UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended October 30, 1994 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to _________ Commission File Number 0-11822 MICHAELS STORES, INC. (Exact name of registrant as specified in its charter) Delaware 75-1943604 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 5931 Campus Circle Drive, Irving, Texas 75063 P.O. Box 619566, DFW, Texas 75261-9566 (Address of principal executive offices including zip code) (214) 714-7000 (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 3 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 X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Shares Outstanding as Title of December 12 , 1994 Common stock, par value $.10 per share 21,332,235 MICHAELS STORES, INC. FORM 10-Q Part I - FINANCIAL INFORMATION Item 1. Financial Statements MICHAELS STORES, INC. Consolidated Balance Sheets (In thousands except share data) (Unaudited) ASSETS October 30, January 30, 1994 1994 ----------- ----------- Current assets: Cash and equivalents $ 4,096 $ 867 Marketable securities 18,418 67,956 Merchandise inventories 381,456 206,185 Deferred income taxes 20,414 2,952 Prepaid expenses and other 20,183 13,052 -------- -------- Total current assets 444,567 291,012 -------- -------- Property and equipment, at cost 191,423 119,555 Less accumulated depreciation (56,325) (43,683) -------- -------- 135,098 75,872 -------- -------- Costs in excess of net assets of acquired operations, net 100,803 23,503 Other assets 6,054 7,443 -------- -------- 106,857 30,946 -------- -------- $686,522 $397,830 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $134,467 $ 42,309 Bank debt 50,000 13,000 Income taxes payable - 7,866 Accrued liabilities and other 66,228 46,021 -------- -------- Total current liabilities 250,695 109,196 -------- -------- Convertible subordinated notes 96,950 97,750 Deferred income taxes and other 7,135 5,469 -------- -------- Total long-term liabilities 104,085 103,219 -------- -------- 354,780 212,415 -------- -------- Commitments and contingencies Shareholders' equity: Common stock, 21,266,472 shares outstanding 2,127 1,670 Additional paid-in capital 242,722 107,168 Retained earnings 86,893 76,577 -------- -------- Total shareholders' equity 331,742 185,415 -------- -------- $686,522 $397,830 ======== ======== See accompanying notes to consolidated financial statements. MICHAELS STORES, INC. Consolidated Statements of Income (In thousands except per share data) (Unaudited) Quarter Ended -------------------------- October 30, October 31, 1994 1993 ----------- ----------- Net sales $283,069 $155,750 Cost of sales and occupancy expense 187,566 101,588 Selling, general and administrative expense 80,676 46,343 -------- -------- Operating income 14,827 7,819 Interest expense 2,511 1,595 Other income, net (430) (1,666) -------- -------- Income before income taxes 12,746 7,890 Provision for income taxes 4,933 3,038 ------- -------- Net income $ 7,813 $ 4,852 ======= ======== Earnings per common and common equivalent share $.36 $.28 ==== ==== Weighted average common and common equivalent shares 21,930 17,287 ====== ====== See accompanying notes to consolidated financial statements. MICHAELS STORES, INC. Consolidated Statements of Income (In thousands except per share data) (Unaudited) Nine Months Ended --------------------------- October 30, October 31, 1994 1993 ----------- ----------- Net sales $617,071 $384,125 Cost of sales and occupancy expense 402,314 249,017 Selling, general and administrative expense 180,709 115,571 Store closing and conversion costs <F1> 7,074 - -------- -------- Operating income 26,974 19,537 Interest expense 6,895 4,708 Other income, net (1,911) (5,147) -------- -------- Income before income taxes 21,990 19,976 Provision for income taxes 8,497 7,691 -------- -------- Net income $ 13,493 $ 12,285 ======== ======== Earnings per common and common equivalent share $.69 $.71 ==== ==== Weighted average common and common equivalent shares 19,521 17,188 ====== ====== <F1> $4,385 net of tax, or $.22 per share. See accompanying notes to consolidated financial statements. MICHAELS STORES, INC. Consolidated Statements of Cash Flows (In thousands) (Unaudited) Nine Months Ended ------------------------ October 30, October 31, 1994 1993 ----------- ----------- Operating activities: Net income $ 13,493 $ 12,285 Depreciation and amortization 13,414 9,125 Change in assets and liabilities excluding the effects of acquisitions: Merchandise inventories (127,286) (114,028) Prepaid expenses and other assets (6,050) (8,729) Accounts payable 68,572 47,355 Income taxes payable (8,363) (1,260) Accrued and other liabilities (10,144) 9,929 -------- -------- Net change in assets and liabilities (83,271) (66,733) -------- -------- Net cash used in operating activities (56,364) (45,323) -------- -------- Investing activities: Additions to property and equipment (51,959) (32,651) Net proceeds from sales of marketable securities 46,184 13,997 Acquisitions and other (48,820) (1,349) -------- -------- Net cash used in investing activities (54,595) (20,003) -------- -------- Financing activities: Net borrowings under bank credit facilities 36,500 21,000 Proceeds from issuance of common stock and other 77,688 3,428 -------- -------- Net cash provided by financing activities 114,188 24,428 -------- -------- Net increase (decrease) in cash and equivalents 3,229 (40,898) Cash and equivalents at beginning of year 867 42,075 -------- -------- Cash and equivalents at end of period $ 4,096 $ 1,177 ======== ======== Cash payments for: Interest $ 4,253 $ 2,507 Income taxes 16,506 7,828 See accompanying notes to consolidated financial statements. MICHAELS STORES, INC. Notes to Consolidated Financial Statements For the Three Months and Nine Months ended October 30, 1994 (Unaudited) Note A The accompanying consolidated financial statements are unaudited (except for the Consolidated Balance Sheet as of January 30, 1994) and, in the opinion of management, reflect all adjustments that are necessary for a fair presentation of financial position and results of operations for the three months and nine months ended October 30, 1994. All of such adjustments are of a normal and recurring nature. Because of the seasonal nature of the Company's business, the results of operations for the three months and nine months ended October 30, 1994 are not indicative of the results to be expected for the entire year. Note B In February 1994, the Company acquired Treasure House Stores, Inc. ("THSI"), a chain of nine arts and crafts stores operating primarily in the Seattle market, for 280,000 shares of Michaels common stock in a transaction accounted for as a pooling-of-interests. In April 1994, the Company acquired the affiliated arts and crafts store chains of Oregon Craft & Floral Supply Co. ("OCF"), with eight stores located primarily in the Portland, Oregon area, and H&H Craft & Floral Supply Co. ("H&H"), with eight stores located in southern California, for a total of 455,000 shares of Michaels common stock in a transaction accounted for as a purchase. This transaction resulted in the Company recording an addition to goodwill in the amount of $22.7 million. Note C Effective July 10, 1994, Michaels acquired Leewards Creative Crafts, Inc. ("Leewards"), an arts and crafts retailer with 98 stores located primarily in the midwestern and northeastern United States. The acquisition consideration consisted of $7.9 million in cash and 1,257,279 shares of Michaels common stock valued at $39.9 million. Upon consummation of the Leewards acquisition, Michaels also repaid $39.6 million of Leewards' indebtedness. The transaction was accounted for as a purchase; accordingly, the purchase price has been preliminarily allocated to assets and liabilities based on estimated values as of the acquisition date. The cost in excess of the estimated fair value of net assets acquired was recorded as goodwill in the amount of $57.9 million, which will be amortized on a straight-line basis over a period of 40 years. The results of operations since the acquisition date are included in the accompanying consolidated financial statements. The following pro forma combined net sales, net income and earnings per share data summarize the results of operations for the nine months ended October 30, 1994 and October 31, 1993 as if Leewards had been acquired as of the beginning of fiscal 1993. Pro Forma ----------------------------- Nine Months Ended ----------------------------- Oct. 30, 1994 Oct. 31, 1993 ------------- ------------- Net sales $679,424 $487,926 ======== ======== Net income $ 14,123 $ 11,032 ======== ======== Earnings per share $.70 $.60 ==== ==== The pro forma combined financial results do not purport to represent the results of operations which would have occurred had such transactions been consummated at the beginning of the period indicated or the Company's results of operations for any future period. Anticipated operational efficiencies from the integration of the acquisition are not fully reflected in the above pro forma data. The above pro forma data include adjustments to: eliminate net sales and related expenses of overlapping Leewards stores that have been closed; eliminate the duplicate occupancy costs of Leewards' distribution center and duplicate purchasing costs; amortize goodwill; expense pre-opening costs in the year incurred; reduce interest expense to Michaels' average borrowing rate; and reflect the tax effects of the above adjustments. The pro forma data for the nine-month period ended October 30, 1994 exclude a $7.1 million charge ($4.4 million after tax or $.22 per share) for closure or relocation of approximately ten Michaels stores (of which six have been closed and one relocated as of October 30, 1994) that compete with certain acquired locations, and conversion and training costs associated with the Leewards acquisition. The above pro forma data does not include THSI, OCF or H&H prior to their respective acquisition dates in February 1994 and April 1994, since the acquisitions are not considered material, individually or in the aggregate, to the operating results of the Company. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources - ------------------------------- The Company acquired 123 stores and opened 61 stores during the first nine months of fiscal 1994. Capital expenditures for these stores, and, to a lesser extent, the remodeling and expansion of existing stores, the expansion of two distribution facilities, and system enhancements, amounted to $52.0 million in the first nine months of fiscal 1994. The Company expects capital expenditures during the remainder of fiscal 1994 to be at least $16 million, relating primarily to systems enhancements and the opening of new stores in early fiscal 1995. In July 1994, the Company paid $7.9 million in cash as part of the total consideration provided to acquire Leewards, and repaid $39.6 million of Leewards' outstanding debt. Also in July 1994, the Company completed a public offering of 2,353,432 shares of Michaels common stock. The $72.9 million of net proceeds from the sale were used to reduce outstanding bank debt. At October 30, 1994 the Company had working capital of $193.9 million, compared to $181.8 million at January 30, 1994. The Company currently has a bank credit agreement ("Credit Agreement") which includes an unsecured line of credit and provides for the issuance of letters of credit. Borrowings under the Credit Agreement, which expires June 16, 1997, are limited to the lesser of $150 million or the Company's borrowing base (as defined in the Credit Agreement), in either case minus the aggregate amount of letters of credit. As of October 30, 1994, the Company had $68.3 million in available unused credit capacity under the Credit Agreement. Management believes that the Company has sufficient working capital, cash flow from operating activities, and available unused credit capacity to sustain current growth plans. Results of Operations - --------------------- The following table shows the percentage of net sales that each item in the Consolidated Statements of Income represents. This table should be read in conjunction with the following discussion and with the Company's financial statements, including the notes: For the For the Quarter Ended Nine Months Ended ----------------------- ----------------------- October 30, October 31, October 30, October 31, 1994 1993 1994 1993 ----------- ----------- ----------- ----------- Net sales 100.0% 100.0% 100.0% 100.0% Cost of sales and occupancy expense 66.3 65.2 65.2 64.8 Selling, general and administrative expense 28.5 29.8 29.3 30.1 Store closing and conversion costs - - 1.1 - ----- ----- ----- ----- Operating income 5.2 5.0 4.4 5.1 Interest expense 0.9 1.0 1.1 1.2 Other income, net (0.2) (1.1) (0.3) (1.3) ----- ----- ----- ----- Income before income taxes 4.5 5.1 3.6 5.2 Provision for income taxes 1.7 2.0 1.4 2.0 ----- ----- ----- ----- Net income 2.8% 3.1% 2.2% 3.2% ===== ===== ===== ===== Three months ended October 30, 1994 compared to the - --------------------------------------------------- three months ended October 31, 1993 ----------------------------------- Net sales for the three months ended October 30, 1994 were $283.1 million, an increase of $127.3 million or 82%, compared to the same period of the prior year. The results for the third quarter of fiscal 1994 included sales of 160 stores (net of 24 closures) that were added during the previous twelve months, 32 of which were added during the third quarter of fiscal 1994 and 80 Leewards stores which were included from July 10, 1994. Also included were liquidation sales of 18 Leewards stores that were closed during the third quarter. In the third quarter of fiscal 1994, sales of newer stores (not included in comparable store sales) accounted for $118.8 million of the increase. Comparable store sales chainwide increased 10% over the same period last year, and 7% for Michaels stores excluding the former Leewards stores. Cost of sales and occupancy expense increased by 1.1%, as a percentage of sales, for the third quarter of fiscal 1994 compared to the same period of the prior year. The increase was principally due to higher occupancy costs on new and acquired lower volume stores, the impact of lower margins on liquidation sales in 18 Leewards stores which were closed during the quarter, and a higher level of promotional activity. Selling, general and administrative expense decreased by 1.3%, as a percentage of sales, in the third quarter of fiscal 1994 compared to the same period of the prior year, due primarily to advertising, corporate and administrative expenses being spread over a larger revenue base in the current period. The increase in interest expense for the third quarter of fiscal 1994 to $2.5 million from $1.6 million for the same period a year ago was due primarily to increased bank borrowings. The decrease in other income was due principally to a decline in the average investment portfolio this year compared to the prior year period. The slight increase in the Company's effective tax rate was due principally to the effect of additional amortization of goodwill, which is not deductible for tax purposes, related to the Company's recent acquisitions. Nine months ended October 30, 1994 compared to the - -------------------------------------------------- nine months ended October 31, 1993 ---------------------------------- Net sales for the nine months ended October 30, 1994 were $617.1 million, an increase of $233.0 million or 61% over the same period of the prior year. The results for the first nine months of fiscal 1994 included sales of 160 stores (net of 24 closures) that were added during the previous twelve months, 55 of which were added during the first nine months of this year and 80 Leewards stores which were included from July 10, 1994. In the first nine months of fiscal 1994, sales of newer stores (not included in comparable store sales) accounted for $207.5 million of the increase. Comparable store sales chainwide increased 9% over the same period last year, and 7% for Michaels stores excluding the former Leewards stores. Cost of sales and occupancy expense increased by 0.4%, as a percentage of sales, for the first nine months of fiscal 1994 compared to the same period of the prior year. The increase was primarily due to higher occupancy costs on new and acquired lower volume stores, the impact of lower margins on liquidation sales in 18 Leewards stores which were closed, and a higher level of promotional activity. Selling, general and administrative expense decreased by 0.8%, as a percentage of sales, for the first nine months of fiscal 1994 compared to the same period of the prior year, due primarily to advertising, corporate and administrative expenses being spread over a larger revenue base in the current period. The $7.1 million ($4.4 million net of tax, or $.22 per share) of store closure and conversion costs includes a charge for estimated net costs for closure or relocation of approximately ten Michaels stores (six of which have been closed and one relocated) that compete with certain acquired locations, as well as certain conversion and training costs related to the recently acquired Leewards stores. Interest expense for the first nine months of fiscal 1994 increased to $6.9 million from $4.7 million for the same period a year ago. The increase was due primarily to increased bank borrowings. The decrease in other income was due principally to a decline in the average investment portfolio this year compared to the prior year period. The slight increase in the Company's effective tax rate was due principally to the effect of additional amortization of goodwill, which is not deductible for tax purposes, related to the Company's recent acquisitions. MICHAELS STORES, INC. FORM 10-Q Part II - Other Information Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 11.1 - Computation of Earnings Per Common Share for the three months ended October 30, 1994. Exhibit 11.2 - Computation of Earnings Per Common Share for the nine months ended October 30, 1994. b) Reports on Form 8-K No reports on Form 8-K were filed by the Company during the period covered by this report. 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/ R. Don Morris R. Don Morris Executive Vice President and Chief Financial Officer (Principal Financial Officer) Dated: December 14, 1994 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION PAGE 11.1 Computation of Earnings Per Common Share for the three months ended October 30, 1994. 11.2 Computation of Earnings Per Common Share for the nine months ended October 30, 1994. EXHIBIT 11.1 MICHAELS STORES, INC. Computation of Earnings Per Common Share Three Months Ended October 30, 1994 (Unaudited) Weighted Average Outstanding Equivalent Shares --------------------- Total Fully Outstanding Primary Diluted ----------- ---------- ---------- Outstanding at beginning of quarter 21,103,694 21,103,694 21,103,694 Shares issued during quarter 162,778 74,220 74,220 ---------- ---------- Weighted average outstanding shares 21,177,914 21,177,914 Common Equivalent Shares: Dilutive shares attributable to stock options (computed by the treasury stock method) 752,339 773,741 ---------- ---------- ---------- Total outstanding shares 21,266,472 21,930,253 21,951,655 ========== ========== ========== Earnings per common and common equivalent share $.36 $.36 ==== ==== EXHIBIT 11.2 MICHAELS STORES, INC. Computation of Earnings Per Common Share Nine Months Ended October 30, 1994 (Unaudited) Weighted Average Outstanding Equivalent Shares --------------------- Total Fully Outstanding Primary Diluted ----------- ---------- ---------- Outstanding at January 30, 1994 16,697,357 16,697,357 16,697,357 Shares issued during period 4,569,115 2,068,328 2,068,328 ---------- ---------- Weighted average outstanding shares 18,765,685 18,765,685 Common Equivalent Shares: Dilutive shares attributable to stock options (computed by the treasury stock method) 754,952 781,540 ---------- ---------- ---------- Total outstanding shares 21,266,472 19,520,637 19,547,225 ========== ========== ========== Earnings per common and common equivalent share $.69 $.69 ==== ====