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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One) | ||
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended July 30, 2005 | ||
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 incorporation or organization) | (I.R.S. employer identification number) |
8000 Bent Branch Drive
Irving, Texas 75063
P.O. Box 619566
DFW, Texas 75261-9566
(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 þ No o
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o
Indicate the number of shares outstanding of each of the Registrant’s classes of Common Stock, as of the latest practicable date.
Shares Outstanding as of | ||
Title | August 30, 2005 | |
Common Stock, par value $.10 per share | 135,437,312 |
MICHAELS STORES, INC.
FORM 10-Q
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MICHAELS STORES, INC.
Part I—FINANCIAL INFORMATION
Item 1. | Financial Statements. |
MICHAELS STORES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
July 30, | January 29, | July 31, | ||||||||||||
2005 | 2005 | 2004 | ||||||||||||
ASSETS | ||||||||||||||
Current assets: | ||||||||||||||
Cash and equivalents | $ | 182,909 | $ | 535,852 | $ | 257,443 | ||||||||
Short-term investments | — | 50,379 | 50,000 | |||||||||||
Merchandise inventories | 1,090,239 | 936,395 | 954,736 | |||||||||||
Prepaid expenses and other | 39,010 | 26,613 | 39,655 | |||||||||||
Deferred and prepaid income taxes | 58,580 | 22,032 | 26,865 | |||||||||||
Total current assets | 1,370,738 | 1,571,271 | 1,328,699 | |||||||||||
Property and equipment, at cost | 963,201 | 913,174 | 845,738 | |||||||||||
Less accumulated depreciation | (544,714 | ) | (506,193 | ) | (450,010 | ) | ||||||||
418,487 | 406,981 | 395,728 | ||||||||||||
Goodwill | 115,839 | 115,839 | 115,839 | |||||||||||
Other assets | 18,765 | 17,569 | 14,923 | |||||||||||
134,604 | 133,408 | 130,762 | ||||||||||||
Total assets | $ | 1,923,829 | $ | 2,111,660 | $ | 1,855,189 | ||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||||
Current liabilities: | ||||||||||||||
Accounts payable | $ | 248,645 | $ | 256,266 | $ | 211,408 | ||||||||
Accrued liabilities and other | 232,385 | 242,682 | 194,798 | |||||||||||
Income taxes payable | — | 12,992 | — | |||||||||||
Total current liabilities | 481,030 | 511,940 | 406,206 | |||||||||||
91/4% Senior Notes due 2009 | — | 200,000 | 200,000 | |||||||||||
Deferred income taxes | 26,848 | 30,355 | 28,241 | |||||||||||
Other long-term liabilities | 86,898 | 72,200 | 39,170 | |||||||||||
Total long-term liabilities | 113,746 | 302,555 | 267,411 | |||||||||||
594,776 | 814,495 | 673,617 | ||||||||||||
Commitments and contingencies | ||||||||||||||
Stockholders’ equity: | ||||||||||||||
Preferred Stock, $0.10 par value, 2,000,000 shares authorized; none issued | — | — | — | |||||||||||
Common Stock, $0.10 par value, 350,000,000 shares authorized; shares issued and outstanding of 135,827,039 at July 30, 2005, 135,726,717 at January 29, 2005, and 135,774,156 at July 31, 2004 | 13,583 | 13,573 | 13,577 | |||||||||||
Additional paid-in capital | 425,002 | 451,449 | 463,523 | |||||||||||
Retained earnings | 880,990 | 826,821 | 700,079 | |||||||||||
Accumulated other comprehensive income | 9,478 | 5,322 | 4,393 | |||||||||||
Total stockholders’ equity | 1,329,053 | 1,297,165 | 1,181,572 | |||||||||||
Total liabilities and stockholders’ equity | $ | 1,923,829 | $ | 2,111,660 | $ | 1,855,189 | ||||||||
See accompanying notes to consolidated financial statements.
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MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
Quarter Ended | Six Months Ended | ||||||||||||||||
July 30, | July 31, | July 30, | July 31, | ||||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||||||
Net sales | $ | 745,493 | $ | 682,934 | $ | 1,566,509 | $ | 1,408,786 | |||||||||
Cost of sales and occupancy expense | 463,203 | 425,628 | 979,539 | 891,256 | |||||||||||||
Gross profit | 282,290 | 257,306 | 586,970 | 517,530 | |||||||||||||
Selling, general, and administrative expense | 218,012 | 207,158 | 442,482 | 412,859 | |||||||||||||
Store pre-opening costs | 1,454 | 2,643 | 4,193 | 5,126 | |||||||||||||
Operating income | 62,824 | 47,505 | 140,295 | 99,545 | |||||||||||||
Interest expense | 15,500 | 5,069 | 20,590 | 10,397 | |||||||||||||
Other (income) and expense, net | (2,369 | ) | (877 | ) | (5,049 | ) | (1,666 | ) | |||||||||
Income before income taxes | 49,693 | 43,313 | 124,754 | 90,814 | |||||||||||||
Provision for income taxes | 18,878 | 16,567 | 47,406 | 34,736 | |||||||||||||
Net income | $ | 30,815 | $ | 26,746 | $ | 77,348 | $ | 56,078 | |||||||||
Earnings per common share: | |||||||||||||||||
Basic | $ | 0.23 | $ | 0.20 | $ | 0.57 | $ | 0.41 | |||||||||
Diluted | $ | 0.22 | $ | 0.19 | $ | 0.56 | $ | 0.40 | |||||||||
Dividends per common share | $ | 0.10 | $ | 0.06 | $ | 0.17 | $ | 0.12 | |||||||||
See accompanying notes to consolidated financial statements.
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MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six Months Ended | ||||||||||||
July 30, | July 31, | |||||||||||
2005 | 2004 | |||||||||||
Operating activities: | ||||||||||||
Net income | $ | 77,348 | $ | 56,078 | ||||||||
Adjustments: | ||||||||||||
Depreciation | 48,085 | 43,576 | ||||||||||
Amortization | 194 | 197 | ||||||||||
Loss from early extinguishment of debt | 12,133 | — | ||||||||||
Other | 325 | 521 | ||||||||||
Changes in assets and liabilities: | ||||||||||||
Merchandise inventories | (153,844 | ) | (61,813 | ) | ||||||||
Prepaid expenses and other | (12,397 | ) | (10,457 | ) | ||||||||
Deferred income taxes and other | (4,853 | ) | 1,712 | |||||||||
Accounts payable | (7,621 | ) | 38,700 | |||||||||
Income taxes payable | (32,737 | ) | (2,377 | ) | ||||||||
Accrued liabilities and other | (5,363 | ) | 869 | |||||||||
Other long-term liabilities | 11,584 | 2,190 | ||||||||||
Net cash (used in) provided by operating activities | (67,146 | ) | 69,196 | |||||||||
Investing activities: | ||||||||||||
Additions to property and equipment | (60,510 | ) | (51,861 | ) | ||||||||
Purchases of short-term investments | (226 | ) | (50,000 | ) | ||||||||
Sales of short-term investments | 50,605 | — | ||||||||||
Net proceeds from sales of property and equipment | — | 45 | ||||||||||
Net cash used in investing activities | (10,131 | ) | (101,816 | ) | ||||||||
Financing activities: | ||||||||||||
Repayment of Senior Notes | (209,250 | ) | — | |||||||||
Proceeds from stock options exercised | 25,787 | 18,387 | ||||||||||
Repurchase of Common Stock | (71,197 | ) | (55,114 | ) | ||||||||
Cash dividends paid to stockholders | (23,184 | ) | (16,364 | ) | ||||||||
Proceeds from issuance of Common Stock and other | 2,178 | 1,329 | ||||||||||
Net cash used in financing activities | (275,666 | ) | (51,762 | ) | ||||||||
Net decrease in cash and equivalents | (352,943 | ) | (84,382 | ) | ||||||||
Cash and equivalents at beginning of period | 535,852 | 341,825 | ||||||||||
Cash and equivalents at end of period | $ | 182,909 | $ | 257,443 | ||||||||
See accompanying notes to consolidated financial statements.
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Six Months Ended July 30, 2005
(Unaudited)
Note 1. | Basis of Presentation |
The consolidated financial statements include the accounts of Michaels Stores, Inc. and our wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. All expressions of “us,” “we,” “our,” and all similar expressions are references to Michaels Stores, Inc. and our 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 accounting principles generally accepted in the United States 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 generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals and other items, as disclosed) considered necessary for a fair presentation have been included. Because of the seasonal nature of our business, the results of operations for the quarter and six months ended July 30, 2005 are not indicative of the results to be expected for the entire year.
The balance sheet at January 29, 2005 has been derived from the audited financial statements at that date but does not include all of the information and notes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 29, 2005.
Share and per share data (except par value) presented for all periods reflect the effect of a two-for-one Common Stock split, which was effected in the form of a stock dividend on October 12, 2004, to stockholders of record as of the close of business on September 27, 2004.
All references herein to “fiscal 2005” relate to the 52 weeks ending January 28, 2006 and all references to “fiscal 2004” relate to the 52 weeks ended January 29, 2005. In addition, all references herein to “the second quarter of fiscal 2005” and “the first six months of fiscal 2005” relate to the 13 and 26 weeks ended July 30, 2005 and all references to “the second quarter of fiscal 2004” and “the first six months of fiscal 2004” relate to the 13 and 26 weeks ended July 31, 2004.
Certain reclassifications have been made to conform to the current year presentation.
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Six Months Ended July 30, 2005
(Unaudited)
Note 2. | Earnings per Share |
The following table sets forth the computation of basic and diluted earnings per common share:
Quarter Ended | Six Months Ended | |||||||||||||||||
July 30, | July 31, | July 30, | July 31, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||||
(In thousands, except per share data) | ||||||||||||||||||
Numerator: | ||||||||||||||||||
Net income | $ | 30,815 | $ | 26,746 | $ | 77,348 | $ | 56,078 | ||||||||||
Denominator: | ||||||||||||||||||
Denominator for basic earnings per common share-weighted average shares | 135,774 | 136,304 | 135,896 | 136,432 | ||||||||||||||
Effect of dilutive securities: | ||||||||||||||||||
Employee stock options | 3,360 | 2,976 | 3,307 | 3,054 | ||||||||||||||
Denominator for diluted earnings per common share-weighted average shares adjusted for dilutive securities | 139,134 | 139,280 | 139,203 | 139,486 | ||||||||||||||
Earnings per common share: | ||||||||||||||||||
Basic | $ | 0.23 | $ | 0.20 | $ | 0.57 | $ | 0.41 | ||||||||||
Diluted | $ | 0.22 | $ | 0.19 | $ | 0.56 | $ | 0.40 | ||||||||||
Our purchase and subsequent retirement of 457,900 and 1.9 million shares of our Common Stock in the second quarter and first six months of fiscal 2005, respectively, reduced the number of weighted average shares outstanding by 21,000 and 867,000 shares for the second quarter and first six months of fiscal 2005, respectively. In addition, our purchase and subsequent retirement of 1.8 million shares and 2.2 million shares of our Common Stock in the second quarter and first six months of fiscal 2004, respectively, reduced the number of weighted average shares outstanding by 1.4 million and 701,200 shares for the second quarter and first six months of fiscal 2004, respectively.
Note 3. | Stock-Based Compensation |
We have elected to follow Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees, and related guidance in accounting for our employee stock options. The exercise price of our employee stock options equals the market price of the underlying stock on the date of grant and, as a result, we do not recognize compensation expense for stock option grants.
Pro forma information regarding net income and earnings per common share, as required by the provisions of Statement of Financial Accounting Standards No. 123,Accounting for Stock-Based Compensation, and SFAS No. 148,Accounting for Stock-Based Compensation—Transition and Disclosure, has been determined as if we had accounted for our employee stock options under the fair value method.
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Six Months Ended July 30, 2005
(Unaudited)
Note 3. | Stock-Based Compensation (Continued) |
For purposes of pro forma disclosures, the estimated fair value of the options is amortized over the options’ vesting periods. Our pro forma information is as follows:
Quarter Ended | Six Months Ended | ||||||||||||||||
July 30, | July 31, | July 30, | July 31, | ||||||||||||||
2005 | 2004(1) | 2005 | 2004(1) | ||||||||||||||
(In thousands, except per share data) | |||||||||||||||||
Net income, as reported | $ | 30,815 | $ | 26,746 | $ | 77,348 | $ | 56,078 | |||||||||
Stock-based employee compensation cost: | |||||||||||||||||
As if the fair value method were applied, net of income tax | 3,824 | 3,435 | 6,600 | 6,033 | |||||||||||||
Pro forma net income | $ | 26,991 | $ | 23,311 | $ | 70,748 | $ | 50,045 | |||||||||
Earnings per common share, as reported: | |||||||||||||||||
Basic | $ | 0.23 | $ | 0.20 | $ | 0.57 | $ | 0.41 | |||||||||
Diluted | $ | 0.22 | $ | 0.19 | $ | 0.56 | $ | 0.40 | |||||||||
Pro forma earnings per common share: | |||||||||||||||||
Basic | $ | 0.20 | $ | 0.17 | $ | 0.52 | $ | 0.37 | |||||||||
Diluted | $ | 0.20 | $ | 0.17 | $ | 0.51 | $ | 0.36 | |||||||||
Pro forma weighted average shares outstanding: | |||||||||||||||||
Basic | 135,774 | 136,304 | 135,896 | 136,432 | |||||||||||||
Diluted | 138,408 | 138,661 | 138,459 | 138,660 |
(1) | The pro forma information for the quarter and six months ended July 31, 2004 was revised based on the results of management’s review of prior years’ calculations. The impacts to the pro forma information resulting from the difference between previously reported stock-based employee compensation cost, net of tax, and the revised presentation are as follows: for the second quarter of fiscal 2004, a decrease in stock-based employee compensation cost, net of tax, a corresponding increase in pro-forma net income of $163,000 and an increase in pro-forma diluted weighted average shares outstanding of 325 thousand; for the six months ended July 31, 2004, a decrease in stock-based employee compensation cost, net of tax, a corresponding increase in pro-forma net income of $954,000, an increase in pro-forma diluted weighted average shares outstanding of 186 thousand, and an increase in pro-forma basic earnings per share of $0.01. |
Note 4. | Debt |
91/4% Senior Notes due 2009
In 2001, we issued $200 million in principal amount of 91/4% Senior Notes due July 1, 2009, which were unsecured and interest thereon was payable semi-annually on each January 1 and July 1. On July 1, 2005, we redeemed the Senior Notes at a price of $1,046.25 per $1,000 of principal amount. This early redemption resulted in a pre-tax charge of $12.1 million in the second quarter of fiscal 2005, which represents a combination of a $9.3 million call premium and $2.8 million of unamortized costs associated with the Senior Notes, and was recorded as interest expense.
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Six Months Ended July 30, 2005
(Unaudited)
Note 4. | Debt (Continued) |
Credit Agreement
In October 2004, we signed an extension to our existing $200 million unsecured revolving bank credit facility with Fleet National Bank and other lending institutions, which now expires on April 30, 2006. The Credit Agreement requires us to maintain certain financial covenants and limits certain activities, including, among other things, levels of indebtedness, liens, investments, payments of dividends, Common Stock repurchases, mergers and acquisitions, and sales of assets. In addition to extending the term of the Credit Agreement, we obtained the consent of the lenders to permit the prepayment of the Senior Notes due 2009.
We are in compliance with all terms and conditions of the Credit Agreement. No borrowings were outstanding under our Credit Agreement as of July 30, 2005, January 29, 2005, or July 31, 2004. Borrowings available under the Credit Agreement are reduced by the aggregate amount of letters of credit outstanding under the Credit Agreement ($21.2 million as of July 30, 2005).
Note 5. | Comprehensive Income |
Our comprehensive income is as follows:
Quarter Ended | Six Months Ended | ||||||||||||||||
July 30, | July 31, | July 30, | July 31, | ||||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||||||
(In thousands) | |||||||||||||||||
Net income | $ | 30,815 | $ | 26,746 | $ | 77,348 | $ | 56,078 | |||||||||
Other comprehensive income (loss): | |||||||||||||||||
Foreign currency translation adjustment and other | 1,302 | 2,802 | 4,156 | 170 | |||||||||||||
Comprehensive income | $ | 32,117 | $ | 29,548 | $ | 81,504 | $ | 56,248 | |||||||||
Note 6. | Legal Proceedings |
Stockholder Class Actions
On various dates between February 4, 2003 and March 25, 2003, 10 purported class action lawsuits were filed in the United States District Court for the Northern District of Texas, Dallas Division, against Michaels Stores, Inc. and certain of the current and former directors and officers of Michaels. All of these lawsuits were consolidated. The suits asserted various claims under Sections 10(b), 20(a), and 20A of the Securities Exchange Act of 1934 related to actions prior to Michaels’ announcement on November 7, 2002, that, among other things, it had revised its outlook for the fourth fiscal quarter of 2002, adjusting downward its guidance for annual earnings per diluted share. The consolidated complaint charged that, prior to that announcement, Michaels and certain of the other defendants made misrepresentations and failed to disclose negative information about the financial condition of Michaels while the individual defendants were selling shares of Michaels common stock. On December 10, 2004, the Court granted the defendants’ motion to dismiss the consolidated complaint, dismissing certain allegations supporting the claims with prejudice. For those allegations that were not dismissed with prejudice, the Court allowed the plaintiffs to amend, which they did on January 14, 2005. In that amended consolidated complaint, the plaintiffs added a claim under Section 20A of the Securities Exchange Act of 1934 and repled their Sections 10(b) and 20(a) claims based on allegations similar to those in the original consolidated complaint. After the defendants moved to dismiss the amended consolidated complaint, the plaintiffs filed
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Six Months Ended July 30, 2005
(Unaudited)
Note 6. | Legal Proceedings (Continued) |
a notice of voluntary dismissal May 13, 2005. The Court issued an order on May 18, 2005 dismissing the case in its entirety without prejudice.
Derivative Claims
On March 21, 2003, Julie Fathergill filed a purported stockholder derivative action, which is pending in the 192nd District Court for Dallas County, Texas. The lawsuit names certain former and current officers and directors, including all of Michaels’ current directors, as individual defendants and Michaels as a nominal defendant. In this derivative action, the plaintiff makes allegations of fact similar to those made in the purported securities class actions described above. The plaintiff asserts claims against the individual defendants for breach of fiduciary duties, abuse of control, gross mismanagement, waste of corporate assets, and unjust enrichment. All of these claims are asserted derivatively on behalf of Michaels. We believe these claims are without merit and will vigorously oppose them.
On September 11, 2003, Leo J. Dutil filed a purported stockholder derivative action, which is pending in the United States District Court for the Northern District of Texas, Dallas Division. The lawsuit names certain former and current officers and directors as individual defendants and Michaels as a nominal defendant. In this derivative action, the plaintiff makes allegations of fact similar to those made in the purported stockholder class actions and the Fathergill derivative lawsuit described above. The plaintiff asserts claims against the individual defendants for breach of fiduciary duty, misappropriation of confidential information, and contribution and indemnification. All of these claims are asserted derivatively on behalf of Michaels. We believe these claims are without merit and will vigorously oppose them.
Cotton Claim
On December 20, 2002, James Cotton, a former store manager of Michaels of Canada, ULC, our wholly-owned subsidiary, and Suzette Kennedy, a former assistant manager of Michaels of Canada, commenced a proposed class proceeding against Michaels of Canada and Michaels Stores, Inc. on behalf of themselves and current and former employees employed in Canada. The Cotton claim was filed in the Ontario Superior Court of Justice and alleges that the defendants violated employment standards legislation in Ontario and other provinces and territories of Canada by failing to pay overtime compensation as required by that legislation. The Cotton claim also alleges that this conduct was in breach of the contracts of employment of those individuals. The Cotton claim seeks a declaration that the defendants have acted in breach of applicable legislation, payment to current and former employees for overtime, damages for breach of contract, punitive, aggravated and exemplary damages, interest, and costs. In May of 2005, the plaintiffs delivered material in support of their request that this action be certified as a class proceeding. A date has not yet been set for the hearing with respect to certification. We intend to contest certification of this claim as a class action. Further, we believe we have certain defenses on the merits and intend to defend this lawsuit vigorously. We are unable to estimate a range of possible loss, if any, in this claim.
Clark Claim
On July 13, 2005, Michael Clark, a former assistant manager and Lucinda Prouty, a former department manager in San Diego, California, commenced a proposed class action proceeding against Michaels Stores, Inc. on behalf of themselves and current and former hourly retail employees employed in California from July 13, 2001 to the present. The Clark suit was filed in the Superior Court of California,
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Six Months Ended July 30, 2005
(Unaudited)
Note 6. | Legal Proceedings (Continued) |
County of San Diego and alleges that we failed to pay overtime wages, provide meal and rest periods (or compensation in lieu thereof), and provide itemized employee wage statements. The Clark suit also alleges that this conduct was in breach of California’s unfair competition law. The plaintiffs seek injunctive relief, damages for unpaid overtime pay, meal break penalties, waiting time penalties, interest, and attorneys’ fees and costs. Under the Class Action Fairness Act, we intend to remove the case to federal court. We are in the early stages of our investigation; however, we believe that the Clark claim lacks merit and we intend to vigorously defend our interests.
General
We are a defendant from time to time in lawsuits incidental to our business. Based on currently available information, we believe that resolution of all known contingencies is uncertain. There can be no assurance that future costs of such litigation would not be material to our financial position or results of operations.
Note 7. | Segments |
We consider our Michaels, Aaron Brothers, and Recollections stores and our Star Decorators Wholesale Warehouse operations to be our operating segments for purposes of determining reportable segments based on the criteria set forth in SFAS No. 131,Disclosures About Segments of an Enterprise and Related Information. We determined that our Michaels and Aaron Brothers operating segments have similar economic characteristics and meet the aggregation criteria in paragraph 17 of SFAS No. 131. Our Aaron Brothers operating segment does not meet the quantitative thresholds for separate disclosure set forth in SFAS No. 131, and, our Recollections stores and Star Decorators Wholesale Warehouse operations are immaterial for segment reporting purposes individually, and in the aggregate. Therefore, we combine all operating segments into one reporting segment.
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Six Months Ended July 30, 2005
(Unaudited)
Note 7. Segments — (Continued)
Our sales, operating income, and assets by country are as follows:
Net Sales | Operating Income | Total Assets | ||||||||||
(In thousands) | ||||||||||||
Quarter ended July 30, 2005: | ||||||||||||
United States | $ | 703,288 | $ | 55,534 | $ | 1,843,272 | ||||||
Canada | 42,205 | 7,290 | 80,557 | |||||||||
Consolidated Total | $ | 745,493 | $ | 62,824 | $ | 1,923,829 | ||||||
Quarter ended July 31, 2004: | ||||||||||||
United States | $ | 650,961 | $ | 43,113 | $ | 1,793,865 | ||||||
Canada | 31,973 | 4,392 | 61,324 | |||||||||
Consolidated Total | $ | 682,934 | $ | 47,505 | $ | 1,855,189 | ||||||
Six months ended July 30, 2005: | ||||||||||||
United States | $ | 1,480,188 | $ | 127,459 | $ | 1,843,272 | ||||||
Canada | 86,321 | 12,836 | 80,557 | |||||||||
Consolidated Total | $ | 1,566,509 | $ | 140,295 | $ | 1,923,829 | ||||||
Six months ended July 31, 2004: | ||||||||||||
United States | $ | 1,340,386 | $ | 90,767 | $ | 1,793,865 | ||||||
Canada | 68,400 | 8,778 | 61,324 | |||||||||
Consolidated Total | $ | 1,408,786 | $ | 99,545 | $ | 1,855,189 | ||||||
Canada’s operating income includes allocations of permanent markdown reserves, corporate overhead, and amounts related to our distribution and Artistree operations. We present assets based on their physical, geographic location. Certain assets located in the United States are also used to support our Canadian operations, but we do not allocate those assets or their associated expenses to Canada.
Note 8. | Recent Accounting Pronouncements |
Stock-Based Compensation
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (revised 2004),Share-Based Payment, which is a revision of SFAS No. 123,Accounting for Stock-Based Compensation. SFAS No. 123(R) supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees, and amends SFAS No. 95,Statement of Cash Flows. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values at the time of grant. Pro forma disclosure is no longer an alternative. Our effective date for adoption of the provisions of SFAS No. 123(R) is January 29, 2006 (the first day of our fiscal year 2006); however, we are permitted to early adopt.
As permitted by SFAS No. 123, we currently account for share-based payments to employees using the intrinsic value method under APB No. 25, and, as such, recognize no compensation cost for employee stock options. The adoption of SFAS No. 123(R) and resulting recognition of compensation cost will significantly impact our results of operations but we are unable to quantify the impact because it is dependent upon, among other items, the number of share-based payments granted in the future, our selection of a methodology to determine fair value for grants, and our estimates of forfeitures.
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Six Months Ended July 30, 2005
(Unaudited)
Note 8. Recent Accounting Pronouncements — (Continued)
We do not anticipate a material impact on our overall financial position or total cash flows, but SFAS No. 123(R) does require that we report the benefits of tax deductions in excess of recognized compensation cost as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods following adoption. While we cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amounts of operating cash flows recognized for such excess tax deductions were $9.5 million and $2.3 million for the quarters ended July 30, 2005 and July 31, 2004, respectively, and $16.8 million and $9.8 million for the six months ended July 30, 2005 and July 31, 2004, respectively.
Inventory Costs
In November 2004, the FASB issued SFAS No. 151,Inventory Costs, as an amendment to ARB No. 43. SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current period charges and requires the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We do not currently believe that our adoption of the provisions of SFAS No. 151 will have a material impact on our consolidated results of operations and financial position.
Note 9. | Certain Issues Under the Securities Exchange Act of 1934 |
During the first quarter of fiscal 2005, we were informed by Charles J. Wyly, Jr. and Sam Wyly, who are the Chairman and Vice Chairman of our Board of Directors, respectively, that they have filed a report with the Securities and Exchange Commission under Section 13 of the Securities Exchange Act of 1934 with respect to Michaels securities held by certain non-U.S. trusts and subsidiaries. We understand that Charles Wyly and Sam Wyly and certain of their family members are direct or contingent beneficiaries of certain of those trusts. According to this report, Charles Wyly and Sam Wyly may be deemed the beneficial owners in the aggregate as of March 31, 2005 of 10,868,352 shares of Common Stock or 7.9% of the outstanding common stock. As a result of the Wylys’ filing, we included this ownership information in our proxy statement for the 2005 annual meeting of stockholders.
It is possible that purchases and sales of Michaels securities by the trusts or their subsidiaries may have resulted in short-swing profits under Section 16 of the Securities Exchange Act of 1934. Pursuant to Section 16, Charles Wyly and Sam Wyly will reimburse us for those profits, if any. Any resulting impact will not affect our previously reported consolidated statement of income or adversely affect our consolidated balance sheet.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
All expressions of “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 January 29, 2005. Specific examples of forward-looking statements include, but are not limited to, statements regarding our future cash dividend policy, forecasts of financial performance, capital expenditures, working capital requirements, and stock repurchases. Our actual results could materially differ from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to:
• | our ability to remain competitive in the areas of merchandise quality, price, breadth of selection, customer service, and convenience; | |
• | our ability to anticipate and/or react to changes in customer demand and preferences for products and supplies used in creative activities and the related potential impact to merchandise inventories in categories that represent a significant portion of our business; | |
• | changes in consumer confidence resulting in a reduction in consumer spending on items perceived to be discretionary; | |
• | the execution and management of our store growth, including new concepts, the impact of new competitor stores in locations near our existing stores, and the availability of acceptable real estate locations for new store openings; | |
• | the effective optimization and maintenance of our perpetual inventory and automated replenishment systems and related impacts to inventory levels; | |
• | the identification and implementation of enhancements to our supply chain to enable us to distribute additional SKUs through our distribution centers; | |
• | delays in the receipt of merchandise ordered from our suppliers due to delays in connection with either the manufacture or shipment of such merchandise; | |
• | transportation delays (including dock strikes and other work stoppages) and increases in transportation costs due to fuel surcharges and transportation regulations; | |
• | restrictive actions by foreign governments or changes in United States laws and regulations affecting imports or domestic distribution; | |
• | significant increases in inflation or commodity prices, such as petroleum, natural gas, steel, and paper, which may adversely affect our costs, including cost of merchandise; | |
• | significant increases in tariffs or duties levied on imports which may limit the availability of certain merchandise from our foreign suppliers; | |
• | changes in political, economic, and social conditions; | |
• | significant fluctuations in exchange rates; | |
• | financial difficulties of any of our key vendors, suppliers, and service providers; | |
• | the design and implementation of new management information systems as well as the maintenance and enhancement of existing systems, particularly in light of our continued store growth and the addition of new concepts; | |
• | our ability to maintain the security of electronic and other confidential information; | |
• | our ability to comply with the terms and restrictions of our Credit Agreement; |
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• | our ability to attract and retain qualified personnel to successfully execute our operating plans; | |
• | the seasonality of the retail business; and | |
• | other factors as set forth in our Annual Report on Form 10-K for the fiscal year ended January 29, 2005, particularly in “Critical Accounting Policies and Estimates” and “Risk Factors,” and in our other Securities and Exchange Commission filings. |
We intend these forward-looking statements to speak only as of the time of filing this Quarterly Report on Form 10-Q and do not undertake to update or revise them as more information becomes available.
General
All references herein to “fiscal 2005” relate to the 52 weeks ending January 28, 2006 and all references to “fiscal 2004” relate to the 52 weeks ended January 29, 2005. In addition, all references herein to “the second quarter of fiscal 2005” and “the first six months of fiscal 2005” relate to the 13 and 26 weeks ended July 30, 2005 and all references to “the second quarter of fiscal 2004” and “the first six months of fiscal 2004” relate to the 13 and 26 weeks ended July 31, 2004.
The following table sets forth certain of our unaudited operating data (dollar amounts in thousands):
Quarter Ended | Six Months Ended | ||||||||||||||||
July 30, | July 31, | July 30, | July 31, | ||||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||||||
Michaels stores: | |||||||||||||||||
Retail stores open at beginning of period | 857 | 818 | 844 | 804 | |||||||||||||
Retail stores opened during the period | 13 | 9 | 27 | 23 | |||||||||||||
Retail stores opened (relocations) during the period | 3 | 10 | 11 | 22 | |||||||||||||
Retail stores closed during the period | — | — | (1 | ) | — | ||||||||||||
Retail stores closed (relocations) during the period | (3 | ) | (10 | ) | (11 | ) | (22 | ) | |||||||||
Retail stores open at end of period | 870 | 827 | 870 | 827 | |||||||||||||
Aaron Brothers stores: | |||||||||||||||||
Retail stores open at beginning of period | 165 | 158 | 164 | 158 | |||||||||||||
Retail stores opened during the period | — | 3 | 1 | 3 | |||||||||||||
Retail stores closed during the period | — | (1 | ) | — | (1 | ) | |||||||||||
Retail stores open at end of period | 165 | 160 | 165 | 160 | |||||||||||||
Recollections stores: | |||||||||||||||||
Retail stores open at beginning of period | 9 | 2 | 8 | 2 | |||||||||||||
Retail stores opened during the period | 2 | 3 | 3 | 3 | |||||||||||||
Retail stores open at end of period | 11 | 5 | 11 | 5 | |||||||||||||
Star Wholesale stores: | |||||||||||||||||
Wholesale stores open at beginning of period | 4 | 3 | 3 | 3 | |||||||||||||
Wholesale stores opened during the period | — | — | 1 | — | |||||||||||||
Wholesale stores open at end of period | 4 | 3 | 4 | 3 | |||||||||||||
Total store count at end of period | 1,050 | 995 | 1,050 | 995 | |||||||||||||
Other operating data: | |||||||||||||||||
Average inventory per Michaels store(1) | $ | 1,154 | $ | 1,079 | $ | 1,154 | $ | 1,079 | |||||||||
Comparable store sales increase(2) | 4.2 | % | 5.5 | % | 6.1 | % | 5.7 | % |
(1) | Average inventory per Michaels store calculation excludes our Aaron Brothers, Recollections, and Star Wholesale stores. |
(2) | Comparable store sales increase represents the increase in net sales for stores open the same number of months in the indicated period and the comparable period of the previous year, including stores |
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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. |
Results of Operations
The following table sets forth the percentage relationship to net sales of each line item of our unaudited consolidated statements of 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 | |||||||||||||||
July 30, | July 31, | July 30, | July 31, | |||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Cost of sales and occupancy expense | 62.1 | 62.3 | 62.5 | 63.3 | ||||||||||||
Gross profit | 37.9 | 37.7 | 37.5 | 36.7 | ||||||||||||
Selling, general, and administrative expense | 29.3 | 30.3 | 28.2 | 29.3 | ||||||||||||
Store pre-opening costs | 0.2 | 0.4 | 0.3 | 0.3 | ||||||||||||
Operating income | 8.4 | 7.0 | 9.0 | 7.1 | ||||||||||||
Interest expense | 2.1 | 0.8 | 1.3 | 0.8 | ||||||||||||
Other (income) and expense, net | (0.4 | ) | (0.1 | ) | (0.3 | ) | (0.1 | ) | ||||||||
Income before income taxes | 6.7 | 6.3 | 8.0 | 6.4 | ||||||||||||
Provision for income taxes | 2.6 | 2.4 | 3.1 | 2.4 | ||||||||||||
Net income | 4.1 | % | 3.9 | % | 4.9 | % | 4.0 | % | ||||||||
Quarter Ended July 30, 2005 Compared to the Quarter Ended July 31, 2004 |
Net Sales—Net sales for the second quarter of fiscal 2005 increased $62.6 million, or 9.2%, over the second quarter of fiscal 2004. At the end of the second quarter of fiscal 2005, we operated 870 Michaels, 165 Aaron Brothers, 11 Recollections, and four Star Wholesale stores. The results for the second quarter of fiscal 2005 include sales from 49 Michaels, five Aaron Brothers, six Recollections, and one Star Wholesale store that were opened during the 12-month period ended July 30, 2005, more than offsetting lost sales from the closure of six Michaels stores during the same period. Comparable store sales accounted for $28.2 million of the increase in net sales and sales at our new stores (net of closures) opened since the second quarter of fiscal 2004 accounted for the remaining increase of $34.4 million.
Comparable store sales increased 4.2% in the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004, reflecting increases in the average ticket of 2.4%, customer traffic of 1.4%, and custom framing deliveries of 0.4%. A favorable currency translation, due to the stronger Canadian dollar, contributed approximately 0.4% to the average ticket increase for the quarter. Comparable store sales growth was strongest in our Jewelry and Beading, Paper-crafting, Foam and Yarn categories. Our ability to continue to generate comparable store sales increases is dependent, in part, on our ability to continue to maintain store in-stock positions on the top-selling items, to properly allocate merchandise to our stores, to effectively execute our pricing and sales promotion efforts, to anticipate customer demand and trends in the arts and crafts industry, and to respond to competitors’ activities.
Cost of Sales and Occupancy Expense—Cost of sales and occupancy expense increased $37.6 million primarily due to increased sales from a 5.5% increase in the number of stores operated in the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004, as well as a 4.2% comparable store sales increase.
Cost of sales and occupancy expense, as a percentage of net sales, decreased approximately 20 basis points in the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004. This decrease was primarily a result of improved merchandise margins driven by a 1.3% increase in sales of regular priced merchandise as a percentage of total sales combined with improved margins on clearance
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merchandise, partially offset by higher occupancy costs compared to last year, due primarily to remodeling costs associated with the Perfect Store project. Due to planned promotional activities, recent trends in sales of regular priced merchandise as a percentage of our overall sales may not be indicative of future performance.
Selling, General, and Administrative Expense—Selling, general, and administrative expense was $218.0 million, or 29.3% of net sales, in the second quarter of fiscal 2005 compared to $207.2 million, or 30.3% of net sales, in the second quarter of fiscal 2004. The expense increase was primarily due to an increase in the number of stores we operated compared to last year, in particular, store operating expenses and advertising expenses totaling approximately $7.7 million of the overall $10.8 million increase.
As a percentage of net sales, selling, general, and administrative expenses decreased approximately 100 basis points due to a reduction in store personnel costs over the prior year. Store personnel costs decreased approximately 140 basis points primarily due to the recognition of additional insurance expenses totaling $9.4 million during the second quarter of fiscal 2004 related to the deteriorating financial condition of a previous insurance carrier and higher workers’ compensation expenses. During the second quarter of fiscal 2005, a portion of the favorability to last year was partially offset by an incremental increase in store payroll.
Operating Income—As a result of the improved merchandise margins and the favorable comparison to the workers’ compensation and insurance expenses from the second quarter of fiscal 2004, operating income increased from $47.5 million, or 7.0% of sales, in the second quarter of fiscal 2004 to $62.8 million, or 8.4% of sales, in the second quarter of fiscal 2005. We estimate that our operating margins will increase approximately 80– 100 basis points in the third quarter and approximately 150– 200 basis points in the fourth quarter, primarily due to gross margin expansion with increased sales of our basic assortments and improved sell-through on seasonal merchandise. The expected gross margin expansion will be partially offset by incremental investments in store-level staffing and our advertising program.
Interest Expense—Interest expense increased from $5.1 million in the second quarter of fiscal 2004 to $15.5 million during the second quarter of fiscal 2005. During the second quarter of fiscal 2005, we recognized a pre-tax charge to earnings of approximately $12.1 million related to the redemption of our 91/4% Senior Notes. The charge was comprised of $9.3 million for the call premium and $2.8 million for unamortized debt costs associated with the Senior Notes. As a result of the early redemption, we will no longer incur interest expense in connection with the Senior Notes.
Provision for Income Taxes—The effective tax rate was 38.0% for the second quarter of fiscal 2005 and 38.25% for the second quarter of fiscal 2004.
Net Income—As a result of the above, net income for the second quarter of fiscal 2005 increased 15.2% to $30.8 million, or $0.22 per diluted share, from $26.7 million, or $0.19 per diluted share, for the second quarter of fiscal 2004.
Six Months Ended July 30, 2005 Compared to the Six Months Ended July 31, 2004 |
Net Sales—Net sales for the first six months of fiscal 2005 increased $157.7 million, or 11.2%, over the first six months of fiscal 2004. Comparable store sales accounted for $84.7 million of the increase in net sales and sales at our new stores (net of closures) opened since the first six months of fiscal 2004 accounted for the remaining increase of $73.0 million.
Comparable store sales increased 6.1% in first six months of fiscal 2005 compared to the first six months of fiscal 2004, reflecting increases in customer traffic of 3.2%, average ticket of 2.4%, and custom framing deliveries of 0.5%. Comparable store sales growth was strongest in our Yarn, Jewelry and Beading, Foam and Paper-crafting categories.
Cost of Sales and Occupancy Expense—Cost of sales and occupancy expense increased $88.3 million primarily due to increased sales from a 5.5% increase in the number of stores operated in the first six
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months of fiscal 2005 compared to first six months of fiscal 2004, as well as a 6.1% comparable store sales increase.
Cost of sales and occupancy expense, as a percentage of net sales, decreased approximately 80 basis points in the first six months of fiscal 2005 compared to the first six months of fiscal 2004. This decrease was primarily a result of improved merchandise margins driven by a 1.5% increase in sales of regular priced merchandise as a percentage of total sales and a decrease in clearance markdowns, partially offset by a deleveraging of occupancy costs.
Selling, General, and Administrative Expense—Selling, general, and administrative expense was $442.5 million, or 28.2% of net sales, in the first six months of fiscal 2005 compared to $412.9 million, or 29.3% of net sales, in the first six months of fiscal 2004. The expense increase was primarily due to an increase in the number of stores we operated compared to last year, in particular, store personnel costs, store operating expenses, and advertising expenses totaling approximately $24.3 million of the overall $29.6 million increase.
As a percentage of net sales, store personnel costs decreased approximately 120 basis points primarily due to the recognition of additional insurance expenses during the second quarter of fiscal 2004 related to the deteriorating financial condition of a previous insurance carrier and for higher workers compensation expenses.
Operating Income—As a result of the improved merchandise margins and the favorable comparison to the workers’ compensation and insurance expenses from the first six months of fiscal 2004, operating income increased from $99.5 million, or 7.1% of sales, in the first six months of fiscal 2004 to $140.3 million, or 9.0% of sales, in the second quarter of fiscal 2005. We estimate that our operating margins for the second half of fiscal 2005 will increase approximately 110– 160 basis points, primarily due to gross margin expansion with increased sales of our basic assortments and improved sell-through on seasonal merchandise. The expected gross margin expansion will be partially offset by incremental investments in store-level staffing and our advertising program.
Interest Expense—Interest expense increased from $10.4 million in the first six months of fiscal 2004 to $20.6 million during the first six months of fiscal 2005. During the second quarter of fiscal 2005, we recognized a pre-tax charge to earnings of approximately $12.1 million related to the redemption of our 91/4% Senior Notes. The charge was comprised of $9.3 million for the call premium and $2.8 million for unamortized debt costs associated with the Notes. As a result of the early redemption, we will no longer incur interest expense in connection with the Senior Notes.
Provision for Income Taxes—The effective tax rate was 38.0% for the first six months of fiscal 2005 and 38.25% for the first six months of fiscal 2004.
Net Income—As a result of the above, net income for the first six months of fiscal 2005 increased 37.9% to $77.3 million, or $0.56 per diluted share, from $56.1 million, or $0.40 per diluted share, for the first six months of fiscal 2004.
Liquidity and Capital Resources
Our cash and equivalents decreased $353.0 million, or 65.9%, from $535.9 million at the end of fiscal 2004 to $182.9 million at the end of the second quarter of fiscal 2005 primarily as result of our early redemption of the Senior Notes and strategic incremental purchases of merchandise inventory. Compared to the end of the second quarter of fiscal 2004, cash and equivalents decreased $74.5 million, or 28.9%, primarily because of our early redemption of the Senior Notes, the incremental investment in merchandise inventory in preparation for the fourth quarter holiday selling season, and the repurchases of our Common Stock; all of the above were partially offset by our net income.
We require cash principally for day-to-day operations and to finance capital investments, inventory for new stores, inventory replenishment for existing stores, and seasonal working capital needs. In recent years, we have financed our operations, new store openings, Common Stock repurchases, dividend payments, and
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other capital investments with cash from operations and proceeds from stock option exercises. We expect that cash from operations and proceeds from stock option exercises will be sufficient to fund our anticipated cash requirements. In addition, borrowings under our Credit Agreement may be an additional source of cash for us to finance future growth, inventory purchases, and other capital investments.
Cash Flow from Operating Activities |
Cash flow used in operating activities during the first six months of fiscal 2005 was $67.1 million compared to cash provided by operating activities of $69.2 million during the first six months of fiscal 2004. The increased use of cash of $136.3 million was primarily due to a strategic incremental investment in higher growth inventory categories, net of accounts payable.
Inventories per Michaels store (including warehouse inventory) increased 6.9% from July 31, 2004 to July 30, 2005. During the second quarter of fiscal 2005, we redeployed our inventory from slower selling categories to ones demonstrating higher growth trends. Accordingly, we made incremental inventory investments in the Yarn category and Back to School program and additional inventory investments in support of our promotional feature space. As a result of these strategic investments, we now anticipate average inventory per Michaels store at the end of the third quarter of fiscal 2005 compared to the third quarter of fiscal 2004 to increase approximately 10%, with an approximate 5% increase in average inventory per Michaels store at the end of fiscal 2005.
Cash Flow from Investing Activities |
Cash flow used in investing activities was primarily the result of the following capital expenditure activities:
Six Months Ended | ||||||||
July 30, | July 31, | |||||||
2005(1) | 2004(2) | |||||||
(In thousands) | ||||||||
New and relocated stores and stores not yet opened | $ | 21,285 | $ | 27,067 | ||||
Existing stores | 16,482 | 7,892 | ||||||
Distribution system expansion | 4,112 | 5,841 | ||||||
Information systems | 11,973 | 9,196 | ||||||
Corporate and other | 6,658 | 1,865 | ||||||
$ | 60,510 | $ | 51,861 | |||||
(1) | In the first six months of fiscal 2005, we incurred capital expenditures related to the opening of 27 Michaels, one Aaron Brothers, three Recollections, and one Star Wholesale store, and the relocation of 11 Michaels stores. |
(2) | In the first six months of fiscal 2004, we incurred capital expenditures related to the opening of 23 Michaels, three Aaron Brothers, and three Recollections stores, the relocation of 22 Michaels stores, and the completion of our New Lenox, Illinois distribution center. |
We anticipate capital expenditures for fiscal 2005 to be in the range of $105.0 million to $110.0 million. In fiscal 2005, we plan to open approximately 45 Michaels, two Aaron Brothers, three Recollections, and one Star Wholesale store, and relocate 18 Michaels stores.
During the six months ended July 30, 2005, we liquidated our investment in a Massachusetts business trust for proceeds of approximately $50.6 million, which was classified as a short-term investment for the fiscal year ended January 29, 2005 and second quarter of fiscal 2004.
Cash Flow from Financing Activities |
Proceeds from the exercise of outstanding stock options have served as a source of cash for us, and we expect to receive proceeds from the exercise of outstanding stock options and options to be granted
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under our stock option plans in the future. Proceeds from the exercise of stock options were $25.8 million in the first six months of fiscal 2005 and $18.4 million in the first six months of fiscal 2004.
Cash used for repurchases of our Common Stock increased $16.1 million from $55.1 million in the first six months of fiscal 2004 to $71.2 million in the first six months of fiscal 2005. The following table sets forth information regarding our Common Stock repurchase plans as of July 30, 2005:
Shares | Shares | |||||||||||
Authorized for | Shares | Available for | ||||||||||
Repurchase | Repurchased | Repurchase | ||||||||||
December 5, 2000 repurchase plan (variable portion) | 72,510 | (72,509 | ) | 1 | (1) | |||||||
February 2, 2004 repurchase plan | 5,000,000 | (5,000,000 | ) | — | (2) | |||||||
March 15, 2005 repurchase plan | 3,000,000 | (13,888 | ) | 2,986,112 | (3) | |||||||
8,072,510 | (5,086,397 | ) | 2,986,113 | |||||||||
(1) | Our Board of Directors provided that proceeds of the exercise of options under our 2001 General Stock Option Plan may be used to repurchase shares under the 2000 repurchase plan and that the maximum number of shares authorized to be repurchased under the 2000 repurchase plan may be increased to the extent necessary to so use the proceeds from such option exercises. In fiscal 2004, we repurchased and subsequently retired 54,551 shares of our Common Stock at an average price of $27.03 per share. During the first six months of fiscal 2005, we repurchased and subsequently retired 17,958 shares of our Common Stock at an average price of $40.93 per share. The share repurchases were made using proceeds from exercises of stock options granted under the 2001 General Stock Option Plan that were exercised during fiscal 2004 and fiscal 2005. |
(2) | In the first six months of fiscal 2005, we repurchased and subsequently retired approximately 1.9 million shares of our Common Stock authorized to be repurchased under the 2004 repurchase plan at an average price of $36.78 per share. As a result of these repurchases, and those made in the prior fiscal year, we exhausted our availability for further share repurchases under the 2004 repurchase plan. |
(3) | On March 15, 2005, our Board of Directors authorized an additional repurchase plan for up to 3.0 million shares of our outstanding Common Stock. In the first six months of fiscal 2005, we repurchased and subsequently retired 13,888 shares of our Common Stock authorized to be repurchased under the 2005 repurchase plan at an average price of $41.22 per share. As a result of these repurchases, we have 2,986,112 shares available for repurchase as of July 30, 2005. |
As of August 19, 2005, we have a total of approximately 2.4 million shares available for repurchase. We anticipate that we will continue to repurchase shares of our Common Stock during the remainder of fiscal 2005. Under the agreements governing our outstanding indebtedness, we can only repurchase shares of our Common Stock if we maintain or comply with specified financial ratios and other covenants. We may also be restricted by regulations of the Securities and Exchange Commission from making future repurchases during certain time periods.
We paid dividends of $0.10 per share and $0.06 per share during the quarters ended July 30, 2005 and July 31, 2004, respectively, and dividends of $0.17 and $0.12 per share during the six months ended July 30, 2005 and July 31, 2004, respectively. These dividends reflect the strength of our financial position and our Board of Directors’ commitment to encouraging long-term investment by a diverse stockholder base.
Debt
In 2001, we issued $200 million in principal amount of 91/4% Senior Notes due July 1, 2009, which were unsecured and interest thereon was payable semi-annually on each January 1 and July 1. On July 1, 2005, we redeemed the Senior Notes at a price of $1,046.25 per $1,000 of principal amount. This early redemption resulted in a pre-tax charge of $12.1 million in the second quarter of fiscal 2005, which
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represents a combination of a $9.3 million call premium and $2.8 million of unamortized costs associated with the Senior Notes, which was recorded as interest expense.
In October 2004, we signed an extension to our existing $200 million unsecured revolving bank credit facility with Fleet National Bank and other lending institutions, which now expires on April 30, 2006. The Credit Agreement requires us to maintain certain financial covenants and limits certain activities, including, among other things, levels of indebtedness, liens, investments, payments of dividends, Common Stock repurchases, mergers and acquisitions, and sales of assets. In addition to extending the term of the Credit Agreement, we obtained the consent of the lenders to permit the prepayment of the Senior Notes.
We are in compliance with all terms and conditions of the Credit Agreement. No borrowings were outstanding under our Credit Agreement as of July 30, 2005, January 29, 2005, or July 31, 2004. Borrowings available under the Credit Agreement are reduced by the aggregate amount of letters of credit outstanding under the Credit Agreement ($21.2 million as of July 30, 2005).
General
We believe that our available cash, funds generated by operating activities, funds available under the Credit Agreement, and proceeds from the exercise of stock options will be sufficient to fund planned capital expenditures, working capital requirements, and any anticipated dividend payments or stock repurchases for the foreseeable future. In addition, borrowings under our Credit Agreement may be an additional source of cash for us to finance future growth, inventory purchases, and other capital investments.
Contractual Obligations
Due to our early redemption of the Senior Notes, certain information presented in our table of contractual obligations in our Annual Report on Form 10-K for the fiscal year ended January 29, 2005 materially changed. Specifically, the contractual obligations associated with our long-term debt and the interest on long-term debt were eliminated.
Recent Accounting Pronouncements
Stock-Based Compensation
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (revised 2004),Share-Based Payment, which is a revision of SFAS No. 123,Accounting for Stock-Based Compensation. SFAS No. 123(R) supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees, and amends SFAS No. 95,Statement of Cash Flows. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values at the time of grant. Pro forma disclosure is no longer an alternative. Our effective date for adoption of the provisions of SFAS No. 123(R) is January 29, 2006 (the first day of our fiscal year 2006); however, we are permitted to early adopt.
As permitted by SFAS No. 123, we currently account for share-based payments to employees using the intrinsic value method under APB No. 25, and, as such, recognize no compensation cost for employee stock options. The adoption of SFAS No. 123(R) and resulting recognition of compensation cost will significantly impact our results of operations but we are unable to quantify the impact because it is dependent upon, among other items, the number of share-based payments granted in the future, our selection of a methodology to determine fair value for grants, and our estimates of forfeitures.
We do not anticipate a material impact on our overall financial position or total cash flows but SFAS No. 123(R) does require that we report the benefits of tax deductions in excess of recognized compensation cost as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods following adoption. While we cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amounts of
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operating cash flows recognized in prior periods for such excess tax deductions were $9.5 million and $2.3 million for the quarters ended July 30, 2005 and July 31, 2004, respectively, and $16.8 million and $9.8 million for the six months ended July 30, 2005 and July 31, 2004, respectively.
Inventory Costs
In November 2004, the FASB issued SFAS No. 151,Inventory Costs, as an amendment to ARB No. 43. SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current period charges and requires the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We do not currently believe that our adoption of the provisions of SFAS No. 151 will have a material impact on our consolidated results of operations and financial position.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk. |
We typically invest cash balances in excess of operating requirements primarily in money market mutual funds and short-term interest-bearing securities, generally with maturities of 90 days or less. Due to the short-term nature of our investments, the fair value of our cash and equivalents at July 30, 2005 approximated carrying value. We have market risk exposure arising from changes in interest rates. The interest rates on the Credit Agreement are repriced frequently, at market prices, which would result in carrying amounts that approximate fair value. We had no borrowings outstanding under the Credit Agreement as of July 30, 2005.
Item 4. | Controls and Procedures. |
Evaluation of Disclosure Controls and Procedures
We maintain a set of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934). An evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and our Executive Vice President— Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and our Executive Vice President— Chief Financial Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms. We note that the design of any system of controls is based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Change in Internal Control Over Financial Reporting
There has not been any change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) as promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934) during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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MICHAELS STORES, INC.
Part II—OTHER INFORMATION
Item 1. | Legal Proceedings. |
Stockholder Class Actions
On various dates between February 4, 2003 and March 25, 2003, 10 purported class action lawsuits were filed in the United States District Court for the Northern District of Texas, Dallas Division, against Michaels Stores, Inc. and certain of the current and former directors and officers of Michaels. All of these lawsuits were consolidated. The suits asserted various claims under Sections 10(b), 20(a), and 20A of the Securities Exchange Act of 1934 related to actions prior to Michaels’ announcement on November 7, 2002, that, among other things, it had revised its outlook for the fourth fiscal quarter of 2002, adjusting downward its guidance for annual earnings per diluted share. The consolidated complaint charged that, prior to that announcement, Michaels and certain of the other defendants made misrepresentations and failed to disclose negative information about the financial condition of Michaels while the individual defendants were selling shares of Michaels common stock. On December 10, 2004, the Court granted the defendants’ motion to dismiss the consolidated complaint, dismissing certain allegations supporting the claims with prejudice. For those allegations that were not dismissed with prejudice, the Court allowed the plaintiffs to amend, which they did on January 14, 2005. In that amended consolidated complaint, the plaintiffs added a claim under Section 20A of the Securities Exchange Act of 1934 and repled their Sections 10(b) and 20(a) claims based on allegations similar to those in the original consolidated complaint. After the defendants moved to dismiss the amended consolidated complaint, the plaintiffs filed a notice of voluntary dismissal May 13, 2005. The Court issued an order on May 18, 2005 dismissing the case in its entirety without prejudice.
Derivative Claims
On March 21, 2003, Julie Fathergill filed a purported stockholder derivative action, which is pending in the 192nd District Court for Dallas County, Texas. The lawsuit names certain former and current officers and directors, including all of Michaels’ current directors, as individual defendants and Michaels as a nominal defendant. In this derivative action, the plaintiff makes allegations of fact similar to those made in the purported securities class actions described above. The plaintiff asserts claims against the individual defendants for breach of fiduciary duties, abuse of control, gross mismanagement, waste of corporate assets, and unjust enrichment. All of these claims are asserted derivatively on behalf of Michaels. We believe these claims are without merit and will vigorously oppose them.
On September 11, 2003, Leo J. Dutil filed a purported stockholder derivative action, which is pending in the United States District Court for the Northern District of Texas, Dallas Division. The lawsuit names certain former and current officers and directors as individual defendants and Michaels as a nominal defendant. In this derivative action, the plaintiff makes allegations of fact similar to those made in the purported stockholder class actions and the Fathergill derivative lawsuit described above. The plaintiff asserts claims against the individual defendants for breach of fiduciary duty, misappropriation of confidential information, and contribution and indemnification. All of these claims are asserted derivatively on behalf of Michaels. We believe these claims are without merit and will vigorously oppose them.
Cotton Claim
On December 20, 2002, James Cotton, a former store manager of Michaels of Canada, ULC, our wholly-owned subsidiary, and Suzette Kennedy, a former assistant manager of Michaels of Canada, commenced a proposed class proceeding against Michaels of Canada and Michaels Stores, Inc. on behalf of themselves and current and former employees employed in Canada. The Cotton claim was filed in the Ontario Superior Court of Justice and alleges that the defendants violated employment standards legislation in Ontario and other provinces and territories of Canada by failing to pay overtime compensation as required by that legislation. The Cotton claim also alleges that this conduct was in breach
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of the contracts of employment of those individuals. The Cotton claim seeks a declaration that the defendants have acted in breach of applicable legislation, payment to current and former employees for overtime, damages for breach of contract, punitive, aggravated and exemplary damages, interest, and costs. In May of 2005, the plaintiffs delivered material in support of their request that this action be certified as a class proceeding. A date has not yet been set for the hearing with respect to certification. We intend to contest certification of this claim as a class action. Further, we believe we have certain defenses on the merits and intend to defend this lawsuit vigorously. We are unable to estimate a range of possible loss, if any, in this claim.
Clark Claim
On July 13, 2005, Michael Clark, a former assistant manager and Lucinda Prouty, a former department manager in San Diego, California, commenced a proposed class action proceeding against Michaels Stores, Inc. on behalf of themselves and current and former hourly retail employees employed in California from July 13, 2001 to the present. The Clark suit was filed in the Superior Court of California, County of San Diego and alleges that we failed to pay overtime wages, provide meal and rest periods (or compensation in lieu thereof), and provide itemized employee wage statements. The Clark suit also alleges that this conduct was in breach of California’s unfair competition law. The plaintiffs seek injunctive relief, damages for unpaid overtime pay, meal break penalties, waiting time penalties, interest, and attorneys’ fees and costs. Under the Class Action Fairness Act, we intend to remove the case to federal court. We are in the early stages of our investigation; however, we believe that the Clark claim lacks merit and we intend to vigorously defend our interests.
General
We are a defendant from time to time in lawsuits incidental to our business. Based on currently available information, we believe that resolution of all known contingencies is uncertain. There can be no assurance that future costs of such litigation would not be material to our financial position or results of operations.
Item 2. | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. |
On December 5, 2000, our Board of Directors authorized the repurchase of up to 4.0 million shares of our outstanding Common Stock. By later resolutions, our Board of Directors provided that proceeds of the exercise of options under our 2001 General Stock Option Plan may be used to repurchase shares under the 2000 repurchase plan and that the maximum number of shares authorized to be repurchased under the 2000 repurchase plan may be increased to the extent necessary to so use the proceeds from such option exercises. On June 16, 2005, in connection with the adoption of our 2005 Incentive Compensation Plan, we permanently ceased granting options under the 2001 General Stock Option Plan. As of July 30, 2005, options to purchase 875,000 shares of Common Stock remain outstanding pursuant to prior grants under the 2001 General Stock Option Plan.
On February 2, 2004, and March 15, 2005, our Board of Directors authorized the repurchase of up to 5.0 and 3.0 million shares of our outstanding Common Stock, respectively.
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The following table sets forth our repurchases of Common Stock for each fiscal month in the second quarter of fiscal 2005.
Issuer Purchases of Equity Securities
Total Number | Maximum | |||||||||||||||
of Shares | Number of | |||||||||||||||
Purchased as | Shares That | |||||||||||||||
Part of Publicly | May Yet Be | |||||||||||||||
Total Number | Average | Announced | Purchased | |||||||||||||
of Shares | Price Paid | Plans or | Under the Plans | |||||||||||||
Purchased(1) | per Share | Programs(1) | or Programs(2) | |||||||||||||
May 1, 2005 through May 28, 2005 | — | $ | — | — | 3,426,055 | |||||||||||
May 29, 2005 through July 2, 2005 | — | — | — | 3,426,055 | ||||||||||||
July 3, 2005 through July 30, 2005 | 457,900 | 41.13 | 457,900 | 2,986,113 | ||||||||||||
Total | 457,900 | $ | 41.13 | 457,900 | 2,986,113 | |||||||||||
(1) | Repurchased and subsequently retired 17,958 shares under the variable portion of the 2000 repurchase plan, 426,054 shares under the 2004 repurchase plan, and 13,888 shares under the 2005 repurchase plan. |
(2) | Under our 2000 repurchase plan, the Board of Directors authorized us to repurchase up to 4.0 million shares of our outstanding Common Stock, with the ability to increase the maximum number of shares authorized to be repurchased under the plan to the extent necessary to use the proceeds from stock options exercised under our 2001 General Stock Option Plan to make repurchases. We have used the entire 4.0 million share fixed portion of the authority originally provided in the 2000 repurchase plan. We have used the entire 5.0 million share authorization provided under the 2004 repurchase plan. As of July 30, 2005, we had 2,986,112 shares available for repurchase under the 2005 repurchase plan. |
Item 4. | Submission of Matters to a Vote of Security Holders. |
Our 2005 Annual Meeting of Stockholders was held on June 16, 2005. The following items of business, as proposed in the Proxy Statement dated May 12, 2005, were presented to the stockholders:
Election of Directors
The six director nominees, information with respect to which was set forth in the Proxy Statement under the caption titled “Proposal for Election of Directors,” were elected. The vote with respect to the election of these directors was as follows:
Total Vote | ||||||||
Withheld | ||||||||
Total Vote for | for Each | |||||||
Each Director | Director | |||||||
Charles J. Wyly, Jr. | 123,319,698 | 2,111,873 | ||||||
Sam Wyly | 123,217,336 | 2,214,235 | ||||||
Richard E. Hanlon | 119,642,560 | 5,789,011 | ||||||
Richard C. Marcus | 117,597,314 | 7,834,257 | ||||||
Liz Minyard | 120,893,586 | 4,537,985 | ||||||
Cece Smith | 124,170,454 | 1,261,117 |
Each elected director will serve until the next annual meeting of stockholders or until his or her successor is duly elected and qualified or until the earlier of his or her resignation, death, or removal.
Ratification of the Selection of Our Independent Auditors
The selection of Ernst & Young LLP as our independent auditors for fiscal 2005, information with respect to which was set forth in the Proxy Statement under the caption titled “Proposal for Ratification of
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the Selection of Our Independent Registered Public Accounting Firm,” was ratified. The vote with respect to this ratification was as follows:
For | 124,951,982 | |||
Against | 407,786 | |||
Abstentions | 71,803 | |||
125,431,571 | ||||
Approval of the 2005 Incentive Compensation Plan
The proposal to approve a new incentive compensation plan, the description of which was set forth in the Proxy Statement under the caption titled “Proposal for the Approval of the Michaels Stores, Inc. 2005 Incentive Compensation Plan,” was passed. The vote with respect to this approval was as follows:
For | 93,647,230 | |||
Against | 20,595,098 | |||
Abstentions | 233,402 | |||
114,475,730 | ||||
Item 6. | Exhibits. |
(a) Exhibits:
10.1 | Michaels Stores, Inc. 2005 Incentive Compensation Plan (previously filed as Exhibit 10.1 to Form 8-K, filed by Registrant on June 17, 2005, SEC File No. 001-09338). | |
10.2 | Description of Compensation of Directors (previously filed as Exhibit 10.2 to Form 8-K, filed by Registrant on June 17, 2005, SEC File No. 001-09338). | |
10.3 | Form of Stock Option Agreement relating to June 2005 Director Grants (previously filed as Exhibit 10.3 to Form 8-K, filed by Registrant on June 17, 2005, SEC File No. 001-09338). | |
31.1 | Certifications of R. Michael Rouleau pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed herewith). | |
31.2 | Certifications of Jeffrey N. Boyer 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). |
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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/ Jeffrey N. Boyer |
Jeffrey N. Boyer | |
Executive Vice President— Chief Financial Officer | |
(Principal Financial Officer) |
Dated: September 2, 2005
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INDEX TO EXHIBITS
Exhibit | ||||
Number | Description of Exhibit | |||
10.1 | Michaels Stores, Inc. 2005 Incentive Compensation Plan (previously filed as Exhibit 10.1 to Form 8-K, filed by Registrant on June 17, 2005, SEC File No. 001-09338). | |||
10.2 | Description of Compensation of Directors (previously filed as Exhibit 10.2 to Form 8-K, filed by Registrant on June 17, 2002, SEC File No. 001-09338). | |||
10.3 | Form of Stock Option Agreement relating to June 2005 Director Grants (previously filed as Exhibit 10.3 to Form 8-K, filed by Registrant on June 17, 2005, SEC File No. 001-09338). | |||
31.1 | Certifications of R. Michael Rouleau pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed herewith). | |||
31.2 | Certifications of Jeffrey N. Boyer 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). |