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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 April 29, 2006 | ||
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 number001-09338
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, Texas75261-9566
(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 Noo
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the Registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes o No þ
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 | June 9, 2006 | |
Common Stock, par value $.10 per share | 132,137,792 |
MICHAELS STORES, INC.
FORM 10-Q
FORM 10-Q
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MICHAELS STORES, INC.
Item 1. | Financial Statements. |
MICHAELS STORES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
April 29, | January 28, | April 30, | ||||||||||
2006 | 2006 | 2005 | ||||||||||
ASSETS | ||||||||||||
Current assets: | ||||||||||||
Cash and equivalents | $ | 441,843 | $ | 452,449 | $ | 558,546 | ||||||
Merchandise inventories | 795,047 | 784,032 | 835,765 | |||||||||
Prepaid expenses and other | 46,397 | 44,042 | 26,999 | |||||||||
Deferred and prepaid income taxes | 34,156 | 34,125 | 64,669 | |||||||||
Total current assets | 1,317,443 | 1,314,648 | 1,485,979 | |||||||||
Property and equipment, at cost | 1,046,956 | 1,011,201 | 936,091 | |||||||||
Less accumulated depreciation | (611,495 | ) | (586,382 | ) | (525,555 | ) | ||||||
435,461 | 424,819 | 410,536 | ||||||||||
Goodwill | 115,839 | 115,839 | 115,839 | |||||||||
Other assets | 23,082 | 20,249 | 19,136 | |||||||||
138,921 | 136,088 | 134,975 | ||||||||||
Total assets | $ | 1,891,825 | $ | 1,875,555 | $ | 2,031,490 | ||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 267,154 | $ | 193,595 | $ | 269,684 | ||||||
Accrued liabilities and other | 226,541 | 282,499 | 227,053 | |||||||||
Income taxes payable | 15,730 | 20,672 | — | |||||||||
Total current liabilities | 509,425 | 496,766 | 496,737 | |||||||||
91/4% Senior Notes due 2009 | — | — | 200,000 | |||||||||
Deferred income taxes | 2,791 | 2,803 | 26,848 | |||||||||
Other long-term liabilities | 89,098 | 88,637 | 79,359 | |||||||||
Total long-term liabilities | 91,889 | 91,440 | 306,207 | |||||||||
601,314 | 588,206 | 802,944 | ||||||||||
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; 134,841,303 shares issued and 132,074,903 shares outstanding at April 29, 2006, 133,821,417 shares issued and 132,986,517 shares outstanding at January 28, 2006, and 135,293,468 shares issued and outstanding at April 30, 2005 | 13,484 | 13,382 | 13,529 | |||||||||
Additional paid-in capital | 416,052 | 386,627 | 425,432 | |||||||||
Retained earnings | 946,980 | 907,773 | 781,333 | |||||||||
Treasury Stock (2,766,400 shares at April 29, 2006, 834,900 shares at January 28, 2006, and none at April 30, 2005) | (94,127 | ) | (27,944 | ) | — | |||||||
Accumulated other comprehensive income | 8,122 | 7,511 | 8,252 | |||||||||
Total stockholders’ equity | 1,290,511 | 1,287,349 | 1,228,546 | |||||||||
Total liabilities and stockholders’ equity | $ | 1,891,825 | $ | 1,875,555 | $ | 2,031,490 | ||||||
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 | ||||||||
April 29, | April 30, | |||||||
2006 | 2005 | |||||||
Net sales | $ | 832,481 | $ | 821,016 | ||||
Cost of sales and occupancy expense | 512,041 | 503,204 | ||||||
Gross profit | 320,440 | 317,812 | ||||||
Selling, general, and administrative expense | 241,736 | 227,894 | ||||||
Store pre-opening costs | 1,437 | 2,739 | ||||||
Operating income | 77,267 | 87,179 | ||||||
Interest expense | 172 | 5,089 | ||||||
Other (income) and expense, net | (7,162 | ) | (2,680 | ) | ||||
Income before income taxes and cumulative effect of accounting change | 84,257 | 84,770 | ||||||
Provision for income taxes | 31,807 | 32,216 | ||||||
Income before cumulative effect of accounting change | 52,450 | 52,554 | ||||||
Cumulative effect of accounting change, net of income tax of $54.2 million | — | 88,488 | ||||||
Net income (loss) | $ | 52,450 | $ | (35,934 | ) | |||
Basic earnings (loss) per common share: | ||||||||
Income before cumulative effect of accounting change | $ | 0.40 | $ | 0.39 | ||||
Cumulative effect of accounting change, net of income tax | — | 0.65 | ||||||
Net income (loss) | $ | 0.40 | $ | (0.26 | ) | |||
Diluted earnings (loss) per common share: | ||||||||
Income before cumulative effect of accounting change | $ | 0.39 | $ | 0.38 | ||||
Cumulative effect of accounting change, net of income tax | — | 0.64 | ||||||
Net income (loss) | $ | 0.39 | $ | (0.26 | ) | |||
Dividends declared per common share | $ | 0.10 | $ | 0.07 | ||||
See accompanying notes to consolidated financial statements.
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MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Quarter Ended | ||||||||
April 29, | April 30, | |||||||
2006 | 2005 | |||||||
Operating activities: | ||||||||
Net income (loss) | $ | 52,450 | $ | (35,934 | ) | |||
Adjustments: | ||||||||
Depreciation | 27,341 | 23,680 | ||||||
Amortization | 115 | 99 | ||||||
Share-based compensation | 5,568 | 4,478 | ||||||
Tax benefits from stock options exercised | (8,203 | ) | (7,349 | ) | ||||
Non-cash charge for the cumulative effect of accounting change | — | 142,723 | ||||||
Other | 2 | 254 | ||||||
Changes in assets and liabilities: | ||||||||
Merchandise inventories | (10,964 | ) | (41,972 | ) | ||||
Prepaid expenses and other | (2,689 | ) | (386 | ) | ||||
Deferred income taxes and other | (3,199 | ) | (5,148 | ) | ||||
Accounts payable | 60,874 | 13,418 | ||||||
Accrued liabilities and other | (19,615 | ) | (3,128 | ) | ||||
Income taxes payable | 3,261 | (48,330 | ) | |||||
Other long-term liabilities | 1,526 | 6,982 | ||||||
Net cash provided by operating activities | 106,467 | 49,387 | ||||||
Investing activities: | ||||||||
Additions to property and equipment | (38,920 | ) | (27,488 | ) | ||||
Purchases of short-term investments | — | (226 | ) | |||||
Sales of short-term investments | — | 50,605 | ||||||
Net proceeds from sales of property and equipment | 6 | — | ||||||
Net cash (used in) provided by investing activities | (38,914 | ) | 22,891 | |||||
Financing activities: | ||||||||
Cash dividends paid to stockholders | (26,625 | ) | (19,045 | ) | ||||
Repurchase of Common Stock | (66,182 | ) | (52,363 | ) | ||||
Proceeds from stock options exercised | 14,876 | 13,262 | ||||||
Tax benefits from stock options exercised | 8,203 | 7,349 | ||||||
Proceeds from issuance of Common Stock and other | 1,095 | 1,213 | ||||||
Change in cash overdraft. | (9,526 | ) | — | |||||
Net cash used in financing activities | (78,159 | ) | (49,584 | ) | ||||
Net (decrease) increase in cash and equivalents | (10,606 | ) | 22,694 | |||||
Cash and equivalents at beginning of period | 452,449 | 535,852 | ||||||
Cash and equivalents at end of period | $ | 441,843 | $ | 558,546 | ||||
See accompanying notes to consolidated financial statements.
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Quarter Ended April 29, 2006
(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 toForm 10-Q and Article 10 ofRegulation 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 ended April 29, 2006 are not indicative of the results to be expected for the entire year.
The balance sheet at January 28, 2006 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 onForm 10-K for the fiscal year ended January 28, 2006.
All references herein to “fiscal 2006” relate to the 53 weeks ending February 3, 2007 and all references to “fiscal 2005” relate to the 52 weeks ended January 28, 2006. In addition, all references herein to “the first quarter of fiscal 2006” relate to the 13 weeks ended April 29, 2006 and all references to “the first quarter of fiscal 2005” relate to the 13 weeks ended April 30, 2005.
Amounts as of and for the three months ended April 30, 2005 were restated to reflect weighted average cost accounting for inventory and the impact of expensing stock options under SFAS No. 123(R). The changes to our accounting policies are more fully described in Note 2 to these financial statements.
Note 2. | Changes in Accounting |
As more fully described in our fiscal 2005 Annual Report onForm 10-K, we changed our method of accounting for merchandise inventories from a retail inventory method to the weighted average cost method in the fourth quarter of fiscal 2005, effective as of the beginning of that fiscal year. We also adopted SFAS No. 123(R),Share-Based Payment, during the fourth quarter of fiscal 2005 using the modified retrospective transition method from the beginning of fiscal 2005. As a result of these accounting changes, certain items on our consolidated balance sheets and statements of cash flows for the first quarter of fiscal 2005 are not comparable to previously reported amounts on ourForm 10-Q, although total cash flows did not change as a result of these changes in accounting. We presented the effects on the income statement of adopting these policies in our fiscal 2005 Annual Report onForm 10-K.
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Quarter Ended April 29, 2006
(Unaudited)
Note 2. | Changes in Accounting (Continued) |
The following table reconciles the line items in our consolidated balance sheets and statements of cash flows from the previously reported amounts to the restated amounts:
Quarter Ended April 30, 2005 | ||||||||||||||||
As previously | WAC | SFAS No. 123(R) | As | |||||||||||||
reported | Adjustments | Adjustments | restated | |||||||||||||
(In thousands) | ||||||||||||||||
Balance Sheet | ||||||||||||||||
Merchandise inventories | $ | 964,177 | $ | (128,412 | ) | $ | — | $ | 835,765 | |||||||
Deferred and prepaid income taxes | 22,027 | 42,642 | — | 64,669 | ||||||||||||
Other assets | 17,434 | — | 1,702 | 19,136 | ||||||||||||
Income taxes payable | 6,155 | (6,155 | ) | — | — | |||||||||||
Additional paid-in capital | 420,954 | — | 4,478 | 425,432 | ||||||||||||
Retained earnings | 863,800 | (79,691 | ) | (2,776 | ) | 781,333 | ||||||||||
Accumulated other comprehensive income | 8,176 | 76 | — | 8,252 | ||||||||||||
Statement of Cash Flows | ||||||||||||||||
Net income | 46,533 | (79,691 | ) | (2,776 | ) | (35,934 | ) | |||||||||
Share-based compensation expense | — | — | 4,478 | 4,478 | ||||||||||||
Non-cash charge for the cumulative effect of accounting change | — | 142,723 | — | 142,723 | ||||||||||||
Merchandise inventories | (27,782 | ) | (14,190 | ) | — | (41,972 | ) | |||||||||
Deferred income taxes and other | (3,446 | ) | — | (1,702 | ) | (5,148 | ) | |||||||||
Income taxes payable | 512 | (48,842 | ) | — | (48,330 | ) | ||||||||||
Tax benefit from stock options exercised (a reclassification from operating activities to financing activities) | — | — | 7,349 | 7,349 |
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Quarter Ended April 29, 2006
(Unaudited)
Note 3. | Earnings per Share |
The following table sets forth the computation of basic and diluted earnings (loss) per common share:
Quarter Ended | ||||||||
April 29, | April 30, | |||||||
2006 | 2005 | |||||||
(In thousands, except per share data) | ||||||||
Numerator: | ||||||||
Income before cumulative effect of accounting change | $ | 52,450 | $ | 52,554 | ||||
Cumulative effect of accounting change, net of income tax | — | 88,488 | ||||||
Net income (loss) | $ | 52,450 | $ | (35,934 | ) | |||
Denominator: | ||||||||
Denominator for basic earnings per common share—weighted average shares | 132,399 | 136,018 | ||||||
Effect of dilutive securities: | ||||||||
Employee stock options | 2,218 | 2,417 | ||||||
Denominator for diluted earnings per common share—weighted average shares adjusted for dilutive securities | 134,617 | 138,435 | ||||||
Basic earnings (loss) per common share: | ||||||||
Income before cumulative effect of accounting change | $ | 0.40 | $ | 0.39 | ||||
Cumulative effect of accounting change, net of income tax | — | 0.65 | ||||||
Net income (loss) | $ | 0.40 | $ | (0.26 | ) | |||
Diluted earnings (loss) per common share: | ||||||||
Income before cumulative effect of accounting change | $ | 0.39 | $ | 0.38 | ||||
Cumulative effect of accounting change, net of income tax | — | 0.64 | ||||||
Net income (loss) | $ | 0.39 | $ | (0.26 | ) | |||
Our purchase and subsequent retirement of 1.9 million shares and 1.5 million shares of our Common Stock in the first quarters of fiscal 2006 and 2005, respectively, reduced the number of weighted average shares outstanding by 843,000 and 239,000 for the first quarters of fiscal 2006 and 2005, respectively.
Note 4. | Share-Based Compensation |
Our Compensation Committee administers option and awards plans. On April 21, 2006, our Compensation Committee approved amendments to the award agreements under the 1997 Stock Option Plan and the 2005 Incentive Compensation Plan to add a provision that would accelerate the vesting of awards under those Plans upon a change in control of Michaels. Options issued under our 2001 General Stock Option Plan and 2001 Employee Stock Option Plan already contain an acceleration provision that triggers upon our entering into a change in control agreement. Under the 2001 Plans, our Board of Directors has the power to defer the acceleration of vesting until the actual consummation of a change in control, thereby conforming the accelerated vesting of options under those plans to the accelerated vesting provision in the awards under the 1997 Stock Options Plan and the 2005 Incentive Compensation Plan. Should a change in control occur, we
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Quarter Ended April 29, 2006
(Unaudited)
Note 4. | Share-Based Compensation (Continued) |
will accelerate the recognition of any unrecognized compensation cost related to the accelerated vesting of awards. As of April 29, 2006, unrecognized compensation cost for all Plan awards totaled $33.7 million.
Note 5. | Debt |
91/4% Senior Notes due 2009
In fiscal 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.
Credit Agreement
On November 18, 2005, we entered into a new five-year, $300 million senior unsecured credit facility with Bank of America, N.A. and other lenders. The $300 million Credit Agreement replaced our existing $200 million revolving credit facility with Fleet National Bank and the other lenders, which we terminated immediately prior to entering into our $300 million Credit Agreement. We were in compliance with all terms and conditions of our $200 million credit agreement through the termination date, and we did not incur any early termination penalties in connection with its termination. No borrowings were outstanding under our $200 million credit agreement at any time during fiscal 2005.
Our $300 million Credit Agreement provides for a committed line of credit of $300 million (with a provision for an increase, at our option on stated conditions, of up to a total of $400 million), a $250 million sublimit on the issuance of letters of credit, and a $25 million sublimit for borrowings in Euro, Sterling, Yen, Canadian Dollars, and other approved currencies. We may use borrowings under our $300 million Credit Agreement for working capital and other general corporate purposes, including stock repurchases and permitted acquisitions. Our $300 million Credit Agreement limits our ability to, among other things, create liens, engage in mergers, consolidations and certain other transactions, and requires us to adhere to certain consolidated financial covenants. Our obligations under our $300 million Credit Agreement are guaranteed by Michaels Stores Procurement Company, Inc., our wholly-owned subsidiary, and such other of our subsidiaries as may be necessary to cause the assets owned by us and our subsidiary guarantors to be 85% of our consolidated total assets. Borrowings available under our $300 million Credit Agreement will be reduced by the aggregate amount of letters of credit outstanding, which was $13.7 million as of April 29, 2006. We had no outstanding borrowings under our $300 million Credit Agreement as of January 28, 2006 or April 29, 2006.
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Quarter Ended April 29, 2006
(Unaudited)
Note 6. | Comprehensive Income (Loss) |
Our comprehensive income (loss) is as follows:
Quarter Ended | ||||||||
April 29, | April 30, | |||||||
2006 | 2005 | |||||||
(In thousands) | ||||||||
Net income (loss) | $ | 52,450 | $ | (35,934 | ) | |||
Other comprehensive income: | ||||||||
Foreign currency translation adjustment and other | 611 | 2,854 | ||||||
Comprehensive income (loss) | $ | 53,061 | $ | (33,080 | ) | |||
Note 7. | Commitments and Contingencies |
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. The derivative action relates to actions prior to our announcement on November 7, 2002, that we had revised our outlook for the fourth fiscal quarter of 2002, adjusting downward guidance for annual earnings per diluted share. The plaintiff alleges that, prior to that announcement, certain of the 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. 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. On November 7, 2005, the Court entered a written order granting the defendants’ special exceptions and ordering that the case will be dismissed with prejudice unless the plaintiff amends her petition to state an actionable claim against the defendants. On December 8, 2005, the plaintiff filed an amended petition in which she reasserts many of the same factual allegations, but also adds new allegations questioning, among other things, issues relating to Michaels’ inventory systems and infrastructure, as well as transactions and holdings of Michaels Common Stock by certain family-owned trusts or benefiting trusts of two of Michaels’ directors. In her amended petition, the plaintiff continues to assert all her claims derivatively on behalf of Michaels against the individual defendants for breach of fiduciary duties, abuse of control, gross mismanagement, waste of corporate assets, and unjust enrichment. 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 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.
On June 9, 2006, Feivel Gottlieb and on June 12, 2006, Roberta Schuman each filed purported stockholder derivative actions, which are pending in the 191st and the 14th District Courts for Dallas County,
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Quarter Ended April 29, 2006
(Unaudited)
Note 7. | Commitments and Contingencies (Continued) |
Texas, respectively. The lawsuits name our Chairman of the Board and Vice Chairman of the Board, both in their capacities as officers of Michaels and as directors, and all of Michaels’ other current directors as individual defendants and Michaels as a nominal defendant. The plaintiffs assert claims against the individual defendants for breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment in connection with the granting of stock options by Michaels between 1990 and October 2001 and seek, among other relief, an indeterminate amount of damages from the individual defendants and injunctive relief against Michaels with regard to various corporate governance matters. All of these claims are asserted derivatively on behalf of Michaels. Prior to the filing of these derivative actions, Michaels announced that its Audit Committee (assisted by independent legal counsel and outside accounting experts) had commenced an internal review into Michaels’ historical stock option practices, including a review of Michaels’ underlying option grant documentation and procedures and related accounting. The Audit Committee has not reached any final conclusions as the internal review is not complete and is continuing. See “— Internal Review of Stock Option Practices” below.
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. Michaels filed and served its responding materials opposing class certification on January 31, 2006. 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 Michaels store assistant manager, and Lucinda Prouty, a former Michaels store department manager, 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 Michaels 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 removed the case to federal court on August 5, 2005. 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.
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Quarter Ended April 29, 2006
(Unaudited)
Note 7. | Commitments and Contingencies (Continued) |
Morris Claim
On November 16, 2005, Geoffrey Morris, a former Aaron Brothers employee in San Diego, California, commenced a proposed class action proceeding against Aaron Brothers, Inc. on behalf of himself and current and former Aaron Brothers employees in California from November 16, 2001 to the present. The Morris suit was filed in the Superior Court of California, County of San Diego, and alleges that Aaron Brothers failed to pay overtime wages, reimburse the plaintiff for necessary expenses (including the cost of gas used in driving his car for business purposes), and provide adequate meal and rest breaks (or compensation in lieu thereof). The Morris suit also alleges that this conduct was in breach of California’s unfair competition law. The plaintiff seeks injunctive relief, damages for unpaid overtime pay, meal break penalties, waiting time penalties, interest, and attorneys’ fees and costs. We are in the early stages of our investigation; however, we believe that the Morris claim lacks merit, and we intend to vigorously defend our interests.
Olivas Claim
On December 2, 2005, Sandra Olivas and Jerry Soskins, former Michaels store managers in Los Angeles, California, commenced a proposed class action proceeding against Michaels Stores, Inc. on behalf of themselves and current and former salaried store employees employed in California from December 1, 2001 to the present. Michaels was served with the complaint on January 31, 2006. The Olivas suit was filed in the Superior Court of California, County of Los Angeles, and alleges that Michaels failed to pay overtime wages, accurately record hours worked, and provide itemized employee wage statements. The Olivas 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, penalties, interest, and attorneys’ fees and costs. On March 1, 2006, we removed the case to the United States District Court for the Central District of California. We are in the early stages of our investigation; however, we believe that the Olivas claim lacks merit, and we intend to vigorously defend our interests.
Governmental Inquiries and Related Matters
In early 2005, the District Attorney’s office of the County of New York and the SEC opened inquiries concerningnon-U.S. trusts that directly or indirectly hold and have held shares of Michaels Common Stock and Common Stock options. The staff of a U.S. Senate subcommittee and a federal grand jury have requested information with respect to the same facts. We are cooperating in these inquiries and requests for information.
Certain of these trusts and corporate subsidiaries of the trusts acquired securities of Michaels in transactions directly or indirectly with Charles J. Wyly, Jr. and Sam Wyly, who are, respectively, Chairman and Vice Chairman of the Board of Directors, or with other Wyly family members. In addition, subsidiaries of certain of these trusts acquired securities directly from us in private placement transactions in 1996 and 1997 and upon the exercise of stock options transferred, directly or indirectly, to the trusts or their subsidiaries by Charles Wyly, Sam Wyly, or other Wyly family members.
We understand that Charles Wyly and Sam Wylyand/or certain of their family members are beneficiaries of irrevocablenon-U.S. trusts. The 1996 and 1997 private placement sales by us of Michaels securities to subsidiaries of certain of these trusts were disclosed by us in filings with the SEC. The transfer by Charles Wylyand/or Sam Wyly (or by other Wyly family members or family-related entities) of Michaels securities to certain of these trusts and subsidiaries was also disclosed in filings with the SEC by usand/or by Charles Wyly and Sam Wyly. Based on information provided to us, our SEC filings did not report securities owned by
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Quarter Ended April 29, 2006
(Unaudited)
Note 7. | Commitments and Contingencies (Continued) |
thenon-U.S. trusts or their corporate subsidiaries as beneficially owned by Charles Wyly and Sam Wyly prior to 2005.
Following the filing by Charles Wyly and Sam Wyly of an amended Schedule 13D with the SEC on April 8, 2005, stating that they may be deemed the beneficial owners of Michaels securities held directly or indirectly by thenon-U.S. trusts, we disclosed in a press release that, as of March 31, 2005, under SECRule 13d-3, Charles Wyly may be deemed the owner of 6,045,818 shares, or 4.4% of our outstanding Common Stock, and Sam Wyly may be deemed the beneficial owner of 4,822,534 shares, or 3.5% of our outstanding Common Stock. In our 2005 and 2006 proxy statements, we included the securities held in thenon-U.S. trusts or their separate subsidiaries, as reported by the Wylys, in the beneficial ownership table of our principal stockholders and management, with appropriate footnotes.
Charles Wyly and Sam Wyly have not reported purchases and sales of Michaels securities by thenon-U.S. trusts and their subsidiaries in reports filed by them with the SEC under Section 16 of the Securities Exchange Act of 1934. In an April 2005 letter from their counsel, Charles Wyly and Sam Wyly undertook to file any additional required Section 16 reports and to pay us the amount of any Section 16 liability. Counsel for Michaels and counsel for the Wylys have exchanged factual information and engaged in discussions of legal issues.
Charles Wyly and Sam Wyly have not filed additional or amended Section 16 reports with respect to the transactions in question. Charles Wyly and Sam Wyly have made a proposal to settle the issue, without admitting or denying that they have or had, for Section 16 purposes, beneficial ownership of Michaels securities that are or were held by thenon-U.S. trusts or their subsidiaries.
On March 15, 2006, the Board of Directors appointed a special committee of the Board to investigate and make decisions on behalf of Michaels with respect to the potential Section 16 liability issue. The members of the special committee are Richard C. Marcus (Chairman), Cece Smith and Liz Minyard, all independent Board members. The special committee has the full authority of the Board to make all decisions with respect to the potential Section 16 issues, including the authority to approve or reject the proposed settlement, to negotiate the terms of any settlement, and, if there is no agreed settlement, to take all other actions it deems necessary or appropriate to resolve the potential Section 16 liability issues other than pursuant to an agreed settlement. The Board of Directors has also given the special committee the full authority of the Board to make decisions for Michaels relating to the new allegations in the Fathergill derivative suit, described above underDerivative Claims, including investigating the new allegations and determining what actions Michaels should take concerning those allegations. In addition, the Board has given the special committee authority to investigate and respond to the governmental inquiries, described above, but reserving to the full Board the authority to decide upon proposed actions or decisions concerning the pursuit, compromise or ultimate resolution of any claim or dispute with respect to those governmental inquiries. The special committee has retained the firm of Debevoise & Plimpton LLP as its independent counsel to advise it in these matters.
Internal Review of Stock Options Practices
The Company’s Audit Committee has initiated an internal review on a proactive basis into the Company’s historical stock option practices, including a review of the Company’s underlying option grant documentation and procedures and related accounting. In accordance with New York Stock Exchange requirements, the Audit Committee is composed solely of independent directors. The Audit Committee’s internal review is being conducted with the assistance of independent legal counsel and outside accounting experts. The Company’s
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Quarter Ended April 29, 2006
(Unaudited)
Note 7. | Commitments and Contingencies (Continued) |
independent registered public accounting firm has been informed about the internal review. The Company has also voluntarily reported the commencement of this review to the Securities and Exchange Commission.
The internal review is focused principally on the period from 1990 to 2001. Since October 2001, the Company has followed a process of utilizing pre-determined effective grant dates and generally pre-determined grant levels for its stock option program. Stock option grants from October 2001 to the present have consistently followed this process.
Prior to October 2001, the Company granted stock options principally utilizing a process in which an authorized committee of the Board would approve stock option grants from time to time through unanimous written consent resolutions with specified effective dates that generally preceded the date on which the consents were fully executed by members of the applicable committee.
The Company has historically considered the effective date specified in the written consents by the applicable committee as the accounting measurement date for determining stock-based compensation expense under APB No. 25,Accounting for Stock Issued to Employees. For the period under review, based on preliminary findings, the Company presently believes that, with respect to certain non-routine grants, the measurement date may differ from the measurement date used in its accounting prior to 2001. Based on the Company’s current analysis, non-cash compensation cost could potentially be recorded in an amount up to approximately $60 million, which relates to periods prior to fiscal 2001. Therefore, the amounts do not affect results of operations or the statement of cash flows in any period presented in the Company’s Annual Report onForm 10-K for fiscal 2005. The Company expects the effect, if any, on its financial position in each of the years presented in the fiscal 2005Form 10-K would be a reclassification of any unrecorded non-cash compensation cost between retained earnings and accumulated paid in capital, with no impact on total stockholders’ equity. Based on the Company’s current analysis, any potential misstatement of the Company’s financial statements presented in its fiscal 2005 Form 10-K is not considered material.
As the Audit Committee’s review is not complete and is ongoing as of the date of this filing, additional information may become available which could cause the current estimate of potential unrecorded compensation to change materially. Once the review is complete, the Company will make a final determination as to what, if any, estimated unrecorded stock-based compensation cost should be recorded in the Company’s financial statements. However, based on its current analysis and estimates, the Company does not believe a restatement of prior period financial statements will be required.
The Company is also evaluating whether previously deducted compensation related to exercised stock options might be non-deductible under Section 162(m) of the Internal Revenue Code, which could result in additional taxes and interest related to the prior deductions. The Company currently believes that the amount of lost tax deductions, if any, previously claimed would not be material to results of operations, cash flow, or the Company’s financial position, but has not finalized its assessment of this matter.
Two derivative lawsuits have been filed against the directors and certain officers of Michaels relating to the Company’s historical stock option procedures. See “— Derivative Claims” above.
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, results of operations, or cash flows.
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Quarter Ended April 29, 2006
(Unaudited)
Note 8. | Segments |
We consider our Michaels, Aaron Brothers, and Recollections stores and our Star Decorators Wholesale 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 operations are immaterial for segment reporting purposes individually, and in the aggregate. Therefore, we combine all operating segments into one reporting segment.
Our sales, operating income, and assets by country are as follows:
Net Sales | Operating Income | Total Assets | ||||||||||
(In thousands) | ||||||||||||
Quarter ended April 29, 2006: | ||||||||||||
United States | $ | 778,356 | $ | 68,576 | $ | 1,808,567 | ||||||
Canada | 54,125 | 8,691 | 83,258 | |||||||||
Consolidated Total | $ | 832,481 | $ | 77,267 | $ | 1,891,825 | ||||||
Quarter ended April 30, 2005: | ||||||||||||
United States | $ | 776,900 | $ | 82,029 | $ | 1,971,499 | ||||||
Canada | 44,116 | 5,150 | 59,991 | |||||||||
Consolidated Total | $ | 821,016 | $ | 87,179 | $ | 2,031,490 | ||||||
Canada’s operating income includes corporate allocations, such as 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 9. | Exploration of Strategic Alternatives |
On March 20, 2006, we announced that our Board of Directors had decided to begin a process to explore strategic alternatives to enhance shareholder value including, but not limited to, a potential sale of Michaels. We retained JPMorgan as a financial advisor in this process, which we said probably would take a number of months. Among the strategic alternatives that may be considered would be a possible sale, recapitalization or similar transaction. The Board has appointed a special advisory committee, with the full power and authority of the Board to consider, evaluate, and negotiate with any third parties the terms of any such transaction and to recommend to our Board that it approve or reject, and, if approved, that the Board recommend to our shareholders any such transaction. The members of the special advisory committee are Cece Smith (Chairman), Richard E. Hanlon, Richard C. Marcus, and Liz Minyard, each of whom is an independent director. The special advisory committee has retained the firm of Wachtell, Lipton, Rosen & Katz as its independent counsel to advise it in this matter.
On March 20, 2006, we also announced certain management changes. Effective on March 15, 2006, R. Michael Rouleau retired as President and Chief Executive Officer and became special advisor to the Board of Directors. The Board has left the office of Chief Executive Officer vacant and has assigned all the duties of that office to our newly appointed co-Presidents, Jeffrey N. Boyer, formerly Executive Vice President—Chief
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MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Quarter Ended April 29, 2006
(Unaudited)
Note 9. | Exploration of Strategic Alternatives (Continued) |
Financial Officer, and Gregory A. Sandfort, formerly Executive Vice President—General Merchandise Manager.
Note 10. | Subsequent Event |
We recorded a $3.0 million pre-tax gain in other income during the first quarter of fiscal 2006 due to the favorable resolution of a civil lawsuit related to a tax matter. This lawsuit was resolved subsequent to the end of the first quarter of fiscal 2006 but pertained to events that occurred prior to fiscal 2006.
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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 onForm 10-Q. The following discussion, as well as other portions of this Quarterly Report onForm 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 onForm 10-K for the fiscal year ended January 28, 2006. 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 anticipateand/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; | |
• | unexpected consumer responses to our promotional programs; | |
• | unusual weather conditions; | |
• | 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 suppliers due to vendor payment delays associated with recently implemented systems or 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, electricity, 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 a6vailability of certain merchandise from our foreign suppliers; | |
• | changes in political, economic, and social conditions; | |
• | significant fluctuations in exchange rates; |
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• | financial difficulties of any of our key vendors, suppliers, or insurance 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 maintain effective internal controls over our newly implemented financial reporting system; | |
• | our ability to comply with the terms and restrictions of our Credit Agreement; | |
• | our exploration of strategic alternatives; | |
• | 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 onForm 10-K for the fiscal year ended January 28, 2006, 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 onForm 10-Q and do not undertake to update or revise them as more information becomes available.
General
All references herein to “fiscal 2006” relate to the 53 weeks ending February 3, 2007 and all references to “fiscal 2005” relate to the 52 weeks ended January 28, 2006. In addition, all references herein to “the first quarter of fiscal 2006” relate to the 13 weeks ended April 29, 2006 and all references to “the first quarter of fiscal 2005” relate to the 13 weeks ended April 30, 2005.
The following table sets forth certain of our unaudited operating data:
Quarter Ended | ||||||||
April 29, | April 30, | |||||||
2006 | 2005 | |||||||
Michaels stores: | ||||||||
Retail stores open at beginning of period | 885 | 844 | ||||||
Retail stores opened during the period | 17 | 14 | ||||||
Retail stores opened (relocations) during the period | 3 | 8 | ||||||
Retail stores closed during the period | (3 | ) | (1 | ) | ||||
Retail stores closed (relocations) during the period | (3 | ) | (8 | ) | ||||
Retail stores open at end of period | 899 | 857 | ||||||
Aaron Brothers stores: | ||||||||
Retail stores open at beginning of period | 166 | 164 | ||||||
Retail stores opened during the period | — | 1 | ||||||
Retail stores closed during the period | (1 | ) | — | |||||
Retail stores open at end of period | 165 | 165 | ||||||
Recollections stores: | ||||||||
Retail stores open at beginning of period | 11 | 8 | ||||||
Retail stores opened during the period | — | 1 | ||||||
Retail stores open at end of period | 11 | 9 |
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Quarter Ended | ||||||||
April 29, | April 30, | |||||||
2006 | 2005 | |||||||
Star Decorators Wholesale stores: | ||||||||
Wholesale stores open at beginning of period | 4 | 3 | ||||||
Wholesale stores opened during the period | — | 1 | ||||||
Wholesale stores open at end of period | 4 | 4 | ||||||
Total store count at end of period | 1,079 | 1,035 | ||||||
Other operating data: | ||||||||
Average inventory per Michaels store(1) | $ | 821 | $ | 909 | ||||
Comparable store sales (decrease) increase(2) | (3.0 | )% | 7.8 | % |
(1) | Average inventory per Michaels store calculation excludes our Aaron Brothers, Recollections, and Star Decorators Wholesale stores. | |
(2) | Comparable store sales (decrease) increase represents the increase or decrease 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 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 2 weeks due to a catastrophic event is not considered comparable during the month it closed. If a store is closed longer than 2 weeks but less than 2 months, it becomes comparable in the month in which it reopens, subject to a mid-month convention. A store closed longer than 2 months becomes comparable in its 14th month of operation after its reopening. |
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 | ||||||||
April 29, | April 30, | |||||||
2006 | 2005 | |||||||
Net sales | 100.0 | % | 100.0 | % | ||||
Cost of sales and occupancy expense | 61.5 | 61.3 | ||||||
Gross profit | 38.5 | 38.7 | ||||||
Selling, general, and administrative expense | 29.0 | 27.8 | ||||||
Store pre-opening costs | 0.2 | 0.3 | ||||||
Operating income | 9.3 | 10.6 | ||||||
Interest expense | 0.0 | 0.6 | ||||||
Other (income) and expense, net | (0.8 | ) | (0.3 | ) | ||||
Income before income taxes and cumulative effect of accounting change | 10.1 | 10.3 | ||||||
Provision for income taxes | 3.8 | 3.9 | ||||||
Income before cumulative effect of accounting change | 6.3 | 6.4 | ||||||
Cumulative effect of accounting change, net of income tax | — | 10.8 | ||||||
Net income | 6.3 | % | (4.4 | )% | ||||
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Quarter Ended April 29, 2006 Compared to the Quarter Ended April 30, 2006
Net Sales—Net sales for the first quarter of fiscal 2006 increased $11.5 million, or 1.4%, over the first quarter of fiscal 2006. At the end of the first quarter of fiscal 2006, we operated 899 Michaels, 165 Aaron Brothers, 11 Recollections, and four Star Decorators Wholesale stores. The results for the first quarter of fiscal 2006 include sales from 49 Michaels, one Aaron Brothers, and two Recollections stores that were opened during the12-month period ended April 29, 2006, more than offsetting lost sales from the closure of seven Michaels and one Aaron Brothers store during the same period. Sales at our new stores (net of closures) opened since the first quarter of fiscal 2005 provided incremental revenue of $36.0 million, which was partially offset by a comparable store sales decline of 3.0%, or $24.5 million.
Comparable store sales decreased 3.0% in the first quarter of fiscal 2006 compared to the first quarter of fiscal 2005, reflecting a decrease in customer transactions of 5.0%, partially offset by increases in the average ticket of 1.6% 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 sales were negatively impacted by a 38% decline in comparable sales of Yarn, an increase in business disruption relative to the first quarter of fiscal 2005 due to earlier merchandising resets, and an overall reduction in store level inventory, particularly in discontinued and clearance products. Our strongest domestic departmental performances came in General Crafts, primarily due to Jewelry and Beads, Custom Floral, Apparel Crafts, and Kids Crafts. Our ability 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 $8.8 million primarily due to a 4.3% increase in the number of stores operated in the first quarter of fiscal 2006 compared to the first quarter of fiscal 2005, as well as an increase in certain occupancy expenses.
Cost of sales and occupancy expense, as a percentage of net sales, increased approximately 20 basis points in the first quarter of fiscal 2006 compared to the first quarter of fiscal 2005. This increase was primarily a result of occupancy expense de-leverage of approximately 50 basis points on negative comparable store sales and incremental costs of our store remodel program. Merchandise margins expanded approximately 30 basis points primarily due to higher margin rates of regular and promotional merchandise and improved sourcing.
Selling, General, and Administrative Expense—Selling, general, and administrative expense was $241.7 million, or 29.0% of net sales, in the first quarter of fiscal 2006 compared to $227.9 million, or 27.8% of net sales, in the first quarter of fiscal 2005. 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, totaling approximately $8.6 million of the overall $13.8 million increase.
As a percentage of net sales, selling, general, and administrative expense increased approximately 120 basis points, with an increase in store operating expenses generating approximately 70 basis points of the increase and the remaining 50 basis points attributable to post-employment benefits for our former CEO and costs related to our exploration of a strategic alternative to enhance shareholder value. The increase in store operating expenses was primarily caused by the de-leveraging of store payroll associated with our comparable store sales decline of 3.0%.
In addition, should a change in control occur, we will accelerate the recognition of any unrecognized compensation cost related to the accelerated vesting of share-based compensation awards. As of April 29, 2006, unrecognized compensation cost for all awards totaled approximately $33.7 million. We may also adjust our estimated rate of forfeitures with respect to those awards should we conclude that a potential change in control will cause our actual forfeiture estimate to be materially different than our current estimate. Should we adjust our estimated forfeiture rate to a level lower than the current rate, the cumulative effect of applying the change in estimate retrospectively is recognized in the period of change. Such a change may materially increase our share-based compensation costs in the period of change.
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Operating Income—As a result of the above, operating income decreased from $87.2 million, or 10.6% of sales, in the first quarter of fiscal 2005 to $77.3 million, or 9.3% of sales, in the first quarter of fiscal 2006.
Interest Expense—Interest expense decreased from $5.1 million in the first quarter of fiscal 2005 to $172,000 during the first quarter of fiscal 2006. During the second quarter of fiscal 2006, we redeemed our 91/4% Senior Notes, and, as a result of the early redemption, we no longer incur interest expense in connection with the Senior Notes.
Other Income—Other income increased from $2.7 million in the first quarter of fiscal 2005 to $7.2 million during the first quarter of fiscal 2006. This increase was primarily due to a $3.0 million gain due to the favorable resolution of a civil lawsuit and higher interest rates associated with our invested cash balances.
Provision for Income Taxes—The effective tax rate was 37.75% for the first quarter of fiscal 2006 and 38.0% for the first quarter of fiscal 2005.
Cumulative Effect of Accounting Change—In fiscal 2005, we changed our method of accounting for merchandise inventories from a retail inventory method to the weighted average cost method. As a result, we recorded a non-cash charge of $88.5 million, net of income tax, or $0.64 per diluted share, in the first quarter of fiscal 2005 for the cumulative effect of accounting change on fiscal years prior to fiscal 2005.
Net Income—As a result of the above, net income for the first quarter of fiscal 2006 increased from a net loss of $35.9 million, or $(0.26) per diluted share, in the first quarter of fiscal 2005 to net income of $52.5 million, or $0.39 per diluted share, after the cumulative effect of accounting change. Income before the cumulative effect of the accounting change decreased slightly from $52.6 million in the first quarter of fiscal 2005, or $0.38 per diluted share, to $52.5 million in the first quarter of fiscal 2006, or $0.39 per diluted share.
Liquidity and Capital Resources
Our cash and equivalents decreased $10.6 million, or 2.3%, from $452.4 million at the end of fiscal 2005 to $441.8 million at the end of the first quarter of fiscal 2006. Compared to the end of the first quarter of fiscal 2005, cash and equivalents decreased $116.7 million, or 20.9%, primarily because of our early redemption of the Senior Notes and the repurchases of our Common Stock, partially offset by our net income before the cumulative effect of the accounting change.
We require cash principally forday-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 other capital investments with cash from operations and proceeds from stock option exercises. We expect that our available cash, cash flow generated from operating activities, and funds available under our Credit Agreement will be sufficient to fund planned capital expenditures, working capital requirements, future growth, and any anticipated dividend payments and stock repurchases for the foreseeable future.
Cash Flow from Operating Activities
Cash flow provided by operating activities during the first three months of fiscal 2006 was $106.5 million compared to $49.4 million during the first three months of fiscal 2005. The $57.1 million increase in cash provided by operating activities was primarily due to a reduction in merchandise inventories, net of accounts payable. The working capital leverage we experienced with respect to inventories and accounts payable during the first three months of fiscal 2006 may not be indicative of full year results.
Inventories per Michaels store (including supporting distribution centers) decreased 9.7% from April 30, 2005 to April 29, 2006, with discontinued and clearance inventory per store down approximately 19%. Additionally, approximately 300 basis points of the 9.7% average inventory per store decrease was the result of the $23.9 million cumulative adjustment recorded in the fourth quarter of fiscal 2005 based on certain refinements we made to our calculation for deferring costs related to preparing inventory for sale and for vendor allowance recognition. We now anticipate average inventory per Michaels store at the end of fiscal 2006 compared to the end of fiscal 2005 to decrease approximately 3%.
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Cash Flow used in Investing Activities
Cash flow used in investing activities was primarily the result of the following capital expenditure activities:
Three Months Ended | ||||||||
April 29, | April, 30 | |||||||
2006(1) | 2005(2) | |||||||
(In thousands) | ||||||||
New and relocated stores and stores not yet opened | $ | 8,590 | $ | 13,597 | ||||
Existing stores | 15,159 | 5,766 | ||||||
Distribution system expansion | 3,815 | 904 | ||||||
Information systems | 10,343 | 6,266 | ||||||
Corporate and other | 1,013 | 955 | ||||||
$ | 38,920 | $ | 27,488 | |||||
(1) | In the first quarter of fiscal 2006, we incurred capital expenditures related to the opening of 17 Michaels stores and the relocation of three Michaels stores. Capital expenditures for existing stores for the first quarter of fiscal 2006 increased $9.4 million over the first quarter of fiscal 2005 primarily due to incremental expenditures associated with our store standardization/remodel program. | |
(2) | In the first quarter of fiscal 2005, we incurred capital expenditures related to the opening of 14 Michaels, one Aaron Brothers, one Recollections, and one Star Decorators Wholesale store, and the relocation of eight Michaels stores. |
During the first quarter of fiscal 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.
Cash Flow used in Financing Activities
Proceeds from the exercise of outstanding stock options have historically served as a source of cash flow for us. Proceeds from the exercise of stock options were $14.9 million in the first quarter of fiscal 2006 and $13.3 million in the first quarter of fiscal 2005.
Cash used for repurchases of our Common Stock increased $13.8 million from $52.4 million in the first quarter of fiscal 2005 to $66.2 million in the first quarter of fiscal 2006. The following table sets forth information regarding our Common Stock repurchase plans as of April 29, 2006:
Shares | Shares | |||||||||||
Authorized for | Shares | Available for | ||||||||||
Repurchase | Repurchased | Repurchase | ||||||||||
December 5, 2000 repurchase plan (variable portion) | 72,510 | (72,509 | ) | 1 | (1) | |||||||
December 6, 2005 repurchase plan | 5,000,000 | (2,428,688 | ) | 2,571,312 | (2) | |||||||
5,072,510 | (2,501,197 | ) | 2,571,313 | |||||||||
(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 years 2005 and 2004, we repurchased and subsequently retired 17,958 shares and 54,551 shares of our Common Stock, respectively, at average prices of $40.93 and $27.03 per share, respectively, using proceeds from exercises of stock options granted under the 2001 General Stock Option plan. | |
(2) | In the first quarter of fiscal 2006, we repurchased approximately 1.9 million shares of our Common Stock authorized to be repurchased under the December 2005 repurchase plan at an average price of $34.26 per share and, as a result, we had approximately 2.6 million shares available for repurchase under the plan as of April 29, 2006. We hold the repurchased shares as Treasury Stock. |
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We anticipate that we will continue to repurchase shares of our Common Stock during the remainder of fiscal 2006, until such time we may be restricted pending any developments in our exploration of strategic alternatives. 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 $0.20 per share and $0.14 per share during the quarters ended April 29, 2006 and April 30, 2005, respectively. During each quarter, we paid the current quarter’s dividend declaration as well as the previous quarter’s dividend declaration.
Debt
In fiscal 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, which was recorded as interest expense.
On November 18, 2005, we entered into a new five-year, $300 million senior unsecured credit facility with Bank of America, N.A. and other lenders. The $300 million Credit Agreement replaced our existing $200 million revolving credit facility with Fleet National Bank and the other lenders, which we terminated immediately prior to entering into our $300 million Credit Agreement. We were in compliance with all terms and conditions of our $200 million credit agreement through the termination date, and we did not incur any early termination penalties in connection with its termination. No borrowings were outstanding under our $200 million credit agreement at any time during fiscal 2005.
Our $300 million Credit Agreement provides for a committed line of credit of $300 million (with a provision for an increase, at our option on stated conditions, of up to a total of $400 million), a $250 million sublimit on the issuance of letters of credit, and a $25 million sublimit for borrowings in Euro, Sterling, Yen, Canadian Dollars, and other approved currencies. We may use borrowings under our $300 million Credit Agreement for working capital and other general corporate purposes, including stock repurchases and permitted acquisitions. Our $300 million Credit Agreement limits our ability to, among other things, create liens, engage in mergers, consolidations and certain other transactions, and requires us to adhere to certain consolidated financial covenants. Our obligations under our $300 million Credit Agreement are guaranteed by Michaels Stores Procurement Company, Inc., our wholly-owned subsidiary, and such other of our subsidiaries as may be necessary to cause the assets owned by us and our subsidiary guarantors to be 85% of our consolidated total assets. Borrowings available under our $300 million Credit Agreement will be reduced by the aggregate amount of letters of credit outstanding, which was $13.7 million as of April 29, 2006. We had no outstanding borrowings under our $300 million Credit Agreement as of January 28, 2006 or April 29, 2006.
Recent Accounting Pronouncements
In June 2005, the FASB issued SFAS No. 154,Accounting Changes and Error Corrections. This statement supersedes APB Opinion No. 20,Accounting Changes and SFAS No. 3,Reporting Accounting Changes in Interim Financial Statements. The statement applies to all voluntary changes in accounting principle and changes the requirements for accounting and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior period financial statements of a voluntary change in accounting principle unless it is impracticable to do so. The statement requires that a change in method of depreciation, amortization, or depletion for long-lived, nonfinancial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The statement does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this statement. We adopted SFAS No. 154 during the first quarter of fiscal 2006, which did not have a material impact on our consolidated results of operations, financial position, or cash flows.
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Recent Events
On March 20, 2006, we announced that our Board of Directors had decided to begin a process to explore strategic alternatives to enhance shareholder value including, but not limited to, a potential sale of Michaels. We retained JPMorgan as a financial advisor in this process, which we said probably would take a number of months. Among the strategic alternatives that may be considered would be a possible sale, recapitalization or similar transaction. The Board has appointed a special advisory committee, with the full power and authority of the Board to consider, evaluate, and negotiate with any third parties the terms of any such transaction and to recommend to our Board that it approve or reject, and, if approved, that the Board recommend to our shareholders any such transaction. The members of the special advisory committee are Cece Smith (Chairman), Richard E. Hanlon, Richard C. Marcus, and Liz Minyard, each of whom is an independent director. The special advisory committee has retained the firm of Wachtell, Lipton, Rosen & Katz as its independent counsel to advise it in this matter.
There can be no assurance that a transaction will result from this exploration of strategic alternatives, and we do not intend to disclose developments regarding this exploration unless and until a specific transaction has been approved.
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 April 29, 2006 approximated carrying value. We have market risk exposure arising from changes in interest rates. The interest rates on our new $300 million Credit Agreement will reprice frequently, at market rates, which will likely result in carrying amounts that approximate fair value. No borrowings were outstanding under our $300 million Credit Agreement as of April 29, 2006.
Item 4. | Controls and Procedures. |
Evaluation of Disclosure Controls and Procedures
We maintain a set of disclosure controls and procedures (as defined inRules 13a-15(e) and15d-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 President and Chief Financial Officer and our President and Chief Operating Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report onForm 10-Q. Based on that evaluation, our President and Chief Financial Officer and our President and Chief Operating 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 SEC 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
During the first quarter of fiscal 2006, we completed the implementation of a new financial reporting system. We believe the conversion to and implementation of this new system further strengthened our existing internal control over financial reporting by automating certain processes and activities and enhancing certain business processes.
Other than the change described above, there has not been any change in our internal control over financial reporting (as defined inRules 13a-15(f) and 15d-15(f) as promulgated by the SEC 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
Part II—OTHER INFORMATION
Item 1. | Legal Proceedings. |
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. The derivative action relates to actions prior to our announcement on November 7, 2002, that we had revised our outlook for the fourth fiscal quarter of 2002, adjusting downward guidance for annual earnings per diluted share. The plaintiff alleges that, prior to that announcement, certain of the 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. 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. On November 7, 2005, the Court entered a written order granting the defendants’ special exceptions and ordering that the case will be dismissed with prejudice unless the plaintiff amends her petition to state an actionable claim against the defendants. On December 8, 2005, the plaintiff filed an amended petition in which she reasserts many of the same factual allegations, but also adds new allegations questioning, among other things, issues relating to Michaels’ inventory systems and infrastructure, as well as transactions and holdings of Michaels Common Stock by certain family-owned trusts or benefiting trusts of two of Michaels’ directors. In her amended petition, the plaintiff continues to assert all her claims derivatively on behalf of Michaels against the individual defendants for breach of fiduciary duties, abuse of control, gross mismanagement, waste of corporate assets, and unjust enrichment. 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 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.
On June 9, 2006, Feivel Gottlieb and on June 12, 2006 Roberta Schuman each filed purported stockholder derivative actions, which are pending in the 191st and the 14th District Courts for Dallas County, Texas, respectively. The lawsuits name our Chairman of the Board and Vice Chairman of the Board, both in their capacities as officers of Michaels and as directors, and all of Michaels’ other current directors as individual defendants and Michaels as a nominal defendant. The plaintiffs assert claims against the individual defendants for breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment in connection with the granting of stock options by Michaels between 1990 and October 2001 and seek, among other relief, an indeterminate amount of damages from the individual defendants and injunctive relief against Michaels with regard to various corporate governance matters. All of these claims are asserted derivatively on behalf of Michaels. Prior to the filing of these derivative actions, Michaels announced that its Audit Committee (assisted by independent legal counsel and outside accounting experts) had commenced an internal review into Michaels’ historical stock option practices, including a review of Michaels’ underlying option grant documentation and procedures and related accounting. The Audit Committee has not reached any final conclusions as the internal review is not complete and is continuing. See “— Internal Review of Stock Option Practices” below.
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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. Michaels filed and served its responding materials opposing class certification on January 31, 2006. 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 Michaels store assistant manager, and Lucinda Prouty, a former Michaels store department manager, 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 Michaels 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 removed the case to federal court on August 5, 2005. 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.
Morris Claim
On November 16, 2005, Geoffrey Morris, a former Aaron Brothers employee in San Diego, California, commenced a proposed class action proceeding against Aaron Brothers, Inc. on behalf of himself and current and former Aaron Brothers employees in California from November 16, 2001 to the present. The Morris suit was filed in the Superior Court of California, County of San Diego and alleges that Aaron Brothers failed to pay overtime wages, reimburse the plaintiff for necessary expenses (including the cost of gas used in driving his car for business purposes), and provide adequate meal and rest breaks (or compensation in lieu thereof). The Morris suit also alleges that this conduct was in breach of California’s unfair competition law. The plaintiff seeks injunctive relief, damages for unpaid overtime pay, meal break penalties, waiting time penalties, interest, and attorneys’ fees and costs. We are in the early stages of our investigation; however, we believe that the Morris claim lacks merit, and we intend to vigorously defend our interests.
Olivas Claim
On December 2, 2005, Sandra Olivas and Jerry Soskins, former Michaels store managers in Los Angeles, California, commenced a proposed class action proceeding against Michaels Stores, Inc. on behalf of themselves and current and former salaried store employees employed in California from December 1, 2001 to the present. Michaels was served with the complaint on January 31, 2006. The Olivas suit was filed in the Superior Court of California, County of Los Angeles, and alleges that Michaels failed to pay overtime wages, accurately record hours worked, and provide itemized employee wage statements. The Olivas 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, penalties, interest, and attorneys’ fees and costs. On March 1, 2006, we
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removed the case to the United States District Court for the Central District of California. We are in the early stages of our investigation; however, we believe that the Olivas claim lacks merit, and we intend to vigorously defend our interests.
Governmental Inquiries and Related Matters
In early 2005, the District Attorney’s office of the County of New York and the SEC opened inquiries concerningnon-U.S. trusts that directly or indirectly hold and have held shares of Michaels Common Stock and Common Stock options. The staff of a U.S. Senate subcommittee and a federal grand jury have requested information with respect to the same facts. We are cooperating in these inquiries and requests for information.
Certain of these trusts and corporate subsidiaries of the trusts acquired securities of Michaels in transactions directly or indirectly with Charles J. Wyly, Jr. and Sam Wyly, who are, respectively, Chairman and Vice Chairman of the Board of Directors, or with other Wyly family members. In addition, subsidiaries of certain of these trusts acquired securities directly from us in private placement transactions in 1996 and 1997 and upon the exercise of stock options transferred, directly or indirectly, to the trusts or their subsidiaries by Charles Wyly, Sam Wyly, or other Wyly family members.
We understand that Charles Wyly and Sam Wylyand/or certain of their family members are beneficiaries of irrevocablenon-U.S. trusts. The 1996 and 1997 private placement sales by us of Michaels securities to subsidiaries of certain of these trusts were disclosed by us in filings with the SEC. The transfer by Charles Wylyand/or Sam Wyly (or by other Wyly family members or family-related entities) of Michaels securities to certain of these trusts and subsidiaries was also disclosed in filings with the SEC by usand/or by Charles Wyly and Sam Wyly. Based on information provided to us, our SEC filings did not report securities owned by thenon-U.S. trusts or their corporate subsidiaries as beneficially owned by Charles Wyly and Sam Wyly prior to 2005.
Following the filing by Charles Wyly and Sam Wyly of an amended Schedule 13D with the SEC on April 8, 2005, stating that they may be deemed the beneficial owners of Michaels securities held directly or indirectly by thenon-U.S. trusts, we disclosed in a press release that, as of March 31, 2005, under SECRule 13d-3, Charles Wyly may be deemed the owner of 6,045,818 shares, or 4.4% of our outstanding Common Stock, and Sam Wyly may be deemed the beneficial owner of 4,822,534 shares, or 3.5% of our outstanding Common Stock. In our 2005 and 2006 proxy statements, we included the securities held in thenon-U.S. trusts or their separate subsidiaries, as reported by the Wylys, in the beneficial ownership table of our principal stockholders and management, with appropriate footnotes.
Charles Wyly and Sam Wyly have not reported purchases and sales of Michaels securities by thenon-U.S. trusts and their subsidiaries in reports filed by them with the SEC under Section 16 of the Securities Exchange Act of 1934. In an April 2005 letter from their counsel, Charles Wyly and Sam Wyly undertook to file any additional required Section 16 reports and to pay us the amount of any Section 16 liability. Counsel for Michaels and counsel for the Wylys have exchanged factual information and engaged in discussions of legal issues.
Charles Wyly and Sam Wyly have not filed additional or amended Section 16 reports with respect to the transactions in question. Charles Wyly and Sam Wyly have made a proposal to settle the issue, without admitting or denying that they have or had, for Section 16 purposes, beneficial ownership of Michaels securities that are or were held by thenon-U.S. trusts or their subsidiaries.
On March 15, 2006, the Board of Directors appointed a special committee of the Board to investigate and make decisions on behalf of Michaels with respect to the potential Section 16 liability issue. The members of the special committee are Richard C. Marcus (Chairman), Cece Smith and Liz Minyard, all independent Board members. The special committee has the full authority of the Board to make all decisions with respect to the potential Section 16 issues, including the authority to approve or reject the proposed settlement, to negotiate the terms of any settlement, and, if there is no agreed settlement, to take all other actions it deems necessary or appropriate to resolve the potential Section 16 liability issues other than pursuant to an agreed settlement. The Board of Directors has also given the special committee the full authority of the Board to make decisions
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for Michaels relating to the new allegations in the Fathergill derivative suit, described above underDerivative Claims, including investigating the new allegations and determining what actions Michaels should take concerning those allegations. In addition, the Board has given the special committee authority to investigate and respond to the governmental inquiries, described above, but reserving to the full Board the authority to decide upon proposed actions or decisions concerning the pursuit, compromise or ultimate resolution of any claim or dispute with respect to those governmental inquiries. The special committee has retained the firm of Debevoise & Plimpton LLP as its independent counsel to advise it in these matters.
Internal Review of Stock Option Practices
The Company’s Audit Committee has initiated an internal review on a proactive basis into the Company’s historical stock option practices, including a review of the Company’s underlying option grant documentation and procedures and related accounting. In accordance with New York Stock Exchange requirements, the Audit Committee is composed solely of independent directors. The Audit Committee’s internal review is being conducted with the assistance of independent legal counsel and outside accounting experts. The Company’s independent registered public accounting firm has been informed about the internal review. The Company has also voluntarily reported the commencement of this review to the Securities and Exchange Commission.
The internal review is focused principally on the period from 1990 to 2001. Since October 2001, the Company has followed a process of utilizing pre-determined effective grant dates and generally pre-determined grant levels for its stock option program. Stock option grants from October 2001 to the present have consistently followed this process.
Prior to October 2001, the Company granted stock options principally utilizing a process in which an authorized committee of the Board would approve stock option grants from time to time through unanimous written consent resolutions with specified effective dates that generally preceded the date on which the consents were fully executed by members of the applicable committee.
The Company has historically considered the effective date specified in the written consents by the applicable committee as the accounting measurement date for determining stock-based compensation expense under APB No. 25,Accounting for Stock Issued to Employees. For the period under review, based on preliminary findings, the Company presently believes that, with respect to certain non-routine grants, the measurement date may differ from the measurement date used in its accounting prior to 2001. Based on the Company’s current analysis, non-cash compensation cost could potentially be recorded in an amount up to approximately $60 million, which relates to periods prior to fiscal 2001. Therefore, the amounts do not affect results of operations or the statement of cash flows in any period presented in the Company’s Annual Report onForm 10-K for fiscal 2005. The Company expects the effect, if any, on its financial position in each of the years presented in the fiscal 2005Form 10-K, would be a reclassification of any unrecorded non-cash compensation cost between retained earnings and accumulated paid in capital, with no impact on total stockholders’ equity. Based on the Company’s current analysis, any potential misstatement of the Company’s financial statements presented in its fiscal 2005 Form 10-K is not considered material.
As the Audit Committee’s review is not complete and is ongoing as of the date of this filing, additional information may become available which could cause the current estimate of potential unrecorded compensation to change materially. Once the review is complete, the Company will make a final determination as to what, if any, estimated unrecorded stock-based compensation cost should be recorded in the Company’s financial statements. However, based on its current analysis and estimates, the Company does not believe a restatement of prior period financial statements will be required.
The Company is also evaluating whether previously deducted compensation related to exercised stock options might be non-deductible under Section 162(m) of the Internal Revenue Code, which could result in additional taxes and interest related to the prior deductions. The Company currently believes that the amount of lost tax deductions, if any, previously claimed would not be material to results of operations, cash flow, or the Company’s financial position, but has not finalized its assessment of this matter.
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Two derivative lawsuits have been filed against the directors and certain officers of Michaels relating to the Company’s historical stock option procedures. See “— Derivative Claims” above.
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. | Unregistered Sales of Equity Securities and Use of Proceeds. |
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 April 29, 2006, options to purchase 875,000 shares of Common Stock remained outstanding pursuant to prior grants under the 2001 General Stock Option Plan.
On December 6, 2005, our Board of Directors authorized the repurchase of up to 5.0 million shares of our outstanding Common Stock.
The following table sets forth our repurchases of Common Stock for each fiscal month in the first quarter of fiscal 2006.
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) | |||||||||||||
January 29, 2006 through February 25, 2006 | 647,700 | 31.95 | 647,700 | 3,855,113 | ||||||||||||
February 26, 2006 through April 1, 2006 | 484,400 | 32.48 | 484,400 | 3,370,713 | ||||||||||||
April 2, 2006 through April 29, 2006 | 799,400 | 37.22 | 799,400 | 2,571,313 | ||||||||||||
Total | 1,931,500 | $ | 34.26 | 1,931,500 | 2,571,313 | |||||||||||
(1) | Shares repurchased during the first quarter were under the December 6, 2005 repurchase plan and are held as Treasury shares. | |
(2) | As of January 28, 2006, we had used the entire fixed portion of the authority originally provided in the 2000 repurchase plan. No repurchases from proceeds of stock option exercises under the 2001 General Stock Option Plan were made in the first quarter of fiscal 2006 since there were no additional options exercised under the 2001 General Stock Option Plan during that quarter. As of April 29, 2006, we had 2,571,312 shares available for repurchase under the December 6, 2005 repurchase plan. |
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Item 6. | Exhibits. |
(a) Exhibits:
Exhibit | ||||
Number | Description of Exhibit | |||
10 | .1 | Forms of Award Agreements under the Registrant’s 2005 Incentive Compensation Plan (filed herewith). | ||
10 | .2 | Form of Change in Control Severance Agreement (filed herewith). | ||
10 | .3 | Change in Control Retention Bonus Plan (filed herewith). | ||
10 | .4 | Fiscal Year 2006 Bonus Plan Enhancement (filed herewith). | ||
31 | .1 | Certifications of Jeffrey N. Boyer pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed herewith). | ||
31 | .2 | Certifications of Gregory A. Sandfort 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
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
President and Chief Financial Officer
(Principal Financial Officer)
Dated: June 13, 2006
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INDEX TO EXHIBITS
Exhibit | ||||
Number | Description of Exhibit | |||
10 | .1 | Forms of Award Agreements under the Registrant’s 2005 Incentive Compensation Plan (filed herewith). | ||
10 | .2 | Form of Change in Control Severance Agreement (filed herewith). | ||
10 | .3 | Change in Control Retention Bonus Plan (filed herewith). | ||
10 | .4 | Fiscal Year 2006 Bonus Plan Enhancement (filed herewith). | ||
31 | .1 | Certifications of Jeffrey N. Boyer pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed herewith). | ||
31 | .2 | Certifications of Gregory A. Sandfort 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). |