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 October 28, 2017

 

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 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 or emerging growth company (as defined in Rule 12b-2 of the Exchange Act).

 

As of November 24, 2017, 181,248,635 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 39 weeks ended October 28, 2017 and October 29, 2016 (unaudited)

3

 

 

 

 

Consolidated Balance Sheets as of October 28, 2017, January 28, 2017 and October 29, 2016 (unaudited)

4

 

 

 

 

Consolidated Statements of Cash Flows for the 39 weeks ended October 28, 2017 and October 29, 2016 (unaudited)

5

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

6

 

 

 

Item 2. 

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

17

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

26

 

 

 

Item 4. 

Controls and Procedures

26

 

 

 

Part II—OTHER INFORMATION 

 

 

 

Item 1. 

Legal Proceedings

27

 

 

 

Item 1A. 

Risk Factors

27

 

 

 

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

27

 

 

 

Item 6. 

Exhibits

28

 

 

 

Signatures 

 

29

 

 

 

2

 


 

Table of Contents

 

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 28,

 

October 29,

 

October 28,

 

October 29,

 

 

2017

 

2016

 

2017

 

2016

Net sales

 

$

1,240,196

 

$

1,227,206

 

$

3,471,352

 

$

3,446,438

Cost of sales and occupancy expense

 

 

756,088

 

 

760,598

 

 

2,117,100

 

 

2,124,383

Gross profit

 

 

484,108

 

 

466,608

 

 

1,354,252

 

 

1,322,055

Selling, general and administrative

 

 

329,298

 

 

318,580

 

 

970,561

 

 

939,093

Store pre-opening costs

 

 

952

 

 

1,704

 

 

2,592

 

 

4,238

Operating income

 

 

153,858

 

 

146,324

 

 

381,099

 

 

378,724

Interest expense

 

 

32,818

 

 

31,538

 

 

94,305

 

 

95,711

Losses on early extinguishments of debt and refinancing costs

 

 

 —

 

 

6,887

 

 

 —

 

 

7,292

Other (income) expense, net

 

 

(360)

 

 

259

 

 

950

 

 

188

Income before income taxes

 

 

121,400

 

 

107,640

 

 

285,844

 

 

275,533

Income taxes

 

 

41,640

 

 

31,181

 

 

98,314

 

 

92,692

Net income

 

$

79,760

 

$

76,459

 

$

187,530

 

$

182,841

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment and other

 

 

(4,418)

 

 

(3,650)

 

 

4,254

 

 

5,800

Comprehensive income

 

$

75,342

 

$

72,809

 

$

191,784

 

$

188,641

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.44

 

$

0.37

 

$

1.01

 

$

0.88

Diluted

 

$

0.44

 

$

0.37

 

$

1.00

 

$

0.88

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

180,710

 

 

203,864

 

 

185,521

 

 

205,580

Diluted

 

 

181,987

 

 

205,313

 

 

186,775

 

 

207,293

 

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 28,

 

January 28,

 

October 29,

ASSETS

 

2017

 

2017

 

2016

Current Assets:

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

176,771

 

$

298,813

 

$

149,970

Merchandise inventories

 

 

1,404,206

 

 

1,127,777

 

 

1,394,092

Prepaid expenses and other

 

 

95,993

 

 

87,175

 

 

93,691

Accounts receivable, net

 

 

30,936

 

 

23,215

 

 

36,927

Income taxes receivable

 

 

5,792

 

 

5,825

 

 

26,757

Total current assets

 

 

1,713,698

 

 

1,542,805

 

 

1,701,437

Property and equipment, at cost

 

 

1,545,004

 

 

1,488,136

 

 

1,759,229

Less accumulated depreciation and amortization

 

 

(1,143,112)

 

 

(1,074,972)

 

 

(1,347,027)

Property and equipment, net

 

 

401,892

 

 

413,164

 

 

412,202

Goodwill

 

 

119,074

 

 

119,074

 

 

119,074

Other intangible assets, net

 

 

22,253

 

 

23,702

 

 

24,457

Deferred income taxes

 

 

36,946

 

 

36,834

 

 

30,293

Other assets

 

 

12,233

 

 

12,061

 

 

12,016

Total assets

 

$

2,306,096

 

$

2,147,640

 

$

2,299,479

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

674,222

 

$

517,268

 

$

714,198

Accrued liabilities and other

 

 

400,138

 

 

397,497

 

 

386,280

Current portion of long-term debt

 

 

140,125

 

 

31,125

 

 

24,900

Income taxes payable

 

 

16,673

 

 

78,334

 

 

 —

Total current liabilities

 

 

1,231,158

 

 

1,024,224

 

 

1,125,378

Long-term debt

 

 

2,707,120

 

 

2,723,187

 

 

2,734,758

Other liabilities

 

 

100,656

 

 

98,655

 

 

98,866

Total liabilities

 

 

4,038,934

 

 

3,846,066

 

 

3,959,002

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Deficit:

 

 

 

 

 

 

 

 

 

Common stock, $0.06775 par value, 350,000 shares authorized; 181,263 shares issued and outstanding at October 28, 2017; 193,311 shares issued and outstanding at January 28, 2017; and 204,584 shares issued and outstanding at October 29, 2016

 

 

12,159

 

 

12,948

 

 

13,703

Additional paid-in-capital

 

 

7,722

 

 

233,129

 

 

468,627

Accumulated deficit

 

 

(1,742,749)

 

 

(1,930,279)

 

 

(2,125,597)

Accumulated other comprehensive loss

 

 

(9,970)

 

 

(14,224)

 

 

(16,256)

Total stockholders’ deficit

 

 

(1,732,838)

 

 

(1,698,426)

 

 

(1,659,523)

Total liabilities and stockholders’ deficit

 

$

2,306,096

 

$

2,147,640

 

$

2,299,479

 

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 28,

 

October 29,

 

    

2017

    

2016

Cash flows from operating activities:

 

 

 

 

 

 

Net income

 

$

187,530

 

$

182,841

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

 

 

 

 

 

 

Depreciation and amortization

 

 

86,232

 

 

86,679

Share-based compensation

 

 

18,232

 

 

11,884

Debt issuance costs amortization

 

 

3,823

 

 

5,308

Accretion of long-term debt, net

 

 

(379)

 

 

(217)

Deferred income taxes

 

 

529

 

 

10,106

Losses on early extinguishments of debt and refinancing costs

 

 

 —

 

 

7,292

Losses on disposition of property and equipment

 

 

 —

 

 

56

Excess tax benefits from share-based compensation

 

 

 —

 

 

(7,485)

Changes in assets and liabilities, excluding acquired net assets:

 

 

 

 

 

 

Merchandise inventories

 

 

(275,086)

 

 

(306,925)

Prepaid expenses and other

 

 

(8,818)

 

 

(7,554)

Accounts receivable

 

 

(7,721)

 

 

(4,764)

Other assets

 

 

(1,010)

 

 

(353)

Accounts payable

 

 

150,947

 

 

233,266

Accrued interest

 

 

(314)

 

 

6,716

Accrued liabilities and other

 

 

12,685

 

 

(18,613)

Income taxes

 

 

(61,628)

 

 

(63,001)

Other liabilities

 

 

1,405

 

 

1,280

Net cash provided by operating activities

 

 

106,427

 

 

136,516

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

Additions to property and equipment

 

 

(72,640)

 

 

(82,163)

Acquisition of Lamrite West, net of cash acquired

 

 

 —

 

 

(151,100)

Purchase of long-term investment

 

 

 —

 

 

(1,325)

Net cash used in investing activities

 

 

(72,640)

 

 

(234,588)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Common stock repurchased

 

 

(253,595)

 

 

(160,287)

Payments on term loan credit facility

 

 

(18,675)

 

 

(12,450)

Borrowings on asset-based revolving credit facility

 

 

357,200

 

 

42,000

Payments on asset-based revolving credit facility

 

 

(248,200)

 

 

(42,000)

Payment of debt issuance costs

 

 

 —

 

 

(11,542)

Payment of dividends

 

 

(408)

 

 

(415)

Proceeds from stock options exercised

 

 

7,849

 

 

15,860

Excess tax benefits from share-based compensation

 

 

 —

 

 

7,485

Net cash used in financing activities

 

 

(155,829)

 

 

(161,349)

 

 

 

 

 

 

 

Net change in cash and equivalents

 

 

(122,042)

 

 

(259,421)

Cash and equivalents at beginning of period

 

 

298,813

 

 

409,391

Cash and equivalents at end of period

 

$

176,771

 

$

149,970

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

 

Cash paid for interest

 

$

91,794

 

$

83,958

Cash paid for taxes

 

$

159,013

 

$

144,483

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 January 28, 2017 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 2017” relate to the 53 weeks ending February 3, 2018 and references to “fiscal 2016” relate to the 52 weeks ended January 28, 2017. In addition, all references to “the third quarter of fiscal 2017” relate to the 13 weeks ended October 28, 2017 and all references to “the third quarter of fiscal 2016” relate to the 13 weeks ended October 29, 2016. Finally, all references to “the nine months ended October 28, 2017” relate to the 39 weeks ended October 28, 2017 and all references to “the nine months ended October 29, 2016” relate to the 39 weeks ended October 29, 2016. Because of the seasonal nature of our business, the results of operations for the 13 and 39 weeks ended October 28, 2017 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 2017 presentation.

 

Share Repurchase Program

 

In June 2017, the Board of Directors authorized a new share repurchase program for the Company to purchase $500.0 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. During the nine months ended October 28, 2017, we repurchased 12.7 million shares under our share repurchase programs for an aggregate amount of $249.5 million, including $99.4 million repurchased under our previous authorization. As of October 28, 2017, we had $350.0 million of availability remaining under our current program.

 

Accounting Pronouncements Recently Adopted

 

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 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

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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. We adopted the new guidance on a prospective basis in the first quarter of fiscal 2017. As a result of the adoption, we recognized $0.1 million of excess tax benefits related to share-based compensation in income tax expense for the third quarter of fiscal 2017 and $1.1 million for the nine months ended October 28, 2017. Excess tax benefits were historically recorded in additional paid-in capital. In addition, cash flows related to excess tax benefits are now classified as an operating activity. Cash flows were historically classified as a financing activity. We have elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized each period. None of the other provisions in this amended guidance had a material impact on our consolidated financial statements.

 

Recent Accounting Pronouncements Not Yet Adopted

 

In May 2017, the FASB issued ASU 2017-09, “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting” (“ASU 2017-09”).  ASU 2017-09 provides clarity on when a change to the terms or conditions of a share-based payment award would require an entity to apply modification accounting. ASU 2017-09 is effective on a prospective basis for reporting periods beginning after December 15, 2017, with early adoption permitted.  We do not anticipate a material impact to the consolidated financial statements once implemented.

 

In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). ASU 2017-04 simplifies the measurement of goodwill impairment by removing the second step of the goodwill impairment test, which requires the determination of the fair value of individual assets and liabilities of a reporting unit. Under ASU 2017-04, goodwill impairment is to be measured as the amount by which a reporting unit’s carrying value exceeds its fair value with the loss recognized not to exceed the total amount of goodwill allocated to the reporting unit. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019, with early adoption permitted for interim or annual goodwill impairment tests performed after January 1, 2017. The standard is to be applied on a prospective basis. We do not anticipate a material impact to the consolidated financial statements once implemented.

 

In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory” (“ASU 2016-16”). ASU 2016-16 requires entities to recognize income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 is effective for annual periods beginning after December 15, 2017, including interim reporting periods within that reporting period, with early adoption permitted. We do not anticipate a material impact to the consolidated financial statements once implemented.

 

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”). ASU 2016-15 clarifies how companies should present and classify certain cash receipts and cash payments in the statement of cash flows. ASU 2016-15 is effective for annual periods beginning after December 15, 2017, including interim reporting periods within that reporting period, with early adoption permitted. 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

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financial statements and related disclosures. We believe the most significant impact relates to our accounting for real estate leases, which will be recorded as right-of-use assets and lease liabilities on our balance sheet upon adoption.

 

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 March 2016, the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” 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” 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” which narrowly amended the revenue recognition guidance regarding collectability, noncash consideration, presentation of sales tax and transition. The guidance under each of these standards is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period.  We plan to adopt the standard using the modified retrospective approach. While we continue to assess all potential impacts of the guidance, our focus has been on vendor arrangements in which we act as either a principal or an agent and customer incentive arrangements. We do not anticipate that the adoption of ASU 2014-09 will result in a material adjustment on the date of implementation.

 

2. FAIR VALUE MEASUREMENTS

 

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

 

·

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

 

·

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

 

·

Level 3—Instruments with significant unobservable inputs.

 

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

 

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

 

 

 

 

 

 

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The table below provides the fair values of our senior secured term loan facility (“Amended Term Loan Credit Facility”) and our 5.875% senior subordinated notes maturing in 2020 (“2020 Senior Subordinated Notes ). The fair values of our Amended 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.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

October 28,

 

January 28,

 

October 29,

 

 

2017

 

2017

 

2016

 

 

(in thousands)

Term loan credit facility

 

$

2,250,412

 

$

2,266,304

 

$

2,286,723

Senior subordinated notes

 

 

520,838

 

 

526,575

 

 

526,575

 

 

3. DEBT

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

October 28,

 

January 28,

 

October 29,

 

Interest Rate

 

2017

 

2017

 

2016

Term loan credit facility

Variable

 

$

2,244,800

 

$

2,263,475

 

$

2,269,700

Asset-based revolving credit facility

Variable

 

 

109,000

 

 

 —

 

 

 —

Senior subordinated notes

5.875

%

 

510,000

 

 

510,000

 

 

510,000

Total debt

 

 

 

2,863,800

 

 

2,773,475

 

 

2,779,700

Less unamortized discount/premium and debt costs

 

 

 

(16,555)

 

 

(19,163)

 

 

(20,042)

Total debt, net

 

 

 

2,847,245

 

 

2,754,312

 

 

2,759,658

Less current portion

 

 

 

(140,125)

 

 

(31,125)

 

 

(24,900)

Long-term debt

 

 

$

2,707,120

 

$

2,723,187

 

$

2,734,758

 

 

Revolving Credit Facility

 

As of October 28, 2017 and October 29, 2016, the borrowing base under our senior secured asset-based revolving credit facility was $850.0 million, of which Michaels Stores, Inc. (“MSI”) had unused borrowing capacity of $675.7 million and $792.7 million, respectively. As of October 28, 2017 and October 29, 2016, outstanding standby letters of credit, which reduce our borrowing base, totaled $65.3 million and $57.3 million, 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

 

39 Weeks Ended

 

 

October 28,

 

October 29,

 

October 28,

 

October 29,

 

 

2017

    

2016

    

2017

    

2016

Beginning of period

  

$

(5,552)

 

$

(12,606)

  

$

(14,224)

 

$

(22,056)

Foreign currency translation adjustment and other

 

 

(4,418)

 

 

(3,650)

 

 

4,254

 

 

5,800

End of period

 

$

(9,970)

 

$

(16,256)

 

$

(9,970)

 

$

(16,256)

 

 

5. INCOME TAXES

 

The effective tax rate was 34.3% for the third quarter of fiscal 2017 compared to 29.0% for the third quarter of fiscal 2016 and 34.4% for the nine months ended October 28, 2017 compared to 33.6% for the same period in the prior year. The effective tax rate for both periods of fiscal 2017 was higher than the same periods in the prior year due to certain federal tax credits recognized in the prior year and an increase in state taxes, partially offset by benefits realized associated with our direct sourcing initiatives that began in the second half of fiscal 2016.

 

 

6. EARNINGS PER SHARE

 

The Company’s unvested restricted stock awards contain non-forfeitable rights to dividends and meet the criteria of a participating security as defined by ASC 260, “Earnings Per Share”. In applying the two-class method, net income is allocated to both common and participating securities based on their respective weighted-average shares outstanding for the period. Basic earnings per share is computed by dividing net income allocated to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share is computed by dividing income available to common shareholders by the weighted-average common shares outstanding plus the potential dilutive impact from stock options and restricted stock units. Common equivalent shares are excluded from the computation if their effect is anti-dilutive. There were 5.8 million and 2.7 million anti-dilutive shares during the third quarters of fiscal 2017 and fiscal 2016, respectively. There were 6.0 million and 2.0 million anti-dilutive shares during the nine months ended October 28, 2017 and October 29, 2016, respectively.

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

39 Weeks Ended

 

 

October 28,

 

October 29,

 

October 28,

 

October 29,

 

 

2017

 

2016

 

2017

 

2016

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

79,760

 

$

76,459

 

$

187,530

  

$

182,841

Less income related to unvested restricted shares

 

 

(297)

 

 

(462)

 

 

(789)

 

 

(1,180)

Income available to common shareholders - Basic

 

$

79,463

 

$

75,997

 

$

186,741

 

$

181,661

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding - Basic

 

 

180,710

 

 

203,864

 

 

185,521

 

 

205,580

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.44

 

$

0.37

 

$

1.01

 

$

0.88

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

79,760

 

$

76,459

 

$

187,530

 

$

182,841

Less income related to unvested restricted shares

 

 

(295)

 

 

(459)

 

 

(784)

 

 

(1,171)

Income available to common shareholders - Diluted

 

$

79,465

 

$

76,000

 

$

186,746

 

$

181,670

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding - Basic

 

 

180,710

 

 

203,864

 

 

185,521

 

 

205,580

Effect of dilutive stock options and restricted stock units

 

 

1,277

 

 

1,449

 

 

1,254

 

 

1,713

Weighted-average common shares outstanding - Diluted

 

 

181,987

 

 

205,313

 

 

186,775

 

 

207,293

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.44

 

$

0.37

 

$

1.00

 

$

0.88

 

 

 

 

 

7. 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 chief operating decision makers evaluate historical operating performance and forecast future periods’ operating performance based on operating income.

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

39 Weeks Ended

 

 

October 28,

 

October 29,

 

October 28,

 

October 29,

 

 

2017

 

2016

 

2017

 

2016

United States

 

$

1,117,626

 

$

1,118,273

 

$

3,152,048

 

$

3,152,477

Canada

 

 

122,570

 

 

108,933

 

 

319,304

 

 

293,961

Total

 

$

1,240,196

 

$

1,227,206

 

$

3,471,352

 

$

3,446,438

 

 

 

 

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8. CONTINGENCIES

 

Rea Claim

  

On September 15, 2011, MSI was served with a lawsuit filed in the California Superior Court in and for the County of Orange (“Superior Court”) by four former store managers as a class action proceeding on behalf of themselves and certain former and current store managers employed by MSI in California. The lawsuit alleged that MSI improperly classified its store managers as exempt employees and as such failed to pay all wages, overtime and 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 U.S. District Court for the Central District of California and on May 8, 2014, the class was decertified. Three of the four named plaintiffs’ claims were resolved in September 2014 and the remaining one is set for trial on February 18, 2018. The individual claims of 26 former class members remain pending in the Central District 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. On January 24, 2017, the Company’s motion to dismiss for lack of standing was granted, and the court declined to rule on the merits of plaintiffs’ claims. The dismissal order was stayed for 30 days to allow the plaintiffs to amend their complaints. Because there were no amendments filed, two of the three centralized cases were dismissed and subsequently appealed to the U.S. Court of Appeals for the Third Circuit, and the remaining case (Michelle Bercut) was remanded to California Superior Court. We do not believe the resolution of the lawsuits will have a material effect on our consolidated financial statements.  

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). The plaintiffs were seeking damages including declaratory relief, actual damages, punitive damages, statutory damages,

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attorneys’ fees, litigation costs, remedial action, pre and post judgment interest, and other relief as available. The cases were 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 U.S. District Court for the Northern District of Illinois, Eastern Division. On March 18, 2014, an additional putative class action was filed in the U.S. 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 U.S. 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 appealed the judgment to the U.S. Court of Appeals for the Second Circuit and on May 2, 2017, the Second Circuit affirmed the dismissal and Whalen did not appeal further, thereby concluding the matter.

Consumer Product Safety Commission Claim

 

On April 21, 2015, the U.S. 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. On April 4, 2017, the CPSC filed an amended complaint eliminating their misrepresentation claim. 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 October 28, 2017, the aggregate estimated loss was approximately $10 million, which includes amounts recorded by the Company.

 

9. 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”) owned approximately 40% of our outstanding common stock as of October 28, 2017.

 

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 third quarters of fiscal 2017 and fiscal 2016 were $2.3 million and $2.1 million, respectively.  Payments made during the nine months ended October 28, 2017 and October 29, 2016 were $6.0 

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million and $5.9 million, respectively. These expenses are included in selling, general and administrative (“SG&A”) in the consolidated statements of comprehensive income.

 

The Blackstone Group owns a majority equity position in 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 third quarters of fiscal 2017 and fiscal 2016 were $1.9 million and $1.4 million, respectively. Payments made during the nine months ended October 28, 2017 and October 29, 2016 were $5.1 million and $3.5 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 third quarters of fiscal 2017 and fiscal 2016 were $0.3 million and $0.2 million, respectively. Payments made during the nine months ended October 28, 2017 and October 29, 2016 were $0.7 million.  These expenses are recognized in cost of sales and occupancy expense in the consolidated statements of comprehensive income as the sales are incurred.

 

Two of our current directors, Joshua Bekenstein 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 October 28, 2017, affiliates of The Blackstone Group held $71.7 million of our Amended Term Loan Credit Facility.

 

10. CONDENSED CONSOLIDATED FINANCIAL INFORMATION

 

Our debt covenants restrict MSI, and certain subsidiaries of MSI, from various activities including the incurrence of additional debt, payment of dividends and the repurchase of MSI’s capital stock (subject to certain exceptions), among other things. The following condensed consolidated financial information represents the financial information of MSI and its wholly-owned subsidiaries 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)

 

 

 

 

 

 

 

 

 

 

 

 

 

October 28,

 

January 28,

 

October 29,

ASSETS

    

2017

 

2017

 

2016

Current assets:

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

176,007

 

$

294,054

 

$

145,217

Merchandise inventories

 

 

1,404,206

 

 

1,127,777

 

 

1,394,092

Prepaid expenses and other current assets

 

 

131,695

 

 

116,072

 

 

147,796

Total current assets

 

 

1,711,908

 

 

1,537,903

 

 

1,687,105

Property and equipment, net

 

 

401,892

 

 

413,164

 

 

412,202

Goodwill

 

 

119,074

 

 

119,074

 

 

119,074

Other assets

 

 

72,036

 

 

73,201

 

 

68,401

Total assets

 

$

2,304,910

 

$

2,143,342

 

$

2,286,782

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

674,222

 

$

517,268

 

$

714,198

Accrued liabilities and other

 

 

399,363

 

 

395,745

 

 

385,102

Current portion of long-term debt

 

 

140,125

 

 

31,125

 

 

24,900

Other current liabilities

 

 

60,884

 

 

123,258

 

 

36,263

Total current liabilities

 

 

1,274,594

 

 

1,067,396

 

 

1,160,463

Long-term debt

 

 

2,707,120

 

 

2,723,187

 

 

2,734,758

Other liabilities

 

 

108,112

 

 

103,972

 

 

103,615

Total stockholders’ deficit

 

 

(1,784,916)

 

 

(1,751,213)

 

 

(1,712,054)

Total liabilities and stockholders’ deficit

 

$

2,304,910

 

$

2,143,342

 

$

2,286,782

 

 

Michaels Stores, Inc.

Condensed Consolidated Statements of Comprehensive Income

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

39 Weeks Ended

 

 

October 28,

 

October 29,

 

October 28,

 

October 29,

 

    

2017

    

2016

    

2017

    

2016

Net sales

 

$

1,240,196

 

$

1,227,206

 

$

3,471,352

 

$

3,446,438

Cost of sales and occupancy expense

 

 

756,088

 

 

760,598

 

 

2,117,100

 

 

2,124,383

Gross profit

 

 

484,108

 

 

466,608

 

 

1,354,252

 

 

1,322,055

Selling, general and administrative

 

 

328,855

 

 

318,438

 

 

969,793

 

 

937,849

Store pre-opening costs

 

 

952

 

 

1,704

 

 

2,592

 

 

4,238

Operating income

 

 

154,301

 

 

146,466

 

 

381,867

 

 

379,968

Interest and other expense

 

 

32,460

 

 

38,689

 

 

95,261

 

 

103,207

Income before income taxes

 

 

121,841

 

 

107,777

 

 

286,606

 

 

276,761

Income taxes

 

 

41,806

 

 

31,232

 

 

98,601

 

 

93,149

Net income

 

$

80,035

 

$

76,545

 

$

188,005

 

$

183,612

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment and other

 

 

(4,418)

 

 

(3,650)

 

 

4,254

 

 

5,800

Comprehensive income

 

$

75,617

 

$

72,895

 

$

192,259

 

$

189,412

 

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Michaels Stores, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

39 Weeks Ended

 

 

October 28,

 

October 29,

 

 

2017

 

2016

Cash flows from operating activities:

 

 

 

 

 

 

Net cash provided by operating activities

 

$

109,782

 

$

148,191

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

Additions to property and equipment

 

 

(72,640)

 

 

(82,163)

Acquisition of Lamrite West, net of cash acquired

 

 

 —

 

 

(151,100)

Purchase of long-term investment

 

 

 —

 

 

(1,325)

Net cash used in investing activities

 

 

(72,640)

 

 

(234,588)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Net repayments of debt

 

 

(266,875)