Quarterly Report (10-q)

Date : 12/07/2018 @ 5:24PM
Source : Edgar (US Regulatory)
Stock : The Michaels Companies, Inc. (MIK)
Quote : 15.1  0.04 (0.27%) @ 9:01PM

Quarterly Report (10-q)

 

 

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 November 3, 2018

 

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

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

 

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

 

As of November 27, 2018,  157,694,568 shares of The Michaels Companies, Inc.’s common stock were outstanding.

 

 

 

994

 

 

 


 

 

 

 

 

 

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 November 3, 2018 and October 28, 2017 (unaudited)

3

 

 

 

 

Consolidated Balance Sheets as of November 3, 2018, February 3, 2018 and October 28, 2017 (unaudited)

4

 

 

 

 

Consolidated Statements of Cash Flows for the 39 weeks ended November 3, 2018 and October 28, 2017 (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

 


 

 

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

 

 

November 3,

 

October 28,

 

November 3,

 

October 28,

 

 

2018

 

2017

 

2018

 

2017

Net sales

 

$

1,274,058

 

$

1,240,196

 

$

3,482,835

 

$

3,471,352

Cost of sales and occupancy expense

 

 

795,104

 

 

756,088

 

 

2,173,990

 

 

2,117,100

Gross profit

 

 

478,954

 

 

484,108

 

 

1,308,845

 

 

1,354,252

Selling, general and administrative

 

 

340,593

 

 

329,298

 

 

970,191

 

 

970,561

Restructure charge

 

 

 —

 

 

 —

 

 

44,278

 

 

 —

Store pre-opening costs

 

 

1,196

 

 

952

 

 

3,995

 

 

2,592

Operating income

 

 

137,165

 

 

153,858

 

 

290,381

 

 

381,099

Interest expense

 

 

37,798

 

 

32,818

 

 

109,493

 

 

94,305

Losses on early extinguishments of debt and refinancing costs

 

 

 —

 

 

 —

 

 

1,835

 

 

 —

Other (income) expense, net

 

 

(121)

 

 

(360)

 

 

(2,646)

 

 

950

Income before income taxes

 

 

99,488

 

 

121,400

 

 

181,699

 

 

285,844

Income taxes

 

 

15,719

 

 

41,640

 

 

43,557

 

 

98,314

Net income

 

$

83,769

 

$

79,760

 

$

138,142

 

$

187,530

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment and other

 

 

3,016

 

 

(4,418)

 

 

(3,230)

 

 

4,254

Comprehensive income

 

$

86,785

 

$

75,342

 

$

134,912

 

$

191,784

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.50

 

$

0.44

 

$

0.79

 

$

1.01

Diluted

 

$

0.50

 

$

0.44

 

$

0.78

 

$

1.00

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

165,975

 

 

180,710

 

 

174,949

 

 

185,521

Diluted

 

 

166,570

 

 

181,987

 

 

175,851

 

 

186,775

 

See accompanying notes to consolidated financial statements.

 

3

 


 

THE MICHAELS COMPANIES, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

November 3,

 

February 3,

 

October 28,

ASSETS

 

2018

 

2018

 

2017

Current Assets:

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

102,670

 

$

425,896

 

$

176,771

Merchandise inventories

 

 

1,440,875

 

 

1,123,288

 

 

1,404,206

Prepaid expenses and other

 

 

100,791

 

 

97,830

 

 

95,993

Accounts receivable, net

 

 

42,997

 

 

26,207

 

 

30,936

Income taxes receivable

 

 

6,544

 

 

3,761

 

 

5,792

Total current assets

 

 

1,693,877

 

 

1,676,982

 

 

1,713,698

Property and equipment, at cost

 

 

1,642,838

 

 

1,593,683

 

 

1,545,004

Less accumulated depreciation and amortization

 

 

(1,189,442)

 

 

(1,173,663)

 

 

(1,143,112)

Property and equipment, net

 

 

453,396

 

 

420,020

 

 

401,892

Goodwill

 

 

119,074

 

 

119,074

 

 

119,074

Other intangible assets, net

 

 

20,591

 

 

21,769

 

 

22,253

Deferred income taxes

 

 

23,367

 

 

34,538

 

 

36,946

Other assets

 

 

28,730

 

 

27,832

 

 

12,233

Total assets

 

$

2,339,035

 

$

2,300,215

 

$

2,306,096

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

645,469

 

$

483,002

 

$

674,222

Accrued liabilities and other

 

 

407,684

 

 

370,457

 

 

400,138

Current portion of long-term debt

 

 

240,261

 

 

24,900

 

 

140,125

Income taxes payable

 

 

476

 

 

79,586

 

 

16,673

Total current liabilities

 

 

1,293,890

 

 

957,945

 

 

1,231,158

Long-term debt

 

 

2,690,302

 

 

2,701,764

 

 

2,707,120

Other liabilities

 

 

144,694

 

 

150,001

 

 

100,656

Total liabilities

 

 

4,128,886

 

 

3,809,710

 

 

4,038,934

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Deficit:

 

 

 

 

 

 

 

 

 

Common stock, $0.06775 par value, 350,000 shares authorized; 158,616 shares issued and outstanding at November 3, 2018; 181,919 shares issued and outstanding at February 3, 2018; and 181,263 shares issued and outstanding at October 28, 2017

 

 

10,700

 

 

12,206

 

 

12,159

Additional paid-in-capital

 

 

 —

 

 

21,740

 

 

7,722

Treasury stock

 

 

(12,168)

 

 

 —

 

 

 —

Accumulated deficit

 

 

(1,781,493)

 

 

(1,539,781)

 

 

(1,742,749)

Accumulated other comprehensive loss

 

 

(6,890)

 

 

(3,660)

 

 

(9,970)

Total stockholders’ deficit

 

 

(1,789,851)

 

 

(1,509,495)

 

 

(1,732,838)

Total liabilities and stockholders’ deficit

 

$

2,339,035

 

$

2,300,215

 

$

2,306,096

 

See accompanying notes to consolidated financial statements.

4

 


 

THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

39 Weeks Ended

 

 

November 3,

 

October 28,

 

    

2018

 

2017

Cash flows from operating activities:

 

 

 

 

 

 

Net income

 

$

138,142

 

$

187,530

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

 

 

 

 

 

 

Depreciation and amortization

 

 

89,933

 

 

86,232

Share-based compensation

 

 

20,780

 

 

18,232

Debt issuance costs amortization

 

 

3,759

 

 

3,823

Accretion of long-term debt, net

 

 

(385)

 

 

(379)

Restructure charge

 

 

44,278

 

 

 —

Deferred income taxes

 

 

7,710

 

 

529

Losses on early extinguishments of debt and refinancing costs

 

 

1,835

 

 

 —

Changes in assets and liabilities:

 

 

 

 

 

 

Merchandise inventories

 

 

(338,260)

 

 

(275,086)

Prepaid expenses and other

 

 

(2,886)

 

 

(8,818)

Accounts receivable

 

 

(18,269)

 

 

(7,721)

Other assets

 

 

(1,314)

 

 

(1,010)

Accounts payable

 

 

150,088

 

 

150,947

Accrued interest

 

 

7,850

 

 

(314)

Accrued liabilities and other

 

 

1,077

 

 

12,685

Income taxes

 

 

(79,258)

 

 

(61,628)

Other liabilities

 

 

734

 

 

1,405

Net cash provided by operating activities

 

 

25,814

 

 

106,427

 

 

 

 

 

 

 

Cash flows used in investing activities:

 

 

 

 

 

 

Additions to property and equipment

 

 

(119,553)

 

 

(72,640)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Common stock repurchased

 

 

(430,509)

 

 

(253,595)

Payments on term loan credit facility

 

 

(17,356)

 

 

(18,675)

Borrowings on asset-based revolving credit facility

 

 

307,400

 

 

357,200

Payments on asset-based revolving credit facility

 

 

(89,400)

 

 

(248,200)

Payment of debt refinancing costs

 

 

(1,117)

 

 

 —

Payment of dividends

 

 

(317)

 

 

(408)

Proceeds from stock options exercised

 

 

1,812

 

 

7,849

Net cash used in financing activities

 

 

(229,487)

 

 

(155,829)

 

 

 

 

 

 

 

Net change in cash and equivalents

 

 

(323,226)

 

 

(122,042)

Cash and equivalents at beginning of period

 

 

425,896

 

 

298,813

Cash and equivalents at end of period

 

$

102,670

 

$

176,771

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

 

Cash paid for interest

 

$

98,864

 

$

91,794

Cash paid for taxes

 

$

115,724

 

$

159,013

 

See accompanying notes to consolidated financial statements.

 

5

 


 

THE MICHAELS COMPANIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. BASIS OF PRESENTATION

 

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

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10‑Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Therefore, these financial statements should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended February 3, 2018 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 2018” relate to the 52 weeks ending February 2, 2019 and references to “fiscal 2017” relate to the 53 weeks ended February 3, 2018. In addition, all references to “the third quarter of fiscal 2018” relate to the 13 weeks ended November 3, 2018 and all references to “the third quarter of fiscal 2017” relate to the 13 weeks ended October 28, 2017. Finally, all references to “the nine months ended November 3, 2018” relate to the 39 weeks ended November 3, 2018 and all references to “the nine months ended October 28, 2017” relate to the 39 weeks ended October 28, 2017. Because of the seasonal nature of our business, the results of operations for the 13 and 39 weeks ended November 3, 2018 are not indicative of the results to be expected for the entire year. 

 

Aaron Brothers

 

In March 2018, we closed substantially all of our Aaron Brothers stores and began the process of repositioning our Aaron Brothers brand as a store-within-a-store, providing custom framing services in all Michaels stores. In the first nine months of fiscal 2018, we recorded a restructure charge totaling $44.3 million, consisting primarily of costs associated with the termination of the remaining lease obligations, the write-off of fixed assets and employee-related expenses.  For the nine months ended November 3, 2018 and October 28, 2017, Aaron Brothers net sales totaled approximately $12.9 million and $78.0 million, respectively. Excluding the restructure charge, Aaron Brothers did not have a material impact on the Company’s operating income in the periods presented. 

 

Share Repurchase Program

 

In September 2018, the Board of Directors authorized a new share repurchase program for the Company to purchase $500.0 million of the Company’s common stock on the open market or through accelerated share repurchase transactions. The share repurchase program does not have an expiration date, and the timing and number of repurchase transactions under the program will depend on market conditions, corporate considerations, debt agreements and regulatory requirements. Shares repurchased under the program are held as treasury shares until retired. In June 2018, the Company entered into an accelerated share repurchase agreement (“ASR Agreement”) with JPMorgan Chase Bank, N.A. (“JPMorgan”). Under the ASR Agreement, we paid JPMorgan a purchase price of $250.0 million for delivery of 12.4 million shares of our common stock. The total number of shares repurchased was based upon a volume weighted average price of our stock over a predetermined period. The ASR agreement was completed on August 30, 2018. During the nine

6

 


 

months ended November 3, 2018, we repurchased 23.6 million shares under our share repurchase programs for an aggregate amount of $434.2 million, inclusive of the ASR Agreement. As of November 3, 2018, we had $416.0 million of availability remaining under our current share repurchase program.

 

Accounting Pronouncements Recently Adopted

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 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 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 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 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. We used the modified retrospective transition method to adopt ASU 2014-09 in the first quarter of fiscal 2018 with no adjustments required to our opening retained earnings. The adoption did not have a material impact to the consolidated financial statements; however, it did result in additional disclosures.

 

Recent Accounting Pronouncements Not Yet Adopted

 

In October 2018, the FASB issued ASU 2018-16, “Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes” (“ASU 2018-16”). ASU 2018-16 allows for the use of the Overnight Index Swap ("OIS") rate based on the Secured Overnight Financing Rate ("SOFR") as a U.S. benchmark interest rate for purposes of applying hedge accounting under Accounting Standard Codification (“ASC”) 815, Derivatives and Hedging . ASU 2018-16 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. We are currently evaluating the new standard but do not anticipate a material impact to the consolidated financial statements once implemented.

 

In August 2018, the FASB issued ASU 2018-15, “Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract,” (“ASU 2018-15”) . ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 is effective for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period, with early adoption permitted. The standard is to be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. We are currently evaluating the impact that ASU 2018-15 will have on the consolidated financial statements and related disclosures.

 

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”). ASU 2018-13 removes, modifies and adds certain disclosure requirements for fair value measurements under ASC 820, Fair Value Measurements (“ASC 820”). ASU 2018-13 is effective for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period, with early adoption permitted. We do not anticipate a material impact to the consolidated financial statements once implemented.

 

7

 


 

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 February 2016, the FASB issued ASU 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. The lease standard requires companies to use a modified retrospective transition approach as of the beginning of the earliest comparable period presented in the company’s financial statements. In July 2018, the FASB issued ASU 2018-11, “ Leases (Topic 842): Targeted Improvements ” which provided an additional transition option that allows companies to continue applying the guidance under the current lease standard in the comparative periods presented in the consolidated financial statements. The Company has elected to adopt this transition option and will record a cumulative-effect adjustment to the opening balance of retained earnings on the date of adoption. The guidance under these standards is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, with early adoption permitted. We are currently evaluating the impact that ASU 2016-02 will have on the consolidated 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. We do not expect a material impact on our consolidated statements of comprehensive income or our consolidated statements of cash flows once implemented.

 

2. REVENUE RECOGNITION

 

Our revenue is primarily associated with sales of merchandise to customers within our stores, customers utilizing our e-commerce platforms and through our Darice wholesale business (“Darice”). Revenue is measured based on the amount of consideration that we expect to receive, reduced by estimates for return allowances, point-of-sale coupons and discounts. Revenue also excludes any amounts collected on behalf of third parties, including sales tax. Revenue from sales of our merchandise is recognized when the customer takes possession of the merchandise. Payment for our retail sales is typically due at the time of the sale.

 

Right of Return

 

We allow for merchandise to be returned under most circumstances up to 180 days after purchase. A sales return reserve is established using historical customer return behavior and reduces both revenue and cost of goods sold. Historically, the sales returns reserve was presented net of cost of sales in other current liabilities in the consolidated balance sheets. As a result of adopting ASU 2014-09, the Company presents the gross sales return reserve in other current liabilities and the estimated value of the merchandise expected to be returned in prepaid expenses and other in the consolidated balance sheets. The change did not have a material impact on our consolidated balance sheet as of November 3, 2018.

 

8

 


 

Customer Receivables

 

As of November 3, 2018, February 3, 2018 and October 28, 2017, receivables from customers, which consist primarily of trade receivables related to Darice, were approximately  $30.5 million,  $19.2  million and $23.5 million, respectively, and are included in accounts receivable, net in the consolidated balance sheets.

 

Gift Cards

 

We record a gift card liability on the date we issue the gift card to the customer. We record revenue and reduce the gift card liability as the customer redeems the gift card or when the likelihood of redemption by the customer is remote (“gift card breakage”). We estimate gift card breakage using the expected value method based on customers’ historical redemption rates and patterns. Gift card breakage income is recorded in net sales in the consolidated statements of comprehensive income over the estimated redemption period. The gift card liability is included in accrued liabilities and other in the consolidated balance sheets.

 

The following table includes activity related to gift cards (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

39 Weeks Ended

 

 

November 3,

 

October 28,

 

November 3,

 

October 28,

 

 

2018

 

2017

 

2018

 

2017

Balance at beginning of period

 

$

50,513

 

$

44,185

 

$

56,729

 

$

49,869

Issuance of gift cards

 

 

12,077

 

 

11,582

 

 

36,873

 

 

36,536

Revenue recognized (1)

 

 

(12,403)

 

 

(11,678)

 

 

(41,541)

 

 

(41,190)

Gift card breakage

 

 

(749)

 

 

(454)

 

 

(2,623)

 

 

(1,580)

Balance at end of period

 

$

49,438

 

$

43,635

 

$

49,438

 

$

43,635


(1)

Revenue recognized from the beginning liability during the third quarters of fiscal 2018 and fiscal 2017 totaled $7.1 million. Revenue recognized from the beginning liability during the first nine months of fiscal 2018 and fiscal 2017 totaled $19.9 million and $19.4 million, respectively.

 

 

3. FAIR VALUE MEASUREMENTS

 

As defined in 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

9

 


 

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.

 

The table below provides the fair values of our senior secured term loan facility (“Amended Term Loan Credit Facility”), our 5.875% senior subordinated notes maturing in 2020 (“2020 Senior Subordinated Notes’’) and our interest rate swaps executed in April 2018.

 

 

 

 

 

 

 

 

 

 

 

 

 

November 3,

 

February 3,

 

October 28,

 

 

2018

 

2018

 

2017

 

 

(in thousands)

Assets

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

5,028

 

$

 —

 

$

 —

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Term loan credit facility

 

$

2,195,613

 

$

2,246,302

 

$

2,250,412

Senior subordinated notes

 

 

510,000

 

 

518,288

 

 

520,838

Interest rate swaps

 

 

571

 

 

 —

 

 

 —

 

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 1 inputs within the fair value hierarchy.

 

The fair value of our interest rate swaps was calculated using significant observable inputs including the present value of estimated future cash flows using the applicable interest rate curves and, therefore, were classified as Level 2 inputs within the fair value hierarchy.

 

4. DEBT

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

November 3,

 

February 3,

 

October 28,

 

Interest Rate

 

2018

 

2018

 

2017

Term loan credit facility

Variable

 

$

2,214,994

 

$

2,232,350

 

$

2,244,800

Asset-based revolving credit facility

Variable

 

 

218,000

 

 

 —

 

 

109,000

Senior subordinated notes

5.875

%

 

510,000

 

 

510,000

 

 

510,000

Total debt

 

 

 

2,942,994

 

 

2,742,350

 

 

2,863,800

Less unamortized discount/premium and debt costs

 

 

 

(12,431)

 

 

(15,686)

 

 

(16,555)

Total debt, net

 

 

 

2,930,563

 

 

2,726,664

 

 

2,847,245

Less current portion

 

 

 

(240,261)

 

 

(24,900)

 

 

(140,125)

Long-term debt

 

 

$

2,690,302

 

$

2,701,764

 

$

2,707,120

 

Revolving Credit Facility

 

As of November 3, 2018 and October 28, 2017, 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 $567.0 million and $675.7 million, respectively. As of November 3, 2018 and October 28, 2017, outstanding standby letters of credit, which reduce our borrowing base, totaled $65.0 million and $65.3 million, respectively.

 

10

 


 

Term Loan Credit Facility

 

On May 23, 2018, MSI entered into an amendment with JPMorgan and other lenders to amend and restate our term loan credit facility. The amended and restated credit agreement, together with the related security, guarantee and other agreements, is referred to as the “Amended and Restated Term Loan Credit Facility”. Borrowings under the Amended and Restated Term Loan Credit Facility bear interest at a rate per annum, at MSI’s option, of either (a) a margin of 1.50% plus a base rate defined as the highest of (1) the prime rate of JPMorgan, (2) the federal funds effective rate plus 0.5%, and (3) the one-month London Interbank Offered Rate (“LIBOR”) plus 1% or (b) a margin of 2.50% plus the applicable LIBOR. MSI is required to make scheduled quarterly payments equal to 0.25% of the original principal amount of the term loans (subject to adjustments relating to the incurrence of additional term loans) for the first four years and two quarters of the Amended and Restated Term Loan Credit Facility, with the balance to be paid on January 28, 2023. All other terms under the Amended Term Loan Credit Facility have remained unchanged. As a result of this refinancing, we recorded a loss on the early extinguishment of debt of $1.8 million during the second quarter of fiscal 2018.

 

Interest Rate Swaps

 

In April 2018, we executed two interest rate swaps with an aggregate notional value of $1.0 billion associated with our outstanding Amended Term Loan Credit Facility. The interest rate swaps have a maturity date of April 30, 2021 and were executed for risk management and are not held for trading purposes. The objective of the interest rate swaps is to hedge the variability of cash flows resulting from fluctuations in the one-month LIBOR. The swaps replaced the one-month LIBOR with a fixed interest rate of 2.7765% and payments are settled monthly. The swaps qualify as cash flow hedges and changes in the fair values are recorded in accumulated other comprehensive income in the consolidated balance sheet. The changes in fair value are reclassified from accumulated other comprehensive income to interest expense in the same period that the hedged items affect earnings. We reclassified $1.6 million and $3.7 million from accumulated other comprehensive income to interest expense during the three and nine months ended November 3, 2018, respectively.  As of November 3, 2018, the fair value of the interest rate swaps was a net asset of $4.5 million, consisting of $5.0 million recorded in other assets and $0.6 million recorded in accrued liabilities in our consolidated balance sheets. 

 

5. 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

 

 

November 3,

 

October 28,

 

November 3,

 

October 28,

 

 

2018

    

2017

    

2018

    

2017

Beginning of period

  

$

(9,906)

 

$

(5,552)

  

$

(3,660)

 

$

(14,224)

Foreign currency translation adjustment and other

 

 

(942)

 

 

(4,418)

 

 

(6,528)

 

 

4,254

Interest rate swaps

 

 

3,958

 

 

 —

 

 

3,298

 

 

 —

End of period

 

$

(6,890)

 

$

(9,970)

 

$

(6,890)

 

$

(9,970)

 

 

6. INCOME TAXES

 

The effective tax rate was 15.8% for the third quarter of fiscal 2018 compared to 34.3% for the third quarter of fiscal 2017 and 24.0% for the nine months ended November 3, 2018 compared to 34.4% for the same period in the prior year. The effective tax rate for both the third quarter of fiscal 2018 and the nine months ended November 3, 2018 were lower than the comparable period in the prior year due to benefits recognized related to the enactment of the Tax Cuts and Jobs Act (“Tax Act”) in the fourth quarter of fiscal 2017, including the reduction of the federal statutory tax rate from 35% to 21%. In addition, a provisional charge of $5.0 million was recognized for the nine months ended November 3, 2018 related to repatriation taxes for accumulated earnings of our foreign subsidiaries, partially offset by a provisional benefit of $4.0 million related to the revaluation of our net deferred tax assets as a result of the Tax Act. The U.S. Treasury is

11

 


 

expected to issue additional regulations and guidance in connection with the Tax Act, which may alter interpretations of the new tax law and could materially change our estimated provisional adjustments.

 

 

7. 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 8.4 million and 5.8 million anti-dilutive shares during the third quarters of fiscal 2018 and fiscal 2017, respectively. There were 7.1 million and 6.0 million anti-dilutive shares during the nine months ended November 3, 2018 and October 28, 2017, respectively.

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

39 Weeks Ended

 

 

November 3,

 

October 28,

 

November 3,

 

October 28,

 

 

2018

 

2017

 

2018

 

2017

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

83,769

 

$

79,760

 

$

138,142

  

$

187,530

Less income related to unvested restricted shares

 

 

(138)

 

 

(297)

 

 

(285)

 

 

(789)

Income available to common shareholders - Basic

 

$

83,631

 

$

79,463

 

$

137,857

 

$

186,741

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding - Basic

 

 

165,975

 

 

180,710

 

 

174,949

 

 

185,521

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.50

 

$

0.44

 

$

0.79

 

$

1.01

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

83,769

 

$

79,760

 

$

138,142

 

$

187,530

Less income related to unvested restricted shares

 

 

(138)

 

 

(295)

 

 

(284)

 

 

(784)

Income available to common shareholders - Diluted

 

$

83,631

 

$

79,465

 

$

137,858

 

$

186,746

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding - Basic

 

 

165,975

 

 

180,710

 

 

174,949

 

 

185,521

Effect of dilutive stock options and restricted stock units

 

 

595

 

 

1,277

 

 

902

 

 

1,254

Weighted-average common shares outstanding - Diluted

 

 

166,570

 

 

181,987

 

 

175,851

 

 

186,775

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.50

 

$

0.44

 

$

0.78

 

$

1.00

 

 

 

 

 

12

 


 

8. 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 separately 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

 

 

November 3,

 

October 28,

 

November 3,

 

October 28,

 

 

2018

 

2017

 

2018

 

2017

United States (1)

 

$

1,153,784

 

$

1,117,626

 

$

3,158,393

 

$

3,152,048

Canada

 

 

120,274

 

 

122,570

 

 

324,442

 

 

319,304

Total

 

$

1,274,058

 

$

1,240,196

 

$

3,482,835

 

$

3,471,352


(1)

In March 2018, we closed substantially all of our Aaron Brothers stores. There were no Aaron Brothers net sales in the third quarter of fiscal 2018 and net sales totaled approximately $25.2 million in the third quarter of fiscal 2017. For the nine months ended November 3, 2018 and October 28, 2017, Aaron Brothers net sales totaled approximately $12.9 million and $78.0 million, respectively.

 

 

9. CONTINGENCIES

 

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 was 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 alleged 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 sought 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

13

 


 

California Superior Court. The parties reached a class settlement which was approved by the California Superior Court on October 10, 2018. The resolution of the lawsuits did not 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.

 

10. RELATED PARTY TRANSACTIONS

 

Affiliates of, or funds advised by, Bain Capital Private Equity, L.P. (“Bain Capital”) and The Blackstone Group L.P. (“The Blackstone Group”, together with Bain Capital and their applicable affiliates, the “Sponsors”) owned approximately 46% of our outstanding common stock as of November 3, 2018.

 

The Blackstone Group owns a majority equity position in RGIS, a vendor we utilized until February 2018 to count our store inventory. There were no payments associated with this vendor during the third quarter of fiscal 2018. Payments associated with this vendor during the third quarter of fiscal 2017 were $2.3 million. Payments associated with this vendor during the nine months ended November 3, 2018 and October 28, 2017 were $0.7 million and $6.0  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 2018 and fiscal 2017 were $1.4  million and $2.0 million, respectively. Payments made during the nine months ended November 3, 2018 and October 28, 2017 were $4.7 million and $5.4 million, respectively. These expenses are included in cost of sales and occupancy expense in the consolidated statements of comprehensive income.

 

The Blackstone Group owns a majority equity position in JDA Software Group, Inc., a vendor we utilize for transportation and supply chain software. Payments associated with this vendor during the third quarters of fiscal 2018 and fiscal 2017 were $0.3 million. Payments made during the nine months ended November 3, 2018 and October 28, 2017 were $2.2 million and $1.0 million, respectively. These expenses are included in SG&A in the consolidated statements of comprehensive income.

 

Three of our current directors, Joshua Bekenstein, Ryan Cotton and Peter F. Wallace, are affiliates of either 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 November 3, 2018, affiliates of The Blackstone Group held $93.2 million of our Amended Term Loan Credit Facility.

 

 

14

 


 

11. 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.

 

Michaels Stores, Inc.

Condensed Consolidated Balance Sheets

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

November 3,

 

February 3,

 

October 28,

ASSETS

    

2018

 

2018

 

2017

Current assets:

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

101,895

 

$

425,129

 

$

176,007

Merchandise inventories

 

 

1,440,875

 

 

1,123,288

 

 

1,404,206

Prepaid expenses and other current assets

 

 

146,317

 

 

127,656

 

 

131,695

Total current assets

 

 

1,689,087

 

 

1,676,073

 

 

1,711,908

Property and equipment, net

 

 

453,396

 

 

420,020

 

 

401,892

Goodwill

 

 

119,074

 

 

119,074

 

 

119,074

Other assets

 

 

73,088

 

 

84,537

 

 

72,036

Total assets

 

$

2,334,645

 

$

2,299,704

 

$

2,304,910

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

645,469

 

$

483,002

 

$

674,222

Accrued liabilities and other

 

 

407,252

 

 

369,647

 

 

399,363

Current portion of long-term debt

 

 

240,261

 

 

24,900

 

 

140,125

Other current liabilities

 

 

41,948

 

 

124,881

 

 

60,884

Total current liabilities

 

 

1,334,930

 

 

1,002,430

 

 

1,274,594

Long-term debt

 

 

2,690,302

 

 

2,701,764

 

 

2,707,120

Other liabilities

 

 

156,770

 

 

165,662

 

 

108,112

Total stockholders’ deficit

 

 

(1,847,357)

 

 

(1,570,152)

 

 

(1,784,916)

Total liabilities and stockholders’ deficit

 

$

2,334,645

 

$

2,299,704

 

$

2,304,910

 

15

 


 

 

Michaels Stores, Inc.

Condensed Consolidated Statements of Comprehensive Income

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

39 Weeks Ended

 

 

November 3,

 

October 28,

 

November 3,

 

October 28,

 

    

2018

    

2017

    

2018

    

2017

Net sales

 

$

1,274,058

 

$

1,240,196

 

$

3,482,835

 

$

3,471,352

Cost of sales and occupancy expense

 

 

795,104

 

 

756,088

 

 

2,173,990

 

 

2,117,100

Gross profit

 

 

478,954

 

 

484,108

 

 

1,308,845

 

 

1,354,252

Selling, general and administrative

 

 

340,375

 

 

328,855

 

 

969,500

 

 

969,793

Restructure charge

 

 

 —

 

 

 —

 

 

44,278

 

 

 —

Store pre-opening costs

 

 

1,196

 

 

952

 

 

3,995

 

 

2,592

Operating income

 

 

137,383

 

 

154,301

 

 

291,072

 

 

381,867

Interest and other expense

 

 

37,680

 

 

32,460

 

 

106,857

 

 

95,261

Losses on early extinguishment of debt and refinancing costs

 

 

 —

 

 

 —

 

 

1,835

 

 

 —

Income before income taxes

 

 

99,703