiscal 2019 compared to 39.5% in the first quarter of fiscal 2018. The 130 basis point decrease was primarily due to higher distribution related costs, occupancy cost deleverage and a change in sales mix. The decrease was partially offset by benefits from our ongoing sourcing initiatives and a decrease in promotional activity.

 

Selling, General and Administrative. Selling, general and administrative (“SG&A”) was 29.3% of net sales in the first quarter of fiscal 2019 compared to 28.4% in the first quarter of fiscal 2018. SG&A decreased $8.0 million to $320.6 million in the first quarter of fiscal 2019. The decrease was due to an $11.0 million decrease related to the closure of our Pat Catan’s stores and substantially all of our Aaron Brothers stores during fiscal 2018, a $5.3 million decrease in payroll-related costs and a $2.1 million decrease in marketing expenses. The decrease was partially offset by $5.6 million of CEO severance expense, $2.2 million associated with operating 17 additional Michaels stores (net of closures) and a $1.5 million increase in professional fees.

 

Restructure Charges. We recorded a restructure charge of $3.1 million in the first quarter of fiscal 2019 related to the closure of all of our Pat Catan’s stores during the fourth quarter of fiscal 2018. We recorded a restructure charge of $47.5 million in the first quarter of fiscal 2018 primarily related to the closure of substantially all of our Aaron Brothers stores during the first quarter of fiscal 2018.

 

Interest Expense. Interest expense increased $2.8 million to $37.4 million in the first quarter of fiscal 2019 compared to the same period in the prior year. The increase was primarily due to $2.6 million as a result of a higher interest rate on our amended and restated term loan credit facility and $0.5 million related to settlement payments associated with our interest rate swaps.

 

Other Expense (Income), Net. Other expense (income), net increased $4.8 million in the first quarter of fiscal 2019 compared to the same period in the prior year. The increase was due to a $5.0 million charge related to the write-off of an investment in a liquidated business.

 

Income Taxes. The effective tax rate was 27.9% for the first quarter of fiscal 2019 compared to 41.6% for the first quarter of fiscal 2018. The effective tax rate for the first quarter of fiscal 2019 was lower than the same period in the prior year due primarily to an $8.1 million charge in the first quarter of 2018 related to repatriation taxes for accumulated earnings of our foreign subsidiaries associated with the enactment of the Tax Cuts and Jobs Act of 2017. The decrease was partially offset by $1.8 million of tax expense recorded in the first quarter of fiscal 2019 primarily related to the vesting of restricted shares.

 

Liquidity and Capital Resources

 

We require cash principally for day-to-day operations, to finance capital investments (including possible acquisitions), purchase inventory, service our outstanding debt and for seasonal working capital needs. We expect that our available cash, cash flow generated from operating activities and funds available under our amended revolving credit facility will be sufficient to fund planned capital expenditures, working capital requirements, debt repayments, debt service requirements and anticipated growth for the foreseeable future. Our ability to satisfy our liquidity needs and continue to refinance or reduce debt could be adversely affected by the occurrence of any of the events described under “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended February 2, 2019 or our failure to meet our debt covenants. Our amended revolving credit facility provides senior secured financing of up to $850 million, subject to

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a borrowing base. As of May 4, 2019, the borrowing base was $784.3 million, of which we had $107.2 million of outstanding standby letters of credit and $677.1 million of unused borrowing capacity. Our cash and cash equivalents totaled $246.7 million at May 4, 2019.

 

In September 2018, the Board of Directors authorized a new share repurchase program for the Company to purchase $500.0 million of the Company’s common stock on the open market or through accelerated share repurchase transactions. The share repurchase program does not have an expiration date, and the timing and number of repurchase transactions under the program will depend on market conditions, corporate considerations, debt agreements and regulatory requirements. Shares repurchased under the program are held as treasury shares until retired. As of May 4, 2019, we had $398.4 million of availability remaining under our current share repurchase program.

 

We had total outstanding debt of $2,711.2 million at May 4, 2019, of which $2,201.2 million was subject to variable interest rates and $510.0 million was subject to fixed interest rates. In April 2018, we executed two interest rate swaps with an aggregate notional value of $1.0 billion associated with our outstanding amended and restated term loan credit facility. The swaps replaced the one-month LIBOR with a fixed interest rate of 2.7765%. 

 

Our substantial indebtedness could adversely affect our ability to raise additional capital, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk and prevent us from meeting our obligations. Management reacts strategically to changes in economic conditions and monitors compliance with debt covenants to seek to mitigate any potential material impacts to our financial condition and flexibility.

 

We intend to use excess operating cash flows to invest in growth opportunities (including possible acquisitions), repurchase outstanding shares and repay portions of our indebtedness, depending on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. As such, we and our subsidiaries, affiliates and significant shareholders may, from time to time, seek to retire or purchase our outstanding debt (including publicly issued debt) through cash purchases and/or exchanges, in open market purchases, privately negotiated transactions, by tender offer or otherwise. If we use our excess cash flows to repay our debt, it will reduce the amount of excess cash available for additional capital expenditures.

 

Cash Flow from Operating Activities

 

Cash flows provided by operating activities were $33.8 million in the first quarter of fiscal 2019 compared to $32.5 million in the first quarter of fiscal 2018. The increase in cash provided by operating activities was primarily due to additional collections of outstanding receivables, partially offset by the timing of vendor payments.

 

Inventory at the end of the first quarter of fiscal 2019 decreased $19.8 million, or 1.8%, to $1,101.7 million, compared to $1,121.6 million at the end of the first quarter of fiscal 2018. The decrease in inventory was primarily related to the Pat Catan’s store closures in fiscal 2018. The decrease was partially offset by additional inventory associated with the operation of 17 additional Michaels stores (net of closures) since the first quarter of fiscal 2018 and lower than expected sales. Average inventory per Michaels store (inclusive of distribution centers, in-transit and inventory for the Company’s e-commerce site) increased 1.0% to $822,000 at May 4, 2019 from $814,000 at May 5, 2018.

 

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Cash Flow from Investing Activities

 

The following table includes capital expenditures paid during the periods presented (in thousands):

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

    

2019

    

2018

New and relocated stores including stores not yet opened (1)

 

$

5,006

 

$

6,440

Existing stores

 

 

7,499

 

 

7,713

Information systems

 

 

8,928

 

 

10,617

Corporate and other

 

 

3,668

 

 

3,054

 

 

$

25,101

 

$

27,824


(1)

In the first quarter of fiscal 2019, we incurred capital expenditures related to the opening of 11 Michaels stores, including the relocation of seven stores. In the first quarter of fiscal 2018, we incurred capital expenditures related to the opening of 15 Michaels stores, including the relocation of nine stores.

 

Non-GAAP Measures

 

The following table sets forth certain non-GAAP measures used by the Company to manage our performance and measure compliance with certain debt covenants. The Company defines “EBITDA” as net income before interest, income taxes, depreciation and amortization. The Company defines “Adjusted EBITDA” as EBITDA adjusted for certain defined amounts in accordance with the Company’s amended and restated term loan credit facility and amended revolving credit facility (together the “Senior Secured Credit Facilities”).

 

The Company has presented EBITDA and Adjusted EBITDA to provide investors with additional information to evaluate our operating performance and our ability to service our debt. Adjusted EBITDA is a required calculation under the Company’s Senior Secured Credit Facilities that is used in the calculations of fixed charge coverage and leverage ratios, which, under certain circumstances determine mandatory repayments or maintenance covenants and may restrict the Company’s ability to make certain payments (characterized as restricted payments), investments (including acquisitions) and debt repayments.

 

As EBITDA and Adjusted EBITDA are not measures of liquidity calculated in accordance with U.S. generally accepted accounting principles (“GAAP”), these measures should not be considered in isolation of, or as substitutes for, net cash provided by operating activities as an indicator of liquidity. Our computation of EBITDA and Adjusted EBITDA may differ from similarly titled measures used by other companies.

 

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The following table shows a reconciliation of EBITDA and Adjusted EBITDA to net income and net cash provided by operating activities (in thousands):

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

    

 

2019

 

2018

Net cash provided by operating activities

 

$

33,798

 

$

32,503

Amortization of operating lease assets

 

 

(81,371)

 

 

 —

Depreciation and amortization

 

 

(31,489)

 

 

(29,458)

Share-based compensation

 

 

(7,251)

 

 

(6,969)

Debt issuance costs amortization

 

 

(1,237)

 

 

(1,274)

Loss on write-off of investment

 

 

(5,036)

 

 

 —

Accretion of long-term debt, net

 

 

130

 

 

126

Restructure charges

 

 

(3,087)

 

 

(47,498)

Deferred income taxes

 

 

(140)

 

 

(2,580)

Changes in assets and liabilities

 

 

133,374

 

 

82,035

Net income

 

 

37,691

 

 

26,885

Interest expense

 

 

37,359

 

 

34,594

Income taxes

 

 

14,575

 

 

19,157

Depreciation and amortization

 

 

31,489

 

 

29,458

Interest income

 

 

(811)

 

 

(1,406)

EBITDA

 

 

120,303

 

 

108,688

Adjustments:

 

 

 

 

 

 

Share-based compensation

 

 

7,251

 

 

6,969

Restructure charges

 

 

3,087

 

 

47,498

Severance costs

 

 

8,111

 

 

902

Store pre-opening costs

 

 

1,226

 

 

1,505

Store remodel costs

 

 

66

 

 

515

Foreign currency transaction gains

 

 

(74)

 

 

(570)

Store closing costs

 

 

(821)

 

 

1,062

Other (1)

 

 

964

 

 

725

Adjusted EBITDA

 

$

140,113

 

$

167,294


(1)

Other adjustments primarily relate to items such as moving and relocation expenses, franchise taxes and sign on bonuses.

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Disclosure Regarding Forward-Looking Information

 

The above discussion, as well as other portions of this Quarterly Report on Form 10-Q, contains forward-looking statements that reflect our plans, estimates and beliefs. Statements regarding sufficiency of capital resources and planned uses of excess cash flow as well as any other statements contained herein (including, but not limited to, statements to the effect that Michaels or its management “anticipates”, “plans”, “estimates”, “expects”, “believes”, “intends” and other similar expressions) that are not statements of historical fact should be considered forward-looking statements and should be read in conjunction with our Annual Report. Such forward-looking statements are based upon management’s current knowledge and assumptions about future events and involve risks and uncertainties that could cause actual results, performance or achievements to be materially different from anticipated results, prospects, performance or achievements expressed or implied by such forward-looking statements. Most of these factors are outside of our control and are difficult to predict. Such risks and uncertainties include, but are not limited to the following:

 

·

risks related to the effect of economic uncertainty;

 

·

risks related to our substantial indebtedness;

 

·

restrictions in our debt agreements that limit our flexibility in operating our business;

 

·

changes in customer demand could materially adversely affect our sales, results of operations and cash flow;

 

·

competition, including internet-based competition, could negatively impact our business;

 

·

a weak fourth quarter would materially adversely affect our results of operations;

 

·

unexpected or unfavorable consumer responses to our promotional or merchandising programs could materially adversely affect our sales, results of operations, cash flow and financial condition;

 

·

evolving foreign trade policy (including tariffs imposed on certain foreign-made goods) may adversely affect our business;

 

·

our reliance on foreign suppliers increases our risk of obtaining adequate, timely and cost-effective product supplies;

 

·

our results may be adversely affected by serious disruptions or catastrophic events, including geo-political events and weather;

 

·

our failure to adequately maintain security and prevent unauthorized access to electronic and other confidential information, which could result in an additional data breach, could materially adversely affect our financial condition and operating results;

 

·

we may be subject to information technology system failures or network disruptions, or our information systems may prove inadequate, resulting in damage to our reputation, business operations and financial condition;

 

·

our failure to increase comparable store sales and open new stores could impair our ability to improve our sales, profitability and cash flows;

 

·

damage to the reputation of the Michaels brand or our private and exclusive brands could adversely affect our sales;

 

·

risks associated with the suppliers from whom our products are sourced and transitioning to other qualified vendors could materially adversely affect our revenue and profit growth;

 

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·

changes in regulations or enforcement, or our failure to comply with existing or future regulations, may adversely impact our business;

 

·

significant increases in inflation or commodity prices such as petroleum, natural gas, electricity, steel, wood, and paper may adversely affect our costs, including cost of merchandise;

 

·

improvements to our supply chain may not be fully successful;

 

·

we are exposed to fluctuations in exchange rates between the U.S. and Canadian dollar, which is the functional currency of our Canadian subsidiaries;

 

·

the Company’s ability to execute its strategic initiatives could be impaired if it fails to identify a permanent Chief Executive Officer and retain its senior management team;

 

·

any difficulty executing or integrating an acquisition, a business combination or a major business initiative could adversely affect our business or results of operations;

 

·

our marketing programs, e-commerce initiatives and use of consumer information are governed by an evolving set of laws and enforcement trends and unfavorable changes in those laws or trends, or our failure to comply with existing or future laws, could substantially harm our business and results of operations;

 

·

product recalls and/or product liability, as well as changes in product safety and other consumer protection laws, may adversely impact our operations, merchandise offerings, reputation, results of operation, cash flow, and financial condition;

 

·

changes in estimates or projections used to assess fair value of intangible assets, goodwill and property and equipment may cause us to incur impairment charges that could adversely affect our results of operations;

 

·

disruptions in the capital markets could increase our costs of doing business;

 

·

our real estate leases generally obligate us for long periods, which subjects us to various financial risks;

 

·

we have co-sourced certain of our information technology, accounts payable, payroll, accounting and human resources functions, and may co-source other administrative functions, which makes us more dependent upon third parties;

 

·

failure to attract and retain quality sales, distribution center and other team members in appropriate numbers as well as experienced buying and management personnel could adversely affect our performance;

 

·

affiliates of, or funds advised by, Bain Capital Private Equity, L.P. and The Blackstone Group L.P. own approximately 46% of the outstanding shares of our common stock and as a result will have the ability to strongly influence our decisions, and they may have interests that differ from those of other stockholders; and

 

·

our holding company structure makes us, and certain of our direct and indirect subsidiaries, dependent on the operations of our, and their, subsidiaries to meet our financial obligations.

 

For more details on factors that may cause actual results to differ materially from such forward-looking statements see the Risk Factors section of our Annual Report. Except as required by applicable law, we disclaim any intention to, and undertake no obligation to, update or revise any forward-looking statement.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Foreign Currency Risk

 

We are exposed to fluctuations in exchange rates between the U.S. and Canadian dollar, which is the functional currency of our Canadian subsidiaries. Our sales, costs and expenses of our Canadian subsidiaries, when translated into U.S. dollars, can fluctuate due to exchange rate movement. A 10% increase or decrease in the exchange rate of the Canadian dollar would have increased or decreased net income by approximately $3 million for the 13 weeks ended May 4, 2019.

 

Interest Rate Risk

 

We have market risk exposure arising from changes in interest rates on our amended and restated term loan credit facility and our amended revolving credit facility. The interest rates on our amended and restated term loan credit facility and our amended revolving credit facility will reprice periodically, which will impact our earnings and cash flow. In April 2018, we executed two interest rate swap agreements with an aggregate notional value of $1.0 billion which are intended to mitigate interest rate risk associated with future changes in interest rates for borrowings under our amended and restated term loan credit facility. As a result of these interest rate swaps, our exposure to interest rate volatility for $1.0 billion of our amended and restated term loan credit facility was eliminated beginning in the second quarter of fiscal 2018. The interest rate on our 2020 senior subordinated notes is fixed. Based on our overall interest rate exposure to variable rate debt outstanding as of May 4, 2019, a 100 basis point change in interest rates would impact income before income taxes by approximately $12 million for fiscal 2019. A 100 basis point change in interest rates would impact the fair value of our long-term fixed rate debt by approximately $22 million. A change in interest rates would not materially affect the fair value of our variable rate debt as the debt reprices periodically.

 

Inflation Risk

 

We do not believe inflation and changing commodity prices have had a material impact on our net sales, income from continuing operations, plans for expansion or other capital expenditures for any period presented in this report. However, we cannot be sure inflation and changing commodity prices will not have an adverse impact on our operating results, financial condition, plans for expansion or other capital expenditures in future periods.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

We maintain a set of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated by the SEC under the Exchange Act) designed to provide reasonable assurance that information, which is required to be timely disclosed, is accumulated and communicated to management in a timely fashion. We note the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

An evaluation was carried out under the supervision and with the participation of our management, including our Interim Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Interim Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls are effective to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Exchange Act, is accumulated and communicated to management, including our Interim Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding required disclosure and are effective to provide reasonable assurance that such information is recorded, processed, summarized, and reported within the time periods specified by the SEC’s rules and forms.

 

Change in Internal Control Over Financial Reporting

 

There have been no changes in our internal controls over financial reporting during the quarter ended May 4, 2019 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Part II—OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

There were no material changes to the disclosure made in Note 14 to the consolidated financial statement in our Annual Report on Form 10-K for the fiscal year ended February 2, 2019.

 

ITEM 1A. RISK FACTORS

 

There have been no material changes to the Risk Factors described in the Annual Report on Form 10-K.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

The following table provides certain information with respect to our purchases of shares of the Company’s common stock during the first quarter of fiscal 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Approximate Dollar Value

 

 

 

 

 

 

 

Total Number of

 

of Shares That May

 

 

 

 

 

 

 

Shares Purchased

 

Yet Be Purchased

 

 

Total Number of

 

Average Price

 

as Part of Publicly

 

Under the Plan (2)

Period

    

Shares Purchased (1)

    

Paid per Share

    

Announced Plan (2)

    

(in thousands)

February 3, 2019 - March 2, 2019

 

4,363

 

$

14.14

 

 —

 

$

398,353

March 3, 2019 - April 6, 2019

 

125,118

 

 

11.48

 

 —

 

 

398,353

April 7, 2019 - May 4, 2019

 

3,268

 

 

11.49

 

 —

 

 

398,353

Total

 

132,749

 

$

11.56

 

 —

 

$

398,353


(1)

These amounts reflect the surrender of shares of common stock to the Company to satisfy tax withholding obligations in connection with the vesting of employee restricted stock equity awards.

 

(2)

In September 2018, the Board of Directors authorized the Company to purchase up to $500.0 million of the Company’s common stock on the open market or through accelerated share repurchase transactions. The share repurchase program does not have an expiration date. The Company has retired and intends to continue to retire shares repurchased under the program.

 

 

 

 

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ITEM 6.  EXHIBITS 

 

(a)

Exhibits:

 

 

 

 

Exhibit
Number

    

Description of Exhibit

 

 

 

10.1*

 

Letter agreement, dated February 28, 2019, among The Michaels Companies, Inc., Michaels Stores, Inc. and Mark Cosby (previously filed as Exhibit 10.1 to Form 8-K filed by the Company on February 28, 2019, SEC File No. 001-36501).

 

 

 

10.2*

 

Separation Agreement, dated February 27, 2019, among The Michaels Companies, Inc., Michaels Stores, Inc. and Carl S. Rubin (previously filed as Exhibit 10.2 to Form 8-K filed by the Company on February 28, 2019, SEC File No. 001-36501).

 

 

 

10.3*

 

Addendum and Amendment to Separation Letter, dated March 20, 2019, among The Michaels Companies, Inc., Michaels Stores, Inc. and Carl S. Rubin (previously filed as Exhibit 10.1 to Form 8-K filed by the Company on March 22, 2019, SEC File No. 001-36501).

 

 

 

10.4*

 

Form of Stock Option Agreement under the 2014 Omnibus Long-Term Incentive Plan (filed herewith).

 

 

 

10.5*

 

Form of Restricted Stock Award Agreement, dated February 28, 2019, between Michaels Stores, Inc. and Mark S. Cosby (filed herewith).

 

 

 

10.6*

 

Form of Restricted Stock Award Agreement, dated February 28, 2019, between Michaels Stores, Inc. and Philo T. Pappas (filed herewith).

 

 

 

10.7*

 

Form of Restricted Stock Award Agreement, dated May 6, 2019, between Michaels Stores, Inc. and Mark S. Cosby (filed herewith).

 

 

 

10.8*

 

Form of Restricted Stock Award Agreement, dated May 6, 2019, between Michaels Stores, Inc. and Philo T. Pappas (filed herewith).

 

 

 

31.1

 

Certifications of Mark S. Cosby pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

 

 

31.2

 

Certifications of Denise A. Paulonis pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

 

 

32.1

 

Certification pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

 

 

101.INS

 

XBRL Instance Document

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase

 

 

 

101.LAB

 

XBRL Taxonomy Extension Label Linkbase

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase


*Management contract or compensatory plan or agreement.

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

THE MICHAELS COMPANIES, INC.

 

 

 

By:

/s/ Mark S. Cosby

 

 

Mark S. Cosby

 

 

Interim Chief Executive Officer and Director

 

 

(Principal Executive Officer)

 

 

 

 

By:

/s/ Denise A. Paulonis

 

 

Denise A. Paulonis

 

 

Executive Vice President and Chief Financial Officer

(Principal Financial Officer)

 

Date: June 7, 2019

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