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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 November 2, 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 November 26, 2019, 146,785,176 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 and 39 weeks ended November 2, 2019 and November 3, 2018 (unaudited)

3

Consolidated Balance Sheets as of November 2, 2019, February 2, 2019 and November 3, 2018 (unaudited)

4

Consolidated Statements of Cash Flows for the 39 weeks ended November 2, 2019 and November 3, 2018 (unaudited)

5

Consolidated Statements of Stockholders’ Deficit for the 13 and 39 weeks ended November 2, 2019 and November 3, 2018 (unaudited)

6

Notes to Consolidated Financial Statements (unaudited)

7

Item 2.

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

20

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

31

Item 4.

Controls and Procedures

31

Part II—OTHER INFORMATION

Item 1.

Legal Proceedings

32

Item 1A.

Risk Factors

32

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

32

Item 6.

Exhibits

33

Signatures

34

2

Table of Contents

Part IFINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands, except per share data)

(Unaudited)

13 Weeks Ended

39 Weeks Ended

November 2,

November 3,

November 2,

November 3,

2019

2018

2019

2018

Net sales

$

1,222,021

$

1,274,058

$

3,349,430

$

3,482,835

Cost of sales and occupancy expense

 

780,387

 

795,104

 

2,123,171

 

2,173,990

Gross profit

 

441,634

478,954

 

1,226,259

 

1,308,845

Selling, general and administrative

 

322,807

 

340,593

 

933,478

 

970,191

Restructure and impairment charges

41,376

48,332

44,278

Store pre-opening costs

 

1,402

 

1,196

 

4,370

 

3,995

Operating income

 

76,049

 

137,165

 

240,079

 

290,381

Interest expense

 

38,781

 

37,798

 

116,274

 

109,493

Losses on early extinguishments of debt and refinancing costs

161

1,316

1,835

Other expense (income), net

 

78

 

(121)

 

2,931

 

(2,646)

Income before income taxes

 

37,029

 

99,488

 

119,558

 

181,699

Income taxes

 

8,324

 

15,719

 

28,615

 

43,557

Net income

$

28,705

$

83,769

$

90,943

$

138,142

Other comprehensive income, net of tax:

 

 

 

 

Foreign currency and interest rate swaps

1,230

3,016

(8,358)

(3,230)

Comprehensive income

$

29,935

$

86,785

$

82,585

$

134,912

Earnings per common share:

Basic

$

0.19

$

0.50

$

0.58

$

0.79

Diluted

$

0.19

$

0.50

$

0.58

$

0.78

Weighted-average common shares outstanding:

Basic

150,877

165,975

155,299

174,949

Diluted

150,925

166,570

155,342

175,851

See accompanying notes to consolidated financial statements.

3

Table of Contents

THE MICHAELS COMPANIES, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

(Unaudited)

November 2,

February 2,

November 3,

ASSETS

2019

2019

2018

Current Assets:

Cash and equivalents

$

118,387

$

245,887

$

102,670

Merchandise inventories

 

1,423,367

 

1,108,715

 

1,440,875

Prepaid expenses and other

 

73,223

 

98,659

 

100,791

Accounts receivable, net

25,224

57,328

42,997

Income taxes receivable

 

1,744

 

4,935

 

6,544

Total current assets

 

1,641,945

 

1,515,524

 

1,693,877

Property and equipment, at cost

 

1,733,717

 

1,656,098

 

1,642,838

Less accumulated depreciation and amortization

(1,301,785)

(1,217,021)

(1,189,442)

Property and equipment, net

431,932

439,077

453,396

Operating lease assets

1,613,527

Goodwill

 

94,290

 

112,069

 

119,074

Other intangible assets, net

5,043

17,238

20,591

Deferred income taxes

 

38,075

 

25,005

 

23,367

Other assets

 

20,267

 

19,423

 

28,730

Total assets

$

3,845,079

$

2,128,336

$

2,339,035

LIABILITIES AND STOCKHOLDERS’ DEFICIT

Current Liabilities:

Accounts payable

$

658,182

$

485,004

$

645,469

Accrued liabilities and other

 

374,120

 

378,742

 

407,684

Current portion of operating lease liabilities

303,023

Current portion of long-term debt

 

24,900

 

24,900

 

240,261

Income taxes payable

 

22,520

 

43,907

 

476

Total current liabilities

 

1,382,745

 

932,553

 

1,293,890

Long-term debt

 

2,649,756

 

2,681,000

 

2,690,302

Long-term operating lease liabilities

1,374,555

Other liabilities

 

69,853

 

140,978

 

144,694

Total liabilities

 

5,476,909

 

3,754,531

 

4,128,886

Commitments and contingencies

Stockholders’ Deficit:

Common stock, $0.06775 par value, 350,000 shares authorized; 146,770 shares issued and outstanding at November 2, 2019; 157,774 shares issued and outstanding at February 2, 2019; and 158,616 shares issued and outstanding at November 3, 2018

 

9,850

10,594

 

10,700

Additional paid-in-capital

 

1,245

5,954

 

Treasury stock

(12,168)

Accumulated deficit

 

(1,620,009)

(1,628,185)

 

(1,781,493)

Accumulated other comprehensive loss

 

(22,916)

(14,558)

 

(6,890)

Total stockholders’ deficit

 

(1,631,830)

 

(1,626,195)

 

(1,789,851)

Total liabilities and stockholders’ deficit

$

3,845,079

$

2,128,336

$

2,339,035

See accompanying notes to consolidated financial statements.

4

Table of Contents

THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

39 Weeks Ended

November 2,

November 3,

    

2019

2018

Cash flows from operating activities:

Net income

$

90,943

$

138,142

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

Amortization of operating lease assets

244,258

Depreciation and amortization

 

94,025

 

89,933

Share-based compensation

 

18,664

 

20,780

Debt issuance costs amortization

 

3,509

 

3,759

Loss on write-off of investment

5,036

Accretion of long-term debt, net

 

(195)

 

(385)

Restructure and impairment charges

48,332

44,278

Deferred income taxes

(9,984)

7,710

Losses on early extinguishments of debt and refinancing costs

1,316

1,835

Changes in assets and liabilities:

Merchandise inventories

 

(316,220)

 

(338,260)

Prepaid expenses and other

 

(14,445)

 

(2,886)

Accounts receivable

30,684

(18,269)

Other assets

(4,728)

(1,314)

Operating lease liabilities

(225,951)

Accounts payable

 

162,222

 

150,088

Accrued interest

 

8,441

 

7,850

Accrued liabilities and other

 

(10,471)

 

1,077

Income taxes

 

(18,318)

 

(79,258)

Other liabilities

 

(751)

 

734

Net cash provided by operating activities

 

106,367

 

25,814

Cash flows used in investing activities:

Additions to property and equipment

 

(89,632)

 

(119,553)

Cash flows from financing activities:

Common stock repurchased

(107,908)

(430,509)

Payments on term loan credit facility

 

(18,675)

 

(17,356)

Payment of 2020 senior subordinated notes

(510,000)

Issuance of 2027 senior notes

500,000

Borrowings on asset-based revolving credit facility

 

11,100

 

307,400

Payments on asset-based revolving credit facility

 

(11,100)

 

(89,400)

Payment of debt refinancing costs

 

(8,158)

 

(1,117)

Payment of dividends

(317)

Proceeds from stock options exercised

506

1,812

Net cash used in financing activities

(144,235)

(229,487)

 

 

Net change in cash and equivalents

 

(127,500)

 

(323,226)

Cash and equivalents at beginning of period

245,887

425,896

Cash and equivalents at end of period

$

118,387

$

102,670

Supplemental cash flow information:

Cash paid for interest

$

105,374

$

98,864

Cash paid for taxes

$

56,793

$

115,724

See accompanying notes to consolidated financial statements.

5

Table of Contents

THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT

(in thousands)

(Unaudited)

13 Weeks Ended

Accumulated

Number of

Additional

Other

Common

Common

Treasury

Paid-in

Accumulated

Comprehensive

Shares

  

Stock

  

Stock

  

Capital

  

Deficit

  

Loss

  

Total

Balance at August 3, 2019

  

155,199

$

10,419

$

$

$

(1,573,843)

$

(24,146)

$

(1,587,570)

Net income

28,705

 

28,705

Foreign currency and interest rate swaps

1,230

 

1,230

Share-based compensation

6,424

 

6,424

Exercise of stock options and other awards

242

17

(53)

(36)

Repurchase of stock and retirements

(8,747)

(586)

(5,126)

(74,871)

 

(80,583)

Issuance of restricted stock awards

76

Balance at November 2, 2019

146,770

$

9,850

$

$

1,245

$

(1,620,009)

$

(22,916)

$

(1,631,830)

Balance at August 4, 2018

  

171,375

$

11,504

$

$

$

(1,700,978)

$

(9,906)

$

(1,699,380)

Net income

83,769

 

83,769

Foreign currency and interest rate swaps

3,016

 

3,016

Share-based compensation

8,550

 

8,550

Exercise of stock options and other awards

347

23

340

363

Repurchase of stock and retirements

(13,106)

(827)

(12,168)

(8,890)

(164,284)

 

(186,169)

Balance at November 3, 2018

158,616

$

10,700

$

(12,168)

$

$

(1,781,493)

$

(6,890)

$

(1,789,851)

39 Weeks Ended

Accumulated

Number of

Additional

Other

Common

Common

Treasury

Paid-in

Accumulated

Comprehensive

Shares

  

Stock

  

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

90,943

 

90,943

Foreign currency and interest rate swaps

(8,358)

 

(8,358)

Share-based compensation

19,182

 

19,182

Exercise of stock options and other awards

836

57

449

506

Repurchase of stock and retirements

(11,987)

(801)

(24,340)

(82,767)

 

(107,908)

Issuance of restricted stock awards

147

Balance at November 2, 2019

146,770

$

9,850

$

$

1,245

$

(1,620,009)

$

(22,916)

$

(1,631,830)

Balance at February 3, 2018

181,919

$

12,206

$

$

21,740

$

(1,539,781)

$

(3,660)

$

(1,509,495)

Net income

138,142

 

138,142

Foreign currency and interest rate swaps

(3,230)

 

(3,230)

Share-based compensation

21,597

 

21,597

Exercise of stock options and other awards

847

57

1,755

1,812

Repurchase of stock and retirements

(24,150)

(1,563)

(12,168)

(45,092)

(379,854)

 

(438,677)

Balance at November 3, 2018

158,616

$

10,700

$

(12,168)

$

$

(1,781,493)

$

(6,890)

$

(1,789,851)

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 third quarter of fiscal 2019” relate to the 13 weeks ended November 2, 2019 and all references to “the third quarter of fiscal 2018” relate to the 13 weeks ended November 3, 2018. Finally, all references to “the nine months ended November 2, 2019” relate to the 39 weeks ended November 2, 2019 and all references to “the nine months ended November 3, 2018” relate to the 39 weeks ended November 3, 2018. Because of the seasonal nature of our business, the results of operations for the 13 and 39 weeks ended November 2, 2019 are not indicative of the results to be expected for the entire year.

Restructure and Impairment Charges

In March 2018 and January 2019, we closed our Aaron Brothers and Pat Catan’s stores, respectively. In the first nine months of fiscal 2019, we recorded a restructure charge related to Pat Catan’s totaling $8.2 million, primarily related to employee-related expenses and the impairment of an indefinite-lived intangible asset. In the first nine months of fiscal 2018, we recorded a restructure charge related to Aaron Brothers totaling $44.3 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 nine months of fiscal 2018, Pat Catan's and Aaron Brothers had net sales totaling approximately $75.5 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.

The Company reviews goodwill and other indefinite-lived intangible assets for impairment annually in the fourth quarter, or more frequently if events occur which indicate the carrying value of these assets may not be recoverable. In addition, long-lived assets and definite-lived intangible assets that are subject to amortization are evaluated for indicators of impairment whenever events or changes in circumstances indicate their carrying value may not be recoverable. If indications of impairment exist, fair value is generally determined using the present value of future cash flows using updated financial projections and a weighted-average cost of capital.

During the third quarter of fiscal 2019, the Company identified impairment indicators within our Darice wholesale business that were primarily due to a deterioration in sales associated with overall declining demand from customers. These indicators have led the Company to revise Darice’s forecasted sales expectations downwards resulting in a significantly lower projected operating plan. As a result, the Company performed interim impairment tests as of November 2, 2019 on Darice’s goodwill, indefinite and definite-lived intangible assets and long-lived assets, including operating lease assets.

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As a result of the interim impairment testing, the Company recorded an impairment charge of $40.1 million at November 2, 2019, consisting of $17.8 million related to goodwill, $14.4 million related to long-lived assets, including operating lease assets, and $7.9 million related to indefinite and definite-lived intangible assets. At November 2, 2019, the carrying value of Darice’s operating lease assets adjusted for the impairment charge totaled $32.5 million. The carrying value of the remaining long-lived assets related to Darice, including intangible assets, are not material.

Share Repurchase Program

In September 2018, the Board of Directors authorized a new share repurchase program for the Company to purchase $500 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. During the nine months ended November 2, 2019, we repurchased 11.6 million shares for an aggregate amount of $105.1 million. As of November 2, 2019, we had $293.5 million of availability remaining under our current share repurchase program.

Accounting Pronouncement Recently Adopted

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 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.

Recent Accounting Pronouncement Not Yet Adopted

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326)” (“ASU 2016-13”) which makes significant changes to the accounting for credit losses on financial assets and disclosures. The standard requires immediate recognition of management’s estimates of current expected credit losses. ASU 2016-13 is effective for annual reporting periods beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted. ASU 2016-13 permits only a modified retrospective approach without restatement. We do not anticipate a material impact to the consolidated financial statements once implemented.  

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

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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.

Impairment losses related to goodwill and other indefinite-lived intangible assets are calculated based on the estimated fair value of each reporting unit, which is determined using significant unobservable inputs including the present value of future cash flows expected to be generated by the reporting unit using a weighted-average cost of capital, terminal values and updated financial projections for the next five years and are classified as Level 3 measurements 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 8% senior notes maturing in 2027 (“2027 Senior Notes”), our 5.875% senior subordinated notes maturing in 2020 (“2020 Senior Subordinated Notes’’) and our interest rate swaps.

November 2,

February 2,

November 3,

2019

2019

2018

(in thousands)

Assets

Interest rate swaps

$

$

$

5,028

Liabilities

Term loan credit facility

$

2,135,435

$

2,177,098

$

2,195,613

Senior notes

496,155

Senior subordinated notes

 

511,913

 

510,000

Short-term portion of interest rate swaps

11,938

2,557

571

Long-term portion of interest rate swaps

6,295

3,809

The fair values of our Amended and Restated Term Loan Credit Facility, our 2027 Senior Notes and our 2020 Senior Subordinated Notes were determined based on quoted market prices which are considered Level 1 inputs within the fair value hierarchy.

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.

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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 November 2, 2019, February 2, 2019 and November 3, 2018, receivables from customers, which consist primarily of trade receivables related to Darice, were approximately $18.0 million, $32.1 million and $30.5 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

39 Weeks Ended

November 2,

November 3,

November 2,

November 3,

2019

2018

2019

2018

Balance at beginning of period

$

55,764

$

50,513

$

61,071

$

56,729

Issuance of gift cards

11,878

12,275

36,343

37,552

Revenue recognized (1)

(12,300)

(12,592)

(41,715)

(42,193)

Gift card breakage

(724)

(758)

(1,081)

(2,650)

Balance at end of period

$

54,618

$

49,438

$

54,618

$

49,438

(1)Revenue recognized from the beginning liability during the third quarters of fiscal 2019 and fiscal 2018 totaled $6.9 million and $7.1 million, respectively. Revenue recognized from the beginning liability during the first nine months of fiscal 2019 and fiscal 2018 totaled $19.4 million and $19.7 million, respectively.

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 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.  

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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

39 Weeks Ended

November 2,

November 2,

2019

2019

Operating lease cost (1)

  

$

106,294

$

316,358

Variable lease cost (2)

 

38,319

 

110,836

Total lease cost

$

144,613

$

427,194

(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 periods presented.

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

39 Weeks Ended

November 2,

2019

Operating cash outflows included in the measurement of lease liabilities

$

322,701

Operating lease assets obtained in exchange for new operating lease liabilities

$

222,887

Weighted-average remaining lease term

6.0 years

Weighted-average discount rate

5.6%

Maturities of our lease liabilities are as follows as of November 2, 2019 (in thousands):

Fiscal Year

2019

$

71,036

2020

 

421,971

2021

 

373,165

2022

 

311,434

2023

 

248,741

Thereafter

 

573,554

Total lease payments

$

1,999,901

Less: Interest

(322,323)

Present value of lease liabilities

$

1,677,578

Lease payments exclude $96.1 million related to 28 leases that have been signed as of November 2, 2019 but have not yet commenced.

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5. DEBT

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

November 2,

February 2,

November 3,

Interest Rate

2019

2019

2018

Term loan credit facility

Variable

$

2,188,775

$

2,207,450

$

2,214,994

Asset-based revolving credit facility

Variable

 

 

 

218,000

Senior notes

8.00

%

 

500,000

 

 

Senior subordinated notes

5.875

%

 

 

510,000

 

510,000

Total debt

 

2,688,775

 

2,717,450

 

2,942,994

Less unamortized discount/premium and debt costs

(14,119)

(11,550)

(12,431)

Total debt, net

2,674,656

2,705,900

2,930,563

Less current portion

 

(24,900)

 

(24,900)

 

(240,261)

Long-term debt

$

2,649,756

$

2,681,000

$

2,690,302

Revolving Credit Facility

As of November 2, 2019 and November 3, 2018, the borrowing base under our senior secured asset-based revolving credit facility (“Amended Revolving Credit Facility”) was $850.0 million, of which Michaels Stores, Inc. (“MSI”) had unused borrowing capacity of $768.0 million and $567.0 million, respectively. As of November 2, 2019 and November 3, 2018, outstanding standby letters of credit, which reduce our borrowing base, totaled $82.0 million and $65.0 million, respectively.

On August 30, 2019, MSI, as borrower, and Michaels Funding, Inc. and certain of MSI’s subsidiaries, as guarantors, entered into an amended and restated credit agreement with Wells Fargo Bank, National Association and other lenders. The amendment extends the maturity date of the Amended Revolving Credit Facility to August 30, 2024, subject to an earlier springing maturity date if certain of our outstanding indebtedness has not been repaid, redeemed, refinanced or cash collateralized or if the necessary availability reserves have not been established prior to such time. MSI is required to pay a commitment fee on the unutilized commitments under the Amended Revolving Credit Facility which is 0.25% per annum, subject to reduction to 0.20% when excess availability is less than 50% of the loan cap. The loan cap is defined as the lesser of the commitment amount and the borrowing base. All other significant terms of the Amended Revolving Credit Facility have remained unchanged.

As of November 2, 2019, net debt issuance costs totaled $3.7 million and are being amortized as interest expense over the life of the Amended Revolving Credit Facility. As a result of the refinancing of our Amended Revolving Credit Facility on August 30, 2019, MSI recorded a loss on the early extinguishment of debt of $0.2 million during the third quarter of fiscal 2019.

8% Senior Notes due 2027

On July 8, 2019, MSI issued $500 million in principal amount of 2027 Senior Notes. The 2027 Senior Notes were issued pursuant to an indenture among MSI, certain subsidiaries of MSI, as guarantors, and U.S. Bank National Association, as trustee (the “2027 Senior Notes Indenture”). The 2027 Senior Notes mature on July 15, 2027 and bear interest at a rate of 8% per year, with interest payable semi-annually on January 15 and July 15 of each year, beginning on January 15, 2020.

The net proceeds from the offering and sale of the 2027 Senior Notes, together with cash on hand, were used to redeem MSI’s outstanding 2020 Senior Subordinated Notes.

The 2027 Senior Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by each of MSI’s subsidiaries that guarantee indebtedness under the Amended Revolving Credit Facility and the Amended and Restated Term Loan Credit Facility (collectively defined as the “Senior Secured Credit Facilities”).

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The 2027 Senior Notes are general, unsecured obligations of MSI, and the guarantees of the 2027 Senior Notes are general, unsecured obligations of the guarantors. They (i) rank equally in right of payment with all of MSI’s and the guarantors’ existing and future senior debt, including the Senior Secured Credit Facilities, (ii) are effectively subordinated to any of MSI’s and the guarantors’ existing and future secured debt to the extent of the value of the assets securing such debt, including the Senior Secured Credit Facilities, (iii) are structurally subordinated to all of the liabilities of MSI’s subsidiaries that are not guaranteeing the 2027 Senior Notes, and (iv) are senior in right of payment with all of MSI’s and the guarantors’ existing and future subordinated debt.

At any time prior to July 15, 2022, MSI may redeem (a) up to 40% of the aggregate principal amount of the 2027 Senior Notes with the gross proceeds from one or more Equity Offerings, as defined in the 2027 Senior Notes Indenture, at a redemption price of 108% of the principal amount plus accrued and unpaid interest thereon to, but excluding, the redemption date and/or (b) all or part of the 2027 Senior Notes at 100% of the principal amount plus any accrued and unpaid interest thereon to, but excluding, the redemption date plus a make-whole premium. Thereafter, MSI may redeem all or part of the 2027 Senior Notes at the redemption prices set forth below (expressed as percentages of the principal amount of the 2027 Senior Notes to be redeemed) plus any accrued and unpaid interest thereon to, but excluding, the applicable date of redemption, if redeemed during the twelve month period beginning on July 15 of each of the years indicated below:

Year

Percentage

2022

104

%

2023

102

%

2024 and thereafter

100

%

Upon a change in control, MSI is required to offer to purchase the 2027 Senior Notes at 101% of the aggregate principal amount, plus any accrued and unpaid interest thereon to, but excluding, the date of purchase.

Subject to certain exceptions and qualifications, the 2027 Senior Notes Indenture contains covenants that, among other things, limit MSI’s ability and the ability of its restricted subsidiaries, including the guarantors, to:

incur additional indebtedness or issue certain disqualified stock or preferred stock;

create liens;

pay dividends on MSI’s capital stock or make distributions or redeem or repurchase MSI’s capital stock;

prepay subordinated debt or make certain investments, loans, advances, and acquisitions;

transfer or sell assets;

engage in consolidations, amalgamations or mergers, or sell, transfer or otherwise dispose of all or substantially all of their assets; and

enter into certain transactions with affiliates.

The 2027 Senior Notes Indenture also provides for customary events of default which, if any of them occurs, would require or permit the principal of and accrued interest on the 2027 Senior Notes to become or to be declared due and payable. As of November 2, 2019, MSI was in compliance with all covenants.

As of November 2, 2019, net debt issuance costs totaled $6.0 million and are being amortized over the life of the 2027 Senior Notes. As a result of the redemption of our 2020 Senior Subordinated Notes on July 29, 2019, MSI recorded a loss on the early extinguishment of debt of $1.2 million during the second quarter of fiscal 2019.

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Interest Rate Swaps

In April 2018, we executed two interest rate swaps with an aggregate notional value of $1 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 third quarters of fiscal 2019 and fiscal 2018 were $1.7 million and $1.6 million, respectively. Amounts reclassified from accumulated other comprehensive income to interest expense during the nine months ended November 2, 2019 and November 3, 2018 were $3.3 million and $3.7 million, respectively.

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

39 Weeks Ended

November 2,

November 3,

November 2,

November 3,

2019

    

2018

    

2019

    

2018

Beginning of period

  

$

(24,146)

$

(9,906)

  

$

(14,558)

$

(3,660)

Foreign currency translation

 

972

 

(942)

 

424

 

(6,528)

Interest rate swaps

258

3,958

(8,782)

3,298

End of period

$

(22,916)

$

(6,890)

$

(22,916)

$

(6,890)

7. INCOME TAXES

The effective tax rate was 22.5% in the third quarter of fiscal 2019 compared to 15.8% in the third quarter of fiscal 2018. The effective tax rate in the third quarter of fiscal 2019 was higher than the same period in the prior year primarily due to $7.1 million of tax benefits recognized in the third quarter of fiscal 2018 associated with the enactment of the Tax Cuts and Jobs Act of 2017 (“Tax Act”). The effective tax rate was 23.9% in the nine months ended November 2, 2019 compared to 24.0% in the same period in the prior year. The effective tax rate in the first nine months of fiscal 2019 was slightly lower than the same period in the prior year primarily due to a tax benefit associated with a state income tax settlement in fiscal 2019 and a $1.0 million charge in fiscal 2018 associated with the enactment of the Tax Act, partially offset by the vesting and expiration of share-based compensation awards.

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 10.1 million and 8.4 million anti-dilutive shares during the third quarters of fiscal 2019 and fiscal 2018, respectively. There were 10.6 million and 7.1 million anti-dilutive shares during the nine months ended November 2, 2019 and November 3, 2018, respectively.

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

13 Weeks Ended

39 Weeks Ended

November 2,

November 3,

November 2,

November 3,

2019

2018

2019

2018

Basic earnings per common share:

Net income

$

28,705

$

83,769

$

90,943

  

$

138,142

Less income related to unvested restricted shares

 

(40)

 

(138)

 

(108)

 

(285)

Income available to common shareholders - Basic

$

28,665

$

83,631

$

90,835

$

137,857

Weighted-average common shares outstanding - Basic

150,877

165,975

155,299

174,949