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 July 30, 2016

 

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 large accelerated filer.

 

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

 

As of August 18, 2016, 205,810,700 shares of The Michaels Companies, Inc.’s common stock were outstanding.

 

 

 

994

 

 

 


 

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 July 30, 2016 and August 1, 2015 (unaudited)

3

 

 

 

 

Consolidated Balance Sheets as of July 30, 2016, January 30, 2016 and August 1, 2015 (unaudited)

4

 

 

 

 

Consolidated Statements of Cash Flows for the 26 weeks ended July 30, 2016 and August 1, 2015 (unaudited)

5

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

6

 

 

 

Item 2. 

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

18

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

27

 

 

 

Item 4. 

Controls and Procedures

27

 

 

 

Part IIOTHER INFORMATION 

 

 

 

Item 1. 

Legal Proceedings

28

 

 

 

Item 1A. 

Risk Factors

28

 

 

 

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

28

 

 

 

Item 5. 

Other Information

28

 

 

 

Item 6. 

Exhibits

29

 

 

 

Signatures 

 

30

 

 

 

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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

 

 

 

July 30,

 

August 1,

 

 

July 30,

 

August 1,

 

 

 

2016

    

2015

 

 

2016

    

2015

 

Net sales

    

$

1,060,353

    

$

984,270

 

 

$

2,219,233

    

$

2,061,870

 

Cost of sales and occupancy expense

 

 

669,656

 

 

610,949

 

 

 

1,363,785

 

 

1,246,752

 

Gross profit

 

 

390,697

 

 

373,321

 

 

 

855,448

 

 

815,118

 

Selling, general and administrative

 

 

302,712

 

 

275,699

 

 

 

620,512

 

 

571,270

 

Store pre-opening costs

 

 

908

 

 

1,040

 

 

 

2,534

 

 

3,284

 

Operating income

 

 

87,077

 

 

96,582

 

 

 

232,402

 

 

240,564

 

Interest expense

 

 

31,954

 

 

34,311

 

 

 

64,173

 

 

72,127

 

Losses on early extinguishments of debt and refinancing costs

 

 

405

 

 

6,072

 

 

 

405

 

 

6,072

 

Other (income) expense, net

 

 

(515)

 

 

(136)

 

 

 

(69)

 

 

59

 

Income before income taxes

 

 

55,233

 

 

56,335

 

 

 

167,893

 

 

162,306

 

Provision for income taxes

 

 

19,616

 

 

20,624

 

 

 

61,511

 

 

59,857

 

Net income

 

$

35,617

 

$

35,711

 

 

$

106,382

 

$

102,449

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment and other

 

 

(4,759)

 

 

(7,223)

 

 

 

9,450

 

 

(2,907)

 

Comprehensive income

 

$

30,858

 

$

28,488

 

 

$

115,832

 

$

99,542

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.17

 

$

0.17

 

 

$

0.51

 

$

0.49

 

Diluted

 

$

0.17

 

$

0.17

 

 

$

0.51

 

$

0.49

 

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

205,881

 

 

206,941

 

 

 

206,437

 

 

206,283

 

Diluted

 

 

207,547

 

 

209,423

 

 

 

208,269

 

 

209,240

 

 

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)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

July 30,

 

January 30,

 

August 1,

 

ASSETS

 

2016

 

2016

 

2015

 

Current Assets:

 

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

114,849

 

$

409,391

 

$

70,368

 

Merchandise inventories

 

 

1,145,422

 

 

1,002,607

 

 

1,073,722

 

Prepaid expenses and other

 

 

77,472

 

 

77,000

 

 

75,027

 

Accounts receivable, net

 

 

26,920

 

 

9,484

 

 

8,217

 

Income tax receivables

 

 

42,676

 

 

1,231

 

 

53,499

 

Total current assets

 

 

1,407,339

 

 

1,499,713

 

 

1,280,833

 

Property and equipment, at cost

 

 

1,724,291

 

 

1,661,234

 

 

1,632,755

 

Less accumulated depreciation and amortization

 

 

(1,325,603)

 

 

(1,282,727)

 

 

(1,238,069)

 

Property and equipment, net

 

 

398,688

 

 

378,507

 

 

394,686

 

Goodwill

 

 

119,074

 

 

94,290

 

 

94,290

 

Other intangible assets, net

 

 

23,703

 

 

471

 

 

505

 

Deferred income taxes

 

 

39,780

 

 

40,399

 

 

42,496

 

Other assets

 

 

12,387

 

 

9,897

 

 

6,059

 

Total assets

 

$

2,000,971

 

$

2,023,277

 

$

1,818,869

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

462,099

 

$

457,704

 

$

418,745

 

Accrued liabilities and other

 

 

347,349

 

 

377,606

 

 

349,777

 

Current portion of long-term debt

 

 

66,900

 

 

24,900

 

 

48,900

 

Income taxes payable

 

 

 —

 

 

44,640

 

 

873

 

Total current liabilities

 

 

876,348

 

 

904,850

 

 

818,295

 

Long-term debt

 

 

2,735,187

 

 

2,744,942

 

 

2,902,099

 

Other liabilities

 

 

97,232

 

 

97,580

 

 

91,032

 

Total liabilities

 

 

3,708,767

 

 

3,747,372

 

 

3,811,426

 

 

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Deficit:

 

 

 

 

 

 

 

 

 

 

Common stock, $0.06775 par value, 350,000 shares authorized; 205,824 shares issued and outstanding at July 30, 2016; 208,996 shares issued and outstanding at January 30, 2016; and 208,011 shares issued and outstanding at August 1, 2015

 

 

13,770

 

 

13,979

 

 

13,952

 

Additional paid-in-capital

 

 

493,096

 

 

592,420

 

 

577,104

 

Accumulated deficit

 

 

(2,202,056)

 

 

(2,308,438)

 

 

(2,568,901)

 

Accumulated other comprehensive loss

 

 

(12,606)

 

 

(22,056)

 

 

(14,712)

 

Total stockholders’ deficit

 

 

(1,707,796)

 

 

(1,724,095)

 

 

(1,992,557)

 

Total liabilities and stockholders’ deficit

 

$

2,000,971

 

$

2,023,277

 

$

1,818,869

 

 

See accompanying notes to consolidated financial statements.

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THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

26 Weeks Ended

 

 

July 30,

 

August 1,

 

    

2016

    

2015

Cash flows from operating activities:

 

 

 

 

 

 

Net income

 

$

106,382

 

$

102,449

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

 

 

 

 

 

 

Depreciation and amortization

 

 

58,468

 

 

55,949

Share-based compensation

 

 

6,590

 

 

6,225

Debt issuance costs amortization

 

 

3,760

 

 

4,366

Accretion of long-term debt, net

 

 

(124)

 

 

(66)

Deferred income taxes

 

 

619

 

 

6,514

Losses on early extinguishments of debt and refinancing costs

 

 

405

 

 

6,072

Losses on disposition of property and equipment

 

 

35

 

 

 —

Excess tax benefits from share-based compensation

 

 

(7,271)

 

 

(12,952)

Changes in assets and liabilities, excluding acquired net assets:

 

 

 

 

 

 

Merchandise inventories

 

 

(58,612)

 

 

(115,198)

Prepaid expenses and other

 

 

639

 

 

(2,875)

Accounts receivable

 

 

4,858

 

 

4,534

Other assets

 

 

(445)

 

 

(86)

Accounts payable

 

 

(20,171)

 

 

(19,546)

Accrued interest

 

 

(5,045)

 

 

89

Accrued liabilities and other

 

 

(35,091)

 

 

(53,634)

Income taxes

 

 

(78,816)

 

 

(62,845)

Other liabilities

 

 

(605)

 

 

(2,067)

Net cash used in operating activities

 

 

(24,424)

 

 

(83,071)

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

Additions to property and equipment

 

 

(38,395)

 

 

(63,241)

Acquisition of Lamrite West, net of cash acquired

 

 

(151,100)

 

 

 —

Net cash used in investing activities

 

 

(189,495)

 

 

(63,241)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Payment of PIK notes

 

 

 —

 

 

(184,467)

Payments on restated term loan credit facility

 

 

(12,450)

 

 

(12,450)

Borrowings on asset-based revolving credit facility

 

 

42,000

 

 

24,000

Payment of debt issuance costs

 

 

(3,048)

 

 

 —

Payment of dividends

 

 

(415)

 

 

(443)

Proceeds from stock options exercised

 

 

15,058

 

 

19,586

Excess tax benefits from share-based compensation

 

 

7,271

 

 

12,952

Common stock repurchased

 

 

(129,039)

 

 

(19,822)

Other financing activities

 

 

 —

 

 

(971)

Net cash used in financing activities

 

 

(80,623)

 

 

(161,615)

 

 

 

 

 

 

 

Net change in cash and equivalents

 

 

(294,542)

 

 

(307,927)

Cash and equivalents at beginning of period

 

 

409,391

 

 

378,295

Cash and equivalents at end of period

 

$

114,849

 

$

70,368

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

 

Cash paid for interest

 

$

65,634

 

$

67,707

Cash paid for taxes

 

$

138,394

 

$

116,713

 

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.

 

On February 2, 2016, the Company completed the acquisition of Lamrite West, Inc. and certain of its affiliates and subsidiaries (“Lamrite”) for $150.0 million, prior to certain purchase price adjustments, utilizing our cash on hand. Lamrite operates an international wholesale business under the Darice brand name (“Darice”) and 35 arts and crafts retail stores, located primarily in Ohio and the surrounding states, under the Pat Catan’s brand name (“Pat Catan’s”). See Note 10 for further information.

 

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 30, 2016 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- 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 2016” relate to the 52 weeks ended January 28, 2017 and references to “fiscal 2015” relate to the 52 weeks ended January 30, 2016. In addition, all references to “the second quarter of fiscal 2016” relate to the 13 weeks ended July 30, 2016 and all references to “the second quarter of fiscal 2015” relate to the 13 weeks ended August 1, 2015. Finally, all references to “the six months ended July 30, 2016” relate to the 26 weeks ended July 30, 2016 and all references to “the six months ended August 1, 2015” relate to the 26 weeks ended August 1, 2015. Because of the seasonal nature of our business, the results of operations for the 13 and 26 weeks ended July 30, 2016 are not indicative of the results to be expected for the entire year. 

 

Certain prior year amounts have been reclassified in the accompanying consolidated financial statements to conform to our fiscal 2016 presentation, including the reclassification of current deferred income taxes to non-current deferred income taxes and the reclassification of certain unamortized debt issuance costs from non-current assets to a direct reduction of the related long-term debt obligation as a result of new accounting standards adopted in the fourth quarter of fiscal 2015.

 

Share Repurchase Program

 

In March 2016, the Board of Directors authorized the Company to purchase $200.0 million of the Company’s common stock on the open market. The share repurchase program does not have an expiration date, and the timing and number of repurchase transactions under the program will depend on market conditions, corporate considerations, debt agreements and regulatory requirements. Shares repurchased under the program are held as treasury shares until retired. As of July 30, 2016, we have repurchased 4.7 million shares for an aggregate amount of $126.9 million and have $73.1 million of availability remaining under our share repurchase program.

 

 

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Accounting Pronouncements Recently Adopted

 

In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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. The Company adopted ASU 2015-05 in the first quarter of fiscal 2016 and its adoption did not have a material impact on the Company’s consolidated financial statements.

 

Recent Accounting Pronouncements Not Yet Adopted

 

In March 2016, the FASB issued ASU No. 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016, including interim periods within that reporting period, with early adoption permitted. We are currently evaluating the impact that ASU 2016-09 will have on the consolidated financial statements.

 

In March 2016, the FASB issued ASU No. 2016-04, “Liabilities – Extinguishment of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products” (“ASU 2016-04”). ASU 2016-04 requires that breakage on prepaid stored-value product liabilities (for example, prepaid gift cards) be accounted for consistent with the breakage guidance in Topic 606: Revenue from Contracts with Customers. ASU 2016-04 is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period, with early adoption permitted. This standard is to be applied either using a modified retrospective approach or retrospectively to each period presented. We have evaluated the new standard and it will not have a material impact to the consolidated financial statements once implemented.

 

In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)" ("ASU 2016-02"). Under ASU 2016-02, an entity will be 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. ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, with early adoption permitted. At adoption, this update will be applied using a modified retrospective approach. We are currently evaluating the impact that ASU 2016-02 will have on the consolidated financial statements.

 

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. In July 2015, the FASB decided to delay the effective date of ASU 2014-09 by one year. ASU 2014-09 is now effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The standard is to be applied retrospectively, with early application permitted for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. In March 2016, the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus

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Net)” (“ASU 2016-08”) which is intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing” (“ASU 2016-10”) which provides further guidance on identifying performance obligations and improves the operability and understandability of the licensing implementation guidance. In May 2016, the FASB issued ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients” (“ASU 2016-12”) which narrowly amended the revenue recognition guidance regarding collectability, noncash consideration, presentation of sales tax and transition. ASU 2016-08, ASU 2016-10 and ASU 2016-12 have the same effective date and transition requirements as ASU 2014-09. We are currently evaluating the new standards 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 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 carrying and fair values of our senior secured term loan facility (“Restated Term Loan Credit Facility”) and our 5.875% senior subordinated notes maturing in 2020 (“2020 Senior Subordinated Notes”)  as of July 30, 2016. The fair values of our Restated Term Loan Credit Facility and our 2020 Senior Subordinated Notes were determined based on quoted market prices which are considered Level 2 inputs within the fair value hierarchy.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Notional

    

Fair

 

 

 

Value

 

Value

 

 

 

(in thousands)

 

Restated term loan credit facility

 

$

2,269,700

 

$

2,277,082

 

Senior subordinated notes

 

 

510,000

 

 

530,400

 

 

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3. DEBT

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

July 30,

 

January 30,

 

August 1,

 

 

Interest Rate

 

2016

 

2016

 

2015

 

Restated term loan credit facility

Variable

 

$

2,269,700

 

$

2,282,150

 

$

2,444,600

 

Asset-based revolving credit facility

Variable

 

 

42,000

 

 

 —

 

 

24,000

 

Senior subordinated notes

5.875

%

 

510,000

 

 

510,000

 

 

510,000

 

Total debt

 

 

 

2,821,700

 

 

2,792,150

 

 

2,978,600

 

Less unamortized discount/premium and debt costs

 

 

 

(19,613)

 

 

(22,308)

 

 

(27,601)

 

Total debt, net

 

 

 

2,802,087

 

 

2,769,842

 

 

2,950,999

 

Less current portion

 

 

 

(66,900)

 

 

(24,900)

 

 

(48,900)

 

Long-term debt

 

 

$

2,735,187

 

$

2,744,942

 

$

2,902,099

 

 

Revolving Credit Facility

 

On May 27, 2016, Michaels Stores, Inc. (“MSI”) entered into an amended and restated credit agreement with Wells Fargo Bank, National Association and other lenders to amend various terms of our senior secured asset-based revolving credit facility (“Restated Revolving Credit Facility”). The amended credit agreement, together with the related security, guarantee and other agreements, is referred to as the “Amended Revolving Credit Facility”. The Amended Revolving Credit Facility provides for senior secured financing of up to $850.0 million, subject to a borrowing base, with the right to request up to $200.0 million of additional commitments. The borrowing base under the Amended Revolving Credit Facility equals the sum of: (i) 90% of eligible credit card receivables, (ii) 85% of eligible trade receivables, (iii) 90% to 92.5% of the appraised value of eligible inventory, plus (iv) 90% to 92.5% of the lesser of (a) the appraised value of eligible inventory supported by letters of credit, and (b) the face amount of the letters of credit, less (v) certain reserves. The Amended Revolving Credit Facility matures in May 2021, subject to a springing maturity date if certain of our outstanding indebtedness has not been repaid, redeemed, refinanced, cash collateralized or if the necessary availability reserves have not been established prior to such time. Our obligations under the Amended Revolving Credit Facility are secured by (subject to certain exceptions) a first priority security interest in the current assets of the borrowers and facility guarantors and a second priority security interest in all other assets.

 

As of July 30, 2016 and August 1, 2015, the borrowing base under our senior secured asset-based revolving credit facility was $696.4 million and $650.0 million, respectively, of which MSI had unused borrowing capacity of $597.1 million and $564.0 million, respectively. As of July 30, 2016 and August 1, 2015, outstanding standby letters of credit, which reduce our borrowing base, totaled $57.3 million and $62.0 million, respectively. As of July 30, 2016 and August 1, 2015, borrowings under our senior secured asset-based revolving credit facility were $42.0 million and $24.0 million, respectively.

 

Debt Issuance Costs

 

Accumulated amortization of debt issuance costs was $61.0 million, $61.0 million and $57.6 million as of July 30, 2016, January 30, 2016 and August 1, 2015, 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

 

26 Weeks Ended

 

 

 

July 30,

 

August 1,

 

July 30,

 

August 1,

 

 

 

2016

    

2015

    

2016

    

2015

    

Beginning of period

  

$

(7,847)

 

$

(7,489)

  

$

(22,056)

 

$

(11,805)

  

Foreign currency translation adjustment and other

 

 

(4,759)

 

 

(7,223)

 

 

9,450

 

 

(2,907)

 

End of period

 

$

(12,606)

 

$

(14,712)

 

$

(12,606)

 

$

(14,712)

 

 

 

5.   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.” Under the two-class method, net income per share is computed by dividing net income allocated to common shareholders by the weighted average number of common shares outstanding for the period. 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. Diluted earnings per share is computed by dividing income available to common stockholders by the weighted-average common shares outstanding plus the potential dilutive impact from the exercise of stock options and restricted stock units. Common equivalent shares are excluded from the computation if their effect is anti-dilutive. There were 1.4 million and 0.4 million anti-dilutive shares during the second quarters of fiscal 2016 and fiscal 2015, respectively. There were 1.8 million and 0.3 million anti-dilutive shares during the six months ended July 30, 2016 and August 1, 2015, respectively. 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

26 Weeks Ended

 

 

 

July 30,

 

August 1,

 

July 30,

 

August 1,

 

 

 

2016

 

2015

 

2016

    

2015

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

35,617

 

$

35,711

 

$

106,382

  

$

102,449

  

Less income related to unvested restricted shares

 

 

(234)

 

 

(150)

 

 

(707)

 

 

(438)

 

Income available to common stockholders - Basic

 

$

35,383

 

$

35,561

 

$

105,675

 

$

102,011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding - Basic

 

 

205,881

 

 

206,941

 

 

206,437

 

 

206,283

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.17

 

$

0.17

 

$

0.51

 

$

0.49

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

35,617

 

$

35,711

 

$

106,382

 

$

102,449

 

Less income related to unvested restricted shares

 

 

(232)

 

 

(148)

 

 

(701)

 

 

(431)

 

Income available to common shareholders - Diluted

 

$

35,385

 

$

35,563

 

$

105,681

 

$

102,018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding - Basic

 

 

205,881

 

 

206,941

 

 

206,437

 

 

206,283

 

Effect of dilutive stock options and restricted stock units

 

 

1,666

 

 

2,482

 

 

1,832

 

 

2,957

 

Weighted-average common shares outstanding - Diluted

 

 

207,547

 

 

209,423

 

 

208,269

 

 

209,240

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.17

 

$

0.17

 

$

0.51

 

$

0.49

 

 

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6. SEGMENTS AND GEOGRAPHIC INFORMATION

 

We consider Michaels-U.S., Michaels-Canada, Aaron Brothers, 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, Aaron Brothers 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 as a reportable segment.

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

26 Weeks Ended

 

 

 

July 30,

 

August 1,

 

July 30,

 

August 1,

 

 

    

2016

    

2015

    

2016

    

2015

    

United States

 

$

970,367

 

$

896,004

 

$

2,034,204

 

$

1,879,264

 

Canada

 

 

89,986

 

 

88,266

 

 

185,029

 

 

182,606

 

Total

 

$

1,060,353

 

$

984,270

 

$

2,219,233

 

$

2,061,870

 

 

Our chief operating decision makers evaluate historical operating performance and forecast future periods’ operating performance based on operating income and earnings before interest, income taxes, depreciation, amortization and losses on early extinguishments of debt and refinancing costs (“EBITDA (excluding losses on early extinguishments of debt and refinancing costs)”). We believe these metrics more closely reflect the operating effectiveness of factors over which management has control. A reconciliation of EBITDA (excluding losses on early extinguishments of debt and refinancing costs) to net income is presented below (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

26 Weeks Ended

 

 

 

July 30,

    

August 1,

 

July 30,

    

August 1,

 

 

    

2016

    

2015

    

2016

    

2015

    

Net income

 

$

35,617

 

$

35,711

 

$

106,382

 

$

102,449

 

Interest expense

 

 

31,954

 

 

34,311

 

 

64,173

 

 

72,127

 

Losses on early extinguishments of debt and refinancing costs

 

 

405

 

 

6,072

 

 

405

 

 

6,072

 

Provision for income taxes

 

 

19,616

 

 

20,624

 

 

61,511

 

 

59,857

 

Depreciation and amortization

 

 

28,998

 

 

28,004

 

 

58,468

 

 

55,949

 

Interest income

 

 

(173)

 

 

(57)

 

 

(453)

 

 

(180)

 

EBITDA (excluding losses on early extinguishments of debt and refinancing costs)

 

$

116,417

 

$

124,665

 

$

290,486

 

$

296,274

 

 

 

 

 

 

7. 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 alleged 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 alleged 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 decertified. The named plaintiffs’ claims were resolved in September 2014, but the individual claims of 26 former class members remain pending in the Central District

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of California.  In addition, a separate representative action brought on behalf of store managers throughout the state is pending in the California Superior Court, County of San Diego. 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 employee. 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, five additional purported class action lawsuits with six plaintiffs were filed, Michele Castro and Janice Bercut v. Michaels Stores, Inc., in the U.S. District Court for the Northern District of Texas, Michelle Bercut v. Michaels Stores, Inc. in the Superior Court of California for Sonoma County, Raini Burnside v. Michaels Stores, Inc., in the U.S. District Court for the Western District of Missouri, Sue Gettings v. Michaels Stores, Inc., in the U.S. District Court for the Southern District of New York, and Barbara Horton v. Michaels Stores, Inc., in the U.S. District Court for the Central District of California. All of the plaintiffs alleged violations of the FCRA. In addition, the Castro, Horton and Janice Bercut lawsuits also alleged violations of California’s unfair competition law. The Burnside, Horton and Gettings lawsuits, as well as the claims by Michele Castro, have been dismissed. The Graham, Janice Bercut and Michelle Bercut lawsuits were transferred for centralized pretrial proceedings to the District of New Jersey.

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 for the 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 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 which was granted on December 28, 2015, and judgment was entered in favor of the Company on January 8, 2016. Plaintiff filed a notice of

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appeal on January 27, 2016, appealing the judgment to the United States Court of Appeals for the Second Circuit. The appeal is pending.

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

In connection with the breach, payment card companies and associations assessed us for unauthorized card charges and costs. 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.  The assessments and other charges and costs are immaterial to the consolidated financial statements. In addition, various states’ attorneys general investigated events related to the data breach, including how it occurred, its consequences and our responses. We fully cooperated in these investigations and we do not expect any further action.     

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.

 

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 lawsuits involving the Company, we are able to estimate a range of losses in excess of the amounts recorded, if any, in the accompanying consolidated financial statements. As of July 30, 2016, the aggregate estimated loss is approximately $13 million, which includes amounts recorded by the Company.

 

8. RELATED PARTY TRANSACTIONS

 

Affiliates of, or funds advised by, Bain Capital Partners, LLC (“Bain Capital”) and The Blackstone Group L.P. (“The Blackstone Group”, together with Bain Capital and their applicable affiliates, the “Sponsors”) own approximately 50% of our outstanding common stock as of July 30, 2016.

 

The Blackstone Group owns a majority equity position in RGIS, a vendor we utilize to count our store inventory. Payments associated with this vendor during the second quarters of fiscal 2016 and fiscal 2015 were $1.7 million and $1.5 million, respectively. Payments made during the six months ended July 30, 2016 and August 1, 2015 were $3.7 million and $3.4 million, respectively. These expenses are included in selling, general and administrative (“SG&A”) in the consolidated statements of comprehensive income.

 

The Blackstone Group owns an equity position in Vistar, a vendor we utilize for all of the candy-type items in our stores. Payments associated with this vendor during the second quarters of fiscal 2016 and fiscal 2015 were $6.6 million and $5.7 million, respectively. Payments made during each of the six months ended July 30, 2016 and August 1, 2015

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were $12.9 million. These expenses are recognized in cost of sales and occupancy expense in the consolidated statements of comprehensive income as the sales are incurred.

 

The Blackstone Group owns an equity position in Brixmor Properties Group, Excel Trust, Inc., Blackstone Real Estate DDR Retail Holdings III, LLC. and Blackstone Real Estate RC Retail Holdings, LLC., vendors we utilize to lease certain properties. Payments associated with these vendors during the second quarters of fiscal 2016 and fiscal 2015 were $2.9 million and $2.3 million, respectively. Payments made during the six months ended July 30, 2016 and August 1, 2015 were $5.3 million and $4.7 million, respectively. These expenses are included in cost of sales and occupancy expense in the consolidated statements of comprehensive income.

 

Certain affiliates of The Blackstone Group have significant influence over US Xpress Enterprises, Inc., a vendor we utilize for transportation services. Payments associated with this vendor during the second quarters of fiscal 2016 and fiscal 2015 were $0.2 million and $0.4 million, respectively. Payments made during the six months ended July 30, 2016 and August 1, 2015 were $0.5 million. These expenses are recognized in cost of sales and occupancy expense in the consolidated statements of comprehensive income as the sales are incurred.

 

Four of our current directors, Joshua Bekenstein, Nadim El Gabbani, Lewis S. Klessel and Peter F. Wallace, 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 July 30, 2016, affiliates of The Blackstone Group held $86.0 million of our Restated Term Loan Credit Facility.

 

9. CONDENSED CONSOLIDATED FINANCIAL INFORMATION

 

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

 

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Michaels Stores, Inc.

Condensed Consolidated Balance Sheets

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

July 30,

 

January 30,

 

August 1,

 

ASSETS

    

2016

 

2016

 

2015

 

Current assets:

 

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

110,100

 

$

404,650

 

$

65,631

 

Merchandise inventories

 

 

1,145,422

 

 

1,002,607

 

 

1,073,722

 

Prepaid expenses and other current assets

 

 

104,326

 

 

87,573

 

 

100,437

 

Total current assets

 

 

1,359,848

 

 

1,494,830

 

 

1,239,790

 

Property and equipment, net

 

 

398,688

 

 

378,507

 

 

394,686

 

Goodwill

 

 

119,074

 

 

94,290

 

 

94,290

 

Other assets

 

 

77,503

 

 

56,004

 

 

55,619

 

Total assets

 

$

1,955,113

 

$

2,023,631

 

$

1,784,385

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

462,099

 

$

457,704

 

$

418,745

 

Accrued liabilities and other

 

 

345,844

 

 

375,992

 

 

347,983

 

Current portion of long-term debt

 

 

66,900

 

 

24,900

 

 

48,900

 

Other current liabilities

 

 

3,087

 

 

89,996

 

 

2,885

 

Total current liabilities

 

 

877,930

 

 

948,592

 

 

818,513

 

Long-term debt

 

 

2,735,187

 

 

2,744,942

 

 

2,902,099

 

Other liabilities

 

 

103,296

 

 

95,400

 

 

91,032

 

Total stockholders’ deficit

 

 

(1,761,300)

 

 

(1,765,303)

 

 

(2,027,259)

 

Total liabilities and stockholders’ deficit

 

$

1,955,113

 

$

2,023,631

 

$

1,784,385

 

 

 

Michaels Stores, Inc.

Condensed Consolidated Statements of Comprehensive Income

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

26 Weeks Ended

 

 

 

July 30,

 

August 1,

 

July 30,

 

August 1,

 

 

    

2016

    

2015

    

2016

    

2015

    

Net sales

 

$

1,060,353

 

$

984,270

 

$

2,219,233

 

$

2,061,870

 

Cost of sales and occupancy expense

 

 

669,656

 

 

610,949

 

 

1,363,785

 

 

1,246,752

 

Gross profit

 

 

390,697

 

 

373,321

 

 

855,448

 

 

815,118

 

Selling, general and administrative

 

 

302,146

 

 

275,380

 

 

619,411

 

 

570,729

 

Other operating expense

 

 

908

 

 

1,040

 

 

2,534

 

 

3,284

 

Operating income

 

 

87,643

 

 

96,901

 

 

233,503

 

 

241,105

 

Interest and other expense

 

 

31,849

 

 

34,063

 

 

64,519

 

 

68,415

 

Income before income taxes

 

 

55,794

 

 

62,838

 

 

168,984

 

 

172,690

 

Provision for income taxes

 

 

19,825

 

 

23,034

 

 

61,917

 

 

63,705

 

Net income

 

$

35,969

 

$

39,804

 

$

107,067

 

$

108,985

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment and other

 

 

(4,759)

 

 

(7,223)

 

 

9,450

 

 

(2,907)

 

Comprehensive income

 

$

31,210

 

$

32,581

 

$

116,517

 

$

106,078

 

 

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Michaels Stores, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

26 Weeks Ended

 

 

 

July 30,

 

August 1,

 

 

 

2016

    

2015

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net cash used in operating activities

 

$

(11,866)

 

$

(80,172)

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Additions to property and equipment

 

 

(38,395)

 

 

(63,241)

 

Acquisition of Lamrite West, net of cash acquired

 

 

(151,100)

 

 

 —

 

Net cash used in investing activities

 

 

(189,495)

 

 

(63,241)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Net repayments of debt

 

 

(12,450)

 

 

(12,450)

 

Net borrowings of debt

 

 

42,000

 

 

24,000

 

Payment of dividend to Michaels Funding, Inc.

 

 

(126,962)

 

 

(188,046)