10-Q 1 mik-20190504x10q.htm 10-Q mik_Current folio_10Q

 

 

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 May 4, 2019

 

Commission file number 001-36501


 

THE MICHAELS COMPANIES, INC.

A Delaware Corporation

 

IRS Employer Identification No. 37-1737959

 

 

8000 Bent Branch Drive

Irving, Texas 75063

 

(972) 409-1300


Securities registered pursuant to Section 12(b) of the Act:

 

 

 

 

 

Title of each class

    

Trading Symbol

    

Name of each exchange on which registered

Common Stock, $0.06775 par value

 

MIK

 

Nasdaq Stock Exchange

The Michaels Companies, Inc. (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

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

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

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

As of May 30, 2019, 158,170,366 shares of The Michaels Companies, Inc.’s common stock were outstanding.

 

 

 

 

 

 

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 weeks ended May 4, 2019 and May 5, 2018 (unaudited)

3

 

 

 

 

Consolidated Balance Sheets as of May 4, 2019, February 2, 2019 and May 5, 2018 (unaudited)

4

 

 

 

 

Consolidated Statements of Cash Flows for the 13 weeks ended May 4, 2019 and May 5, 2018 (unaudited)

5

 

 

 

 

Consolidated Statements of Stockholders’ Deficit for the 13 weeks ended May 4, 2019 and May 5, 2018 (unaudited)

6

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

7

 

 

 

Item 2. 

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

16

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

24

 

 

 

Item 4. 

Controls and Procedures

24

 

 

 

Part II—OTHER INFORMATION 

 

 

 

Item 1. 

Legal Proceedings

25

 

 

 

Item 1A. 

Risk Factors

25

 

 

 

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

25

 

 

 

Item 6. 

Exhibits

26

 

 

 

Signatures 

 

27

 

 

 

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

 

 

May 4,

 

May 5,

 

 

2019

 

2018

Net sales

 

$

1,093,720

 

$

1,155,511

Cost of sales and occupancy expense

 

 

676,080

 

 

698,948

Gross profit

 

 

417,640

 

 

456,563

Selling, general and administrative

 

 

320,597

 

 

328,617

Restructure charges

 

 

3,087

 

 

47,498

Store pre-opening costs

 

 

1,226

 

 

1,505

Operating income

 

 

92,730

 

 

78,943

Interest expense

 

 

37,359

 

 

34,594

Other expense (income), net

 

 

3,105

 

 

(1,693)

Income before income taxes

 

 

52,266

 

 

46,042

Income taxes

 

 

14,575

 

 

19,157

Net income

 

$

37,691

 

$

26,885

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

Foreign currency translation and other

 

 

(4,826)

 

 

(7,053)

Comprehensive income

 

$

32,865

 

$

19,832

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

Basic

 

$

0.24

 

$

0.15

Diluted

 

$

0.24

 

$

0.15

Weighted-average common shares outstanding:

 

 

 

 

 

 

Basic

 

 

157,749

 

 

181,523

Diluted

 

 

157,861

 

 

182,652

 

See accompanying notes to consolidated financial statements.

 

3

THE MICHAELS COMPANIES, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

May 4,

 

February 2,

 

May 5,

ASSETS

 

2019

 

2019

 

2018

Current Assets:

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

246,727

 

$

245,887

 

$

422,454

Merchandise inventories

 

 

1,101,729

 

 

1,108,715

 

 

1,121,563

Prepaid expenses and other

 

 

65,304

 

 

98,659

 

 

108,481

Accounts receivable, net

 

 

32,203

 

 

57,328

 

 

30,033

Income taxes receivable

 

 

4,020

 

 

4,935

 

 

2,818

Total current assets

 

 

1,449,983

 

 

1,515,524

 

 

1,685,349

Property and equipment, at cost

 

 

1,676,751

 

 

1,656,098

 

 

1,569,720

Less accumulated depreciation and amortization

 

 

(1,242,869)

 

 

(1,217,021)

 

 

(1,144,815)

Property and equipment, net

 

 

433,882

 

 

439,077

 

 

424,905

Operating lease assets

 

 

1,613,719

 

 

 —

 

 

 —

Goodwill

 

 

112,069

 

 

112,069

 

 

119,074

Other intangible assets, net

 

 

16,960

 

 

17,238

 

 

21,376

Deferred income taxes

 

 

25,577

 

 

25,005

 

 

33,338

Other assets

 

 

27,068

 

 

19,423

 

 

29,496

Total assets

 

$

3,679,258

 

$

2,128,336

 

$

2,313,538

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

406,947

 

$

485,004

 

$

449,687

Accrued liabilities and other

 

 

354,398

 

 

378,742

 

 

384,630

Current portion of operating lease liabilities

 

 

300,489

 

 

 —

 

 

 —

Current portion of long-term debt

 

 

24,900

 

 

24,900

 

 

24,900

Income taxes payable

 

 

55,339

 

 

43,907

 

 

82,219

Total current liabilities

 

 

1,142,073

 

 

932,553

 

 

941,436

Long-term debt

 

 

2,675,602

 

 

2,681,000

 

 

2,696,408

Long-term operating lease liabilities

 

 

1,380,175

 

 

 —

 

 

 —

Other liabilities

 

 

68,766

 

 

140,978

 

 

159,615

Total liabilities

 

 

5,266,616

 

 

3,754,531

 

 

3,797,459

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Deficit:

 

 

 

 

 

 

 

 

 

Common stock, $0.06775 par value, 350,000 shares authorized; 158,126 shares issued and outstanding at May 4, 2019; 157,774 shares issued and outstanding at February 2, 2019; and 182,055 shares issued and outstanding at May 5, 2018

 

 

10,620

 

 

10,594

 

 

12,225

Additional paid-in-capital

 

 

11,900

 

 

5,954

 

 

27,463

Accumulated deficit

 

 

(1,590,494)

 

 

(1,628,185)

 

 

(1,512,896)

Accumulated other comprehensive loss

 

 

(19,384)

 

 

(14,558)

 

 

(10,713)

Total stockholders’ deficit

 

 

(1,587,358)

 

 

(1,626,195)

 

 

(1,483,921)

Total liabilities and stockholders’ deficit

 

$

3,679,258

 

$

2,128,336

 

$

2,313,538

 

See accompanying notes to consolidated financial statements.

4

THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

    

2019

 

2018

Cash flows from operating activities:

 

 

 

 

 

 

Net income

 

$

37,691

 

$

26,885

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

 

 

 

 

 

 

Amortization of operating lease assets

 

 

81,371

 

 

 —

Depreciation and amortization

 

 

31,489

 

 

29,458

Share-based compensation

 

 

7,251

 

 

6,969

Debt issuance costs amortization

 

 

1,237

 

 

1,274

Loss on write-off of investment

 

 

5,036

 

 

 —

Accretion of long-term debt, net

 

 

(130)

 

 

(126)

Restructure charges

 

 

3,087

 

 

47,498

Deferred income taxes

 

 

140

 

 

2,580

Changes in assets and liabilities:

 

 

 

 

 

 

Merchandise inventories

 

 

6,966

 

 

(18,755)

Prepaid expenses and other

 

 

(6,412)

 

 

1,523

Accounts receivable

 

 

23,705

 

 

(4,892)

Other assets

 

 

(12,964)

 

 

(842)

Operating lease liabilities

 

 

(56,843)

 

 

 —

Accounts payable

 

 

(81,237)

 

 

(46,639)

Accrued interest

 

 

7,706

 

 

8,325

Accrued liabilities and other

 

 

(25,611)

 

 

(35,356)

Income taxes

 

 

12,318

 

 

11,689

Other liabilities

 

 

(1,002)

 

 

2,912

Net cash provided by operating activities

 

 

33,798

 

 

32,503

 

 

 

 

 

 

 

Cash flows used in investing activities:

 

 

 

 

 

 

Additions to property and equipment

 

 

(25,101)

 

 

(27,824)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Common stock repurchased

 

 

(2,172)

 

 

(2,119)

Payments on term loan credit facility

 

 

(6,225)

 

 

(6,225)

Payment of dividends

 

 

 —

 

 

(317)

Proceeds from stock options exercised

 

 

540

 

 

540

Net cash used in financing activities

 

 

(7,857)

 

 

(8,121)

 

 

 

 

 

 

 

Net change in cash and equivalents

 

 

840

 

 

(3,442)

Cash and equivalents at beginning of period

 

 

245,887

 

 

425,896

Cash and equivalents at end of period

 

$

246,727

 

$

422,454

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

 

Cash paid for interest

 

$

29,164

 

$

25,344

Cash paid for taxes

 

$

2,320

 

$

5,370

 

See accompanying notes to consolidated financial statements.

5

THE MICHAELS COMPANIES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT

(in thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

Number of

 

 

 

 

Additional

 

 

 

 

Other

 

 

 

 

Common

 

Common

 

Paid-in

 

Accumulated

 

Comprehensive

 

 

 

 

Shares

  

Stock

  

Capital

  

Deficit

  

Loss

  

Total

Balance at February 2, 2019

  

157,774

 

$

10,594

 

$

5,954

 

$

(1,628,185)

 

$

(14,558)

 

$

(1,626,195)

Net income

 

 —

 

 

 —

 

 

 —

 

 

37,691

 

 

 —

 

 

37,691

Foreign currency translation and other

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(4,826)

 

 

(4,826)

Share-based compensation

 

 —

 

 

 —

 

 

7,604

 

 

 —

 

 

 —

 

 

7,604

Exercise of stock options and other awards

 

555

 

 

38

 

 

502

 

 

 —

 

 

 —

 

 

540

Repurchase of stock and retirements

 

(229)

 

 

(12)

 

 

(2,160)

 

 

 —

 

 

 —

 

 

(2,172)

Issuance of restricted stock awards

 

26

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Balance at May 4, 2019

 

158,126

 

$

10,620

 

$

11,900

 

$

(1,590,494)

 

$

(19,384)

 

$

(1,587,358)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at February 3, 2018

  

181,919

  

$

12,206

  

$

21,740

  

$

(1,539,781)

  

$

(3,660)

  

$

(1,509,495)

Net income

 

 —

  

 

 —

 

 

 —

 

 

26,885

 

 

 —

 

 

26,885

Foreign currency translation and other

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(7,053)

 

 

(7,053)

Share-based compensation

 

 —

 

 

 —

 

 

7,321

 

 

 —

 

 

 —

 

 

7,321

Exercise of stock options and other awards

 

374

 

 

25

 

 

515

 

 

 —

 

 

 —

 

 

540

Repurchase of stock and retirements

 

(238)

 

 

(6)

 

 

(2,113)

 

 

 —

 

 

 —

 

 

(2,119)

Balance at May 5, 2018

 

182,055

 

$

12,225

 

$

27,463

 

$

(1,512,896)

 

$

(10,713)

 

$

(1,483,921)

 

See accompanying notes to consolidated financial statements.

6

THE MICHAELS COMPANIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. BASIS OF PRESENTATION

 

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

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10‑Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Therefore, these financial statements should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended February 2, 2019 filed with the Securities and Exchange Commission (“SEC”) pursuant to Section 13 or 15(d) under the Securities Exchange Act of 1934. In the opinion of management, all adjustments (consisting of normal recurring accruals and other items) considered necessary for a fair presentation have been included.

 

We report on the basis of a 52-week or 53-week fiscal year, which ends on the Saturday closest to January 31. All references to fiscal year mean the year in which that fiscal year began. References to “fiscal 2019” relate to the 52 weeks ending February 1, 2020 and references to “fiscal 2018” relate to the 52 weeks ended February 2, 2019. In addition, all references to “the first quarter of fiscal 2019” relate to the 13 weeks ended May 4, 2019 and all references to “the first quarter of fiscal 2018” relate to the 13 weeks ended May 5, 2018. Because of the seasonal nature of our business, the results of operations for the 13 weeks ended May 4, 2019 are not indicative of the results to be expected for the entire year.

 

Restructure Charges

 

In March 2018, we closed substantially all of our Aaron Brothers stores and in January 2019, we closed all 36 of our Pat Catan’s stores. In the first quarter of fiscal 2019, we recorded a restructure charge related to Pat Catan’s totaling $3.1 million, primarily related to employee-related expenses. In the first quarter of fiscal 2018, we recorded a restructure charge related to Aaron Brothers totaling $47.5 million, primarily related to the transfer of the rights to sell inventory and other assets to a third party to facilitate the store closures and assist with the disposition of our remaining lease obligations and employee-related expenses. In the first quarter of fiscal 2018, Pat Catan's and Aaron Brothers had net sales totaling approximately $25.8 million and $12.9 million, respectively. Excluding the restructure charges, Aaron Brothers and Pat Catan’s did not have a material impact on the Company’s operating income in the periods presented.

 

Share Repurchase Program

 

In September 2018, the Board of Directors authorized a new share repurchase program for the Company to purchase $500.0 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. As of May 4, 2019, we had $398.4 million of availability remaining under our current share repurchase program.

 

Accounting Pronouncement Recently Adopted

 

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)" ("ASU 2016-02"). Under ASU 2016‑02, an entity is required to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. ASU 2016-02 offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising

7

from leases. The lease standard requires companies to use a modified retrospective transition approach as of the beginning of the earliest comparable period presented in the company’s financial statements. In July 2018, the FASB issued ASU 2018-11, “Leases (Topic 842): Targeted Improvements”  which provided an additional transition option that allows companies to continue applying the guidance under the current lease standard in the comparative periods presented in the consolidated financial statements. We utilized the additional transition option to adopt ASU 2016-02 in the first quarter of fiscal 2019. As a result, the standard was applied starting February 3, 2019 and prior periods were not restated. We also elected the practical expedient permitted under the transition guidance which permits companies not to reassess prior conclusions on lease identification, historical lease classification and initial direct costs. The adoption of the standard resulted in the recognition of operating lease assets and liabilities of approximately $1.7 billion as of February 3, 2019. The adoption did not result in a material impact on our consolidated statements of comprehensive income.

 

2. FAIR VALUE MEASUREMENTS

 

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

 

·

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

 

·

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

 

·

Level 3—Instruments with significant unobservable inputs.

 

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

 

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

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

May 4,

 

February 2,

 

May 5,

 

 

2019

 

2019

 

2018

 

 

(in thousands)

Assets

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

 —

 

$

 —

 

$

1,106

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Term loan credit facility

 

$

2,187,467

 

$

2,177,098

 

$

2,237,256

Senior subordinated notes

 

 

511,275

 

 

511,913

 

 

518,925

Short-term portion of interest rate swaps

 

 

3,686

 

 

2,557

 

 

4,930

Long-term portion of interest rate swaps

 

 

5,408

 

 

3,809

 

 

 —

 

The fair values of our Amended and Restated 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.

8

 

The fair value of our interest rate swaps was calculated using significant observable inputs including the present value of estimated future cash flows using the applicable interest rate curves and, therefore, were classified as Level 2 inputs within the fair value hierarchy. The short-term and long-term interest rate swap liabilities are recorded in accrued liabilities and other liabilities, respectively, in our consolidated balance sheets. The interest rate swap asset in fiscal 2018 is recorded in other assets in our consolidated balance sheets.

 

3. REVENUE RECOGNITION

 

Our revenue is primarily associated with sales of merchandise to customers within our stores, customers utilizing our e-commerce platforms and through our Darice wholesale business (“Darice”). Revenue from sales of our merchandise is recognized when the customer takes possession of the merchandise. Payment for our retail sales is typically due at the time of the sale.

 

Right of Return 

 

A sales return reserve is established using historical customer return behavior and reduces both revenue and cost of goods sold. The Company presents the gross sales return reserve in other current liabilities and the estimated value of the merchandise expected to be returned in prepaid expenses and other in the consolidated balance sheets.

 

Customer Receivables

 

As of May 4, 2019, February 2, 2019 and May 5, 2018, receivables from customers, which consist primarily of trade receivables related to Darice, were approximately $22.4 million, $32.1 million and $18.4 million, respectively, and are included in accounts receivable, net in the consolidated balance sheets.

 

Gift Cards

 

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

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

 

2019

 

2018

Balance at beginning of period

 

$

61,071

 

$

56,729

Issuance of gift cards

 

 

11,325

 

 

11,543

Revenue recognized (1)

 

 

(15,747)

 

 

(15,916)

Gift card breakage

 

 

(941)

 

 

(843)

Balance at end of period

 

$

55,708

 

$

51,513


(1)

Revenue recognized from the beginning liability during the first quarters of fiscal 2019 and fiscal 2018 totaled $10.7 million. 

 

 

4. LEASES

 

We lease our retail store locations, distribution centers, office facilities and certain equipment under non-cancelable operating leases. Substantially all store leases have initial lease terms of approximately 10 years, the majority of which provide for one or more five-year renewal options. The exercise of lease renewal options is at the Company’s sole discretion. We include the lease renewal option periods in the calculation of our operating lease assets and liabilities when it is reasonably certain that we will renew the lease.

Our operating lease assets represent our right to use an underlying asset for the lease term and our operating lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. In addition, operating lease assets exclude lease incentives received. As most of our leases do not contain an implicit rate of return, we

9

use our estimated incremental borrowing rate based on the information available at the lease commencement date in determining the present value of lease payments. For operating leases that commenced prior to the adoption date of the new lease accounting standard, we used the incremental borrowing rate as of the adoption date. Lease expense for lease payments is recognized on a straight-line basis over the lease term. 

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

 

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

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

 

2019

Operating lease cost (1)

  

$

105,465

Variable lease cost  (2)

 

 

36,440

Total lease cost

 

$

141,905


(1)

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

(2)

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

 

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

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

 

2019

Operating cash outflows included in the measurement of lease liabilities

 

$

106,998

Operating lease assets obtained in exchange for new operating lease liabilities

 

$

52,709

Weighted-average remaining lease term

 

 

6.2 years

Weighted-average discount rate

 

 

5.6 %

 

Maturities of our lease liabilities are as follows as of May 4, 2019 (in thousands):

 

 

 

 

 

Fiscal Year

 

 

2019

 

$

284,284

2020

 

 

392,335

2021

 

 

337,625

2022

 

 

276,194

2023

 

 

213,765

Thereafter

 

 

509,549

Total lease payments

 

$

2,013,752

Less: Interest

 

 

(333,088)

Present value of lease liabilities

 

$

1,680,664

 

Lease payments exclude $125.2 million related to 33 leases that have been signed as of May 4, 2019 but have not yet commenced.

 

 

 

 

10

5. DEBT

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

May 4,

 

February 2,

 

May 5,

 

Interest Rate

 

2019

 

2019

 

2018

Term loan credit facility

Variable

 

$

2,201,225

 

$

2,207,450

 

$

2,226,125

Senior subordinated notes

5.875

%

 

510,000

 

 

510,000

 

 

510,000

Total debt

 

 

 

2,711,225

 

 

2,717,450

 

 

2,736,125

Less unamortized discount/premium and debt costs

 

 

 

(10,723)

 

 

(11,550)

 

 

(14,817)

Total debt, net

 

 

 

2,700,502

 

 

2,705,900

 

 

2,721,308

Less current portion

 

 

 

(24,900)

 

 

(24,900)

 

 

(24,900)

Long-term debt

 

 

$

2,675,602

 

$

2,681,000

 

$

2,696,408

 

Revolving Credit Facility

 

As of May 4, 2019 and May 5, 2018, the borrowing base under our senior secured asset-based revolving credit facility was $784.3 million and $770.7 million, respectively, of which Michaels Stores, Inc. (“MSI”) had unused borrowing capacity of $677.1 million and $674.0 million, respectively. As of May 4, 2019 and May 5, 2018, outstanding standby letters of credit, which reduce our borrowing base, totaled $107.2 million and $96.7 million, respectively.

 

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 and Restated Term Loan Credit Facility. The interest rate swaps have a maturity date of April 30, 2021 and were executed for risk management and are not held for trading purposes. The objective of the interest rate swaps is to hedge the variability of cash flows resulting from fluctuations in the one-month LIBOR. The swaps replaced the one-month LIBOR with a fixed interest rate of 2.7765% and payments are settled monthly. The swaps qualify as cash flow hedges and changes in the fair values are recorded in accumulated other comprehensive income in the consolidated balance sheet. The changes in fair value are reclassified from accumulated other comprehensive income to interest expense in the same period that the hedged items affect earnings. Amounts reclassified from accumulated other comprehensive income to interest expense during the first quarters of fiscal 2019 and fiscal 2018 were not material.

 

6. ACCUMULATED OTHER COMPREHENSIVE LOSS

 

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

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

 

2019

    

2018

Beginning of period

  

$

(14,558)

 

$

(3,660)

Foreign currency translation adjustment

 

 

(2,807)

 

 

(4,147)

Interest rate swaps

 

 

(2,019)

 

 

(2,906)

End of period

 

$

(19,384)

 

$

(10,713)

 

 

7. INCOME TAXES

 

The effective tax rate was 27.9% for the first quarter of fiscal 2019 compared to 41.6% for the first quarter of fiscal 2018. The effective tax rate for the first quarter of fiscal 2019 was lower than the same period in the prior year due primarily to an $8.1 million charge in the first quarter of 2018 related to repatriation taxes for accumulated earnings of our foreign subsidiaries associated with the enactment of the Tax Cuts and Jobs Act of 2017. The decrease was partially offset by $1.8 million of tax expense recorded in the first quarter of fiscal 2019 primarily related to the vesting of restricted shares.

11

8. EARNINGS PER SHARE

 

The Company’s unvested restricted stock awards contain non-forfeitable rights to dividends and meet the criteria of a participating security as defined by ASC 260, “Earnings Per Share”. In applying the two-class method, net income is allocated to both common and participating securities based on their respective weighted-average shares outstanding for the period. Basic earnings per share is computed by dividing net income allocated to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share is computed by dividing income available to common shareholders by the weighted-average common shares outstanding plus the potential dilutive impact from stock options and restricted stock units. Common equivalent shares are excluded from the computation if their effect is anti-dilutive. There were 11.1 million and 5.7 million anti-dilutive shares during the first quarters of fiscal 2019 and fiscal 2018, respectively.

 

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

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

 

2019

 

2018

Basic earnings per common share:

 

 

 

 

 

 

Net income

 

$

37,691

  

$

26,885

Less income related to unvested restricted shares

 

 

(39)

 

 

(67)

Income available to common shareholders - Basic

 

$

37,652

 

$

26,818

 

 

 

 

 

 

 

Weighted-average common shares outstanding - Basic

 

 

157,749

 

 

181,523

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.24

 

$

0.15

 

 

 

 

 

 

 

Diluted earnings per common share:

 

 

 

 

 

 

Net income

 

$

37,691

 

$

26,885

Less income related to unvested restricted shares

 

 

(39)

 

 

(66)

Income available to common shareholders - Diluted

 

$

37,652

 

$

26,819

 

 

 

 

 

 

 

Weighted-average common shares outstanding - Basic

 

 

157,749

 

 

181,523

Effect of dilutive stock options and restricted stock units

 

 

112

 

 

1,129

Weighted-average common shares outstanding - Diluted

 

 

157,861

 

 

182,652

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.24

 

$

0.15

 

 

9. SEGMENTS AND GEOGRAPHIC INFORMATION

 

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

 

12

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

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

 

2019

 

2018

United States(1)

 

$

994,101

 

$

1,048,001

Canada

 

 

99,619

 

 

107,510

Total

 

$

1,093,720

 

$

1,155,511


(1)

In the first quarter of fiscal 2018 we closed substantially all of our Aaron Brothers stores and in the fourth quarter of fiscal 2018 we closed all of our Pat Catan’s stores. In the first quarter of fiscal 2018, Pat Catan’s and Aaron Brothers sales totaled approximately $25.8 million and $12.9 million, respectively.

 

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 May 4, 2019.

 

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 first quarter of fiscal 2019. Payments associated with this vendor during the first quarter of fiscal 2018 were $0.7 million. 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 ShopCore Properties, LP, Blackstone Real Estate DDR Retail Holdings III, LLC and Blackstone Real Estate RC Retail Holdings, LLC and has significant influence over Edens Limited Partnership, vendors we utilize to lease certain properties. Payments associated with these vendors during the first quarters of fiscal 2019 and fiscal 2018 were $2.3 million and $2.8 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 first quarters of fiscal 2019 and fiscal 2018 were $0.7 million and $1.3 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 May 4, 2019, affiliates of The Blackstone Group held $93.8 million of our Amended and Restated Term Loan Credit Facility.

 

13

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)

 

 

 

 

 

 

 

 

 

 

 

 

 

May 4,

 

February 2,

 

May 5,

ASSETS

    

2019

 

2019

 

2018

Current assets:

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

245,944

 

$

245,108

 

$

421,685

Merchandise inventories

 

 

1,101,729

 

 

1,108,715

 

 

1,121,563

Prepaid expenses and other current assets

 

 

101,423

 

 

160,767

 

 

141,229

Total current assets

 

 

1,449,096

 

 

1,514,590

 

 

1,684,477

Property and equipment, net

 

 

433,882

 

 

439,077

 

 

424,905

Operating lease assets

 

 

1,613,719

 

 

 —

 

 

 —

Goodwill

 

 

112,069

 

 

112,069

 

 

119,074

Other assets

 

 

69,607

 

 

61,667

 

 

84,608

Total assets

 

$

3,678,373

 

$

2,127,403

 

$

2,313,064

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

406,947

 

$

485,004

 

$

449,687

Accrued liabilities and other

 

 

353,961

 

 

378,313

 

 

384,170

Current portion of operating lease liabilities

 

 

300,489

 

 

 —

 

 

 —

Current portion of long-term debt

 

 

24,900

 

 

24,900

 

 

24,900

Other current liabilities

 

 

55,339

 

 

43,907

 

 

127,568

Total current liabilities

 

 

1,141,636

 

 

932,124

 

 

986,325

Long-term debt

 

 

2,675,602

 

 

2,681,000

 

 

2,696,408

Long-term operating lease liabilities

 

 

1,380,175

 

 

 —

 

 

 —

Other liabilities

 

 

125,761

 

 

199,705

 

 

173,162

Total stockholders’ deficit

 

 

(1,644,801)

 

 

(1,685,426)

 

 

(1,542,831)

Total liabilities and stockholders’ deficit

 

$

3,678,373

 

$

2,127,403

 

$

2,313,064

 

14

 

Michaels Stores, Inc.

Condensed Consolidated Statements of Comprehensive Income

(in thousands)

 

 

 

 

 

 

 

 

 

 

13 Weeks Ended

 

 

May 4,

 

May 5,

 

    

2019

    

2018

Net sales

 

$

1,093,720

 

$

1,155,511

Cost of sales and occupancy expense

 

 

676,080

 

 

698,948

Gross profit

 

 

417,640

 

 

456,563

Selling, general and administrative

 

 

320,387

 

 

328,392

Restructure charges

 

 

3,087

 

 

47,498

Store pre-opening costs

 

 

1,226

 

 

1,505

Operating income

 

 

92,940

 

 

79,168

Interest and other expense, net

 

 

40,469

 

 

32,904

Income before income taxes

 

 

52,471

 

 

46,264

Income taxes

 

 

14,624

 

 

19,211

Net income

 

$

37,847

 

$

27,053

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

Foreign currency translation and other

 

 

(4,826)

 

 

(7,053)

Comprehensive income

 

$

33,021

 

$

20,000

 

 

 

Michaels Stores, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)