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 2, 2015

 

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


 

 

 

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 and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted 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 non-accelerated filer.

 

The Michaels Companies, Inc. is not a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

As of May 29, 2015, 207,510,359 shares of The Michaels Companies, Inc.’s common stock were outstanding.

 

 

 

 

 

 

 


 

Table of Contents

 

 

 

 

 

THE MICHAELS COMPANIES, INC.

 

TABLE OF CONTENTS

 

Part IFINANCIAL INFORMATION 

 

 

 

Page

 

 

 

Item 1. 

Financial Statements

3

 

 

 

 

Consolidated Statements of Comprehensive Income for the 13 weeks ended May 2, 2015 and May 3, 2014 (unaudited)

3

 

 

 

 

Consolidated Balance Sheets as of May 2, 2015, January 31, 2015 and May 3, 2014 (unaudited)

4

 

 

 

 

Consolidated Statements of Cash Flows for the 13 weeks ended May 2, 2015 and May 3, 2014 (unaudited)

5

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

6

 

 

 

Item 2. 

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

16

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

23

 

 

 

Item 4. 

Controls and Procedures

24

 

 

 

Part IIOTHER INFORMATION 

 

 

 

Item 1. 

Legal Proceedings

25

 

 

 

Item 1A. 

Risk Factors

25

 

 

 

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

25

 

 

 

Item 5. 

Other Information

25

 

 

 

Item 6. 

Exhibits

26

 

 

 

Signatures 

 

27

 

 

 

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

 

 

 

May 2,

 

May 3,

 

 

 

2015

    

2014

 

Net sales

    

$

1,077,600 

    

$

1,052,048 

 

Cost of sales and occupancy expense

 

 

635,803 

 

 

623,305 

 

Gross profit

 

 

441,797 

 

 

428,743 

 

Selling, general and administrative

 

 

292,231 

 

 

280,823 

 

Share-based compensation

 

 

3,340 

 

 

4,160 

 

Related party expenses

 

 

 —

 

 

3,328 

 

Store pre-opening costs

 

 

2,244 

 

 

1,232 

 

Operating income

 

 

143,982 

 

 

139,200 

 

Interest expense

 

 

37,816 

 

 

57,091 

 

Other expense and (income), net

 

 

195 

 

 

(49)

 

Income before income taxes

 

 

105,971 

 

 

82,158 

 

Provision for income taxes

 

 

39,233 

 

 

36,744 

 

Net income

 

$

66,738 

 

$

45,414 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

Foreign currency translation adjustment and other

 

 

4,316 

 

 

(1,124)

 

Comprehensive income

 

$

71,054 

 

$

44,290 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

Basic

 

$

0.32 

 

$

0.26 

 

Diluted

 

$

0.32 

 

$

0.25 

 

Weighted-average shares outstanding:

 

 

 

 

 

 

 

Basic

 

 

205,632 

 

 

175,121 

 

Diluted

 

 

209,350 

 

 

178,853 

 

 

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 2,

 

January 31,

 

May 3,

 

ASSETS

 

2015

 

2015

 

2014

 

Current Assets:

 

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

272,568 

 

$

378,295 

 

$

114,989 

 

Merchandise inventories

 

 

985,376 

 

 

958,171 

 

 

930,131 

 

Prepaid expenses and other

 

 

83,798 

 

 

84,894 

 

 

95,290 

 

Deferred income taxes

 

 

38,446 

 

 

38,345 

 

 

37,039 

 

Income tax receivables

 

 

 —

 

 

2,418 

 

 

8,000 

 

Total current assets

 

 

1,380,188 

 

 

1,462,123 

 

 

1,185,449 

 

Property and equipment, at cost

 

 

1,607,156 

 

 

1,579,446 

 

 

1,628,699 

 

Less accumulated depreciation and amortization

 

 

(1,219,266)

 

 

(1,193,074)

 

 

(1,266,203)

 

Property and equipment, net

 

 

387,890 

 

 

386,372 

 

 

362,496 

 

Goodwill

 

 

94,290 

 

 

94,290 

 

 

94,290 

 

Debt issuance costs, net

 

 

38,336 

 

 

40,613 

 

 

49,928 

 

Deferred income taxes

 

 

20,349 

 

 

20,245 

 

 

22,408 

 

Other assets

 

 

1,695 

 

 

1,638 

 

 

1,644 

 

Total assets

 

$

1,922,748 

 

$

2,005,281 

 

$

1,716,215 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

367,587 

 

$

447,165 

 

$

312,768 

 

Accrued liabilities and other

 

 

330,402 

 

 

391,997 

 

 

333,550 

 

Current portion of long-term debt

 

 

205,750 

 

 

24,900 

 

 

16,400 

 

Income taxes payable

 

 

4,758 

 

 

25,570 

 

 

30,005 

 

Total current liabilities

 

 

908,497 

 

 

889,632 

 

 

692,723 

 

Long-term debt

 

 

2,937,266 

 

 

3,124,374 

 

 

3,673,116 

 

Deferred income taxes

 

 

14,889 

 

 

9,580 

 

 

1,058 

 

Other liabilities

 

 

93,410 

 

 

93,220 

 

 

83,357 

 

Total liabilities

 

 

3,954,062 

 

 

4,116,806 

 

 

4,450,254 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Deficit:

 

 

 

 

 

 

 

 

 

 

Common Stock, $0.06775 par value, 350,000 shares authorized; 207,466 shares issued and outstanding at May 2, 2015; 205,803 shares issued and outstanding at January 31, 2015; and 175,326 shares issued and outstanding at May 3, 2014

 

 

13,914 

 

 

13,799 

 

 

11,878 

 

Additional paid-in-capital

 

 

566,873 

 

 

557,831 

 

 

100,250 

 

Accumulated deficit

 

 

(2,604,612)

 

 

(2,671,350)

 

 

(2,845,241)

 

Accumulated other comprehensive loss

 

 

(7,489)

 

 

(11,805)

 

 

(926)

 

Total stockholders’ deficit

 

 

(2,031,314)

 

 

(2,111,525)

 

 

(2,734,039)

 

Total liabilities and stockholders’ deficit

 

$

1,922,748 

 

$

2,005,281 

 

$

1,716,215 

 

 

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 2,

 

May 3,

 

 

    

2015

    

2014

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

66,738 

 

$

45,414 

 

Adjustments to reconcile net income to net cash used in operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

27,945 

 

 

26,627 

 

Share-based compensation

 

 

2,720 

 

 

3,683 

 

Debt issuance costs amortization

 

 

2,277 

 

 

2,858 

 

Accretion of long-term debt, net

 

 

(33)

 

 

(328)

 

Deferred income taxes

 

 

5,104 

 

 

5,903 

 

Excess tax benefits from share-based compensation

 

 

(10,199)

 

 

(208)

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

Merchandise inventories

 

 

(27,117)

 

 

(27,414)

 

Prepaid expenses and other

 

 

1,107 

 

 

204 

 

Other assets

 

 

(87)

 

 

(297)

 

Accounts payable

 

 

(64,987)

 

 

(44,834)

 

Accrued interest

 

 

10,430 

 

 

(31,181)

 

Accrued liabilities and other

 

 

(71,989)

 

 

(44,694)

 

Income taxes

 

 

(18,394)

 

 

(6,035)

 

Other liabilities

 

 

265 

 

 

(4,056)

 

Net cash used in operating activities

 

 

(76,220)

 

 

(74,358)

 

 

 

 

 

 

 

 

 

Cash flows used in investing activities:

 

 

 

 

 

 

 

Additions to property and equipment

 

 

(34,964)

 

 

(30,802)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Payments on restated term loan credit facility

 

 

(6,225)

 

 

(4,100)

 

Payment of dividends

 

 

(317)

 

 

(403)

 

Change in cash overdraft

 

 

(4,552)

 

 

(12,404)

 

Proceeds from stock options exercised

 

 

25,778 

 

 

5,582 

 

Common stock repurchased

 

 

(19,426)

 

 

(7,571)

 

Excess tax benefits from share-based compensation

 

 

10,199 

 

 

208 

 

Other financing activities

 

 

 —

 

 

(27)

 

Net cash provided by (used in) financing activities

 

 

5,457 

 

 

(18,715)

 

 

 

 

 

 

 

 

 

Net change in cash and equivalents

 

 

(105,727)

 

 

(123,875)

 

Cash and equivalents at beginning of period

 

 

378,295 

 

 

238,864 

 

Cash and equivalents at end of period

 

$

272,568 

 

$

114,989 

 

 

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. Disclosures for Michaels Stores, Inc. (“MSI”) have been included to meet the disclosure requirements of Rule 12-04 of Regulation S-X as further discussed in Note 10.

 

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 January 31, 2015 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 2015” relate to the 52 weeks ended January 30, 2016 and references to “fiscal 2014” relate to the 52 weeks ended January 31, 2015. In addition, all references to “the first quarter of fiscal 2015” relate to the 13 weeks ended May 2, 2015 and all references to “the first quarter of fiscal 2014” relate to the 13 weeks ended May 3, 2014. Because of the seasonal nature of our business, the results of operations for the 13 weeks ended May 2, 2015 are not indicative of the results to be expected for the entire year. 

 

Recent Accounting Pronouncements

 

In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-03, “Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs” (“ASU 2015-03”).  ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Amortization of the costs will continue to be reported as interest expense. ASU 2015-03 is effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period and is to be applied retrospectively, with early application permitted.  As of May 2, 2015, the reduction to our long-term assets and debt would be approximately $33 million.  We are currently evaluating the requirements of the standard to determine when we will adopt and implement its provisions.

 

In April 2015, the FASB issued ASU 2015-05, “Intangibles — Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement (“ASU 2015-05”).  ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license.  If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses.  If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract.  The new guidance does not change the accounting for a customer’s accounting for service contracts.  ASU 2015-05 is effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. We are currently evaluating the impact, if any, of the adoption of this new standard on our consolidated financial statements and related disclosures.

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In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”).  ASU 2014-09 supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605)”, and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. Currently, ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period and is to be applied retrospectively, with early application not permitted.  However, on April 1, 2015, the FASB proposed a deferral of the effective date of the standard by one year, but the proposal would also permit companies to adopt ASU 2014-09 as of the current effective date. We are evaluating the new standard, but 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 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.

 

The table below provides the carrying and fair values of our senior secured term loan facility (“Restated Term Loan Credit Facility”), our 5.875% senior subordinated notes maturing in 2020 (“2020 Senior Subordinated Notes”),  and our PIK Notes (as defined in Note 3) as of May 2, 2015. The fair value of our Restated Term Loan Credit Facility, our 2020 Senior Subordinated Notes and our PIK Notes were determined based on quoted market prices which are considered Level 2 inputs within the fair value hierarchy.

 

 

 

 

 

 

 

 

 

 

    

Carrying

    

Fair

 

 

 

Value

 

Value

 

 

 

(In thousands)

 

Restated term loan credit facility

 

$

2,447,709 

 

$

2,459,061 

 

Senior subordinated notes

 

 

514,457 

 

 

532,313 

 

PIK notes

 

 

180,850 

 

 

184,693 

 

 

 

 

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3. DEBT

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

May 2,

 

January 31,

 

May 3,

 

Interest Rate

 

2015

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

Restated term loan credit facility

Variable

 

$

2,447,709 

 

$

2,453,770 

 

$

1,623,600 

Senior notes

7.75 

%

 

 —

 

 

 —

 

 

1,005,916 

Senior subordinated notes

5.875 

%

 

514,457 

 

 

514,654 

 

 

260,000 

PIK notes

7.50 % / 8.25

%

 

180,850 

 

 

180,850 

 

 

800,000 

Total debt

 

 

 

3,143,016 

 

 

3,149,274 

 

 

3,689,516 

Less current portion

 

 

 

(205,750)

 

 

(24,900)

 

 

(16,400)

Long-term debt

 

 

$

2,937,266 

 

$

3,124,374 

 

$

3,673,116 

 

The restated term loan credit facility, senior notes and senior subordinated notes are obligations held by MSI, a wholly-owned subsidiary of The Michaels Companies, Inc.  The above table presents all debt disclosures required by MSI in accordance with Rule 12-04 under the SEC’s Regulation S-X. Cash paid for interest totaled $25.1 million and $85.9 million for the 13 weeks ended May 2, 2015 and May 3, 2014, respectively.

 

7.50%/8.25% PIK Toggle Notes

 

On April 6, 2015, an irrevocable notice of redemption was delivered to the holders of the 7.50%/8.25% PIK Toggle Notes due 2018 (“PIK Notes”). Pursuant to the notice, the remaining $180.9 million in principal of the PIK Notes was redeemed on May 6, 2015 and has been classified as current debt in the consolidated balance sheets.  In the second quarter of fiscal 2015, the Company will record approximately $6 million of debt extinguishment costs, which consists of a 2% redemption premium and approximately $2 million of unamortized debt issuance costs. This final payment retired the PIK Notes and discharged the obligations under the indenture governing the PIK Notes.

 

Restated Revolving Credit Facility

 

As of May 2, 2015, the borrowing base of our senior secured asset-based revolving credit facility (“Restated Revolving Credit Facility”) was $650.0 million, of which MSI had $590.5 million of unused borrowing capacity. Outstanding standby letters of credit, which reduce our borrowing base, totaled $59.5 million as of May 2, 2015. There were no outstanding borrowings under the Restated Revolving Credit Facility as of May 2, 2015.

 

Debt Issuance Costs

 

Accumulated amortization of debt issuance costs was $56.8 million, $54.6 million, and $58.1 million as of May 2, 2015, January 31, 2015 and May 3, 2014, respectively. 

 

 

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4. 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 2, 

 

May 3, 

 

 

2015

    

2014

Beginning of period

  

$

(11,805)

 

$

198 

Foreign currency translation adjustment and other

 

 

4,316 

 

 

(1,124)

End of period

 

$

(7,489)

 

$

(926)

 

 

 

5.  INCOME TAXES

 

The effective tax rate was 37.0% and 44.7% for the first quarter of fiscal 2015 and fiscal 2014, respectively. The effective tax rate for the first three months of fiscal 2015 is lower than the same period in the prior year due to a change in the status of our Canadian subsidiary from a branch for U.S. tax purposes to a controlled foreign corporation in the first quarter of fiscal 2014 which resulted in the write off of certain deferred tax assets.  Additionally, in the current year, we changed our assertion related to Canadian earnings and intend to indefinitely reinvest fiscal 2015 earnings into our operations outside the U.S.  Accordingly, we have not provided for U.S. federal or foreign income taxes, including withholding taxes, on fiscal 2015 earnings of our Canadian subsidiaries' undistributed earnings. However, if any portion were to be distributed, the related U.S. tax liability may be reduced by foreign income taxes paid on those earnings. We currently estimate our annualized effective tax rate for fiscal 2015 to be approximately 37%.

 

Cash paid for income taxes totaled $42.7 million and $36.1 million for the 13 weeks ended May 2, 2015 and May 3, 2014, respectively.

 

 

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6.   EARNINGS PER SHARE

 

Basic earnings per share is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding. Diluted earnings per share is computed by dividing income available to common stockholders by the weighted-average shares outstanding plus the potential dilutive impact from the exercise of stock options and restricted shares. Common equivalent shares are excluded from the computation if their effect is anti-dilutive.  There were 0.2 million and 2.9 million anti-dilutive shares during the first quarters of fiscal 2015 and fiscal 2014, respectively.

 

The following table presents a reconciliation of the diluted weighted-average shares (in thousands, except per share data):

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

 

May 2,

 

May 3,

 

 

 

2015

    

2014

 

Numerator:

 

 

 

 

 

 

 

Net income

  

$

66,738 

  

$

45,414 

 

Income related to vested restricted shares

 

 

290 

 

 

170 

 

Income available to common stockholders

 

$

66,448 

 

$

45,244 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

Basic weighted-average shares

 

 

205,632 

 

 

175,121 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options

 

 

3,418 

 

 

3,667 

 

Restricted shares

 

 

300 

 

 

65 

 

Dilutive weighted-average shares

 

 

209,350 

 

 

178,853 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.32 

 

$

0.26 

 

Diluted earnings per common share

 

$

0.32 

 

$

0.25 

 

 

7. SEGMENTS AND GEOGRAPHIC INFORMATION

 

We consider our Michaels-U.S., Michaels-Canada and Aaron Brothers 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 each of our operating segments have similar economic characteristics and meet the aggregation criteria set forth in ASC 280. Therefore, we combine our operating segments into one reporting segment.

 

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

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

 

May 2,

 

May 3,

 

 

    

2015

    

2014

 

Net Sales:

 

 

 

 

 

 

 

United States

 

$

983,260 

 

$

951,799 

 

Canada

 

 

94,340 

 

 

100,249 

 

Consolidated Total

 

$

1,077,600 

 

$

1,052,048 

 

 

Our chief operating decision makers evaluate historical operating performance and plan and forecast future periods’ operating performance based on operating income and earnings before interest, income taxes, depreciation and 

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amortization (“EBITDA”). We believe these metrics more closely reflect the operating effectiveness of factors over which management has control. A reconciliation of EBITDA to net income is presented below (in thousands):

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

 

May 2,

    

May 3,

 

 

    

2015

    

2014

 

Net income

 

$

66,738 

 

$

45,414 

 

Interest expense

 

 

37,816 

 

 

57,091 

 

Provision for income taxes

 

 

39,233 

 

 

36,744 

 

Depreciation and amortization

 

 

27,945 

 

 

26,627 

 

Other

 

 

(123)

 

 

(68)

 

EBITDA

 

$

171,609 

 

$

165,808 

 

 

8. CONTINGENCIES

 

Rea Claim

 

On September 15, 2011, MSI was served with a lawsuit filed in the California Superior Court in and for the County of Orange (“Superior Court”) by four former store managers as a class action proceeding on behalf of themselves and certain former and current store managers employed by MSI in California. The lawsuit alleges that MSI improperly classified its store managers as exempt employees and as such failed to pay all wages, overtime, waiting time penalties and failed to provide accurate wage statements. The lawsuit also alleges that the foregoing conduct was in breach of various laws, including California’s unfair competition law. On December 3, 2013, the Superior Court entered an order certifying a class of approximately 200 members.  MSI successfully removed the case to the United States District Court for the Central District of California and on May 8, 2014, the class was de‑certified.  As a result of the decertification, we have approximately 40 individual claims pending as well as a separate representative action pending in the California Superior Court in and for the County of San Diego brought on behalf of store managers throughout the state. We believe we have meritorious defenses and intend to defend the lawsuits vigorously. We do not believe the resolution of the lawsuits will have a material effect on our consolidated financial statements.  

Fair Credit Reporting Claim

On December 11, 2014, MSI was served with a lawsuit, Christina Graham v. Michaels Stores, Inc., filed in the U.S. District Court for the District of New Jersey by a former associate.  The lawsuit is a purported class action, bringing plaintiff’s individual claims, as well as claims on behalf of a putative class of applicants who applied for employment with Michaels through an online application, and on whom a background check for employment was procured. The lawsuit alleges that MSI violated the Fair Credit Reporting Act (“FCRA”) and the New Jersey Fair Credit Reporting Act by failing to provide the proper disclosure and obtain the proper authorization to conduct background checks.  Since the initial filing, another named plaintiff joined the lawsuit, which was amended in February 2015, Christina Graham and Gary Anderson v. Michaels Stores, Inc., with substantially similar allegations.  The plaintiffs seek statutory and punitive damages as well as attorneys’ fees and costs. 

Following the filing of the Graham case in New Jersey, four additional purported class action lawsuits with five plaintiffs were filed, Raini Burnside v. Michaels Stores, Inc., pending in the U.S. District Court in the Western District of Missouri, Michele Castro and Janice Bercut v. Michaels Stores, Inc., in the U.S. District Court in the Northern District of Texas, Sue Gettings v. Michaels Stores, Inc., in the U.S. District Court in the Southern District of New York, and Barbara Horton v. Michaels Stores, Inc., in the U.S. District Court in the Central District of California. All five plaintiffs alleged violations of the FCRA.  In addition, Castro, Horton and Bercut also alleged violations of California’s unfair competition law.  The Burnside, Horton and Gettings lawsuits have been dismissed and an offer of judgment has been accepted in the Castro lawsuit and will be dismissed. The Graham and Bercut lawsuits were transferred by the U.S. Judicial Panel on Multidistrict Litigation for centralized pretrial proceedings to the District of New Jersey.

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The Company intends to defend the remaining lawsuits vigorously. We cannot reasonably estimate the potential loss, or range of loss, related to the lawsuits, if any.

Data Security Incident

 

Five putative class actions were filed against MSI relating to the January 2014 data breach.  The plaintiffs generally alleged that MSI failed to secure and safeguard customers’ private information including credit and debit card information, and as such, breached an implied contract, and violated the Illinois Consumer Fraud Act (and other states’ similar laws) and are seeking damages including declaratory relief, actual damages, punitive damages, statutory damages, attorneys’ fees, litigation costs, remedial action, pre and post judgment interest, and other relief as available.  The cases are as follows: Christina Moyer v. Michaels Stores, Inc., was filed on January 27, 2014; Michael and Jessica Gouwens v. Michaels Stores, Inc., was filed on January 29, 2014; Nancy Maize and Jessica Gordon v. Michaels Stores, Inc., was filed on February 21, 2014; and Daniel Ripes v. Michaels Stores, Inc., was filed on March 14, 2014. These four cases were filed in the United States District Court-Northern District of Illinois, Eastern Division.  On March 18, 2014, an additional putative class action was filed in the United States District Court for the Eastern District of New York, Mary Jane Whalen v. Michaels Stores, Inc., but was voluntarily dismissed by the plaintiff on April 11, 2014 without prejudice to her right to re‑file a complaint. On April 16, 2014, an order was entered consolidating the Illinois actions. On July 14, 2014, the Company’s motion to dismiss the consolidated complaint was granted. On August 11, 2014, plaintiffs filed a motion to alter or amend the judgment, which was denied on October 14, 2014. The deadline to file a notice of appeal expired on November 13, 2014. 

 

On December 2, 2014, Whalen filed a new lawsuit against MSI related to the data breach in the United States District Court for the Eastern District of New York, Mary Jane Whalen v. Michaels Stores, Inc., seeking damages including declaratory relief, monetary damages, statutory damages, punitive damages, attorneys’ fees and costs, injunctive relief, pre and post judgment interest, and other relief as available. The Company filed a motion to dismiss and is awaiting a decision from the Court. 

The Company intends to defend these lawsuits vigorously. We cannot reasonably estimate the potential loss, or range of loss, related to the lawsuits, if any.

In connection with the breach, payment card companies and associations may seek to require us to reimburse them for unauthorized card charges and costs to replace cards and may also impose fines or penalties in connection with the data breach, and enforcement authorities may also impose fines or other remedies against us. We have also incurred other costs associated with the data breach, including legal fees, investigative fees, costs of communications with customers and credit monitoring services provided to our customers. In addition, state and federal agencies, including states’ attorneys general and the Federal Trade Commission may investigate events related to the data breach, including how it occurred, its consequences and our responses. Although we intend to cooperate in these investigations, we may be subject to fines or other obligations, which may have an adverse effect on how we operate our business and our results of operations. We cannot reasonably estimate the potential loss or range of loss related to any reimbursement costs, fines or penalties that may be assessed, if any. Such amounts incurred to date are immaterial to the consolidated financial statements. 

Consumer Product Safety Commission Claim

 

On April 21, 2015, the United States Department of Justice, on behalf of the Consumer Product Safety Commission (the “CPSC”), filed a complaint against MSI and Michaels Stores Procurement Company, Inc. (“MSPC”) in the U.S. District Court for the Northern District of Texas.   The complaint seeks civil penalties for an alleged failure to timely report a potential product safety hazard to the CPSC related to the breakage of certain glass vases. The complaint also alleges the report contained a material misrepresentation and seeks injunctive relief requiring MSI and MSPC to, among other things, establish internal recordkeeping and compliance monitoring systems. We believe we have meritorious defenses and intend to defend the lawsuit vigorously. We do not believe the resolution of the lawsuit will have a material effect on our consolidated financial statements.

 

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General

In addition to the litigation discussed above, we are now, and may be in the future, involved in various other lawsuits, claims and proceedings incident to the ordinary course of business. The results of litigation are inherently unpredictable. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in diversion of significant resources.

For some of the matters disclosed above, as well as other matters previously disclosed in the Company’s filings with the SEC, the Company is able to estimate a range of losses in excess of the amounts recorded, if any, in the accompanying consolidated financial statements.  As of May 2, 2015, the aggregate estimated loss is approximately $15 million, which includes amounts recorded by the Company. 

 

9. RELATED PARTY TRANSACTIONS

 

Bain Capital Partners, LLC (“Bain Capital”) and The Blackstone Group L.P. (“The Blackstone Group”, together with Bain Capital, the “Sponsors”) own approximately 69% of our outstanding common stock as of May 2, 2015. Prior to our initial public offering (“IPO”) on July 2, 2014, the Sponsors and another common stockholder, Highfields Capital Management LP (“Highfields”), received annual management fees of $12.0 million and $1.0 million, respectively. In connection with the IPO, the management agreement was terminated and the Company paid the Sponsors and Highfields an aggregate $30.2 million termination fee. In the first quarter of fiscal 2014, we recognized expense of $3.3 million related to management fees and reimbursement of out-of-pocket expenses. These expenses are included in related party expenses in the consolidated statements of comprehensive income.

 

The Blackstone Group owns a majority equity position in RGIS, an external vendor we utilize to count our store inventory. Payments associated with this vendor during the first quarters of fiscal 2015 and fiscal 2014 were $1.9 million and $2.0 million, respectively, and 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 Vistar, an external vendor we utilize for all of the candy-type items in our stores. Payments associated with this vendor during each of the first quarters of fiscal 2015 and fiscal 2014 were $7.2 million, and are recognized in cost of sales as the sales are incurred.

 

The Blackstone Group owns an equity position in Brixmor Properties Group, a vendor we utilize to lease certain properties. Payments associated with this vendor during the first quarters of fiscal 2015 and fiscal 2014 were $0.7 million and $1.0 million, respectively. These expenses are included in cost of sales and occupancy expense in the consolidated statements of comprehensive income.

 

Our current directors (other than Karen Kaplan, John J. Mahoney, James A. Quella, Beryl B. Raff, and Carl S. Rubin) are affiliates of 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 2, 2015, affiliates of The Blackstone Group held $45.4 million of our Restated Term Loan Credit Facility.

 

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10. 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.  The information is presented in accordance with the requirements of Rule 12-04 under the SEC’s Regulation S-X. In addition, disclosure requirements of Rule 12-04 of Regulation S-X regarding material contingencies and long-term obligations are included in Note 3. Debt, Note 5. Income Taxes and Note 8. Contingencies, where applicable.

 

Michaels Stores, Inc.

Condensed Consolidated Balance Sheets

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

May 2,

 

January 31,

 

May 3,

 

ASSETS

    

2015

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

267,831 

 

$

373,559 

 

$

112,227 

 

Merchandise inventories

 

 

985,376 

 

 

958,171 

 

 

930,131 

 

Prepaid expenses and other

 

 

83,611 

 

 

84,675 

 

 

94,421 

 

Deferred income taxes

 

 

38,382 

 

 

38,281 

 

 

36,972 

 

Income tax receivables

 

 

 —

 

 

2,418 

 

 

8,000 

 

Total current assets

 

 

1,375,200 

 

 

1,457,104 

 

 

1,181,751 

 

Property and equipment, net

 

 

387,890 

 

 

386,372 

 

 

362,496 

 

Goodwill

 

 

94,290 

 

 

94,290 

 

 

94,290 

 

Debt issuance costs, net

 

 

35,889 

 

 

37,978 

 

 

35,756 

 

Deferred income taxes

 

 

20,349 

 

 

20,245 

 

 

22,261 

 

Long-term receivable from Parent

 

 

8,771 

 

 

4,445 

 

 

5,477 

 

Other assets

 

 

1,699 

 

 

1,637 

 

 

1,644 

 

Total assets

 

$

1,924,088 

 

$

2,002,071 

 

$

1,703,675 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

367,587 

 

$

447,016 

 

$

312,768 

 

Accrued liabilities and other

 

 

324,437 

 

 

388,785 

 

 

315,233 

 

Current portion of long-term debt

 

 

24,900 

 

 

24,900 

 

 

16,400 

 

Income taxes payable

 

 

40,511 

 

 

59,885 

 

 

46,970 

 

Total current liabilities

 

 

757,435 

 

 

920,586 

 

 

691,371 

 

Long-term debt

 

 

2,937,266 

 

 

2,943,524 

 

 

2,873,116 

 

Deferred income taxes

 

 

15,002 

 

 

9,693 

 

 

1,058 

 

Other liabilities

 

 

93,410 

 

 

93,220 

 

 

83,357 

 

Total stockholders’ deficit

 

 

(1,879,025)

 

 

(1,964,952)

 

 

(1,945,227)

 

Total liabilities and stockholders’ deficit

 

$

1,924,088 

 

$

2,002,071 

 

$

1,703,675 

 

 

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Michaels Stores, Inc.

Condensed Consolidated Statements of Comprehensive Income

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

 

May 2,

 

May 3,

 

 

 

2015

    

2014

 

Net sales

 

$

1,077,600 

 

$

1,052,048 

 

Cost of sales and occupancy expense

 

 

635,803 

 

 

623,305 

 

Gross profit

 

 

441,797 

 

 

428,743 

 

Selling, general and administrative

 

 

292,009 

 

 

280,591 

 

Share-based compensation

 

 

3,340 

 

 

4,160 

 

Related party expenses

 

 

 —

 

 

3,328 

 

Store pre-opening costs

 

 

2,244 

 

 

1,232 

 

Operating income

 

 

144,204 

 

 

139,432 

 

Interest expense

 

 

34,163 

 

 

41,173 

 

Other expense and (income), net

 

 

189 

 

 

(49)

 

Income before income taxes

 

 

109,852 

 

 

98,308 

 

Provision for income taxes

 

 

40,671 

 

 

41,988 

 

Net income

 

$

69,181 

 

$

56,320 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

Foreign currency translation adjustment and other

 

 

4,316 

 

 

(1,124)

 

Comprehensive income

 

$

73,497 

 

$

55,196 

 

 

Michaels Stores, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

 

May 2,

 

May 3,

 

 

 

2015

    

2014

 

Cash flows used in operating activities:

 

 

 

 

 

 

 

Net cash used in operating activities

 

$

(79,811)

 

$

(41,555)

 

 

 

 

 

 

 

 

 

Cash flows used in investing activities:

 

 

 

 

 

 

 

Additions to property and equipment

 

 

(34,964)

 

 

(30,802)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Net repayments of debt

 

 

(6,225)

 

 

(4,100)

 

Payment of dividend to Holdings

 

 

 —

 

 

(30,333)

 

Other financing activities

 

 

15,272 

 

 

(15,143)

 

Net cash provided by (used in) financing activities

 

 

9,047 

 

 

(49,576)

 

 

 

 

 

 

 

 

 

Net change in cash and equivalents

 

 

(105,728)

 

 

(121,933)

 

Cash and equivalents at beginning of period

 

 

373,559 

 

 

234,160 

 

Cash and equivalents at end of period

 

$

267,831 

 

$

112,227 

 

 

 

 

 

 

 

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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), and 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 January 31, 2015 (“Annual Report”) filed with the Securities and Exchange Commission (“SEC”) pursuant to Section 13 or 15(d) under the Securities Act of 1934 on March 19, 2015.

 

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- 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 2015” relate to the 52 weeks ended January 30, 2016 and references to “fiscal 2014” relate to the 52 weeks ended January 31, 2015.  In addition, all references to “the first quarter of fiscal 2015” relate to the 13 weeks ended May 2, 2015 and all references to “the first quarter of fiscal 2014” relate to the 13 weeks ended May 3, 2014.  Because of the seasonal nature of our business, the results of operations for the 13 weeks ended May 2, 2015 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, under the retail brands of Michaels and Aaron Brothers.  We also operate a market-leading vertically-integrated custom framing business.  At May 2, 2015, we operated 1,177 Michaels stores and 118 Aaron Brothers stores.

 

Net sales for the first quarter of fiscal 2015 increased 2.4% compared to the same period in the prior year.  The increase in net sales was due primarily to the opening of 33 additional stores (net of closures).  Comparable stores sales increased 0.3% during the first quarter of fiscal 2015, or 1.4% at constant exchange rates.  Gross profit as a percent of sales increased 20 basis points to 41.0% during the first quarter of fiscal 2015 primarily related to leverage associated with occupancy costs and a sales mix change to higher margin private brand merchandise, partially offset by higher promotional activity. Operating income increased $4.8 million to $144.0 million during the first quarter of fiscal 2015.  The increase was due primarily to an improvement in gross profit and a reduction in related party expenses due to the termination of the management services agreement in July 2014, partially offset by an increase in selling, general and administrative (“SG&A”) expenses primarily related to costs associated with 33 additional stores (net of closures) and legal related costs. 

 

On April 6, 2015, an irrevocable notice of redemption was delivered to the holders of the 7.50%/8.25% PIK Toggle Notes due 2018 (“PIK Notes”). Pursuant to the notice, the remaining $180.9 million in principal of the PIK Notes was redeemed on May 6, 2015 and has been classified as current debt in the consolidated balance sheets.  In the second quarter of fiscal 2015, the Company will record approximately $6 million of debt extinguishment costs, which consists of a 2% redemption premium and approximately $2 million of unamortized debt issuance costs. This final payment retired the PIK Notes and discharged the obligations under the indenture governing the PIK Notes.

 

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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.

 

Operating Information

 

The following table sets forth certain operating data: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

 

 

May 2, 

 

May 3, 

 

 

 

 

2015

 

2014

    

Michaels stores:

 

 

 

 

 

 

 

 

  Open at beginning of period

 

 

1,168 

 

 

 

1,136 

 

  New stores

 

 

10 

 

 

 

 

  Relocated stores opened

 

 

10 

 

 

 

 

  Closed stores

 

 

(1)

 

 

 

 —

 

  Relocated stores closed

 

 

(10)

 

 

 

(5)

 

  Open at end of period

 

 

1,177 

 

 

 

1,144 

 

 

 

 

 

 

 

 

 

 

Aaron Brothers stores:

 

 

 

 

 

 

 

 

  Open at beginning of period

 

 

120 

 

 

 

121 

 

  Closed stores

 

 

(2)

 

 

 

(3)

 

  Open at end of period

 

 

118 

 

 

 

118 

 

Total store count at end of period

 

 

1,295 

 

 

 

1,262 

 

 

 

 

 

 

 

 

 

 

Other Operating Data:

 

 

 

 

 

 

 

 

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

 

$

810 

 

 

$

783 

 

Comparable store sales

 

 

0.3 

%  

 

 

3.8 

%  

Comparable store sales, at constant currency

 

 

1.4 

%  

 

 

4.6 

%  


(1)

The calculation of average inventory per Michaels store excludes our Aaron Brothers stores.

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Results of Operations

 

The following table sets forth the percentage relationship to net sales of line items of 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 2, 

 

May 3, 

 

 

 

   

2015

 

2014

 

 

Net sales

 

100.0 

%

100.0 

%

 

Cost of sales and occupancy expense

 

59.0 

 

59.2 

 

 

  Gross profit

 

41.0 

 

40.8 

 

 

Selling, general and administrative

 

27.1 

 

26.7 

 

 

Share-based compensation

 

0.3 

 

0.4 

 

 

Related party expenses

 

 —

 

0.3 

 

 

Store pre-opening costs

 

0.2 

 

0.1 

 

 

  Operating income

 

13.4 

 

13.2 

 

 

Interest expense

 

3.5 

 

5.4 

 

 

Other expense and (income), net

 

 —

 

 —

 

 

Income before income taxes

 

9.8 

 

7.8 

 

 

Provision for income taxes

 

3.6 

 

3.5 

 

 

  Net income

 

6.2 

%

4.3 

%

 

 

13 Weeks Ended May 2, 2015 Compared to the 13 Weeks Ended May 3, 2014

 

Net Sales. Net sales increased $25.6 million in the first quarter of fiscal 2015, or 2.4%, compared to the first quarter of fiscal 2014.  The increase in net sales was due to a $22.7 million increase primarily related to 33 additional stores opened (net of closures) since May 3, 2014 and a $2.9 million increase in comparable store sales. Comparable store sales increased 0.3%, or 1.4% at constant exchange rates, due primarily to an increase in our average ticket, partially offset by a decrease in customer transactions.  

 

Gross Profit. Gross profit was 41.0% of net sales in the first quarter of fiscal 2015 compared to 40.8% in the first quarter of fiscal 2014.  The 20 basis point improvement is primarily related to leverage associated with occupancy costs and a sales mix change to higher margin private brand merchandise, partially offset by higher promotional activity.

 

Selling, General and Administrative. SG&A was 27.1% of net sales for the first quarter of fiscal 2015 compared to 26.7% in the first quarter of fiscal 2014.  SG&A increased $11.4 million to $292.2 million for the first quarter of fiscal 2015. The increase is due primarily to a $4.7 million increase in costs associated with operating 33 additional stores (net of closures), $4.5 million of legal related costs and a $2.2 million increase in performance-based compensation. 

 

Share-based Compensation. Share-based compensation expenses decreased $0.8 million to $3.3 million in the first quarter of fiscal 2015 compared to the first quarter of fiscal 2014.  The decrease was due primarily to option awards which became fully vested since the first quarter of fiscal 2014. 

 

Related Party Expenses. Related party expenses decreased $3.3 million in the first quarter of fiscal 2015 compared to the same period in the prior year due to the termination of the management services agreement in connection with our IPO completed in July 2014.

 

Interest Expense. Interest expense decreased $19.3 million to $37.8 million in the first quarter of fiscal 2015 compared to the first quarter of fiscal 2014. The decrease is primarily attributable to $11.6 million of interest savings from

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the partial pay down of the PIK Notes in the second and fourth quarters of fiscal 2014 and $7.4 million of interest savings from the refinancing of the 7.75% Senior Notes in the second quarter of fiscal 2014.

 

Provision for Income Taxes. The effective tax rate was 37.0% for the first quarter of fiscal 2015 compared to 44.7% for the first quarter of fiscal 2014.  The effective tax rate is lower than the same period in the prior year due to a change in the status of our Canadian subsidiary from a branch for U.S. tax purposes to a controlled foreign corporation in the first quarter of fiscal 2014 which resulted in the write off of certain deferred tax assets. Additionally, in the current year, we changed our assertion related to Canadian earnings and intend to indefinitely reinvest fiscal 2015 earnings into our operations outside the U.S., which decreased the effective tax rate by approximately 100 basis points.  

 

Liquidity and Capital Resources

 

We require cash principally for day-to-day operations, to finance capital investments, to purchase inventory, to 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 senior secured asset-based revolving credit facility (“Restated 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 Report on Form 10-K for the fiscal year ended January 31, 2015 or our failure to meet our debt covenants. Our Restated Revolving Credit Facility provides senior secured financing of up to $650.0 million. As of May 2, 2015, the borrowing base was $650.0 million, of which we had no outstanding borrowings, $59.5 million of outstanding standby letters of credit and $590.5 million of unused borrowing capacity. Our cash and cash equivalents totaled $272.6 million at May 2, 2015.

 

We had total outstanding debt of $3,143.0 million at May 2, 2015, of which $2,447.7 million was subject to variable interest rates and $695.3 million was subject to fixed interest rates.

 

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 repay portions of our indebtedness, depending on market conditions, and to invest in growth opportunities. If we use our excess cash flows to repay our debt, it will reduce the amount of excess cash available for additional capital expenditures. 

 

On April 6, 2015, an irrevocable notice of redemption was delivered to the holders of the PIK Notes. Pursuant to the notice, the remaining $180.9 million in principal of the PIK Notes was redeemed on May 6, 2015 and has been classified as current debt in the consolidated balance sheets. In the second quarter of fiscal 2015, the Company will record approximately $6 million of debt extinguishment costs, which consists of a 2% redemption premium and approximately $2 million of unamortized debt issuance costs.  This final payment retired the PIK Notes and discharged the obligations under the indenture governing the PIK Notes.

 

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. Such repurchases or exchanges, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors.

 

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Cash Flow from Operating Activities

 

Cash flows used in operating activities was $76.2 million in the first quarter of fiscal 2015 and $74.4 million in the first quarter of fiscal 2014.  The increase in cash used in operating activities is primarily the result of the timing of payments made to merchandise vendors and payments related to fiscal 2014 performance-based compensation.  The increase was partially offset by interest savings from the partial paydown of the PIK Notes and the debt refinancing that occurred in fiscal 2014. 

 

Average inventory per Michaels store (including e-commerce and distribution centers) increased 3.4% to $810,000 at May 2, 2015, from $783,000 at May 3, 2014. The increase is primarily due to a decision to maintain higher inventory levels at our distribution centers to replenish stores more quickly and mitigate the impact of third-party shipping delays.

 

Cash Flow from Investing Activities

 

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

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

 

May 2,

 

May 3,

 

 

    

2015

    

2014

 

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

 

$

8,721 

 

$

8,938 

 

Existing stores

 

 

16,401 

 

 

4,480 

 

Information systems

 

 

8,273 

 

 

12,136 

 

Corporate and other

 

 

1,569 

 

 

5,248 

 

 

 

$

34,964 

 

$

30,802 

 


(1)

In the first quarter of fiscal 2015, we incurred capital expenditures related to the opening of 20 Michaels stores, including the relocation of 10 Michaels stores. In the first quarter of fiscal 2014, we incurred capital expenditures related to the opening of 13 Michaels stores, including the relocation of 5 Michaels stores.

 

Non-GAAP Measures

 

The following table sets forth certain non-GAAP measures the Company uses 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 Restated Term Loan Credit Facility and Restated Revolving Credit Facility (collectively, the “Adjustments”).

 

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 Restated Term Loan Credit Facility and its Restated Revolving Credit Facility, together the “Senior Secured Credit Facilities”. As it relates to the Senior Secured Credit Facilities, Adjusted EBITDA 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 operating performance or liquidity calculated in accordance with U.S. generally accepted accounting principles (“GAAP”), these measures should not be considered in isolation of, or as a substitute for, net income, as an indicator of operating performance, or 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 used in operating activities (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

 

May 2, 

 

May 3, 

 

 

    

2015

    

2014

 

Net cash used in operating activities

 

$

(76,220)

 

$

(74,358)

 

Depreciation and amortization

 

 

(27,945)

 

 

(26,627)

 

Share-based compensation

 

 

(2,720)

 

 

(3,683)

 

Debt issuance costs amortization

 

 

(2,277)

 

 

(2,858)

 

Accretion of long-term debt, net

 

 

33 

 

 

328 

 

Deferred income taxes

 

 

(5,104)

 

 

(5,903)

 

Excess tax benefits from stock-based compensation

 

 

10,199 

 

 

208 

 

Changes in assets and liabilities

 

 

170,772 

 

 

158,307 

 

Net income

 

 

66,738 

 

 

45,414 

 

Interest expense

 

 

37,816 

 

 

57,091 

 

Provision for income taxes

 

 

39,233 

 

 

36,744 

 

Depreciation and amortization

 

 

27,945 

 

 

26,627 

 

Other

 

 

(123)