SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 1, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-11822
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MICHAELS STORES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 75-1943604
(State of incorporation) (I.R.S. employer
identification number)
8000 BENT BRANCH DRIVE, IRVING, TEXAS 75063
P.O. BOX 619566, DFW, TEXAS 75261-9566
(Address of principal executive offices, including zip code)
(972) 409-1300
(Registrant's telephone number, including area code)
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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 X NO
--- ---
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 SEPTEMBER 9, 1998
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Common stock, par value $.10 per share 29,668,794
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)
August 1, 1998 January 31, 1998
-------------- ----------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 42,918 $ 162,283
Merchandise inventories 553,851 385,580
Income taxes receivable and
deferred income taxes 11,292 11,291
Prepaid expenses and other 19,204 14,029
-------------- ----------------
Total current assets 627,265 573,183
-------------- ----------------
PROPERTY AND EQUIPMENT, AT COST 353,755 331,755
Less accumulated depreciation (157,245) (138,719)
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196,510 193,036
-------------- ----------------
COSTS IN EXCESS OF NET ASSETS OF
ACQUIRED OPERATIONS, NET 134,893 136,827
DEFERRED INCOME TAXES 2,694 2,695
OTHER ASSETS 2,519 2,753
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140,106 142,275
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$ 963,881 $ 908,494
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-------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 149,755 $ 109,456
Accrued liabilities and other 99,785 105,036
-------------- ----------------
Total current liabilities 249,540 214,492
-------------- ----------------
SENIOR NOTES 125,000 125,000
CONVERTIBLE SUBORDINATED NOTES 96,940 96,940
OTHER LONG-TERM LIABILITIES 28,927 30,151
-------------- ----------------
Total long-term liabilities 250,867 252,091
-------------- ----------------
500,407 466,583
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COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, 29,661,386 shares
outstanding 2,966 2,903
Additional paid-in capital 366,810 350,977
Retained earnings 93,698 88,031
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Total stockholders' equity 463,474 441,911
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$ 963,881 $ 908,494
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-------------- ----------------
See accompanying notes to consolidated financial statements.
2
MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands except per share data)
(Unaudited)
Quarter Ended
--------------------------
August 1, August 2,
1998 1997
--------- ---------
NET SALES $314,171 $278,038
Cost of sales and occupancy expense 215,325 190,998
Selling, general and administrative
expense 90,942 85,393
Store pre-opening costs 2,283 154
--------- ---------
OPERATING INCOME 5,621 1,493
Interest expense 5,580 5,702
Other (income) and expense, net (982) 461
--------- ---------
INCOME (LOSS) BEFORE INCOME TAXES 1,023 (4,670)
Provision (benefit) for income taxes 389 (1,775)
--------- ---------
NET INCOME (LOSS) $ 634 $ (2,895)
--------- ---------
--------- ---------
EARNINGS (LOSS) PER COMMON SHARE:
Basic $0.02 $(0.11)
Diluted $0.02 $(0.11)
COMMON SHARES USED IN PER SHARE CALCULATIONS:
Basic 29,602 26,299
Diluted 31,408 26,299
See accompanying notes to consolidated financial statements.
3
MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands except per share data)
(Unaudited)
Six Months Ended
--------------------------
August 1, August 2,
1998 1997
--------- ---------
NET SALES $649,941 $599,356
Cost of sales and occupancy expense 440,199 411,126
Selling, general and administrative
expense 187,503 177,277
Store pre-opening costs 4,071 154
--------- ---------
OPERATING INCOME 18,168 10,799
Interest expense 11,283 11,444
Other income, net (3,010) (1,088)
--------- ---------
INCOME BEFORE INCOME TAXES 9,895 443
Provision for income taxes 3,760 168
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NET INCOME $ 6,135 $ 275
--------- ---------
--------- ---------
EARNINGS PER COMMON SHARE:
Basic $0.21 $0.01
Diluted $0.20 $0.01
COMMON SHARES USED IN PER SHARE CALCULATIONS:
Basic 29,462 25,764
Diluted 31,342 26,882
See accompanying notes to consolidated financial statements.
4
MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six Months Ended
-----------------------
August 1, August 2,
1998 1997
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OPERATING ACTIVITIES:
Net income $ 6,135 $ 275
Adjustments:
Depreciation 21,064 20,178
Amortization 2,141 2,114
Other 558 802
Change in assets and liabilities:
Merchandise inventories (168,271) (69,614)
Prepaid expenses and other (5,175) (2,657)
Deferred income taxes and other (500) 4,897
Accounts payable 40,299 (7,235)
Accrued liabilities and other (3,295) (9,573)
--------- ---------
Net change in assets and liabilities (136,942) (84,182)
--------- ---------
Net cash used in operating activities (107,044) (60,813)
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INVESTING ACTIVITIES:
Additions to property and equipment (41,510) (15,836)
Net proceeds from sales of property
and equipment 19,155 1,594
Net proceeds from sales of investments - 3,386
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Net cash used in investing activities (22,355) (10,856)
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FINANCING ACTIVITIES:
Payment of other long-term liabilities (2,555) (2,065)
Proceeds from stock options exercised 6,461 50,172
Proceeds from issuance of common stock
and other 6,128 --
--------- ---------
Net cash provided by financing
activities 10,034 48,107
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NET DECREASE IN CASH AND EQUIVALENTS (119,365) (23,562)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 162,283 59,069
--------- ---------
CASH AND EQUIVALENTS AT END OF PERIOD $ 42,918 $ 35,507
--------- ---------
--------- ---------
See accompanying notes to consolidated financial statements.
5
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Six Months Ended August 1, 1998
(Unaudited)
NOTE A - BASIS OF PRESENTATION
The accompanying consolidated financial statements are unaudited (except
for the Consolidated Balance Sheet as of January 31, 1998) and have been
prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management,
all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Because of the
seasonal nature of the Company's business, the results of operations for the
three and six months ended August 1, 1998 are not indicative of the results
to be expected for the entire year. Certain fiscal 1997 amounts have been
reclassified to conform to the fiscal 1998 presentation. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's annual report on Form 10-K for the year
ended January 31, 1998.
NOTE B - SUPPLEMENTAL CASH FLOW INFORMATION
Investing and financing activities not affecting cash during the six
months ended August 1, 1998 included additions to property and equipment
through capital lease obligations of $2,390,000 related to the acquisition of
new computer equipment.
NOTE C - DEBT
In August 1998, the Company replaced its Credit Agreement and entered into a
new unsecured revolving credit agreement with BankBoston, N.A. and other
lending institutions (the "Revolving Credit Agreement") providing for a
revolving loan of $100 million which may be increased to $125 million
pursuant to certain terms and conditions as set forth in the Revolving Credit
Agreement. Borrowings available under the Revolving Credit Agreement are
reduced by the aggregate amount of letters of credit outstanding. The
interest rate on the Revolving Credit Agreement is generally (a) the higher
of (i) an annual rate of interest announced from time to time by BankBoston,
N.A. or (ii) one-half of one percent (1/2%) above the Federal Funds Effective
Rate or (b) the Eurodollar Rate as defined by the Revolving Credit Agreement.
The Company is required to pay a commitment fee of up to .3% on the unused
portion of the revolving line of credit. The Revolving Credit Agreement
provides certain annual restrictions on the aggregate amount of capital
expenditures, restricts the payment of dividends and requires that the
Company maintain compliance with various financial ratios. The Revolving
Credit Agreement expires in August 2001.
NOTE D - CONTINGENCIES
A lawsuit was commenced against the Company and several other parties on
September 19, 1994 in the Superior Court of Stanislaus County, California, on
behalf of a former employee, Naomi Snyder, her child, and her husband. The
complaint alleges that the former employee and her then-unborn child were
exposed to excessive levels of carbon monoxide in one of the Company's stores
caused by a propane gas powered floor buffer which was operated by an outside
cleaning service, resulting, among other things, in severe and permanent
6
injuries to the child. Plaintiffs' Statement of Damages, filed on or about
January 26, 1995, seeks $11 million. On April 10, 1995 the trial court ruled
the plaintiff's pleadings did not state a cause of action against the Company
upon which relief could be granted. However, the ruling by the trial court
was overturned by the Court of Appeals of the State of California, Fifth
Appellate District, on September 23, 1996. On October 30, 1997, the
California Supreme Court sustained the appellate court ruling and remanded
the case to the trial court. A settlement agreement has been reached by the
parties and the Company's portion of the settlement amount is expected to be
fully covered by insurance.
The Company is a defendant from time to time in lawsuits incidental to
its business. Based on currently available information, the Company believes
that resolution of all known contingencies is uncertain, and there can be no
assurance that future costs related to such litigation would not be material
to the Company's financial position or results of operations.
NOTE E - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per common share:
Quarter Ended Six Months Ended
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August 1, August 2, August 1, August 2,
1998 1997 1998 1997
--------- --------- --------- ---------
(In thousands except per share amounts)
Numerator:
Net income (loss) $ 634 $(2,895) $ 6,135 $ 275
--------- --------- --------- ---------
--------- --------- --------- ---------
Denominator:
Denominator for basic
earnings per share-weighted
average shares 29,602 26,299 29,462 25,764
Effect of dilutive securities:
Employee stock options 1,806 - 1,880 1,118
--------- --------- --------- ---------
Denominator for diluted
earnings per share-adjusted
weighted average shares and
assumed conversions 31,408 26,299 31,342 26,882
--------- --------- --------- ---------
--------- --------- --------- ---------
Basic earnings (loss) per
common share $0.02 $(0.11) $0.21 $0.01
--------- --------- --------- ---------
--------- --------- --------- ---------
Diluted earnings (loss) per
common share $0.02 $(0.11) $0.20 $0.01
--------- --------- --------- ---------
--------- --------- --------- ---------
The convertible subordinated notes were not included in the diluted
earnings per common share calculation because they were antidilutive for the
periods presented. The convertible subordinated notes could potentially
affect diluted earnings per common share in the future.
7
NOTE F - STORE PRE-OPENING COSTS
In April 1998, the AICPA issued Statement of Position 98-5 ("SOP 98-5"),
REPORTING THE COSTS OF START-UP ACTIVITIES, which requires that costs related
to start-up activities be expensed as incurred. Prior to fiscal 1998, the
Company deferred store pre-opening costs until the fiscal year in which the
store opened. The Company adopted the provisions of SOP 98-5 in its
financial statements for the first quarter of fiscal 1998 and, as a result,
began expensing pre-opening costs as incurred.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
Certain statements contained in this discussion and analysis which are
not historical facts are forward looking statements that involve risks and
uncertainties, including, but not limited to, customer demand and trends in
the arts and crafts industry, related inventory risks due to shifts in
customer demand, the effect of economic conditions, the impact of
competitors' locations or pricing, the effectiveness of advertising
strategies, the availability of acceptable real estate locations for new
stores, difficulties with respect to new information system technologies and
the Company's ability to address the Year 2000 Issue, supply constraints or
difficulties, the results of financing efforts, and other risks detailed in
the Company's Securities and Exchange Commission filings.
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship to net sales
of each line item of the Company's Consolidated Statements of Operations.
This table should be read in conjunction with the following discussion and
with the Company's Consolidated Financial Statements, including the related
notes.
Quarter Ended Six Months Ended
------------------- --------------------
August 1, August 2, August 1, August 2,
1998 1997 1998 1997
--------- --------- --------- ---------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales and occupancy
expense 68.5 68.7 67.7 68.6
Selling, general and
administrative expense 29.0 30.7 28.9 29.6
Store pre-opening costs 0.7 0.1 0.6 0.0
--------- --------- --------- ---------
Operating income 1.8 0.5 2.8 1.8
Interest expense 1.8 2.0 1.7 1.9
Other (income) and expense,
net (0.3) 0.2 (0.4) (0.2)
--------- --------- --------- ---------
Income (loss) before income
taxes 0.3 (1.7) 1.5 0.1
Provision (benefit) for income
taxes 0.1 (0.7) 0.6 0.0
--------- --------- --------- ---------
Net income (loss) 0.2% (1.0)% 0.9% 0.1%
--------- --------- --------- ---------
--------- --------- --------- ---------
In the discussion below, all percentages given for expense items are
calculated as a percentage of net sales.
9
QUARTER ENDED AUGUST 1, 1998 COMPARED TO THE
QUARTER ENDED AUGUST 2, 1997
Net sales in the second quarter of fiscal 1998 increased $36.1 million,
or 13%, over the second quarter of fiscal 1997. The results for the second
quarter of fiscal 1998 included sales from 33 Michaels and 4 Aaron Brothers
stores that were opened during the 12-month period ended August 1, 1998.
During the second quarter, sales at the new stores (net of 4 closures)
accounted for an increase of $18.0 million. Same-store sales increased 7% in
the second quarter of fiscal 1998 compared to the second quarter of fiscal
1997, which contributed $18.1 million to the net sales increase. The sales
increases were driven by increases in the Company's core categories of art
supplies, floral, ribbon and hobbies. By utilizing the information provided
by our point-of-sale system to continue to improve our store in-stock
position in top-selling items and properly allocating seasonal merchandise to
the stores based upon anticipated sales trends, we expect same-store sales
increases to continue.
Cost of sales and occupancy expense, as a percentage of net sales, for
the second quarter of fiscal 1998 was 68.5%, a decrease of 0.2% compared to
the second quarter of fiscal 1997. This decrease was primarily attributable
to better leveraging of occupancy expense and reduced remodel expenses
compared to the second quarter of fiscal 1997.
Selling, general and administrative expense, as a percentage of net
sales, decreased by 1.7% in the second quarter of fiscal 1998 compared to the
second quarter of fiscal 1997. This decrease was due to reduced legal and
professional fees, and to improved expense leverage in store labor and all
other categories of store operating expenses.
Store pre-opening costs, as a percentage of net sales, increased by 0.6%
in the second quarter of fiscal 1998 compared to the second quarter of fiscal
1997 as the Company adopted a change in accounting rules requiring that store
pre-opening costs be expensed as incurred. See Note F in the Notes to
Consolidated Financial Statements.
10
SIX MONTHS ENDED AUGUST 1, 1998 COMPARED TO THE
SIX MONTHS ENDED AUGUST 2, 1997
Net sales in the first six months of fiscal 1998 increased $50.6
million, or 8%, over the first six months of fiscal 1997. The results for
the first six months of fiscal 1998 included sales from 33 Michaels and 4
Aaron Brothers stores that were opened during the 12-month period ended
August 1, 1998. During the first six months, sales of the new stores (net of
11 closures) accounted for an increase of $26.0 million. Same-store sales
increased 4% in the first six months of fiscal 1998 compared to the first six
months of fiscal 1997, which contributed $24.6 million to the net sales
increase. The improvement in same-store sales performance was due to a
strong performance in the Company's core categories of art supplies, ribbon,
needlecrafts and hobbies.
Cost of sales and occupancy expense, as a percentage of net sales, for
the first six months of fiscal 1998 decreased by 0.9% compared to the first
six months of fiscal 1997. This decrease was principally due to improved
gross margins, reduced remodel expenses, and an improved leveraging of fixed
occupancy costs.
Selling, general and administrative expense, as a percentage of net
sales, decreased by 0.7% in the first six months of fiscal 1998 compared to
the first six months of fiscal 1997. This decrease was due to reduced legal
and professional fees, and to improved expense leverage in store labor and
nearly all other categories of store operating expenses with the exception of
advertising, which reflects the impact of increased grand openings and higher
costs associated with production and distribution of print advertising during
the first six months of fiscal 1998 compared to the prior year.
Store pre-opening costs of $4.1 million, or 0.6% as a percentage of net
sales, were recognized in the first six months of fiscal 1998 as the Company
adopted a change in accounting rules requiring that store pre-opening costs
be expensed as incurred. See Note F in the Notes to Consolidated Financial
Statements.
11
LIQUIDITY AND CAPITAL RESOURCES
Cash flow used by operating activities during the first six months of
fiscal 1998 was $107.0 million compared to $60.8 million of cash flow used by
operating activities during the first six months of fiscal 1997. These
results are consistent with the Company's plan to build inventory and open
and relocate stores early in the fiscal year. Inventories per Michaels store
increased 24% to $1,117,000 at August 1, 1998 compared to $904,000 at August
2, 1997 as a result of increasing the number of items replenished by the
Company's distribution centers from approximately 6,200 in the prior year to
approximately 11,000 in fiscal 1998, and to an earlier receipt of fall basic
product compared to the previous year.
The Company opened 28 Michaels and 1 Aaron Brothers stores and relocated
7 Michaels and 4 Aaron Brothers stores during the first six months of fiscal
1998. Capital expenditures for the newly opened stores amounted to
approximately $19.0 million. Additional capital expenditures of approximately
$22.5 million during the first six months of fiscal 1998 related primarily to
existing stores, and for interim construction costs for the relocation of the
Company's California distribution center, and various systems enhancements.
The Company completed two sale/leaseback transactions for the California
distribution facility and a portion of its equipment during the second
quarter of fiscal 1998 with gross proceeds amounting to $19.0 million. The
Company expects additional capital expenditures during the remainder of
fiscal 1998 to total approximately $38 to $43 million, relating primarily to
costs for new stores, store relocations and remodeling, merchandising and
other information systems and various other projects.
At August 1, 1998, the Company had working capital of $377.7 million
compared to $358.7 million at January 31, 1998. At August 1, 1998, the
Company had a bank credit agreement ("Credit Agreement") which provided for
an unsecured revolving line of credit of up to $100 million. There were no
borrowings outstanding on the revolving line of credit at any time during
fiscal 1997 or the first six months of fiscal 1998. In August 1998, the
Company replaced its Credit Agreement and entered into a new unsecured
revolving credit agreement with BankBoston, N.A. and other lending
institutions (the "Revolving Credit Agreement") providing for a revolving
loan of $100 million which may be increased to $125 million pursuant to
certain terms and conditions as set forth in the Revolving Credit Agreement.
Borrowings available under the Revolving Credit Agreement are reduced by the
aggregate amount of letters of credit outstanding. The interest rate on the
Revolving Credit Agreement is generally (a) the higher of (i) an annual rate
of interest announced from time to time by BankBoston, N.A. or (ii) one-half
of one percent (1/2%) above the Federal Funds Effective Rate or (b) the
Eurodollar Rate as defined by the Revolving Credit Agreement. The Company is
required to pay a commitment fee of up to .3% on the unused portion of the
revolving line of credit. The Revolving Credit Agreement provides certain
annual restrictions on the aggregate amount of capital expenditures,
restricts the payment of dividends and requires that the Company maintain
compliance with various financial ratios. The Revolving Credit Agreement
expires in August 2001. Management believes that the Company's available
cash, funds generated by operating activities, funds available under the
Revolving Credit Agreement and lease financing, should be sufficient to
finance continuing operations and sustain current growth plans. Management
believes that the Company can finance an annual store expansion at a rate of
12% to 15% (on a square footage basis) from internally generated cash flow.
12
MICHAELS STORES, INC.
FORM 10-Q
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For a description of legal proceedings, see Note D to "Notes to
Consolidated Financial Statements," which description is incorporated
herein by this reference.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 4 - Credit Agreement dated as of August 28, 1998 among
Michaels Stores, Inc., BankBoston, N.A. and the other lenders
signatory thereto.
Exhibit 27 - Financial Data Schedule.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the period covered by
this report.
13
MICHAELS STORES, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MICHAELS STORES, INC.
By: /s/ Bryan M. DeCordova
-----------------------------
Bryan M. DeCordova
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
Dated: September 15, 1998
14
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION PAGE
4 Credit Agreement dated as of August 28, 1998
among Michaels Stores, Inc., BankBoston, N.A.
and the other lenders signatory thereto.
27 Financial Data Schedule
15