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 October 31, 2020

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 such files).

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

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

As of November 24, 2020, 147,649,500 shares of The Michaels Companies, Inc.’s common stock were outstanding.

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THE MICHAELS COMPANIES, INC.

TABLE OF CONTENTS


Part I—FINANCIAL INFORMATION

		Page

Item 1.	Financial Statements	3

	Consolidated Statements of Comprehensive Income for the 13 and 39 weeks ended October 31, 2020 and November 2, 2019 (unaudited)	3

	Consolidated Balance Sheets as of October 31, 2020, February 1, 2020 and November 2, 2019 (unaudited)	4

	Consolidated Statements of Cash Flows for the 39 weeks ended October 31, 2020 and November 2, 2019 (unaudited)	5

	Consolidated Statements of Stockholders’ Deficit for the 13 and 39 weeks ended October 31, 2020 and November 2, 2019 (unaudited)	6

	Notes to Consolidated Financial Statements (unaudited)	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31

Item 4.	Controls and Procedures	31

Part II—OTHER INFORMATION

Item 1.	Legal Proceedings	32

Item 1A.	Risk Factors	32

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33

Item 6.	Exhibits	34

Signatures		35

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Part I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands, except per share data)

(Unaudited)


	13 Weeks Ended				39 Weeks Ended
	October 31,		November 2,		October 31,		November 2,
	2020		2019		2020		2019
Net sales	$	1,406,212	$	1,222,021	$	3,354,270	$	3,349,430
Cost of sales and occupancy expense		824,496		780,387		2,208,220		2,123,171
Gross profit		581,716		441,634		1,146,050		1,226,259
Selling, general and administrative		373,193		322,807		943,587		933,478
Restructure and impairment charges		9,388		41,376		9,388		48,332
Store pre-opening costs		184		1,402		1,528		4,370
Operating income		198,951		76,049		191,547		240,079
Interest expense		37,370		38,781		112,233		116,274
Losses on early extinguishments of debt and refinancing costs		22,044		161		22,044		1,316
Other expense (income), net		131		78		(1,426)		2,931
Income before income taxes		139,406		37,029		58,696		119,558
Income taxes		28,284		8,324		18,836		28,615
Net income	$	111,122	$	28,705	$	39,860	$	90,943

Other comprehensive income, net of tax:
Foreign currency and cash flow hedges		3,910		1,230		(1,466)		(8,358)
Comprehensive income	$	115,032	$	29,935	$	38,394	$	82,585

Earnings per common share:
Basic	$	0.75	$	0.19	$	0.27	$	0.58
Diluted	$	0.74	$	0.19	$	0.27	$	0.58
Weighted-average common shares outstanding:
Basic		147,402		150,877		147,188		155,299
Diluted		150,292		150,925		148,796		155,342

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)


	October 31,		February 1,		November 2,
ASSETS	2020		2020		2019
Current Assets:
Cash and equivalents	$	851,996	$	409,964	$	118,387
Merchandise inventories		1,170,504		1,097,109		1,423,367
Prepaid expenses and other		69,663		62,287		73,223
Accounts receivable, net		24,232		30,442		26,968
Total current assets		2,116,395		1,599,802		1,641,945
Property and equipment, at cost		1,772,473		1,706,520		1,733,717
Less accumulated depreciation and amortization		(1,356,945)		(1,276,088)		(1,301,785)
Property and equipment, net		415,528		430,432		431,932
Operating lease assets		1,542,059		1,610,013		1,613,527
Goodwill		94,290		94,290		94,290
Other intangible assets, net		58,666		66,417		5,043
Deferred income taxes		18,825		18,201		38,075
Other assets		17,558		18,940		20,267
Total assets	$	4,263,321	$	3,838,095	$	3,845,079

LIABILITIES AND STOCKHOLDERS’ DEFICIT

Current Liabilities:
Accounts payable	$	895,200	$	476,298	$	658,182
Accrued liabilities and other		452,669		347,136		374,120
Current portion of operating lease liabilities		321,868		306,796		303,023
Current portion of long-term debt		16,700		24,900		24,900
Income taxes payable		48,064		41,236		22,520
Total current liabilities		1,734,501		1,196,366		1,382,745
Long-term debt		2,483,702		2,644,460		2,649,756
Long-term operating lease liabilities		1,314,987		1,357,821		1,374,555
Other liabilities		120,061		85,912		69,853
Total liabilities		5,653,251		5,284,559		5,476,909

Commitments and contingencies

Stockholders’ Deficit:
Common stock, $0.06775 par value, 350,000 shares authorized; 147,546 shares issued and outstanding at October 31, 2020; 146,803 shares issued and outstanding at February 1, 2020; and 146,770 shares issued and outstanding at November 2, 2019		9,908		9,852		9,850
Additional paid-in-capital		22,956		4,872		1,245
Accumulated deficit		(1,398,497)		(1,438,357)		(1,620,009)
Accumulated other comprehensive loss		(24,297)		(22,831)		(22,916)
Total stockholders’ deficit		(1,389,930)		(1,446,464)		(1,631,830)
Total liabilities and stockholders’ deficit	$	4,263,321	$	3,838,095	$	3,845,079

See accompanying notes to consolidated financial statements.

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THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)


	39 Weeks Ended
	October 31,		November 2,
	2020		2019
Cash flows from operating activities:
Net income	$	39,860	$	90,943
Adjustments to reconcile net income to net cash provided by operating activities:
Non-cash operating lease expense		241,040		244,258
Depreciation and amortization		95,382		94,025
Share-based compensation		19,759		18,664
Debt issuance costs amortization		2,757		3,509
Loss on write-off of investment		—		5,036
Accretion of long-term debt, net		480		(195)
Restructure and impairment charges		9,388		48,332
Impairment of intangible assets		3,500		—
Deferred income taxes		(289)		(9,984)
Gain on sale of building		(101)		—
Losses on early extinguishments of debt and refinancing costs		22,044		1,316
Changes in assets and liabilities:
Merchandise inventories		(74,009)		(316,220)
Prepaid expenses and other		(7,377)		(14,445)
Accounts receivable		13,368		30,684
Other assets		790		(4,728)
Operating lease liabilities		(207,334)		(225,951)
Accounts payable		414,286		162,222
Accrued interest		11,217		8,441
Accrued liabilities and other		97,539		(10,471)
Income taxes		3,660		(18,318)
Other liabilities		26,900		(751)
Net cash provided by operating activities		712,860		106,367

Cash flows from investing activities:
Additions to property and equipment		(79,545)		(89,632)
Proceeds from sale of building		875		—
Net cash used in investing activities		(78,670)		(89,632)

Cash flows from financing activities:
Common stock repurchased		(1,103)		(107,908)
Payments on term loan credit facility		(541,775)		(18,675)
Payment of 2020 senior subordinated notes		—		(510,000)
Issuance of senior notes		—		500,000
Issuance of senior secured notes		375,000		—
Borrowings on asset-based revolving credit facility		600,000		11,100
Payments on asset-based revolving credit facility		(600,000)		(11,100)
Payment of debt refinancing costs		(24,267)		(8,158)
Proceeds from stock options exercised		105		506
Other financing activities		(118)		—
Net cash used in financing activities		(192,158)		(144,235)

Net change in cash and equivalents		442,032		(127,500)
Cash and equivalents at beginning of period		409,964		245,887
Cash and equivalents at end of period	$	851,996	$	118,387

Supplemental cash flow information:
Cash paid for interest	$	98,494	$	105,374
Cash paid for taxes	$	15,681	$	56,793

See accompanying notes to consolidated financial statements.

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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 August 1, 2020		147,437	$	9,897	$	18,046	$	(1,509,619)	$	(28,207)	$	(1,509,883)
Net income		—		—		—		111,122		—		111,122
Foreign currency and cash flow hedges		—		—		—		—		3,910		3,910
Share-based compensation		—		—		5,348		—		—		5,348
Exercise of stock options and other awards		211		14		91		—		—		105
Repurchase of stock and retirements		(102)		(3)		(529)		—		—		(532)
Balance at October 31, 2020		147,546	$	9,908	$	22,956	$	(1,398,497)	$	(24,297)	$	(1,389,930)

Balance at August 3, 2019		155,199	$	10,419	$	—	$	(1,573,843)	$	(24,146)	$	(1,587,570)
Net income		—		—		—		28,705		—		28,705
Foreign currency and cash flow hedges		—		—		—		—		1,230		1,230
Share-based compensation		—		—		6,424		—		—		6,424
Exercise of stock options and other awards		242		17		(17)		—		—		—
Repurchase of stock and retirements		(8,747)		(586)		(5,162)		(74,871)		—		(80,619)
Issuance of restricted stock awards		76		—		—		—		—		—
Balance at November 2, 2019		146,770	$	9,850	$	1,245	$	(1,620,009)	$	(22,916)	$	(1,631,830)


	39 Weeks Ended
									Accumulated
	Number of				Additional				Other
	Common		Common		Paid-in		Accumulated		Comprehensive
	Shares		Stock		Capital		Deficit		Loss		Total
Balance at February 1, 2020		146,803	$	9,852	$	4,872	$	(1,438,357)	$	(22,831)	$	(1,446,464)
Net income		—		—		—		39,860		—		39,860
Foreign currency and cash flow hedges		—		—		—		—		(1,466)		(1,466)
Share-based compensation		—		—		19,138		—		—		19,138
Exercise of stock options and other awards		1,127		76		29		—		—		105
Repurchase of stock and retirements		(412)		(20)		(1,083)		—		—		(1,103)
Issuance of restricted stock awards		28		—		—		—		—		—
Balance at October 31, 2020		147,546	$	9,908	$	22,956	$	(1,398,497)	$	(24,297)	$	(1,389,930)

Balance at February 2, 2019		157,774	$	10,594	$	5,954	$	(1,628,185)	$	(14,558)	$	(1,626,195)
Net income		—		—		—		90,943		—		90,943
Foreign currency and cash flow hedges		—		—		—		—		(8,358)		(8,358)
Share-based compensation		—		—		19,182		—		—		19,182
Exercise of stock options and other awards		836		57		449		—		—		506
Repurchase of stock and retirements		(11,987)		(801)		(24,340)		(82,767)		—		(107,908)
Issuance of restricted stock awards		147		—		—		—		—		—
Balance at November 2, 2019		146,770	$	9,850	$	1,245	$	(1,620,009)	$	(22,916)	$	(1,631,830)

See accompanying notes to consolidated financial statements.

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THE MICHAELS COMPANIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

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

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Therefore, these financial statements should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended February 1, 2020 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 2020” relate to the 52 weeks ending January 30, 2021 and references to “fiscal 2019” relate to the 52 weeks ended February 1, 2020. In addition, all references to “the third quarter of fiscal 2020” relate to the 13 weeks ended October 31, 2020 and all references to “the third quarter of fiscal 2019” relate to the 13 weeks ended November 2, 2019. Finally, all references to “the nine months ended October 31, 2020” relate to the 39 weeks ended October 31, 2020 and all references to “the nine months ended November 2, 2019” relate to the 39 weeks ended November 2, 2019. The results of operations for the 13 and 39 weeks ended October 31, 2020 are not indicative of the results to be expected for the entire year due to the seasonal nature of our business and the financial impact of the COVID-19 pandemic.

COVID-19 Pandemic

In March 2020, the World Health Organization declared the current COVID-19 outbreak to be a global pandemic. In response to the pandemic, many state and local jurisdictions ordered non-essential businesses closed and executed extensive stay-at-home orders. These orders resulted in the temporary closure of over 900 of our 1,272 stores which had a material adverse impact on our results of operations during the first quarter of fiscal 2020. During the second quarter of fiscal 2020, we reopened all of our stores and experienced a significant improvement in our business as net sales increased 13.2% during the preceding six month period ending October 31, 2020 compared to the same period in the prior year. Our liquidity position, which includes cash on hand and amounts available under our senior secured asset-based revolving credit facility (“Amended Revolving Credit Facility”), increased from $1.1 billion as of May 2, 2020 to $1.6 billion as of October 31, 2020. However, there remains significant uncertainty surrounding the future impact of the COVID-19 pandemic on our results of operations, and future waves of the pandemic could require us to close stores again if certain restrictions are reinstated by state and local authorities. We intend to continue to manage our liquidity position closely and invest in our omnichannel capabilities to meet the growing customer demand for a seamless omnichannel experience.

Share Repurchase Program

In September 2018, the Board of Directors authorized a share repurchase program for the Company to purchase $500 million of the Company’s common stock on the open market or through accelerated share repurchase transactions. The share repurchase program does not have an expiration date, and the timing and number of repurchase transactions under the program will depend on market conditions, corporate considerations, debt agreements and regulatory requirements. Shares repurchased under the program are held as treasury shares until retired. During the nine months ended

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October 31, 2020, we did not repurchase any shares under our share repurchase program. As of October 31, 2020, we had $293.5 million of availability remaining under our current share repurchase program.

Darice Liquidation

In May 2020, the Company adopted a plan to close the Darice wholesale operations (“Darice”). As a result of the closure, we recorded a charge totaling $45.7 million in the first nine months of fiscal 2020, consisting primarily of a $37.9 million charge in gross profit related to the liquidation of inventory and $7.8 million included in selling, general and administrative associated with the write-off of indefinite-lived intangible assets and employee-related expenses. The closure process will be completed in November 2020 and we do not expect to incur significant additional costs related to the liquidation. In the first nine months of fiscal 2020 and fiscal 2019, Darice’s net sales totaled $36.1 million and $61.1 million, respectively. Excluding the charges, Darice did not have a material impact on the Company’s operating income in the periods presented.

Restructure and Impairment Charges

In the third quarter of fiscal 2020, we recorded a $9.4 million impairment charge related to operating lease assets and leasehold improvements primarily as a result of our decision to relocate our corporate offices in Irving, Texas.

During the third quarter of fiscal 2019, we identified impairment indicators within Darice that were primarily due to a deterioration in sales associated with overall declining demand from customers. These indicators led us to revise Darice’s forecasted sales downward and resulted in a significantly lower operating plan. As a result, we performed impairment tests on Darice’s goodwill, indefinite and definite-lived intangible assets and long-lived assets, including operating lease assets. As a result of this impairment testing, Darice recorded an impairment charge of $40.1 million in the third quarter of fiscal 2019, consisting of $17.8 million related to goodwill, $14.4 million related to long-lived assets, including operating lease assets, and $7.9 million related to indefinite and definite-lived intangible assets.

In the fourth quarter of fiscal 2018, we closed all of our Pat Catan’s stores. As a result of the closures, we recorded a charge totaling $8.2 million in the first nine months of fiscal 2019, primarily related to employee-related expenses and the impairment of an indefinite-lived intangible asset.

Accounting Pronouncements Recently Adopted

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, “Financial Instruments - Credit Losses (Topic 326)” (“ASU 2016-13”) which makes significant changes to the accounting for credit losses on financial assets and disclosures. The standard requires immediate recognition of management’s estimates of current expected credit losses. We adopted ASU 2016-13 in the first quarter of fiscal 2020 using a modified retrospective approach without restatement. The adoption did not result in a material impact to our consolidated financial statements.

In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes” (“ASU 2019-12”), which simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. We adopted ASU 2019-12 in the first quarter of fiscal 2020. The adoption did not result in a material impact to our consolidated financial statements.

In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”). ASU 2020-04 provides optional expedients and exceptions to contract modifications and hedging relationships that reference LIBOR or another reference rate expected to be discontinued. We elected certain provisions of ASU 2020-04 in the third quarter of fiscal 2020. These elections did not result in a material impact to our consolidated financial statements.

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2. FAIR VALUE MEASUREMENTS

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. Accounting Standards Codification 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 property and equipment are calculated using significant unobservable inputs including the present value of future cash flows expected to be generated using a risk-adjusted weighted-average cost of capital and comparable store sales growth assumptions, and therefore, are classified as a Level 3 measurement in the fair value hierarchy. Impairment losses related to store-level operating lease assets are calculated using rent per square foot derived from observable market data, and therefore, are classified as a Level 2 measurement in the fair value hierarchy.

Impairment losses related to goodwill and other indefinite-lived intangible assets are calculated based on the estimated fair value of each reporting unit, which is determined using significant unobservable inputs including the present value of future cash flows expected to be generated by the reporting unit using a weighted-average cost of capital, terminal values and updated financial projections for the next five years and are classified as Level 3 measurements in the fair value hierarchy.

Due to the impact of COVID-19, we performed an interim impairment assessment of goodwill and other long-lived assets as of May 2, 2020, which included estimated future cash flow assumptions incorporating the impact of our temporary store closures. Due to the uncertainty around COVID-19, our projected future cash flows may differ materially from actual results. There were no material impairment losses identified as a result of this assessment.

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

The table below provides the fair values of our term loan credit facility, our senior notes, our senior secured notes and our cash flow hedges.


	October 31,		February 1,		November 2,
	2020		2020		2019

	(in thousands)
Liabilities
Term loan credit facility	$	1,640,838	$	2,119,802	$	2,135,435
Senior notes		515,655		449,675		496,155
Senior secured notes		367,654		—		—
Short-term portion of cash flow hedges		11,051		13,007		11,938
Long-term portion of cash flow hedges		6,769		3,555		6,295

The fair values of our term loan credit facility, our senior notes and our senior secured notes were determined based on quoted market prices which are considered Level 1 inputs within the fair value hierarchy.

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The fair value of our cash flow hedges were 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 portions of our cash flow hedges are recorded in accrued liabilities and other liabilities, respectively, 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 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.

Customer Receivables

As of October 31, 2020, February 1, 2020 and November 2, 2019, receivables from customers, which consist primarily of trade receivables related to Darice, were approximately $6.1 million, $13.3 million and $18.0 million, respectively, and are included in accounts receivable, net in the consolidated balance sheets.

Gift Cards

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


	13 Weeks Ended				39 Weeks Ended
	October 31,		November 2,		October 31,		November 2,
	2020		2019		2020		2019
Balance at beginning of period	$	60,123	$	55,764	$	64,130	$	61,071
Issuance of gift cards		12,784		11,878		31,095		36,343
Revenue recognized ⁽¹⁾		(12,980)		(12,300)		(35,199)		(41,715)
Gift card breakage		(621)		(724)		(720)		(1,081)
Balance at end of period	$	59,306	$	54,618	$	59,306	$	54,618

(1)

Revenue recognized from the beginning liability during the third quarters of fiscal 2020 and fiscal 2019 totaled $6.5 million and $6.9 million, respectively. Revenue recognized from the beginning liability during the first nine months of fiscal 2020 and fiscal 2019 totaled $16.3 million and $19.4 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. The commencement date is the earlier of the date when we become legally obligated for the rent payments or the date when we take possession of the building for construction purposes. In addition, operating lease assets are net of lease incentives received. As 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. In fiscal 2020, we began negotiating certain rent concessions with our landlords, which consists primarily of

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rent abatements, to mitigate the economic effects of the COVID-19 pandemic. As of October 31, 2020, we received approximately $18 million in rent abatements that are included in our straight-line rent calculation.

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

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


	13 Weeks Ended				39 Weeks Ended
	October 31,		November 2,		October 31,		November 2,
	2020		2019		2020		2019
Operating lease cost ⁽¹⁾	$	109,196	$	106,294	$	322,823	$	316,358
Variable lease cost ⁽²⁾		40,420		38,319		117,991		110,836
Total lease cost	$	149,616	$	144,613	$	440,814	$	427,194

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

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

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


	39 Weeks Ended
	October 31,		November 2,
	2020		2019
Operating cash outflows included in the measurement of lease liabilities	$	288,742	$	322,701
Operating lease assets obtained in exchange for new operating lease liabilities	$	198,840	$	222,887
Weighted-average remaining lease term		5.8 years		6.0 years
Weighted-average discount rate		6.7%		5.6%

Maturities of our lease liabilities are as follows as of October 31, 2020 (in thousands):


Fiscal Year
2020	$	94,172
2021		428,442
2022		376,416
2023		314,319
2024		248,873
Thereafter		533,763
Total lease payments	$	1,995,985
Less: Interest		(359,130)
Present value of lease liabilities	$	1,636,855

Lease payments exclude $48.3 million related to 14 leases that have been signed as of October 31, 2020 but have not yet commenced.

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5. DEBT

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


			October 31,		February 1,		November 2,
	Interest Rate		2020		2020		2019
Term loan credit facility	Variable		$	1,665,825	$	2,182,550	$	2,188,775
Senior notes	8.00	%		500,000		500,000		500,000
Senior secured notes	4.75	%		375,000		—		—
Total debt				2,540,825		2,682,550		2,688,775
Less unamortized discount and debt costs				(40,423)		(13,190)		(14,119)
Total debt, net				2,500,402		2,669,360		2,674,656
Less current portion				(16,700)		(24,900)		(24,900)
Long-term debt			$	2,483,702	$	2,644,460	$	2,649,756

Revolving Credit Facility

As of October 31, 2020 and November 2, 2019, the borrowing base under our Amended Revolving Credit Facility was $838.0 million and $850.0 million, respectively, of which Michaels Stores, Inc. (“MSI”) had unused borrowing capacity of $750.5 million and $768.0 million, respectively. As of October 31, 2020 and November 2, 2019, outstanding standby letters of credit, which reduce our borrowing base, totaled $87.5 million and $82.0 million, respectively.

Senior Secured Notes

On October 1, 2020, MSI issued $375 million in aggregate principal amount of our 4.75% senior secured notes maturing in 2027 (“Senior Secured Notes”). The Senior Secured Notes were issued pursuant to an indenture among MSI, Michaels Funding, Inc. and certain subsidiaries of MSI, as guarantors, and U.S. Bank National Association, as trustee (the “Senior Secured Notes Indenture”). The Senior Secured Notes will mature on October 1, 2027 and bear interest at a rate of 4.75% per year, with interest payable semi-annually on April 1 and October 1 of each year, beginning on April 1, 2021.

The net proceeds from the Senior Secured Notes, together with cash on hand, were used to voluntarily pay down $500.1 million of MSI’s then outstanding term loan credit facility and to pay related fees and expenses.

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

The Senior Secured Notes are senior secured obligations of MSI, and the guarantees are senior secured obligations of the guarantors. The Senior Secured Notes and guarantees will be secured equally and ratably with the Amended Term Loan Credit Facility and, accordingly, will be secured, subject to certain exceptions, by substantially all of the assets of MSI and the guarantors, including:

●

a first-priority pledge of MSI’s capital stock and all of the capital stock held directly by MSI and its subsidiaries that guarantee the Senior Secured Notes (which pledge, in the case of any foreign subsidiary or foreign subsidiary holding company, is limited to 65% of the voting stock of such foreign subsidiary or foreign subsidiary holding company and 100% of the non-voting stock of such subsidiary);

●

a first-priority security interest in, and mortgages on, substantially all other tangible and intangible assets of MSI and each guarantor, including substantially all of MSI’s and the guarantors’ owned real property and equipment, but excluding, among other things, the collateral described below (collectively, and together with the pledge of capital stock described in the immediately preceding paragraph, referred to as the “Term Priority Collateral”); and

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●

a second-priority security interest in personal property consisting of inventory and related accounts, cash, deposit accounts, all payments received by MSI or the guarantors from credit card clearinghouses and processors or otherwise in respect of all credit card charges and debit card charges for sales of inventory by MSI and the guarantors, and certain related assets and proceeds of the foregoing.

At any time prior to October 1, 2023 MSI may redeem (a) up to 40% of the Senior Secured Notes with the gross proceeds from one or more Equity Offerings, as defined in the Senior Secured Notes Indenture, at a redemption price of 104.75% of the principal amount plus accrued and unpaid interest and/or (b) all or part of the Senior Secured Notes at 100.0% of the principal amount plus any accrued and unpaid interest plus a make-whole premium. Thereafter, MSI may redeem all or part of the notes at the redemption prices set forth below (expressed as percentages of the principal amount of the Senior Secured Notes to be redeemed) plus any accrued and unpaid interest, if redeemed during the twelve month period beginning on October 1 of each of the years indicated below:


Year	Percentage
2023	102.375	%
2024	101.188	%
2025 and thereafter	100.000	%

Upon a change of control, MSI is required to offer to purchase the Senior Secured Notes at 101.0% of the aggregate principal amount plus accrued and unpaid interest. In addition, if MSI or its restricted subsidiaries sells certain assets constituting Term Priority Collateral, then under certain circumstances MSI will be required to offer to repurchase the notes at 100.0% of the aggregate principal amount plus accrued and unpaid interest.

Subject to certain exceptions and qualifications, the Senior Secured 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 or preferred stock;

●

create liens;

●

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

●

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

●

transfer or sell assets;

●

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

●

enter into certain transactions with affiliates.

The Senior Secured Notes Indenture also provides for customary events of default which, if any of them occurs, would require or permit the principal and accrued interest to become or to be declared due and payable. As of October 31, 2020, MSI was in compliance with all covenants.

As of October 31, 2020, net debt issuance costs totaled $5.2 million and are being amortized as interest expense over the life of the Senior Secured Notes.

Term Loan Credit Facility

On October 1, 2020, MSI entered into an amendment with JPMorgan Chase Bank N.A. and other lenders to our term loan credit facility. The amended credit agreement, together with the related security, guarantee and other agreements, are referred to as the “Amended Term Loan Credit Facility”. In connection with this amendment, MSI voluntarily prepaid

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$500.1 million in principal of the then outstanding term loan credit facility. The Amended Term Loan Credit Facility totaled $1,665.8 million as of October 31, 2020.

Borrowings under the Amended Term Loan Credit Facility were issued at 98.5% of face value and bear interest at a rate per annum, at MSI’s option, of either (a) a margin of 2.50% plus a base rate defined as the highest of (1) the prime rate published by The Wall Street Journal, (2) the greater of the federal funds effective rate and the overnight bank funding rate determined by the Federal Reserve Bank of New York, plus 0.5%, and (3) the one-month London Interbank Offered Rate (“LIBOR”) plus 1%, in each case, subject to a 1.75% floor, or (b) a margin of 3.50% plus the applicable LIBOR, subject to a 0.75% floor. The Amended Term Loan Credit Facility matures on October 1, 2027 subject to a springing maturity date of April 15, 2027 if certain other indebtedness, including MSI’s 8% senior notes maturing in 2027, exceeds $100 million as of such earlier date.

Under the Amended Term Loan Credit Facility, MSI has the right to request additional term loans in an aggregate amount of up to the sum of (a) the greater of $650 million and 100% of Adjusted EBITDA (as defined in the Amended Term Loan Credit Facility) for the most recently ended four fiscal quarters, plus (b) the aggregate amount of voluntary prepayments of certain indebtedness, plus (c) at MSI’s election, an amount of additional indebtedness if the consolidated secured debt ratio (as defined in the Amended Term Loan Credit Facility) is no more than 3.25 to 1.00 on a pro forma basis as of the last day of the most recently ended four fiscal quarters, subject to certain adjustments. The lenders will not be under any obligation to provide any such additional term loans and the incurrence of any additional term loans is subject to customary conditions precedent.

MSI is required to make scheduled quarterly payments equal to 0.25% of the original principal amount of the term loans (subject to adjustments relating to the incurrence of additional term loans) for the first six years of the Amended Term Loan Credit Facility, with the balance to be paid on October 1, 2027. The Amended Term Loan Credit Facility provides for a 1.0% soft call premium in connection with certain Repricing Transactions (as defined in the Amended Term Loan Credit Facility) occurring on or prior to April 1, 2021.

As of October 31, 2020 net debt issuance costs totaled $4.9 million and are being amortized as interest expense over the life of the Amended Term Loan Credit Facility. As a result of the refinancing, we recorded a loss on the early extinguishment of debt of $22.0 million during the third quarter of fiscal 2020.

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 Term Loan Credit Facility. The interest rate swaps have a maturity date of April 30, 2021 and were executed for risk management and are not held for trading purposes. The objective of the interest rate swaps is to hedge the variability of cash flows resulting from fluctuations in the one-month LIBOR. The swaps replaced the one-month LIBOR with a fixed interest rate of 2.7765% and payments are settled monthly. The swaps qualify as cash flow hedges and changes in the fair values are recorded in accumulated other comprehensive income in the consolidated balance sheet. The changes in fair value are reclassified from accumulated other comprehensive income to interest expense in the same period that the hedged items affect earnings. Amounts reclassified from accumulated other comprehensive income to interest expense during the third quarters of fiscal 2020 and fiscal 2019 were $4.5 million and $1.7 million, respectively. Amounts reclassified from accumulated other comprehensive income to interest expense during the nine months ended October 31, 2020 and November 2, 2019 were $12.5 million and $3.3 million, respectively.

Interest Rate Caps

In April 2020, we executed two interest rate cap agreements with an aggregate notional value of $2 billion associated with our outstanding Amended Term Loan Credit Facility. The interest rate caps have an effective date of September 30, 2020 and April 30, 2021, respectively. During the third quarter of fiscal 2020, we amended the September 30, 2020 interest rate cap agreement and reduced the notional value from $1 billion to $300 million. The interest rate caps have a maturity date of April 30, 2025 and were executed for risk management and are not held for trading purposes. The interest rate caps will effectively cap our LIBOR exposure on a portion of our Amended Term Loan Credit Facility at 1%. The interest rate caps qualify as cash flow hedges and changes in the fair values are recorded in accumulated

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other comprehensive income in the consolidated balance sheet. The changes in fair value are reclassified from accumulated other comprehensive income to interest expense in the same period that the hedged items affect earnings. Amounts reclassified from accumulated other comprehensive income to interest expense during the third quarter of fiscal 2020 and the nine months ended October 31, 2020 were not material.

6. ACCUMULATED OTHER COMPREHENSIVE LOSS

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


	13 Weeks Ended				39 Weeks Ended
	October 31,		November 2,		October 31,		November 2,
	2020		2019		2020		2019
Beginning of period	$	(28,207)	$	(24,146)	$	(22,831)	$	(14,558)
Foreign currency translation		1,291		972		(513)		424
Cash flow hedges		2,619		258		(953)		(8,782)
End of period	$	(24,297)	$	(22,916)	$	(24,297)	$	(22,916)

7. INCOME TAXES

Income tax expense increased $20.0 million for the third quarter of fiscal 2020 to $28.3 million compared to the same period in the prior year primarily due to an increase in operating income. Income tax expense decreased $9.8 million for the first nine months of fiscal 2020 to $18.8 million compared to the same period in the prior year primarily due to a decrease in operating income, partially offset by a tax benefit associated with a state income tax settlement in fiscal 2019.

8. EARNINGS PER SHARE

The Company’s unvested restricted stock awards contain non-forfeita