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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 August 3, 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 August 28, 2019, 155,274,639 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 26 weeks ended August 3, 2019 and August 4, 2018 (unaudited)

3

Consolidated Balance Sheets as of August 3, 2019, February 2, 2019 and August 4, 2018 (unaudited)

4

Consolidated Statements of Cash Flows for the 26 weeks ended August 3, 2019 and August 4, 2018 (unaudited)

5

Consolidated Statements of Stockholders’ Deficit for the 13 and 26 weeks ended August 3, 2019 and August 4, 2018 (unaudited)

6

Notes to Consolidated Financial Statements (unaudited)

7

Item 2.

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

18

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

28

Item 4.

Controls and Procedures

28

Part II—OTHER INFORMATION

Item 1.

Legal Proceedings

29

Item 1A.

Risk Factors

29

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

29

Item 6.

Exhibits

30

Signatures

31

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

26 Weeks Ended

August 3,

August 4,

August 3,

August 4,

2019

2018

2019

2018

Net sales

$

1,033,689

$

1,053,267

$

2,127,408

$

2,208,778

Cost of sales and occupancy expense

 

666,703

 

679,938

 

1,342,783

 

1,378,887

Gross profit

 

366,986

373,329

 

784,625

 

829,891

Selling, general and administrative

 

290,074

 

300,981

 

610,670

 

629,598

Restructure charges

3,869

(3,220)

6,956

44,278

Store pre-opening costs

 

1,743

 

1,295

 

2,969

 

2,799

Operating income

 

71,300

 

74,273

 

164,030

 

153,216

Interest expense

 

40,134

 

37,101

 

77,493

 

71,695

Losses on early extinguishments of debt and refinancing costs

1,155

1,835

1,155

1,835

Other (income) expense, net

 

(252)

 

(832)

 

2,853

 

(2,525)

Income before income taxes

 

30,263

 

36,169

 

82,529

 

82,211

Income taxes

 

5,716

 

8,681

 

20,291

 

27,838

Net income

$

24,547

$

27,488

$

62,238

$

54,373

Other comprehensive income, net of tax:

 

 

 

 

Foreign currency and interest rate swaps

(4,762)

807

(9,588)

(6,246)

Comprehensive income

$

19,785

$

28,295

$

52,650

$

48,127

Earnings per common share:

Basic

$

0.16

$

0.15

$

0.39

$

0.30

Diluted

$

0.16

$

0.15

$

0.39

$

0.30

Weighted-average common shares outstanding:

Basic

157,272

177,348

157,511

179,436

Diluted

157,273

178,215

157,535

180,426

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)

August 3,

February 2,

August 4,

ASSETS

2019

2019

2018

Current Assets:

Cash and equivalents

$

130,981

$

245,887

$

123,191

Merchandise inventories

 

1,256,465

 

1,108,715

 

1,280,095

Prepaid expenses and other

 

69,672

 

98,659

 

98,742

Accounts receivable, net

18,234

57,328

31,095

Income taxes receivable

 

5,707

 

4,935

 

16,523

Total current assets

 

1,481,059

 

1,515,524

 

1,549,646

Property and equipment, at cost

 

1,703,912

 

1,656,098

 

1,613,115

Less accumulated depreciation and amortization

(1,266,421)

(1,217,021)

(1,167,985)

Property and equipment, net

437,491

439,077

445,130

Operating lease assets

1,611,029

Goodwill

 

112,069

 

112,069

 

119,074

Other intangible assets, net

14,082

17,238

20,983

Deferred income taxes

 

28,142

 

25,005

 

31,532

Other assets

 

23,277

 

19,423

 

26,180

Total assets

$

3,707,149

$

2,128,336

$

2,192,545

LIABILITIES AND STOCKHOLDERS’ DEFICIT

Current Liabilities:

Accounts payable

$

533,473

$

485,004

$

555,270

Accrued liabilities and other

 

321,847

 

378,742

 

351,987

Current portion of operating lease liabilities

298,993

Current portion of long-term debt

 

24,900

 

24,900

 

140,261

Income taxes payable

 

11,974

 

43,907

 

427

Total current liabilities

 

1,191,187

 

932,553

 

1,047,945

Long-term debt

 

2,655,391

 

2,681,000

 

2,695,087

Long-term operating lease liabilities

1,377,039

Other liabilities

 

71,102

 

140,978

 

148,893

Total liabilities

 

5,294,719

 

3,754,531

 

3,891,925

Commitments and contingencies

Stockholders’ Deficit:

Common stock, $0.06775 par value, 350,000 shares authorized; 155,199 shares issued and outstanding at August 3, 2019; 157,774 shares issued and outstanding at February 2, 2019; and 171,375 shares issued and outstanding at August 4, 2018

 

10,419

10,594

 

11,504

Additional paid-in-capital

 

5,954

 

Accumulated deficit

 

(1,573,843)

(1,628,185)

 

(1,700,978)

Accumulated other comprehensive loss

 

(24,146)

(14,558)

 

(9,906)

Total stockholders’ deficit

 

(1,587,570)

 

(1,626,195)

 

(1,699,380)

Total liabilities and stockholders’ deficit

$

3,707,149

$

2,128,336

$

2,192,545

See accompanying notes to consolidated financial statements.

4

Table of Contents

THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

26 Weeks Ended

August 3,

August 4,

    

2019

2018

Cash flows from operating activities:

Net income

$

62,238

$

54,373

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

Amortization of operating lease assets

162,861

Depreciation and amortization

 

62,730

 

59,054

Share-based compensation

 

12,006

 

12,334

Debt issuance costs amortization

 

2,539

 

2,522

Loss on write-off of investment

5,036

Accretion of long-term debt, net

 

(262)

 

(256)

Restructure charges

6,956

44,278

Deferred income taxes

39

770

Losses on early extinguishments of debt and refinancing costs

1,155

1,835

Changes in assets and liabilities:

Merchandise inventories

 

(148,311)

 

(177,586)

Prepaid expenses and other

 

(10,782)

 

2,217

Accounts receivable

37,674

(6,366)

Other assets

(9,391)

(1,165)

Operating lease liabilities

(140,287)

Accounts payable

 

44,537

 

54,823

Accrued interest

 

(1,045)

 

553

Accrued liabilities and other

 

(54,843)

 

(49,838)

Income taxes

 

(34,327)

 

(87,341)

Other liabilities

 

(631)

 

3,231

Net cash used in operating activities

 

(2,108)

 

(86,562)

Cash flows used in investing activities:

Additions to property and equipment

 

(57,533)

 

(69,908)

Cash flows from financing activities:

Common stock repurchased

(27,325)

(252,508)

Payments on term loan credit facility

 

(12,450)

 

(11,790)

Payment of 2020 senior subordinated notes

(510,000)

Issuance of 2027 senior notes

500,000

Borrowings on asset-based revolving credit facility

 

 

133,600

Payments on asset-based revolving credit facility

 

 

(15,600)

Payment of debt refinancing costs

 

(6,032)

 

(1,069)

Payment of dividends

(317)

Proceeds from stock options exercised

542

1,449

Net cash used in financing activities

(55,265)

(146,235)

 

 

Net change in cash and equivalents

 

(114,906)

 

(302,705)

Cash and equivalents at beginning of period

245,887

425,896

Cash and equivalents at end of period

$

130,981

$

123,191

Supplemental cash flow information:

Cash paid for interest

$

76,991

$

69,101

Cash paid for taxes

$

54,676

$

114,950

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

Paid-in

Accumulated

Comprehensive

Shares

  

Stock

  

Capital

  

Deficit

  

Loss

  

Total

Balance at May 4, 2019

  

158,126

$

10,620

$

11,900

$

(1,590,494)

$

(19,384)

$

(1,587,358)

Net income

24,547

 

24,547

Foreign currency and interest rate swaps

(4,762)

 

(4,762)

Share-based compensation

5,154

 

5,154

Exercise of stock options and other awards

39

2

2

Repurchase of stock and retirements

(3,011)

(203)

(17,054)

(7,896)

 

(25,153)

Issuance of restricted stock awards

45

Balance at August 3, 2019

155,199

$

10,419

$

$

(1,573,843)

$

(24,146)

$

(1,587,570)

Balance at May 5, 2018

  

182,055

  

$

12,225

  

$

27,463

  

$

(1,512,896)

  

$

(10,713)

  

$

(1,483,921)

Net income

27,488

 

27,488

Foreign currency and interest rate swaps

807

 

807

Share-based compensation

5,726

 

5,726

Exercise of stock options and other awards

126

9

900

909

Repurchase of stock and retirements

(10,806)

(730)

(34,089)

(215,570)

 

(250,389)

Balance at August 4, 2018

171,375

$

11,504

$

$

(1,700,978)

$

(9,906)

$

(1,699,380)

26 Weeks Ended

Accumulated

Number of

Additional

Other

Common

Common

Paid-in

Accumulated

Comprehensive

Shares

  

Stock

  

Capital

  

Deficit

  

Loss

  

Total

Balance at February 2, 2019

157,774

$

10,594

$

5,954

$

(1,628,185)

$

(14,558)

$

(1,626,195)

Net income

62,238

 

62,238

Foreign currency and interest rate swaps

(9,588)

 

(9,588)

Share-based compensation

12,758

 

12,758

Exercise of stock options and other awards

594

40

502

542

Repurchase of stock and retirements

(3,240)

(215)

(19,214)

(7,896)

 

(27,325)

Issuance of restricted stock awards

71

Balance at August 3, 2019

155,199

$

10,419

$

$

(1,573,843)

$

(24,146)

$

(1,587,570)

Balance at February 3, 2018

181,919

$

12,206

$

21,740

$

(1,539,781)

$

(3,660)

$

(1,509,495)

Net income

54,373

 

54,373

Foreign currency and interest rate swaps

(6,246)

 

(6,246)

Share-based compensation

13,047

 

13,047

Exercise of stock options and other awards

500

34

1,415

1,449

Repurchase of stock and retirements

(11,044)

(736)

(36,202)

(215,570)

 

(252,508)

Balance at August 4, 2018

171,375

$

11,504

$

$

(1,700,978)

$

(9,906)

$

(1,699,380)

See accompanying notes to consolidated financial statements.

6

Table of Contents

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 second quarter of fiscal 2019” relate to the 13 weeks ended August 3, 2019 and all references to “the second quarter of fiscal 2018” relate to the 13 weeks ended August 4, 2018. Finally, all references to “the six months ended August 3, 2019” relate to the 26 weeks ended August 3, 2019 and all references to “the six months ended August 4, 2018” relate to the 26 weeks ended August 4, 2018. Because of the seasonal nature of our business, the results of operations for the 13 and 26 weeks ended August 3, 2019 are not indicative of the results to be expected for the entire year.

Restructure Charges

In March 2018, we closed substantially all of our Aaron Brothers stores and in January 2019, we closed all 36 of our Pat Catan’s stores. In the first six months of fiscal 2019, we recorded a restructure charge related to Pat Catan’s totaling $7.0 million, primarily related to employee-related expenses and the impairment of an indefinite-lived intangible asset. In the first six 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 six months of fiscal 2018, Pat Catan's and Aaron Brothers had net sales totaling approximately $48.7 million and $12.9 million, respectively. Excluding the restructure charges, Aaron Brothers and Pat Catan’s did not have a material impact on the Company’s operating income in the periods presented.

Share Repurchase Program

In September 2018, the Board of Directors authorized a new share repurchase program for the Company to purchase $500 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 six months ended August 3, 2019, we repurchased 3.0 million shares for an aggregate amount of $25.1 million. As of August 3, 2019, we had $373.4 million of availability remaining under our current share repurchase program.

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Accounting Pronouncement Recently Adopted

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)" ("ASU 2016-02"). Under ASU 2016-02, an entity is required to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. ASU 2016-02 offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. The lease standard requires companies to use a modified retrospective transition approach as of the beginning of the earliest comparable period presented in the company’s financial statements. In July 2018, the FASB issued ASU 2018-11, “Leases (Topic 842): Targeted Improvements” which provided an additional transition option that allows companies to continue applying the guidance under the current lease standard in the comparative periods presented in the consolidated financial statements. We utilized the additional transition option to adopt ASU 2016-02 in the first quarter of fiscal 2019. As a result, the standard was applied starting February 3, 2019 and prior periods were not restated. We also elected the practical expedient permitted under the transition guidance which permits companies not to reassess prior conclusions on lease identification, historical lease classification and initial direct costs. The adoption of the standard resulted in the recognition of operating lease assets and liabilities of approximately $1.7 billion as of February 3, 2019. The adoption did not result in a material impact on our consolidated statements of comprehensive income.

2. FAIR VALUE MEASUREMENTS

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

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

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

Level 3—Instruments with significant unobservable inputs.

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

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

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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.

August 3,

February 2,

August 4,

2019

2019

2018

(in thousands)

Assets

Interest rate swaps

$

$

$

2,342

Liabilities

Term loan credit facility

$

2,125,045

$

2,177,098

$

2,217,784

Senior notes

481,525

Senior subordinated notes

 

511,913

 

513,825

Short-term portion of interest rate swaps

9,679

2,557

3,233

Long-term portion of interest rate swaps

8,902

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.

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 August 3, 2019, February 2, 2019 and August 4, 2018, receivables from customers, which consist primarily of trade receivables related to Darice, were approximately $15.4 million, $32.1 million and $23.9 million, respectively, and are included in accounts receivable, net in the consolidated balance sheets.

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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

26 Weeks Ended

August 3,

August 4,

August 3,

August 4,

2019

2018

2019

2018

Balance at beginning of period

$

55,708

$

51,513

$

61,071

$

56,729

Issuance of gift cards

13,140

13,734

24,465

25,278

Revenue recognized (1)

(13,668)

(13,685)

(29,415)

(29,601)

Gift card breakage

584

(1,049)

(357)

(1,893)

Balance at end of period

$

55,764

$

50,513

$

55,764

$

50,513

(1)Revenue recognized from the beginning liability during the second quarters of fiscal 2019 and fiscal 2018 totaled $7.5 million and $7.6 million, respectively. Revenue recognized from the beginning liability during the first six months of fiscal 2019 and fiscal 2018 totaled $15.8 million and $16.0 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.  

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

26 Weeks Ended

August 3,

August 3,

2019

2019

Operating lease cost (1)

  

$

104,600

$

210,065

Variable lease cost (2)

 

36,077

 

72,517

Total lease cost

$

140,677

$

282,582

(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.

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

26 Weeks Ended

August 3,

2019

Operating cash outflows included in the measurement of lease liabilities

$

214,439

Operating lease assets obtained in exchange for new operating lease liabilities

$

133,137

Weighted-average remaining lease term

6.2 years

Weighted-average discount rate

5.6%

Maturities of our lease liabilities are as follows as of August 3, 2019 (in thousands):

Fiscal Year

2019

$

179,032

2020

 

406,190

2021

 

353,635

2022

 

292,097

2023

 

229,286

Thereafter

 

545,236

Total lease payments

$

2,005,476

Less: Interest

(329,444)

Present value of lease liabilities

$

1,676,032

Lease payments exclude $78.2 million related to 26 leases that have been signed as of August 3, 2019 but have not yet commenced.

5. DEBT

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

August 3,

February 2,

August 4,

Interest Rate

2019

2019

2018

Term loan credit facility

Variable

$

2,195,000

$

2,207,450

$

2,220,560

Asset-based revolving credit facility

Variable

 

 

 

118,000

Senior notes

8.00

%

 

500,000

 

 

Senior subordinated notes

5.875

%

 

 

510,000

 

510,000

Total debt

 

2,695,000

 

2,717,450

 

2,848,560

Less unamortized discount/premium and debt costs

(14,709)

(11,550)

(13,212)

Total debt, net

2,680,291

2,705,900

2,835,348

Less current portion

 

(24,900)

 

(24,900)

 

(140,261)

Long-term debt

$

2,655,391

$

2,681,000

$

2,695,087

Revolving Credit Facility

As of August 3, 2019 and August 4, 2018, the borrowing base under our senior secured asset-based revolving credit facility (“Amended Revolving Credit Facility”) was $789.3 million and $850.0 million, respectively, of which Michaels Stores, Inc. (“MSI”) had unused borrowing capacity of $686.1 million and $644.8 million, respectively. As of August 3, 2019 and August 4, 2018, outstanding standby letters of credit, which reduce our borrowing base, totaled $103.2 million and $87.2 million, respectively. On August 30, 2019, the Amended Revolving Credit Facility was amended to extend the maturity to August 2024. There were no other significant changes to the terms under the Amended Revolving Credit Facility.

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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”).

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;

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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 August 3, 2019, MSI was in compliance with all covenants.

As of August 3, 2019, net debt issuance costs totaled $6.1 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.

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 second quarters of fiscal 2019 and fiscal 2018 were $0.9 million and $2.0 million, respectively. Amounts reclassified from accumulated other comprehensive income to interest expense during the six months ended August 3, 2019 and August 4, 2018 were $1.6 million and $2.1 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

26 Weeks Ended

August 3,

August 4,

August 3,

August 4,

2019

    

2018

    

2019

    

2018

Beginning of period

  

$

(19,384)

$

(10,713)

  

$

(14,558)

$

(3,660)

Foreign currency translation

 

2,259

 

(1,440)

 

(549)

 

(5,587)

Interest rate swaps

(7,021)

2,247

(9,039)

(659)

End of period

$

(24,146)

$

(9,906)

$

(24,146)

$

(9,906)

7. INCOME TAXES

The effective tax rate was 24.6% for the six months ended August 3, 2019 compared to 33.9% for the same period in the prior year. The effective tax rate in fiscal 2019 was lower than the same period in the prior year due primarily to an $8.1 million charge recognized in fiscal 2018 related to repatriation taxes for accumulated earnings of our foreign subsidiaries associated with the enactment of the Tax Cuts and Jobs Act of 2017 and a tax benefit associated with a state income tax settlement in fiscal 2019. The decrease in the effective tax rate was partially offset by the vesting of restricted shares and the expiration of certain vested stock options.  

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8. EARNINGS PER SHARE

The Company’s unvested restricted stock awards contain non-forfeitable rights to dividends and meet the criteria of a participating security as defined by ASC 260, “Earnings Per Share”. In applying the two-class method, net income is allocated to both common and participating securities based on their respective weighted-average shares outstanding for the period. Basic earnings per share is computed by dividing net income allocated to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share is computed by dividing income available to common shareholders by the weighted-average common shares outstanding plus the potential dilutive impact from stock options and restricted stock units. Common equivalent shares are excluded from the computation if their effect is anti-dilutive. There were 11.3 million and 7.3 million anti-dilutive shares during the second quarters of fiscal 2019 and fiscal 2018, respectively. There were 11.6 million and 7.0 million anti-dilutive shares during the six months ended August 3, 2019 and August 4, 2018, respectively.

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

13 Weeks Ended

26 Weeks Ended

August 3,

August 4,

August 3,

August 4,

2019

2018

2019

2018

Basic earnings per common share:

Net income

$

24,547

$

27,488

$

62,238

  

$

54,373

Less income related to unvested restricted shares

 

(29)

 

(56)

 

(68)

 

(123)

Income available to common shareholders - Basic

$

24,518

$

27,432

$

62,170

$

54,250

Weighted-average common shares outstanding - Basic

157,272

177,348

157,511

179,436

Basic earnings per common share

$

0.16

$

0.15

$

0.39

$

0.30

Diluted earnings per common share:

 

 

Net income

$

24,547

$

27,488

$

62,238

$

54,373

Less income related to unvested restricted shares

 

(29)

(56)

 

(68)

(122)

Income available to common shareholders - Diluted

$

24,518

$

27,432

$

62,170

$

54,251

Weighted-average common shares outstanding - Basic

157,272

177,348

157,511

179,436

Effect of dilutive stock options and restricted stock units

1

867

24

990

Weighted-average common shares outstanding - Diluted

157,273

178,215

157,535

180,426

Diluted earnings per common share

$

0.16

$

0.15

$

0.39

$

0.30

9. SEGMENTS AND GEOGRAPHIC INFORMATION

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

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

13 Weeks Ended

26 Weeks Ended