Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 


 

FORM 10-Q/A

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended August 3, 2013

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from           to           

 

Commission file number 001-09338

 


 

MICHAELS STORES, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

75-1943604

(State or other jurisdiction of

 

(I.R.S. employer

incorporation or organization)

 

identification number)

 

8000 Bent Branch Drive

Irving, Texas 75063

(Address of principal executive offices, including zip code)

 

(972) 409-1300

(Registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the Registrant: (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.* Yes o  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

As of August 26, 2013, 100 shares of the Registrant’s Common Stock were outstanding.

 


*The Registrant has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, but is not required to file such reports under such sections.

 

 

 


 


Table of Contents

 

Explanatory Note

 

Michaels Stores, Inc. (“Company”) is filing this Amendment No. 1 (“Form 10-Q/A”) to its Quarterly Report on Form 10-Q for the quarter ended August 3, 2013, filed with the Securities and Exchange Commission (“SEC”) on August 30, 2013 (the “Form 10-Q”), for the purpose of correcting historical share-based compensation expense caused by the Company’s repurchase of shares that had not been held for at least six months following the exercise of stock options under its equity incentive plans. Since the participants held such shares for less than six months following exercise (“immature shares”), liability accounting applies to the plan.

 

The Company has determined its previously issued unaudited interim consolidated financial statements for the three and six month periods ended August 3, 2013 and July 28, 2012, contained an error with respect to ASC 718, Compensation — Stock Compensation. Specifically, former participants in the Company’s Equity Incentive Plan and its successor Plan (The Michaels Companies, Inc. (“Parent”) Equity Incentive Plan, together the “Plan”) exercised stock options upon their termination from the Company, and the Company repurchased the immature shares. The Company consistently repurchased shares in this manner and therefore, under accounting rules, established a pattern of repurchasing immature shares during the third quarter of 2011. The Company determined all stock options should have been treated as liability awards in accordance with the rules of ASC 718-10-25-9. Under liability accounting, the Company re-measures the fair value of stock compensation each period and recognizes changes in fair value as awards vest and until the award is settled. The Company originally recognized expense ratably over the vesting period based on the grant date fair value of the option in accordance with the fixed method of accounting. The Company determined the accounting error was material to fiscal 2011 and fiscal 2012 financial statements and those financial statements required restatement. As a result, the Company is also restating its financial statements for the three and six months ended August 3, 2013 and July 28, 2012. The impact to share-based compensation expense for the three and six months ended August 3, 2013 was $7 million ($5, Net of tax) and $12 million ($8, Net of tax), respectively. For the three and six months ended July 28, 2012 the impact was $6 million ($4, Net of tax) and $9 million ($5, Net of tax), respectively. As part of the restatement, the Company also recorded other adjustments related to merchandise inventories and the reserve for closed facilities which were previously determined to be immaterial to the respective periods. In total, the adjustments resulted in a decline of net income by $3 million and $4 million for the three and six month periods ended August 3, 2013, respectively, and by $4 million and $6 million for the three and six month periods ended July 28, 2012.

 

In connection with the restatement of our consolidated financial statements described herein, management re-evaluated the Company’s internal controls over financial reporting and disclosure controls and share repurchase procedures. It was determined a material weakness existed beginning in the third quarter of 2011 due to management’s failure to identify the accounting implications under ASC 718 related to the Company’s practice of repurchasing immature shares following option exercises by employees upon termination of employment, as well as its failure to follow internal controls relating to the repurchase of shares. For a discussion of management’s consideration of the Company’s internal control over financial reporting and the material weakness identified, see Item 4.

 

For convenience of the reader, this amended filing sets forth the original filing, in its entirety. The following items have been amended principally as a result of, and to reflect, the restatement:

 

Part I, Item 1

- Financial Statements (unaudited)

 

 

Part I, Item 2

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

 

 

Part I, Item 4

- Controls and Procedures

 

In accordance with applicable SEC rules, this Amended Filing includes new certifications as required by Rule 12b-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) from our Chief Executive Officer and Chief Financial Officer dated as of the date of filing of this Amended Filing.

 

The remaining items contained within this amended report consist of all other items originally contained in the Form 10-Q and are included for the convenience of the reader. The sections of the Form 10-Q which were not amended are unchanged and continue in full force and effect as originally filed. This amended report speaks as of the date of the original filing and has not been updated to reflect events occurring subsequent to the original filing other than those associated with the restatement of our financial statements.

 

2


 


Table of Contents

 

MICHAELS STORES, INC.

FORM 10-Q

 

Part I—FINANCIAL INFORMATION

 

Item 1.

Financial Statements

 

 

Consolidated Balance Sheets as of August 3, 2013, February 2, 2013, and July 28, 2012 (unaudited) (Restated)

4

 

Consolidated Statements of Comprehensive Income for the quarters and six months ended August 3, 2013 and July 28, 2012 (unaudited) (Restated)

5

 

Consolidated Statements of Cash Flows for the quarters and six months ended August 3, 2013 and July 28, 2012 (unaudited) (Restated)

6

 

Notes to Consolidated Financial Statements for the quarter and six months ended August 3, 2013 (unaudited) (Restated)

7

Item 2.

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

23

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

33

Item 4.

Controls and Procedures

34

Part II—OTHER INFORMATION

 

Item 1.

Legal Proceedings

34

Item 5.

Other Information

35

Item 6.

Exhibits

36

Signatures

 

37

 

3


 


Table of Contents

 

MICHAELS STORES, INC.

Part I—FINANCIAL INFORMATION

 

Item 1.  Financial Statements.

 

MICHAELS STORES, INC.

CONSOLIDATED BALANCE SHEETS

(in millions, except share data)

(Unaudited)

 

 

 

August 3,

 

February 2,

 

July 28,

 

 

 

2013

 

2013

 

2012

 

 

 

(Restated)

 

(Restated)

 

(Restated)

 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and equivalents

 

$

51

 

$

56

 

$

113

 

Merchandise inventories

 

909

 

862

 

925

 

Prepaid expenses and other

 

96

 

86

 

89

 

Deferred income taxes

 

38

 

37

 

42

 

Income tax receivable

 

36

 

3

 

27

 

Total current assets

 

1,130

 

1,044

 

1,196

 

Property and equipment, at cost

 

1,542

 

1,502

 

1,438

 

Less accumulated depreciation and amortization

 

(1,195

)

(1,164

)

(1,112

)

Property and equipment, net

 

347

 

338

 

326

 

Goodwill

 

94

 

94

 

95

 

Debt issuance costs, net of accumulated amortization of $54, $54, and $82, respectively

 

40

 

46

 

51

 

Deferred income taxes

 

29

 

30

 

32

 

Other assets

 

5

 

3

 

3

 

Total non-current assets

 

168

 

173

 

181

 

Total assets

 

$

1,645

 

$

1,555

 

$

1,703

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

289

 

$

263

 

$

277

 

Accrued liabilities and other

 

335

 

367

 

353

 

Share-based compensation liability

 

19

 

35

 

29

 

Current portion of long-term debt

 

238

 

150

 

1

 

Deferred income taxes

 

4

 

4

 

1

 

Income taxes payable

 

 

37

 

 

Total current liabilities

 

885

 

856

 

661

 

Long-term debt

 

2,882

 

2,891

 

3,363

 

Deferred income taxes

 

2

 

2

 

11

 

Share-based compensation liability

 

26

 

27

 

23

 

Other long-term liabilities

 

81

 

83

 

86

 

Total long-term liabilities

 

2,991

 

3,003

 

3,483

 

Total liabilities

 

3,876

 

3,859

 

4,144

 

Commitments and contingencies

 

 

 

 

 

 

 

Stockholders’ deficit:

 

 

 

 

 

 

 

Common Stock, $0.10 par value, 100 shares authorized; 100 shares issued and outstanding

 

 

––

 

––

 

Additional paid-in capital

 

61

 

49

 

52

 

Accumulated deficit

 

(2,296

)

(2,359

)

(2,499

)

Accumulated other comprehensive income

 

4

 

6

 

6

 

Total stockholders’ deficit

 

(2,231

)

(2,304

)

(2,441

)

Total liabilities and stockholders’ deficit

 

$

1,645

 

$

1,555

 

$

1,703

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

 

MICHAELS STORES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in millions)

(Unaudited)

 

 

 

Quarter Ended

 

Six Months Ended

 

 

 

August 3,

 

July 28,

 

August 3,

 

July 28,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(Restated)

 

(Restated)

 

Net sales

 

$

904

 

$

892

 

$

1,897

 

$

1,870

 

Cost of sales and occupancy expense

 

567

 

557

 

1,151

 

1,124

 

Gross profit

 

337

 

335

 

746

 

746

 

Selling, general, and administrative expense

 

254

 

251

 

526

 

510

 

Share-based compensation

 

8

 

3

 

11

 

7

 

Related party expenses

 

3

 

4

 

7

 

7

 

Store pre-opening costs

 

1

 

1

 

3

 

2

 

Operating income

 

71

 

76

 

199

 

220

 

Interest expense

 

45

 

61

 

92

 

127

 

Refinancing costs and losses on early extinguishment of debt

 

 

 

7

 

 

Other (income) and expense, net

 

1

 

 

1

 

(1

)

Income before income taxes

 

25

 

15

 

99

 

94

 

Provision for income taxes

 

8

 

6

 

36

 

34

 

Net income

 

17

 

9

 

63

 

60

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment and other

 

(1

)

(2

)

(2

)

 

Comprehensive income

 

$

16

 

$

7

 

$

61

 

$

60

 

 

See accompanying notes to consolidated financial statements.

 

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MICHAELS STORES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(Unaudited)

 

 

 

Six Months Ended

 

 

 

August 3,

 

July 28,

 

 

 

2013

 

2012

 

 

 

(Restated)

 

Operating activities:

 

 

 

 

 

Net income

 

$

63

 

$

60

 

Adjustments:

 

 

 

 

 

Depreciation and amortization

 

50

 

46

 

Share-based compensation

 

13

 

11

 

Debt issuance costs amortization

 

4

 

8

 

Refinancing costs and losses on early extinguishment of debt

 

7

 

 

Changes in assets and liabilities:

 

 

 

 

 

Merchandise inventories

 

(47

)

(82

)

Prepaid expenses and other

 

(13

)

(9

)

Accounts payable

 

43

 

(23

)

Accrued interest

 

(2

)

(4

)

Accrued liabilities and other

 

(59

)

(42

)

Income taxes

 

(71

)

(46

)

Other long-term liabilities

 

(2

)

1

 

Net cash used in operating activities

 

(14

)

(80

)

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

Additions to property and equipment

 

(50

)

(45

)

Net cash used in investing activities

 

(50

)

(45

)

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

Redemption of senior subordinated notes due 2016

 

(142

)

 

Repurchase of subordinated discount notes due 2016

 

 

(127

)

Repayments on senior secured term loan facility

 

(4

)

 

Borrowings on asset-based revolving credit facility

 

375

 

 

Payments on asset-based revolving credit facility

 

(154

)

 

Payment of capital leases

 

(2

)

(1

)

Change in cash overdraft

 

(14

)

(5

)

Net cash provided by (used in) financing activities

 

59

 

(133

)

 

 

 

 

 

 

Net decrease in cash and equivalents

 

(5

)

(258

)

Cash and equivalents at beginning of period

 

56

 

371

 

Cash and equivalents at end of period

 

$

51

 

$

113

 

 

 

 

 

 

 

Supplemental Cash Flow Information:

 

 

 

 

 

Cash paid for interest

 

$

89

 

$

122

 

Cash paid for income taxes

 

$

109

 

$

80

 

 

See accompanying notes to consolidated financial statements.

 

6


 


Table of Contents

 

MICHAELS STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter and Six Months Ended August 3, 2013

(Unaudited)

 

Note 1.   Summary of Significant Accounting Policies

 

Basis of Presentation

 

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

 

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 notes 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, 2013.

 

The balance sheet at February 2, 2013 has been derived from the restated audited financial statements at that date, but does not include all of the information and notes required by GAAP for complete financial statements.

 

In the opinion of management, all adjustments (consisting of normal recurring accruals and other items) considered necessary for a fair presentation have been included.

 

Because of the seasonal nature of our business, the results of operations for the quarter ended August 3, 2013 are not indicative of the results to be expected for the entire year.

 

We report on the basis of a 52- or 53-week fiscal year, which ends on the Saturday closest to January 31. All references herein to “fiscal 2013” relate to the 52 weeks ending February 1, 2014, and all references to”fiscal 2012” relate to the 53 weeks ended February 2, 2013.  In addition, all references herein to “the second quarter of fiscal 2013” relate to the 13 weeks ended August 3, 2013, and all references to “the second quarter of fiscal 2012” relate to the 13 weeks ended July 28, 2012. Finally, all references to “the six months ended August 3, 2013” relate to the 26 weeks ended August 3, 2013, and “the six months ended July 28, 2012” relate to the 26 weeks ended July 28, 2012.

 

Recent Accounting Pronouncements

 

In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss or a Tax Credit Carryforward Exists.” ASU 2013-11 requires unrecognized tax benefits to be presented as a decrease in a net operating loss, similar tax loss or tax credit carryforward  if certain criteria are met.    ASU 2013-11, which is prospective, is effective for reporting periods beginning after December 15, 2013, with earlier adoption permitted.  Retrospective application is also permitted. We are still evaluating the standard to determine when we will adopt the standard but we do not believe the implementation of this standard will result in a material impact to our financial statements.

 

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Table of Contents

 

Note 2.   Restatement — Share-based Compensation

 

The Company has determined its previously issued unaudited interim consolidated financial statements for the three and six month periods ended August 3, 2013 and July 28, 2012, contained an error with respect to Accounting Standards Codification (“ASC”) 718, Compensation — Stock Compensation. Specifically, former participants in the Company’s Equity Incentive Plan and its successor Plan (The Michaels Companies, Inc. (“Parent”) Equity Incentive Plan, together the “Plan”) exercised stock options upon their termination from the Company, and the Company repurchased the immature shares. The Company consistently repurchased shares in this manner and therefore, under accounting rules, established a pattern of repurchasing immature shares during the third quarter of 2011. The Company determined all stock options should have been treated as liability awards in accordance with the rules of ASC 718-10-25-9. Under liability accounting, the Company re-measures the fair value of stock compensation each period and recognizes changes in fair value as awards vest and until the award is settled. The Company originally recognized expense ratably over the vesting period based on the grant date fair value of the option in accordance with the fixed method of accounting. The Company determined the accounting error was material to fiscal 2011 and fiscal 2012 financial statements and those financial statements required restatement. As a result, the Company is also restating its financial statements for the three and six months ended August 3, 2013 and July 28, 2012. The impact to share-based compensation expense for the three and six months ended August 3, 2013, was $7 million ($5, net of tax) and $12 million ($8, net of tax), respectively.   The impact to share-based compensation expense for the three and six months ended July 28, 2012, was $6 million ($4, net of tax) and $9 million ($5, net of tax), respectively.   As part of the restatement, the Company also recorded other adjustments related to merchandise inventories and the reserve for closed facilities which were previously determined to be immaterial to the respective periods. In total, the adjustments resulted in a decline of Net income by $3 and $4 million for the three and six months ended August 3, 2013, and $4 and $6 million for the three and six months ended July 28, 2012.

 

The following footnotes have been restated:

 

·                  Note 6 — Income Taxes

 

·                  Note 9 — Segments and Geographic Information

 

·                  Note 11 — Condensed Consolidating Financial Information

 

The following tables illustrate the correction as associated with certain line items in the unaudited interim consolidated financial statements (amounts in millions):

 

 

 

Consolidated Balance Sheet
As of August 3, 2013

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Merchandise inventories

 

$

905

 

$

4

 

$

 

$

909

 

Deferred income taxes

 

37

 

1

 

 

38

 

Income tax receivable

 

34

 

2

 

 

36

 

Total current assets

 

1,123

 

7

 

 

1,130

 

Deferred income taxes

 

13

 

16

 

 

29

 

Total non-current assets

 

152

 

16

 

 

168

 

Accrued liabilities and other

 

338

 

(3

)

 

335

 

Share-based compensation liability

 

 

19

 

 

19

 

Income taxes payable

 

1

 

(1

)

 

 

Total current liabilities

 

870

 

15

 

 

885

 

Share-based compensation liability

 

 

26

 

 

26

 

Total long-term liabilities

 

2,965

 

26

 

 

2,991

 

Additional paid-in capital

 

60

 

1

 

 

61

 

Accumulated deficit

 

(2,277

)

(19

)

 

(2,296

)

Total stockholders’ deficit

 

(2,213

)

(18

)

 

(2,231

)

 

 

 

Consolidated Balance Sheet
As of July 28, 2012

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Merchandise inventories

 

$

922

 

$

3

 

$

 

$

925

 

Total current assets

 

1,193

 

3

 

 

1,196

 

Deferred income taxes

 

18

 

14

 

 

32

 

Total non-current assets

 

167

 

14

 

 

181

 

Accrued liabilities and other

 

351

 

2

 

 

353

 

Share-based compensation liability

 

 

29

 

 

29

 

Income taxes payable

 

2

 

(2

)

 

 

Total current liabilities

 

632

 

29

 

 

661

 

Share-based compensation liability

 

 

23

 

 

23

 

Total long-term liabilities

 

3,460

 

23

 

 

3,483

 

Additional paid-in capital

 

62

 

(10

)

 

52

 

Accumulated deficit

 

(2,474

)

(25

)

 

(2,499

)

Total stockholders’ deficit

 

(2,406

)

(35

)

 

(2,441

)

 

 

 

Consolidated Statements of Comprehensive Income
Quarter Ended August 3, 2013

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Cost of sales and occupancy expense

 

$

567

 

$

1

 

$

(1

)

$

567

 

Gross Profit

 

337

 

(1

)

1

 

337

 

Selling, general and administrative expense

 

258

 

(2

)

(2

)

254

 

Share-based compensation

 

 

8

 

 

8

 

Operating income

 

75

 

(7

)

3

 

71

 

Income before income taxes

 

29

 

(7

)

3

 

25

 

Provision for income taxes

 

9

 

(2

)

1

 

8

 

Net income

 

20

 

(5

)

2

 

17

 

Comprehensive income

 

19

 

(5

)

2

 

16

 

 

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Table of Contents

 

 

 

Consolidated Statements of Comprehensive Income 
Six Months Ended August 3, 2013

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Cost of sales and occupancy expense

 

$

1,153

 

$

2

 

$

(4

)

$

1,151

 

Gross Profit

 

744

 

(2

)

4

 

746

 

Selling, general and administrative expense

 

529

 

(1

)

(2

)

526

 

Share-based compensation

 

 

11

 

 

11

 

Operating income

 

205

 

(12

)

6

 

199

 

Income before income taxes

 

105

 

(12

)

6

 

99

 

Provision for income taxes

 

38

 

(4

)

2

 

36

 

Net income

 

67

 

(8

)

4

 

63

 

Comprehensive income

 

65

 

(8

)

4

 

61

 

 

 

 

Consolidated Statements of Comprehensive Income
Quarter Ended July 28, 2012

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Cost of sales and occupancy expense

 

$

553

 

$

4

 

$

 

$

557

 

Gross Profit

 

339

 

(4

)

 

335

 

Selling, general and administrative expense

 

252

 

(1

)

 

251

 

Share-based compensation

 

 

3

 

 

3

 

Operating income

 

82

 

(6

)

 

76

 

Income before income taxes

 

21

 

(6

)

 

15

 

Provision for income taxes

 

8

 

(2

)

 

6

 

Net income

 

13

 

(4

)

 

9

 

Comprehensive income

 

11

 

(4

)

 

7

 

 

 

 

Consolidated Statements of Comprehensive Income
Six Months Ended July 28, 2012

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Cost of sales and occupancy expense

 

$

1,119

 

$

4

 

$

1

 

$

1,124

 

Gross Profit

 

751

 

(4

)

(1

)

746

 

Selling, general and administrative expense

 

512

 

(2

)

 

510

 

Share-based compensation

 

 

7

 

 

7

 

Operating income

 

230

 

(9

)

(1

)

220

 

Income before income taxes

 

104

 

(9

)

(1

)

94

 

Provision for income taxes

 

38

 

(4

)

 

34

 

Net income

 

66

 

(5

)

(1

)

60

 

Comprehensive income

 

66

 

(5

)

(1

)

60

 

 

 

 

Cash Flow Data
Six Months Ended August 3, 2013

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Operating Activities:

 

 

 

 

 

 

 

 

 

Net income

 

$

67

 

(7

)

3

 

$

63

 

Share-based compensation

 

1

 

12

 

 

13

 

Merchandise inventories

 

(40

)

(2

)

(5

)

(47

)

Accrued liabilities and other

 

(38

)

(21

)

 

(59

)

Income taxes

 

(71

)

(2

)

2

 

(71

)

Net cash provided by (used in) operating activities

 

6

 

(20

)

 

(14

)

Repurchase of common stock

 

(45

)

45

 

 

 

Proceeds from stock options exercised

 

25

 

(25

)

 

 

Net cash provided by financing activities

 

39

 

20

 

 

59

 

 

 

 

Cash Flow Data
Six Months Ended July 28, 2012

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Operating Activities:

 

 

 

 

 

 

 

 

 

Net income

 

$

66

 

(5

)

(1

)

$

60

 

Share-based compensation

 

3

 

8

 

 

11

 

Merchandise inventories

 

(82

)

(1

)

1

 

(82

)

Income taxes

 

(43

)

(3

)

 

(46

)

Net cash used in operating activities

 

(79

)

(1

)

 

(80

)

Repurchase of common stock

 

(3

)

3

 

 

 

Proceeds from stock options exercised

 

2

 

(2

)

 

 

Net cash provided by (used in) financing activities

 

(134

)

1

 

 

(133

)

 

9



Table of Contents

 

Note 3.   Debt

 

Our outstanding debt is detailed in the table below. We were in compliance with the terms and conditions of all debt agreements for all periods presented.

 

 

 

August 3, 2013

 

February 2, 2013

 

July 28, 2012

 

Interest Rate

 

 

 

 

 

(in millions)

 

 

 

 

 

Senior secured term loan

 

$

1,636

 

$

1,640

 

$

1,996

 

Variable

 

Senior notes

 

1,007

 

1,007

 

795

 

7.750%

 

Senior subordinated notes

 

255

 

393

 

393

 

11.375%

 

Subordinated discount notes

 

 

 

180

 

13.000%

 

Asset-based revolving credit facility

 

222

 

1

 

 

Variable

 

Total debt

 

3,120

 

3,041

 

3,364

 

 

 

Less current portion

 

238

 

150

 

1

 

 

 

Long-term debt

 

$

2,882

 

$

2,891

 

$

3,363

 

 

 

 

113/8% Senior Subordinated Notes due 2016

 

                On January 28, 2013, we caused to be delivered to the holders of our outstanding 113/8% Senior Subordinated Notes due November 1, 2016 (the “Senior Subordinated Notes”) an irrevocable notice relating to the redemption of $137 million in aggregate principal amount of the Senior Subordinated Notes. On February 27, 2013, we redeemed the $137 million of Senior Subordinated Notes at a redemption price equal to 103.792%.  In accordance with Accounting Standards Codification (“ASC”) 470 Debt, we recorded a loss on early extinguishment of debt of approximately $7 million related to the partial redemption of our Senior Subordinated Notes. The $7 million loss is comprised of a $5 million redemption premium and $2 million to write off related debt issuance costs.

 

Restated Revolving Credit Facility

 

As of August 3, 2013, the borrowing base of our restated senior secured asset-based revolving credit facility (“the Restated Revolving Credit Facility”) was $650 million, of which we had $222 million in borrowings, $61 million of outstanding letters of credit and the unused borrowing capacity was $367 million.

 

Restated Term Loan Credit Facility

 

The Company is required to make scheduled quarterly payments, each equal to 0.25% of the original principal amount of the term loans, subject to adjustments relating to the incurrence of additional term loans under the Restated Term Loan Credit Facility, for the first six years and three quarters, with the balance paid on January 28, 2020.  The Company paid $4 million for the quarter ended August 3, 2013 and the current portion of debt includes $16 million that will be paid during the next four quarters.

 

Note 4.   Comprehensive Income

 

Accumulated other comprehensive income, net of tax, is reflected in the Consolidated Balance Sheets as follows:

 

 

 

Foreign Currency
Translation
and Other

 

 

 

(in millions)

 

Balance at February 2, 2013

 

$

6

 

Foreign currency translation adjustment

 

(2

)

Balance at August 3, 2013

 

$

4

 

 

Note 5.   Fair Value Measurements

 

As defined in ASC 820, Fair Value Measurements and Disclosures, 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.

 

We apply fair value techniques on a non-recurring basis for the establishment of potential impairment loss related to goodwill pursuant to ASC 350, Intangibles—Goodwill and Other and determining the fair value of long-lived assets pursuant to ASC 360, Property, Plant, and Equipment. During the quarter and six months ended August 3, 2013, there were no material events or changes in circumstances indicating the carrying amounts of our goodwill or long-lived assets may not be recoverable.

 

The table below provides the carrying and fair values of our senior secured term loan facility (“Restated Term Loan Credit Facility”), our 7 3/4% Senior Notes that mature in 2018 (“2018 Senior Notes”) and our Senior Subordinated Notes, (together, with our 2018 Senior Notes, “our notes”) as of August 3, 2013. The fair value of our Restated Term Loan Credit Facility was determined based on quoted market prices of similar instruments which are considered Level 2 inputs within the fair value hierarchy. The fair value of our notes was determined based on recent trades which are considered Level 1 inputs within the fair value hierarchy.

 

 

 

Carrying Value

 

Fair Value

 

 

 

(in millions)

 

Senior secured term loan

 

$

1,636

 

$

1,645

 

Senior notes

 

1,007

 

1,079

 

Senior subordinated notes

 

255

 

267

 

 

10



Table of Contents

 

Note 6.   Income Taxes

 

The effective tax rate was 32.0% for the second quarter of fiscal 2013. The effective tax rate was 40.0% for the second quarter of fiscal 2012. The current year tax rate is lower than the prior year tax rate due primarily to the realization of state tax credits this year.

 

The effective tax rate was 36.4% for the first six months of fiscal 2013. The effective tax rate was 36.2% for the first six months of fiscal 2012. The rate was higher than the prior year six month tax rate due primarily to the realization of state tax credits this year partly offset by the prior year favorable impact related to our reserve for uncertain tax positions. We currently estimate our annualized effective tax rate for fiscal 2013 to be 37.4%.

 

Note 7.   Commitments and Contingencies

 

We are involved in ongoing legal and regulatory proceedings.  Other than those described in the following paragraphs, there were no material changes to our disclosures of commitments and contingencies from our Annual Report on Form 10-K for the fiscal year ended February 2, 2013 and our Quarterly Report on Form 10-Q for the quarterly period ended May 4, 2013.

 

Consumer Class Action Claims

 

Massachusetts Zip Code Claims

 

Relying in part on the California Supreme Court decision, an additional purported class action lawsuit was filed on May 20, 2011 against the Company: Melissa Tyler v. Michaels Stores, Inc. in the U.S. District Court-District of Massachusetts, alleging violation of a Massachusetts statute regarding the collection of personally identification information in connection with a credit card transaction.   On March 11, 2013, the Massachusetts Supreme Judicial Court ruled on certified questions on the interpretation of the statute and remanded the case to the U.S. District Court for further proceedings.  Following the Judicial Court’s decision, an additional purported class action lawsuit asserting the same allegations in Tyler was filed in the U.S. District Court-District of Massachusetts by Susan D’Esposito, and the two cases have been consolidated.   On August 12, 2013, a tentative settlement that is subject to Court approval was reached for an amount that will not have a material effect on our Consolidated Financial Statements.

 

Governmental inquiries and related matters

 

Non-U.S. trust inquiry

 

In early 2005, the District Attorney’s office of the County of New York and the SEC opened inquiries concerning non-U.S. trusts that directly or indirectly held shares of Michaels common stock and common stock options. On July 29, 2010, the SEC filed a civil enforcement action in federal district court for the Southern District of New York against Charles Wyly, Sam Wyly, the Wylys’ attorney—Michael French, and others alleging, among other things, violations of various federal securities laws, including those governing ownership reporting and trading of securities, in connection with the non-U.S. trusts and their subsidiaries. Additional information may be obtained at the SEC’s website. Sam Wyly, the estate of Charles Wyly and Mr. French, also a former director of the Company, have requested indemnification from the Company for certain legal costs with respect to these matters. The Company has resolved all claims with regards to Sam Wyly and the estate of Charles Wyly for an immaterial amount.

 

On April 12, 2012, Mr. French filed a lawsuit against the Company and the non-U.S. trusts in the District Court of Dallas County, Texas. The matter was dismissed as to the non-U.S. trusts. Mr. French seeks damages from the Company for breach of contract, attorneys’ fees and costs related to the Company’s alleged indemnification obligations to Mr. French and attorneys’ fees and costs related to the lawsuit. On August 9, 2013, the dispute was settled for an amount that will not have a material effect on our Consolidated Financial Statements.

 

General

 

In addition to the litigation discussed above, we are, and in the future, may be 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.

 

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Table of Contents

 

ASC 450, Contingencies, governs the disclosure and recognition of loss contingencies, including potential losses from litigation and regulatory matters. It imposes different requirements for the recognition and disclosure of loss contingencies based on the likelihood of occurrence of the contingent future event or events. It distinguishes among degrees of likelihood using the following three terms: “probable”, meaning that “the future event or events are likely to occur”; “remote”, meaning that “the chance of the future event or events occurring is slight”; and “reasonably possible”, meaning that “the chance of the future event or events occurring is more than remote but less than likely”. In accordance with ASC 450, the Company accrues for a loss contingency when we conclude that the likelihood of a loss is probable and the amount of the loss can be reasonably estimated. When the loss cannot be reasonably estimated we estimate the range of amounts, and if no amount in the range constitutes a better estimate than any other amount, we accrue for the amount at the low end of the range. We adjust our accruals from time to time as we receive additional information, but the loss we incur may be significantly greater than or less than the amount we have accrued. We disclose loss contingencies if there is at least a reasonable possibility that a material loss has been incurred. No accrual or disclosure is required for losses that are remote.

 

For some of the matters disclosed above, as well as other matters previously disclosed in the Company’s filings with the Securities and Exchange Commission (“SEC”), the Company is currently able to estimate a reasonably possible loss or range of loss in excess of amounts accrued (if any). For some of the matters included within this estimation, an accrual has been made because a loss is believed to be both probable and reasonably estimable, but an exposure to loss exists in excess of the amount accrued; in these cases, the estimate reflects the reasonably possible range of loss in excess of the accrued amount. For other matters included within this estimation, no accrual has been made because a loss, although estimable, is believed to be reasonably possible, but not probable; in these cases the estimate reflects the reasonably possible loss or range of loss within the ranges identified. For the various ranges identified, the aggregate of these estimated amounts is approximately $10 million, which is also inclusive of amounts accrued by the Company.

 

For other matters disclosed above or as previously disclosed in the Company’s filings with the SEC, the Company is not currently able to estimate the reasonably possible loss or range of loss, and has indicated such. Many of these matters remain in preliminary stages (even in some cases where a substantial period of time has passed since the commencement of the matter), with few or no substantive legal decisions by the court defining the scope of the claims, the class (if any), or the potentially available damages, and fact discovery is still in progress or has not yet begun. For all these reasons, the Company cannot at this time estimate the reasonably possible loss or range of loss, if any, for these matters.

 

It is the opinion of the Company’s management, based on current knowledge and after taking into account its current legal accruals, the eventual outcome of all matters described in this Note would not be likely to have a material impact on the consolidated financial condition of the Company. Nonetheless, given the substantial or indeterminate amounts sought in certain of these matters, and the inherent unpredictability of such matters, an adverse outcome in certain of these matters could, from time to time, have a material effect on the Company’s consolidated results of operations or cash flows in particular quarterly or annual periods.

 

Note 8.   The Michaels Companies and its Subsidiaries

 

In July 2013, Michaels was reorganized into a holding company structure (“Reorganization”).  The Michaels Companies, Inc. (“Parent”), Michaels FinCo Holdings, LLC (“FinCo Holdings”), Michaels FinCo, Inc. (“ FinCo Inc”) and Michaels Funding, Inc. (“Holdings”) and Michaels Stores Merger Co, Inc. (“MergerCo”) were formed in connection with the Reorganization: (i) MergerCo was merged with and into Michaels with Michaels being the surviving corporation; (ii) each share of Michaels’ common stock was converted into the right to receive one share of Parent common stock, subject to the same vesting conditions, if any, as applied to the share so converted, and each such share of Michaels’ common stock was cancelled and retired and ceased to exist; and (iii)  each option to purchase one or more shares of common stock of Michaels was assumed by Parent and converted into an option to purchase an equivalent number of shares of common stock of Parent with the remaining terms of each such option remaining unchanged except as was necessary to reflect the Reorganization. Approximately 118 million shares of Michaels’ common stock were converted into Parent common stock. The Michaels’ shares were then cancelled and retired and an amount equal to the par value of the original shares was transferred from the common stock account to paid-in capital. Michaels then issued 100 shares of stock with a $0.10 par value to Holdings. In addition, common stock issued and outstanding and additional paid-in capital for February 2, 2013 and July 28, 2012 on the Consolidated Balance Sheets have been adjusted to reflect this transaction as if it happened prior to those dates.

 

As a result of the Reorganization, FinCo Holdings is wholly owned by the Parent.  FinCo Inc and Holdings are wholly owned by FinCo Holdings.  Michaels is wholly owned by Holdings.

 

Subsequent to the Reorganization, on July 29, 2013, FinCo Holdings and FinCo Inc issued $800 million aggregate principal amount of 7.50%/8.25% PIK Toggle Notes due 2018 (“PIK Notes”). The PIK Notes were issued in a private transaction.  Interest payments on the PIK Notes are due February 1 and August 1 of each year until maturity.  The first two interest payments and the last interest payment are required to be paid entirely in cash.  All other interest payments must be made in cash, except that all or a portion of the interest on the PIK Notes may be paid by increasing the principal amount of the outstanding PIK Notes or by issuing additional PIK Notes depending on the amount of cash dividends that can be paid by the Company under our credit agreements governing our Senior Secured Credit Facilities, the terms of the indentures governing our outstanding notes and the terms of our other indebtedness outstanding at the time.  The proceeds from the debt issuance were about $782 million, after deducting the initial purchasers’ discount and estimated fees and expenses.  FinCo Holdings distributed the net proceeds to Parent and the proceeds were used to fund a cash dividend to the Parent’s equity and equity-award holders and pay related fees and expenses.

 

12



Table of Contents

 

The PIK Notes are senior unsecured obligations of FinCo Holdings and FinCo Inc and are not guaranteed by the Company or any of the Company’s subsidiaries.  In addition, neither the PIK Notes nor the dividend transaction is reflected in the financial statements of the Company.  If interest on the PIK Notes is paid in cash, annual interest payments will total $60 million or a total of approximately $301 million from July 29, 2013 until August, 1, 2018, the maturity date.  Any cash interest payments will be funded by the Company through a cash dividend to Holdings.

 

Note 9.   Segments and Geographic Information

 

We consider our Michaels — U.S., Michaels — Canada, Aaron Brothers and online scrapbooking business operations to be our operating segments for purposes of determining reportable segments based on the criteria of ASC 280, Segment Reporting. We determined that our Michaels — U.S., Michaels — Canada, and Aaron Brothers operating segments have similar economic characteristics and meet the aggregation criteria set forth in ASC 280. Therefore, we combine those operating segments into one reporting segment.  During the second quarter of 2013, the online scrapbooking business was discontinued; as an operating segment, it is immaterial to the financial statements as a whole.

 

Our sales and assets by country are as follows:

 

 

 

Quarter Ended

 

Six Months Ended

 

 

 

August 3, 2013

 

July 28, 2012

 

August 3, 2013

 

July 28, 2012

 

 

 

(in millions)

 

Net Sales:

 

 

 

 

 

 

 

 

 

United States

 

$

819

 

$

812

 

$

1,717

 

$

1,703

 

Canada

 

85

 

80

 

180

 

167

 

Consolidated Total

 

$

904

 

$

892

 

$

1,897

 

$

1,870

 

 

 

 

August 3, 2013

 

February 2, 2013

 

July 28, 2012

 

 

 

 

 

(in millions)

 

 

 

 

 

(Restated)

 

(Restated)

 

(Restated)

 

 

 

Total Assets:

 

 

 

 

 

 

 

 

 

United States

 

$

1,522

 

$

1,446

 

$

1,586

 

 

 

Canada

 

123

 

109

 

117

 

 

 

Consolidated Total

 

$

1,645

 

$

1,555

 

$

1,703

 

 

 

 

Our chief operating decision makers evaluate historical operating performance, plan and forecast future periods’ operating performance based on earnings before interest, income taxes, depreciation, amortization, and refinancing costs and losses on early extinguishment of debt (“EBITDA (excluding refinancing costs and losses on early extinguishment of debt)”). We believe EBITDA (excluding refinancing costs and losses on early extinguishment of debt) represents the financial measure that more closely reflects the operating effectiveness of factors over which management has control. As such, an element of base incentive compensation targets for certain management personnel are based on EBITDA (excluding refinancing costs and losses on early extinguishment of debt). A reconciliation of EBITDA (excluding refinancing costs and losses on early extinguishment of debt) to Net income is presented below.

 

 

 

Quarter Ended

 

Six Months Ended

 

 

 

August 3, 2013

 

July 28, 2012

 

August 3, 2013

 

July 28, 2012

 

 

 

(Restated)

 

(Restated)

 

 

 

(in millions)

 

Net income

 

$

17

 

$

9

 

$

63

 

$

60

 

Interest expense

 

45

 

61

 

92

 

127

 

Refinancing costs and losses on early extinguishments of debt

 

 

 

7

 

 

Provision for income taxes

 

8

 

6

 

36

 

34

 

Depreciation and amortization

 

25

 

22

 

50

 

46

 

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

 

$

95

 

$

98

 

$

248

 

$

267

 

 

13


 


Table of Contents

 

Note 10. Related Party Transactions

 

We pay annual management fees to Bain Capital Partners, LLC (“Bain Capital”) and The Blackstone Group L.P. (“The Blackstone Group” and, together with Bain Capital, the “Sponsors”) and Highfields Capital Management LP in the amount of $12 million and $1 million, respectively. We recognized $3 million and $4 million of expense related to annual management fees during the second quarter of fiscal 2013 and fiscal 2012, respectively and $7 million during the six months ended August 3, 2013 and July 28, 2012, respectively. These expenses are included in related party expenses on the Consolidated Statements of Comprehensive Income.

 

Bain Capital owns a majority equity position in LogicSource, an external vendor we utilize for print procurement services.  Payments associated with this vendor during the second quarters of fiscal 2013 and fiscal 2012 were $1 million and were $2 million and $3 million during the six months ended August 3, 2013 and July 28, 2012, respectively.  These expenses are included in Selling, general and administrative expense on the Consolidated Statements of Comprehensive Income.

 

The Blackstone Group owns a majority equity position in Brixmor Properties Group, a vendor we utilize to lease certain properties. Payments associated with this vendor during each of the second quarters of fiscal 2013 and fiscal 2012 were $1 million and were $2 million during the six months ended August 3, 2013 and July 28, 2012.  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 RGIS, an external vendor we utilize to count our store inventory. Payments associated with this vendor during the second quarters of fiscal 2013 and fiscal 2012 were $2 million and $1 million, respectively and were $3 million during the six months ended August 3, 2013 and July 28, 2012. These expenses are included in Selling, general and administrative expense on the Consolidated Statements of Comprehensive Income.

 

The Blackstone Group owns a majority equity position in Vistar, an external vendor we utilize for all of the candy-type items in our stores.  Payments associated with this vendor during the second quarter of fiscal 2013 and fiscal 2012 were $6 million and were $12 million and $11 million during the six months ended August 3, 2013 and July 28, 2012, respectively. These expenses are recognized in cost of sales as the sales are recorded.

 

Our current directors (other than Jill A. Greenthal and Carl S. Rubin) 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 August 3, 2013, affiliates of The Blackstone Group held $38 million of our Restated Term Loan Credit Facility.

 

As a result of the Reorganization discussed in Note 8, at August 3, 2013, the Company has recorded a receivable from Parent of  $4 million for payments made by the Company related to the repurchase of stock issued by Parent as a result of a stock option exercise by an employee of the Company. Amounts paid by the Company on Parent’s behalf related to the dividend payment discussed in Note 8 and the stock option exercise discussed above were $20 million for the six months ended August 3, 2013.

 

Note 11.  Condensed Consolidating Financial Information

 

All obligations of the Company under its notes, the Restated Revolving Credit Facility and the Restated Term Loan Credit Facility are guaranteed by each of its subsidiaries other than Aaron Brothers Card Services, LLC, Artistree of Canada, ULC and Michaels Stores of Puerto Rico, LLC and will be guaranteed by its direct parent, Holdings. As of August 3, 2013, the financial statements of Aaron Brothers Card Services, LLC, Artistree of Canada, ULC and Michaels Stores of Puerto Rico, LLC were immaterial. Each subsidiary guarantor is 100% owned, directly or indirectly, by the Company and such guarantees of each subsidiary guarantor are (and the guarantee of Holdings will be) joint and several and full and unconditional.

 

The following condensed consolidating financial information represents the financial information of Michaels Stores, Inc. and its wholly-owned subsidiary guarantors, prepared on the equity basis of accounting.  The information is presented in accordance with the requirements of Rule 3-10 under the SEC’s Regulation S-X.  The financial information may not necessarily be indicative of results of operations, cash flows, or financial position had the subsidiary guarantors operated as independent entities.

 

14



Table of Contents

 

Supplemental Condensed Consolidating Balance Sheet

 

 

 

August 3, 2013

 

 

 

Parent Company

 

Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

 

 

(Restated)

 

 

 

 

 

(Restated)

 

 

 

(in millions)

 

ASSETS

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

28

 

$

23

 

$

 

$

51

 

Merchandise inventories

 

619

 

290

 

 

909

 

Intercompany receivables

 

 

484

 

(484

)

 

Other

 

142

 

28

 

 

170

 

Total current assets

 

789

 

825

 

(484

)

1,130

 

Property and equipment, net

 

274

 

73

 

 

347

 

Goodwill

 

94

 

 

 

94

 

Investment in subsidiaries

 

453

 

 

(453

)

 

Other assets

 

72

 

2

 

 

74

 

Total assets

 

$

1,682

 

$

900

 

$

(937

)

$

1,645

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

5

 

$

284

 

$

 

$

289

 

Accrued liabilities and other

 

205

 

130

 

 

335

 

Share-based compensation liability

 

6

 

13

 

 

19

 

Current portion of long-term debt

 

238

 

 

 

238

 

Intercompany payable

 

484

 

 

(484

)

 

Other

 

4

 

 

 

4

 

Total current liabilities

 

942

 

427

 

(484

)

885

 

Long-term debt

 

2,882

 

 

 

2,882

 

Share-based compensation liability

 

17

 

9

 

 

26

 

Other long-term liabilities

 

72

 

11

 

 

83

 

Total stockholders’ deficit

 

(2,231

)

453

 

(453

)

(2,231

)

Total liabilities and stockholders’ deficit

 

$

1,682

 

$

900

 

$

(937

)

$

1,645

 

 

15



Table of Contents

 

Supplemental Condensed Consolidating Balance Sheet

 

 

 

February 2, 2013

 

 

 

Parent Company

 

Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

 

 

(Restated)

 

 

 

(In millions)

 

ASSETS

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

37

 

$

19

 

$

 

$

56

 

Merchandise inventories

 

591

 

271

 

 

862

 

Intercompany receivables

 

 

329

 

(329

)

 

Other

 

105

 

21

 

 

126

 

Total current assets

 

733

 

640

 

(329

)

1,044

 

Property and equipment, net

 

271

 

67

 

 

338

 

Goodwill, net

 

94

 

 

 

94

 

Investment in subsidiaries

 

284

 

 

(284

)

 

Other assets

 

76

 

3

 

 

79

 

Total assets

 

$

1,458

 

$

710

 

$

(613

)

$

1,555

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

5

 

258

 

 

263

 

Accrued liabilities and other

 

235

 

132

 

 

367

 

Share-based Compensation

 

22

 

13

 

 

35

 

Current portion of long-term debt

 

150

 

 

 

150

 

Intercompany payable

 

329

 

 

(329

)

 

Other

 

36

 

5

 

 

41

 

Total current liabilities

 

777

 

408

 

(329

)

856

 

Long-term debt

 

2,891

 

 

 

2,891

 

Other long-term liabilities

 

73

 

12

 

 

85

 

Share based Compensation

 

21

 

6

 

 

27

 

Total stockholders’ deficit

 

(2,304

)

284

 

(284

)

(2,304

)

Total liabilities and stockholders’ deficit

 

$

1,458

 

$

710

 

$

(613

)

$

1,555

 

 

16



Table of Contents

 

Supplemental Condensed Consolidating Balance Sheet

 

 

 

July 28, 2012

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

 

 

(Restated)

 

 

 

 

 

(Restated)

 

 

 

(in millions)

 

ASSETS

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

93

 

$

20

 

$

 

$

113

 

Merchandise inventories

 

603

 

322

 

 

925

 

Intercompany receivables

 

 

556

 

(556

)

 

Other

 

135

 

23

 

 

158

 

Total current assets

 

831

 

921

 

(556

)

1,196

 

Property and equipment, net

 

265

 

61

 

 

326

 

Goodwill

 

95

 

 

 

95

 

Investment in subsidiaries

 

569

 

 

(569

)

 

Other assets

 

83

 

3

 

 

86

 

Total assets

 

$

1,843

 

$

985

 

$

(1,125

)

$

1,703

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

8

 

$

269

 

$

 

$

277

 

Accrued liabilities and other

 

234

 

119

 

 

353

 

Share-based compensation liability

 

19

 

10

 

 

29

 

Current portion of long-term debt

 

1

 

 

 

1

 

Intercompany payable

 

556

 

 

(556

)

 

Other

 

1

 

 

 

1

 

Total current liabilities

 

819

 

398

 

(556

)

661

 

Long-term debt

 

3,363

 

 

 

3,363

 

Share-based compensation liability

 

16

 

7

 

 

23

 

Other long-term liabilities

 

86

 

11

 

 

97

 

Total stockholders’ deficit

 

(2,441

)

569

 

(569

)

(2,441

)

Total liabilities and stockholders’ deficit

 

$

1,843

 

$

985

 

$

(1,125

)

$

1,703

 

 

17



Table of Contents

 

Supplemental Condensed Consolidating Statement of Comprehensive Income

 

 

 

Quarter Ended August 3, 2013

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

 

 

(Restated)

 

 

 

 

 

(Restated)

 

 

 

(in millions)

 

Net sales

 

$

783

 

$

534

 

$

(413

)

$

904

 

Cost of sales and occupancy expense

 

522

 

458

 

(413

)

567

 

Gross profit

 

261

 

76

 

 

337

 

Selling, general, and administrative expense

 

221

 

33

 

 

254

 

Share-based compensation

 

6

 

2

 

 

8

 

Related party expenses

 

3

 

 

 

3

 

Store pre-opening costs

 

1

 

 

 

1

 

Operating income

 

30

 

41

 

 

71

 

Interest expense

 

45

 

 

 

45

 

Refinancing costs and losses on early extinguishment of debt

 

 

 

 

 

Other (income) and expense, net

 

 

1

 

 

1

 

Intercompany charges (income)

 

12

 

(12

)

 

 

Equity in earnings of subsidiaries

 

52

 

 

(52

)

 

Income before income taxes

 

25

 

52

 

(52

)

25

 

Provision for income taxes

 

8

 

13

 

(13

)

8

 

Net income

 

17

 

39

 

(39

)

17

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment and other

 

(1

)

 

 

(1

)

Comprehensive income

 

$

16

 

$

39

 

$

(39

)

$

16

 

 

18



Table of Contents

 

Supplemental Condensed Consolidating Statement of Comprehensive Income

 

 

 

Quarter Ended July 28, 2012

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

 

 

(Restated)

 

 

 

 

 

(Restated)

 

 

 

(in millions)

 

Net sales

 

$

777

 

$

521

 

$

(406

)

$

892

 

Cost of sales and occupancy expense

 

519

 

444

 

(406

)

557

 

Gross profit

 

258

 

77

 

 

335

 

Selling, general, and administrative expense

 

218

 

33

 

 

251

 

Share-based compensation

 

2

 

1

 

 

3

 

Related party expenses

 

4

 

 

 

4

 

Store pre-opening costs

 

1

 

 

 

1

 

Operating income

 

33

 

43

 

 

76

 

Interest expense

 

61

 

 

 

61

 

Other (income) and expense, net

 

 

 

 

 

Intercompany charges (income)

 

15

 

(15

)

 

 

Equity in earnings of subsidiaries

 

58

 

 

(58

)

 

Income before income taxes

 

15

 

58

 

(58

)

15

 

Provision for income taxes

 

6

 

22

 

(22

)

6

 

Net income

 

9

 

36

 

(36

)

9

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

(2

)

 

 

(2

)

Comprehensive income

 

$

7

 

$

36

 

$

(36

)

$

7

 

 

19



Table of Contents

 

Supplemental Condensed Consolidating Statement of Comprehensive Income

 

 

 

Six Months Ended August 3, 2013

 

 

 

 

 

Guarantor

 

 

 

 

 

 

 

Parent Company

 

Subsidiaries

 

Eliminations

 

Consolidated

 

 

 

(Restated)

 

 

 

(in millions)

 

Net sales

 

$

1,652

 

$

1,081

 

$

(836

)

$

1,897

 

Cost of sales and occupancy expense

 

1,077

 

910

 

(836

)

1,151

 

Gross profit

 

575

 

171

 

 

746

 

Selling, general, and administrative expense

 

455

 

71

 

 

526

 

Share-based compensation

 

9

 

2

 

 

11

 

Related party expenses

 

7

 

 

 

7

 

Store pre-opening costs

 

3

 

 

 

3

 

Operating income

 

101

 

98

 

 

199

 

Interest expense

 

92

 

 

 

92

 

Refinancing costs and losses on early extinguishment of debt

 

7

 

 

 

7

 

Other (income) and expense, net

 

 

1

 

 

1

 

Intercompany charges (income)

 

25

 

(25

)

 

 

Equity in earnings of subsidiaries

 

122

 

 

(122

)

 

Income before income taxes

 

99

 

122

 

(122

)

99

 

Provision for income taxes

 

36

 

44

 

(44

)

36

 

Net income

 

63

 

78

 

(78

)

63

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment and other

 

(2

)

 

 

(2

)

Comprehensive income

 

$

61

 

$

78

 

$

(78

)

$

61

 

 

20



Table of Contents

 

Supplemental Condensed Consolidating Statement of Comprehensive Income

 

 

 

Six Months Ended July 28, 2012

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

 

 

(Restated)

 

 

 

 

 

(Restated)

 

 

 

(in millions)

 

Net sales

 

$

1,638

 

$

1,070

 

$

(838

)

$

1,870

 

Cost of sales and occupancy expense

 

1,056

 

906

 

(838

)

1,124

 

Gross profit

 

582

 

164

 

 

746

 

Selling, general, and administrative expense

 

442

 

68

 

 

510

 

Share-based compensation

 

6

 

1

 

 

7

 

Related party expenses

 

7

 

 

 

7

 

Store pre-opening costs

 

2

 

 

 

2

 

Operating income

 

125

 

95

 

 

220

 

Interest expense

 

127

 

 

 

127

 

Other (income) and expense, net

 

 

(1

)

 

(1

)

Intercompany charges (income)

 

32

 

(32

)

 

 

Equity in earnings of subsidiaries

 

128

 

 

(128

)

 

Income before income taxes

 

94

 

128

 

(128

)

94

 

Provision for income taxes

 

34

 

46

 

(46

)

34

 

Net income

 

60

 

(82

)

(82

)

60

 

Comprehensive income

 

$

60

 

$

82

 

$

(82

)

$

60

 

 

Supplemental Condensed Consolidating Statement of Cash Flows

 

 

 

Six Months Ended August 3, 2013

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

 

 

(Restated)

 

 

 

 

 

(Restated)

 

 

 

(in millions)

 

Operating activities:

 

 

 

 

 

 

 

 

 

Net cash (used in) provided by operating activities

 

$

(33

)

$

66

 

$

(47

)

$

(14

)

 

 

 

 

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

 

 

 

 

Cash paid for property and equipment

 

(35

)

(15

)

 

(50

)

Net cash used in investing activities

 

(35

)

(15

)

 

(50

)

 

 

 

 

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

 

 

 

 

Net repayments of short-term debt

 

75

 

 

 

75

 

Intercompany dividends

 

 

(47

)

47

 

 

Other financing activities

 

(16

)

 

 

(16

)

Net cash provided by (used in) financing activities

 

59

 

(47

)

47

 

59

 

 

 

 

 

 

 

 

 

 

 

Decrease in cash and equivalents

 

(9

)

4

 

 

(5

)

Beginning cash and equivalents

 

37

 

19

 

 

56

 

Ending cash and equivalents

 

$

28

 

$

23

 

$

 

$

51

 

 

21



Table of Contents

 

Supplemental Condensed Consolidating Statement of Cash Flows

 

 

 

Six Months Ended July 28, 2012

 

 

 

Parent

 

Guarantor

 

 

 

 

 

 

 

Company

 

Subsidiaries

 

Eliminations

 

Consolidated

 

 

 

(Restated)

 

 

 

 

 

(Restated)

 

 

 

(in millions)

 

Operating activities:

 

 

 

 

 

 

 

 

 

Net cash used in operating activities

 

$

(99

)

$

68

 

$

(49

)

$

(80

)

 

 

 

 

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

 

 

 

 

Cash paid for property and equipment

 

(38

)

(7

)

 

(45

)

Net cash used in investing activities

 

(38

)

(7

)

 

(45

)

 

 

 

 

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

 

 

 

 

Net repayment of long term debt

 

(127

)

 

 

(127

)

Intercompany dividends

 

 

(49

)

49

 

 

Other financing activities

 

(6

)

 

 

(6

)

Net cash used in financing activities

 

(133

)

(49

)

49

 

(133

)

 

 

 

 

 

 

 

 

 

 

Decrease in cash and equivalents

 

(270

)

12

 

 

(258

)

Beginning cash and equivalents

 

363

 

8

 

 

371

 

Ending cash and equivalents

 

$

93

 

$

20

 

$

 

$

113

 

 

22



Table of Contents

 

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

 

All expressions of the “Company”, “us,” “we,” “our,” and all similar expressions are references to Michaels Stores, Inc. and its consolidated wholly-owned subsidiaries, unless otherwise expressly stated or the context otherwise requires.

 

Disclosure Regarding Forward-Looking Information

 

The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. The following discussion, as well as other portions of this Quarterly Report on Form 10-Q, contains forward-looking statements that reflect our plans, estimates, and beliefs. Any statements contained herein (including, but not limited to, statements to the effect that Michaels or its management “anticipates,” “plans,” “estimates,” “expects,” “believes,” and other similar expressions) that are not statements of historical fact should be considered forward-looking statements and should be read in conjunction with our consolidated financial statements and related notes in our Annual Report on Form 10-K for the fiscal year ended February 2, 2013. Such forward-looking statements are based upon management’s current knowledge and assumptions about future events and involve risks and uncertainties that could cause actual results, performance or achievements to be materially different from anticipated results, prospects, performance or achievements expressed or implied by such forward-looking statements. Such risks and uncertainties include, but are not limited to:

 

·                  risks related to general economic conditions; if recovery from the economic downturn continues to be slow or prolonged, it could continue to adversely affect consumer confidence and retail spending, decrease demand for our merchandise and adversely impact our results of operations, cash flows and financial condition;

 

·                  risks related to our substantial indebtedness, as our leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our obligations under our notes and credit facilities;

 

·                  our ability to open new stores and increase comparable store sales growth, as our growth depends on our strategy of expanding our base of retail stores; and if we are unable to continue this strategy, our ability to increase our sales, profitability, and cash flow could be impaired;

 

·                  our reliance on foreign suppliers increases our risk of obtaining adequate, timely, and cost-effective product supplies;

 

·                  damage to the reputation of the Michaels brand or our private and exclusive brands could adversely affect our sales;

 

·                  significant increases in inflation or commodity prices such as petroleum, natural gas, electricity, steel, wood and paper may adversely affect our costs, including cost of merchandise;

 

·                  our suppliers may fail us;

 

·                  risks associated with the vendors from whom our products are sourced could materially adversely affect our revenue and gross profit;

 

·                  product recalls and/or product liability, as well as changes in product safety and other consumer protection laws, may adversely impact our operations, merchandise offerings, reputation, results of operation, cash flow, and financial condition;

 

·                  unexpected or unfavorable consumer responses to our promotional or merchandising programs could materially adversely affect our sales, results of operations, cash flow and financial condition;

 

·                  improvements to our supply chain may not be fully successful;

 

·                  changes in customer demand could materially adversely affect our sales, results of operations, and cash flow;

 

·                  how well we manage our business;

 

·                  competition could negatively impact our business;

 

23



Table of Contents

 

 

·                  failure to adequately maintain security and prevent unauthorized access to electronic and other confidential information and data breaches could materially adversely affect our financial condition and operating results;

 

·                  our information systems may prove inadequate;

 

·                  risks related to our disclosed material weakness in our internal control over financial reporting related to our accounting for share-based compensation expense that could affect our ability to report our financial condition, results of operations or cash flows accurately and on a timely basis;

 

·                  failure to attract or retain senior management could adversely affect our operations;

 

·                  a weak fourth quarter would materially adversely affect our results of operations;

 

·                  changes in newspaper subscription rates may result in reduced exposure to our circular advertisements;

 

·                  our material weakness in internal control over financial reporting related to our accounting for share-based compensation expense;

 

·                  changes in regulations or enforcement may adversely impact our business;

 

·                  restrictions in our debt agreements that limit our flexibility in operating our business, as our senior secured credit facilities and the indentures governing our notes contain various covenants that limit our ability to engage in specified types of transactions and require that we maintain specified financial ratios upon the occurrence of certain events;

 

·                  disruptions in the capital markets could increase our costs of doing business;

 

·                  our real estate leases generally obligate us for long periods, which subjects us to various financial risks;

 

·                  we have co-sourced certain of our information technology, accounts payable, payroll, accounting and human resources functions, and may co-source other administrative functions, which makes us more dependent upon third parties;

 

·                  we are exposed to fluctuations in exchange rates between the U.S. and Canadian dollar, which is the functional currency of our Canadian subsidiaries;

 

·                  failure to attract and retain quality sales, distribution center and other associates in appropriate numbers as well as experienced buying and management personnel could adversely affect our performance;

 

·                  our results may be adversely affected by serious disruptions or catastrophic events, including geo-political events and weather; and

 

·                  the interests of our indirect parent, FinCo Holding, and our Sponsors may conflict with the interests of our debt holders.

 

For more details on factors that may cause actual results to differ materially from such forward-looking statements, please see Item 1A. Risk Factors of our Annual Report on Form 10-K for the fiscal year ended February 2, 2013, and other reports from time to time filed with or furnished to the Securities and Exchange Commission (“SEC”). We disclaim any intention to, and undertake no obligation to, update or revise any forward-looking statement.

 

General

 

We report on the basis of a 52- or 53-week fiscal year, which ends on the Saturday closest to January 31.  All references herein to “fiscal 2013” relate to the 52 weeks ending February 1, 2014 and all references to “fiscal 2012” relate to the 53 weeks ended February 2, 2013. In addition, all references herein to “the second quarter of fiscal 2013” relate to the 13 weeks ended August 3, 2013 and all references to “the second quarter of fiscal 2012” relate to the 13 weeks ended July 28, 2012. Finally, all references to “the six months ended August 3, 2013” relate to the 26 weeks ended August 3, 2013, and “the six months ended July 28, 2012” relate to the 26 weeks ended July 28, 2012.

 

24



Table of Contents

 

The following table sets forth certain of our unaudited operating data:

 

 

 

Quarter Ended

 

Six Months Ended

 

 

 

August 3,

 

July 28,

 

August 3,

 

July 28,

 

 

 

2013

 

2012

 

2013

 

2012

 

Michaels stores:

 

 

 

 

 

 

 

 

 

Retail stores open at beginning of period

 

1,113

 

1,066

 

1,099

 

1,064

 

Retail stores opened during the period

 

6

 

8

 

21

 

10

 

Retail stores opened (relocations) during the period

 

4

 

4

 

8

 

10

 

Retail stores closed during the period

 

 

 

(1

)

 

Retail stores closed (relocations) during the period

 

(4

)

(4

)

(8

)

(10

)

Retail stores open at end of period

 

1,119

 

1,074

 

1,119

 

1,074

 

 

 

 

 

 

 

 

 

 

 

Aaron Brothers stores:

 

 

 

 

 

 

 

 

 

Retail stores open at beginning of period

 

122

 

130

 

125

 

134

 

Retail stores opened (relocations) during the period

 

1

 

 

2

 

 

Retail stores closed during the period

 

(1

)

(2

)

(4

)

(6

)

Retail stores closed (relocations) during the period

 

 

 

(1

)

 

Retail stores open at end of period

 

122

 

128

 

122

 

128

 

 

 

 

 

 

 

 

 

 

 

Total store count at end of period

 

1,241

 

1,202

 

1,241

 

1,202

 

 

 

 

 

 

 

 

 

 

 

Other operating data:

 

 

 

 

 

 

 

 

 

Average inventory per Michaels store (in thousands) (1)

 

$

774

 

$

823

 

774

 

$

823

 

Comparable store sales (decrease) increase (2)

 

(1.3

)%

2.9

%

(1.0

)%

2.1

%

 


(1)                      The calculation of average inventory per Michaels store excludes our Aaron Brothers stores.

(2)                      Comparable store sales (decrease) increase represents the (decrease) increase in Net sales for Michaels and Aaron Brothers stores open the same number of months in the indicated period and the comparable period of the previous year, including stores that were relocated or expanded during either period. A store is deemed to become comparable in its 14th month of operation in order to eliminate grand opening sales distortions. A store temporarily closed more than two weeks is not considered comparable during the month it closed. If a store is closed longer than two weeks but less than two months, it becomes comparable in the month in which it reopens, subject to a mid-month convention. A store closed longer than two months becomes comparable in its 14th month of operation after its reopening.

 

25



Table of Contents

 

Restatement - Share-based Compensation

 

The Company has determined its previously issued unaudited interim consolidated financial statements for the three and six month periods ended August 3, 2013 and July 28, 2012, contained an error with respect to ASC 718, Compensation — Stock Compensation.  Specifically, former participants in the Company’s Equity Incentive Plan and its successor Plan (The Michaels Companies, Inc. (“Parent”) Equity Incentive Plan, together the “Plan”) exercised stock options upon their termination from the Company, and the Company repurchased the immature shares. The Company consistently repurchased shares in this manner and therefore, under accounting rules, established a pattern of repurchasing immature shares during the third quarter of 2011. The Company determined all stock options should have been treated as liability awards in accordance with the rules of ASC 718-10-25-9. Under liability accounting, the Company re-measures the fair value of stock compensation each period and recognizes changes in fair value as awards vest and until the award is settled. The Company originally recognized expense ratably over the vesting period based on the grant date fair value of the option in accordance with the fixed method of accounting. The Company determined the accounting error was material to fiscal 2011 and fiscal 2012 financial statements and those financial statements required restatement. As a result, the Company is also restating its financial statements for the three and six months ended August 3, 2013 and July 28, 2012. The non-cash impact to share-based compensation expense for the three and six months ended August 3, 2013 was $7 million ($5, Net of tax) and $12 million ($8, net of tax), respectively. The impact to share-based compensation expense for the three and six months ended July 28, 2012, was $6 million ($4, net of tax) and $9 million ($5, net of tax), respectively.   As part of the restatement, the Company also recorded other adjustments related to merchandise inventories and the reserve for closed facilities which were previously determined to be immaterial to the respective periods. In total, the adjustments resulted in a decline of Net income by $3 and $4 million for the three and six months ended August 3, 2013, and $4 and $6 million for the three and six months ended July 28, 2012.  The following tables illustrate the correction as it is associated with certain line items in the financial statements (amounts in millions):

 

 

 

Consolidated Balance Sheet
As of August 3, 2013

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Merchandise inventories

 

$

905

 

$

4

 

$

 

$

909

 

Deferred income taxes

 

37

 

1

 

 

38

 

Income tax receivable

 

34

 

2

 

 

36

 

Total current assets

 

1,123

 

7

 

 

1,130

 

Deferred income taxes

 

13

 

16

 

 

29

 

Total non-current assets

 

152

 

16

 

 

168

 

Accrued liabilities and other

 

338

 

(3

)

 

335

 

Share-based compensation liability

 

 

19

 

 

19

 

Income taxes payable

 

1

 

(1

)

 

 

Total current liabilities

 

870

 

15

 

 

885

 

Share-based compensation liability

 

 

26

 

 

26

 

Total long-term liabilities

 

2,965

 

26

 

 

2,991

 

Additional paid-in capital

 

60

 

1

 

 

61

 

Accumulated deficit

 

(2,277

)

(19

)

 

(2,296

)

Total stockholders’ deficit

 

(2,213

)

(18

)

 

(2,231

)

 

 

 

Consolidated Balance Sheet
As of July 28, 2012

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Merchandise inventories

 

$

922

 

$

3

 

$

 

$

925

 

Total current assets

 

1,193

 

3

 

 

1,196

 

Deferred income taxes

 

18

 

14

 

 

32

 

Total non-current assets

 

167

 

14

 

 

181

 

Accrued liabilities and other

 

351

 

2

 

 

353

 

Share-based compensation liability

 

 

29

 

 

29

 

Income taxes payable

 

2

 

(2

)

 

 

Total current liabilities

 

632

 

29

 

 

661

 

Share-based compensation liability

 

 

23

 

 

23

 

Total long-term liabilities

 

3,460

 

23

 

 

3,483

 

Additional paid-in capital

 

62

 

(10

)

 

52

 

Accumulated deficit

 

(2,474

)

(25

)

 

2,499

 

Total stockholders’ deficit

 

(2,406

)

(35

)

 

2,441

 

 

 

 

Consolidated Statements of Comprehensive Income
Quarter Ended August 3, 2013

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Cost of sales and occupancy expense

 

$

567

 

$

1

 

$

(1

)

$

567

 

Gross profit

 

 

337

 

 

(1

)

 

1

 

 

337

 

Selling, general and administrative expense

 

 

258

 

 

(2

)

 

(2

)

 

254

 

Share-based compensation

 

 

8

 

 

8

 

Operating income

 

75

 

(7

)

3

 

71

 

Income before income taxes

 

29

 

(7

)

3

 

25

 

Provision for income taxes

 

9

 

(2

)

1

 

8

 

Net income

 

20

 

(5

)

2

 

17

 

Comprehensive income

 

19

 

(5

)

2

 

16

 

 

26



Table of Contents

 

 

 

Consolidated Statements of Comprehensive Income 
Six Months Ended August 3, 2013

 

 

 

As 
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Cost of sales and occupancy expense

 

$

1,153

 

$

2

 

$

(4

)

$

1.151

 

Gross Profit

 

744

 

(2

)

4

 

746

 

Selling, general and administrative expense

 

529

 

(1

)

(2

)

526

 

Share-based compensation

 

 

11

 

 

11

 

Operating income

 

205

 

(12

)

6

 

199

 

Income before income taxes

 

105

 

(12

)

6

 

99

 

Provision for income taxes

 

38

 

(4

)

2

 

36

 

Net income

 

67

 

(8

)

4

 

63

 

Comprehensive income

 

65

 

(8

)

4

 

61

 

 

 

 

Consolidated Statements of Comprehensive Income
Quarter Ended July 28, 2012

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Cost of sales and occupancy expense

 

$

553

 

$

4

 

$

 

$

557

 

Gross Profit

 

339

 

(4

)

 

335

 

Selling, general and administrative expense

 

252

 

(1

)

 

251

 

Share-based compensation

 

 

3

 

 

3

 

Operating income

 

82

 

(6

)

 

76

 

Income before income taxes

 

21

 

(6

)

 

15

 

Provision for income taxes

 

8

 

(2

)

 

6

 

Net income

 

13

 

(4

)

 

9

 

Comprehensive income

 

11

 

(4

)

 

7

 

 

 

 

Consolidated Statements of Comprehensive Income
Six Months Ended July 28, 2012

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Cost of sales and occupancy expense

 

$

1,119

 

$

4

 

$

1

 

$

1,124

 

Gross Profit

 

751

 

(4

)

(1

)

746

 

Selling, general and administrative expense

 

512

 

(2

)

 

510

 

Share-based compensation

 

 

7

 

 

7

 

Operating income

 

230

 

(9

)

(1

)

220

 

Income before income taxes

 

104

 

(9

)

(1

)

94

 

Provision for income taxes

 

38

 

(4

)

 

34

 

Net income

 

66

 

(5

)

(1

)

60

 

Comprehensive income

 

66

 

(5

)

(1

)

60

 

 

 

 

Cash Flow Data
Six Months Ended August 3, 2013

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Operating Activities:

 

 

 

 

 

 

 

 

 

Net income

 

$

67

 

(7

)

3

 

$

63

 

Share-based compensation and other

 

1

 

12

 

 

13

 

Merchandise inventories

 

(40

)

(2

)

(5

)

(47

)

Accrued liabilities and other

 

(38

)

(21

)

 

(59

)

Income taxes

 

(71

)

(2

)

2

 

(71

)

Net cash provided by (used in) operating activities

 

6

 

(20

)

 

(14

)

Repurchase of common stock

 

(45

)

45

 

 

 

Proceeds from stock options exercised

 

25

 

(25

)

 

 

Net cash provided by financing activities

 

39

 

20

 

 

59

 

 

 

 

Cash Flow Data
Six Months Ended July 28, 2012

 

 

 

As
Reported

 

Share-based
compensation
Adjustment

 

Other
Adjustments

 

As
Restated

 

Operating Activities:

 

 

 

 

 

 

 

 

 

Net income

 

$

66

 

(5

)

(1

)

$

60

 

Share-based compensation

 

3

 

8

 

 

11

 

Merchandise inventories

 

(82

)

(1

)

1

 

(82

)

Income taxes

 

(43

)

(3

)

 

(46

)

Net cash used in operating activities

 

(79

)

(1

)

 

(80

)

Repurchase of common stock

 

(3

)

3

 

 

 

Proceeds from stock options exercised

 

2

 

(2

)

 

 

Net cash provided by (used in) financing activities

 

(134

)

1

 

 

(133

)

 

27



Table of Contents

 

Results of Operations

 

The following table sets forth the percentage relationship to Net sales of each line item of our unaudited Consolidated Statements of Comprehensive Income. This table should be read in conjunction with the following discussion and with our consolidated financial statements, including the related notes, contained herein.

 

 

 

Quarter Ended

 

Six Months Ended

 

 

 

August 3,

 

July 28,

 

August 3,

 

July 28,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(Restated)

 

(Restated)

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of sales and occupancy expense

 

62.7

%

62.4

%

60.7

%

60.1

%

Gross profit

 

37.3

%

37.6

%

39.3

%

39.9

%

Selling, general, and administrative expense

 

28.1

%

28.1

%

27.7

%

27.3

%

Share-based compensation

 

0.9

%

0.3

%

0.6

%

0.4

%

Related party expenses

 

0.3

%

0.4

%

0.4

%

0.4

%

Store pre-opening costs

 

0.1

%

0.1

%

0.2

%

0.1

%

Operating income

 

7.9

%

8.5

%

10.5

%

11.8

%

Interest expense

 

5.0

%

6.8

%

4.8

%

6.8

%

Refinancing costs and losses on early extinguishment of debt

 

0.0

%

0.0

%

0.4

%

0.0

%

Other (income) and expense, net

 

0.1

%

0.0

%

0.1

%

-0.1

%

Income before income taxes

 

2.8

%

1.7

%

5.2

%

5.0

%

Provision for income taxes

 

0.9

%

0.7

%

1.9

%

1.8

%

Net income

 

1.9

%

1.0

%

3.3

%

3.2

%

 

Quarter Ended August 3, 2013 Compared to the Quarter Ended July 28, 2012

 

Net Sales—Net sales increased for the second quarter of fiscal 2013 by $12 million, or 1.3%, over the second quarter of fiscal 2012 due primarily to $24 million of incremental revenue from our non-comparable store sales, partially offset by a $12 million decrease in comparable store sales. Comparable store sales decreased 1.3% due to a 3.6% decrease in customer transactions and a 0.4% negative impact from deferred custom framing revenue, which was partially offset by a 2.7% increase in the average ticket.  The fluctuation in the exchange rates between the United States and Canadian dollars adversely impacted the average ticket by 10 basis points.  Two of our strongest categories were home accents and yarn.  The increase in home accents was due to positive customer response to our expanded assortment and improved presentation.  Our yarn growth is primarily driven by positive customer response to trend products.

 

Cost of Sales and Occupancy Expense—Cost of sales and occupancy expense increased $10 million to $567 million in the second quarter of fiscal 2013 from $557 million in the second quarter of fiscal 2012.  Cost of sales increased $4 million due to lower recognition of vendor allowances and $3 million due primarily to increased merchandise costs for higher sales compared to the prior year.   This is partly offset by $4 million due to favorable shrink experience, $3 million due to improved efficiencies and new product offerings in our vertically integrated framing operations and $3 million favorable due to liability accounting for share-based compensation.  In addition, we had a $13 million increase in rent and related expenses, including $5 million from opening new stores, a $6 million increase in store remodel and improvement expenses and a $1 million increase due to the timing of maintenance costs.

 

Cost of sales and occupancy expense increased 30 basis points points as a percentage of Net sales to 62.7% for the second quarter of fiscal 2013 from 62.4% for the second quarter of fiscal 2012. Occupancy costs increased 120 basis points due to increased remodel expenses, pre-opening lease expenses on new stores and the timing of maintenance costs. Merchandise costs decreased 80 basis points driven by our direct import and private brand initiatives, as well as improved pricing and promotion management.  In addition, cost of sales decreased due to a 30 basis point improvement in efficiencies and new product offerings in our vertically integrated framing operation, and a 30 basis point decrease due to liability accounting for share-based compensation.  These amounts were partially offset by a 70 basis point increase in freight and distribution costs.

 

Selling, General and Administrative Expense— Selling, general and administrative expense was $254 million in the second quarter of fiscal 2013 compared to $251 million in the second quarter of fiscal 2012. Selling, general and administrative expense increased by $7 million due to incremental store costs related to operating an additional 45 additional Michaels stores at the end of the second quarter of fiscal 2013 compared to the end of the second quarter of fiscal 2012.  These increases were partially offset by $6 million in savings for bonus expense. As a percentage of Net sales, Selling, general and administrative expense was flat for the second quarter of 2013 at 28.1% due to the reasons described above.

 

28



Table of Contents

 

Share-Based Compensation—Share-based compensation expenses increased to $8 million in the second quarter of fiscal 2013 from $3 million in the second quarter of fiscal 2012 primarily driven by the vesting of options and an increase in the fair value of option awards, which are fair valued at the end of each fiscal period.

 

Related Party Expenses—Related  party expenses were $3 million and $4 million in the second quarter of fiscal 2013 and fiscal 2012, respectively, consisting of management fees and associated expenses paid to affiliates of two investment firms: Bain Capital Partners, LLC and The Blackstone Group, L.P. (collectively, together with their applicable affiliates, the “Sponsors”) and Highfields Capital Management, LP.

 

Interest Expense—Interest expense decreased $16 million to $45 million in the second quarter of fiscal 2013 from $61 million in the second quarter of fiscal 2012. The decrease is attributable to a $244 million reduction in our total debt outstanding and by a lower average interest rate associated with our amended senior secured term loan facility.

 

Provision for Income Taxes—The effective tax rate was 32.0% for the second quarter of fiscal 2013. The effective tax rate was 40.0% for the second quarter of fiscal 2012. The current year tax rate is lower than the prior year tax rate primarily due to the realization of state tax credits this year.  We currently estimate our annualized effective tax rate for fiscal 2013 to be 37.4%.

 

Six Months Ended August 3, 2013 Compared to the Six Months Ended July 28, 2012

 

Net Sales—Net sales increased for the first six months of fiscal 2013 by $27 million, or 1.4%, over the first six months of fiscal 2012 due primarily to $45 million of incremental revenue from our non-comparable store sales, partially offset by a $18 million decrease in comparable store sales. Comparable store sales decreased 1.0% driven by a 3.4% decrease in customer transactions, partially offset by a 2.3% increase in the average ticket.  The fluctuation in the exchange rates between the United States and Canadian dollars adversely impacted the average ticket by 20 basis points.  Two of our strongest categories were yarn and custom framing.  Our yarn growth is primarily driven by positive customer response to trend products. The increase in custom framing is driven by product mix and visualization capabilities in our stores.

 

Cost of Sales and Occupancy Expense—Cost of sales and occupancy expense increased $27 million to $1,151 million for the first six months of fiscal 2013 from $1,124 million for the first six months of fiscal 2012.  We had a $24 million increase in rent and related expenses, including $10 million from opening new stores, a $7 million increase in store remodel and improvement expenses and a $5 million increase due to the timing of maintenance costs. In addition, cost of sales increased $4 million due to a $12 million increase in merchandise costs associated with higher sales, a $3 million increase in inventory markdowns due to an increase in discontinued stock keeping units associated with planned merchandise resets and a slower sell through of this merchandise and a $4 million reduction in the recognition of vendor allowances compared to the prior year. This was partially offset by a $6 million decrease due to improved efficiencies and new product offerings in our vertically integrated framing operations, a $3 million decrease due to timing of recognition of capitalized inventory costs, $3 million decrease due to our direct import penetration  and private brand initiatives and $3 million of favorable shrink experience in the current year compared to the prior year.

 

Cost of sales and occupancy expense increased 60 basis points as a percentage of Net sales to 60.7% for the first six months of fiscal 2013 from 60.1% for the first six months of fiscal 2012.  Occupancy costs increased 110 basis points due to increased remodel expenses and lease expenses on new stores as well as the timing of repairs and maintenance expenses compared to the prior year. In addition, cost of sales decreased by 50 basis points for the reasons indicated above.

 

Selling, General, and Administrative Expense— Selling, general and administrative expense was $526 million for the first six months of fiscal 2013 compared to $510 million for the first six months of fiscal 2012. The $16 million increase was driven primarily by $14 million of incremental costs related to operating 45 additional Michaels stores.  Additionally, Selling, general and administrative expense increased by $4 million for payroll and payroll-related costs, $3 million for increased advertising, $3 million for higher strategic initiative consulting fees and $2 million for executive signing costs. These amounts were partially offset by $9 million in savings for bonus expenses.

 

29



Table of Contents

 

As a percentage of Net sales, Selling, general and administrative expense increased 40 basis points due to an 80 basis point increase in new store costs and a 20 basis point increase in strategic initiative consulting fees. These percentages were partially offset by a 40 basis point decrease in bonus expense.

 

Share-Based Compensation—Share-based compensation expenses increased to $11 million in the first six months of fiscal 2013 from $7 million in the first six months of fiscal 2012 primarily driven by the vesting of options and an increase in the fair value of option awards, which are fair valued at the end of each fiscal period.

 

Related Party Expenses—Related party expenses were $7 million for the first six months of each of fiscal 2013 and fiscal 2012, consisting of management fees and associated expenses paid to our Sponsors and Highfields Capital Management, LP.

 

Interest Expense— Interest expense decreased $35 million to $92 million in the second quarter of fiscal 2013 from $127 million in the second quarter of fiscal 2012. The decrease is attributable to a $244 million reduction in our total debt outstanding and by a lower average interest rate associated with our amended senior secured term loan facility.

 

Refinancing Costs and Losses on Early Extinguishment of Debt— We recorded a loss on the early extinguishment of debt of $7 million during the first six months of fiscal 2013, consisting of a $5 million redemption premium and $2 million to write off debt issuance costs related to the redemption of $137 million in aggregate principal amount of our 113/8% Senior Subordinated Notes due November 1, 2016 (the “Senior Subordinated Notes”).  See Note 3 to the consolidated financial statements for further discussion.

 

Other (Income) and Expense, net—Other  (income) and expense is related primarily to a $1 million foreign exchange rate loss for the first six months of fiscal 2013 and a $1 million foreign exchange rate gain for the first six months of fiscal 2012.

 

Provision for Income Taxes—The effective tax rate was 36.4% for the first six months of fiscal 2013. The effective tax rate was 36.2% for the first six months of fiscal 2012. The rate was higher than the prior year six month tax rate due primarily to the realization of state tax credits this year partly offset by the prior year favorable impact related to our reserve for uncertain tax positions. We currently estimate our annualized effective tax rate for fiscal 2013 to be 37.4%.

 

Liquidity and Capital Resources

 

We require cash principally for day-to-day operations, to finance capital investments, to purchase inventory, to service our outstanding debt, and for seasonal working capital needs. We expect that our available cash, cash flow generated from operating activities, and funds available under our restated senior secured asset-based revolving credit facility (“Restated Revolving Credit Facility”) will be sufficient to fund planned capital expenditures, working capital requirements, debt repayments, debt service requirements and anticipated growth for the foreseeable future. Our ability to satisfy our liquidity needs and continue to refinance or reduce debt could be adversely affected by the occurrence of any of the events described under Item 1A. Risk Factors of our Annual Report on Form 10-K for the fiscal year ended February 2, 2013 or our failure to meet our debt covenants as described in “—Liquidity and Capital Resources—Cash Flow from Financing Activities”. Our Restated Revolving Credit Facility provides senior secured financing of up to $650 million, subject to a borrowing base. As of August 3, 2013, the borrowing base was $650 million, of which we had $222 million in outstanding borrowings, $61 million of outstanding letters of credit and $367 million of unused borrowing capacity. Our cash and equivalents decreased $5 million from $56 million at February 2, 2013 to $51 million at August 3, 2013.

 

Our substantial indebtedness could adversely affect our ability to raise additional capital, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk, and prevent us from meeting our obligations. Management reacts strategically to changes in economic conditions and monitors compliance with debt covenants to seek to mitigate any potential material impacts to our financial condition and flexibility.

 

The Company intends to use excess operating cash flows to repay portions of its indebtedness, pay dividends to its parent and fund growth opportunities, depending on market conditions. If the Company uses its excess cash flows to pay dividends or repay its debt, it will reduce the amount of excess cash available for additional capital expenditures.  The Company intends to make a dividend to its parent to fund the February 1 payment due on the PIK Notes, as defined below.

 

As of February 2, 2013, we had an aggregate principal amount of $393 million of our Senior Subordinated Notes scheduled to mature in November 2016.  On February 27, 2013, we redeemed $137 million in aggregate principal amount of the outstanding Senior Subordinated Notes with cash on hand and borrowings made under our senior secured term loan facility (“Restated Term Loan Credit Facility”) for an aggregate redemption price (including the applicable redemption premium and accrued and unpaid interest) of $147 million.  The 7 3/4% Senior Notes mature in 2018 (“2018 Senior Notes”), and the Restated Term Loan Credit Facility matures in or after 2018. Although no assurance can be given, depending on market conditions and other factors, we plan to repay or refinance such indebtedness prior to maturity.

 

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Table of Contents

 

We and our subsidiaries, affiliates, and significant shareholders may continue from time to time to seek to retire or purchase our outstanding debt through cash purchases and/or exchanges, in open market purchases, privately negotiated transactions, by tender offer or otherwise.  Such repurchases or exchanges, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors.

 

Cash Flow from Operating Activities

 

Cash flow used in operating activities during the first six months of fiscal 2013 was $14 million compared to cash flow used in operating activities of $80 million during the first six months of fiscal 2012. The $66 million change was primarily due to a $66 million increase for the timing of vendor payments and a $34 million increase due to the timing of inventory purchases. These amounts were partially offset by the exercise of options by certain former employees and the subsequent repurchase of the shares.

 

Average inventory per Michaels store (including supporting distribution centers) decreased 6.0% from $823,000 at July 28, 2012 to $774,000 at August 3, 2013, primarily driven by decreasing inventory in the distribution centers.

 

Cash Flow from Investing Activities

 

Cash flow used in investing activities represents the following capital expenditure activities:

 

 

 

Six Months Ended

 

 

 

August 3,

 

July 28,

 

 

 

2013

 

2012

 

 

 

(in millions)

 

New and relocated stores and stores not yet opened (1)

 

$

19

 

$

15

 

Existing stores

 

11

 

8

 

Information systems

 

13

 

16

 

Corporate and other

 

7

 

6

 

 

 

$

50

 

$

45

 

 


(1)                                 In the first six months of fiscal 2013, we incurred capital expenditures related to the opening of 21 Michaels stores in addition to the relocation of 8 Michaels stores. In the first six months of fiscal 2012, we incurred capital expenditures related to the opening of 10 Michaels stores in addition to the relocation of 10 Michaels stores.

 

Cash Flow from Financing Activities

 

Cash flow provided by financing activities during the first six months of fiscal 2013 was $59 million compared to cash used in financing activities of $133 million during the first six months of fiscal 2012. Cash flow used in financing activities for the first six months of fiscal 2013 was impacted by the redemption of the $137 million of Senior Subordinated Notes at a redemption price of 103.792%, or a total of $142 million, and net borrowings of $221 million under our Restated Revolving Credit Facility.

 

Other

 

In July 2013, Michaels was reorganized into a holding company structure (“Reorganization”).  The Michaels Companies, Inc. (“Parent”), Michaels FinCo Holdings, LLC (“FinCo Holdings”), Michaels FinCo, Inc. (“ FinCo Inc”) and Michaels Funding, Inc. (“Holdings”) and Michaels Stores Merger Co, Inc. (“MergerCo”) were formed in connection with the Reorganization: (i) MergerCo was merged with and into Michaels with Michaels being the surviving corporation; (ii) each share of Michaels’ common stock was converted into the right to receive one share of Parent common stock, subject to the same vesting conditions, if any, as applied to the share so converted, and each such share of Michaels’ common stock was cancelled and retired and ceased to exist; and (iii)  each option to purchase one or more shares of common stock of Michaels was assumed by Parent and converted into an option to purchase an equivalent number of shares of common stock of Parent with the remaining terms of each such option remaining unchanged except as was necessary to reflect the Reorganization.

 

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As a result, FinCo Holdings is wholly owned by the Parent.  FinCo Inc and Holdings are wholly owned by FinCo Holdings.  Michaels is wholly owned by Holdings.

 

Subsequent to the Reorganization, FinCo Holdings and FinCo Inc issued $800 million aggregate principal amount of 7.50%/8.25% PIK Toggle Notes due 2018 (“PIK Notes”). The PIK Notes were issued in a private transaction.  Interest payments on the PIK Notes are due February 1 and August 1 of each year until maturity.  The first two interest payments and the last interest payment are required to be paid entirely in cash.  Otherwise, under certain circumstances, all or a portion of the interest on the PIK Notes may be paid by increasing the principal amount of the outstanding PIK Notes or by issuing additional PIK Notes.  The PIK Notes are not guaranteed by the Company or any of its subsidiaries.  The proceeds from the debt issuance were about $782 million, after deducting the initial purchasers’ discount and estimated fees and expenses.  FinCo Holdings distributed the net proceeds to Parent and the proceeds were used to fund a cash dividend to the Parent’s equity and equity-award holders and pay related fees and expenses.

 

While not required, the Company intends to make a dividend to its parent to fund the February 1, 2014 interest payment of approximately $31 million on the PIK Notes and, to the extent that such dividends can be made consistent with covenants applicable to the Company, future interest payments on the PIK Notes.  If interest on the PIK Notes is paid in cash, annual interest payments will total $60 million or a total of approximately $301 million from July 29, 2013 until August, 1, 2018, the maturity date.

 

Non-GAAP Measures

 

The following table sets forth the Company’s Earnings before Interest, Taxes, Depreciation, Amortization, and Loss on early extinguishment of debt (“EBITDA excluding refinancing costs and losses on early extinguishment of debt”). The Company defines EBITDA (excluding refinancing costs and losses on early extinguishment of debt) as Net income before interest, income taxes, depreciation, amortization and loss on early extinguishment of debt. Additionally, the table presents Adjusted Earnings before Interest, Taxes, Depreciation and Amortization (“Adjusted EBITDA”).  The Company defines Adjusted EBITDA as EBITDA (excluding refinancing costs and losses on early extinguishment of debt) adjusted for certain defined amounts that are added to, or subtracted from, EBITDA (excluding refinancing costs and losses on early extinguishment of debt)  (collectively, the “Adjustments”) in accordance with the Company’s Restated Term Loan Credit Facility and Restated Revolving Credit Facility. The Adjustments are described in further detail in the table and the footnotes to the table below.

 

The Company has presented EBITDA (excluding refinancing costs and losses on early extinguishment of debt) and Adjusted EBITDA to provide investors with additional information to evaluate our operating performance and our ability to service our debt.  The Company uses EBITDA (excluding refinancing costs and losses on early extinguishment of debt), among other metrics, to evaluate operating performance, to plan and forecast future periods’ operating performance and as an element of its incentive compensation targets. Adjusted EBITDA is a required calculation under the Company’s Restated Term Loan Credit Facility and its Restated Revolving Credit Facility. As it relates to the Restated Term Loan Credit Facility, Adjusted EBITDA is used in the calculations of fixed charge coverage and leverage ratios, which, under certain circumstances may result in limitations on the Company’s ability to make restricted payments as well as the determination of mandatory repayments of the loans. Under the Restated Term Loan Credit Facility, Adjusted EBITDA is used in the calculation of fixed charge coverage ratios, which under certain circumstances, may restrict the Company’s ability to make certain payments (characterized as restricted payments), investments (including acquisitions) and debt repayments.

 

As EBITDA (excluding refinancing costs and losses on early extinguishment of debt) and Adjusted EBITDA are not measures of operating performance or liquidity calculated in accordance with U.S. generally accepted accounting principles (“GAAP”), these measures should not be considered in isolation of, or as a substitute for, Net income, as an indicator of operating performance, or net cash provided by operating activities as an indicator of liquidity.  Our computation of EBITDA (excluding refinancing costs and losses on early extinguishment of debt) and Adjusted EBITDA may differ from similarly titled measures used by other companies. As EBITDA (excluding refinancing costs and losses on early extinguishment of debt) and Adjusted EBITDA exclude certain financial information compared with Net income and Net cash provided by operating activities, the most directly comparable GAAP financial measures, users of this financial information should consider the types of events and transactions which are excluded.

 

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The table below shows a reconciliation of EBITDA (excluding refinancing costs and losses on early extinguishment of debt) and Adjusted EBITDA to Net income and Net cash used in operating activities.

 

 

 

Quarter Ended

 

Six Months Ended

 

 

 

August 3,

 

July 28,

 

August 3,

 

July 28,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(Restated)

 

 

 

(in millions)

 

Net cash provided by (used in) operating activities

 

$

(16

)

$

(121

)

$

(14

)

$

(80

)

Depreciation and amortization

 

(25

)

(22

)

(50

)

(46

)

Share-based compensation

 

(9

)

(7

)

(13

)

(11

)

Debt issuance costs amortization

 

(2

)

(4

)

(4

)

(8

)

Refinancing costs and losses on early extinguishment of debt

 

 

 

(7

)

 

Changes in assets and liabilities

 

69

 

163

 

151

 

205

 

Net income

 

17

 

9

 

63

 

60

 

Interest expense

 

45

 

61

 

92

 

127

 

Refinancing costs and losses on early extinguishment of debt

 

 

 

7

 

 

Provision for income taxes

 

8

 

6

 

36

 

34

 

Depreciation and amortization

 

25

 

22

 

50

 

46

 

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

 

95

 

98

 

248

 

267

 

Adjustments:

 

 

 

 

 

 

 

 

 

Share-based compensation

 

9

 

7

 

13

 

11

 

Sponsor fees

 

3

 

4

 

7

 

7

 

Termination expense

 

1

 

 

1

 

 

Store pre-opening costs

 

1

 

1

 

3

 

2

 

Store remodel costs

 

4

 

 

4

 

 

Foreign currency transaction losses (gains)

 

1

 

 

1

 

(1

)

Store closing costs

 

1

 

2

 

1

 

2

 

Other (1)

 

2

 

2

 

4

 

2

 

Adjusted EBITDA

 

$

117

 

$

114

 

$

282

 

$

290

 

 


(1) Other adjustments relate to items such as moving & relocation expenses, franchise taxes, certain signing bonuses and certain legal settlements.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

 

We are exposed to fluctuations in exchange rates between the U.S. and Canadian dollar, which is the functional currency of our Canadian subsidiaries. Our sales, costs and expenses of our Canadian subsidiaries, when translated into U.S. dollars, can fluctuate due to exchange rate movement. As of August 3, 2013, a 10% increase or decrease in the exchange rate of the U.S. and Canadian dollar would have a minimal impact on Net income.

 

We have market risk exposure arising from changes in interest rates on our Restated Term Loan Credit Facility and our Restated Revolving Credit Facility, together the (“Senior Secured Credit Facilities”). The interest rates on our Senior Secured Credit Facilities will reprice periodically, which will impact our earnings and cash flow. The interest rates on our 2018 Senior Notes and Senior Subordinated Notes are fixed.  Based on our overall interest rate exposure to variable rate debt outstanding as of August 3, 2013, a 1% increase or decrease in interest rates would increase or decrease income before income taxes by $19 million. A 1% increase in interest rates would decrease the fair value of our long-term fixed rate debt by $13 million. A 1% decrease in interest rates would increase the fair value of our long-term fixed rate debt by $14 million. A change in interest rates would not materially affect the fair value of our variable rate debt as the debt reprices periodically.

 

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Item 4.  Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report.

 

Based on the evaluation discussed above, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this report due to the material weakness identified in the Company’s internal control over financial reporting described below.

 

We did not maintain effective controls related to the administration of our share repurchases.  Specifically, the Company established a pattern of repurchasing common stock shares at the time option awards were exercised following termination of employment of participants in the Plan. Since the repurchased shares were not owned for a period of more than six months, the holders of the shares were, according to accounting rules, not subject to the risk and rewards of ownership. The pattern of repurchasing immature shares, demonstrates an administrative practice that results in all stock options being treated as liability awards under the accounting rules of ASC 718-10-25-9, Compensation — Stock Compensation (ASC 718). The control deficiency resulted in an adjustment to share-based compensation costs (which are classified in cost of sales and share-based compensation expense), merchandise inventories, income tax expense, additional paid-in capital, and deferred taxes. Under liability accounting, the Company re-measures the fair value of stock compensation each period and recognizes changes in fair value as awards vest and until the award is settled. The Company originally recognized expense ratably over the vesting period based on the grant date fair value of the option in accordance with the fixed method of accounting. As a result of this material error, management concluded a material weakness exists in the Company’s internal controls related to the administration of share repurchases and  controls were ineffective at timely detecting and correcting errors related to share-based compensation in accordance with U.S. generally accepted accounting principles.

 

As the material weakness was not remediated as of August 3, 2013, the material weakness could result in a misstatement of the aforementioned account balances or disclosures that would result in a material misstatement to our annual or interim consolidated financial statements that would not be prevented or detected.

 

Management will implement the following procedures related to this material weakness and expects testing of the operating effectiveness to be successfully completed during the fourth quarter of fiscal 2013.

 

·                  Establish and monitor additional internal control procedures related to share repurchases to ensure all required approvals are received prior to repurchase, including our Board, CEO, and CFO. In addition, the accounting department will review repurchases for appropriate accounting under ASC 718 prior to a commitment to repurchase.

 

·                  Perform a formal review with the Company officers and Board members responsible for the administration of stock repurchases regarding the terms of the Plan and the Stockholders Agreement with recurring training when responsibilities change.

 

·                  Provide enhanced education of the Company’s financial reporting staff on ASC 718 and ensure the Company complies with all aspects of the accounting standard.

 

In addition, the Company will distribute formal communication to all option holders and stockholders emphasizing the exercise terms under the Plan and related option agreements, and the call feature repurchase restrictions contained in the Stockholders Agreement. Consequently, the Company expects to account for share-based compensation under the equity method beginning in the fourth quarter of fiscal 2013.

 

Change in Internal Control Over Financial Reporting

 

There were no changes in the Company’s internal control over financial reporting during the fiscal quarter ended August 3, 2013, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

MICHAELS STORES, INC.

Part II—OTHER INFORMATION

 

Item 1.  Legal Proceedings.

 

Information regarding legal proceedings is incorporated herein by reference from Note 7 to our Consolidated Financial Statements.

 

Item 1A. Risk Factors

 

Information regarding the Company’s risk factors appears in Item 1A. Risk Factors disclosed in our Annual Report on Form 10-K for the fiscal year ended February 2, 2013.

 

There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended February 2, 2013 other than the risk factors set forth below:

 

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Table of Contents

 

Damage to the reputation of the Michaels brand or our private and exclusive brands could adversely affect our sales.

 

We believe the Michaels brand name and many of our private and exclusive brand names are powerful sales and marketing tools and we devote significant resources to promoting and protecting them. To be successful in the future, we must continue to preserve, grow and utilize the value of Michaels’ reputation. Reputational value is based in large part on perceptions of subjective qualities, and even isolated incidents may erode trust and confidence. In addition, we develop and promote private and exclusive brands, which we believe have generated national recognition. Our private label brands amounted to approximately 49% of total Net sales in fiscal 2012, and represent a growing portion of our overall sales. Damage to the reputations (whether or not justified) of our brand names could arise from product failures, litigation or various forms of adverse publicity (including, adverse publicity generated as a result of a vendor’s or a supplier’s failure to comply with general social accountability practices), especially in social media outlets, and may generate negative customer sentiment, potentially resulting in a reduction in our sales and earnings.

 

We are controlled by our indirect parent, FinCo Holdings, and the Sponsors, whose interests as equity holders may conflict with those of our debt investors and those of our Company.

 

We are controlled by our indirect parent, FinCo Holdings, which is controlled by our Sponsors, who currently indirectly own approximately 93% of our common stock in the aggregate. FinCo Holdings and the Sponsors control the election of our directors and thereby have the power to control our affairs and policies, including the appointment of management, the issuance of additional equity and the declaration and payment of dividends if allowed under the terms of the credit agreements governing our Senior Secured Credit Facilities, the terms of the indentures governing our outstanding notes and the terms of our other indebtedness outstanding at the time. Neither FinCo Holdings nor the Sponsers have any liability for any obligations under or relating to our Senior Secured Credit Facilities, our outstanding notes or our other indebtedness, and their respective interests may be in conflict with those of our debt investors. For example, if we encounter financial difficulties or are unable to pay our debts as they mature, the Sponsors may pursue strategies that favor equity investors over debt investors. In addition, our equity holders may have an interest in pursuing acquisitions, divestitures, financing or other transactions that, in their judgment, could enhance their equity investments, even though such transactions may involve risk to our debt investors. FinCo Holdings is a holding company, and its only material assets are the capital stock of Holdings and FinCo Inc. FinCo Holdings has no operations of its own. Accordingly, repayment of FinCo Holdings’ indebtedness, including the PIK Notes, is dependent, to a significant extent, on the generation of cash flow by the Company and its ability to make such cash available to FinCo Holdings, by dividend, debt repayment or otherwise.  FinCo Holdings and FinCo Inc are required to pay cash dividends on the PIK Notes, unless certain conditions set forth in the indenture governing the PIK Notes are satisfied, in which case, all or a portion of the interest on the PIK Notes may be paid by increasing the principal amount of the outstanding PIK Notes or by issuing additional PIK Notes. Additionally, the Sponsors may make investments in businesses that directly or indirectly compete with us, or may pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. For information concerning our arrangements with the Sponsors, see “Item 10. Directors, Executive Officers and Corporate Governance” and “Item 13. Certain Relationships and Related Transactions, and Director Independence of our Annual Report on Form 10-K for the fiscal year ended February 2, 2013.

 

Item 5.  Other Information

 

Submission of Matters to a Vote of Security Holders

 

By a written consent dated July 22, 2013, holders of 92.90% of the common stock of the Company voted their shares to approve the merger between MergerCo and the Company and to amend the Company’s Amended and Restated Certificate of Incorporation in order to, among other things, change the authorized number of shares of common stock from 220,000,000 shares to 100 shares, and  include any additional changes required by Section 251(g) of the Delaware General Corporation Law. The affirmative vote of more than 50% of the stockholders was required to take such action.

 

Iran Sanctions Related Disclosure

 

Under the Iran Threat Reduction and Syrian Human Rights Act of 2012, which added Section 13(r) of the Securities Exchange Act of 1934, we are required to include certain disclosures in our periodic reports if we or any of our “affiliates” knowingly engaged in certain specified activities during the period covered by this Quarterly Report on Form 10-Q. Because the SEC defines the term “affiliate” broadly, it includes any entity controlled by us as well as any person or entity that controls us or is under common control with us (“control” is also construed broadly by the SEC). We do not believe we and our consolidated subsidiaries have knowingly engaged in any transaction or dealing reportable under Section 13(r) of the Exchange Act during the quarter ended August 3, 2013.

 

The Blackstone Group L.P., one of our Sponsors, informed us of disclosures publicly filed and/or provided to them by Hilton Worldwide, Inc., and Travelport Limited, which may be considered their affiliates. These disclosures are included in, and the Company hereby incorporates by reference herein, Exhibit 99.1 to this this Quarterly Report on Form 10-Q.

 

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Table of Contents

 

Item 6.  Exhibits.

 

(a) Exhibits:

 

Exhibit
Number

 

Description of Exhibit

 

 

 

2.1

 

Agreement and Plan of Merger, dated as of July 22, 2013, by and among Michaels Stores, Inc., The Michaels Companies, Inc., Michaels FinCo Holdings, LLC, Michaels Funding, Inc., and Michaels Stores MergerCo. Inc. (previously filed as Exhibit 2.1 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).

 

 

 

3.1

 

Amended and Restated Certificate of Incorporation of Michaels Stores, Inc. (previously filed as Exhibit 3.1 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).

 

 

 

4.1

 

Amendment No. 1 to Registration Rights Agreement, dated as of July 22, 2013, among Michaels Stores, Inc. and certain stockholders thereof (previously filed as Exhibit 4.1 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).

 

 

 

10.1

 

The Michaels Companies, Inc. Equity Incentive Plan (previously filed as Exhibit 10.1 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).*

 

 

 

10.2

 

Form of Stock Option Agreement under the Michaels Companies, Inc. Equity Incentive Plan (previously filed as Exhibit 10.2 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).*

 

 

 

10.3

 

Form of Restricted Stock Award Agreement under the Michaels Companies, Inc. Equity Incentive Plan (previously filed as Exhibit 10.3 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).*

 

 

 

10.4

 

Amendment No. 1 to Amended and Restated Shareholders Agreement, dated as of July 22, 2013, among Michaels Stores, Inc. and certain stockholders thereof (previously filed as Exhibit 10.4 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).

 

 

 

31.1

 

Certifications of Carl S. Rubin pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

 

 

31.2

 

Certifications of Charles M. Sonsteby pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

 

 

32.1

 

Certification pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

 

 

99.1

 

Section 13 (r) Disclosure.

 

 

 

101.INS

 

XBRL Instance Document

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase

 

 

 

101.LAB

 

XBRL Taxonomy Extension Label Linkbase

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase

 


*Management contract or compensatory plan or arrangement.

 

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Table of Contents

 

MICHAELS STORES, INC.

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

MICHAELS STORES, INC.

 

 

 

 

 

By:

/s/ Carl S. Rubin

 

 

 

Carl S. Rubin

 

 

 

Chief Executive Officer

 

 

 

(Principal Executive Officer)

 

 

 

 

 

 

 

 

By:

/s/ Charles M. Sonsteby

 

 

 

Charles M. Sonsteby

 

 

 

Chief Administrative Officer & Chief Financial Officer

 

 

 

(Principal Financial Officer)

 

 

 

Dated: December 9, 2013

 

 

 

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Table of Contents

 

INDEX TO EXHIBITS

 

Exhibit
Number

 

Description of Exhibit

 

 

 

2.1

 

Agreement and Plan of Merger, dated as of July 22, 2013, by and among Michaels Stores, Inc., The Michaels Companies, Inc., Michaels FinCo Holdings, LLC, Michaels Funding, Inc., and Michaels Stores MergerCo. Inc. (previously filed as Exhibit 2.1 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).

 

 

 

3.1

 

Amended and Restated Certificate of Incorporation of Michaels Stores, Inc. (previously filed as Exhibit 3.1 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).

 

 

 

4.1

 

Amendment No. 1 to Registration Rights Agreement, dated as of July 22, 2013, among Michaels Stores, Inc. and certain stockholders thereof (previously filed as Exhibit 4.1 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).

 

 

 

10.1

 

The Michaels Companies, Inc. Equity Incentive Plan (previously filed as Exhibit 10.1 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).*

 

 

 

10.2

 

Form of Stock Option Agreement under the Michaels Companies, Inc. Equity Incentive Plan (previously filed as Exhibit 10.2 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).*

 

 

 

10.3

 

Form of Restricted Stock Award Agreement under the Michaels Companies, Inc. Equity Incentive Plan (previously filed as Exhibit 10.3 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).*

 

 

 

10.4

 

Amendment No. 1 to Amended and Restated Shareholders Agreement, dated as of July 22, 2013, among Michaels Stores, Inc. and certain stockholders thereof (previously filed as Exhibit 10.4 to Form 10-Q filed by Company on August 30, 2013, SEC File No. 001-09338).

 

 

 

31.1

 

Certifications of Carl S. Rubin pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

 

 

31.2

 

Certifications of Charles M. Sonsteby pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

 

 

32.1

 

Certification pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

 

 

99.1

 

Section 13 (r) Disclosure.

 

 

 

101.INS

 

XBRL Instance Document

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase

 

 

 

101.LAB

 

XBRL Taxonomy Extension Label Linkbase

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase

 


*Management contract or compensatory plan or arrangement.

 

38